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This is the first pullback we’ve seen for years that has been driven purely by concern over valuation. Over the last few years we’ve seen pullbacks, corrections and even bear markets in a number of global indices. Whilst high valuations have been part of the issue, the initial sell-off has always been triggered by a geo-political or some other macro-related concern.
The selling in some of the stocks with extreme valuations has not been a two or three day affair, however the trend break on Friday in the NASDAQ has been keenly noted. The bulls will now hope this targeted selling doesn’t spill out into other sectors, and judging by the broad-based selling yesterday, it seems this could be materialising. It could get ugly if the bulls really pull bids from the market, as there is confusion as to exactly what has changed since last week. The spike in the VIX to 15.5% is testament to the fact that traders are happy to buy put protection incase sentiment really does turn down.
Traders looking at markets without central bank support
Perhaps it’s the realisation that the economy is just about hot enough for the Fed to finish its asset purchase program in October (coincidently in-line with QE1 and QE2), but it’s probably not hot enough to spur on the levels of earnings growth needed to replace stimulus support. Markets are supposed to be efficient and they’ve had plenty of time to adjust to the concept of no QE. Perhaps this is the watershed moment, where Friday’s payrolls were sufficient to have traders saying ‘we’re on our own here’.
Low inflation in developed economies has seen bonds better bid of late, with the US 10-year now at 2.69%. Unless we see a worsening of newsflow and US data, 2.60% to 2.63% should contain the falls and even provide those expecting the fed funds rate to go up in the first half of 2015 a good entry point for shorts. Still, it’s interesting that what is working well as result of lower yields is the hunt for high yielding assets and the carry trade.
In the forex markets the carry trade is in full effect, with the Brazilian real, Turkish lira, Columbian and Mexican peso all looking good. USD/BRL looks especially good for shorts and is testing the uptrend drawn from the 2011 low. We could see a bounce here given trend support, but while you have a pick-up in index volatility, volatility in the forex space is non-existent and this is the perfect breeding ground for USD funded carry trades.
The JP Morgan FX volatility index is at the lowest levels since 2012, and EUR/USD one-year volatility at the lowest levels since 2007 and all this points to further appreciation in yield assets. In theory this should also support the AUD and NZD, given the real bond rates on offer.
China back trading after the long weekend
Newsflow in Asia has centred firmly on Japan, although the Chinese market has re-opened and is currently up 1%. The PBoC lowered the daily CNY fix thirty pips and perhaps this appeased some traders who have been brave enough to keep USD/CNY and USD/CNH shorts on through the process of curbing speculation. However it was certainly positive to see the CSI 300 rally 1% despite the biggest move higher in the repo market in two weeks (with the seven-day repo gaining 57 basis points). At 3.57% liquidity is hardly tight and we will have to see rates closer to 7-8% before the market really feels close to a RRR (reserve ratio requirement) cut from the PBoC.
In early trade we saw Japan swing back to a current account surplus; the first in five months. Still, if you look at this data point on a seasonally adjusted basis, the economy registered another deficit, predominately as a function of a sharp drop in imports (falling ¥595 billion from the prior month), while exports fell much more modestly. If imports are going to fall we need to see a weaker JPY to offset this, as part of Abenomics is premised on importing inflation, thus a weaker JPY puts purchasing power in its trading partners hands.
It was also interesting to see data that Japanese firms had bought A$1.1 billion of AUD assets in February, bringing the total to A$6.5 billion in the last five months, although there is still some A$27 billion to go before funds replenish what they sold through 2012 and into 2013.
Europe looks like it will open on a mixed note, but it’s interesting to see a slight bid come back into US futures and this could mean that we could see better days for US and European stocks. Data is fairly light with French trade balance and business sentiment, UK industrial production and housing data in Canada. Earnings from Alcoa also come into play, although earnings really ramp up later in the week with JP Morgan and Wells Fargo due to report.