Bullish reversal but volatility remains

The S&P is yet to experience four consecutive days in the red this year after closing in the green overnight.

Source: Bloomberg

The price action on the S&P was ‘textbook’ in that it made a lower low intraday before rallying strongly to close above the previous day’s close – a clear bullish reversal.

That suggests the bulls are still in control and, as I have been suggesting, the US market will remain in the uptrend until there is a clear breakdown in the futures market (a 5% pullback). However, the price action from the past two weeks also supports my call that volatility has to increase as macro pressures rise. Fed ‘debate’ is only going to intensify over the coming year as divisions open up.

Cleveland Fed President Loretta Mester expressed her views around the direction of monetary policy overnight. Her desire is to ‘reformulate’ the Fed’s pledge to keep the Fed funds rate low for a ‘considerable period’. As a voting member, this is only going to ramp up expectations of movements. Mester also stated that ‘forward guidance should evolve over time to give more information about the contentions we systematically assess in calibrating the stance of policy to the economy’s actual progress and anticipated progress.’

Both statements can be considered hawkish and the forward guidance communication is never going to be perfect. A clear example was the September statement – downgrades to inflation expectations, upgrades to employment expectations and increases in the dots all suggesting rate expectations in 2015 and 2016 are going to be dramatically higher even though growth will remain benign.

This alone is a signal for volatility, let alone the fact the US market is about to be forced to stand on its own two feet come the end of October with  the end of the asset purchase program. Questions are also being asked about growth in the two other global economies: China and Europe.

It would be nice to see green on the screen today. However, I still see further downside from here as concerns around the erosion of total returns, elevated multiples and the ability to leg higher following the longest, loosest monetary policy in history take effect. There are clear volatility events coming, along with elevated signs of market overreactions.

Ahead of the Australian open

We’re currently calling the ASX 200 up 31 points to 5407. BHP is pointing to a 1% jump as Chinese markets continue to bounce off Monday’s lows.

The 31 points should see the market recouping most of the losses from yesterday, adding to the consolidation pattern developing around the 5400 level. The last three days of trade has seen the ASX start to form a wedge-like pattern, which is most likely to come to a head early next week. The banks remain the key driver of the market’s performance and, after yesterday’s slide in the big four, the bounce is likely to be driven again by trade in the banks.

What may have a slight bearing on this is RBA governor, Glenn Stevens, who is due to contribute to a panel discussion at the Melbourne Economic Forum. After the release of an interesting financial stability report yesterday and the board’s concerns around property investment and ‘unbalanced’ lending, there are signs he might need to break his mantra around macro-prudentials and increase regulation. This may weigh on the equity rally.

IGA, may distribute information/research produced by its respective foreign marketing partners within the IG Group of companies pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, IGA accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact IGA at 6390 5118 for matters arising from, or in connection with the information distributed.

This information/research prepared by IGA or IGA Group is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. 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. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update.

See important Research Disclaimer.