In times of low volatility, the ASX 200 is the place to be

The ASX has found its mojo after a period of strong underperformance.

  • US equities were once again the place to be as implied volatility was smashed for the second day in a row. The NASDAQ 100 is the index of choice for traders to express a bullish bias on US equities, although the S&P 500 is looking constructive too, with a session gain of 0.7%.
  • In the S&P 500, financials lagged (unsuprising given the three-basis-point flattening of the yield curve), with REITS and telcos working well. Volumes were in-line with the long-run average.
  • Initial USD weakness was met with some better buying as the session grew, which seems to have taken some of the heat out of further risk sentiment.
  • AUD/USD traded to a high of $0.7675 (session range of $0.7604 to $0.7604) and sits mid-range now. With the Rseserve Bank of Australia (RBA) holding a neutral bias, it seems further upside could be seen in AUD/USD. A weekly close above $0.7720 (trend resistance drawn from the August 2013 low) would be the key to open good upside. A renewed period of low volatility would clearly help the higher yielding currencies.
  • Put GBP/AUD on the radar with price making a series of lower lows. The pair is eyeing a break of A$1.7000 area again after recently rallying to A$1.7802. Given the strength behind the selling, I’d use the five day EMA as guide to trial stops lower.
  • Renewed focus has been placed financial risks. Not only did we get the weekend report from the Bank of International Settlement (BIS) highlighting the leverage in China, but yesterday’s report from the United Nations suggesting the third leg of the financial crisis is yet to come (source: Telegraph) is also a worry. The fact is the Federal Reserve (Fed) are playing a dangerous game and almost pushing the ‘hunt for yield’ trade as far as they can. The Fed have crushed volatility again in yesterday’s meeting and the trade once again is to be long yield, but this cannot go on forever without huge consequences.
  • The ASX 200 is likely to test 5400 on open today (+0.5%), taking the weekly gain to 104 points or 2%. After the poor run it’s no surprise to see the ASX 200 outperforming. Despite having an elevated price-to-earnings ratio (which developed market hasn’t?) the index also has the highest yield. International money managers know the ASX 200 is a yield play. With volatility so low, and confidence that the AUD isn’t going to collapse as many had forecasted, we expect short-term outperformance from the Aussie market.
  • Keep an eye on what worked well yesterday, with solid gains seen in names like SAR, ACX, FMG, MDN, NCM and IGO. Further gains in RSG takes its annual gain to a lazy 808%.
  • BHP and CBA’s ADRs (American Depository Receipt) are both pointing to fairly flat opens, although CBA looks the better bid of the two. Both BHP and RIO had huge gains in London, but the ADRs are not suggesting it will necessarily flow through to Aussie trade today. Watch for any break in BHP through the recent high of $21.57 as the momentum and trend traders will be happy to add here.
  • Next week we all become political analysts with the First Presidential Debate taking place at 11am to 12.30pm (AEST) at Hofsta University in New York. There are a number of topics that have been pre-released and these include ‘achieving prosperity’, ‘securing America’ and ‘America’s direction’. It's show time, and should make for entertaining television.

It’s interesting to see such a strong inverse correlation between the ASX 200 and US volatility index (VIX) and this simply highlights the use of the ASX 200 as a vehicle to trade volatility and the ‘hunt for yield’. However, while we can see this inverse correlation first hand by simply overlapping the two charts, one can see that the big gains actually came from the names most exposed to a falling USD and that is the commodity plays and the industrial names that are naturally so leveraged to this space. As we have seen in the last six weeks or so implied volatility is absolute key as a catalyst for the local market.

For those who like things a bit less vanilla and happy to look at pairs trading, one of the best ways to play (and for those with a lower risk tolerance) volatility is to trade the ASX 200 against the S&P 500 as a pairs trade. In periods of low volatility (like we are seeing now), the trade is long ASX 200/short S&P 500. In time of increased volatility (and when we expect yield trades to be unwound) the trade is to go short ASX 200/long S&P 500. Volatility is the driving force by which dictates investment strategies and the companies you buy, and for traders it's one of the most key determinant of risk and money management.

Expect a stronger open today. As mentioned earlier, with the market now having a greater understanding around policy changes from the Bank of Japan and Federal Reserve and with a light week ahead on the data front, next week it’s all about politics. Donald Trump has somewhat closed the gap, but still has a lot of work to do. He will come out firing next week and it should make for some entertaining and no doubt highly controversial watching. Expect US banks and the MXN (Mexican peso) to be the two weapons of choice for traders to express a view here on who wins the first debate.

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