Trader thoughts - the long and short of it

Volatility is up, and risk appetite has been dulled. The VIX traded towards the 22 figure overnight, while currency safe havens such as the Yen were sought amid a somewhat remarkable sell-off across global equities during the European and North American sessions.

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Source: Bloomberg

Volatility: It’s a matter of markets continuing to adjust to a world of higher interest rates and US Treasury yields – coupled with the expected panic when prices recalibrate to evolving fundamentals. A strong enough argument can be made that we are witness the beginning of the end for the US bull-market: there’s no shortage of voices out there suggesting so. It stands to reason that perhaps riskier plays into growth stocks should be replaced by more conservative investment strategies – say, by rotating into defensive, higher yield stocks. The idea holds merit, but a few days of selling on the back of a less than assured spike in global bond yields isn’t a cogent enough argument to abandon all risk-taking.

North America: Wall Street has demonstrated a broad-based sell-off. Once more: investors are adjusting to changing fundamentals in the face of higher global rates. Sectors with what may be dubbed stretched valuations are struggling, unaided by the kick-up in discount rates and unattractive yields. The tech-sector, embodied by the NASDAQ, has delivered the most significant losses for the US session, down in the realm of 4 percent; but the Dow Jones and S&P isn’t far behind, down about 3.1 per cent and 2.6 per cent (give-or-take) themselves. The sectoral map across all three of these indices is painted a rich red today: traders are apparently grabbing cash here, liquidating what they can before they get lost in the herd.

The end of a cycle? When markets experience the sorts of structural shifts being witnessed in the last fortnight-or-so, falling back on conventional wisdom can be illuminating. Not to say it provides the answers, but more so that historical knowledge can be drawn upon to show nuance and contrast in the haze of the present moment. What of the economic cycle here? The rationale behind traders’ behaviour might be described as a response to the ever-beating mechanics of the macro-economic process. The Fed is raising rates and growth is apparently reaching a peak, meaning that upside for capital growth may be diminishing. Turning these gains into cash and distributing profit could be the smart-money driver of equity markets, in the expectation that little more can be reaped from what has been sowed.

Upside exists: While compelling, markets function at the influence of far too many distortions to rest on the belief that we are end of cycle. The Fed’s unwinding balance sheet and progressive interest rate normalization is an act without precedent: cycles have been bent and interfered with, making prices a less reliable indicator of financial market phenomena. It’s in part why a sell-off such as the one witnessed in Europe and North America overnight elicits such nervousness. Markets can’t be sure what was once true still applies. In digesting the US experience and how it relates to Fed policy, it must be counter-balanced with notion that global monetary policy is still very accommodative. Granted, this is less so than 4 or 5 years ago, but in the grand scheme of things, with Europe and Japan still in negative interest rates, not to mention a Chinese government with a stimulus bias, reason to believe markets remain well supported are ample.

Bears abound: It’s intermingled with other concerns, for sure, so a bearish sentiment permeating markets is easy to understand. Mystery still reigns regarding the health of China’s economy, and the European Union and the economic zone it presides over looks inherently unsound. European markets participated in the equity market dumping, sucked into that black-hole by widespread panic selling, driving the DAX and FTSE 100 down 2.2 per cent and 1.3 per cent respectively. Rates and bond markets de-risked slightly, however, boosted by the news that key Brexit negotiator Michel Barnier believes a Brexit deal could arrive as soon as next week. The pound has flown toward 1.32 while the EUR is sustaining itself at 1.1520, supported by a diversifying of risk across G4 currencies in response to the night’s equity rout.

Asian equities: The Chinese growth story may be the biggest determinant of the Australian share-market’s fortunes, however: slow growth in China means slow growth in Australia, so the ASX200’s sell-off this month can be explained-away easily when also factoring the raucous activity in global bond markets. The technicals become interesting for the ASX 200 here, especially given that SPI futures are pointing to a dumping this morning, with weekly trend-line resistance at ~5860 in risk of being breached. For investors with a preference for the Asian region, attractive valuations abound, explaining the little jump in the Hang Seng yesterday, with investors lured into an appealing P/E ratio across that index below 10:1. Similar valuations exist in Chinese shares, offering a high-risk-high-reward dynamic for investors: a strong will is a requirement before jumping into Asian markets however, because volatility will stay the norm.

The Middle Kingdom: China will struggle for as long as the trade-war rages, but on balance policy markets appear well equipped to tackle the matter. Overnight it was announced that the Chinese government would include a greater number of financial institutions “systemically important” (read: too big to fail), to offset the weekend’s credit-boosting endeavour of cutting the Reserve Ratio Requirement. The slip of the off-shore Yuan to around 6.93 last night also suggests the PBOC will calmly and gradually let the currency ease to support China’s growth. Although lost in the bloodbath last night, commodities prices, down on aggregate apparently due to the tumble in oil, are displaying signs of some green shoots: industrial metals are broadly of off their lows, suggesting some signs of optimism toward Chinese growth and the region’s markets.

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