Given the time of year and the prospect that a number of big US money managers have taken an extended break this week and with S&P 500 implied volatility (i.e. the “VIX) now back below 10% (currently 9.86% - 7.5%), one can say that the leads we have today for Asia are about as upbeat for risk appetite as the bulls could hope for.
Financial conditions have become even more accommodative, and of course this just compounds the notion that the Federal Reserve are not only looking to hike rates in December (now a 97% implied probability), but the pricing in the fed funds future through to end-2018 and 2019 also looks too pessimistic and throws weight to calls from JP Morgan and Goldman Sachs that the Fed will hike four times in 2018. So, we look around the markets and see the USD index lower by 0.2%, we can see high yield and investment-grade credit spreads tightening by 4 and 1 basis points respectively and as mentioned implied volatility in the S&P 500 has dropped below 10%, with the S&P 500 gaining 0.6% and momentarily breaking 2600. It must be said that volumes, predictably, have been on the light side and some 11% below the 30-day average. We can also see the Dow Transport index and Russell 2000 index gaining 0.9% and 0.8% respectively.
Perhaps two aspects that dampen the mood somewhat have been the 3bp rise in ‘real’ (or inflation-adjusted) US 5-year Treasury yields and at 31bp is now at the highest level since January 2016 – clearly this move higher in real rates is not yet seen as an equity negative . The eyes of the fixed income world, however, is on the yield curve and the pick-up in social media interest around this rampant flattening of the 2’s vs 5’s or 5’s vs 30’s Treasury curve has many divided on what the market is truly saying about future growth and inflation trends in the US economy.
The fact we have seen such aggressive selling in the front end of the Treasury curve is obviously the driver here and we do question how much more upside there is, specifically in 2-year Treasury’s, which at 1.77% are the highest levels since 2008 and coincidentally now higher than Australia’s 2-year government bond yields - the first time since December 2000. Taking the 2’ v 10’s Treasury curve in isolation, more rational thinkers have seen this as a sign of strong growth in the US and global economy, but of course the bigger concern is whether there is a breaking point for broader risk sentiment and what level this occurs at, as an inverted curve (i.e. the 2-year Treasury commands a higher yield than that of 10-year Treasury’s) has prophesied each recession in the US economy over the past 50 years (source: BoA/ML). The 2/10’s spread is 3bp lower on the day at 58bp.
Emerging markets are flying and this is where traders are really generating outperformance. Asia, in particular, is looking super strong, with the Hang Seng, H-shares and CSI 300 all on fire yesterday and on sizeable volumes too. The Hang Seng is up 35.5% year-to-date (40.7% on a total return basis) and remains the poster child of trend and momentum, which will naturally happen when Tencent, with its 12.5% weighting on the index has rallied 126% year-to-date. There is a genuine chase for performance from active money managers here and looking at the ASHR ETF (CSI 300 ETF) and EEM ETF (Emerging market ETF), which are trading up 2.9% and 1.4% respectively on the NYSE and one can sense that it should be another upbeat open for Asia and any pullbacks through this week will be supported.
We can throw in constructive moves in Europe too, with the DAX gaining 0.8% and where a close in my opinion through 13,186 indicates increasing (or initiating) long positions in this index. Aussie SPI futures did trade to 6006 overnight, and are not far off these highs now and sit up 19 points, taking our ASX 200 opening call to 5992. Whether the bulls have got the ability and the impetus to push the local index through to close above 6000 is yet to be seen, but there are certainly enough in the leads for this to materialise. A strong session in Japan, Hong Kong, and China would help here and lift S&P 500 futures.
We can see that in the commodity complex that it is really only spot iron (closing -1.5%) that has shown weakness. Elsewhere, we have seen iron ore futures close up 1%, while steel and coking coal futures have both rallied strongly, closing up 2% and 4% respectively. Copper is up 1%, while US crude has closed up 0.8%, so with these leads in commodities we see the S&P 500 energy sector up 0.3% (most of the buying in US equities were in tech), while BHP Billiton (LON:BLT) Ltd ADR (NYSE:BHP) looks set to open 0.8% higher and we see VALE SA (NYSE:VALE)'s US-listing up nearly 4%. So a good day for small caps locally.