Stocks in the US and Europe were higher again overnight as traders increasingly bet the UK referendum is likely to see the Remain camp prevail.
That’s helped the SPI 200 September futures rally 15 points suggesting the ASX 200 will open in the 5290/5300 short term resistance zone it pulled back from yesterday.
On forex markets, the pound surged to its highest level for the year before falling 120 points. That fall dragged the Aussie dollar off its own six-week high at 0.7512 and it’s back in the mid-74 cent region this morning after the US dollar was a little stronger across the board.
Oil was down a lot early but only a little at the end of the day’s trade. Gold fell and then recovered, copper is higher, and iron ore slightly higher.
We are entering the twilight zone in the next 36 hours before we get the official Brexit result, so markets could get very thin.
Here’s the scoreboard (8.03am):
- Dow: 17829 +25 (+0.14%)
- S&P 500: 2088 +6 (+0.27%)
- SPI200 Futures (September): 5,230, 15 (+0.3%)
- AUDUSD: 0.7451 +0.0019 (+0.25%)
Now, the Top Stories
1. This is important – UBS Warns of Potential Trading Hiccups Surrounding ‘Brexit’ Vote. I’m leading with this one because it is really important for traders who haven’t sat through all the crises since 1988 the way I have that they understand the type of liquidity evaporation and price gaps you can get when big shocks hit the market. Of course, the Brexit vote is well telegraphed and traders should be prepared for it. But as Capital Economics pointed out earlier this week, the stark contrast between impacts of the vote means there are four ways this week’s Brexit vote could hit markets. All of them entail big moves for the pound and other markets.
The key to all this, and something that global investment banking giant UBS has warned clients about, is that banks “may have difficulty accommodating trading in the run-up to, and in the wake of, this week’s U.K. vote on European Union membership”, the Wall Street Journal reports. UBS joins many other big banks, and brokers, who are trying to get their clients to understand they may not be able to get trades done, or stop losses set at the levels they expect.
From the Journal:
UBS said in an emailed notification that while it’s difficult to predict market conditions just before Thursday’s vote and immediately after results are expected the following day, “we may see an increase in volatility and an impact on trading volumes”. That could lead to a situation where prices become “non-tradable” for certain periods, the bank said.
To quote myself from something I wrote for AxiTrader clients earlier this week, what traders need to understand is that “the uncertainty around the vote and these possible price gaps means I have no real way of managing my risk in the effective manner I usually do. And, because trading is first and foremost the business of managing risk, I will sit this one out and run square with no open positions over the period of the Brexit count and announcement.” Many professional traders I know are doing the same.
2. Brexit Watch – too-close-to-call but the market is betting on Remain. Two big polls were released overnight which continues to suggest the vote is close but Remain will win on Thursday nights vote. That’s seen stock traders were nervously optimistic even if forex traders, who pumped the pound to the highest level for the year with a high of 1.4781, have backed off quite a bit since then.
On the poll front, the latest IG/Survation poll put “Remain” at 45% and “Leave” at 44%. But, an ORB poll for The Daily Telegraph newspaper found support for Remain at 53 per cent, up 5 percentage points on the previous one, with support for Leave on 46 per cent, down three points. Ben Moshinsky has more here.
Overall this week we’ve seen a rally in stocks, strength in the pound and commodity currencies, a sell off in bond rates, and a pretty big fall in gold. That says the market is betting Remain will win the referendum. Let’s hope that is the case, otherwise the very big risks of market dislocation UBS highlights above are going to be realised.
Here’s the latest update in the Polls – from the group who predicted the general election result.
3. Janet Yellen did not sound like the Fed is going to hike any time soon. Aussie could rocket if Britain stays in the Euro. Janet Yellen wandered up Capitol Hill last night to make the first of her two-day appearance before US lawmakers. She didn’t deviate too far from what she had to say recently in her post-FOMC press conference. But she did sound a little more cautious on the outlook for the economy, according to many of the reports I’ve read so far this morning.
Yellen said there is “considerable uncertainty” in the US economy at the moment which is evident in the slowdown in the growth of employment. She warned of the risk of Brexit, and of China, but also highlighted the strong pickup from consumers.
It was balanced but certainly quite dovish. And I think you can see in Yellen’s comments the impact of St Louis Fed president James Bullard’s new thinking that the Fed is going to have rates lower for longer. That’s certainly something that Ian Shepherdson, economist at Pantheon Macroeconomics, said via the FastFT. He said “Dr. Yellen did introduce perhaps a further element of doubt when she said that hiking ‘cautiously’ will keep policy supportive ‘…while we assess whether growth is returning to a moderate pace, whether the labor market will strengthen further, and whether inflation will continue to make progress toward our 2 percent objective’.”
If the Fed isn’t going to be hiking rates anytime soon and the RBA doesn’t look like a bank in a hurry to cut then this combination and a vote by Britain to stay in the EU could ignite a big rally in the AUDUSD.
4. The Fed said stocks are expensive – but you can ignore that using their own argument. Here’s why. While Yellen spoke to Congress, the Fed also released a Monetary Policy Report. In that report the Fed said that stocks are looking expensive, Bob Bryan reports.
The report said (my emphasis):
Forward price-to-earnings ratios for equities have increased to a level well above their median of the past three decades. Although equity valuations do not appear to be rich relative to Treasury yields, equity prices are vulnerable to rises in term premiums to more normal levels, especially if a reversion was not motivated by positive news about economic growth.
I’ve emphasised a different bit to Bob in his report because I think the key to the argument is rates, not valuations. The whole point of low rates is to goose up risk assets. Super low rates reduce the discount rate of future cashflows which increases the present value of those cash flows. So if stocks aren’t elevated against bond rates then in the current environment they are not elevated. Only when rates are going to rise, and then sharply, does risk increase. And Yellen, and Mario Draghi, both showed that isn’t going to happen in a hurry.
5. One of the fathers of behavioural finance showed how Brexit makes finance models redundant. As a trader and money manager I was uneasy with much of the theoretical pillars of finance theory when I was doing my Master of Applied Finance back in the late 1990s. As a practitioner, I’d seen too many events that just didn’t fit. But, part of the course introduced me to youngish new area of behavioural finance and economics and I’ve spent the last 18 years devouring everything I can learn about the topic, about people, and about markets. It’s increased my understanding of how economies and markets work and it’s made me and those I work with quite a bit of money over the years as I applied this to my trading and investing.
So I am on board when Chloe Pfeiffer reports that one of the fathers of behavioural economics, Richard Thaler, explains that the Brexit vote is a good example of individuals diverging from this kind of purely rational behaviour economic and finance theory suggests.
“Standard economics would think that voters would be making the kind of calculation that the op-ed writers and the Wall Street Journal or the Economist are doing — crunching a bunch of numbers and saying the pros and cons of being in the EU and so forth and so on,” Thaler said. “You know, if you can find a hundred voters in Britain that have made that calculation, I’d like to talk to them.
Rather the decision won’t be analytical on the Leave side, he said, “people behind the Leave campaign are voting with their guts. There’s no spreadsheet.” It’s also why the murder of Jo Cox has and can swing the vote back toward Remain. Emotion – not in the models but front and centre of decision making in uncertainty.
6. When Brexit is done, and we get back to focusing on the global economy, Mohamed El Erian says we need a ‘Sputnik moment’ or ‘something really bad is going to happen’. The world is stuck in a low growth environment, according to Allianz’s chief economic advisor. Bob Bryan reports El-Erian says something needs to get done to help fix the economy and it’s going to need a spark like the West’s recognition that the Soviets had launched the Sputnik satellite to galvanise resolve and get people working together.
He’s right, but I’m not holding my breath. Which means that El-Erian’s warning that “unless we do something about low and non inclusive growth, then the problem will be multiplied economic, financial, political and social”. YUP.
Key data for the past 24 hours (with thanks to BNZ markets)
RBA minutes – not Dovish!
GE: ZEW survey of expectations, Jun: 19.2 vs. 4.8 exp.
Fed’s Yellen “…cautious approach to interest rate increases remains appropriate”.
ECB’s Draghi “…inflation dynamics in the euro area remain rather subdued”.
You can catch me on Twitter.
And now from CMC Markets’ Ric Spooner is today’s Stock of the Day
CYBG PLC (CYB: ASX)
This chart reflects the stance that markets have taken leading into the Brexit vote. CYBG is the recently listed holding company for the Clydesdale Bank and Yorkshire Bank brands. These were recently spun off from NAB. CYB is listed in London but the ADR can be traded on the ASX and the majority of shareholders are Australian.
The stock has basically unwound most of the Brexit risk premium over the past 3 days. The market is positioned either for a remain vote or for the likelihood that reaction to a leave vote will be negligible. If they are wrong, there could be a significant sell off.
These UK banks have a largely domestic and retail customer base. “Brexit” is not likely to make much or any difference to business, certainly in the short to medium term. However, for Australian shareholders, the immediate risk is a sharp decline in the Pound against the Aussie Dollar. This would be a negative for the $A share price.
Yesterday, CYB stopped neatly at the 78.6% Fibonacci retracement. A continued rally from here and past the recent peak at $5.86 would be a positive development. A peak here would be a warning sign, carrying the possibility of a decline into the major price gap created by the company’s profit report a month ago.
Ric Spooner, chief market analyst, CMC Markets
You can follow Ric on Twitter @ricspooner_CMC