VIX-ing the market

Fed chatter; commodities either in bear markets or heading towards them; equity valuations being questioned on several fronts, and the impact of central bank policies all ringing in investors’ ears.

Source: Bloomberg

Global VIX indices are poised to see a big return in the next few months.

What’s spiking my interest (for volatility)

The S&P bounced off the 200-day moving average again. The reasoning is vague in my opinion: ‘M&A deals’, ‘earnings consolidation’ and ‘economic growth’. I agree with the economic growth part but this only brings the Fed lift-off scenario into play.

The US VIX is back at 12.2 – that is back at complacency levels. The trend in the US VIX for the last two years has been towards complacency trading. The average level of the US VIX has been 13.6. Anything inside 10 to 14 is considered complacent.

Complacency trading makes me very nervous as markets are effectively unhedged to volatility – and volatility is clearly coming. The probable behaviour of the global markets to a Fed lift-off scenario are unknown and equity markets are currently the last to position themselves for the possibility of a September move.

The other concern I currently have around the US markets is the fact only a handful of stocks are driving the indices higher. If you remove the likes of Facebook, Google, Gilead Sciences and Apple (which officially corrected last night) the bulk of US stocks have gone backwards as the USD bites.

The E in P/E is becoming a fundamental concern for US markets. The S&P currently trades on 18.6 times earnings and is forecasted to fall to 17.76 times earnings on the forward estimates – is this a value trap? This is what concerns me about complacency trading – the unwind gets volatile, quick.

A VIX index that is going backward is China – yesterday China had its broadest rally in history. Only 2 of 1400-odd stocks were down yesterday. There are clear signs the ‘stability mechanisms are taking full effect’. Chinese volatility is likely to be artificially lower for longer.

What makes my ears pick up from China is the trade balance data. The weekend’s release showed a narrowing of the surplus as exports collapsed. However, the level of production and shipments (both in and out) were near record highs. That shows that the collapse in commodity prices is hurting China as much as other commodity-based economies.

The Australian VIX index, however, has risen over 30% since the start of August. I always believed the ASX was in a textbook ‘buy the rumour, sell the fact’ trading pattern heading into earning season.

The savage selling of Ansell is a clear example of why. Granted, FX headwinds and slightly lower-than-expected forward earnings estimates on top of a P/E of 29 times is not a good mix. But it lays down a precedent that high multiples are likely to see pressure on even the slightest miss. The 20% sell-off seems an overreaction and the stock now trades on a current P/E of 12.3 times – ANN will be attractive once the dust settles.

The themes to watch this earnings season have already formed, and they are: Are capital requirements being met? Is the E justifying the P? And regarding forward guidance; are the growth stocks justifying their growth tag? The reaction to these questions is going to be irrational (ie. ANN and even JBH’s trade could be considered irrational trading on the upside). Make sure you are across the fundamentals ahead of a result.

The XVI (Australian VIX index) is going to savagely swing in both directions in August and September as the Fed lift-off theories gain momentum. It will likely trend higher still – puts are going to see solid buying over the coming weeks.

Ahead of the open

Ahead of the open, we are calling the ASX up 28 points to 5537 as global leads add upside and the bank sell-off settles.

Companies of note that are reporting today include Cochlear, Transurban and Magellan. TCL is an interesting one: there should be no surprises in the results considering it pre-released sales data a little over six weeks ago. However, it is trading on a current P/E of 56 times; will any result justify the $10 price point?

I really like the stock and think its operations and cash flow numbers are very strong. However, it may be due a pullback because of the highly elevated multiples – its forward guidance is not strong enough.

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