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France a key concern for 2014

The quants on stock market seasonality have started to rollout in style and traders seem to be taking notice, with multiple news sources detailing positive historical patterns for this (and the next) week.

If past performance is anything to go by; we should stay long US and presumably global equity markets this week.

With December Triple Witching due this Friday in the US, this period is traditionally one of the strongest weeks of the year, rallying ten of the last twelve and gaining 74% of the time in the last 31 years (or at least since the creation of equity index futures). The fact that the VIX pushed up modestly to 16% suggests further buying of put option protection from traders, which again is positive for stocks. It also has to be said that global asset managers are significantly short on S&P futures, thus any short covering in the futures market naturally has positive ramifications on the cash market.

European markets continue show some interesting trends, no more so than the continued divergence between France and the rest of Europe. I’ve highlighted France as the potential elephant in the room before and once again it is clear that at 1.3800, EUR/USD is killing its economy. When you see the government spend (as a percentage of GDP) at levels higher than any other EMU country, you have to be concerned when you see manufacturing and services PMI at seven and six month lows respectively. Spain is now considered by many to be more competitive than France, and you can see this in the bond market, with yields on the Spanish ten-year bond falling from a 535 basis point (bp) premium over French ten-year bonds in 2012, to currently stand at a 162 basis point premium. It is also clear that we are seeing a strong outperformance of the DAX against the CAC of late, and thus being long the DAX index/short the CAC index seems to be a trade that removes much of the risk on, risk off trade and should continue to work well. Today’s German ZEW business confidence will be another short-term catalyst.

With the Bundesbank upgrading its growth forecasts and EUR/USD looking like it won’t fall to the levels where France needs it to be anytime soon, France has clearly fallen out of the ‘core Europe’ basket. The fact that Marine Le Pen (leader of the French National Front party) and Geert Wilders (head of the Dutch Party of Freedom party) are working together in next year’s European parliament elections to create what could be an anti-Euro ‘powerhouse’ is certainly significant. When you see 11% unemployment (the highest in years) you know it’s never been easier to sell the anti-euro ideal to the French public. So for me, as long as France continues to suffer and we see the current French fiscal policy unchanged there will be risks, and therefore the feedback loop between economics and politics in Europe will continue to be a major theme in 2014.

The ASX 200 has found sellers through the day

With the overnight leads between fairly upbeat, we’ve seen better days in Japan and Australia, although the ASX has found sellers in early trade. The Nikkei has put on 1%, and whilst I’m on the subject of politics it’s worth highlighting Shinzo Abe’s cabinet approval support has dropped to nine points to 47.4%, according to SANKEI. It’s also interesting to see the divergence seen between USD/JPY and the S&P futures overnight; where there has been a strong correlation of late. USD/JPY continues to oscillate around the 103 handle and that is more a function of traders running a raft of scenarios through the market for this weeks Fed meeting.

The Nikkei (as a function of USD/JPY strength) gets its big kicker if we see the Fed taper its bond buying program by $10 billion or more, but more importantly we don’t see forward guidance with regards to putting up the funds rate being strengthened. It’s important to understand the Fed currently have a threshold for raising the Fed funds rate for when unemployment hits 6.5%. Given the Fed sees the unemployment rate falling to 6% by 2015, and the market is already pricing in 60 basis points of hikes by December 2015, a change in its forward guidance to 6% (from 6.5%) is therefore already priced in and thus we shouldn’t see too much of  a move in USD, gold, fixed income and equities. Thus, for a reaction we will need to see the Fed lower its threshold for raising the funds rate 100bp to 5.5%.

Australia has clearly seen its fair share of event risk today, with assistant governor Guy Debelle speaking, the December RBA meeting minutes and the mid-year economic and fiscal outlook (MYEFO) in view. The Debelle speech and RBA minutes didn’t really carry anything of substantial interest and the AUD/USD was thrown around after these events purely on positioning. Looking at the MYEFO, the deficit over its forward estimates is now expected to total $122.7 billion, which is in-line with prior warnings that were well telegraphed in the local press. The AUD/USD showed limited movement on this detail and seemingly paid a great deal of attention to the Shanghai Composite, which is crazy given the Treasury’s forecasts over the coming years argue for the RBA to move significantly. Ultimately its politics which loses from this, with both political parties shouldering the blame for Australia’s deteriorating economic fundamentals.

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