City Index Market Watch

<p>Trade around these key market events next week with analysis and insight from our expert analysts.</p>

City Index Market Watch  

 

Key Themes:

Pound weakness gets real as stocks and the economy show signs of stress

October is proving to be a bad month for the pound. We are only half way through, but GBPUSD is down more than 5% already, and it has experienced a loss against all other G10 currencies. In our view we are entering the second phase of GBP weakness. Firstly, we had the initially reaction to the EU referendum result, and the decline in GBPUSD to 1.30 between June and July. After that we moved sideways over the summer months, but things started to change at the start of October. At this point politics, and in particular fears that the government will embark on a “Hard Brexit” and ditch the single market in favour of immigration controls, has unleashed the second wave of a GBP pounding.

Second wave of GBP selling, more ferocious than the first

Overall, this second wave could prove to be more toxic British assets than the initial wave of GBP weakness earlier this year. The sell-off in the pound since the Tory party conference has been sharp and severe, and shows no sign of slowing down. Essentially, the pound is being driven by unstable forces, including news headlines and politics, rather than actual economic data, which has been relatively resilient of late. Thus, if the pound continues to fall on every “Hard Brexit” headline in the next few weeks, then GBPUSD could fall below the $1.20 mark even before the US election.

Sterling triggers Marmite wars

Recent events also suggest that the decline in sterling is having an effect on the real economy. Tesco has said it will no longer stock Marmite and other items produced by Unilever because it wanted a 10% increase in prices. Marmite lovers everywhere can breathe a sigh of relief, we do expect both sides to reach an agreement so the product is likely to return to Tesco shelves very soon, however they need to be prepared to pay for it. The ugly side of a pound devaluation is upon us, and that means higher prices for everyday goods, and an erosion of living standards in the UK.

The Bank of England’s hands are tied

The Bank of England usually reacts to rising prices by raising interest rates, however, the Bank could be out of ammunition to try and bring down costs at this juncture because of the threats to economic growth from weak investment during Brexit negotiations. Inflation has risen its head just at the wrong time, and there may be nothing the Bank can do about it.

Thus, even though UK bond yields are rising, the 10-year UK Gilt yield has risen more than 35 basis points so far this month, they are not able to prop up sterling. Essentially, rising bond yields are a sign that inflation could get out of hand in the UK, and this is bad news for the economy and for sterling.

The FTSE 100 starting to show signs of Brexit weakness

This theme may also impact the FTSE 100 going forward. Typically an increase in bond yields weigh on stocks because of the rising cost of borrowing and a slowing economy. Last week we saw the FTSE 100 hit record highs, however, it failed to extend gains above this level, suggesting that FTSE bulls may start to lose momentum. Another factor that could weigh on the FTSE 100 is UK earnings season, which is currently under way. If, on balance, companies are worried about the economic outlook during the UK’s Brexit negotiations and uses it as an excuse to scale back investing in the UK, then we could see further losses.

Overall, we remain in headline-trading territory, with politics the key driver of UK markets. Watch the bond market for further direction for the pound and the FTSE 100, as bond yields that rise for the wrong reasons could weigh heavily on some key UK assets.

 

Figure 1: This chart highlights the dangers of rising bond yields on the FTSE 100

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Source: Bloomberg and City Index

The dollar is king as the Fed looks set to hike rates and Clinton surges ahead in the polls

We expect the dollar to outperform in the FX space, as the market continues to price in a 67% probability of a rate hike from the Federal Reserve in December. Next week’s CPI data is also important for the buck, if it shows a gradual increase in price pressure, which is expected, then the bar to raising interest rates will drop dramatically.

With Hillary Clinton’s support for the US Presidential race rising in recent days, here’s our view on the how the dollar may react to the outcome of the election. If Hillary Clinton wins the US Presidency next month, then we may see a relief rally in the greenback since it could trigger further gains in Treasury yields, which have been a key support to the US dollar in recent weeks. In contrast, a win for Trump could trigger a flight to safety, including mass buying of Treasuries, which could weigh on Treasury yields, and thus the dollar.

Look Ahead: Indices UK

FTSE 100 needs a more sure-footed record high

What are the chances of the FTSE 100 rallying further in the medium term after, finally, eking out a new all-time high?Ironically, the answer partly lies in the international colour of the benchmark’s money, its single biggest tailwind this year.

Whilst the pound’s 31-year lows have boosted shares of dollar-earning groups that dominate the FTSE, weak sterling leaves the gauge some 6% lower for the year in dollar terms.

The size of that discount may be immaterial for major overseas investors—Britain’s diminished currency is inflating values in financial markets worldwide—but it’s a potential headache for others.

For instance, hedging out the translation effects, perhaps with foreign exchange forward contracts, only makes cost-benefit sense for high-volume investors. Furthermore, the investment case for would-be buyers of individual British stocks will now be most attractive when it is backed by prospects of a speedy sterling recovery. Such prospects seem remote as Britain navigates the largely political phase of Brexit. That is a key reason why the latest FTSE record will not get as much love from investors as previous ones.

For another thing, good cheer wasn’t well distributed among FTSE shares on the day of its new all-time trading high. 34 were below their 200-week moving average, a trend watched closely by traders. Some FTSE shares also traded below that important trend having been among the market’s leaders earlier in the year. They include recovering miners Glencore and Anglo American, which have risen by triple-digit percentage points in the year to date

From a purer technical perspective, the FTSE 100’s weaker close itself, on a record-breaking day, did not bode particularly well, and the index struggled in the days that followed its peak. The FTSE has also caught up with its Relative Strength Index, which began diverging from cycle highs a week before the underlying index followed. Typically, prices which fall into line after diverging from indicators tend to follow-through.

Whether or not the index could soon continue the rally that began when Britain voted to leave the European Union and the pound tanked will be easier to forecast if the index succeeds in remaining above the clear rising trend commencing in mid-June.

A breach of 6,826-6,734—a major resistance broken before the FTSE’s new high and which has now in theory become support—would also reduce the odds of a near-term attempt by the FTSE to etch an even higher record.

 

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Look Ahead: Stocks UK

Burberry shares may be lifted further by currency tailwind

Recent signs of an economic turnaround in China boosted shares of luxury goods groups last week including Burberry, lifting investor hopes that two years of declining sales at the trench coat maker could be coming to an end.

The group’s shares joined a rally by other clothing brands in the UK and also in Europe, with shares of firms generally regarded as being at the luxury end benefiting the most. Burberry profits—derived from revenues which are mostly generated in Asia—are expected to see a strong currency tailwind.

Burberry’s share price comeback has lifted it into the top 5 of Britain’s retail stocks for the year to date, with a rise of 26% by the middle of last week, as investors eye stabilisation of its profit after they fell 10% in its last fiscal year.

The group guided for a £90m benefit on full-year revenues when it reported first-quarter (Q1) trading in July, but the pound has fallen some 8% more since then.

Investors hope the group will upgrade profit guidance when it releases a half-year trading statement on Tuesday, with an eye to improved sales in the Asia-Pacific region, particularly Hong Kong, and with a currency tailwind from the devalued pound.

Thomson Reuters consensus forecasts currently project Burberry revenues of £1.9bn for its fiscal year ending in March 2017, compared to £1.8bn in the year before. Pre-tax profits are seen at £395.31m, down about 5%.

The group saw like-for-like sales in Britain grow by a single-mid percentage in the quarter to 30th June. A similar level of sales growth would be consistent with higher revenues and profits in the full year, and potentially a further uplift for the Burberry share price.

 

Look Ahead: Stocks Asia 

Rio Tinto (ASX: RIO) – Hovering below 55.30 significant resistance with risk of setback

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Key elements

  • The on-going multi-month rally seen in Rio Tinto from the 03 February 2016 medium-term swing low of 36.53 is now coming close to significant resistance of 55.30.
  • The aforementioned significant resistance of 55.30 is defined by a confluence of multiple elements (multi-year descending trendline resistance in place since February 2011, former broken support nowt turns pull-back resistance and a Fibonacci cluster) (see weekly chart).
  • Significant medium-term supports rests at 47.80 (ascending trendline in place since 03 February) follow by 41.80.
  • The movement of Rio Tinto’s share price has direct correlation with the movement in the global commodities market given the nature of its business. The recent rally seen in Rio Tinto has coincided with the 90% rally seen in WTI crude oil from its February 2016 low of US$26.05/barrel. As seen on the correlation chart, the movement of Rio Tinto and WTI crude oil has a high 30-period rolling Pearson’s correlation coefficient of 0.79 which indicates that that movement of WTI crude oil is likely have a significant impact on the share price of Rio Tinto.
  • As seen from the long-term (weekly) chart of WTI crude oil futures, it has rallied into the upper limit of the key long-term pivotal resistance of 51.10 after the recent OPEC’s production cut announcement on 28 September 2016. Technical elements are advocating for a potential medium-term setback/consolidation above the 43.00 support. These observations suggest that the recent rally seen in Rio Tinto may take a pause as well.

Key levels (1 to 3 weeks)

Intermediate resistance: 53.30

Pivot (key resistance): 55.30

Supports: 47.80 & 41.80

Next resistance: 60.00

Conclusion

As long as the 55.30 pivotal resistance is not surpassed, technical elements and cross assets intermarket analysis are advocating for a potential setback for Rio Tinto towards the 47.80 support. Only a clear break below 47.80 (daily close) is likely to open up scope for a deeper decline towards the next support at 41.80.

However, a clearance above 55.30 may invalidate the setback scenario to see the continuation of the multi-month up move to target the next resistance at 60.00.

Charts are from eSignal as at Thurs, 13 Oct 2016

 

Look Ahead: Commodities

Compared to last week when both gold and silver took a big plunge, precious metals have been a little bit more stable so far this week. After that vicious drop, bearish speculators have eased off the gas a little and probably booked some profit on their short positions. And who would blame them given that both metals have tested their technically-important 200-day moving averages? However, the selling for gold or silver may not be over just yet and the pressure could increase further if market participants grow more confident in foreseeing a rate rise in the US before the year is out. These buck-denominated and noninterest-bearing assets tend to weaken when yields and the dollar are both rising. As yields and the dollar are still rising – as evidenced, for example, by the EUR/USD dipping below the 1.10 handle – precious metals could fall further in the coming days.

For gold, you don’t need to squint to know where the key technical levels are. The short-term bias would be bullish if $1265 resistance breaks, which could then pave the way for a run towards the next key resistance at $1300.  Conversely, a break below $1249 support could pave the way towards $1200 or even $1270, which is the 61.8% Fibonacci retracement level against the low in December.

Meanwhile silver has found support in recent days from the key $17.15 level where a bullish trend line meets the rising 200-day moving average. The bounce from this level has been noticeable but not in a meaningful way, not yet anyway. So far, the sellers have been able to hold the price of silver down below the $17.75/82 resistance area.

The final nail for silver could be a potential break below the $17.15 support level. If seen, the grey metal could then quickly drop to the next potential support and bearish target area of $16.25-$16.50. Here, the previous support/resistance area meets the 61.8% Fibonacci retracement against the December low. But silver has not yet broken its bullish trend line or the 200-day moving average for that matter, and for all we know it could start its next up leg from here. Thus a potential bullish scenario here would be if silver were to climb above the $17.75/82 resistance level. In this scenario, a quick rally towards the long-term support and resistance area of $18.40/50 would not come as a surprise to us.

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FX Technical Outlook

Key FX pair to watch is AUD/USD next week

Next week will be a key one for the AUD/USD currency pair due to the sheer number of top-tier economic data from Australia, China and the US. It will all kick off on Tuesday with the publication of the latest CPI inflation data form the US. This could potentially have a big impact on rate hike expectations, and in turn the US dollar. Meanwhile Australia’s treasury will publish on Wednesday its mid-year economic and fiscal outlook, which will include updated growth forecasts. The always-important Australian employment figures will be released a day later on Thursday. We have all that to look forward to. But there is more: China will be releasing some important economic pointers of its own, including GDP and industrial production figures on Wednesday. The Aussie dollar should move sharply on these numbers, given that China is Australia’s largest trading partner. If the latest trade figures, which were released on Thursday of this week, are anything to go by, then China’s economic figures next week could disappoint expectations and potentially cause the Aussie dollar to slump.

So, as things stand, the fundamentals point to a potential drop in the AUD/USD exchange rate. Luckily, the AUD/USD is at a crossroads, which, from a technical stand point, means market participants could just wait for the pair to make its move and take advantage of the break in the direction of the break, without having to keep up with abovementioned fundamental events, though that might be better. As can be seen from the weekly chart, the AUD/USD has struggled to get past the 0.75-0.77 area in recent times which is important to note because this is where the top of the long-term bearish channel comes into play. Thus a potential move lower from here should not come as a surprise. The bears will now want to see the breakdown of the intermediate bullish trend line, which was being tested at the time of this writing at just above the 0.7500 handle. Below here, the prior short-term swing low is at 0.7440 and then there is little further reference points seen until 0.7150, the low from May. These are among our bearish targets for this pair.

That being said, in the very short-term outlook it is possible that the AUD/USD will bounce off that bullish trend line. However for our bearish view to become invalidated we do need to see a breakout from that long-term bearish channel and ideally confirmed by a weekly close above the 0.7700/20 resistance area. If that were to happen then the Aussie could easily rally towards the next psychological level 0.8000.

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