Category: Countries & Regions

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Bond spreads: Financial risk is easing

Bond spreads are an important indicator of risk in financial markets. When corporate bond yields are at a substantial premium to Treasury yields, that indicates higher default risk among large corporations. The graph below, from the RBA chart pack, shows the premium charged for AA-rated corporations compared to US Treasuries. Anything over 150 basis points (bps) indicates elevated risk. For lower-rated BBB corporations, a spread greater than 300 bps is cause for concern. At present, both credit spreads are trending lower, suggesting that financial risk is easing.

US Credit Spreads

Australia displays a similar picture, with AA-rated spreads trending lower. BBB spreads are also falling but remain high at 200 bps relative to 150 bps in the US, reflecting Australia’s vulnerability to commodities and real estate (both here and in China).

Australian Credit Spreads

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India: Sensex breaks support

India’s Sensex broke support at 27600, after breaking below its trend channel, warning of a correction to 26000. Bearish divergence on Twiggs Money Flow indicates long-term selling pressure.

SENSEX

Some would argue that the target should be 25000, the low of September 2015. The recent primary down-trend (March 2015 to February 2016) was followed by a strong reaction, from 23000 to 29000, which exceeded the previous high of 27500 (October 2015). Correction is likely to retrace at least half of the reaction, in other words at least to 26000, but there is no clear support level other than the February/March lows at 23000.

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Gold: “Trump rally” unlikely to last

Gold reacted with urgency to the news that Donald Trump was closing on Hillary Clinton in the polls. After a lackluster start the rally gained new energy in the last week, with the yellow metal climbing to test resistance at $1300/ounce.

Spot Gold

Experienced pollsters seem to think that Trump’s gains are too little and too late. According to GOP pollster Whit Ayres, in this PBS Newshour interview, Trump has about the same chance of winning as drawing an inside straight in poker. “He has spent his entire campaign preaching to the converted rather than reaching out to undecided voters….”

Unless there is an upset in next week’s election, I expect gold to respect resistance at $1300/ounce, followed by a test of primary support at $1200.

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India

India’s Sensex continues to consolidating above support at 27600 after breaking below its trend channel. Bearish divergence on Twiggs Money Flow warns of long-term selling pressure. Breach of 27600 remains likely and would signal a correction to 26000.

SENSEX

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China

Hong Kong’s Hang Seng Index is testing support at 23000. Breach would warn of a correction to test the long-term rising trendline. Declining Twiggs Money Flow indicates medium-term selling pressure. Breakout above 24000 is unlikely but would signal a fresh advance.

Hang Seng Index

The Shanghai Composite Index is again testing resistance at 3100. Breakout is likely and would signal a fresh advance, offering a target of 3400.

Shanghai Composite Index

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DAX

Germany’s DAX is testing resistance at 10800 after a shallow, saucer-shaped correction. Declining Twiggs Money Flow has leveled off above zero. Breakout would signal a primary advance with a target of 11500*.

DAX

* Target calculation: 10500 + ( 10500 – 9500 ) = 11500

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Footsie bullish

Narrow consolidation on the FTSE 100, below long-term resistance at 7100, is a bullish sign. The decline in Twiggs Money indicates medium-term selling pressure, not long-term. Breakout above 7100 would offer a long-term target of 8000. Retreat below 6900, however, would warn of a correction to 6500.

FTSE 100

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Gold: Further weakness likely

US Treasury yields are rising, with the 10-year yield breaking through 1.80 percent to signal a test of 2.0 percent. Further rises are likely on the back of stronger GDP figures for the last quarter.

10-year Treasury Yields

The Chinese Yuan continues to depreciate against the Dollar in anticipation of another rate rise from the Fed.

USDCNY

Spot gold displays a weak retracement off support at $1250/ounce, with short candles indicating a lack of conviction. Another primary decline is likely and would test primary support at $1200.

Spot Gold

The ASX All Ordinaries Gold Index respected the descending trendline, suggesting another decline. Reversal below 4300 would confirm, offering a target of 4000.

All Ordinaries Gold Index

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ASX Banks: Picking up pennies in front of the bulldozer

Earlier this week I wrote:

“The ASX 300 Banks Index broke through resistance at 8000. Twiggs Money Flow is still negative but recovery above zero now looks likely. Breakout would signal an advance to 8700 but I remain cautious and would wait for a retracement to respect the new support level.”

ASX 300 Banks Index

The picture changed within 24 hours. Breakout transformed into a false break, reversing below the 8000 support level. Twiggs Money Flow turned down and now recovery above zero looks unlikely.

Trading breakouts is like picking up pennies in front of a bulldozer. Especially when fundamentals offer scant support. I have never done an accurate count, but for every successful breakout there must me at least five, if not ten, false breaks and/or bull or bear traps. Not good odds if you want to preserve your capital. Far better to wait for confirmation, even if that means a higher entry price.

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Bob Doll’s bullet points

From Bob Doll’s weekly commentary for Nuveen Investments:

  • Third-quarter earnings started strong. Should this persist, it may mark the end of the earnings recession.
  • It looks likely that Hillary Clinton will win the presidency while the House remains in GOP hands.
  • Equity markets face near-term pressures, but the economic and earnings environment should provide tailwinds….

Bob is right that earnings excluding the Energy sector are improving. The graph below compares As Reported earnings per share (EPS) for the S&P 500 to those excluding the Energy sector.

S&P 500 Index

But while EPS may be increasing, profit margins are shrinking. Which makes me wonder how long EPS will continue to rise.

Profit margins (after tax) per unit of gross value added

Source: Weekly Investment Commentary from Bob Doll | Nuveen

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