21st December Equity Markets overview
21st December 2009
Equity Index
Overview
Equity markets have continued to hold predominately within the horizontal channel that has contained them since mid-November. This represents the 1080.00-1085.00 to 1110.00-1112.00 areas on the S&P 500 futures. The EuroStoxx and Dax futures, both briefly spiked up through their channel highs on last week’s FOMC policy announcement, however have come back into the channel since. 2930 and 5900.0 are the channel highs for the EuroStoxx and Dax futures respectively. Equity markets have shown surprising resilience in spite of the unwinding of carry trades against the USD.
Thoughts from the trading floor
Having rejected probes to the 1112.00 handle in the S&P 500 future last week, the market has traded gradually lower towards the lower third of the horizontal channel, around the 1090.00 handle. It would seem that the market is content to trade within this well defined channel going into the Christmas holiday period, which casts some doubt over the much touted “Christmas rally” in equity markets. Should we see a break of the 1112.00 level this week, much of the focus will then be on the 1121.50 level on the S&P 500 cash index (around 1116.00 in the future), which represents the 50% retracement of the market’s losses from its 2007 peak. A break above here may signal a strong push higher going into the New Year. For the Dax future, 5921.0 is the 50% retracement from its 2007 highs, which was briefly tested after the FOMC rate decision last week.
We have seen the USD enter into a strong up-trend this month, since the release of the US Employment data. This has resulted into a flight out of carry trades against the USD. Despite this, equity markets have remained somewhat resilient to these carry trade unwinds. This may be due to participants unwilling to take big positions ahead of the holiday period, and end of year book adjustments by long-term market participants, resulting in equity markets becoming “out-of-sync” with fundamental market flows. The major equity market to have been hit by this carry trade unwinding has been the FTSE 100 index, which has consistently underperformed its European and US peers. Thus, should the USD remain buoyant going into next year, we may see equity markets play catch up rather quickly. According to our ‘model’, with the Euro/USD around the 1.4400 handle, the S&P should be at 1050.00 given that the strength of the correlation remains as it has for the most of this year. If we are seeing a genuine sea change in the sentiment in the USD, we do not expect the carry trade unwinding to be orderly even if macro economic data is supportive of equity markets in the medium term.
Bull View
Bulls will hope that the markets can break key up-side resistance, the 1121.50 for S&P 500 cash index. They will need the USD to re-enter its strong downtrend that had been in place for much of this year, or carry trade unwinds to be orderly.
Bear View
Bears will feel that the strength of the USD and the air of uncertainty should provide a natural cap for equity markets. They will feel confident that the recent high prints in the S&P, 1112.00-1114.50 will hold, however may have to wait until the New Year for their shorts to come good. They will hope that the unwinding of carry trades is disorderly enough to spark a strong short-medium term correction in equity markets.
Futex View
We continue to back the bears as long as the USD remains well supported. We favour the recent high prints in equity markets to hold and see the current ‘mispricing’ in equity markets against commodities and the USD as a good selling opportunity for equities.
