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As expected, Janet Yellen’s appointment as Chairman of the Fed went through the Senate and traders are keen to hear the new Chairman speak to markets (no set date at this stage), especially after taking into consideration this week’s US payrolls report. Ms Yellen has time on her hands before the stress of the role kicks in and will be passed an economy to manage that is on the up and progressing fairly well. It won’t be for some time that her skills will be called upon and when they do she will earn her crust, as the ability to fully understand market expectations and communicate future actions to calm volatility will be in play.
Two key scenarios for the Fed to potentially deal with
There are two scenarios where both Ms Yellen and Stanley Fischer will need to be at their very best. Firstly (and the more likely scenario) is if we see the market testing the credibility of the current forward guidance for putting up the Fed funds rate. Being able to control the yield curve will be fundamental here as the market will be quick to push up short-end rates if they genuinely feel the Fed are going to hike rates quicker than what is currently expected (i.e. late 2015). The alternative issue comes if we see core PCE (personal consumption expenditure) fall below 1%, and the monthly payrolls report falling to average of say 130,000 a month, which in turn pushes the unemployment rate higher. This scenario is a possibility, but it is not expected by the market and thus carries a high degree of risk.
Asian markets are mixed, with the ASX 200 putting on 0.2%, while China has fallen a further 0.4% and Japan is all over the place. Gains in the ASX 200 have been largely assisted by good moves in the banks, while material names have been on the other side of that ledger. Gold stocks have seen profit-taking despite gold holding ground and continuing to eye $1250. The resource space seems to be taking its cues from China, which of course won’t surprise anyone; however traders are punishing equities, without the same price action seen in the underlying commodity space. Copper for example has not reacted at all to the moves in the CSI 300, or the below consensus data of late out of China.
25% of ASX listed firms with lower price targets
It’s interesting as well to see the 25% of ASX 200 listed companies now have downside risks if you believe the consensus price targets held by sell-side brokers are indeed correct. Of course from a pure fundamental stand point these targets generally represent the net discounted cash flows to earnings and thus so called ‘fair value’. So as long the variables that factor into these earnings models are correct, then we have a quarter of the market, including banks (CBA for example) which value investors won’t feel are ‘worth’ paying up for over the next twelve months. There are even nine companies, where the consensus price targets are 10% lower than current levels.
As mentioned, China and the multitude of regional markets are finding further sellers and there seems a number of factors which are keeping investors and traders away from what are on paper are the cheapest index valuations around. There are further issues around the shadow banking committee, while the property sector is always in the spotlight, especially after comments from Vanke yesterday about the excess capacity in the third and fourth tier markets. This is not just a story of selling ahead of the raft of IPO’s due this year, but seems much to do with a loss of confidence around the external demand picture, mixed with a clear message that authorities need to control the supply of credit, while we’ve seen the pace of growth in the service sector slow as well. China is defiantly in play right now and while I still hold a neutral view on China in terms of its impact of regional sentiment, we certainly aren’t seeing the sort of flows that suggest the Chinese and Hong Kong markets are going to see double-digit appreciation this year.
It’s interesting to see the Australia November trade balance figures, with a smaller-than-forecast deficit being seen at $118 million. Certainly from an AUD perspective there was no relief whatsoever; in fact we actually saw sellers with AUD/USD falling to a low of 0.8923, although this was replicated with falls in EUR/USD and USD/JPY strength, suggesting it was more a USD move. Even a 1.4% increase in exports to China didn’t help. It’s now fairly clear that for the AUD to rally substantially from here, the FX market wants to see an improving employment picture, with the read through to business and consumer confidence and the end result being retail sales closer to 1%.
Stronger European open expected
Turning to Europe and a brighter start is expected, with small gains seen in US futures helping support the calls. Germany takes central focus with retail sales and labour market data due. We also get euro CPI estimate due and economists expecting another slight fall in price pressures. EUR/USD will clearly take its cues here ahead of the ECB meeting this week and with good demand seen in the pair below 1.36 a squeeze to 1.3690 becomes a good level to sell into in my opinion.