5 Trade Opportunities for the Third Quarter

27 June 2017

Report by Przemysław Kwiecień

David Cheetham
Chief Market Analyst

  • EU50/US500 - could European stocks start outperforming the US on a regular basis?
  • NZDCAD - could we see a turning point as the pair approaches parity?
  • Soybean - deteriorating weather could be a game changer for grain markets
  • Oil - OPEC was unable to prop up prices, but will fundamentals start improving?
  • TRYZAR - could these high-yielding currencies see their fortunes reversed?
Equity Indices: EU50 likely market bias long, US500 likely market short

2017 has been kind to equity markets thus far. The US S&P500 (US500) index increased by 7.7% for the first five months of the year, while the European Stoxx50 (EU50) blue chip index advanced by 6.6%. Around the world in many cases indices are close to all-time highs and valuations remain elevated. The price to earnings ratio for S&P500 companies has climbed to around 24, compared with an average of 18.8 for this decade.

These ratios are not as relatively high for European indices but they also remain well above their average since 2010. Therefore, fundamentally speaking, both these markets could be candidates for short positions but technically we are still looking at upward trends. However, when we look at the relationship between the EU50 and US500 we discover that it is around the lowest level seen this decade. This is a result of a relatively faster growth period in the US economy during the first half of the current decade and the 2011-12 euro crisis that hurt the valuations of European companies. However, the outlook going forward could change as the European economy has accelerated this year, while the US has underperformed. We can see that the EU50/US500 relationship is no longer declining and could have bottomed out. This view is also supported by macroeconomic fundamentals.

Additionally, we’ve not yet seen any major negative impacts from the political uncertainty in the US on the US equity markets yet, even as President Trump faces increasing pressure related to dealing with Russia. This could be seen as leaving little political capital to push forward an ambitious economic agenda. Unless the tax reform is agreed on during the summer, it is unlikely to be implemented in the 2018 fiscal year and this could pose a risk to US equities. Given such a background, investors could consider going long on the EU50 and short on the US500 at the same time.

Source: xStation5

EU50 could be considered cheap when compared to the US500. Source: Macrobond, XTB Research


Commodities: Soybean likely market bias long

Soft commodities like soybean, wheat or corn may not make for as popular investments as gold or oil but sometimes they can be more attractive. Arguably, this could currently be the case for soybean which trades around the lowest level in over a year and less than 10% off the decade’s lows. These lower prices are a function of solid output from South America combined with a moderate demand from China that when combined have pushed inventories higher in United States.

Additionally, the United States Department of Agriculture quite recently projected that soybean yields would be at the record highs. However, the outlook could change. We can already see higher demand from smaller markets this season and it is quite likely that China will be next as demand for livestock feed could increase. US exports prospects are the best in years and while this is yet to show up in weekly sales reports the inventories-consumption ratio is currently at 26%, an improvement versus the end of 2016. The last time the ratio improved it signalled the beginning of a rally. Some concerns over US output have already emerged as well. There are doubts whether the US production will be as strong as the USDA’s forecasts assume. Spring brought excessive rainfalls in the US and that could have hampered sowings of corn and soybean. For that reason, cuts of the US yields estimates cannot be ruled out. However, the biggest chance for the soybean bulls could come from positioning. The net speculative positioning in soybean is the most negative on record, according to the Commodity Futures Trading Commission reports. Historically, a dip below -50,000 contracts often heralded a price rally and we are now close to -80,000 contracts. This means that many on the market hold short positions and very few hold long ones in a scenario often referred to as a crowded short.

Should bullish news occur (ie weather disruptions or higher demand) it could force shorts to cover and spark a rally. To sum up, long soybean could offer a good upside at a reasonable risk.

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Outlook for the Soybean market

Source: xStation5

Soybean prices could rally if weather conditions deteriorate. Source: XTB Research


Currencies: NZDCAD likely market bias short

NZDCAD is often called a commodity cross because both New Zealand’s dollar (NZD) and Canadian dollar (CAD) are, to some extent, dependent on commodity prices of dairy products and oil respectively. This fact is highlighted with a correlation between NZDCAD and a ratio between milk and oil prices which has been at nearly 0.7 during this decade. Milk prices have outperformed oil prices lately, being one of the factors leading the pair close to decade highs, just below parity. These high levels could provide an interesting selling opportunity. First of all, the pair has not been at parity or higher during this century.

While the latest developments in commodity prices have been supportive for the NZD, the commodity ratio is far below levels from early 2016 and could be seen to not have much of an upside itself. Oil prices could soon see support as the OPEC agreement helps balance the market, whereas significant milk output from Europe could limit upside in dairy prices.

From the macroeconomic point of view both New Zealand and Canada present a solid picture with a relatively robust labour market and strong domestic demand in both. In the case of Canada, investors could be concerned with declining measures of core inflation although the country currently boasts better manufacturing performance when compared to New Zealand. Recovering oil extraction supports GDP growth in Canada and that tendency should be continued for as long as oil prices stay close to $45 a barrel or higher.

Central banks are happy with the current state of the monetary policy and while the Reserve Bank of New Zealand is seen as more likely to increase interest rates first, it’s unlikely to do so before the second half of 2018. Therefore from the macroeconomic point of view both countries look similar, maybe with a slight edge for New Zealand. However this is at odds with the relatively high valuations of the NZD versus the CAD. Furthermore, the RBNZ could not be happy with high exchange rate and the currency could be affected by the deteriorating macroeconomic situation in China. Taking all these factors into consideration, traders could consider short positions in NZDCAD for the third quarter of this year.
wykres-2.png

Source: xStation5

NZDCAD could be considered overvalued as the pair approaches parity. Source: xStation5


Commodities: Oil likely market bias long

Despite the OPEC decision to extend its output cut for nine months ending in March 2018, oil prices declined in May and started June in negative territory. Investors seemingly looked through the Cartel’s commitment to focus on rising output from the US and many have decided to take profits from a substantial rally so far in 2016. However, a lowered price could present an interesting buying opportunity.

One of the main reasons that oil prices failed to rally after the OPEC meeting was the presence of elevated expectations going into the event. Speculative positioning was much higher heading into last month’s meeting than ahead of the prior one in November when OPEC was able to deliver a positive surprise to the market and drive oil prices up. Oil bears also point at the continued expansion of the shale industry in the US. The number of drilling rigs has been rising consistently since late 2016 and as the shale industry becomes more efficient, the US output may exceed 10 million barrels per day (mbd) in the second half of the year. However, whilst US production has grown, output in Russia has declined. The latest figures showed production below 10 mbd which reflects an exemplary commitment to its pledge in reducing output. Taken together with impressive levels of discipline amongst the majority of the OPEC members, this agreement could drag the oil market into a deficit in excess of 1.5 mbd in the third quarter of this year.

Simply put, a deficit means more demand for oil than supply and is supportive of price. Although there is an excess of oil inventories at present, especially in the US, we can already see tangible signs of improvement. A seasonal increase in US inventories through the first five months of the year was the smallest in this decade, down from second largest when measured in mid-March. A look at inventories on a seasonally adjusted basis already reflects significant declines with this metric showing that the OPEC agreement has already had an impact on the market. Libya could provide a negative shock to the market as the country seeks an increase in output from the current 750kbd but this has been partly discounted and remains far from certain given political situation in the country. Oil prices could be seen as attractive even at present levels and a decline to around $44 a barrel of Brent (instrument OIL on xStation) could provide an excellent buying opportunity.


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wykres-2.png

Source: xStation5

Oil prices could find technical and fundamental support below $45 per barrel. Source: xStation5


Currencies: TRYZAR long (USDTRY short, USDZAR long) likely market bias long

The Turkish Lira (TRY) and South African Rand (ZAR) are two important emerging market currencies. Just like any other peer from the emerging market segment, they often face periods of significant volatility but unlike others these days - such as HUF and PLN - they offer high nominal interest rates. These rates often attract capital during good times but they also cover higher inflation rates and country risk.

In both countries, political risk has flared up recently. In Turkey, President Erdogan pushed through a controversial referendum granting him powers close to dictatorship. Meanwhile in South Africa, President Zuma dismissed market-friendly Finance Minister Pravin Gordhan in a move that could block much needed reforms in the country. Both markets score poorly on the economic front as well. Unlike Poland and Hungary which flourish off the back of a European recovery or even Mexico that does better than expected, Turkey and South Africa are at the border line of recession. Consumer demand is soft, labour market is weak and manufacturing stagnant.

Having said that, we see compelling reasons why the Lira could do better than the Rand in months ahead. First of all, the TRYZAR cross is close to the lowest levels in this century. This is partly because of higher inflation in Turkey but it does not explain a tumble from 5.5 in late 2015, to just above 3.5 at the time of writing. Secondly, while political environment in Turkey has deteriorated, much of it could be already priced in. Additionally, we could expect more political skirmishes as Jacob Zuma looks to install his wife as a successor when he steps down as the ANC leader at the end of the year.

On the economic front, Turkey could benefit from a European recovery more than South Africa where recession disappointment is still fresh and could exert downward pressure on the ZAR. Furthermore, while all three major rating agencies have similar ratings for Turkey (within the BB - BB+ range) Moody’s sees South Africa two steps higher than S&P and Fitch (both BB+) and has the country on a watch list, so a downgrade is not beyond the realms of possibility. Considering all these factors together, we see good potential and a decent risk ratio on TRYZAR long. To gain such exposure, traders could consider going long USDZAR and short USDTRY.

Source: xStation5

Investors can trade TRYZAR long by matching USDZAR long with USDTRY short. Source: Macrobond, XTB Research

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X-Trade Brokers Dom Maklerski S.A.
A person preparing a recommendation
Przemysław Kwiecień
Other persons participating in preparation of recommendation
David Cheetham
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Komisja Nadzoru Finansowego
Date and hour of preparation of recommendation
16.06.2017 15:00
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19.06.2017 16:00
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XTB clients and potential clients
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Bloomberg, Macribond
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Until target levels are reached or a recommendation is updated
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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with XTB Limited. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with XTB Limited. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with XTB Limited. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.