Stability has returned to Asia, and the moves are a far cry from what saw yesterday. It seems Asia has had a reassessment, and calmer heads have prevailed as we close out the week.
Again, there is no clear smoking gun as to the turnaround, but we can make assumptions. Firstly, the view from the floor is that perhaps what we have seen a fair chunk of what has been a rapid shake-out of very crowded and over-owned US assets, and this makes sense as we have seen the evidence time-and-time again in fund managers surveys around a sizeable overweight in US equities. We have seen it in the performance, with such incredible divergence between US equities (notably the NASDAQ 100) and the rest of the world. Although its hard to say if we will see convergence, as the recent weakness in US equity indices has promoted another leg lower in European and Asian markets. 
Given the cost to hedge these positions, and we can include Treasury’s too, the fact the USD has weakened in this period of risk aversion seems testament to foreign investors liquidating and repatriating capital back to their domestic markets. We have seen that EURUSD has rallied from $1.1432 and is currently holding the 1.16 handle. 
There has been a decent discussion from market participants that much of the drawdown of the past two days was premised on the market plumbing and technicalities involving the mandates of various market participant and funds. It’s no surprise that when the S&P 500 fell through the 200-day average at 2765 we saw the selling accelerate and we suspect this was trend-following (CTA) funds having to liquidate – strange things happen below the 200-day MA. Higher implied volatility (we look at the VIX index) has seen volatility targeting funds having to reduce risk, and there is always talk around the traps of a quant fund blowing up here and there. The point here is that much of what has played out has been a short, sharp liquidation based on a rapid change in the structure of the market and we have seen that in the volumes (nearly 4m S&P 500 futures contracts were traded yesterday – the highest since 6 February). This at a time when corporate buybacks have not supported prices. 
I had been focused on the S&P 500 cash index of late and had previously highlighted the long-term chart. However, let’s look at the S&P 500 futures, which traded into 2712 by 05:43 aedt and we can find this at 2765 now, some 2% higher. It is probably too early to say we are out of the volatility woods just yet, but if the long-only funds are going to support this market they need to do it today, and even then, there has been much damage to the psyche of the market that we really need to see a series of higher highs develop.
So, we see the S&P 500 futures regaining the 2016 uptrend, which is positive, but the 200-day MA caps price. Recall, trend following funds can go short, and should momentum build to the downside then it could change this whole dynamic of buying pullbacks. We can also focus on in the US bond market, where the UST 10-year Treasury fell to 3.12% in the latter stages of yesterday’s cash session, only to reverse and head higher and currently sits at 3.16%. So, if moves in nominal and real bond yields were one of the triggers for this flush out in positioning, then a move through 3.19% (yesterday’s high) could see volatility really kick-up again. Let’s not forget that a VIX at 25% means that at any moment the S&P 500 can rally or fall 2% in a short duration of time. 
(Source: Bloomberg)
The fact we are hearing the news today that the US Treasury Department will not label China a currency at next weeks review is a positive, albeit fully expected and as said yesterdays should that have played out would have the world’s financial market go into a meltdown. We are also hearing that Trump is due to meet President Xi next month and that could be interesting and tactically it feels as though risk assets could rally into that meet. There is even news that we could be close to a deal in the Brexit negotiations, although this theme has been concentrated in UK assets and to an extent in European markets and would still need to pass through the UK parliament. So, a few good news stories and we can also look at the market internals or technical we can see markets pricing in a decent amount of pessimism. 
So, some signs of good news, or lat least ess bad, and it’s interesting that there was no change overnight in US high yield credit spreads and that is undoubtedly something Asia-based equity traders have focused on and has been a green light to add risk. We can see the ASX 200 moving firmly off the morning low of 5846 and modestly higher, with material stocks working well, notably gold stocks. The Hang Seng is pushing higher and sits +1.1%, and mainland Chinese markets are mostly higher, with the CSI 300 +0.7% on the session.
I mention gold stocks looking very interesting, but spot gold had a stellar break-out of the recent trading range of $1214 to $1180, with the holy trinity of factors working for the metal yesterday. These being, a weaker USD, lower bond yields and higher implied vol. The breakout is firmly on the radar though, and ideally, I’d like to see a pullback into the breakout high of $1214, followed by a strong bid to confirm this as support. Resistance comes in at $1238 (the 38.2% retracement of the April to August sell-off), and it’s hard to be excited about gold until we can see a closing break here.
Oil is another market that is firmly on the radar, with implied volatility in oil the highest since August. The weekly chart is always useful to gain a healthy perspective, and it’s this timeframe where we can devise a strong playbook. There is a confluence of resistance levels into $77, and clearly, the price needs a weekly close above here for the bullish momentum to come back in, and it’s here that we can talk about $100 a barrel again. The downside is perhaps more interesting though, with the neckline of the double-top seen at $64.27, which is a similar level as the 55-week average. We can see a triple divergence between price and stochastic momentum and to confirm a reversal a weekly close through $64.27 would work. 
(Weekly chart of crude)
(Source: Bloomberg)
Published by Chris Weston, Head of Research, Pepperstone