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Still, I don’t feel that sentiment is shot to pieces even though certain developed markets have pulled back by 10% or more and others (such as the ASX 200) look ominously poised to hit the arbitrary 10% percentage level that constitutes a ‘technical correction’.
More of a concern are emerging markets. They certainly warrant a cautious stance, with the MSCI emerging market index falling for 12 consecutive days and the iShare MSCI Emerging market ETF (EEM) moving into deeply oversold territory in the process.
The moves in developed market bonds are clearly a concern for the equity bulls. The fact remains that equity market stress is being caused as German and French yields move higher and short EUR FX hedges are unwound. At the same time, as yields move higher and global inflation remains low in places such the US, China and to a lesser degree Australia, we are actually seeing a quasi-tightening of monetary conditions. Again, this works against equity markets.
The value-focused bond funds are generally still bullish on fixed income if they take a 12 month view, but now is not the time to fight this tape and it will be interesting to see if more conviction arises if the US 10-year trades into a 2.50% to 2.6% range, the German 10-year bunds into 1.25% and Aussie 10 year into 3.25%. I feel these levels represent a far more compelling level of value given the improving data trends and positioning readjustment that’s underway.
Yesterday’s US job openings clearly supported the bond sell-off, with job openings hitting a 14-year high, although its really the longer-term maturirites that are getting sold, in turn pushing the US yield curve to the steepest level this year.
US financials like Goldman’s and Citigroup have been the natural beneficiary of the steepening curve as they borrow at the short end and lend at the long end of the curve, so margins will naturally benefit here. The long financial trade may still have some juice in it yet but it is a mature trade, so I wouldn’t advocate allocating fresh capital to the trade at these levels, especially when most sell-side fixed income is expecting a flattening of the curve.
Equity market internals around the developed market are deteriorating somewhat and this caught the market’s attention. Most commentators have picked up on the 57% of S&P 500 companies above the long-term 200-day moving average – the lowest level since October 2014.
However, I think the more short-term 20-day average is more interesting. The fact is only 21% of stocks are now above the 20-day average, down from 73% in late May. However, since 2014 when this percentage falls into a 15 to 20% area the buyers tend to come back into the market. This would correspond with the strong trend support drawn from the February low, so it wouldn't necessarily be a huge surprise to see a technical bounce from here, even if the macro backdrop doesn’t necessarily warrant it.
Here in Asia the big talking point among traders was the MSCI emerging market index review. As detailed yesterday, the market held the view that we would not see greater representation from Chinese equities just yet. However, it was almost a fait accompli that the MSCI would detail greater inclusion was on the cards over the coming 12 months.
That’s exactly what we heard, with traders expressing modest disappointment, with the Shanghai Composite and CSI 300 down by around 0.5%. The prospect of a pullback remains elevated in the Chinese markets, but given real yields (bond yields adjusted for inflation) are on the rise I think we can expect a benchmark interest cut or banks reserve ratio requirements within the coming weeks, meaning pullbacks in the mainland markets should be supported. Outperformance from the Hong Kong markets is likely from here, in my opinion.
The moves higher in the Aussie bond market look interesting (the 10-year bond is now at 3.04%) and came despite a near-7% deterioration in consumer confidence. Then, just as the earlier bond sell-off was looking like becoming a sizeable headwind for the Aussie yield plays, Glenn Stevens hit the market with fairly bearish rhetoric that traders clearly weren’t expecting. AUD/USD traded to a session low of $0.7635, GBP/AUD to A$2.0130 and AUD/NZD nine pips shy of my target for the week (suggested in yesterday’s note).
What was interesting was that the ASX 200 found no real inspiration from the Reserve Bank governor, suggesting there is a ‘possibility of further easing’ and that the ‘exchange rate needs to fall further’. In fact, just prior to this speech the market had oscillated above and below the unchanged mark 12 times, highlighting that traders have such limited conviction to push prices higher – feeding into the idea of a missing catalyst. It seems that interest rate cuts are not as supportive as they once were and that energy- and AUD-sensitive names are the place to be at present.