Trader's View - US markets re-open, and risks remain the same

Markets returning to normal trade

Traders in the US and UK returned to their desks overnight, and if price action is any guide, their verdict of the weekend news flow is “not much has really changed”. This isn’t to say the movements in financial markets in the past 12-18 hours have been ones of major conviction. Afterall, volumes are still light and the extent of the moves in price witnessed were modest. Nevertheless, despite what was notionally a tranquil weekend for financial market news, market participants have seen it fit to continue to take risk off the table, as if nothing has really changed at all.

Risk-off still the bias

An assessment of risk-conditions finds merit in this notion. Yes, several risk events have been traversed since Friday, but none really provided the market with any reason to change existing biases. Fundamentally, the trade-war is still a growing problem, with sentiment finding itself sapped by the apparent intractability of that issue. Practically, no economic data has been released from any of the major economic powers since last week too, so markets remain mired in the perception that the global economy is on a soft footing. Perhaps a level of uncertainty is gone for now, however the balance of risks have seemingly remained the same.

Indicators for global growth flashing amber

That’s resulted in some classic risk-off behaviour. Not that the moves were overly frightening, but they were stark enough to take notice. The conspicuous activity was in the bond market – especially US Treasuries. The yield on the 10 Year note fell 5 basis points to 2.26%, which marks its lowest point in almost 18 months. The significance of that milestone is noteworthy, too, and perhaps a small marker of where markets are in the current cycle: the last time yields on 10 Year US Treasuries were this low, it was smack-bang around the time of President Trump’s famous tax-reform package in December 2017.

An end of a cycle?

Recall, it was the implementation of this massive cutting of corporate taxes that ignited the US economy, and by extension the US equity market. The dynamic fuelled market sentiment, and was a major catalyst behind the several record highs achieved by the
S&P 500 in 2018. Though only a crude measure, the fact the US 10 Year bond yield is back at where it was at that stage of history speaks volumes of current market perceptions. Markets are anticipating a global economic slowdown – an end to some small cycle – that will weigh on US growth, and probably force the US Federal Reserve to cut interest rates.

A split between the market and policymakers

In fact, such an attitude is being baked into rates-market pricing – an 80 per cent chance of a rate-cut from the US Federal Reserve is priced-in before year end. This view is deeply at odds with what the Fed has flagged to the market in all its communications so far this year. Regardless, perhaps somewhat like the beginning of this year, whereby a breakdown in financial conditions more-or-less halted the Fed’s rate-hiking cycle, markets are assuming the Fed will again be bent to its will. And this is where the risk lies: if markets have got this wrong, heightened volatility is the (almost) certain outcome.

Bullishness is absent right now

The problem right now, as it relates to risk assets, is that rather than solid earnings that’s propelled US stocks to its most recent record high, it’s been a lowering of interest rate expectations that’s really been responsible for bring about that phenomenon. Perhaps, this is what’s making the current pullback in the S&P 500 so worrisome. Discount rates keep falling, just as they have been all year, however US equities remain in a short-term downtrend. The signal is that markets are positioning for an economic slowdown, at least just right now, brought about by the deterioration in trade-relations between the US and Chinese governments.

Stock market softness persisting

As such, the S&P 500 sold off in the final hours of US trade, pushing that index to psychological support around 2800, and bringing closer the completion of a much-watched head-and-shoulders pattern for that index. A caveat here: the action could be something of a manifestation of end of month flows. But judging by market activity in Europe too, where stocks also dipped, the lion’s share of this price dynamic does look attributable to a significant risk-off sentiment. It’s something that will apparently plague the ASX, too: SPI Futures are pointing to a 44-point drop at this morning’s open.