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Global Markets: An Orderly Selloff Just Got Disorderly

Contributor:
Fuseworks Media
Fuseworks Media

In the last couple of days the market selloff has become more anti-cyclical and more indiscriminate...

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With fiscal concerns in the euro-area periphery centre stage, weakness was chiefly focused on related assets.

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But, the macro data, our primary lodestar, has been extremely encouraging in many parts of the world.

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So the collateral damage wrought by the less focussed selloff creates opportunities and entry points for core positions where the fundamental arguments are still sound.

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In equities, Russian and Chinese equities, where we have top trade recommendations ...

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... and US Consumer and German equities look interesting from this perspective.

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We have been stopped out of our short Dec-10 3mth Eonia trade recommendation.

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ECB meeting and UK General Election in focus today.

1. Overnight Markets and Data

Markets have continued to trade weakly overnight, with US markets closing down about half a percent, but above its intra-day lows. Equity volatility also moved up across the term structure, and credit continued to widen. US treasuries continue to remain well supported, and at around 3.5%, the 10Y are now at our 6 month forecast.

Europe continues to be in the eye of the storm, with the Eur weakening to 1.29 yesterday and seeing further pressure this morning, and major equity indices also continue to be hit after a weak session in Asia. The market volatility also took us out of our short positions at the front-end of Eurozone forward curve. We introduced a short Dec-10 3mth EONIA recommendation reflecting our view of an early removal of "stealth easing" relative to market pricing at that time. The recent market turbulence has pushed the front end of the curve in the opposite direction and our trade recommendation has been stopped out with a potential loss of 25bps.

Today's ECB meeting will be a key market focus, but as Erik Nielsen pointed out yesterday, despite all the market rumours to the contrary, we do not expect any changes in polices - no rate cut, no change in repos, and no announcement on purchases of sovereign securities. But we do expect that recognising the huge uncertainties in the market Trichet is unlikely to categorically rule out anything. The Czech central bank also meets today, where we expect no change in the policy rate. In an otherwise light day for macro data, US jobless claims will be important to watch, especially for any signs of further moderation (as consensus expects) after the recent stall.

Polls have opened in the UK General Election. The polls close at 10pm UK time (5pm EST), and the first exit poll is published immediately after the voting booths close. There is a great deal of market focus on the results given the very close opinion poll, and Ben Broadbent's note from yesterday summarizes the main things to watch for. On the markets side we are exposed via our short EURGBP tactical recommendation, which has made steady gains.

2. An Orderly Selloff No More

In the last couple of days the market selloff has become somewhat more indiscriminate. Hitherto, with fiscal concerns in the euro-area periphery centre stage, weakness was chiefly focused on related assets. Sovereign bond spreads in the euro-area periphery widened, the trade-weighted EUR was under pressure and in equities, euro-area financials along with Spanish equities bore the brunt of the selloff.

In the US equities had held up well, supported by continued evidence of domestic economic strength - personal consumer spending data released on Monday showed solid gains for March and we expect another firm labour market report at the end of the week (even though at +175k we are somewhat below consensus of +200k for payrolls) - and consumer-facing equities there hovered not far off their highs. And in Asia too, regional equities were mainly swinging to the tune of strong cyclical data on the one hand - strong China PMI and accelerating Korean exports most recently - and tightening policy on the other.

Even within Europe, there were clear pockets of strength as we pointed out in a daily last week ("German equities shine in lagging Euro-area markets", April 27, 2010). Parts of the equity universe, that were more clearly leveraged into the strength of the global industrial cycle - indices such as the Swedish OMX and German DAX, for example - had been largely unimpaired until the last couple of days.

But as concerns about the severity of the required Greek fiscal adjustment have grown, and as these concerns have spread, the nature of the market selloff has changed qualitatively. The consequent damage has been much less focussed and has taken on a broader anti-cyclical tilt. In the last couple of days a diverse range of assets, arguably at arms' length from the debt problems in the euro-area periphery, have been hard hit. Within Europe, DAX is down c. 3.5% and the MDAX and the OMX are down about 5.5% in the last couple of days. Elsewhere, our UK Cyclical Growth basket is down 2.5%, oil is down 6$ and back below 80$/bbl, and Russian equities (one of our Top Trade recommendations) are down 8%. Copper is also down significantly although China tightening concerns may be weighing here too, and in Asia, a number of cyclical FX crosses weakened against the Yen, although there has been comparatively greater pressure on the European EM periphery like HUF, CZK and PLN.

3. Collateral damage also provides opportunities

From the perspective of our macro trading stance, two points are relevant here. First, we continue to view the Greek fiscal problems, and the required adjustments, as very distinct to those of Portugal, Spain and the others (and an order of magnitude less severe). Of course, these fears can spread in the market without sufficiently fine distinctions and these risks are always hard to handicap, but this is not our baseline expectation. Second, the macro data, our primary lodestar, has been extremely encouraging in all parts of the world. Our Global Leading Indicator summarizes the health of the global industrial cycle, and the momentum here has been accelerating for the last couple of months.

So the collateral damage wrought by the less focussed selloff of the past few days may well create attractive opportunities and entry points for core positions where the fundamental arguments are still sound. As Dominic Wilson highlighted yesterday in the Global Market Views, the risk is that one is too early here, but the risk-reward here is better now than for several weeks. Below we highlight a few areas of the equity market where we think this is true.

US Consumer Growth: We are once again recommending long positions in our US Wavefront Consumer Growth Basket. As discussed in Tradewinds yesterday, Consumer cyclicals look to still have significantly more upside left relative to the still improving macro data, and the sharp US market selloff - owing to global worries - made this dislocation even more evident. Despite fewer proximate counterweights to the data strength here, this position was also hit by the selloff over the past couple of days. We may very well get some quick resolution here, with a significant set of data points upcoming: weekly UI claims and same-store retail sales, and, on Friday, the April employment situation report.

Russian equities: The manufacturing PMI here moved up to 52.1 in April from 50.2 in March. This is the highest point since May 2008. With inflation staying extremely benign, our economists believe that this will allow for a further 50bp in rate cuts. So the macro backdrop here continues to be extremely supportive, and we continue to like our recommended exposure via the Top Trade here.

German equities: The case for German equities rests on the twin considerations of strong leverage into a global industrial cycle largely unimpaired by current economic worries, coupled with the (Greece-induced) easier financial conditions. Indeed, from peak levels only about six months ago the trade-weighted euro has depreciated by more than 10% and 10year bond yields at around 2.8% are back to the lows reminiscent of March 2009. This should constitute a significant boost to corporates that restructured when the euro was much stronger, and it is noticeable that even in this most recent downdraft both the DAX and the MDAX have outperformed their euro-area analogues.

Further afield, China-linked assets such as copper and H-Shares have also been hit in the crosswinds, but here fears of continued China tightening may be as relevant as the Euro-area fiscal problems. Our commodities team recently re-iterated their bullish view on copper, viewing the current dip as a buying opportunity. And we continue to recommend Chinese equities via our recently initiated top trade: the momentum of growth continues to be solid in line with the latest PMI, and while the ongoing tightening cycle is clearly a headwind here, as Mike Buchanan points out in the latest Asian Economics Analyst, this is still a "friendly tightening" aimed at policy normalisation rather than the more nasty variety that seeks to drive growth below trend to fight entrenched inflation.

4. Current Trading Views

The following trading ideas from the Global Markets Group reflect shorter-term views, which may differ from the longer-term "structural" positions included in our "Top Trades" list further below.

In FX:

1. Stay short USD/TWD, opened at 31.74 on 31 Mar 2010, with a target of 31.0, and a stop on a close above 32.10, now at 31.70. 2. Stay long TRY/BRL, opened at 1.18 on 14 Apr 2010, with a target of 1.26, and a stop on a close below 1.14, now at 1.1642. 3. Stay short EUR/GBP, opened at 0.8695 on 21 Apr 2010, with a target of 0.83, and a one-day stop on a close above 0.8850, now at 0.8476.

On rates:

1. Stay short 5yr credit protection in Mexico vs. long 5yr credit protection in Colombia, opened at a spread of -3bp on 16 Nov 2009, with a target of -150 bp, and a stop of 75 bp, now at -30.71 bp. 2. Stay short 5yr credit protection in Argentina vs. long 5yr credit protection in Venezuela, opened at a spread of 75 bp on 19 Jan 2010, with a target of -200 bp, and a stop at 250 bp, now at -52.03 bp.

3. Stay long 10yr Gilts vs. short SONIA (3.75% Sep-19 Gilt vs. 10yr spot Sonia), opened at 60 bp on 25 Feb 2010, with a target of 35 bp, and a stop on a close above 70 bp, now at 49.43 bp. 4. Close short Dec-10 3m EONIA, opened at 84.5bp on 04 March 2010, with a target of 110bp, and a stop at 70bp (for a potential loss of 25 bp). 5. Position for 2s5s flatteners in Indian swaps, opened at 119 bp on 22 Mar 2010, with a target of 70 bp, and a stop on a close above 135 bp, now at 129.00 bp. 6. Position for 2s-10s flatteners in USTs, opened at 272 bp on 24 Mar 2010, with a target of 240, and a stop above 285 bp, now at 271.34 bp. 7. Stay short 5-yr JPY swaps vs. a combination of 2s and 10s, opened at -41 bp on 24 Mar 2010, with a target of -20 bp, and a stop on a close below -50 bp, now at -43.70 bp. 8. Stay long 10-yr US Treasuries vs. 10-yr Bunds, opened at 75 bp on 26 Apr 2010, with a target of 40-50 bp, and a stop on a close above 85 bp, now at 68.3 bp.

Equity Trading Strategies:

1. Stay long Wavefront US Consumer Growth (GSWBCOGA), opened at 109.37 on 04 May 2010, with a target of 120.00, and a stop of 106.00, now at 107.87.

5. Recommended Top Trades for 2010 (opened on 02 Dec 2009 unless otherwise stated) 1. Stay short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, opened at 28.20, with a target of 21, now at 26.9254. 2. Stay long Russian Equities (RDXUSD), opened at 1645.9 for a target of 2050, now at 1627.96. 3. Stay long GBP/NZD, opened at 2.29, with a target of 2.60, now at 2.0829. 4. Close short 2yr GBP swap rates vs. long 2yr AUD swap rates on a 1yr forward basis, opened at -268.5 bp, for a potential loss of 24 bp (inclusive of carry). 5. Stay short 2yr TRY rates through cross-currency swaps, opened at 8.77%, with a target of 12.0%, now at 9.15%. 6. Close long 5yr credit protection in Spain vs. short 5yr credit protection in Ireland at 13 bp, opened at 70 bp, with a target of 20 bp, for a potential profit of 2.9% (inclusive of carry). 7. Stay long the GS FX Growth Current, opened at 103.5, with a target of 111.8, now at 106.6399. 8. Stay long PLN/JPY, opened at 32.1, with a target of 37.5, now at 29.0685. 9. Long Chinese Equities (HSCEI), opened at 12616.01 on 01 Apr 2010, with a target of 15000, now at 11350.83.

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