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Trader thoughts - the long and short of it

US trade has provided us with an extension of the positive flow we saw on Friday, with the S&P 500 pushing up a further 1%, and the Dow an even more impressive 1.5%.

Source: Bloomberg

We can also look around the respective markets and see high yield credit working ok, with the HYG ETF (iShares High Yield ETF) gaining 0.2% and looking to break above the key 7 February high of $81.61, which in my view would suggest short-term trading long positions. We also have US crude underpinning the move in risk, with a 0.5% gain in the barrel and we can see no major change to the USD, with fixed income markets sanguine ahead of tonight’s (00:30 AEDT) testimony to the House by Federal Reserve Chair, Jerome Powell.

So, the world is a fairly happy and content place again, with S&P 500 implied volatility falling and we can see US March Volatility Index (or “VIX”) futures eyeing a move through 16, which could result in a test of 14.43, and the lows seen on the day of the huge volatility spike on 5 February - where VIX futures traded into 30 and the cash VIX index into 50. This more sanguine level of S&P 500 implied volatility (vols) may yet prove to be premature and there is no doubt that vols will almost certainly rise in the coming weeks and months and it will be a key feature of 2018. But for today, price action in US equities reeks of a market in no way concerned that the new Fed chair will say anything that materially moves interest rate (such as Eurodollar or fed funds futures) or Treasury markets. In fact, we can see very modest buying in US Treasury’s across the curve, with the 10-year sitting at 2.86%.

I will tend to look at the S&P 500 over the Dow, not just because it is a market-cap weighted index, but because Aussie SPI futures tend to have a stronger correlation with this benchmark. That said, as a trader if I am going to buy an index or futures market I want to be long (or own) the strongest and today the Dow holds that accolade. Price has smashed through the 61.8% retracement of the January to February sell-off (26,705 to 23,112) at 25,335 and the path of least resistance seems higher from here and I would be trailing stops and exiting longs on a daily close through the five-day EMA (Exponential Moving Average), which currently sits at 25,274.  The S&P 500 naturally looks interesting too and unless we see something that clearly is not expected by Powell then the S&P 500 should be back above 2800 at some stage this week, and from here it really isn’t out of the question that we see new highs in the index – a fate I personally didn’t see materialise so quickly.

Clearly the c. $170 billion in announced corporate buy-backs are helping here!

With limited fixed income moves we have seen the USD index trade in a fairly tight range of 89.70 to 89.14, but on balance, if we focus on the four-hour chart, we can see price breaking out of downtrend resistance drawn from the 22 February high of 89.89 and should we see a test of this level in the short-term it will likely result in EUR/USD heading into the February lows of $1.2205. EUR/USD has held in well today despite ECB governor, Mario Draghi, providing fairly cautious commentary in his introductory remarks at the Hearing of the Committee on Economic and Monetary Affairs of the European Parliament and the market feels these are in-line with commentary heard last week in the ECB statement and minutes last week.

Perhaps the bigger move has really been seen against the CAD, with USD/CAD eyeing a move into $01.2700. AUD/USD found good sellers into $0.7893 and from 18:30 AEDT has come well off its highs, although price is just holding Fridays highs at present, but with little data on the docket to drive through Asia (ANZ Roy Morgan Consumer Confidence at 09:30 AEDT won’t be an event risk), it’s all eyes on managing exposures into Powell’s testimony, which will become an event risk between 12:30 AEDT and 02:00 AEDT. Keep in mind we also have to navigate through Eurozone M3 money supply and confidence numbers, as well as German inflation and US trade balance and durable goods data. So plenty of event risk and potential landmines.

We are also seeing good interest to short the JPY crosses despite a further push higher in risk appetite. CAD/JPY has been one of the weaker links here and is trending lower and eyeing a break of the recent lows of ¥84.84. EUR/JPY has been a favoured pair too, although the price has held the 200-day MA at ¥131.23 and the bears (including yours truly) wanting to see a close through the 200-day MA to open up far greater downside. EUR/JPY (and also CHF/JPY) offers traders a compelling vehicle to hedge German and Italian political event risk, although of the two events most now see the results of the German SPD ballot on forming a grand coalition as the key event risk. The Italian elections do not specifically pose a “gapping risk” for the EUR given the polls close at 09:00 AEDT on Monday and exit polls should come out shortly after. Keep in mind IG will be offering a Sunday German DAX market for clients to trade just after the polls close, which will roll into the out-of-hours DAX index at 09:40 AEDT. We then offer the Italian MIB index to trade from 10:00 AEDT and that could get some attention.

So aggregating the overnight leads we can see the ASX 200 eyeing an open into 6069, for a gain of 27 points (or 0.4%), with decent gains (on open) in Japan and onshore/offshore Chinese markets. As mentioned yesterday, earnings season is almost behind us and we have now had a thorough chance to mark-to-market the outlooks from CEOs and assess how the half-year numbers fit into the assumptions for full-year earnings estimates. Consensus earnings have been revised higher of late and we see consensus (12-month blended forward) EPS now at the highest levels since 2012 and this has eased the 12-month P/E ratio somewhat lower into 15.74x. This multiple is still elevated relative to the long-run average, but there is scope to push into 16x and that would result in the ASX 200 trading into 6100 to 6150.

That said, with earnings now in the price and the risk premium for the index probably higher than it was in Q4’18, if we see the Aussie index wearing a multiple of 16x it becomes far more vulnerable to pullbacks and with that in mind, I still see the higher conviction to short the index into this range. For now, though the bulls are in charge, the leads from offshore equity indices and commodity markets constructive and the rates and fixed income markets, perhaps incorrect in this assumption, are not expecting fireworks from Jerome Powell’s testimony. We shall see.

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