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If the S&P 500 is going to keep pushing away from 1287, it seems logical to us that US data will need to improve, although the caveat is that really strong data could actually work against the market.
The Fed chairman has beaten his drum hard enough that the market has drawn a more distinct line between the start of ‘tapering’ and a rise in the Fed funds rate; you can see this once again in the Fed funds future (December 2014) contract, which is now pricing in 31bp (basis points) of hikes, down from 33.5bp on Tuesday, while expectations for a hike in the funds rate in December 2015 has decreased from 101bp to 93bp. Still, it was positive yesterday to see a decline in the weekly claims and such a strong regional manufacturing print (out of Philadelphia); although a closer look at this data point showed that while new orders actually decreased, on the ‘six months forward’ part of the survey, US businesses were quite optimistic about the prospects for new orders, not to mention their own situation on future job creation.
Earnings are in full flow now; with around 18% of S&P companies having detailed quarterly earnings, 52% have beaten on the revenue line, while 71% have outperformed on the EPS line. What’s more, thus far we’ve seen 4.5% revenue growth, which, if this trend continues, should justify the rally we have seen. General Electric (GE) will steal the limelight today, with expectations of Q2 EPS of 35 cents on revenue of $35.56 billion, while the market is also expecting margin expansion of 70bp. With little data to move the market over the next ten hours or so, GE has the potential to be at the heart of any moves in US/European markets.
So, with the S&P 500 pushing to new highs, we haven’t really seen the same sort of optimism in Asia. China is down 0.4%, the Nikkei is softer by 1% and the ASX 200 is lower by 0.5%.Clearly Japan is the stand-out, with both the equity market and JPY showing once again how quickly and aggressively this index can move. After trading to a high of 14,953 in early trade, a sharp move (we believe to be futures led) saw the equity market drop 3.6% or 540 points in a couple of hours.
There was no smoking gun that we could see, although looking at volumes in the futures market in the two hours when we saw the cash market fall, 55,800 contracts were traded, which is huge, given the average for each whole day has been 54,000 contracts. It’s also worth highlighting that at 11:23:04 (AEST) a decent series of one lot contracts were traded in succession, suggestive of high frequency activity; or as one trader said ‘an algo gone bad’. There has also been talk that a CTA (commodity trader advisors) may have been active and exiting a sizeable position, but again this is merely speculation.
The fundamental triggers for such a fall stem from two fronts. Firstly, Koichi Hamada (advisor to Shinzo Abe) has been on the wires talking about a rise in sales tax. Mr Hamada seems cautious, and while from an absolute perceptive a rise in consumption tax from 5% to 8% (and onto 10% in 2015) would hurt any economy, the Japanese really have no choice, especially if the economy is improving (which it is) as they simply have to increase revenues. With a debt to GDP ratio of around 240%, they must raise taxes to increase revenue, because of the limited increase in productivity they can extract from its aging population. The other key issue today is positioning around the weekend’s upper house election in Japan. With 121 seats up for grabs, according to the polls it seems Shinzo Abe’s LDP party will get the 63 seats to gain a majority in the upper house, with talk of 70 or even more. In terms of a playbook, we would expect a modest spike lower in the JPY; higher in the Nikkei if the result shows the LDP/New Kameito (junior coalition) picks up 76 seats (out of 121), thus achieving an ‘absolute stable majority’. However, the big moves come if the LDP party can take seats off the Democratic Party of Japan (DPJ) and win 72 seats on its own, and thus doesn’t have to rely on support from its junior coalition partner longer term.
The ASX 200 is following Japan lower today, with traders booking profits in material names, whilst industrial stocks also felt no love. Once again 5012 has been the line in the sand, and it feels like we are going to need a really strong lead from US trade, followed by a landslide victory for the LDP party over the weekend to get the index over the line next week. AUD/USD looks interesting with the pair having recently breaking the downtrend drawn from the May 1 high. We actually feel pull-backs to 0.9125 (just above the July 15 high) could be buying opportunities, with a potential stop at 0.8990, and a move to the June 26 high of 0.9344 as a target, although the upside could be capped here and we’d look to reverse positions. Talk now is that the federal election could be called in the next few days, which might also provide support.
European markets look to give back some of their good gains yesterday, although momentum and trend indicators are pointing higher and thus pullbacks should be relatively contained. Data is relatively light, with UK public sector borrowing, Italian industrial sales, Netherlands consumer spending, Spain’s trade balance, German producer prices and the Greek current account balance on the docket. Angela Merkel will be fielding calls from journalists, while starting to ramp up her September election rhetoric. The G20 starts in earnest as well, with finance minsters likely to spend most of their time talking Fed policy and the impact it is having, and will have on the global economy.