Unpredictable markets proving tough to trade

These are tough markets to trade; on one hand you have volatility in the forex markets at a multi-year low, with commodity markets trading as a derivative of the USD. 

On the other, developed market equities are up big one day, even closing on their highs and then down heavily the next.

Looking at US trade, there didn’t seem any single red flag behind the equity liquidation, but it seems that Wednesday’s post-FOMC minutes euphoria proved nothing more than a head fake. The NASDAQ has pulled back below the long-term uptrend, and while there is still a couple of weeks to go, a close below February’s low of 3418 would print a bearish month reversal at the all-time high: a fate no bull wants to see. With the five-day moving average accelerating below the ten-day moving average, it certainly suggests staying cautious here.

All is not lost though, and while traders piled into put protection (with the VIX spiking 15%); sentiment seems that fickle that we could easily rally 1% in US trade today. JP Morgan and Wells Fargo, arguably two of the most important stocks to report given their leverage to the US economy, hit the market with Q1 earnings in the pre-market. JP Morgan trades on just under 10x adjusted earnings, which is a slight discount to the sector, but does not have a brilliant pedigree around earnings. Overlap JPM’s chart to that of the S&P 500 and you can see the close correlation, so a poor result today could see the broader market struggle. Although, a lot will be determined by the theme behind the miss/beat and whether it can be exported into other stocks or sectors.

In Asia today one of the talking points was around yesterday’s agreement between the Shanghai and Hong Kong regulators on a pilot project for improved access to each other markets. This should be seen as a strong longer-term positive here for China, as one gets the impression that foreign ownership in China’s mainland market should increase from the woeful level of 3%. However, unless sentiment improves there’s no reason to think that Hong Kong residents are going to rush to buy Chinese mainland equities. Clearly the beneficiaries of this will be the Hong Kong exchange (the stock is up 10% today) and a handful of Chinese brokers. Perhaps the big trading opportunities that will arise from this (and what the institutional traders are looking at) are valuation arbitrage opportunities that are prevalent in a number of the dual-listed names. Still, any goodwill we saw in the Chinese market has dissipated today, with the CSI 300 down 0.9%.

Nikkei recording a 7% weekly drop

Japan has been hit from pillar to post this week and a 7% drop on the week is the sort of moves you’d expect in a frontier market. USD/JPY is at a critical juncture, with the pair testing the February 4 uptrend at 101.50. It’s hard to pin-point the move lower here solely on the USD, although the re-pricing of US rate expectations has been aggressive this week, with the December 2015 Fed funds future falling a massive nineteen basis points over the last five days. It’s hard to remember a shift in policy expectations like we have seen first-hand in this market. Naturally, on the other hand the failure of the BoJ to hint at easing this week has caught everyone long (Nikkei) and like the Fed funds, we’ve seen a huge re-positioning exercise.

In Australia the market is struggling, although utilities and telcos are holding up. The theme of selling high valuation, strong momentum names is taking place again, similar to what we saw earlier in the week. While funds would be increasing shorts positions in this space, this is an area of the market I feel most excited about. Unlike the US where concept stocks rallied strongly as the market felt the full force of a wave of excess liquidity, names like CSL, REA, CRZ and SEK are actually quality businesses. They are getting hit because of the valuation premium (to their five-year average). SEK for example has return of capital of 24%, free cash flow growth of 84% and revenue (consensus) growth of 19.2%. This is where the value-focused investors welcome the short sellers, as they move stocks closer to perceived value levels much more quickly. Buyers will be waiting.

Europe likely to struggle

Europe has to deal with the fact that US futures are 1.1% lower from where the different cash markets closed. It’s going to be a fairly bleak and miserable open for those who are long; given the positive price action yesterday there would certainly have been a few who thought the buying would be more than a one-day affair. There’s a bit of economic data to sift through, however when markets are down 1% or so, then data will largely be a sideshow. Earnings from JPM and WFC should get the lion’s share of attention.

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