Trader's thoughts - Wall Street rally has some calling a bottom

A big bounce, but a bottom?

There’s little shortage of folks calling a bottom in the market this morning, but in truth it’s too early to tell if we are there yet. Sentiment indicators and other market internals suggest that the market could be oversold right now, however a short squeeze here-and-there and a shake-out of a few opportunistic bears doesn’t necessarily mark a change of trend. It’ll be returned to towards the end of this note, but in the interest of providing context, Wall Street is registering a solid day of activity, with its three major indices up over 2-and-a-half per sent so far in the session. It’s setting up a solid day’s trading for the Asian region, and likely Europe when it re-opens tonight, on what poses as a thin albeit positive day for stocks.

Wall Street momentum to lift ASX

After a two-day hiatus, Australian equity markets reopen this morning. The last price on SPI Futures is indicating a 35-point pop for the ASX 200 at today’s open. Though at that price, it must be remarked, comes from its closing price on December 24^th. A lot has transpired in the 48 hours-or-so during the Christmas public holiday period: immense sell-offs in certain markets, more political chaos and uncertainty in the US, and now an ample bounce in US stocks. Considering the time of year, the Australian share market is more than likely to experience another session of thin trade today. Monday’s session, for example, saw volume 63.40 per cent below the 30-day average. In saying this, though unsubstantial, Wall Street’s momentum looks likely to carry our market higher.

The stories moving markets

The financial press has been comparatively quiet owing to the holiday period, meaning major headlines from the media-machine are lacking so-far this morning. A recap is in order, perhaps, to touch-on some of the market moving stories this week. Much of the focus has centred on the machinations of US President Donald Trump and his administration, predictably. Given the US Government shut-down, the US President, by his own admission, has spent much of his time “all alone” in the White House – apparently pondering who to fire next. Of course, his ire hasn’t left the US Federal Reserve and its Chair Jerome Powell. But in the last few days or so, rumours are circulating faster that the latest career-fatality on the White House merry-go-round will be US Treasury Secretary Steven Mnuchin.

Mnuchin’s mistake

One can somewhat understand the frustration of US President Trump toward Mnuchin: financial markets seemingly experienced a dose of it Monday, after the Treasury Secretary called a crack-squad of America’s largest bankers to confirm that the market was supported with ample liquidity. Trader’s hated the notion, labelling it akin to calling-out in a crowded cinema “Nobody panic, the fire department is on its way!”. It was this move by Mnuchin that hobbled already weak sentiment on Monday and resulted in the worst Christmas eve performance in US stocks in history. Fortunately for Mnuchin (and his job-prospects), traders have moved passed the gaffe; however, the disorder in Washington, and even more so the White House, remains an ongoing concern.

Risk appetite piqued

With a little over an hour to go in Wall Street’s trading session, the solid gains for the day look likely to hold. Appetite for growth stocks has led the charge: the Nasdaq is up over 4% presently, courtesy of a surge in Amazon’s share price on the back of reports of strong holiday consumption within the US economy. Oil prices have also rallied in response to a commitment from OPEC over the holiday break that it remains committed to managing production and supply. The dynamic has narrowed credit spreads marginally and provided further support for equities, while risk-on sentiment has culminated in a climb in US Treasury yields and the USD, with the yield on the US Year note jumping to about 2.80%.

US growth expectations unchanged

The curious matter behind today’s moves though, is that under the surface traders are still pricing in softer US growth. Although equities are up, along with the US Dollar and bond yields, interest rate markets are still moving in the direction of pricing out hikes from the US Fed in 2019. It must be said that US break-evens have bounced with equities today, implying on the 5-year spread a rate of inflation around 1.55%. However, in absolute and historical terms, that is still very low – a fact reflecting as much in implied probabilities of US rate hikes. There is presently only 9-basis points of interest rate hikes being factored in by traders for next year, suggesting slower than forecast fundamental growth is still baked in to market expectations.

The jury is out

It begs the question whether last night’s activity is just a technical bounce, driven by short term factors. Picking tops-and-bottoms in markets is nigh-on impossible, so any argument for or against whether we are seeing a dead-cat bounce, or a meaningful turnaround, should be read in that context. The matter is, the bearish-narratives that have led the market lower haven’t dissipated yet. As such, volatility is still high – above 30 on the VIX – and considerable rallies, like last night’s, is the norm in bear markets. The trend is the best guide, and the shorter-term trend remains lower for now. It’ll take a while to get there, but a retest of 2600 for the S&P 500 may validate the view a reversal is in play; further falls to below 2290/2300 would provide firmer confirmation that the post-GFC bull run is over.