The reflation trade has not been revitalised and, whilst some indices suggest a break to new highs could be on the cards, we note several signals may either delay this outcome or hamper their upside.
On a purely technical front, we like the potential for the ASX200 to break to new highs. At time of writing the ASX200 sits just beneath 5830 resistance and appears ready break to the upside. A double bottom, which can be used as a bullish continuation pattern if preceded by an uptrend, could also be in the making. If successful, the pattern projects an approximate target around 6095. However, there are some developments which make us wonder if this could now morph into a triple bottom, or perhaps fail to materialise.
- Oil prices are fell notably lower
- US Q1 GDP forecast is very low (per Fed Atlanta’s GDPnow model)
- Growth potential may have already been priced in to US stocks
- TED spread is moving broadly higher and volatility ahs picked up, ye VIX remains historically low
Falling oil prices are one such measure which has seen both Brent and WTI below 50$ per barrel and the markets continue to wonder if further downside is on the way. If oil prices remain weak, this undermines the global inflationary pressures and we could see further unwind for the great ‘reflation trade’ which helped send stocks and bond yields soaring higher once Trump had been elected. Additionally, Trump is yet to fully unveil his fiscal stimulus or tax plans and if he is to deregulate the energy market, this also puts a cap on oil prices.
The S&P500 remain in a clear uptrend and just below record highs. There has been no real challenge to a prior swing low since Trump was elected, although the potential for sideways trading or minor pullback is on the cards thank to lower oil prices, bond yields and growth expectations. Shorting at current levels would likely result in a low probability trade, yet once out altogether it means we can lower our expectations for the ASX200 to break out. Yet markets can change quickly so, if we are to see a recovery in oil prices, bond yields and growth expectations, then we could easily see US indices explode higher once more and drag the ASX200 towards 6,000 and possibly beyond.
What should lend a helping hand for the bull camp is the Fed’s failure to increase their lift-off, which provides less reasons to be concerned that their hike will suppress stocks. Yet this impact is likely limited as we remain at historically low interest rates, so the traditionally bearish signal (of further hikes) has less of a detrimental impact on the stock market. The fact US stocks remain just below record highs underscores this point.
Prior analysis has shown our bullish ness on US growth for this year by the ISM PMI reads for service and manufacturing. Yes, there is already a strong likelihood that a lot of this support has already been priced in. What is not helping as well, is Fed Atlanta’s GDPnow model currently predicts Q1 growth to e 0.9%. Whilst the first release of Q1 tends to be weaker and often inaccurate (as it often gets revised higher) it is likely to be removing some confidence from the stock market perma-bulls for now.
The VIX remains historically (and stubbornly) low, whilst the S&P500 remains just below record highs. A quick glance at the VIX chart shows we are likely long overdue a volatility spike and the same can be said for a retracement on the S&P500. Since Trump’s election there has been no real test of a prior low. The TED spread has been gradually rising since 2014, which is a pattern which has preceded all liquidity-related market crashes. Like VIX, this itself does not provide the timing of, or sell-signal to pre-empt any such event, yet it is something to be mindful of as stocks move higher with the Ted spread and the VIX remains low.
Overall, we have remained optimistic of the US economy and continue to see upside for growth overall in 2017. Yet we cannot completely ignore the slow and steady rise of the TED spread whilst VIX remains low. This is not a warning to call the end of the bull market, but more of a reminder to not be swept away from the bullish euphoria as the underlying dynamics of markets have changed in recent week and, until a clearer picture emerges, we may see any upside on the S&P500 and markets such as ASX200 as limited.
Matt Simpson | Senior Market Analyst
A certified technical analyst, combining macro themes, monetary policy and business cycles to generate Forex and commodity trade ideas.
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