The macro risk or bottom value

Sentiment is an amazing thing – the expectations ahead of tomorrow’s FOMC is, as you would expect, building. Expectations are for clarity around timing and direction.

bg_VIX trading stock shares equities 4
Source: Bloomberg

But it’s this stat that could explain the market’s ‘exuberance’ in last night’s trading heading into the meeting and press conference for the FOMC. For the total of Janet Yellen’s tenure as Fed Chair 80% of the time markets have rallied strongly when she has given a press conference.

What’s spiking my interest:

  • The European bond VIX index had a gleeful night as Greece threw haymakers at whoever it could. ‘Criminal responsibility’ for the austerity has been imposed. PM Tsipras is not mincing his words about the IMF, the ECB and the European commission.
  • It’s clear to all and sundry that no deal will be done tomorrow night. However, those comments saw European bonds having the most volatile trading night of 2015 and peripheral bonds were even more savaged.
  • There is one fact that marks the bond markets more strongly than any other: If bond investors get a whiff of default or contagion or sovereign risk, that nation’s bonds will be mauled and yields with be at eye watering levels in a matter of minutes.
  •  The US Fed Reserve ‘lift off’. When? And how much?
  • China – further broad sell offs, CSI 300 -3% A-shares slid again. The slides on Monday and Tuesday could be blamed on: 1) worry around liquidity tightening and 2) CSRC regulation intensifying. That’s the macro view.
  • Digging deeper, A-shares have some bottom-up ‘concerns’. Valuations are exorbitant (small caps trading on up to 206 times earnings). Trade velocity is at record highs (value through the A-shares is currently double the daily average of the S&P). Finally, it has the world’s highest level of margining and fundamentals are at breakneck levels.

Ahead of the Australian open

We are currently calling the ASX up 36 at 5572. Based on the rally in the US, it’s understandable why the ASX will leg higher today.

What is more interesting for the ASX is the 9% pull back over the past two months and particularly the savage selling in the defensive space. It has created interesting fundamental values.

  • The ASX is trading at a 9% discount to the MSCI World index on a P/E basis. At 15.8 times it is becoming a little more attractive and will be globally more appealing as you would expect it to gap up.
  • The discount is the second largest discount of this decade – the largest was 11%. Versus peers, the ASX is trading at a 3% discount to Europe, 4% to Japan, 13% to the US, and a whopping 23% to Asia ex-Japan. Many Asian investors are currently using Australia as a funding source for Asian investment – that will reverse over time.
  • The unwind in the yield trade over the past eight weeks has seen the gap in Australia’s yield at the highest level in the past four years versus global peers. Australia’s yield gap is now 1.9 times that of the MSCI world index.
  • Over 70% of Australian large cap stocks offer discounted value to global peers on a P/E, P/B, yield and enterprise value to earnings ratio. Only 10% are in the bottom percentile of global peers.

Macro risk aside, the ASX has taken its much needed breather – there is value to be had on the medium-term view.

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