The way I see the current state of play is the bulls have got full control here and that US equities and many other developed markets are going higher, at least in the short-term.
Perhaps the moves have been seen most prominently in the small cap space, where the Russell 2000 has rallied for 13 consecutive days and gained 15% since early November. In effect, the move really started in February and the index has rallied some 41% since then. We also learnt yesterday that it is not only the Russell 2000 trading at an all-time high, but the S&P 500, Dow and NASDAQ too. This is the first time since 1999 that we’ve had simultaneous record highs for all four indices.
In terms of assessing whether there is too much euphoria baked into markets, we can focus on the market internals and the various inputs I follow are not at stretched levels either. 63% of S&P companies are trading above their 50-day average and 24% at a four-week high. I would be fading the momentum if I saw these percentages at 80% and 40% respectively, but for now, US markets are not over-loved or over-owned here.
The interesting dynamic playing out now is the interest rate markets now pricing a 100% probability of a hike from the Federal Reserve (Fed) in December. In truth, the market is right, as the Fed have been guiding market participants to believe they always wanted to hike in December. They just need a little bit more information before increasing rates, which they now have enough of. So the question everyone should be asking is how many times they raise in 2017 and 2018, and most prominently, what is the longer-term (or ‘terminal’) federal funds rate?
By way of a guide around current market pricing, and if we include the December meeting, the interest rate markets are now pricing 2.6 hikes through 2017 and 4.3 through 2018. Prior to the election, the market had priced 1.7 hikes through 2017 and 2.4 through 2018.
Still, despite this increase in rate hike expectations, we are seeing implied volatility falling (the US volatility index or ‘VIX’ is at a low 12.55%), emerging markets have found support and are even attracting buyers (the iShare emerging market ETF gained 1.2% overnight), and high yield credit is also working positively too. If the Fed were to assess financial conditions in the wake of a potential rate hike, they would be wholly enthused.
Turning to the Asian open
We should fairly calm conditions for today’s Asia market open too. The ASX 200 has regained its mojo and looks as though it wants to move back to the October highs, potentially back to the 5500 (and a term I loathe so much: the ‘Santa Claus’ rally). However, the daily chart looks upbeat and there seems little in the price action to suggest taking short positions with any confidence here. The low volatility environment suits higher yielding stocks, such as financials, and one can expect a flat to modestly stronger open this morning in this sector.
On the commodity side, energy stocks had their day in the sun yesterday, but US crude prices are 2% lower from the ASX 200 close yesterday thanks to scuttlebutt that OPEC was struggling to agree on specific supply cut levels for Iran and Iraq. As a short-term trading opportunity, I favour buying weakness in energy names as I see crude trading higher in the 30 November OPEC meeting. However, if I look at the price action in crude, indecision has been seen and I really want to see a close above $48.96 before I increase my conviction on this trade. If a deal falls through on 30 November, it will be likely down to Iraq or Iran not agreeing to the terms.
Perhaps the bigger talking point today has been the interest from the Chinese speculator looking at bulk commodities and base metals in a positive light again. While the iron ore (spot) price has rallied 6.5%, the leading indicator is the futures markets, where we can see iron ore, steel and coking coal futures rallying 8.8%, 3.9% and 1.6% respectively. Copper has rallied 1.1%. Some have blamed bad weather making it difficult to get iron ore to the steel mills. Some have talked about Goldman Sachs upgrading their three-, six- and 12-month forecasts for iron ore, although I don’t buy this view at all.
The fact is the Chinese speculator is at the heart of the move, so expect more volatility here. If I were to take a view on anything China-related now, it would be long CSI 300 cash index, which is effectively a small version of the Shanghai Composite. The index is trading at the highest levels since early January and is breaking out to the top side. Ideally, I would like to see a re-test of the August highs, but I am not sure I get one. Stay long for 3500 here.