Bottom or top – where do you look?

I cannot remember a 48 hours of trade like we’ve seen in the first two days of this week – and I mean ever.

Source: Bloomberg

2008, 2011 and 2012 were more volatile and had longer declines and rises, but never a 4.1% down day then immediately followed up with a 2.7% gain.

Monday and Tuesday paint a very interesting trading picture: To follow fundamentals or macro sentiment?





Bottom up view

Asian indices stock fundamentals are near some of the cheapest levels they have been in the past four years:

  • The ASX is trading on a trailing P/E of 14.7 times the cheapest level since mid-2012 and a dividend yield of 5.2%
  • The Nikkei is at 18.6 times trailing P/E, – a 52 week low and a yield of 1.7%
  • Hang Seng is at 9.2 times trailing P/E – lowest level since March 2012 with a yield of 3.9%
  • Strait Times Index is at 12.98 times trailing P/E – also a 52-week low and a yield of 3.98%

Getting stock specific, BHP now has the larger discount to net present value in a post GFC world. Although the earnings numbers after market yesterday were mixed-to-slightly-weak, the discount does appear overdone.

Valuation fundamentals are making very strong cases to buy. The price reaction in the Australian banks yesterday clearly tells you that there is strong fundamental support from bottom up views.

Top down views

As predicted, the People’s Bank of China (PBoC) has gone down the European Central Bank (ECB) and Fed route of doing ‘whatever it takes’ to support their economy. Last night, the PBoC cut benchmark interest rates by 25 basis points (deposit and lending) and cut the reverse requirement ratio (RRR) by 50 basis points to 17.5%. Estimates vary but it’s believed the cut to the RRR will inject around RMB600 to RMB700 billion into the economy. Will this be enough?

Asia remains the epicentre of the current market instability as fears of emerging market (EM) growth and currency run-ons invoke memories of the 1997/1998 Asian financial crisis. The difference here is that country fundamentals are much stronger, currency reserves are bigger than the mid-1990s, and as are balance sheets.  

Market ‘stability’ will then come from this region – however the slide in China and Japan suggest sentiment is ruling price action and hyper-fear trading is still in control.

The slide in China is even more interesting as it’s not about the collapse in the equity markets and the possible ‘flow-on’ effect to the economy. In actuality, the connection between the Chinese equity market and the Chinese economy is very limited. It’s the fact that there is now a perception of ‘loss of control’ and a ‘loss of face’ for the central government. 

The US markets strike me as the biggest dilemma for global trade. Plenty are blaming EM growth fears and global deflation for US trade; however, I see it differently. This feels like ‘taper tantrum’ in 2013, and ‘hike hysteria’ is clearly the other factor pushing on US trader. Volatile trade is only going to get stronger as each Federal Open Market Committee (FOMC) meeting approaches.

Secondly, implied volatility is going to move markets like we saw in the final two hours of US trade. Not one single piece of news explains this downward move, and with the VIX at 40, moves like the final hour will happen regularly in the short term.

Click to enlarge

I can make clear arguments for buying this market, and I can similarly make a compelling case to sell it.

Yesterday’s bounce was a clear sign that panic selling was the driving force for ‘Black Monday’ and the fundamentals were too strong to ignore. But macro themes are not pointing to a crisis but to whip trading. Volatility is in control and this will create events similar to the final hour in the US markets.

Ahead of the open, we are calling the ASX down three points to 5134. However, with the Aussie VIX at 31, we to are exposed to massive swings.

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication.