We Told You Didn't We?

We’re bullish. Are you? Since the lows seen in late August, we had been playing it safe. We’re now bullish risk in general, and we’ve many reasons for that. The bull is out, and you’d better stand aside especially if you’re short.
— Business Of Finance, 12 October 2015

Are you having fun yet? We sure are because 2 weeks ago, we publicly proclaimed that we were outright bullish risk markets, and we couldn't have been more right. It didn't take too long before the raging bull started charging upwards, finishing off the last few standing bears, and in the process stunning many analysts and commentators. Who saw that coming? We certainly did. We told you didn't we?

 The S&P 500 (SPX) index has rallied more than 70 points since our prior call. Many factors including technical forces, positive environment on the macro and micro, and dovish central bank rhetoric have contributed to this bull run.   Chart by Business Of Finance

The S&P 500 (SPX) index has rallied more than 70 points since our prior call. Many factors including technical forces, positive environment on the macro and micro, and dovish central bank rhetoric have contributed to this bull run. 

Chart by Business Of Finance

So what's up with our bravado? Well you see, having correctly called such a move when the majority of traders and investors were either on the sidelines or were short, a little bravado won't hurt. It's good to be right, and even better to be profiting from a good call. Members of our Premium Signals Service saw first hand how we positioned ourselves in this bull run.

Remember, before the markets are where they are today, a lot actually stood in the way of the current bull market. Poor sentiment, unfavorable technical factors, uncertainty as to when (if even) the Fed would liftoff, and so on.

From where we stand, we believe the dynamics of the current market are quickly changing. The pace of such changes has hastened quite substantially over the last couple of weeks.

However, most readers only want to know... are we still bullish after this bull run? Yes. Do we know where this market is headed to? No, and good luck guessing. But as always, we are totally ready to turn on a dime and flip sides when and if the market drops a signal.

It took a lot for the market to do what it did, and it speaks volumes: There's very little reason to sell. When the market does this sort of thing, you better listen up because it's telling you something. In today's snippet, we talk about some of the key points in brief.

Being dovish is cool again

Over the last 2 weeks after our last snippet, nothing much has materially changed. That was until this Thursday during the ECB's October interest rate decision and press conference starring what is perhaps the world's most prolific jawboner, Mario Draghi, head of the ECB.

 A visual timeline depicting the comments from ECB president Mario Draghi, and how the market (EURUSD) reacted in actual time. There was mention of more future accommodation, the scaling up of the ECB's PSPP, and further reduction to the deposit rate. The euro capped the week after its worst in 11 months.  Chart courtesy of Barclays

A visual timeline depicting the comments from ECB president Mario Draghi, and how the market (EURUSD) reacted in actual time. There was mention of more future accommodation, the scaling up of the ECB's PSPP, and further reduction to the deposit rate. The euro capped the week after its worst in 11 months.

Chart courtesy of Barclays

While the ECB kept all 3 of its interest rates unchanged as expected, Draghi's press conference dropped massive bombshells which hinted of more monetary stimuli in the future, and as soon as December. Markets were kind of expecting this, but surely not the blatant rhetoric of lowering the deposit rate further.

 The euro suffered its worst week against the U.S. dollar since the start of 2015. EURUSD has broken a weekly trendline dating back to March 2015. This has significant implications in the longer run.  Chart by Business Of Finance

The euro suffered its worst week against the U.S. dollar since the start of 2015. EURUSD has broken a weekly trendline dating back to March 2015. This has significant implications in the longer run.

Chart by Business Of Finance

Recall that the interest rate on the ECB's deposit facility is already negative, implying that ECB board members had some intention (the extent of which is unknown) of venturing further into the twilight zone of negative interest rate policy (NIRP).

While we won't go into the minutiae of the details, we're saving this for a separate piece, Thursday's ECB's event was undoubtedly dovish, and was probably the final nail in the markets' coffin for more accommodation by the ECB before year's end.

How dovish you ask? Dovish enough to plunge EURUSD to depths not seen since August with Friday's close almost under the 1.1 handle, down a staggering 350 pips pre-ECB.

The effect of all this dovishness had on risk markets was more or less predictable. Any hint of more monetary accommodation almost always fuels a bull run, which was exactly what we got and perhaps what the market wanted. We felt the markets were waiting for such a catalyst to rally through resistance, evidenced by backing and filling action before Thursday's event.

Caveat to the buyer though. Things might not be as straightforward as it superficially seems. We're not taking this development in isolation. Neither are we too eager to bet the house that the ECB delivers on those latest hints. There are both upside and downside risks. Ask yourself these questions: Have markets discounted the ECB's hints? If so, to what extent? We'll leave it hanging here.

It was then China's turn

If markets thought Draghi's press conference was the party popper for the week, they were certainly caught off guard when China 'unexpectedly' announced another round of interest and reserve rate cuts in early Friday trading. We aren't surprised. After all, we warned of more easing from the PBoC earlier in May this year; don't expect China's binge to end anytime soon.

Bloomberg has the facts:

  • CHINA CUTS BANKS’ RESERVE REQUIREMENT RATIO
  • CHINA CUTS INTEREST RATES
  • CHINA CUTS 1-YEAR LENDING RATE BY 0.25%
  • CHINA CUTS 1-YEAR DEPOSIT RATE BY 0.25%
  • CHINA REMOVES DEPOSIT RATE CEILING FOR BANKS
  • CHINA CUTS RESERVE RATIO BY 0.5%
  • CHINA INTEREST RATE CUT EFFECTIVE FROM OCT 24

#China just reported its 3Q15 #GDP figures. Marginally better than estimates for a 6.8% YoY growth coming in at 6.9% but...

Posted by Business Of Finance on Sunday, 18 October 2015

Friday's 'surprise' marks the 6th time China has cut interest rates since November 2014, crowning the PBoC the king of the doves amongst the DM central banking cartel. There are obvious reason's for China's reluctance to lift its foot off the gas.

Early in the week, China reported 3Q GDP figures just shy of the targeted 7%. The 6.9% annualized growth rate was a hairline better than expectations but didn't at all placate President Xi and his board of economic advisers. We'll go easy on the details here, but just know that most, if not all of China's state-reported economic data is most likely grotesquely overstated.

Nevertheless, it gave the PBoC an easy reason to act. Markets initially reacted on a sugar high; everything from stocks, copper, to the Aussie dollar were jerked higher. After the exuberance, risk began to fade on the stoic realization that the PBoC's actions were potentially pointing to continued weakness in the world's second largest economy.

We'll leave Citi to opine on this:

"Bottom line: Impacts of China rate announcements on the G10 are falling. Investors remain cautious ahead of this weekend’s announcements, and what policy cuts imply for the region.

One day after a dovish ECB, China cuts interest rates by 25bp and RRR cut by 50bps. Accommodative policy begets accommodative policy it seems. Our economics team has been expecting further policy accommodation out of China, the issue was just a matter of timing. Unlike other major central banks, the PBOC doesn’t announce policy on a set schedule – but this doesn’t mean there isn’t a pattern to it. Before today, it had announced cuts to the RRR or interest rate six times in 2015 – the last being on 25 August.

So today was a surprise in terms of action, but not completely unexpected. We prefer to see the easing can be seen in the larger picture of China adjusting to weaker growth in a systematic and controlled manner, rather than a reaction to a new economic shock.

Today’s rate cut comes ahead of this weekend’s Fifth plenum, and previous ones haven’t been sufficient to reverse the economic slowdown. Additionally, this weekend it has been expected GDP targets for the next 5-years will be announced (currently at 7%, but broadly expected to fall), along with other fiscal plans and goals. Without knowing the full baseline of what China expects and is working towards, it is difficult to chase price action. The main drivers of EM Asia lower has been poor growth and trade in the region – hence we main cautious. Policy adjustments now could be a way to soften the impact of further weak economic growth."

Implications? China weighs heavily on the markets, so keep a close eye on the dragon. An accomodative PBoC should mostly be a plus for risk appetite, but this placebo seems to be slowly loosing its magic. Do too much of the same thing and it looses its effects. Still, good for the bull run.

Improving Sentiment Boosts Confidence

 Headlines such as these bolster broad sentiment amongst retail investors which itself has been recovering well. Before we made our bullish call 2 weeks ago, sentiment was still biased bearish. Now, positive sentiment should start to engage fresh inflows into equity funds - a positive for risk markets.  Screenshot from Facebook

Headlines such as these bolster broad sentiment amongst retail investors which itself has been recovering well. Before we made our bullish call 2 weeks ago, sentiment was still biased bearish. Now, positive sentiment should start to engage fresh inflows into equity funds - a positive for risk markets.

Screenshot from Facebook

This is something not talked about much in the press nor amongst alternative financial media outlets, but has been crucial in the formation of our baseline view.

Similar to the crowded trade theory, that most traders are on one side of the market before it reverses, high degrees of antagonism towards a general trading idea or concept usually yields similar outcomes.

However, instead of an inflection point, we can expect the prevailing move, still in its infancy, to accelerate and persist. This was what we saw. If you paid attention to media headlines, the difference between them now and a month back is like day and night.

Equity options are pricing in record tail risk, usually to the downside. Skew measures the perceived tail risk of the...

Posted by Business Of Finance on Friday, 16 October 2015

Positive sentiment fuels rallies because they encourage inflows into certain markets and outflows from others. The backbone of any stock market rally is the c-word, confidence. Once both the big and small players commingle in a merry zest of confidence, it's hard to stop a bull run. Very hard indeed.

Technicals & Earnings

 High yield (HY) and emerging market (EM) debt funds saw strong inflows last week, after having consistently seen liquidations on the heels of a global de-risking trade running in parallel to the major corrections/bear markets in stock markets across the world. If all goes well, institutional flows like this should herald a much more secular bull market across various asset classes.    Chart courtesy of BofAML

High yield (HY) and emerging market (EM) debt funds saw strong inflows last week, after having consistently seen liquidations on the heels of a global de-risking trade running in parallel to the major corrections/bear markets in stock markets across the world. If all goes well, institutional flows like this should herald a much more secular bull market across various asset classes.  

Chart courtesy of BofAML

We've talked at length about the technicals. We haven't talked about the micro side of things, or corporate earnings. We hope you know it's earnings season for most publicly traded companies because it's starting to matter quite a bit, at least more than it used to for the previous 3 quarters. But first, the technicals.

 Besides massive inflows into HY and EM bonds, pay attention to flows into and from emerging market and developed market equity funds. So far this year, DM equities have seen an almost commensurate inflow as outflows from EM equities; a classic de-risking trade. Long-only equity funds saw a staggering $121bn outflow since January, according to BofAML's FICC data. You are encourage to read well into this insightful graphic for greater color.  Chart courtesy of BofAML

Besides massive inflows into HY and EM bonds, pay attention to flows into and from emerging market and developed market equity funds. So far this year, DM equities have seen an almost commensurate inflow as outflows from EM equities; a classic de-risking trade. Long-only equity funds saw a staggering $121bn outflow since January, according to BofAML's FICC data. You are encourage to read well into this insightful graphic for greater color.

Chart courtesy of BofAML

Apart from divergences in volatility metrics we track, capital flows into risk markets such as HY and EM funds have seen healthy and assuring rebound. For a market to keep rallying, there consistently has to be fresh dry power.

As long as we keep seeing inflows into such funds, there's one more reason to stay reassuringly bullish. Still, we believe this landscape remains conflicted in certain areas as much as it is convicted in others. We're keeping a lookout.

On earnings, things are looking pretty solid. Mega caps are just beginning to report their performances for the last quarter, and they have so far been more upbeat than downbeat.

It doesn't matter to us if the positively skewed beat:miss ratio is due to overly pessimistic expectations and guidance from last quarter, or due to companies actually performing well. This earnings season in the U.S. has started on a good note, and the markets have taken it well. Next week, the world's most profitable company, Apple, is slated to report its earnings Tuesday. Although our focus on this front isn't global, we have our antennas affixed.

Your turn, Mr. Market

We've aired our throat for now. We're positioned the way we want and will constantly be adjusting our exposures and allocations inline with our views.

To get our latest updates, follow us on our official Facebook page.

Then again, markets will remain unpredictable and unforgiving. Try not to disrespect this fact. Happy scouting for opportunities, folks.