As the AUD/USD broke down through the .7600 support level, and the XJO dropped over 1% on the day, the two biggest gainers in the local ETF market were BBOZ and YANK.
The BBOZ is an ASX listed inverse Exchange Traded Fund tied to the local share market, which means the price of the shares rose over 2% to $18.05 as the shares on the XJO index traded lower.
Similarly, the YANK is an inverse fund based on the price of the AUD/USD. It has a weighting of 2.5%.
As such, shares of the YANK ETF rose 3.15% to $14.60 as the price of the AUD/USD fell close to 1.5% to .7550.
In remarks earlier today, Fed President Janet Yellen indicated a readiness to raise the US funds rate at the FOMC’s March 14-15 meeting.
In fairly explicit language, she said that as long as “employment and inflation are continuing to evolve in line with expectations”, “a further adjustment of the federal funds rate would likely be appropriate”.
As a result, we now see a hike at the March meeting as close to a done deal, and see the market probability raised to 95%.
Considering the fact that the Fed Funds futures contract was reflecting a probability of around 30% just over a week ago, this has been a very sharp turn in policy sentiment.
As a result, US 10-year yields touched 2.52%; close to a 3-month high.
In typical market conditions, a US rate hike is Bullish for the US Dollar and Bearish for Stocks, Commodities and Crude Oil
US stocks pulled back from Wednesday’s records while the dollar strengthened on positive US data and growing expectations the Federal Reserve will soon raise interest rates.
XJO is under pressure from both resources and banking stocks.
Since February 2nd, when the DOW Jones 30 index crossed above 20,000, four individual DOW components have been responsible for over 500 points of the gains which lifted the index up to today’s close of 21, 115.
These four shares are Goldman Sachs (160 DOW points), Boeing (150 points), 3M (110 points) and Apple (80 points)
Not surprisingly, these four companies stand to benefit from the three most broad policy measures from the Trump administration: Infrastructure expansion, tax reform and financial deregulation.
However, against the backdrop of today’s stock market rally, US interest rate markets are beginning to aggressively price in an increase in the Fed Funds rates at this month’s FOMC meeting.
As of last Friday, the odds that the FED would lift rates on March 15th were 30%. At the close of trade today, the odds have soared to 82% with the yields on the US 2-year notes reaching a 9-year high of 1.30%.
Much of this price increase has been prompted by comments from voting FED Governors; who have been uncharacteristically direct in their concern about waiting too long to normalise rates.
On February 9th, President Trump jarred the US stock market by saying he was going to make a “phenomenal” tax announcement in a few weeks.
A few weeks are up, and Mr Trump will be speaking to a joint session of Congress at around 1pm Sydney time today.
Since Mr Trump’s original announcement , the SP 500 has gained over 60 points , or close to 3.5%, largely on three key policy expectations: tax reform, aggressive infrastructure spending and a more business-friendly approach to market regulation.
Considering the unprecedented nature of today’s speech, it’s difficult to precisely gauge the amount of time Mr Trump will spend on these economic policy initiatives and the level of detail he will provide.
It is very likely that the market will react sharply to any comments on the timing of tax reform. This includes comments about the Border Adjustment Tax (BAT); which has not been popular with retail and banking stocks.
In the lead up to today’s speech, administration officials have watered down some of the dynamics of these three policy measures. Despite this lowering of expectations, the US stock market has still traded at elevated levels relative to earnings valuations.
On balance, we believe that Mr Trump’s speech will fall short of “phenomenal” with respect to the specific details of tax reform for US corporations and individuals. Technically, the DOW, SP 500 and the NASDAQ are all overdue for a correction.
Whether today’s speech marks the beginning of this correction depends on the degree of detail that Mr Trump provides about these three key policy measures.
A late push on Wall Street helped US Stocks recover and allow the DOWJONES 30 Index to extend its winning streak to an 11th day.
For the week, the DOW rose 1%, the SP 500 picked up 0.7% and the NASDAQ closed out the week pretty much unchanged.
Looking ahead to next week, President Trump will deliver a speech before a joint session of Congress, when he is expected to give more details about his tax plan, trade policies and the direction of health care in the USA.
It’s interesting to see that the Investor Signals ALGO engine gave a sell signal for 2 pharmaceutical companies today: Eli Lilly (LLY) and Pfizer (PFE). Those sell signals were posted at $82.85 and $34.25, respectfully.
US Drug companies have shown weakness on Mr Trump’s comments about health care reform in the past and investors will be listening closely to his speech on Tuesday.
The DOW Jones 30 Index posted its 10th straight winning day in a row overnight. The fact that each one of those 10 winning days was a new record high has not been achieved since 1987.
This most recent leg higher in Dow started on November 8th, after the result of the US election. Since then, the DOW has gained 2,515 points, or 13.75%.
A widely held theme for the US equity rally has been the reflation of the US economy under a more business-friendly administration. This reflation theme was largely based on across the board tax cuts and a country-wide infrastructure construction plan.
The idea being that these new policy measures would stimulate growth and push inflation, interest rates and stock prices higher. Along these lines, the yield on the US 10-year note climbed over 83 basis points, or 6%, from mid-November to late December.
However, over the last several weeks, the US yields have stopped moving higher and the Treasury curve has stopped steepening. In fact, over the last 10 day rally in the DOW, yields on the 10-year notes have actually dropped from 2.48% to 2.37%.
In short, while the DOW has firmed to new highs over the last 10 sessions, the inflation part of the reflation trade is beginning to fade.
From a traditional value-metric point of view, if the recent move higher in US stocks were signalling a new leg higher in valuations, we would have expected the 10-year yields to have traded higher, not lower.
The XJO remains near recent resistance as more than 50% of top 200 companies have reported their earnings. Average reported revenue is up 3.4% on the same time last year and underlying average profits are up 6%.
The Dow Jones chart shows the index breaking to the upside of the recent 20,000 consolidation range.
We remain cautious of the extended share price valuations and moderate underlying earnings growth.
For this reason we continue to tilt client portfolio’s towards defensive assets. We prefer reducing exposure to resource and banking stocks across the next quarter and increasing exposure to healthcare and consumer staples.
Our tight covered call overlay is boosting cash flow to 10 – 12% per year.
Goldman Sachs and JP Morgan remain within the consolidation range which began in early December.
In our local market we’ve seen BOQ & BEN sell off 10% from the January peak-to-trough. NAB reported weak revenue growth and higher than expected expenses, leading to a 1% fall in profit.
CBA report their half year results on Wednesday, we expect NPAT of $4.8b and DPS $2.00. 3 – 5% underlying EPS growth on the same time last year.
ANZ corrected 10% from peak-to-trough.
We’ll watch the US banks in the weeks ahead to see which way they break from their current consolidation range.
Chart – Goldman SachsChart – JP MorganChart – CBA
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