Global investors are searching developed markets and questioning where the value is. However, there probably hasn’t been deep-rooted value for a while now and developed markets PEs (price to earnings ratio) have moved up on price expansion alone as earnings haven’t really followed; however many analysts do expect reasonable earnings growth next year. If you look at the S&P put-call options ratio, this metric is at the year’s low and another signal that investors and traders are complacent; however it seems justified right now.
Traders will focus on the momentum that is rebuilding in equities and after yesterday’s 0.7% gain in the S&P 500; a break of resistance between 1687 to 1690 (the May 22 high and 76.4% retracement of the August sell-off) will be needed for developed markets to continue their upward trajectory. What exactly will cause a real shake-out of long positions is yet to be seen as markets seem very comfortable with developments in Syria; next week’s Fed meeting; Italian and German politics; a hike in Japanese sales tax; the upcoming US debt ceiling debate (although this could get more traction) and potentially Larry Summers at the helm of the Fed in 2014.
The rise in global growth seems to be the bigger trump card and it’s clear that this is supporting inflows into equities. Emerging markets have stabilised; this is partially a reflection of different controls and initial reforms adopted by various governments to balance deficits, encourage capital inflows and stem the free-fall in the domestic currency. With the benefit of hindsight, last week’s US payrolls report has probably been extremely favourable for emerging markets as the number at 169,000 was strong enough to encourage the Fed to announce a ‘mini-taper’ next week, but not strong enough to cause a fresh wave of capital re-allocation out of emerging markets and into developed markets. The stabilisation in emerging markets (EM) is also having positive ramifications on EUR/USD, GBP/USD and AUD/USD, as well as emerging market central banks which don’t have to sell these pairs to replenish their USD reserves.
Nowhere can the stabilisation be seen more prominently than China, with its economics and equity market rising in tandem. The valuation on the different Chinese markets from a P/E and P/B (price to book) was as cheap as it’s ever been in late June, early July; all investors needed was clarity and confidence that earnings were going to hold up. This has clearly materialised and the Shanghai Composite has not only rallied 21.5% from the June 26 lows, but has broken and closed above a number of key resistance levels including the February downtrend and different retracement levels from sell-off this year.
Yesterday’s data has highlighted the recovery taking place, although it probably has to be said that it is coming off a low base in 2012. The huge expansion in credit (as seen in the M2 money supply and aggregate financing numbers at Rmb 1.57 trillion - 65% above consensus) has clearly assisted the strong industrial production yesterday. However, it’s worth highlighting that power generation grew at 13.4%, which was the first time since July 2011 that power generation exceeded industrial production and is a bullish development for the Chinese economy. Clearly upside risks to the October 18 Q3 GDP print prevail and it seems that Chinese authorities are happy to keep a pro-growth stance, until the Fed pulls more aggressively on the stimulus handbrake to encourage capital inflows and deter redemptions.
Long AUD/USD trades continue to work, although we’d expect to see a wall of supply hit the market around 0.9400. AUD/JPY is performing more aggressively; however right now, as not only are traders getting the kicker from the improvement in global growth and repricing for Australian rate expectations (especially after today’s strong increase in Australian consumer confidence), but the carry trade is working well. When markets gradually creep higher and volatility subsides, traders will flock to the carry trade, picking up capital returns, but also the carry from interest rate and yield differentials. This is another reason why EM currencies have stabilised, but is a clear reason why AUD/JPY has broken above the July 9 high of 93.07 and is testing the 38.2% retracement of the April to August sell-off at 93.66). A close above 93.66 should bring 95.91 into play over the coming weeks.
Elsewhere the ASX 200 looks set to close above the September 3 high of 5207.7 (currently up 0.5% at 5225), with traders eyeing the year’s high of 5249.6. Materials names have performed well and this should be replicated in European trade. Japan has reclaimed the 14,500 level, with USD/JPY now firmly above 100.00, hitting a high of 100.54. We would stay long USD/JPY in the short term and look for 105.00 at year-end.
Moves in the USD, gold and oil prices have been fairly whippy today, especially during President Obama’s 15 minute address. It has to be said that it’s hard to find a more market-friendly outcome from the developments and Russia, the US, Syria, Israel, and many other nations will be fairly content about the fact that ultimately key leaders are finding good middle ground and developed nation governments have appeased their voting majority. We expect the President’s actions today are largely in the price given the outcome of delaying the Senate vote was talked about yesterday.
However, it should still support European assets today and with limited data to drive it’s hard to see traders looking to offload long positions. UK jobs numbers will be out in early trade, although traders will be keener to position around tomorrow’s speech from Mark Carney and a number of other BoE officials in London. With the ten-year UK gilt above 3%, the chance that Dr Carney tries to push back on rate hike expectations is real. We will also be looking at the level of demand at today’s US $21 billion ten-year bond auction, with the prior bid-to-cover at 2.45 times. This should give us a reasonable sense of how bond funds feel about current yields, which seem to be making a renewed push to 3%.