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 Thursday 17 November 2016

Equity rally slows - AM Bulletin

 

 

Indices Update

It’s been a mixed start for the major global stock indices today. This follows on from yesterday’s performance where most US and European indices closed weaker. There was a slight rebalancing following the sharp sector rotation seen over the past week. The NASDAQ made modest gains as investors took advantage of the recent sell-off to pick up “beaten down” stocks in the tech and telecom sectors. Meanwhile, profit-takers came in and sold banks and industrials.

So it feels as if some of the market exuberance which followed Donald Trump’s presidential victory last week has faded. It feels perfectly reasonable that investors will want to take stock following the sharp moves in equities, FX, bonds and commodities since last Wednesday morning.

We’ve heard comments from a number of Federal Reserve members this week. Yesterday St. Louis Federal Reserve President James Bullard told a UBS conference in London that, "a single policy-rate increase, possibly in December, may be sufficient to move monetary policy to a neutral setting." In other words, even if the Fed does hike rates next month, it won’t mean it’s the beginning of an aggressive tightening cycle. He went on to say that: "there were a lot of predictions that if the election went the way of Republicans and President-elect Donald Trump, then there would be great deal of volatility, but that has not materialized so far." This would appear to dampen speculation that the Fed would want to hold off from a December hike should a Trump win create turmoil in financial markets.

On Tuesday Robert Kaplan, president of the Federal Reserve Bank of Dallas said that it was time to start raising and "normalizing" interest rates because the low rate environment had distorted markets.

The FTSE 100 ended the day 43 points lower at 6,749.7

The German DAX fell 71.3 points or 0.7% to end the day at 10,663.9

The US30 closed 54.9 points lower to finish at 18,868.1 The S&P 500 ended down 0.16 % at 2,176.9 while the Nasdaq 100 rose 0.6% to close at 4,792.3

Equities

Rolls-Royce (RR) fell close to 4% in early trade yesterday but managed to recoup most of these losses as the session progressed. The iconic company which makes engines for military and civilian aircraft, ships and nuclear-powered submarines reported a further downturn in business aviation although demand for engines for extra-wide-body civil aircraft was strong. Rolls-Royce has issued five profit warnings over the past eighteen months. The company’s problems have been compounded by falling oil prices although the long-term order book is close to record levels. The UK engine maker said the short-term outlook in some markets was tough but that it was on track to meet forecasts for annual profit. Cost savings for the year will be about £200m, which is at the high end of its guidance. The stock ended 2.1% lower at 738.5 pence.

Commodities Update

On Tuesday crude oil put in its best one day performance since April, soaring by around 6%. The rally looked like it was mainly a short-covering bounce after WTI and Brent hit multi-month lows on Monday. However, the trigger appeared to come on the back of renewed hopes that OPEC will somehow manage to agree to production cuts when it meets later this month. Some OPEC-member energy ministers are expected to meet informally in Doha on Friday in an effort to reach some form of accommodation ahead of the full OPEC meeting on 30th November.

After Tuesday’s close the American Petroleum Institute (API reported a crude build of 3.65 million barrels which was bigger than the 1 million expected. The data also showed the biggest build at the Cushing, Oklahoma hub since August and the first increase in distillate stocks in two months. There was a drawdown in gasoline, but this was considerably smaller than expected. All in all, the report was bearish for oil and that was reflected in the sell-off in early trade yesterday morning. Then the Department of Energy released the official inventory data yesterday afternoon. This also showed a bigger-than-expected build in inventories across the complete energy complex. Prices dipped, then rallied as news agencies reported that Russia’s oil minister saw “big chances for OPEC to agree (at its next meeting)”, then dipped again.

The International Energy Agency (IEA) left its long-term global supply and demand forecasts unchanged. The IEA released its annual World Energy Outlook and noted that: "The difficulty of finding alternatives to oil in road freight, aviation and petrochemicals means that, up to 2040, the growth in these three sectors alone is greater than the growth in global oil demand. “ This was despite the 2015 Paris Climate Change Agreement coming into force.

Gold and silver were both little-changed in early trade yesterday. However, the ongoing dollar rally eventually proved too much for precious metals investors who yet again felt pressured into cutting long positions. Typically, dollar-denominated commodities (such as gold and silver) struggle when the greenback is rising. This is because a stronger dollar makes it more expensive for non-dollar holders to convert their currencies prior to purchasing dollar-denominated commodities.  For now, the dollar appears to still have some upside momentum, not least as investors are now convinced that the US Federal Reserve will raise rates at its meeting next month. Higher US interest rates also put pressure on the dollar price of gold and silver. This is because investors can expect a better return from assets which pay interest than from non-yielding precious metals.

So far, gold has managed to hang on above $1,220 on a closing basis. This roughly marks the 50% retracement of the December 2015-July 2016 rally. Yesterday silver failed to consolidate above $17 and, in the absence of a sharp sell-off in the US dollar, further losses can’t be ruled out.

Forex Update

The rally in the US dollar continued yesterday. The EURUSD broke below 1.0700 to hit its lowest point this year. The USDJPY pushed up towards 110.00 to trade at its highest level since the beginning of June while the People’s Bank of China fixed the yuan at an 8-year low against the US dollar.

All this represented a big turnaround for the greenback when compared to last week. The Dollar Index slumped in early hours of last Wednesday when it became apparent that Donald Trump had clinched the presidency. But it is now up around 4.6% from its low point last week and trading over the 100.00 level - an area of resistance which has held on a number of occasions since March 2015. The Dollar Index is currently trading at highs last seen back in early December 2015. This was just ahead of an important European Central Bank (ECB) meeting when ECB President Mario Draghi was expected to announce additional monetary stimulus (he didn’t). It was also just days before the US Federal Reserve was expected to raise rates for the first time since June 2006 - it did. Yesterday the Dollar Index came within 0.2% of hitting a 13.5 year high.

The overriding reason for the dollar rally is the market reaction to Donald Trump’s policy proposals. These include corporate and personal tax cuts, a proposed deal to repatriate US profits from overseas, tariffs on imports from China and Mexico and infrastructure spending of around $1 trillion. These measures are all inflationary and so bond prices are falling as rates rise on expectations that Fed will hike in December. According to the CME FedWatch tool, the probability of a Fed rate hike next month is now 95%.

But the stronger dollar is a real problem, particularly if it breaks out from its current trading ranges. The US Fed has printed around $3.4 trillion of new money from 2008 to 2015 and this has been the basis for over $60 trillion of new dollar-denominated debt, much of which has been bought by overseas (that is to say, non-dollar) investors.  A stronger dollar means dollar-denominated debt is more expensive to service and repay for non-dollar holders

On Tuesday the Bank for International Settlements (the central bankers’ bank) warned of the dangers to dollar borrowers of USD appreciation and how banking sector can exacerbate the situation by pulling back from intermediation activity: "When so many borrowers have borrowed so much in dollars... dollar appreciation exposes borrowers and lenders to valuation changes and, in turn, impacts their balance sheets. If banks react to resurgent volatility by reducing their intermediation activity, as happened during the 2007-09 crisis, the banking sector may become an amplifier of shocks rather than an absorber of shocks."

So what does the Fed do now? Financial conditions are already tightening as bond yields rise along with inflation expectations. Yet the longer-term trend in US GDP is down and tax breaks and infrastructure spending can only provide a temporary boost while adding to the national debt. It could be that the 95% probability of a December hike is too high and Fed holds off. If so, that could really see the wind taken out of US dollar

Upcoming events

Today’s key economic data releases and events include UK Retail Sales, Euro zone CPI and the ECB’s Monetary Policy Meeting Accounts. From the US we have CPI, Building Permits, the Philly Fed Manufacturing Index, Unemployment Claims and Housing Starts. Federal Reserve Bank of New York President and FOMC-voting member William Dudley will speak in New York while Federal Reserve Chair Janet Yellen is due to testify about the economic outlook before the Joint Economic Committee, in Washington DC.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: AM Bulletin


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