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Equities are looking relatively attractive

The market seems to have come to terms with geo-politics almost being the ‘new normal’, although comments from Russian President Vladimir Putin have given some confidence for traders to continue holding a long bias towards global equities.

ASX 200
Source: Bloomberg

We are by no means out of the woods here, and with a number of Russian aid-carrying vehicles making their way into the Ukraine, it seems markets won’t completely rest easy.

The S&P 500 has already recovered over 50% of the 4.4% pullback which started in late July, and a break now above the 61.8% retracement of the pullback at 1958.31 could see the all-time being tested once again. So, despite calls for a correction, it seems we will have to wait a little longer, with calls that the US has become a haven for global funds given it’s comparatively better growth, strong corporate landscape and lower direct impact that geo-politics plays into the US economy.

The interesting dynamic has been the fall in bond yields, with a number of countries seeing record low borrowing costs. This won’t be a major issue for the likes of Germany though, which won’t actually need to even go to the primary market for borrowing next year; however the fall in yield is key, especially with yield differentials between nations really feeding into currency valuations.

Equities relatively attractive

We have seen periods throughout the last couple of years where bond yields have fallen, coinciding with good buying in equities; however that was driven predominately by central bank liquidity. This time around, things look very different; while the question of the day is why Warren Buffet doesn’t undertake a stock split, the more pressing concern suddenly seems to be around global growth. It’s this issue, along with poor, and in many cases negative real wages, that is causing yields to fall. At the same time, investors and traders alike are scanning the capital markets and seeing little alternatives other than global equities, especially on a risk-adjusted basis.

The US then seems in a better spot with such a strong snap-back in Q2 growth, but we have seen terrible growth numbers in Japan (although we are likely to see growth of 2.5% in Q3); Europe (despite signs of better days in Spain and Greece) looks weak, while the July financing numbers in China have led to concerns about China’s Q3 numbers. I would certainly temper concerns around China with the view that there were special factors that led to an 86% decline in total financing, however this does make the August number fairly important and one would expect a healthy increase in this metric. Of course you can also add in the technical recession in Italy and deflationary environment in Spain, Portugal and Greece as well.

UK growth will once again come back into focus today, although the Q2 print is a revision and not expected to diverge from the original print of 3.1%. Cable has fallen 3% since the July 15 peak and has closed below the May 29 low of 1.6693. Technically the bias has to be short for this pair given the strong underlying downtrend that is evident on the daily chart, however the pair is oversold at current levels and due a rebound of sorts.

Divergence seen in cable between the technicals and fundamentals

Fundamentally the market has re-positioned itself fairly aggressively around Bank of England actions, with the swaps market now pricing in 53 basis points (or two interest rate hikes) over the coming 12 months. Interest rate futures have seen a sizeable move of late with short-sterling futures suggesting the cash rate will be around 89 basis points by March 2015. This has fallen from 117 basis points after the spike higher in expectations after Mark Carneys Mansion House speech in June. Fundamentally I wouldn’t be shorting sterling as rates have probably come back to more realistic levels, so there seems some divergence between the fundamentals and technical.

We close the week on a positive note in Asia with Japan underperforming and China and the Hang Seng (at a six-year high) continuing to move higher, presumably helped by local speculation (China Securities News) that we could see target interest rate cuts in the second half of the year. Earnings in Australia have been fairly soft today from the cluster of companies that have reported, however with the week coming to a close here it’s worth having a look at the bigger picture. With 22% of ASX 200 companies having reported full-year earnings we have seen 68.2% beaten consensus on the bottom line, 64% on the sales line, with 11.66% aggregate earnings growth. This seems strong, especially when we saw 54% of companies beating last year.

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