Trader thoughts - the long and short of it

It’s that time of year where the bulls traditionally have a distinct advantage and this seasonal strength is playing out once again, with global equity markets firing up as we extract just that little bit more performance out of the markets into year-end.

Market data
Source: Bloomberg

A positive outcome in the US tax bill was the buzz on Friday and also through the weekend. This spilled over into Asia yesterday and should be prevalent today.

There are still many scenically views as to the ethics involved in getting the Republican Senate fully on board and the provision placed into the tax bill. This benefits owners of complex real estate investments, which has subsequently been the trigger for Senator Bob Corker to disregarded his well publicised concerns around a blow out in fiscal deficit and is now fully on board with tax reform.

This concern on the deficit blow out may no longer be one Senator Corker is too worried about, but ratings agency Moody’s has weighed into the debate, detailing that tax reform is a long-term negative for the US economy. We should still see a vote in tonight’s session in the House, followed by a more meaningful vote through the Senate with Trump signing this into law later this week.

The question of how much of the tax reform story is now in the price, is one many share. One suspects a great deal, with the S&P 500, Dow Jones and Nasdaq 100 all pushing to new all-time highs, with Apple showing its position as market leader and trading into $177.16 – again, a new all-time high. Volumes have been in-line with the 30-day average, while breadth has been solid, with 75% of S&P 500 companies pushing higher.

The Russell 2000 has put on another 1.1% and should be supported on any pullbacks here. Interestingly though, we have seen limited moves in high yield or investment-grade credit and spreads are largely unchanged despite equities pushing ever higher.

We can also see the good flows into European markets too and there seems little anxiety around this Thursdays Catalan election, while local media has focused on the Italian elections (expected in March), where it seems the Five Star Movement may actually be looking to form a coalition, which suggests a slightly less extreme stance from this populist movement.

The German DAX has been on the watch list  for a break of the 13,200 to 12,900 trading range it had been confined to since 10 November. As it rallied 1.6% overnight, we have seen the bulls win this battle fairly emphatically. 13,500 and higher seems like an elevated probability on this development.

In central bank chatter, we have seen some fairly pessimistic comments from Fed member Neel Kashkari, but did we expect anything else given he voted to keep rates on hold in December? His view that a “flatter yield curve signaled a higher recession risk” and that “bond market telling us the odds of recession are rising” is a feature of daily commentary from the bears of late. To be fair, even Janet Yellen has previously made mention that the Fed would take into account the Treasury curve in assessing policy. Mr Kashkari did mention that he “doesn’t see urgent financial stability risks at the moment” and perhaps this is the point of contention within the Fed’s ranks, as there are others who would certainly see asset price inflation as an issue which could manifest into something more tangible in 2018, with a belief in the feedback loop between higher asset prices and broad economics and thus raising rates is still the prudent step.

So some interesting comments and Mr Kashkari’s justification for not voting for the hike, but the bond market cared little and we have seen stronger selling in the back-end of the US yield curve, with the 10-year Treasury pushing up 4bp and into the top part of the 2.42% to 2.3% range it has been stuck in since 27 October. A break of this range will be closely watched through this week, but the overnight moves has actually resulted a reasonable steepening of the curve and this may be providing some relief to US banks, who actually benefit quite nicely from tax relief anyhow.

It’s also interesting that despite the sell-off in US fixed income, not to mentioned all the narrative around higher USD funding (seen in 3 month USD basis swaps) that the USD hasn’t moved higher, in fact the USD index is lower by 0.3% and the USD is down vs all G10 currencies. AUD/USD has pushed off session lows of $0.7641 into a high of $0.7677. It was just failing to close above its 200-day moving average and consolidation seems to be the name of the game.

Aggregating all the overnight action in equity markets, as well as mixed moves in commodity markets, we can see Aussie SPI futures up 27 points at 6068 and the highest levels here since January 2008. With the fair value calculation, our call for the ASX 200 sits at 6063 and a new year-to-date high should be seen on open, although the question is whether we can see a close through 6052 (the cash session high printed on 9 November).

As things stand the backdrop is clearly positive and sentiment is certainly supportive and we can see BHP and CBA eyeing an open 1.1% and 0.5% higher respectively, if the ADR proves to be a good indication. Market internals suggest even at these levels we are not at a point of euphoric conditions, with just 6% of stocks at 52 week highs, 11% of ASX 200 companies with an RSI greater than 70 and 65% trading above its 20-day average.

This suggests we can feasibly squeeze higher and the fact the ASX 200 now trades on a forward earnings multiple of 16.56x, a new high for the year, is of little significance this week in a market that is looking to close out the year on a high.

So as it stands the ASX 200 is up 6.6% year-to-date (12.7% on a total return basis) and one would argue that even though we have lagged the moves in other developed markets, this is a great outcome for the bulls.

It also suggest that returns are going to be far harder to achieved in 2018, as outside of materials and select industrials one questions where the earnings upgrades going to come from. On 16.5x, from a fundamental basis one struggles to see investors paying over 17x in 2018 for the index.

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