Blind optimism from equity markets

At the close of business today, the ASX will log its seventh consecutive north print, making this the 12th week out of 14 weeks to register a north print since the June low.

The ASX is up 10.2% for the quarter and is the third best performer out of the 20 Asian markets across the region. It is trailing the Hang Seng which is up 11.2% and Shenzhen Composite, up a massive 17%, though it should be noted that this is a very small regional market with very low liquidity.

With two days to go the market is gunning for another leg higher and considering this is the best quarter since third quarter of 2009, it is possible the ASX might find itself perched in very uncharted waters; around 5350 plus come the Monday night.

We are very cautious at the moment; the almost blind optimism in the equity markets has a feeling that it is just waiting for the rug to be pulled out from underneath it. There is so much geopolitical concern coming out of the world’s benchmark economy, with the debt ceiling and the very messy communication from the Fed. That coupled with moderate news out of Europe and Japan over the last four weeks shows the markets are supremely confident things will be ironed out. It is almost like markets are saying ‘she’ll be right, they’ll sort it out’.

What is also apparent is the window dressing heading into Monday’s close. This Tuesday’s 0.8% pop that bucked regional and global trends was due to rumours that US custodial funds were ‘gold rushing’ into Aussie equities and bid up stocks. While fund managers and hedge funds prepping for options expiry has lead no one to really question why the market is running away, despite the very subdued outlook and a price to earnings ratio of 15.4.

It is this blind optimism which will make the next two to six weeks a very interesting trade period.

Once again we see the Republicans playing hard ball regarding the debt ceiling. Republican House leader John Boehner openly expressed he has no interest in renegotiating the funding bill. It’s either pass the bill as is or come Tuesday the US government will shut down.

Although the chance of a government shut out is low (probably only 20%), third time is a charm and the probability is growing. The extreme polarisation in Washington is apparent and the fact that the Senate majority leader Harry Reid looks like stripping out the language to defund Obamacare at the last minute means all the pressure falls back on Boehner who is beholden to the far right in the tea party, despite his best efforts to distance himself from these views.

Saving your political head versus voting with your belief is a very thin line to be walking. A shutout is a possibility despite most believing it is unlikely – Tuesday’s global trade will have one thing in common; volatility.

If a shutdown was to occur and with the debt ceiling due 17 days after the vote on Tuesday the effect of no move on the debt ceiling will be seen in small scale. Non-essential public servants would be sent home, non-essential spending cut and public services would grind to a standstill.

There is even a prospect of the shutout affecting the Fed as Friday weeks’ official non-farm payroll numbers would not be released and considering the emphasis the Fed places on employment, it is likely it would stay its hand on tapering for at least another month.

Although these scenarios are purely academic for the time being, the fact the market is ignoring the politicians is something to be concerned about.   

However, as stated earlier, the market is gunning for a leg higher despite the macro noise, and ahead of the open we are calling the ASX 200 up 23 points to 5318 (+0.43%) which would be the year-to-date high and a five and half year high. Trade will be strong today despite the fact it’s the Friday before the AFL grand final. Trade history has shown that there is a marked jump in volumes the Friday before the grand final, as they position ahead of the end of quarter close.

BHP’s ADR is suggesting the stock could tread a downward path; dropping 13 cents to $36.22 (-0.36%) however this will be buck for the quarter close and we expect BHP to finish in the green.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 79% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.