Over the past four years the ASX’s amazing appreciation has been down to going long defensives and short the material plays. In the main, it has been a monstrous return trade and on an accumulative basis even more so. However, we have finally reached a point of exhaustion in this trade.
The issue I have been arguing for over the past few months is that prices of defensive stocks are hyper-inflated compared to actual underlying earnings – and in the current market where volatility is ramping up; the price to the underlying fundamental gap differential is likely to close and that will lead to the market suffering further losses.
I see marginal changes to my current short term outlook - which is for the ASX to move further to the downside on the reasoning above.
However, yesterday’s trade was pleasing. The recovery in the afternoon session was something that could flow through into the final two days of trade for this week, having made up almost all of the loss from the morning session. Plus the fact the ASX has given up 6.4% in value since its intraday high makes the current position a little more attractive for buyers than it was six weeks ago - when the ASX 200 was pushing 6000 points - and should limit the downside. In the main, however, downside risk is slightly larger than the upside.
The Fed keeps us guessing
There are marginal changes in expectations around the expected 2015 rate hike to the Fed funds rate after the release of the minutes of the April FOMC meeting. The conclusions: general market expectations for the minutes were met, with a slightly dovish undertone. The majority of the participants stated that a June hike was unlikely – but no further guidance on time was given.
Interestingly, members still viewed the weakness in the Q1 GDP figures as being impacted by temporary factors (the weather mainly). However, they were also concerned about weakness in consumer spending (which is approximately two-thirds of US GDP), the forecasts for exports and the underperformance of the energy space. Interestingly, they did maintain growth was likely to rebound to levels previously estimated.
I would also say that these are the April minutes – in the four weeks since the FOMC meeting, economic data in the areas mentioned have remained weak. Housing has been strong, employment in line yes, but if Q2 GDP estimates are to be reached the slight misses in spending in May will only add to the idea Q2 might not recover as fast as estimated.
The minutes all but confirm what most analysts believe - In the most recent Bloomberg survey of investment houses - September continues to firm as the most likely month for the first rate rise with 50 analysts expecting an increase to the Fed funds rate in September, up from 41 in the April survey. This could explain why the US markets have been fairly calm around the prospect of a rise to the Fed funds as early as June. Expectations for ‘no change’ to monetary policy in the coming three months are now so high only one analyst is calling for rate rise in June - down from seven in April and 30 in March – the market is very confident that the rate won’t change anytime soon.
So, with the risk in US equities being fundamentals rather than macro factors, trade is choppy but positive - I don’t like fighting momentum (which is still to the upside). However, I have not seen this sort of trading indifference in markets for several years. I am hyper-vigilant currently as there are several global and fundamental factors that could cause markets to topple over in the middle of the calendar year.
Ahead of the Australian open
We are currently calling the ASX 200 up four points – oil bounced, iron ore fell 2.4% and the US markets were down. China’s HSBC manufacturing data is due for release at 11.45 AEST and is likely to further influence the AUD and trading in the material space. Choppy trade is very much expected.