We’ve seen the market reduce its G20 hedges, and with the G20 Summit in the rear-view mirror, we look around the markets and revert to what are the clear drivers – liquidity, and the view of further aggressive central bank easing and increased money supply.
The ‘buy everything’ trade, a somewhat cynical view of markets I heard used recently by a friend, James Whelan (of VFS Securities), is working like a dream. If we look at a multi-asset overview of markets, we see the S&P 500 (white) at an all-time high (ATH), and high yield credit spreads narrowing relative to investment-grade credit (yellow), while the US 2-year Treasury is oscillating in a 1.7% to 1.8% range, consolidating after a huge rally. In fact, it’s the longer-end of the curve that’s getting the attention as funds increase duration risk, with the US 10yr Treasury now at 1.95% – the lowest yield since November 2016.
The hunt for yield is still very much in play.
The hunt for yield can be linked to implied volatility (IV) in the S&P 500 (purple line – above), and at this juncture, we see the VIX index below 13%. In fact, I can see a world where IV heads into a 11% to 13% range, as the financial system is pretty much set up to sell volatility. It would not surprise to see carry trades in FX ramp up as the flavour du jour again, and traders wanting to be paid to be in a position. Although saying that, USDJPY is finding sellers easy to come by, with spot trading at 107.59, so maybe if you want to buy risk, hedge with long JPY positions.
In the options market, we can certainly see the demand and premium for S&P 500 ‘put’ volatility flattening out relative to ‘call’ vols, and this tells us that options traders, while still hedging downside risk, don’t see potential price moves as pronounced as they possibly could have been a week or two ago. For any hedge fund that uses volatility as a key input into how invested they are in the market, then one could argue that the S&P 500, Dow and Nasdaq 100 still have further upside.
While it’s hard not to be cautious, I for one, am loath to hold short exposures in an index trading at an ATH. In fact, while we question everything, I was once taught that if you absolutely have to hold a position, a market at 52-week highs should only be traded from the long side, as is the case in a market at ATH’s – where, at its most simplistic, you can’t really get any more bullish. I guess that holds merit again, although while we sit at an ATH in the S&P 500, I’d like to see this play out in the Dow and Nasdaq 100 too, although the price is not far off. But this is about liquidity, and with economics and crude giving us a few red flags that fundamentals may exert themselves, we don’t have the clarity at this stage to be wholly concerned.
The fact that equities are bid, and US Treasuries are also finding renewed buying tells us G20 Summit is behind us and we’re back to looking at the path of central bank easing. In fact, gold is flying today, as is Bitcoin, and it feels like they are the same trade, with gold a bit of a leading indicator.
However, we can also look at global money supply (the purple line), and the G30 balance sheet (red line) and see the backdrop for the MSCI world equity index. With the ECB expected to restart QE later this year, and the Fed to halt its balance sheet normalisation program (known as quantitative tightening or ‘QT’), in the next month or two, we can argue the red line will start to head higher soon.
Europe looks interesting too, especially now we have confirmation Christine Lagarde is the ECB chief, and that removes the threat of a less market-focused candidate at the helm. The market will like this recruitment. Certainly, the German DAX looks bullish, although there is a gap that needs to be filled, but if price starts to move higher, and EURUSD kicks lower, I would be jumping on board.
Published by Chris Weston, Head of Research, Pepperstone