Trend reversals and new lows - APAC brief 12 Oct
What happened? The sell-off continues, and despite a brief pause during Wall Street trade that opened hopes of an end to this rout, it was quickly dashed as investors went back to dumping stocks. The chaos that has ensued in the last 24 hours raised myriad of questions. But the first one is inevitably this: why did that happen? In short: there’s not a clear answer. That isn’t to say that there isn’t reasoning behind the sell-off; on the contrary, there’s plenty to explain it. Rather, it’s a matter of “why now?” – an explanation that has proven elusive for market participants. From some sort of academic perspective, it’s a matter that begs to be resolved, but for those with skin in the game and money on the line, it’s secondary to the fact that this is happening, and a rapid-response has been required.
Higher rates: This being so, it warrants an examination on the state of play. US equities – the shining beacon atop the dimming global financial landscape – became hobbled about a fortnight ago after a slew of US Federal Reserve speakers came-out to implore that growth was so “extra-ordinary” that interest rates may not yet be near the “neutral rate”. Not only that, the US economy could run so hot that a move in rates above the “neutral rate” may be required, to lean on a booming US economy. Bond markets responded violently to the new information – as is well known – with traders demanding higher yields on US Treasuries, sending the US Dollar higher, stretching US stock valuations in certain segments of the markets to unattractive levels, and generally denting risk appetite.
Slower growth? Though such structural challenges reared their head, the initial reactions from investors were on-balance positive: the Fed needs to raise rates because the US economy is just that strong. This is a positive thing, it was rationalized: fundamentals are good, so the bull-market should continue. This idea became challenge this week for US investors, as dark clouds started to brew on the eastern horizon: China looks as though it could be slowing, and the trade war could make this worse. A world of slower Chinese growth is a world without a strong economy; and that means, for the many US corporates exposed to the slings and arrows of China’s outrageous economic fortunes, lower profits and lower returns for their shareholders.
Panic-stations: With this as the very simple fundamentals, momentum in the US equity market slowed-down, probably as flow-chasers exited the market, robbing equities of their bid and beginning the cascade in prices that we’ve witnessed the last 48 hours. Frenzy has of course ensued, as investors bank profits where they can and take advantage of the gains the mighty bull-run on Wall Street has delivered. The panic has naturally spread to equity markets throughout Asia and to Europe, sparking calls that the divergence in US markets and the rest of world – that has characterized months of trade – is coming to an end: the last bastion of strength in the post-GFC, easy-money-era bull run is falling.
Trend reversals and new lows: Trend lines and support levels are being broken everywhere you look. The global recovery (good since March) following February’s massive correction has ended. Chinese and Hong Kong markets have hit new lows, on some indices ones not seen since 2014, even despite very attractive valuations. Japan’s Nikkei has tumbled from 27-year highs to wallow back around the low-22,000-mark. European shares are on the precipice of breaking-levels that would open downside to near-12-month lows. And the ASX is hugging an upward trendline resistance level established in early-2016, when the global growth story was barely a twinkle in the global economy’s eye. Here, the bears have begun to circle, waiting to profit from a massive, long term trend reversal that vindicates the widely held view that markets can’t possibly prosper without central bank support.
Market psychology: Here, it’s time for a moment of pause. The whirlwind of panic-selling and confusion that has stripped market participants of their rational faculties has laid the fertile soil for the described narrative to flourish. It’s not that individual traders aren’t aware of this either – the hysteria is easy to see, and more importantly see through. But when your money is on the line, and precious profits are being eroded, why hold your position when you can’t be sure that everyone else isn’t crazy? Or even more appropriately: why hold your position when you can’t be sure that everyone else isn’t thinking that you are crazy, and that they aren’t about to dump their positions in anticipation of you dumping yours in some hysterical haste? Either way, as a rational, self-interest investor, it’s best not to risk it – sell now and take profit before the herd wipes it all away.
Waiting for calm: So now markets get stuck in a death spiral, and though plenty of contrarians try to pick a bottom, most generally get swept aside by the wave of selling. The weekend couldn’t come sooner for markets now because a break from the madness is needed to regain some equanimity. A focus on the fundamentals is required, to assess where true value lies in the current market milieu. Price action on Wall Street last night indicated signs that perhaps this is beginning to manifest: the session saw another close in the realms of 1-2 per cent lower, but the extent of losses vacillated throughout the day. US tech, which with its high concentration of rate-sensitive stocks, demonstrated that investors still have appetite for growth stocks, with the NASDAQ registering the smallest losses of the major US indices.
Day ahead: Risk appetite won’t be whetted by what happened on Wall Street (or Europe too, after credit spreads blew out again courtesy of new animosity between Rome and Brussels) overnight. Futures markets are pointing to another ugly Asian session, characterized by some rather aggressive selling. Buying into equities anyway (no-less in riskier Asian markets) at this time would be considered especially imprudent. Safe-havens will be in vogue today: the growth-versus-risk proxy, the AUD/JPY, remains wedded to the 79.00 handled, US Treasuries have climbed, with the yield on bench mark 10 Year note falling to 3.13 per cent (perhaps supported by last night’s soft US CPI print), while the US Dollar is being punished, driving funds into gold, which has torn above the $US1220 price.
Australia: SPI futures point to a 47-point drop at the open for the ASX200, with IG pricing suggesting the market should land just above support at 5810. If this proves to be so, and a close below 5860 is registered, a 2-and-a-half-year trend will come to an end. Health care stocks may see some staunching of their falls, if the activity in US tech is anything to go by; but the energy sector and materials space will likely struggle, given the drop-in oil prices to $US80.00 last night, coupled with the general dip in commodity prices. The Australian Dollar is experiencing strength, but only because of a weaker USD, with the strength of our currency possibly hinging on how well the contained slide in the Yuan can be managed by the PBOC. All in all, the day shapes up as another challenging one, as Australian investors enter the final trading session of a week, that for many, couldn’t end sooner.
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