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Trader thoughts - the long and short of it

After a short, two-week break and a chance to refresh, not much has really changed despite two weeks being a long time in financial markets.

Market data
Source: Bloomberg

I see implied volatility in the S&P 500 (‘VIX’) still below 10%, despite so many talking up the risks in the system, with this week’s Barron front page titled ‘Echoes of the 1987 Crash’ a read that aggregates and epitomises all the worry.

US and German equity markets are finding new highs, although bullish moves have also been in Japan too, with the Nikkei 225 hitting a 21-year high and is the primary market. Along with the China CSI 300 to trade, if your strategy is focused on trend or momentum.

The ASX 200 though has certainly come onto the radar, after last week’s stellar 1.8% gain and after 20 weeks of trading in a 5800 to 5675 range, the Aussie index has closed at the highest close since May. So the question for traders here, is whether this is a genuine break of the range that needs to be fully respected, or is this a level for short exposures?

Our call for the ASX 200 this morning sits at 5834, so an open 0.3% higher, with SPI futures a driving force, with a clear bullish set-up on either the daily or weekly timeframe. The weekend news that needs to be discounted for the open is fairly limited and thus the index call shouldn’t be impacted to any great degree. We can see this with USD/JPY or AUD/JPY (two good proxies of risk sentiment) trading largely unchanged in early trade.

This, then should give us a good understanding of how traders and investors want to deal with a market where the bulls have shown they are in full control of this move, with SPI futures also closing close to the session high. Ideally, one would want to see a move lower and a re-test of the former breakout point with the buyers steeping back in to confirm the new range, so my preference is to have patience here before moving to an outright bullish bias on the ASX 200.

Fundamentally, the ASX 200 is expensive by historical standards on 16.03x forward earnings, but we have seen investors happy to pay up for this multiple. I would expect far greater vulnerabilities when the index traded north of 16.5x. Looking at the market internals and naturally when you see a 1.8% gain on the week, we want to see the level of participation to assess the quality of the move. So while all sectors of the ASX 200 rallied last week (consumer discretionary +4.4%, utilities +3.5%, industrials +3.1% the three standouts), we have also seen the percentage of companies trading above their 20-day moving average move to 81%, 74% above their 50-day average and 33% of the index closing a four-week high.

So participation has been strong, which is another bullish sign, but we are not a million miles away from levels where the index has priced in signs of euphoria and we may see a reversal. That could come later this week and is on the radar.

In terms of news to discount for the open, and the focus on Friday was on US data, with September core CPI and retail sales coming in just below the streets forecasts at 1.7% and 1.6% respectively. This was enough for the market to hit the bid in fixed income, with the US 10-year treasury falling four basis points (bp) on the day to 2.27%, taking the 2’s-10’s treasury yield curve 3bp to 77bp, while ‘real’ (or inflation-adjusted) yields fell modestly and was a key reasoning for the 0.8% gain on gold.

The implied probability for a December rate hike did fall at touch to 72%. However, digging into the retail sales report we can see the ‘control group’ element (the basket of goods that feeds directly in the Q3 GDP calculation) increasing 0.4%, which when economists feed this into their models, would have seen a boost to the expected Q3 GDP tracking rate. I see this somewhere around 3% at this stage.

Aside from fixed income and the lead for the S&P 500, which also has the factor of Q3 earnings to impact this coming week, commodity markets should see good flows into materials and energy names. This can be aggregated in BHP’s ADR that closed 1.5% higher on Friday and is a good indication of how the rest of the sector should open.

By way of a guide, spot iron ore closed up 4.1%, while in the Dalian futures exchange iron ore, steel and coking coal futures gained an impressive 5%, 3.5% and 2.8% respectively. US crude closed up 1.7% and has the tailwind of US rig count falling by five rigs last week, so the futures open at 9:00am AEST should be interesting. So, given leads from Wall Street and commodity moves today is not the day to aggressively fading the index in my opinion, as sentiment is strong and markets are not at a euphoric stage yet.

Weekend news has centred on the talk fest from the IMF and World Bank meetings, with key note addresses from Janet Yellen, Mario Draghi and Bank of Japan chief Haruhiko Kuroda. From the headlines I have seen there is no new message to be learnt, although Janet Yellen struck an upbeat tone, detailing “economic activity in the United States has been growing moderately so far this year, and the labour market has continued to strengthen”.

It seems perhaps, the more pressing issue (according to news sources) is around who will lead the Federal Reserve after Janet Yellen’s tenure is up. We can now add John Taylor to the mix, with Taylor also being interviewed for the role last week. However, Kevin Warsh and Jerome Powell are still the two leading candidates, with some discussion that we may see a Warsh coming in as the chair and Taylor the vice-chair, which would be one of the most disruptive combinations and situation the market would have to understand.

In terms of event risk today, the focus is on China, as it will for most of the week with the Party Congress getting underway on Wednesday and Q3 GDP (consensus sits at 6.8%), retail sales, industrial production and fixed asset investment. Today though the focus is on inflation data, with CPI and PPI expected to print 1.6% and 6.4% respectively. These are important numbers, as they form part of the argument around the global reflation thematic priced into markets of late, but whether we see an initial move in asset prices seems unlikely.

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