Global equities at the point of peak bearishness

It feels as though we are right in the epi-centre of the fear, panic and confusion in global markets.

Source: Bloomberg

The trading community is asking whether they should jump on the trend, ramp up their short sale exposure and follow the money flow. Or is it time to think more contrarian, counter-trend and look for some reversion to the mean?

The investment community is asking whether to shy away from the news flow, as there is a crescendo of bearish headlines deeply affecting emotions and making people less rational. Many are simply increasing cash weightings and hedges within their portfolio.

The key constant regardless of timeframe and portfolio objective is volatility. How investors and traders assess, harness and adapt for volatility is absolutely essential. Certainly, those who think much more short-term, adapting for volatility will often mean the difference between strong drawdown, capital preservation and profits. So when we see a 48% increase in the S&P 500 volatility index (VIX) last week, with FX and fixed income volatility elevated, we have to adapt our risk and money management. This means adjusting where we place any stop loss and positon size. Take the ASX 200 for example, the average trading range over a five period stands at 94 points, which is the highest since October. This has to play into the thought process and will mean a wider stop and smaller position.

Sentiment is another key variable that plays into my daily process, along with volatility, positioning, technicals and market internals. There is no doubt sentiment is shot to pieces and if you look at the big macro concerns they are easily trumping economic data, hence why the market swiftly bought US treasuries and sold stocks after a strong payrolls number. It’s not often economic data is given such little attention, but in this environment, economic data is a strong lagging indicator. Politics, geo-politics, rising expectations around disinflation, a potential recession (in the US) and USD liquidity issues (think massive capital outflows and use of FX reserves in emerging markets) will drive generally economics.

Today’s Asian open is again not going to be a pretty picture. Traders have to deal with the US market closing on its low, breadth was terrible (84% of S&P 500 stocks closed lower) and the safe haven sectors (utilities and telcos) outperformed. Both high yield and investment-grade credit spreads have widened, implied volatility has increased and once again, financial conditions deteriorated. The US yield curve has flattened to 118 basis points and one just has to look into the Fed funds future to see modest pricing here with only three rate hikes priced into the market through to the end of 2017!

Once again we look to the 30 January Q4 US GDP print where the Atlanta Fed’s model is suggesting 0.8% annualised growth (Morgan Stanley are calling for just 0.1%) and again the concern that the Federal Reserve raised rates in a sub 1% growth quarter is very telling. The respected economist Larry Summers recently put out a research piece ( where his analysis detailed that over the past 60 years when the unemployment rate is sub 6% and the recovery has five years underway then the chances of a recession are 57% over two years and 77% within three years. US growth has been recovering since December 2008.

Our call for the ASX 200 stands at 4905, so a drop of 1.7%, taking the falls year-to-date to 7.3%. There will be some interest on whether the index can hold the 15 December low of 4909, where we saw the index rally 8.6% over 10 sessions. BHP’s American Deposit Receipt (ADR) is suggestive of an open 3.4% weaker, while CBA and WPL ADRs are 1.5% and 1.6% lower respectively. Similar to the ASX 200, can these names hold their 15 December lows? This promises to be a very interesting session, especially with a many of the big money managers coming back to work.

I touched on it on Friday, but we are at peak bearishness. Market internals on the S&P 500 are now flashing ‘buy’ with a mere 9% and 12% of stocks above their 20- and 50-day moving averages respectively. 73% of stocks printed a four-week low on Friday, which, again, is at extremes. This is backed by the fact that price in the S&P 500 is three standard deviations from the 20-day average, while the RSI is below 30. Things are not so stretched here in Australia (36% of stocks are still above the 50-day average), but should get a boost from any buying in the US. On market internals, the elastic band has been stretched just a little too far and mean reversion seems likely.

One suspects the trigger has to come from Asia though given the bulk of the concern is headed this way, but we also know US and Australian earnings season is upon us. The transparency this provides will be key, with CEO’s offering their account on how business is leveraged to oil, emerging market concerns, the rising USD and general asset price volatility.

As always, watch today’s ‘fixing’ from the People’s Bank of China at 12:15 AEDT.

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