Trader thoughts - the long and short of it

The growth-versus-risk paradigm shifted further in favour of the latter in the last 24 hours, as a multitude of stories compounded the bearish sentiment mounting in global markets.

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Source: Bloomberg

Growth v. Risk: Though Chinese markets were more stable yesterday, an IMF report downgrading global growth forecasts for the first time since 2016 reinforced the possible growth-sapping impacts of the unfolding US-China trade war. Risks in Europe piqued again, following renewed inflammation of tensions between the Italian government and European bureaucrats, weakening the EUR/USD and pushing European bond spreads wider. While the trade war story also dented the growth story, after news broke that the US Treasury Department may be poised to officially label China a currency manipulator.

ASX200: SPI futures are indicating a 4-point drop for the ASX 200, following another belting of Australian shares yesterday. Futures markets have unwound the projected falls at the open for the ASX200 throughout the North American session, courtesy of an overall lukewarm but stable night’s trading on global markets. Support levels were brushed aside in local trade yesterday, with 6100 and 6060 offering little inertia, squashing the index into its eventual closing price at 6040. Downside momentum has really taken hold of the ASX now, shaping the perception that a short-term downtrend is emerging for the market. The daily-RSI reading suggests the sell-off is somewhat overcooked, but the prospect of a complete and immediate recovery of this week’s losses appears remote.

Risk factors: Tuesday’s trading provided much of the necessary insight, however, into what cascading set of influences is driving the Australian share market. There are more than enough risk factors percolating through markets now to fuel bearishness on the ASX, but as always, the interest is in determining what weight each variable carries for the success and failure of the index. The global growth story is one of those, tied into fears of a Chinese economic slow-down and the effects of the trade war on financial markets. Another is the numerous risks to local and international financial stability, taking the form of underperformance from bank stocks, possible fiscal crises in Europe, and a possible blow up in emerging markets. All those stories play their part to a build-up in downside risk, but market-activity yesterday suggests that the biggest issue plaguing the market is this: the global sell-off in equities in the face of higher global interest rates.

Local market drivers: The sectoral map for the ASX200 yesterday handed the clearest insight into this dynamic. For one, the bank’s stock prices pulled back after their modest recovery last week, no longer exhibiting signs of upside from higher global long-term bond yields; and the materials and energy sector also faulted, even despite a modest tick-up in oil and metal prices, and the easing of selling-pressures in Chinese equity markets. Though the truth in the ASX’s fortunes will often lie within activity in any one of these three sectors, the lion’s share of market action yesterday was generated by the heavy 4.11 per cent loss of the health care sector, catalysed by a 4.5 per cent and 5.2 per cent dumping of market darlings CSL and Cochlear, respectively.

Heath care stocks: The rout in health care stocks ties back into a theme manifesting the world over: that growth stocks are coming out of vogue as global discount rates increase. Much alike the tech giants in the US, Australia’s major healthcare stocks – again, the likes of CSL and Cochlear – have carried the Australian share market this year, collectively generating a YTD return of over 21 per cent. These companies, better defined as bio-tech firms, have traded with increasingly stretched valuations, and with naturally lower yields. The spike in global rates over the past week has put pressure on valuations, as well driven investors to chase returns in safer, higher yielding assets. It’s a phenomenon playing out at a fundamental level the world-over, causing drag across equity markets and consequently an overall bearish sentiment within them. Although no reason for alarm yet, with opportunities still ample ahead of projected strong earnings growth, the combination may portend bearishness for ASX200 traders moving forward into the back end of 2018 and start of 2019.

Risk-off: The parameters dictating market sentiment presently is tipping markets away from riskier assets and into safe havens. The already described activity in equity markets evidences this, but less structural and more transient and nebulous concerns are materializing in other asset classes. The Japanese Yen, for one, has attracted flows this week, falling back below the 1.13 handle last night. The stronger currency and risk-off dynamic has quashed the Nikkei’s bullishness, pulling that index down from its recent 27-year highs. Paradoxically, the AUD/USD has climbed within this context, bouncing off the bottom of the pair’s trend channel back above the 0.7100; however, after the multiyear lows registered last week, this is probably reflective of some opportunistic profit taking from short-sellers, with the more accurate growth-versus-risk currency pair, the AUD/JPY, falling below the significant 80.00 handle last night.

North America: The rotation out of growth stocks is afflicting Wall Street indices, however the thrust behind this process did ease last night. The reasoning for this was the settling in US Treasury yields, which fell throughout the day, after the benchmark US 10 Year Treasury clocked new 7 highs at 3.26 per cent during the early stages of the session. The NASDAQ was subsequently allowed to arrest its 3-day tumble, closing effectively flat, while the comprehensive S&P500 dipped 0.1 per cent. The far narrower Dow Jones lost 0.2 per cent for the day and demonstrated best the unfolding rotation into defensive strategies by investors: putting aside the jump in oil prices that led the rally in the energy sector, once more the conservative consumer staples, communication and health care stocks proved the leaders of the day’s trade.

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