Saturday, 6 July 2013

Post BoE/ECB Markets Landscape: Small-caps, US Dollar show relative strength, Commodities still laggards

BoE, ECB lower for longer?

Following the forward guidance given both by the new Bank of England Governor Mark Carney, and President Draghi of the European Central Bank at their respective central bank rate-setting meetings, what can we divine from the reaction of various financial markets?

First off, no bones about it - both the Bank of England and the ECB remain fully engaged in supporting the fragile economic growth rates seen in Europe (Bloomberg - ECB signals prolonged low rates). We have been recently reminded of how fragile any economic stability is across the Continent by the volatile reactions to the resignations of 2 ministers in the Portuguese government, plus the emergence of cracks in support for the incumbent Italian government. Notice how the Portuguese bond yield surged beyond 7% in short order in response to this renewed political volatility, triggering reactions across the whole of Europe. 

Portuguese 10-year bond yield spikes up to 7+%
Let's have a quick tour of the various financial markets, to see where there are enduring trends to be identified. 

FX: US Dollar rules

As far as currencies go, the strength of the US employment data on Friday with 195,000 new jobs created in the month of June, plus upwards revisions to the jobs data for both April and May (BLS - US employment situation, June 2013), supported the US dollar, with the US dollar index (DXY) responding by making a new 1-year high.

US Dollar index breaks a new 12-month high

Sterling has been a major loser in contrast, with GBP/USD dipping below $1.50 following the Bank of England statement. 

Bonds: Still making new lows

The bond markets have not managed to reverse their bearish trend, with bond indices still sliding lower following the various central bank statements and the US economic data releases on Friday. Not yet time to dip back into buying government bonds, just yet then. 

US Treasury bond ETFs hit a new 12-month low on Friday

Commodities: Industrial metals, foodstuffs still weak as well

Another area not yet ready for buying is the commodities space: despite sizeable slumps in industrial metals, precious metals, and foodstuffs over the last 12 months, there has not yet been any discernable change in underlying trend... The mining sector continues to mirror this commodities malaise, still the worst-performing sector in the European stock market in the year to date.

Sugar dives ever lower

Don't try to catch this European Mining falling knife

Stock Markets: Small-caps holding up best,
No reason to return to Emerging markets yet

Looking at the UK and US stock markets, the outperformance of small-cap stocks continues to surprise me. However, they remain of course a good play on improving economic momentum in both countries, particularly relative to other areas such as Banks (which tend to be large-caps) or even Emerging Markets. Within Asian equities, Japan clearly remains the place to be, with the Baillie Gifford Japan investment trust (BGFD) returning to within a whisker of its 2013 peak on Friday.

US S&P Smallcap 600 Index Breaks New Highs

While UK Small-caps also look ready to return to recent highs

However, within European large-caps I would be wary of the Banks sector which has broken its 200-day moving average, while Emerging Market equities remain firmly out of favour. 

No inflection point yet for Emerging Market equities

And European Banks also look vulnerable

Conclusion: Small-Cap stocks look good, but beware Banks, Commodities

Stay long UK, US small-caps, and housing-related areas including Lumber (but not US homebuilders, which have already benefited from enormous revaluation). Stay long Japanese shares too, although the Yen will likely weaken further against the US dollar.

In contrast, there is a long list of financial assets to avoid or even short outright potentially: Emerging Market equities, European banks, industrial metals like copper and the related Mining stocks, and European Oil & Gas stocks. This is not to mention most commodity foodstuffs like sugar and coffee, which continue to touch new 12-month lows. 

Good luck for Monday and hope you are profiting from the belated arrival of Summer in the UK and France,


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