While we were prepared for a boring week-end with non-event news coming from J.Hole symposium, we have to admit this week-end was very intense in terms of events and news. In order to be short, here is a non-exhaustive list of main events:
- North Korea launched 3 short range missiles but the USA consider it is a sign of de-escalation because it was “only” short range missiles. To be honest, we are rather surprised with this comment…
- A violent Hurricane hit the Texas and this will have major implications for the US economy. Insurance companies and reinsurers will be hardly hit while other industries and refineries will be shut during a couple of weeks. The direct consequence of the shutdown of some US refineries (located in Texas) is a sharp increase in gasoline price. This is not good for the US consumer. On the positive side, we can consider that companies associated to the rebuilding phase (Caterpillar, Home Depot, …) should benefit of this situation. The auto manufacturers should also benefit from this situation because a lot of cars need to be replaced.
- Once again, D.Trump sent some tweets during the week-end. Those tweets were related to the building of Mexican Wall and the end of NAFTA. On top of that, some US media reported that President Trump required adopting tariffs against Chinese products. If this news is confirmed, it could trigger a commercial war between the USA and China.
- M.Draghi didn’t announce any change in monetary policy during J.Hole’s symposium. On top of that, as he didn’t mention the strength of the euro as a problem for the European recovery, some market commentators interpreted this as a sign the ECB is not ready to intervene on the FX market in order to stop the euro strengthening. In this context, the euro continues to strengthen this morning and it is now trading at 1.1930 vs the USD.
- During her speech at J.Hole, J.Yellen talked a lot about the benefits of the financial regulation that has been implemented after the 2009 financial crisis. There is no doubt that her view is in total contradiction with D.Trump’s intention to deregulate the financial sector with the withdrawal of the Dodd-Frank act. So (after her speech), there is now a high probability that J.Yellen won’t be reconducted as Fed chairwoman.
- Even if Brexit negotiations are now out of the radar screen (it seems the equity market doesn’t care about it), the third round of negotiations will start next week and divergences are still very important between the EU and the UK. In this context, it is unclear if an agreement will be found in the near future.
With all these tensions in the market, the gold price is finally breaking above its key resistance at usd1305/Oz. A close above this level would clear the way till the next resistance at usd1350-1370/Oz.
Following a sharp decline in US economic surprises during several weeks, the US economic surprises are now bouncing back (blue line) but remain in negative territory. On the other side, European economic surprises which were highly resilient during the US decline are now deteriorating but remain in positive territory. So, the European economy continues to surprises to the upside but much less than few weeks ago while the US economy continues to disappoint but much less than a few weeks ago.
Following the sharp appreciation of European equities in early 2017, our European valuation score (red line) declined from ‘3’ (neutral) to ‘2’ (unattractive) and it remains at this level this week. So, we can consider that, based on historical price multiples, the European equity market is relatively expensive even if it is much less expensive than the US equity market (in absolute terms).
The US valuation score remains at ‘2’ (unattractive). It is true that the US equity market is trading close to all-time highs while positive earnings revisions are rather limited. This situation implies that the US equity market is getting more and more expensive.
The US 12months forward P/E (PENTM, second chart) is trading at unseen levels since early 2003. The 12 months trailing P/E (third chart) is currently trading above 20 for the first time since 2001 and the EV/Sales ratio is trading at levels close to the ones from the internet bubble (in 2000).
The « bull/bear spread » (blue curve) is going down which underlines that the bearish sentiment is gaining some momentum in the market. On top of that, as the neutral sentiment (pink line) is below 30%, this means the « bull/bear spread » is relevant (when neutral sentiment is above 30%, too many investors are neutral and then the « bull/bear spread” is meaningless). Nevertheless, as the bearish sentiment isn’t extreme at this stage, we can’t adopt a contrarian approach (right now), we still have to wait for further deterioration.
Following a sharp increase in the volatility index (VIX) few weeks ago, this index seems to be (now) in consolidation. As the VIX printed higher lows (blue circle) and higher highs (red circle) there is a meaningful probability we are in presence of a trend reversal. We consider a close above the ‘17’ level would confirm the market environment is changing from ultra-low volatility (around 10) to normalized volatility (range between 15 and 20). If this situation is confirmed, investors will have to face deeper setbacks in the equity market because, usually, more volatility means more and deeper consolidation phases.
The number of companies trading above their 20 weeks moving average sharply declined in recent weeks (grey line). This underlines a major deterioration in the internal dynamic of the equity market. Nevertheless, current levels are not extreme (yet) which means it is still too early to adopt a contrarian strategy.
The number of companies printing new 6 months highs (green line) sharply declined while the number the number of companies printing new 6 months lows (red line) increased in recent weeks. This situation underlines a meaningful deterioration in the internal dynamic of the equity market..
Following the loss of momentum on major European indexes since Mid-May, our European technical score (red line) declined from ‘5’ (strong uptrend) to ‘4’ (uptrend) in June and to ‘3’ (neutral) in July. This week, the European technical score is unchanged at ‘3’ (neutral)
In the USA, the loss of momentum seen on some major indexes (Russell2000, S&P Mid Cap400, DJ Transport, …) reduced our US technical score (red line) from ‘4’ (uptrend) to ‘3’ (neutral).
The Sigma Whole Europe Index remains in its downtrend (blue lines). The index looks in danger and the low end of the trend channel will probably be tested in coming sessions.
The CAC, DAX and the EuroStoxx50 remain above the lows of the North Korean tensions which is rather positive.
The Sigma Whole US Index remains above its major supports (green lines). Nevertheless, it is too early to say if last week rebound was a short term bounce back or the beginning of a new leg up. It is important to keep in mind that Harvey hurricane will have major financial impact on the US economy and both internal (debt ceiling, financial tax reform, …) and external tensions (risk of commercial war with China, tensions with North Korea, NAFTA, Mexican wall, …) are not over. According to some financial analysts, more than 300 companies out of the S&P500 will suffer from negative consequences of the hurricane. In this context, we would not be surprised to notice further selling pressure in the US equity market in the near future.
Despite last week rebound, US indexes remain in danger because most of them are still trading in a downtrend channel. It will be important to monitor the Russell2000 and the DJ transport and to see if they can stay above their major support (have a look at following charts)..
After staying for several months in an environment of low volatility, equity indexes seem to become more nervous. The factors justifying this increase in volatility are of course the tensions between the US and North Korea but also the tensions within the Trump administration itself. The financial consequences of Hurricane Harvey in the US will also have a significant (negative) impact on the US economy. In Europe, the strength of the euro continues to cause fear of a significant loss of competitiveness for European companies on international markets and the European indexes therefore (logically) suffer from this situation. Moreover, in a context of tight valuations, deterioration of economic surprises and a climate of high complacency of investors (reflected by low volatility), a market decline seems inevitable. The question is not whether such a decline will take place but only when it will take place and what the trigger will be. In this context, we maintain a highly defensive profile (with a large portion of cash) because we consider that the risk vs expected return is not at all favorable at the moment and we fear further increase in volatility in coming weeks.