IG Markets: Notes on Australian markets today

Kyle Rodda, Market Analyst, Australia

The day's key takeaways:

- US and China trade-deal supports sentiment, adds fuels to charge in higher in risk assets

- Welcome to the roaring 20s: stocks showing signs of a spoon full of irrational exuberance

- A growing risk of a big pullback: is this a replay of the January 2018 stock market sell-off?

- A few open questions about the US and China trade-deal, and what it means for the future

The run down:

Overall, the market has taken well to the signing of a trade-deal between the US and China. As always, the devil is in the detail when it comes to the deal itself, with the document still being digested by the market. However, the images of amicability shared between Vice Premier Liu He, and China’s trade-delegates, and US President Donald Trump, and members of his administration, have added a bit of sugar on top of a market looking almost sickly-sweet right now. Market prices have been somewhat choppy since the actual Trade Agreement was published, to be sure. And as it stands right now, riskier and growth-tied assets are somewhat mixed. Asian stocks are slightly higher following Wall Street’s reasonably positive lead to edge higher today. The Australian Dollar and New Zealand Dollar has climbed, as has the offshore Yuan. The ASX200 continues its melt up, surging above the 7000 mark and to fresh record highs.

Global stocks are looking in pretty rarefied air right now. Arguably, this market, at least outwardly, is displaying symptoms of a small case of “irrational exuberance”, as equity gauges across the globe run-on into fresh record-highs. Stock indices are climbing on very littler “new-news”, and without terribly strong justification. This isn’t to posit an overall bear case for global equities. The foundations, what with ample central bank support, lower geopolitical risks, and gradually improving fundamentals, are certainly establishing the foundations for stock market strength going into the first part of the year. But it’s looking like price action is getting a trifle ahead of itself. Valuations, both in Australia and abroad, are looking mighty rich, and raise the possibility of a potential painful pullback when the sufficient catalyst arises. Sentiment is complacent, after all, with the VIX plumbing low-levels at around the 12-mark, and the put-to-call ratio an uber-bullish 0.44.

There’s a slight January/February 2018 vibe to the market emerging – though it must be said sentiment doesn’t look quite as extreme this time. Back then, stocks were running higher on the optimism engendered by strong economic fundamentals, as well as the passage of US President Donald Trump’s corporate tax cut legislation. Valuations, like now, ran up very aggressively, as the market priced in the prospect of a super-hot US economy, and booming corporate profits. The market moved way too aggressively, and was probably caught chasing price, when a necessary, and rapid, lift in US Treasury yields sunk the momentum in stock prices. We could see a bit of history repeat itself here. US Treasury yields look again behind the curve in pricing in a global growth rebound. A swift correction in yields could be the catalyst to halt the momentum in this market, and force a short-term re-calibration in equity markets.

Returning to the trade-deal, and while in general, the signing of a “phase-one” agreement is, on balance, a positive thing the market, it would seem some risks remain in the US-China’s ongoing trade-war. Significant questions exist throughout the trade-agreement, and apply to all its major pillars. Does China really have the capacity to purchase the value of US goods it has committed to? How effective, transparent and enforceable is the exchange rate mechanism going to be? Can the Chinese legal system fairly and legitimately implement, administer and police the proposed changes to intellectual property and forced technology transfer laws? How well equipped is the Chinese financial system to greater openness to US firms and capital market forces? And most importantly: how can the deal in general move forward smoothly enough to ensure that it provides the adequate scope to initiating, and then perhaps implementing, some sort of “phase two” trade deal?