background image

Equity rally continues but be aware of rising Japanese yields and crowded VIX trade

Equities 5 minutes to read
Picture of Peter Garnry
Peter Garnry

Chief Investment Strategist

Summary:  Equities are higher again today with South Korean equities leading the way. However, the most interesting market to watch right now is Japanese government bonds where the 10-year yield made its biggest move in six years last week and rose again today closing in on zero for the first time since March. This could be the beginning of higher rates and the end of negative rates as central banks recognise that negative deposit rate breaks the credit transmission from banks. In addition the short VIX trades are becoming crowded which is always a bad sign for equity investors of a potential violent move down.


While equities continue their ascent, new signals are brewing beneath the surface ready to change the trading environment. The Japanese 10-year government bond yield is up 28 basis points from the lows in August and is close to break above zero not observed since March. Last week’s move in the key Japanese benchmark yield was the biggest move in six years. Financial markets are generally very noisy so when you observe significant moves like in the Japanese bonds it is a signal to watch. One of our key contrarian views for 2020 is that the negative rates could come to an end as central banks recognise that it makes the banking system impotent and thus breaks the credit transmission mechanism. Higher yields mean that value and banking stocks could be the essential exposure in the portfolio over the next year.

12_PG_1
Source: Bloomberg

As we talk about in today’s Market Call podcast there is an inflection point where higher rates are bad for equities. If we assume no change in inflation expectations, then the rising yields are signs of higher expected growth (real rates go up) and real term premia go up as well. This means that the initial move in yields are not bad for equities as the growth component is larger than the negative effect from the discount rate (nominal rate) as it comes from very low levels. However, as we have seen when the US 10-year yield goes into the 2.5-3% area then growth expectations come down due to high debt levels in the economy but also because the higher discount rate compresses growth stocks valuations which dominate the key equity indices in terms of index weights.

But for now, the higher rates are not negative equities and today’s price action in the leading South Korea equity index, KOSPI 200, was encouraging as the index shrugged off the negative sentiment from yesterday. There are clear signs that things are turning in South Korea with the official leading indicators at the highest levels this year. If South Korea is turning, then the global economy is turning so we recommend everyone to closely watch South Korea and the KOSPI 200 Index.

12_PG_2
Source: Bloomberg

Outside the current positive narrative on global equities there are potentially dark clouds gathering. The short VIX futures trade is becoming crowded again with record speculative positions short VIX futures. One of the drivers is of course the potential roll yield of shorting the front months VIX futures. The chart below shows the current expected roll yield shorting the second front month VIX futures contract assuming unchanged spot (VIX Index). What is clear is that the current VIX slope is attracting many speculators, but these trades always come with a tail-risk of a violent upward move in the VIX Index as we saw in February 2018. So, keep an eye on the VIX curvature as indications of accelerating risk-off dynamics.

12_PG_3

Saudi Aramco is starting its IPO on November 17 allowing investors to begin bidding for its shares. The recent prospectus has left investors in the dark in terms of the size but also pricing range which means that the IPO could get cancelled if investors are setting the price high enough for the Saudi government likings. There are indications that the government prefers a substantial retail investor base in the company allowing an allocation around 0.5% and the rumours are that the final IPO size could reach around 1%. With an estimated total market value around $1.6trn this translate into a free float market value of $15bn which will not meaningfully impact the MSCI Emerging Markets Index or change its composition. The real impact from the Aramco IPO is that it gives a new dynamic and link in the oil market, and a rare quarterly insight into production and return on capital. 

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.