Trader thoughts - the long and short of it

The interesting theme I have seen from the US trade is the divergence in markets, with US equities being the mover on a risk-adjusted basis.

Bank of Japan
Source: Bloomberg

The Japanese yen has found strong buyers, especially against the GBP (GBP/JPY is down 1.8%), but we cannot say we have seen genuine risk aversion because gold is a mere 0.4% higher, US treasuries are largely unchanged across the curve and corporate credit spreads have not really widened.

We have seen equity portfolio protection in demand, with the US volatility index (the ‘VIX’) increasing a sizeable 15%. But let’s not forget the hedge fund community were running a record 134,224 contract net short position here, so the prospect of a position unwind was high. As always when trading, extreme positioning plays into the risk-to-reward profile and while some traders have been buying ‘put’ options to protect US equity portfolios in the event of further falls in the S&P 500, we can see that traders who have sold short VIX futures have also closed out, which in turn has pushed up the market. This move in the VIX is normal and doesn’t indicate the world is about to collapse!

We can also see that last week traders increased their long positions in S&P 500 futures by 106% to 72,903 contracts. So I question if a number of traders who bought last week and held weak conviction for further upside in the index have closed out today, which in turn has pushed the S&P 500 cash market lower.

While we haven’t seen it reflected in other asset classes, what we can see in US equities are signs of risk aversion, with 80% of stocks lower on the day and sectors where business has a defensive and largely non-cyclical revenue stream (utilities, staples and telcos) falling - but by a far lesser extent. In the S&P 500, tech has taken the largest points out of the market, although energy is having the biggest percentage decline.

There has been some buying off the intra-day lows of 2268, but for traders who follow price we can see that there is still a lot of ground to cover to close the opening gap lower and to fill this we need to see the market moving back to 2291.62. What we can also see is that despite early cries that the market was down over 1%, the buying we have seen has helped steady the ship and we can eye another day where the index will close out without a move of more than 1%. We have to go back to 10 October to see the last day where the market closed down 1% or more, which is 74 trading sessions ago and the longest streak since 2006.

The moves in US markets have naturally pulled the SPI futures lower, but the Aussie futures market is only down 13 points at present and our opening call for the ASX 200 sits at 5640. We can factor in the view that the ASX 200 fell far more heavily than the S&P 500 futures did during yesterday’s Asia trade, so US markets have played some catch up here. Still, we are coming to a number of important technical levels in the Aussie market and specifically, I would be watching 5555 (the 23 January low) on the SPI futures, and while that is some 0.6% away, a break here would be taken badly and lead the ASX 200 (cash market) lower. One should question if there is a real catalyst to buy risk today, on the view that investors with cash may sit on the sidelines for now and just see how the political situation evolves.

There seems little in the way of key event risk today to drive, with NAB business confidence and private sector credit unlikely to drive equities. I suspect even the AUD will not be overly sensitive to the data, where we can see price trading in a super tight range on the session of $0.7567 to $0.7528. Clearly this data flow is not going to move the dial. Moves this week are more likely to come from the USD side of the equation, with manufacturing data, the Federal Open Market Committee meeting and Friday’s jobs report.

The Bank of Japan meeting statement will be disclosed in the afternoon (no set time) and this should, in theory, be a non-event, judging by the very low levels of USD/JPY overnight implied options volatility. We could well see a 20bp or so upgrade to the central banks 2017 growth forecasts (to 1.5%), but it would be a huge surprise if we saw changes to their policy settings (ie deeper negative rates, increased ETF buying or changes to the yield targeting). Just like the AUD/USD, traders are more likely to express a view on USD/JPY on whether they feel ‘Trumponomics’ will spur the Federal Reserve on in the months ahead. If we look at the pricing in the fed funds market, we can see the market is pricing in a mere 20% chance of a hike in March (source: CME Fedwatch) so interest rate traders still need a lot of convincing.

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