Stable markets or a tinderbox waiting to ignite?

Last week saw stability creeping back into equity trading – which is strange considering what’s happening in other asset classes.

Source: Bloomberg

The S&P bucked the historical trend of ‘sell in May go away’ (May is historically the second-worst trading month of the year) to be up 1.8%, making a new record high.

After the violence in fixed income markets of the past three weeks and the expectations of contagion, the weekly gain in equity markets around all regions is impressive.

There is strong belief, however, that the credit market will lead the equity market – currently that theory has not come to fruition but it’s an ever-growing risk. The correlation between fixed income and currencies markets is well known, as are the links between currency fluctuations and equities. The sell-off in the bond markets will, one way or another, come home to impact equities but the jury is out as to the extent and speed of the impact.

The VIX index, which had reached its highest level in 2015 the week before, has given all that back plus interest on what looks like a response to expectations the Fed may delay the expected increase to the Fed funds rate – risk appetite is back.

Strange that risk aversion has fallen that fast – economic data is disjointed at best. Employment is no doubt solid, but inflation, purchasing power, confidence, wage growth and trade are subdued in the US.

This was further confirmed on the weekend in the Michigan consumer sentiment index – yes, the size of the survey is tiny compared to the countrywide read but a reading of 88.6 versus an estimated read of 96 and down from last month’s 95.9 puts Michigan very much on the side of pessimism – something that was a surprise at last month’s full survey as well. I believe the stability in equities is on shaky ground.

The dollar index has now fallen for its fifth consecutive week – US data is painting an indifferent picture around rate expectations and its appreciation at the start of the year has made US corporates uncompetitive.

The pullback will be good for the bottom line for this quarter. However, the question is: how long will it last? The futures market is still expecting that the Fed funds rate will be higher come December – just not by the same margin as it was two weeks ago. Will an increase to rates induce taper tantrum 2.0?

Ahead of Australian open

Very flat open is expected for the ASX this morning. Based on the futures markets from Saturday we are calling the ASX up a handful of point to 5739. The AUD’s appreciation over the past few weeks is a concern and, on a trade-weighted basis, it is back at ‘uncomfortable’ levels – but not ‘out of control’ levels.

Be aware iron ore is creeping lower almost by stealth. Having moved up over 20% since the low in March, questions have been raised as to the sustainability of the rise due to the expected supply-glut due in the middle of the year. This should filter into the AUD over time.

Staying in the iron ore space, Sout32 will become its own entity today with a listing at noon AEST. The valuations are vast – between $2 and $3.5 a share. That values the company between US$7 billion and US$15.6 billion (a big difference). What will be more interesting is whether BHP’s re-weighting is met with excitement or pessimism – watch to see if BHP’s decline today is less than the value of the South32 share price. Expectations here are also mixed.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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