Put/Call spreads are clearly illustrating this and that is catching my attention. Volatility is dissipating and risk buying is grinding high.
State of play:
- Complacent markets are scary markets – Are markets really that satisfied with the current macro on micro situation? – Because the lull it will create in the coming month will only make a possible pull back all the more violent.
- Deutsche bank’s ‘emotion indicator’ which is the ratio of P/E:VIX and that is currently 1.3 - a range of 1.2 to 1.5 signals complacency.
- The S&P’s P/E ratio is back at post-GFC highs at 18 times trailing P/E (that is 12% above the average since 1960) and on a forward P/E of 17.3 (22% above the average since 1960).
- Last week was the lowest volume week in the S&P in 2015 since New Year (which is historically always the slowest week of the year) yet it moved higher and its range was the tightest range of the year.
- What is also becoming clear from Janet Yellen’s press conference is that markets have re-entered – ‘Fed-watch’ mode.
- Yellen’s speech on Saturday morning clearly had enough in it for everyone. ‘Yes we will raise rates in 2015’, ‘No, we won’t do it at the cost of stalling the recovery’, ‘Yes, we will likely to do so slow and steadily’ ‘but we won’t rush in because the data still isn’t where we want it to be’.
- The fact the Fed continues to delay rate rises will only add to the current situation in equities
By design then – bonds are staying low. The USD will be an asset currency and the EUR, JPY and the CHF are going to funding sources and equites will rejoice. Expectations are for the S&P to be trading at 18.5 times by year end – that would put it at the same level the S&P was in 1997 to 2000 – how does that not make you nervous?
- With the ECB likely to increase its bond buying programs heading into summer and the Fed ruling out June as a possible lift off month there is no reason however that equities wont grid higher.
- The ASX 200 has now underperformed global markets of two consecutive months - by as much as 8% in common currency.
- The ASX 200 is trading on a forward PE of 15.6 times (based on Bloomberg consensus figures) which is still 9% above the 20 year historical average. So underperformance is likely to continue.
- The banks, on a points weighted-basis have been the biggest contributor to this underperformance. Fundamentally, they are still expensive and second – Aussie bond yields continue to rise make them and the whole defensive sector on the ASX (which is over 60%) at risk of further selling.
- Last week was the fifth consecutive week that Aussie bonds yields have risen – the ten-year is at 2.94% a full 65 basis points higher from the January low.
- What would you rather have? AAA-rated bond at 2.94% or a price premium, high risk asset yielding 5.9% (NAB) that is correcting and is yet to find a floor? - It a pretty simple trade for institutional investors to make
- The issue is, the ASX’s underperformance is likely to stay as global equities look far more attractive on the current macro and micro picture - even with complacency increasing the risk of a sell off.
Ahead of the Australian open
The lack of volume and direction in global markets on Friday night saw futures markets just blowing in the wind at the close on Saturday. We are currently calling the ASX up three points to 5667 but the SPI futures market closed down 16 points. Brent fell over the weekend however, iron ore bounced 3.4% to $59.90 – something the London listing of BHP and RIO didn’t miss on Friday night and jumped higher.
However, the DOW and SP futures have all decline since the close of business on Friday and if China also opens the week in in the red those three points are going to be hard to hold on too.