Taking stock (part II)

The sell-off in Australian equities yesterday was much stronger than futures and most leading indicators had predicted.

Oil
Source: Bloomberg

However, it’s not that unsurprising considering last week the ASX was one of the best performing indices in Asia, and the world for that matter. It managed to escape the selling in the middle of the week as the industrial commodities bounce and the ridiculous moves in the iron ore allowed a solid bounce in cyclical plays on the ASX.

The banks continued to grind higher as pessimism around the underlying lending market and the Australian economy is unwound. Considering they make up over 24% of the ASX, their direction governs all.

However, yesterday’s pull back in my view is another sign that we are stuck in this horizontal range trade which will have a historically wider trading range with relatively low aggregated capital growth.

The ‘tubby’ strategy has yet to show any signs of being wrong as these issues will continue to come up time and time again (and will continue to do so for most of this year).

Macroeconomic fundamentals

The Fed remains the biggest macro impactor for markets. The US markets are clearly pricing in the idea that Yellen and co will only have the opportunity to hike once (if at all). However, the dot plots (for now) suggest four. The mismatch will need to close and will cause fluctuations of positive and negative proportions when this occurs – tomorrow even?

Elsewhere on the macroeconomic front, the negative interest rates debate is ramping up. Yesterday, the Bank of Japan joined the European Central Bank in removing the prospect of further moves into negative territory. Instead, both are now looking at other ‘unconventional’ monetary stimulus programs to invigorate their respective economies. This suggests the interest rate cut cycle is over, and explains the moves in JPY and EUR. What is unknown is  how these new ‘unconventional’ policy programs will impact markets.

The oil price

Oil continues to gyrate, falling back to US$36 a barrel overnight having reached $39 a barrel last week. Iran is continuing to stand firm and will not sign onto a ‘freeze agreement’ until it reaches its pre-sanction output levels. Stock piling is starting to decline but is still well above previous record levels and demand, while increasing, is still well below supply. Oil will remain a leading commodity and its movements will govern equity markets in the short term.

Inflation

This is the big unknown in my eyes. Most economists see strong inflation levels coming in the US, Australia and even China. However, as yet, inflation has not materialised and I believe it is still a way off.

Wage growth is at some of its lowest levels in decades in turn but consumption has remained lacklustre. If inflation is to ramp up to central bank mandated levels, wages will need to expand and they are not. 

This is all leaving markets in a state of flux, and I see profit-taking as a likely short term scenario. I can’t see any real justification for traders and investors to leg the ASX higher. Nor do I see a reason they will desert the index as seen during the January-February rout.

The tubby strategy is likely to play out as expected and I believe we are likely to see further easing today ahead of what will be an interesting press conference from the Federal Open Market Committee. The debate around how many rate hikes will we see in 2016 will likely be the biggest short term factor in driving the market in one way or another.

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