UBS: The stock market rally's endgame is approaching and volatility is about to increase

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Even though it’s been a wild eight months since China surprised markets by devaluing its currency, the yuan, and a violent two years of sideways trading, the global macro strategy team at UBS in New York says “the majesty of the 7+ year S&P 500 bull market is frequently forgotten”.

Just last week the bull market in US stocks, which has run for 2,611 days, became the second longest in US history, UBS said.

“Age alone does not portend the definitive end of a Bull Market,” strategists Julian Emmanuel, Omar Elangawy and associate strategists Sibi Gnanasundaram and Patrick Buckley wrote in the UBS report.

But the “signs of the top”are becoming clearer they say.

“A surge in M&A activity in 2015 exceeding the heady days of 1999-2000 and 2007 followed by a lull in deal-making catalyzed by extreme market volatility, ending in the largest quarterly rebound since 1933, from -11.4% to close the quarter +0.8%,” they said.

They also noted that “the first hike (from the US Federal Reserve) in the cycle traditionally being the demarcation point for the countdown to the bull market peak, with an intervening ‘time to the top’ of as short as 8 months to as long as 41 months post the first hike”.

That means Emmanuel and his colleagues aren’t bearish outright here and now. Indeed, they think a new high is likely in US stocks before the peak.

But they do say the shift in leadership in US stocks from utilities to financials “is reminiscent of the last stages of the 1999-2000 bull market top”.

But the problem for the market, and the Fed, is that “the economy stubbornly refuses to accelerate”. That’s problematic given inflation is growing faster than the economy, something usually associated with market volatility, UBS says.

What has been a consistent feature of these periods where Core PCE is greater than US GDP is elevated volatility – greater risk – and in this context we would expect a reversion to the longer run mean in the days and weeks ahead as the uncertainty over Fed policy, BOJ policy, the US economy, and politics, both abroad and in the US, persists and likely intensifies.

That’s exactly the scenario that forex traders are grappling with at the moment. The yen and euro are strengthening at a time when conventional wisdom would say they should be weakening and the US dollar gaining ground. At 106.26 this morning, USDJPY is the weakest (yen strong) it has been since late 2014.

The ASX has already had a torrid time this year. But, after a period of positive economic news and price action, it seems the next bout of 2016’s volatility is about to kick off for stock market traders and investors.

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