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All posts for the month November, 2016

Let’s quickly dismiss the view that investors learnt from Brexit how to react to the election of Trump. US options are the world’s most liquid and the three month market that we track has consistently shown that President-elect Trump would be a sanguine outcome for stocks. Commentators are falling over themselves after the event to explain why this is, but OTAS has portrayed a consistent message of financial calm.

US Large Cap. Implied Volatility

US Large Cap. Implied Volatility

There have been three notable spikes in implied volatility over the past 16 months. Two of those, which we have labelled China and Recession, took this measure to exceptional levels, as fears mounted that a slowdown in Asia would cause the world economy to crater. The third spike, in the aftermath of the vote for Brexit, saw risk rise to unusual, but not exceptional levels. Politics may have rediscovered Paul Graham’s mantra that “It’s charisma, stupid” to explain which candidate wins a two-horse race, but the market remains firmly fixated on the economy.

By now we all have the received wisdom that Trump is good for certain regulated industries, such as banks and pharmaceuticals and his fiscal policies will mean more inflation and higher interest rates. The perceived riskiness of utilities relative to financials has jumped to unusual levels, last seen just before everyone remembered that Greece was about to default. With a while to wait to find out what Trump really stands for, big banks could be less risky than energy distributors for a while.

Implied Volatilty of Utilities Relative to Diversified Financials

Implied Volatilty of Utilities Relative to Diversified Financials

Central banks may have come to realise that forever easier money does not generate growth, but now they have the perfect foil to allow them to reverse course. Governors around the world have been beseeching politicians to do more to generate growth and the public has responded by electing those who promise to do something rather than nothing. There are incumbents who need to wise up fast. If Renzi’s reform bid fails then he may be gone, and if it succeeds and leads to a German imposed bail-in of bank depositors, then he’ll likely be gone a little later. The French also have an activist alternative to hamstrung mainstream politicians. Keep track daily of the implied volatility of the relevant markets and sectors with OTAS.

The chart of PE for the US top stocks suggests that the post-election move has room to run further and it would take a 7% re-rating to lift the valuation back to the highs of May 2015, when forward PE was last in touching distance of exceptional levels.

US Lage Cap. PE Valuation

US Large Cap. PE Valuation

One piece of received wisdom that is not playing out is that Trump will be unreservedly bad for trade and hence China and Emerging Markets. Mexico has taken a kicking, but perceived risk among China Enterprise stocks is almost unchanged. Once again it is fears of economic slowdown that floats this boat and clearly investors are not worried about a slowdown at present. Perhaps they believe that China wins relative to Mexico.

China Enterpise Implied Volatility

China Enterpise Implied Volatility

UK media is fretful the economy will suffer from trade restrictions. It is not obvious why Trump would single out the UK for harsh treatment when everything he has said points the other way and the immediate stock market weakness is likely to be currency related. The financial community in the UK is too savvy to confuse its own post-Brexit well-being with the health of the economy, when the opposite may be true. Keep an eye on implied volatility in the UK and be prepared to buy when threshold levels are reached. Threshold low PE ratios are also approaching.

One more thought going back to our blog of October 17, in which we argued that insurance stocks would be back in business once interest rate rises were on the cards. It may take a while for recalcitrant European central banks to get it, but the valuation of US insurance stocks in the last couple of days reinforces the conclusions we drew about what happens when they do.

US Insurance Sector PE Valuation

US Insurance Sector PE Valuation

After years of impasse, when the conclusion of culture wars rather than the economy occupied politicians, there are signs that activism is bringing markets to life. People worry that cultural change will be reversed, but let us hope that politicians and central bankers focus on the most important task of restoring growth for the benefit of all.

The OTAS Microstructure stack offers a range of charts which breakdown the intraday characteristics of stock trading, allowing you to visualise potential inflection points and changes in trend which may ultimately affect price behaviour and return. Whilst our Alerts immediately inform you of any extreme outliers across metrics such as return(vs basket,) liquidity and spread our volume analysis provides users granular insight into trade weight and direction bias making it easy to identify subtle changes in order flows.

Two charts which demonstrate this quite succinctly are the Volume(Realised –Mean) and Traded Volume Shares.

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In the example above we can see that from the market open today’s realised traded volume(Chart 2) is significantly ahead of what is typically expected and remains high for the next few hours. To establish who the aggressors were over this time period we can refer to the traded volume shares(Chart 1.)
Here it is observed that sellers were in the ascendancy as the bid volume(blue line) is markedly higher than the offer(pink line) indicating a keenness by them to cross the spread and hit bids.

As the traded volume begins to normalise the directional tilt converges as bid volume slows and offer volume picks up suggesting that the sellers are slowing participation(or coming to the end of their order) and that buyers are increasing their aggression. This could represent a support level for the shares and/or a potential inflection point.

Interpretation of changing volume trend behaviour allows traders to assess the potential impact on price and react accordingly.