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Why wait for the inevitable?

If you want to know what will happen in the equity market – follow the money.

USD
Source: Bloomberg

That means following the currency that matters - the USD.

The yearly record levels are tumbling currently, EUR/USD 12 year lows, USD/JPY eight year highs, AUD/USD lowest level since mid-2009 and has clearly broken the 76.90 support level. The bear flag for AUD/USD is 74.50 - this level will need some strong reasoning, meaning the RBA would need to really move on rates and oil would need to tank to drive the AUD to a sub 74 cent read in the short term. However, come year end there is no doubt the AUD (as well as the JPY and euro) will be significantly lower than the current level on higher Fed rates.

And that is the point – why wait for the inevitable - the jobs report on Friday has awoken the currency markets to this fact and the equity market is now feeling the early effects of what to come. The USD is driving market volatility.

The employment data saw the jobs rate at pre-Lehmann Brothers lows. The employment change is well and truly above the Fed’s target range – couple this with Fed speak over the past four weeks from the likes of Fischer, Fisher, Williams, Mester, Lacker and Bullard and rates are moving - soon.

Richard Fisher’s comments sum this up perfectly: ‘I would rather see rates rise early and gradually than later and steeper.’ Perfect summary and the very likely path the Fed funds rate will take.

Unfortunately, the market doesn’t behave in such a linear and measured manner – it is currently playing catch up to this fact and it’s why the USD is strengthening and why questions are now to be asked about the equity market – the hot money is not looking so hot now.

Yesterday was the six year anniversary of the bull market – today the S&P 500 and the Wall Street Cash were smashed, as the risk around the strengthening USD hits fundamental value. Profit growth in the USD looks set to take a severe hit on FX headwinds and considering the hot money that has found its way into the equity market over the QE period, total return erosion is building.

What is also against US corporates currently is the scope to do more. February was a record in share buy backs with over US$180 billion spent on buying back shares. Yesterday, a further US$20 billion was added to this with GM and Qatcom announcing buy backs. Since 2011, US corporates have spent $900 billion on buying back their own shares or dividends. To put it another way: 20% of the total market capitations in today’s equity prices have been paid out by US corporates. 

With the USD strength, profit growth slowing and global consumption remaining sluggish, US corporates are running out of scope for further enticements. With rates likely to move sooner - the market isn’t prepared to wait for the inevitable. The S&P and the Dow have now given back all gains for the year – the seven year bull market hoodoo looks like it may come again in the US. 

Ahead of the Australian open

What does that mean for Asia and Oceania? China has also announced it expects 2015 to be a slower year than 2014 – GDP is expected to be lower, inflation is expected to be lower (despite inflation jumping off five-year-lows in February), fixed asset investment, industrial production and retail sales are all expected to slide as well. If the US markets finally exits the six year bull market and China does indeed slow faster than expect – Asian markets are in for a rude shock.

The interesting correlation to watch now is the inverse relationship between the Nikkei and the JPY. There is a clear breakout of USD/JPY and this should see the Nikkei higher – the question will be what happens when this correlation breaks down.

The Australian market is now contending with the lowest iron ore price since records began, oil well below the two year average and revenue growth of just 2%. The AUD decline is going to have a positive effect on those with international exposure however this will be offset by the bottoming prices. The only saviour has been the RBA with rate cuts – however even this has a limit.

We are currently the ASX down 66 points to 5758.

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