Market Matters Report / Market Matters Weekend Report Sunday 7th October 2018

By Market Matters 07 October 18

Market Matters Weekend Report Sunday 7th October 2018

Market Matters Weekend Report Sunday 7th October 2018

Last week felt busy on the local bourse but when you stand back after the dust has all settled it was actually fairly quiet with the ASX200 closing down just 22-points, or -0.35%. On the sector level energy & resources remained strong while the broader market was relatively soft with some of the high growth / valuation names standing out amongst the decliners e.g. Wisetech Global (WTC) -9%, Altium (ALU) -6% and A2 Milk (A2M) -5.9%.

Asia was relatively quiet last week on the turnover front due to the Golden Week holiday in China, this may have exacerbated the volatility in many related markets with the Hang Seng falling -4.4% and the Chinese Yuan continuing its aggressive decline. We will cover in more detail later in this report how we expect markets to unfold next week in Asia as China returns to work and the stories gain momentum of China hacking US companies on a huge scale – perhaps the perfect catalyst to create a panic in the region assisted by the US-China trade war appearing to slowly escalate.

The US mid-term elections are looming on November 6th, it feels highly unlikely that President Trump is going to vaguely back down on his trade stance over the next 3 weeks, in fact some more aggressive tweets actually feel more likely – in the US his popularity has received mixed ratings around his America first / trade negotiations but he’s just implementing what he promised in 2016 and that helped him win the US election.

The ASX200 remains around the same level as back in January this year with the market remaining particularly range bound since the 6th of September i.e. 22 trading days in a 132-point range between 6234 and 6102. Our opinion is a breakout of this range is likely to follow through in either direction for at least 100-points.

  • At MM we remain short-term bearish the ASX200 targeting a break below the psychological 6000 area.

NB A break back above 6240 will turn us bullish and for subscribers who dabble in short-term trading we believe buying / selling  the breakout with a 20-point stop offers excellent risk / reward.

ASX200 Index Chart

One thing we’ve been watching very closely over the last few weeks is the differing performance between the respective different US indices i.e. the broader market against the heavyweight few.

1 - The Russell 2000 peaked on the last day of August and has since corrected over 7%.

2 - The Dow Jones peaked over a month later and it’s still 1.9% above where it was when the Russell 2000 peaked – the Dow also remains less than 2% below its all-time high.

NB The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index, itself a benchmark of the largest 3,000 companies in the US stock market. Whereas the Dow is simply made up of 30 large US companies like APPLE, 3M, IBM, Microsoft and Disney.

We believe many global investors are “parking” monies that would have previously been allocated to bonds into large cap US stocks gaining exposure to both the $US and strong economy without the capital risk that many perceive in bonds at present. Many subscribers would be surprised to know that the 16th largest “listed equity” in the world is actually a S&P500 ETF making it a larger entity than household names like Intel, Nestle, Cisco, 3M, Nike and of course our own BHP.

If we are correct when this “parked monies” exits the ETF looking for a new / better home it will probably be pretty ugly BUT obviously it may not happen for months, or even years.

Remember bonds fall in price as yields rise hence buying bonds if you believe inflation and interest rates are set to continue rising makes no sense.

A large part of this Weekend Report is a more focused look at a number of points covered last week but when markets are this interesting its important to be totally clear on plans / scenarios on the radar moving forward.

Dow Jones v Russell 2000 Index Chart

I can imagine many saying who cares if the small caps fall when the large caps rise as long as the market keeps rallying – a fair thought / question which definitely requires an explanation.

While divergences can be a hard phenomenon to interpret, especially as they regularly last longer than many expect, at MM we do watch them closely e.g. we have started to buy the emerging markets against US stocks due to their huge relative underperformance in 2018.

We recently read a perfect yet slightly unpleasant analogy to explain the behaviour of stocks when the cash (buying) dries up – it first shows up in the lower quality stocks, like the weak animals dying first in a drought. However, eventually the lack of water effects all animals including the strong, it simply kills the weak first.

We are already seeing the effect when the “tap of cash” is turned off in the Australian property market by likes of the Hayne banking commission and restrictions on Chinese buyers. No money equals no buyers, although the suburbs that are currently falling the hardest are being driven by more specific situations like the ~20% drop in interest from Chinese buyers. In the US the Fed has ended Quantitative Easing and is raising interest rates, slowly removing cash from the system, which historically has a large detrimental impact on assets – its just about picking the “uncle point” when they go up too far and higher interest rates starts to constrain the economy, there are no signs of this yet in the US.

The real warning comes when we look back in history at some of the largest corrections in stocks – the advance / decline regularly turns down ahead of the market itself as the below chart illustrates perfectly. Simply put the large “blue chips” cannot do the heavy lifting forever when the broad market is rolling over.

Importantly at this stage it’s only been around 6-weeks that this market phenomenon has been unfolding but all major fires start with one spark. We will be watching this closely over the months ahead.

MM is currently long the leveraged BBUS ETF (bearish the S&P500) and long the emerging markets ETF (IEM) but overall we are net short due to both the combination of position size and leverage. We may consider adding to “spreading” against the BBUS by adding to our IEM position as previously planned and / or even buying a  position in the Blackrock IJR US SmallCap 600 ETF.

Advance / decline in US markets Chart

1 Global bond yields

Different markets / macro-economic influences take in it turns to be the dominant influence in driving stocks and its currently well and truly US bond yields, they are putting the huge issue of an escalating US – China trade war into the shade.

Friday night gave us another decent clue to the short term strength in the bond market following the release of the US employment data on Friday night:

The US created only 134,000 new jobs compared to the expected 185,000 but unemployment fell to its lowest level since 1969 while average hourly earnings rose +2.8% from a year ago.

The results were also potentially dampened by Hurricane Florence but the underlying theme, although headline number was a pretty big miss, was there’s nothing to imply the Fed wont continue raising rates – bond yields rallied steadily throughout the day closing at 7-year highs.

Our theme for 2018 remains very much in play – “bond yields are going higher the only question is how fast”. Considering unemployment is now sitting at an almost 50-year low any surprises to the upside from inflation indicators could easily see acceleration higher in bond yields.

Our underlying takeout is we continue to have no interest to stocks that may be negatively influenced by rising bond yields.

US 10-year bond yields Chart

The differential between local and American bond yields continues to increase and while we would not fight this trend the most important point to remember is that effectively interest rates are going to rise in Australia, even if the RBA stay put at 1.5%.

With ~30% of Australian banks interest rate exposure offshore while US bond yields continue to rise we should anticipate further upwards tweaks in domestic mortgage rates i.e. doing the RBA’s job for it in the process.

US v Australian 10-year bond yields Chart

2 Currency markets

Two things did initially surprise us on Friday amongst the major market moves following the US jobs report and it wasn’t the rising bond yields we discussed above:

1 - While US stocks fell as we’ve been expecting the only 2 sectors to close positive were the interest rate sensitive real estate and utilities groups, not in sync with soaring bond yields.

2 - The $US index slipped marginally lower although bond yields rose, again not in sync with soaring bond yields.

Our preferred scenario remains the $US “pops higher” by around 2% in the coming days / weeks before a period of consolidation. The above 2 points suggests to us that traders may be well and truly positioned for rising bond yields, hence we are considering the below:

1 - The period of major underperformance by the real estate and utilities sectors may almost be finished short- term –  in the US over the last year while the S&P500 is up +13% real estate is down -2% and the utilities are up only +0.3%.

2 - The $US index has appreciated +almost 10% since its February low, the trend is up but it feels as if many investors, like us, are already long, hence a pullback would not surprise.

In our Friday morning report we discussed a looming inflection point for stocks, the market moves on Friday night / Saturday night provides weight to this view in our opinion.

The $US Index Chart

The $A simply cannot take a trick at the moment, even when the $US slipped against a basket of currencies on Friday night the $A still fell to its lowest level since February 2016.

We remain short the $A versus the $US in our Platinum Portfolio via the BetaShares $US but as we outlined last week MM may take profit on this position into further short-term weakness, ideally when the $US spikes higher.

NB We remain sellers of the $A into a ~3c bounce which now feels very overdue i.e. we remain bearish the $A medium-term– the $A has fallen 13.4% from 81.36 to 70.43 with no more than a 2.65c bounce on its travels.

The Aussie Dollar ($A) Chart

3 Asia & Emerging markets

No major change to what we have been discussing all week but the markets slowly but surely coming our way.

MM is looking to buy the emerging markets via the IEM ETF into fresh 2018 lows with our best guess now only 1-2% lower.

NB We are initially only looking for a 10% bounce, this is not a long term play at this point in time.

MSCI Emerging markets Index (MXEF) Chart

The correlation between the Emerging Markets Index and the $A is extremely high,  illustrating why we are discussing a potential inversion point across a number of markets, as opposed to just the one.

If we are correct both the $A and Emerging Markets should form a short-term bottom very soon, as the chart below shows its unlikely that one will go without the other.

This fits our plan to take profit on our BetaShares $US ETF and to add to our Emerging Markets ETF (IEM).

The Australian Dollar $A v Emerging Markets Chart

4 Resource stocks

The resources sector has enjoyed an excellent 2018 but if we are close to some short-term turns in global markets we must consider if it’s time for the resources to come back to the back, at least for a while.

Interestingly I started writing this piece on Friday night with increasing caution in my thoughts as I progressed and on Saturday morning I woke to see BHP down almost 2% in the US.

Vale is the largest nickel and iron ore producer in the world and technically we believe it looks net bearish with a target around $US12, or 20% lower – not a crazy call in this volatile stock / sector, just back to the levels of about a month ago.

Vale (US) Chart

At MM we have been looking at a number resource stocks to buy into a pullback, while this plan of action has not changed we will be very fussy on entry levels.

Some of the stocks and importantly levels we are considering in the sectors are:

1 – RIO Tinto (RIO) add to our position around the $77 area.

2 – Fortescue Metals (FMG) around $3.25.

3 – BHP Billiton (BHP) around $30.

4 – Western Areas (WSA) around $2.20.

5 – OZ Minerals (OZL) around

6 – Iluka (ILU) under $9.

Obviously a number of these levels are over 10% away but if Vale does correct ~20% there’s a strong possibility our targeted areas will be in play.

RIO Tinto (RIO) Chart


Remain patient and look to accumulate stocks carefully into weakness ideally below 6000 and invest around the infection point (s) we have discussed in today’s report:

  1. Take profit on our $US ETF position, ideally when we see a sharp ~2% appreciation in the $US.
  2. Look to take profit on our BEAR ETF basis the ASX200 under 6000 and increase out long exposure to stocks
  3. Close the BBUS ETF basis the S&P500 5% lower and / or hold against an increased position in the emerging markets, or a small cap US ETF on a spread basis.
  4. Add to our IEM ETF into new lows, ideally around the 56 area.
  5. Add to Westpac around $26.50.
  6. Add to JHG below $35 and buy CYB below $5.25.
  7. Buy Macquarie around $116.
  8. Buy the ASX around $60.
  9. Buy Oil Search around $8.90.
  10. Buy Cochlear / CSL around $185.
  11. Add to our RIO below $77 and other resources mentioned earlier.

Standout technical chart (s) of the week

At MM we have been targeting the 1615 area for the US small cap Russell 2000 index for around 4-weeks – it was basically achieved during Fridays trading in the US.

MM is now short term bullish the Russell 2000 targeting a 8-10% bounce, relatively tight stops can be worked around the 1590 level.

Russell 2000 Index Chart

Trading Opportunities on our radar

We have 2 trading opportunities today although the  second is simply an updated version of the last 2 weeks.

Infant formula producer Bellamy’s (BAL) has been falling over recent weeks along with A2 milk (A2M) – major insider / director selling in A2M has certainly not helped the sentiment towards these previous high flying stocks.

We like BAL from a market driven  perspective as the Chinese consumers will continue to grow, albeit at a much slower rate. The current negatives sentiment towards BAL feels almost opposite to the optimism which was experienced earlier in the year.

MM likes BAL around the $8 region while leaving some ammunition to average if its final plunge heads lower.

Bellamy’s (BAL) Chart

The previous 2 weeks we have run with Kidman Resources and today its still fitting the bill

  • Buy KDR into new lows below 90c targeting above $1.20 - excellent risk / reward.

Kidman Resources (KDR) Chart

Investing on our radar

See today’s conclusion as we look to buy short-term weakness in a number of markets.

Weekend Chart Pack

The weekend report includes a vast number of charts covering both domestic and international markets, including stock, indices, interest rates, currencies, sectors and more. This is the engine room of our weekend analysis. We encourage subscribers to utilise this resource which is available by clicking below.

Our Holdings

Our positions as of Friday. All past activity can also be viewed on the website through this link

Have a Sunday!

James & the Market Matters Team


Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.


All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 6/10/2018

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