27 April 2016
Correction Deferred But Not Indefinitely
by POSB Investment Insight
Equities are helped higher by negative interest rates, better economic data from China, and higher crude oil prices
The broad commodities index is boosted by the impact of adverse weather conditions on “softs”
USD/JPY rises as market speculation of BOJ negative rates on loans boosts Japanese equities
But stocks are at technical, channel highs and equities volatility is at lows
However, currency volatility has diverged from equities volatility
The equities correction we expected in April has been deferred, but not indefinitely
More importantly, equities could develop a sideways range after the coming correction
Risk asset markets appear very toppish, in technical terms, at current levels. And that is across a range of markets – from equities to commodities to Asia ex-Japan currencies. Recently, we wrote that the correction in equities we expected in April had been deferred by a few weeks. The correction will come. Beyond that, we could see markets trading sideways. But a new bull market was unlikely. That remains our view.
What has changed over recent weeks is data emerging from China. The figures suggest that in the trade-off between growth and reform, China’s policy makers are leaning once again towards growth. This has driven global equities and commodities higher on hopes that renewed Chinese stimulus would ease global deflationary pressures. Higher crude oil prices – which may have their own dynamics quite separate from Chinese economic conditions – have also helped. US corporate earnings – which have outperformed already beaten down expectations – also contributed to the positive sentiment.
But stock indices around the world are sitting at channel highs and technical conditions are overbought. Equities volatility is sitting at channel lows – suggesting either that all is good again or that markets are complacent. Interestingly, over recent weeks, we have seen higher currency volatility amidst declining equities volatility. This eerie and uncommon divergence could well be a manifestation of equities market stability bought at the expense of rotating monetary stimulus and undertaken, in turn, by the various central banks. This quiet “currency war” is probably not sustainable. Similarly, the revival in China’s credit growth, which followed the People’s Bank of China’s (PBOC) recent monetary stimulus measures, is probably not sustainable in the long run either. We simply note that China’s credit-intensive growth of recent years was followed by a surge in non-performing loans. But we have been – and remain – open to the possibility of risk assets trading in a sideways range over coming months on China’s postponing a slowdown in economic activity to maintain social stability.
Hence, the neutral weightings for emerging markets, Asia ex-Japan, and commodities in our asset allocations.
Equities are helped higher by negative interest rates, better economic data from China, and higher crude oil prices
The broad commodities index is boosted by the impact of adverse weather conditions on “softs”
USD/JPY rises as market speculation of BOJ negative rates on loans boosts Japanese equities
But stocks are at technical, channel highs and equities volatility is at lows
However, currency volatility has diverged from equities volatility
The equities correction we expected in April has been deferred, but not indefinitely
More importantly, equities could develop a sideways range after the coming correction
Risk asset markets appear very toppish, in technical terms, at current levels. And that is across a range of markets – from equities to commodities to Asia ex-Japan currencies. Recently, we wrote that the correction in equities we expected in April had been deferred by a few weeks. The correction will come. Beyond that, we could see markets trading sideways. But a new bull market was unlikely. That remains our view.
What has changed over recent weeks is data emerging from China. The figures suggest that in the trade-off between growth and reform, China’s policy makers are leaning once again towards growth. This has driven global equities and commodities higher on hopes that renewed Chinese stimulus would ease global deflationary pressures. Higher crude oil prices – which may have their own dynamics quite separate from Chinese economic conditions – have also helped. US corporate earnings – which have outperformed already beaten down expectations – also contributed to the positive sentiment.
But stock indices around the world are sitting at channel highs and technical conditions are overbought. Equities volatility is sitting at channel lows – suggesting either that all is good again or that markets are complacent. Interestingly, over recent weeks, we have seen higher currency volatility amidst declining equities volatility. This eerie and uncommon divergence could well be a manifestation of equities market stability bought at the expense of rotating monetary stimulus and undertaken, in turn, by the various central banks. This quiet “currency war” is probably not sustainable. Similarly, the revival in China’s credit growth, which followed the People’s Bank of China’s (PBOC) recent monetary stimulus measures, is probably not sustainable in the long run either. We simply note that China’s credit-intensive growth of recent years was followed by a surge in non-performing loans. But we have been – and remain – open to the possibility of risk assets trading in a sideways range over coming months on China’s postponing a slowdown in economic activity to maintain social stability.
Hence, the neutral weightings for emerging markets, Asia ex-Japan, and commodities in our asset allocations.
