Category: US Markets

We’re interested in the large pickup in traded volume over the past few weeks in the Dow Jones Index. By any measure the volume is abnormal, even compared to prior end of year volume traded.

The conclusion we draw from this is: whilst ETF’s are helping to accelerate index volumes, it seems a reasonable conclusion that it could be part of a series of indicators which are helping to suggest that we’re near an exhaustion point in the US equity rally. We’ve seen market tops coincide with big volume distribution patterns like this before.

Chart – Dow Jones

Both the Dow Jones 30 and SP 500 finished the first week of 2017 in positive territory gaining 1% and 1.5%, respectively.

Many market commentators are suggesting the potential for overbought conditions as the major US stock indexes have added about $2 trillion in share value over the last 8 weeks.

There’s no question that the Bulls are currently in charge. However, with earnings season just a few weeks away, investors need to be cognizant of the index earnings required to maintain these lofty price valuations.

Earnings over the last three years have been in a tight range between $116.50 and $118.00. Based on our calculations, if US companies don’t post EPS growth of 10% and only deliver a flat $120.00 of average annualised EPS, the Dow Jones 30 is worth 16,500 points with 10-year bond yields at 2%.

Although energy and commodity companies should help to lift the average from the prior 12 months, bank earnings should also be up in the fourth quarter. With this in mind, the middle ground may result in 5% average EPS growth ($125 per share), which then supports the Dow Jones Index trading at or near 18,000 points.

On 13th of January, the first of the major US financial institutions begin announcing their fourth quarter earnings results.  Bank of America, JP Morgan and Wells Fargo will be the key results to watch.

The rise in US financials has been significant by any measure; multiples have expanded ahead of what investors are hoping to be record levels of profit and bullish forward guidance. The US financial sector has been boosted by the expectation of higher interest rates, deregulation and high trading earnings to drive profits.

However, we have concerns: economic growth in the US is not that strong, the year-over-year GDP growth rate was only 1.7 percent in the third quarter, S&P500 average year on year EPS growth was only +4% in the third quarter and it’s had to see growth improve dramatically in 2017, especially with a stronger US dollar.

Looking across the financial horizon, it appears by many measures that 2016 is ending with similar dynamic as 2015: G-7 stock indexes are at or near their highs, the USD Index is on an upswing, the US Federal Reserve lifted rates causing bond yield to firm and Gold prices are stabilizing after a sharp November drop.

As such, the financial media is content to wrap up the year by only focusing on the price action from the last two months and ignoring the two-way market volatility experienced in the previous 10 months.

Looking into 2017, it’s worth noting that as optimistic as the end of 2015 outlook was, the SP 500 started 2016 under pressure and dropped over 250 points, or 12% by January 20th.

We have identified three potential flashpoints which may trigger a significant correction from the recent post-US election rally during the month of January.

First, the Italian banking sector continues to sag as political manoeuvring has greatly outpaced the progress of any meaningful economic solution. At this point, the focus has been on the bailout of Monte Paschi Bank. Recent  “stress tests” have shown that the solvency gap needed to rescue Italy’s oldest lender has grown from €5.5 billion to over €10 billion.

The immediate contagion risk has spread to 10 other EU banks who are holding substantial Monte Paschi debt obligations.

The second potential flash point stems from recent liquidity shocks in the Chinese bond market. Credit conditions have tighten sharply over the last two weeks as over 25 corporate bond issue face a potential default.

This pressure has seen 2-year swap rates spike higher, which has forced the Peoples Bank of China (PBoC) to inject over $60 billion into the short-term money market just to keep the secondary Treasury market from triggering a trading halt…….like it did on December 15th.

Many investors overlook the impact that even temporary credit shocks can have on global equity markets. However, according to some estimates, the global bond market has more than tripled in size over the last 15 years and now exceeds over $ 100 trillion.

By contrast, Dow Jones Research puts the value of the global stock market at just under $65 trillion. In the US alone, bond markets make up over $40 trillion in value, compared to less than $20 trillion for the domestic stock market. In this sense, as G-7 Central bank policies have removed traditional market anchors, a liquidity or solvency shock in a domestic bond market can have a profound impact on global equity markets.

The third potential flash point involves the US earnings season. US companies will begin reporting in the fist week of January with JP Morgan , BoA and Wells Fargo leading the banks starting on January 13th. Forward estimates suggest that the post-election rally has lifted many of the banking names into price valuations which the earnings reports may not be able to support.

It’s not our base case that an external market shock will trigger a protracted sell off in global equity prices and derail the bull market structure during 2017. However, we feel that it’s important for investors to be aware of the potential of such risks and have a strategy in place to protect portfolio holdings during a market correction.

A product which fits this description is the BetsShares BEAR Exchange traded fund (ETF). The BEAR EFT Gives investors a simple and accessible way to obtain ‘short’ exposure to the market.

If you would like to learn more about how the Beta-Share BEAR ETF can protect the long-side of your portfolio, or if you just want to learn how to profit from a downside correction in the ASX 200, get in contact with us and we’ll be happy to introduce you to this dynamic product.

Going into 2017, one of the biggest decisions investors face is what portfolio weighting to allocate to Australian banks.

Over the past three years, the Australian banking sector has grown to represent over 30% of the ASX 100 capitalization.

This growth has been supported by record bank profits, weakness in other sectors and the chase for yield by offshore investors as central banks in Europe, Japan and the USA have pushed interest rates to historically low levels.

This has contributed to all four of Australia’s primary banks now being in the top 15 global banks by market capitalization, despite their relatively small footprint in the global financial system. In fact, as of February 2016, both CBA and Westpac were listed in the top 10 global banks in terms of market capitalization.

Over the past five years, Australian banks have been very successful in generating profits from their domestic branches which operate in a snug banking oligopoly. Competition from non-bank lenders hasn’t increased materially in the mortgage area and bad debts remain at manageable levels.

Nevertheless, Australian banking shares (while offering high dividend yields) are likely to face a fairly constrained pricing environment and higher loan losses, should the domestic economy continue to slow in 2017.

It’s been reported that international fund managers have been systematically, shorting Australian banks based on the belief that the domestic housing market is overvalued and primed for the same dramatic decline which occurred in Ireland, Spain and the USA over the last 10 years. 

Furthermore, a growing number of analysts are suggesting that protracted weakness in the local economy will burst the housing bubble, contributing to the Government losing its AAA credit rating and putting downward pressure on Australian bank share prices throughout 2017.

Our base case is not quite that grim. However, we do expect to see limited upside to the share prices of the big four banks from current levels and eventual rotation into healthcare companies and yield names.

From a technical perspective, we expect to see price resistance for the four major banks around the following levels: WBC $33.50, CBA $86.00, ANZ $32.50, NAB $32.00.

Flash points for the global equity markets in 2017 remain Italian Banks, Chinese Economy & uncertainty around Trump presidency.