After five days of gains in the likes of the FTSE 100 and S&P 500, it seems the momentum is waning somewhat. If we focus specifically on the European open, then the recent positive price action should come to a temporary halt.
Asian markets have been mixed on the day, but on the whole the momentum is running out of steam. A number of traders have been asking whether the 6.1% and 5.8% intra-day rally in the MSCI World index and S&P 500, respectively, were premised prominently on short covering. We know the leveraged community have been running the largest net short positioning on S&P futures since 2011 and, if you look at what’s been working in the last five days, it’s been the names with high short interest.
Correlations in global indices are about as high as you will ever see and a rising tide is moving more boats than at any stage. Stock picking is about as tough as it has been in recent memory, although it is not going to surprise anyone that there have been some very constructive flows into energy names.
Here in Australia, the S&P/ASX 200 energy sub-sector has put on a further 6% today, taking the gains on the last five days to 12%, and the only sector trying to keep pace is the materials space (+7% in the last five days). Keep in mind the energy sector is still down 21% for the year and, but with some $10 million in short interest in the sector, the rally could still have legs.
Moves in oil have been very much in focus and the majority of client flow has been on the long side, positioning for further upside. There seems a strong technical focus here, with the WTI crude breaking a key triangle consolidation pattern, which would be targeting a move into the $55 to $56 area. A closing break of the 31 August high and through $50 would be positive and suggest adding to long positions. Of course, in this environment we are seeing upside in petro currencies with USD/CAD lower for the sixth day in a row, something we haven’t seen since mid-2013.
(Daily chart of WTI)
Despite the positivity to the CAD, AUD/CAD interestingly printed a bullish key day reversal yesterday. As long as yesterday’s low of C$0.9248 can hold, I wouldn’t be surprised to see a move into C$0.9500. Perhaps a better way to express a short-term positive view on the AUD is against the EUR, although my conviction to be short EUR/AUD would be significantly heightened on a close through the August and September double bottom at A$1.5600. I would then even look at adding to short positions on a break of the April uptrend, which currently sits around A$1.5400.
Watch out for narrative from European Central Bank governor Mario Draghi, who speaks a few hours after the European equity close.
Back in equities land, the ASX 200 is showing it is in a really nice place right now. Valuation-wise the market is trading in line with the longer-term average (at 15x forward earnings) but, if we look more sceptically at the market internals, we can see the 14-day RSI is right in the middle of the so-called ‘overbought/oversold’ reading at 52, while 96% of stocks have a 14-day RSI between 70 and 30.
We can also see 53% of ASX 200 companies are now trading above the medium-term 50-day moving average. This all tells me the current set-up in the ASX 200 is about as ‘neutral’ as possible, although my view will change on a deeper move through the key 5000 level.
We’ve seen some support with China releasing its September FX reserves which, despite declining by $43billion, were not as low as feared. One of the big issues of late has been the outflows withdrawn from a number of emerging market economies, notably China. Various central banks have stemmed, or at least tried to stem, the falls in their exchange rate by using their build-up of foreign currency holdings. However, this has generally created a tightening of financial conditions, or what has been labelled ‘quantitative tightening’. With today’s FX reserves above expectations, it adds to the building momentum that perhaps China is not going to implode anytime soon – perhaps some of the negative sentiment will unwind.
Markets have responded in kind with modest buying in the CNY (offshore yuan), while the Hang Seng rallied 0.5%. It’ll therefore be interesting to see how the mainland Chinese markets re-open tomorrow.
The other key event risk today has been the Bank of Japan meeting, although very little new news has been provided to markets. As a result, we have seen a reasonable bid in JPY and selling in Japanese equities. USD/JPY fell from ¥120.17 to ¥119.77, with a small contingent of traders positioned for a surprise announcement of additional easing.
Clearly, BoJ head Kuroda has not made anywhere near the right noises about increasing stimulus, although many would point to the fact that he didn’t at last October’s meeting, causing a huge stir in financial markets.
The BoJ evidently feels things are going in the right direction, which is fairly bizarre in itself, but there is little doubt to me that one of the single biggest macro risks over the next few years will be the Japanese fiscal position and ultimately how (or if) they stop QE.
While most will focus on China and emerging markets, I suspect Japan will soon emerge as the real risk. For now, though, short-term traders should focus more closely on whether or not we see new stimulus measures announced on 30 October.
Ahead of the open we are calling the FTSE at 6306 -20, DAX 9880 -22, CAC 40 4643 -17, IBEX 35 10078 -25, FTSE MIB 22070 -13