Market action: the first 20 minutes
Mike Mackenzie’s daily analysis of what’s moving global markets
One of the most important aspects of directing any action or thriller movie is making sure you give the audience a chance to recover from a big shock. An opening scene replete with explosions or drama is followed by a notable moderation in pace, a temporary breather before the next bout of rising action.
After last week’s shock, markets are all over the place on Monday — China sold off, as did Japan, while Europe eked out a modest gain and Wall Street was back under some pressure led by renewed selling of technology shares. The S&P 500 index is having trouble clawing back above its 200-day moving average of 2,766 points. This key level is now acting as a ceiling for the broad market. The usual havens of the Japanese yen and gold have registered modest gains.
In movie terms we have just experienced the first turning point. So enjoy the popcorn and settle back in your seats as we are only 20 minutes into this two-hour feature.
The villain in some eyes is a 10-year Treasury note yield, stuck at 3.16 per cent, and this matters as the US benchmark remains in the breakout zone, above May’s high of 3.12 per cent.
Here’s a blunt appraisal of US stocks from Morgan Stanley’s equity strategy team:
“Despite the slide in multiples we saw last week, growth, discretionary and tech remain among the groups least impacted by the marketwide derating this year. Energy, materials, financials and industrials have seen near 20 per cent corrections in their multiples since the S&P’s valuation peak on December 18, the day before the tax bill was signed. We do not think the pain is over for growth, discretionary and tech and the rolling bear will likely be back for more.”
They add another interesting observation:
“We like to think about valuation in the context of rates and the equity risk premium. Assuming rates stay between 3 per cent and 3.25 per cent, an equity risk premium of 300 to 325 basis points puts us at an S&P multiple of 15-16 times. In short, 16.0x is now the ceiling for market multiples while it was the floor in February’s lower rate environment.”
Earlier on Monday I caught up with Diego Parrilla, from Quadriga Asset Managers, and he thinks we are just seeing the start of volatility and correlations normalising. That means a lot of investors who have sold volatility and chased ever-declining yields face a hefty squeeze on their portfolios. The risk now, argues Diego, is that as implied and realised volatility rise, value at risk models will cut back and thus tighten market liquidity further.
If we look at the most important players in the financial system, dubbed systemically important financial institutions, or SIFIs, a red flag has been fluttering for a while.
This grouping of banks along with a few asset managers and insurers remains firmly out of favour as this chart via Absolute Strategy shows. About three-quarters of the 39 global SIFIs have fallen more than 20 per cent from their 12-month peak. Negative rates in Japan and the eurozone, UK Brexit uncertainty and China’s crackdown on leverage have all taken a toll on the sector.
Among the standouts and worth watching in my view is Standard Chartered, whose share price has fallen 13 per cent since September 21. Just as a weaker Australian dollar reflects the financial markets anticipating a slowing Chinese economy, the markets appear to have adopted StanChart as a barometer of credit worries in China. Likewise the poor performance of French banks tells us that the market is worried about their loan exposures across the eurozone. Not a good look when Italy and the EU are circling each other like a couple of bare knuckle boxers.
Also lagging well below their 12-month highs are US banks, and this may appear surprising to some given a robust economy fuelled by tax cuts in recent months. Not even the recent steepening in the US yield curve has helped the sector. On Monday solid earnings from Bank of America with the sting of weaker loan growth prompted selling in its shares, just as we saw on Friday when JPMorgan Chase delivered a better than forecast third quarter. Of the major US banks only JPM remains up on the year, and that’s a rise of less than 1 per cent.
This tells us a couple of important things. First, if we consider the performance of banks, we are in late-cycle territory for the global economy, including the US. And it also says be very careful about what you buy in the value stocks bucket as growth rivals take a hit from a higher 10-year Treasury yield.