- The big mover on Friday was undoubtedly implied volatility. The VIX (US volatility index) had the biggest move since the UK referendum, gaining 39.9%. This has huge bearing on trader’s risk management and future position sizing.
- Bond markets are at the epi-centre of concerns, with investors selling bonds at the longer end of the curve, helping fuel an unwind of the carry or hunt for yield trade.
- Federal Reserve member Eric Rosengren detailed his desire to lift US interest rates on Friday, with traders citing this as a catalyst for the volatility. His comments shouldn’t be taken in isolation though and in fact the probability of a hike from the Fed only increased two percentage points on the day.
- The steepening yield curves in Japan, Europe, US and the UK are right at the heart of market participant’s mindsets and we are starting to see credit markets respond as well. A natural red flag for equity markets.
- The S&P 500 closed -2.5%, on the session lows with higher yielding sectors under pressure (real estate -3.9%, utilities -3.8% and telco’s -3.4%). Volume 21% above the 30 day average.
- Higher yielding currencies were savaged, with AUD/USD following as soon as London desks were manned and confirming Thursday bearish reversal. The 31 August low of $0.7490 the target.
- Emerging markets have been sold aggressively, with the EEM (Emerging market ETF) closing down 3.4%.
- The ASX 200 has fallen for four weeks now and is likely to open -1.7% at 5249. Higher yielding stocks should once again be at heart of the sell-off, although BHP is expected to open 1.9% lower, while CBA just less than 1%.
- The S&P/ASX 200 looking grossly oversold, but moves into 5330 to 5350 will cap any rallies as the moves in the S&P 500 could have only just begun.
US crude is down 3.3% from Fridays ASX 200 close, while iron ore closed down a fifth consecutive day for a loss of 0.6%. - All the focus now on Fed member Lael Brainard who speaks at 03:15 est in Chicago on the ‘Economic Outlook’. Lael Brainard is about as dovish as anyone, so her comments could drive sentiment around a hike from the Fed this year.
There are certainly a number of people scratching their heads as to why such a big move on Friday. This seems fair as there is not one catalyst to cause such a big move in market, but rather a collection that has finally seen the S&P 500 break its 2190 to 2150 trading range and traders rushing to hedge portfolios. The terms ‘hedge because you can (and its cheap) and not because you have to’ was certainly something that investors should have thought about last week, however its worth remembering the 40% move in the VIX was grossly exaggerated by perhaps the biggest net short position ever seen in the VIX futures.
As soon as the S&P 500 broke below the lower limits of its recent range of 2150 (see chart below) the algo’s went crazy and the computers widely took over markets. Any stock which had benefitted through most of 2016 from having a higher yield was quickly sold, as bond yields rose and the discount factor used in working out the net present value for future cash flows of equity holdings increased. This is an issue that will no doubt flow into Asian markets.
The moves in equity and risk sentiment more broadly seem a culmination of less supportive central banks, steepening yield curves pushing up longer dated bonds and the impact this has on expensive equity valuations. There is even a view, which I share, that if the Fed are really hell-bent on raising this calendar year when the data doesn’t support it, it is because they are doing so more out of concern about overheating valuations in corporate bond markets and therefore lower dislocations in various markets. So should we be concerned too?
The ASX 200 has actually become somewhat of a leading indicator behind the moves of late in markets. The index, with its highest aggregate dividend yield in developed markets has been sold since 23 August and if our call for 5249 comes to fruition we would have lost 325 points or 5.8% in the process. Participation has not just centred on the high yielders, but in this time we have seen the percentage of companies trading above their 20-day average falling from 95% to currently stand at 26%. It must be said though that the market is grossly oversold and due a technical bounce, although I would be fading rallies into 5330 to 5350. Perhaps Lael Brainard can cool tensions of a near-term hike from the Fed, however given her pessimistic view of late expect any clear hints of a hike this year (which currently sits at 60%) to be magnified, in turn causing the global sell-off in fixed income to ramp up.
Expect the Nikkei to open at 16796 (-1%) and the Hang Seng to open at 23599 (-2%).
Putting the trading hat on, it’s good to see a bit of life back in these here markets and where there is volatility there are dislocations and this breed’s opportunity!
