US Markets

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.

The US Stock market slipped lower on the back of the Federal Open Market Committee’s (FOMC) policy announcement today. The market wasn’t surprised by the FED’s 25 basis point increase in the Overnight Fed Funds target, but the “Dot Plot” forward guidance shows policymakers are looking for 3 rate hikes of 25 basis points in 2017.

This view is more aggressive than the 50 basis point move the FOMC discussed back in September, which pushed equities lower and lifted the yield on the US 10-year treasury notes to a three year high of 2.57%. It’s worth noting that the 10-year yield traded at 1.35% in July; which means the yield on the US benchmark treasury note has essentially doubled in less than 5 months.

In her post-announcement press conference, FED chief, Janet Yellen, described the move as a “very modest adjustment”, which suggests this year’s forward guidance may mean another move on rates as early as May 2017.

We don’t see this a trend-changer in the major US stock indexes. However, we do see scope for a near-term correction back to the 19,450 level in the DOW Jones 30 and a move back to 2190 in the SP 500.