Once again the bulls have been in control, with the Nikkei breaking out above the November high and at the highest level since 2007. As detailed before, the Japanese market should outperform nicely this year, although investors and traders clearly need to hedge their JPY exposure. The economy is only likely to grow 2% to 2.5% in 2015 (nowhere near enough to create the level of nominal growth to lower its debt to GDP ratio). However, the investment case is premised on comparatively attractive valuations and buybacks equating to 20% of free cash flow, which can only be supported by the $2.3 trillion of cash on company balance sheets. The fact that business investment is still so low, suggests CEO’s will prefer the return of capital route. Of course, the Bank of Japan is still expanding its balance sheet.
Investors also get the added kicker of USD/JPY appreciating if the Federal Reserve hikes this year, which helps the export side of the market. The BoJ talked positively about this in today’s central bank meet. I think the potential for a normalisation in policy from the Fed is only starting to be realised and could hold great unexpected consequences.
The US bond sell-off getting attention from traders
The US 10-year has risen from 1.63% to 2.13% in 11 sessions, with the US curve steepening nearly 30 basis points in the process. The December Fed funds future has risen to 56 basis points and the market is now priced that we get so called ‘lift-off’ in September. There is a multi-step process in place for traders to build expectations around and therefore price in the upcoming event risk. That process has started with Fed members Lacker, Lockhart, Williams (all voters) and Plosser (soon to leave the board) all recently stating the Fed should lift rates in June.
Tonight’s FOMC minutes could set the scene for next week’s semi-annual Congressional testimony from Janet Yellen. In turn, this should play into the view that the Fed will soon lose its ‘patient’ stance on normalising policy. This should be the cue for the US bond market to once again become the epicentre of the financial markets. The same can be said of the US five-year treasury and emerging Asian market bonds/currencies. But importantly, the USD should do nicely, again throwing up the idea that the S&P 500 should underperform. The fact that the S&P also trades on 17 times forward earnings (27 times cyclically adjusted earnings) plays into this view.
I like long Eurostoxx/short S&P 500 as a pair’s trade, or for those who like ETF’s being short the SPY, long EMU (Euro ETF) or HEWG (German ETF hedged) would work.
Gold and silver looking bearish
Gold also seems to be warming to the view that the Fed could evolve its policy setting, with the spot price trading under the former neckline of the inverse head and shoulders pattern. A rally and subsequent rejection off $1,215 would suggest gold is an outright short, for a move into good bids around $1,180. Silver (on the weekly chart) is looking even more bearish and is breaking out of a bearish flag formation, although we need to see a weekly close below the rising trend to advocate short trades. The fundamental picture is certainly warming to shorts, and the techincals are clearly mirroring this.
In Australia, the market has picked itself off the morning low, with some money flowing back into the banks. There have been some heavyweights like Woodside Petroleum who have reported and pleased the market, but the biggest story of the day has been Japan Post’s move away from Japanese Government Bonds and into riskier assets ahead of the upcoming IPO.
Shareholders have held Toll for its 5% yield and judging by the multi-year sideways trend not for the capital appreciation. The stock is now trading at a modest discount to the A$9.04 bid suggesting investors see a small chance of a rejection from FIRB, although shareholders can also still vote this down. But at a 55% premium to the consensus 12-month price target you’d question the logic. Still, there would have been a few traders questioning if Japan Post had bought the right stock with the 49% premium to the prior closing price!
European markets should open on a moderately firmer footing and I will continue to hold a bullish bias despite plenty of fundamental reasons not to be. With markets at all-time highs, multi-year highs and 52-week highs, the bias should be to be long, not short. Follow the trend and ultimately the money, although one must be nimble if Greece doesn’t get its anticipated loan extension that has been speculated as being announced today.