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The underperformance of the S&P 500 is building by the day, especially against Eurostoxx 50, China CSI 300 and also the ASX 200. In the equity space, the trade continues to be favouring markets where the underlying central bank is undergoing radical balance sheet expansion, or cutting interest rates. The natural beneficiaries of this stimulus are the sectors that have sizeable weightings on the markets (such as the ASX 200).
The USD has been talked about more in the last 48 hours than I have seen for years, which seems to be having a more pronounced effect on the US markets. It begs the question where would the S&P 500 be if corporates hadn’t taken full advantage of the low interest environment to undertake a massive capital management program? Yesterday this issue was epitomised with Bank of America, Morgan Stanley, Fifth Third and American Express adding to the raft of firms that have already undertaken such initiatives.
Pairs trades – a great way to play diverging markets
Still, liquidity trumps capital management it seems, and long Eurostoxx 50/short S&P 500 as a pairs trade is an idea I have liked for some time, and continues to work in earnest. The outperformance has been huge, with the ratio (i.e. Eurostoxx 50/S&P 500) increasing from 1.48x in January to 1.78x at the close of play. Put the trade into AUDs and the outperformance isn’t as pronounced, with the ratio gaining 7% in the same period. The big risk to the trade is that the Federal Reserve may hold off from removing its ‘patient’ language in next week’s meeting in a bid to halt the USD’s assent, which should see the US markets do nicely. This seems unlikely though given commentary from US central bankers of late, suggesting we are not at breaking point just yet.
Looking at the ASX 200/S&P 500 ratio, this has increased some 13.4% since December (if the trade was carried out unhedged), but put both markets in AUD terms and the performance is a little lower at 5.5%. Either way, the ASX 200 is outperforming, and being long the Australian cash index or SPI futures and short the S&P 500 or E-mini futures index (making sure you net off the AUD exposure at best fit), it looks like it will still work despite many feeling that the boat has sailed.
The price action in the ASX 200 has been positive and has seen a strong move after the first hour. There has been a strong ‘buy the dips’ mentality from local investors and there would have been very few traders who would have seen the local market rallying 1% pre-market. It seems investors both domestic and internationally are accumulating financial and discretionary stocks on any weakness, and it’s hard to see this trade reverse in the short-term at least. We have seen traders try and short both sectors, but they are fighting real underlying strength and short positions are best left to the materials and energy spaces where traders are still debating how much further the commodities can fall.
Today’s Australian employment data was a modest net positive, although traders have not really acted on the numbers; after a slight pop in AUD/USD to $0.7629 sellers have come in again. Importantly the employment to population ratio remains unchanged at 60.6%. Interbank pricing has reacted very modestly to the drop in the unemployment rate and is now pricing a 37% chance of a cut in April and a 91% chance of May. Stay short AUD/USD for $0.7450.
China A50 cash index looks like a buy
The 1.5% rally in the Chinese equity market hasn’t provided the AUD with any real impetus to push prices higher and local news flow has been that we should see a further Reserve Ratio Requirement cut some time shortly. The best way to trade further easing in China is directly through Chinese markets these days and the AUD or Aussie mining stocks are a poor proxy and have seen little uplift from the recent benchmark rate cuts, liquidity injections or RRR cuts. Long positions on the A50 index (the top 50 mainland companies with the futures traded on the Singapore exchange) look compelling given the recent trend break, with stops below 9950.
Otherwise Asia has seen traders do what they do best, which is bid up the USD and sell EURs. Watch for a break in the US dollar index through the 100 level, which will be the highest level since 2003. But it has to be said that the move lower in EUR/USD is becoming quite ridiculous and the rate of change (i.e. utilising RSIs) has only seen conditions like this once before and that was post-Lehman brothers in 2008. There is an absolute buyers strike going on in EUR/USD, EUR/JPY and EUR/GBP and it takes a brave soul to counter-trend this move. Short GBP/USD is still working nicely and I continue to feel a move to the March and July double bottom at $1.4850 could be on the cards.