David Morrison

Senior Market Strategist

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Weekly look-ahead

By David Morrison  |  12/01/2018 16:50
”bullmarket”/
This article considers the recent price action in stock indices, FX, crude oil and gold and what to look for in the coming week.

Stock indices

Last week brought a succession of fresh record highs for all the major US indices and the UK’s FTSE100. The situation for European indices was more nuanced with weekly gains for some, but with a notable sell-off in the German DAX. The latter struggled even as Chancellor Merkel managed to cobble together a coalition with her old partners the SPD. This means that Germany should have a workable government for the first time since the general election in September. The trouble for German corporations is the current strength of the euro. There are concerns that this will damage the competitiveness of exporters, depressing sales and hurting earnings.
Meanwhile, the fourth quarter earnings season is underway with investors anticipating this will provide yet more ammunition for another push higher in US equities. The majors continue to post fresh record closes on an almost daily basis now with the latest leg of the rally coming in the wake of Trump’s tax reforms which passed through Congress last month.
Earlier in the week the US majors had a slight wobble following a report that China was considering halting purchases of, or even selling, US Treasuries. But even before the news was effectively dismissed by the Chinese authorities, investors had piled back in to “buy the dip” once again.
For now, the momentum is all to the upside. Traders continue to disregard warnings that the market is seriously overvalued. At the same time low volatility is disguising dangers inherent in the current frothy environment. Investors are still prepared to extend their exposure to stocks even as developed world central banks withdraw the monetary stimulus which boosted risk assets in the first place.

FX

The US dollar came under intense selling pressure last week. On Friday news that German Chancellor Merkel had managed to put together a workable coalition government saw the euro fly higher. After numerous failures, the EURUSD finally broke above significant resistance around 1.2100 to trade at a three-year high. The move followed on from gains made in the previous session after the release of a hawkish set of minutes from the last ECB meeting. The central bank was upbeat in its assessment of the Euro zone’s growth prospects and hinted that it may look to speed up the reduction of its Asset Purchase Programme, currently running at €30 billion per month until September this year.
The break of upside resistance on the EURUSD together with a retest of support around 91.00 on the Dollar Index raises the probability of further dollar weakness to come. However, traders will want to ensure that this isn’t a false breakout before adding to their short dollar exposure. It’s worth noting that US Treasury yields are holding on to gains made last week. This is despite China’s State Administration of Foreign Exchange (SAFE) rejecting a report from Bloomberg suggesting that China was considering halting, or even reversing, its purchases of US Treasury bonds. Higher US Treasury yields generally help to support the dollar.

Crude oil

WTI and Brent crude were a touch softer at the end of last week. The move lower looked like little more than profit-taking after both contracts hit their highest levels in over three years on Thursday. The sell-off was relatively mild and contracts managed to hold on to most of the gains made earlier in the week. So the rally which began in June continues for now. It even accelerated at the end of October once prices smashed through a band of resistance that built up in the first few months of last year.
This week WTI (which is the more technically-traded of the two contracts) broke above another strong band of resistance – this time one which held in place through May and June 2015. This saw the front-month contract top $64 while Brent briefly popped its head above $70. If WTI can continue to consolidate above $62.50/63.00 then further gains look possible, although it’s fair to say that the rally is now looking a bit long in the tooth.
Fundamentally, crude continues to get support from a number of sources. Global demand growth is expected to accelerate now in line with a forecast pick-up in GDP across the US, Europe, China and Japan. At the same time the OPEC/non-OPEC production cut continues to reduce stockpiles. However, there’s been some speculation that Russia wants to lift output as soon as global inventories hit their 5-year average, which could be as early as the second half of this year. But last week the UAE energy minister said OPEC would commit to production cut deal for all of 2018.
There had been an expectation that US shale output would rise sharply once crude prices bedded in above $55. But although US production is already at its highest level since the early seventies and is expected to top 10 million barrels per day this year, US inventories have now fallen for nine successive weeks.

Gold

Gold began last week on the back-foot as sellers rushed in to take advantage of the precious metal’s sharp rally since mid-December. But the sell-off reversed quickly following a report from Bloomberg suggesting that China was considering halting, or even reversing, its purchases of US Treasury bonds. The news led to a sharp sell-off in equities and other risk assets and a rush into safe havens such as gold and the Japanese yen. China’s State Administration of Foreign Exchange (SAFE) was quick to rubbish the Bloomberg report. SAFE insisted that its investment in US government bonds is based on market conditions and its needs, adding that it always diversifies its investment of FX reverses. These comments proved more than enough to calm equity traders. But other market participants (particularly investors in US Treasuries themselves) were more cautious and US bond yields remained elevated. Despite this, the sell-off in the dollar gathered pace through to the end of the week. On Friday the EURUSD broke above significant resistance while the Dollar Index dipped below support around 91.00. This was enough to encourage buyers to rush back in to drive gold to a four-month high above $1,330. Gold looks a touch overbought around here, although there’s some decent support around $1,310 – the 61.8% Fibonacci Retracement of the September-December sell-off. But as last week, further gains are currently dependent on continued dollar weakness. 
 

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