A quick look at the price monitor this morning and it’s clear green on screen and the world is a happy place. European equities are flying, with the DAX the best performing European index (+0.9%), smashing to new highs, on volumes 7% above the 30-day average. The S&P 500 has closed up 0.7%, with the NASDAQ maintaining its stance as the superstar developed market index, with a gain of 1%. The Dow closed at 29551 and is honing into the 30,000 level.
Assessing the broad quality of the equity rally
We’ve seen cyclical sectors outperform defensives, small caps outperforming large caps, growth over value and high beta stocks working over low volatility names. Semis are flying, with the Philli semiconductor index up 1.4% and eyeing a break to new highs. So, the quality of the move is there to compel the bulls and we seem to be back firmly in the FOMO driven markets. If you’re active, then you’re acutely aware that the S&P500 is up 4.8% MTD, with the NASDAQ +6.3%. It still feels hard to be long here, but the market has regained its composure and the bull train is back in play.
Implied vols have taken a hit, which in turn has helped the equity trade, with the VIX index moving into 13.74%, and if we look at the S&P500 1-month call to put volatility we see puts trading at a 4.6 vol premium to calls. Given this differential was closer to 7 a few weeks ago, it shows traders have been keen to roll off portfolio hedges, and we have also seen this in the CBOE put/call ratio which is testing multi-year lows. For the hedge funds, the trade is a simple barbel strategy – Go long an equity index, while hedging the position with US Treasury’s and/or gold and this part explains the modest drawdown in equities to the impact from the coronavirus .
As for catalysts, well it tough to identify one smoking gun, but we can go with the usual suspects of liquidity, a reduction in concern/intensity on the coronavirus, or decent corporate earnings. We can also highlight US politics, where the market has a spurious correlation between an increased probability of Bernie Sanders taking the Democrat nominee, which in turn seems to have resulted in a higher probability of a Republican win. The market obviously loves the known and the status quo and regardless of the political view, the market loves a Trump re-election.
Credit has worked fairly well, with high yield credit coming in 2bp vs investment-grade credit. Bond markets have seen modest selling, with yields up between 2 to 3bp across the curve. Importantly, though, for the equity story ‘real’ (inflation-adjusted) Treasury yields are unchanged and as long as real yield stays low and preferably (for the bulls) negative, then equity, especially the NASDAQ, will find buyers easy to come by.
Energy has flown with a punchy short covering rally in play, with gasoline up a lazy 5.4%, with WTI and Brent crude up 3.5% and 4.3% respectively. Copper has gained a modest 0.8%, while iron ore futures sit up 2.3%. It’s not hard to feel energy and materials names in Australia and the broader Asia region will perform well today and sit nicely in a broader equity tape that should work well. Focus falls on the ASX 200, which is up 0.7% and eyeing a test and potential close above the January and ATH of 7144.
Carry driving FX markets
In FX, the story has been about EUR weakness more than anything, with traders ramping up concerns about the EU’s growth prospects and considering the impact on the EUR if the German’s do role out a fiscal stimulus and it puts a dent in the current account surplus. It seems the EUR has been the primary funder for the carry trade, and one just has to focus on moves in EURMXN, which looks even more compelling than EURUSD and the only question for me in this low vol, positive macro backdrop is whether I short now or wait for a modest short-covering rally.
EURUSD has attracted the bulk of the flow though, with price breaking the October lows of 1.0879 and pushing the 76.4% fibo of the 2017 to 2018 rally at 1.0864. A break here will ramp up calls for 1.0700 and even a test of the 2017 lows of 1.0341. I’d want to see price close below the fibo level on a weekly basis.
EURNZD shorts have seen the largest percentage move on the day in G10, with kiwi rates selling off sharply in response to the hawkish narrative from the RBNZ, and we see the prospect of a cut from the RBNZ halving to 26%. We have RBA gov Lowe speaking shortly, although the market is not expecting it to be a vol event with AUDUSD overnight volatility set at 8.09% – the 23rd percentile of the 12-month range. Still, we watch the AUD crosses as traders roll off their coronavirus hedges.
Published by Chris Weston, Head of Research, Pepperstone