The ASX ‘outperformance’

The ASX logged its eighth consecutive daily gain yesterday and, according to the futures market, it will make its ninth today.

Source: Bloomberg

Interestingly, Friday’s close saw the ASX logging its best start to a year since 2013, adding 3.2%. Compare that to the S&P, which has just had its worst month in 12 months. Comparing the two indices on a monthly chart sees the S&P completely inversed vs the ASX from 15 January as the US earning season started to disappoint and rate expectations in Australia mounted.    

Mass divergence amplified on the publication of Australia’s CPI data. Top-line inflation fell below the RBA’s target range to 1.7% as fuel deflation hit the reads. The inflation rate has sparked one of the most furious rate debates in the country for several years as the top-line disinflation goes hand in hand with consumer confidence being below trend, business conditions fluctuating at the bottom end of the cycle and business confidence being virtually non-existent.

Core commodity exports are also impacting on the local economy as they are rooted in bear markets and either at record lows or prices not seen since the depths of the global financial crisis. This is heaping more pressure on corporate earnings and the central government is struggling with a revenue problem. All this explains the hysteria around today’s rate decision.

Over the past week, the swaps market has seen gigantic swings on speculation of an ‘out of character’ cut from the RBA. Currently the chance of a 25-basis-point cut is at 58% according to the swaps market, down from yesterday’s high of 69%.

All the hype has seen the currency fall to five-year lows and has pushed the ASX back to August highs (also a six-year high). Interestingly, the hype was trimmed overnight as the AUD moving higher on some caution - considering only six economists out of 27 believe they will move today, we believe cautious is needed.

The same caution needs to be applied to the equity market. The grab for yield has been feverish over the past 15 days and it is certainly where I have been looking too for capital growth and the return of capital. However, Telstra has added 7.4% in this time and stands at 13-year highs. The rush to the banks and supermarket conglomerates has been so strong and fast on rate speculation that I think an interim pullback is building.

So the question is: If we get no move today, what happens to the hot money that has flown into the equity market? Will it build even more as the chance of a March cut is higher still, or will profits be taken?

From where we stand, the risk of no change is great. On a trimmed mean basis, the inflation read was inside the target band at 2.25%, unemployment was lower than estimated in December (although this is not expected to remain) and terms of trade remained solid over January and December.

Now, we do see the statement changing today and the rate moving lower over the next six months. However, if a ‘period of stability’ in rates remains in the statement and ‘predictability’ makes an entrance, I think a cut today would be a surprise. I believe the RBA will give itself an extra month to accumulate more data to give it a clear picture of the current state of affairs.    

Our Chief Market Strategist Chris Weston has written a playbook on how to trade today’s RBA meeting (you can see that here).

Ahead of the Australian open

Oil closed at its highest level in a month overnight, reaching $49.60 a barrel. The energy space saw a very strong rally yesterday on the closing price in oil on Friday night. It’s likely to see further strength today. I suspect most yield plays, such as the banks, diversified financial and industrials with yield will move higher early on in the session. As we approach 2:30pm AEDT, if rates don’t move, this may quickly reverse as profits are taken and investors scan the statement for clues as to when the RBA will move. We are calling the ASX up 23 points to 5648.

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