Investment Idea

Drones are watching you and the Fed steps aside

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10/02/2020 | 6 min read
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The S&P 500 struggle with its old top. Support is provided from the large capital injections in the market. The underlying concern is estimating the impact that the Corona virus could have on the world economy.

The S&P 500 struggle with its old top. Support is provided from the large capital injections in the market. The underlying concern is estimating the impact that the Corona virus could have on the world economy. From our point of view, the market has underestimated the later factor. But how the stock exchange should respond to the combination of capital injections and future concerns is an impossible equation as the information is incomplete. It is better to see how the market prices in these events and act thereafter, rather than guessing.

China stimulates its fixed income market every day and there is no way to see how big the stimulus is. However, the price chart for the Shanghai Stock Exchange (SSEC) is giving us a hint:

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After a sharp fall, following the opening after two weeks of SSEC being closed, the index has risen for four consecutive days. The formation is extremely uncommon and indicates that someone simply wants the market to rise. This is happening at the same time as the country is being shut down.

While the stock market is rising, interest rates are lagging behind as shown in the graph below. This indicates a buying interest from other actors than the Chines government. The fixed income market does not bet on any quick recovery:

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There is a lot of discussions about how dangerous the Corona virus is and how contagious it is. It seems to have a spread of about 2, i.e. each ill person infects another two people. It is not one of the world's most serious illnesses, but it is 10-20 times more contagious than the regular flu. From spreading exponentially in China, the spread is now more linear. However, this can to a large extent be related to the fact that fewer tests are taken and it seems that many people with less severe symptoms are not reported.

An illustrative example is that Japan took home 565 Japanese from Wuhan and tested all of them, for symptoms. Of these 565, eight were infected but four of the eight completely lacked symptoms. Since these four symptom-free people felt healthy, they would go on with their lives as normal and thus spread the infection.

It is these insights that make China handle the problems most seriously. In some cities only one family member is allowed to go out and shop every fifth day. Other than that, people are only allowed to stay indoors.

For China as a state, the development is very stressful. The censorship is extensive, and the restrictions increase. Drones are used extensively to monitor people making sure they stay at home and wearing masks when being outdoors.

The movie below show an example of how drones urge people to go home.

But the major concern is that the people will rise against the sitting leadership who on top of the Corona virus have difficulty dealing with the United States (Trump) and Hong Kong. The major riots on Tiananmen Square in 1989 were triggered after the popular Chinese leader Hu Yaobang died. He was perceived as the most liberal and in the wake of his death protests arose against the ruling government at the universities, culminating in the riots on the Tiananmen Square.

Many people now point out Li Wenliang as a possible new symbol. He was out early warning about the Corona virus but was silenced by the police. He then died of the Corona virus himself.

China reports low figures for the spread of the infection. At the Johns Hopkins website you can follow the distribution in real time, based on reported cases.

Last week, Professor Robin Shattock at Imperial College in London released a world news when he said he could produce a vaccine within weeks. Now that the dust has settled, he says that the vaccine may be ready this summer at the earliest and probably reach out to the broader masses by late 2020 or early 2021. Already when we saw the first articles, it felt to be a strategic move to raise money to the research.

But one may trade on pretty much everything. JPMorgan has released estimates of the spreading of the virus. The base case shows how many human cases the bank think will be reported in the next month. If there is less it is positive for the market, if it is more it is negative:

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The other big factor affecting the market is the Fed's stimulus. The graph below shows the S&P 500 in red and the Fed's total assets in blue.

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The Fed intervened in the market in September 2019 and began to pour money into the repo market to keep it alive. There is still fierce speculation about who or whom was at risk, but there are several hedge funds that is borrowing cheaply on the repo market and lend on longer maturities. A trade that would have turned nasty if the Fed had not intervened. Such a hedge fund is listed AGNC and the price performance for this fund speaks for itself:

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Since year end 2019, the Fed has begun to downsize the repo market support, as they are obviously no longer needed. This results in a declining trend for the Fed's total assets, which in practice means that the Fed is currently tightening its liquidity.

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Would the world's smartest bank (on paper that is) Fed New York really do such as thing while a potential pandemic is spreading? It is not very likely, but time will tell what is really happening at this trading desk that is the most powerful in the world. Below is one of the few pictures that ever leaked from the Fed New York relatively boring looking trading room.

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We believe, until the market does not prove us wrong, that the Fed is scaling back its support for the repo market so that the banks could return to this market where they trade instruments with maturities of one to 14 days. However, the stimulus continues for longer maturities. Here's what the Fed's balance sheet looks like for T-bills maturing in one year:

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Read more on this here:

As always, it is important to keep an eye on the ball, which in this case is the development of the S&P 500:

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As mentioned earlier, the S&P 500 is struggling with the previous top from January. Even though last Friday´s job figures from the United States were unusually strong, the market still could not break on the upside. This is a sign of weakness and a downwards movement to gain energy. Rising EMA9 and MA20 serves as support levels followed by a rising MA50.

According to Reuters, out of the 71 tech companies in S&P 500, 91 percent has reported earnings above expectation and 84 percent reported sales above expectations. This makes tech the top performing sector on the New York stock exchange. Also, the tech-heavy Nasdaq has managed to establish itself above its previous top from January:

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However, the Friday´s job figures did not inject enough optimism for a new all-time-high. Rising EMA9 and a previous top from January serves as support on the downside.

Copper – a good indication for GDP

The development for copper is a better indicator of what the market believes about GDP development than what the stock exchanges provides. This is as the stock market is more affected by the inflow of money.

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As can be seen in the graph above, copper has managed to find some sort of bottom. This has occurred after China made it clear that they are willing to stimulate both the stock market and the lending market to dampen the economic effect of the Corona virus. Nevertheless, the question on whether this is enough remains to be seen. Probably more and larger injections will be needed.

Copper weights on Boliden

Below shows the relationship between copper and the Swedish share Boliden, YTD. If copper continues to weaken, the Boliden stock is likely to move in the same direction and vice versa.

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The Bolden share is trading below its moving averages pressuring the share downwards towards the first support level around SEK 231:

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A break below the support level and the sight down towards SEK 214 is relatively free. Keep an eye on commodities and copper.

OMXS30 above its previous top but may need a setback

According to Reuters, 86 percent of the OMXS30-companies has reported their Q4 2019 figures. Out of those, 63 percent has managed to beat revenue expectations. Only 42 percent beat earnings expectations compared to the 50 percent that missed earnings expectations. Index-heavy sectors such as financials and industrials performed better than the OMXS30 overall.

The Swedish OMXS30 index has also managed to establish itself above its previous top from January:

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Job figures from the United States also affect the Swedish market. Once again, it is a signal of weakness that Friday´s unusually strong figures did not manage to lift stocks. The previous top from January serves as first level of support.

Weaker SEK could give a boost Swedish stocks

As the concerns about the economic effect of the Corona virus still linger, demand for the US dollar can increase as a secure haven. This is while smaller currencies such as the SEK tend to see a fading demand when there are uncertain times. A weaker SEK is does however boost earnings for some Swedish stocks.

Below shows the currency pair USD/SEK. As can be seen the pair is testing a previous top from January. A rising EMA9 is supporting from below. A break to the upside and the next level can be found around 9.7. A break of this level and the sight up to 9.83 is relatively free:

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Another European index in need of new energy

The previous week was a good week for the German DAX index as well. MACD has generated a buy signal. A setback may once again be needed for new energy to be gathered before the previous top from January can be tested:

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MA20 and EMA9 serves as first level of support followed by MA50.

New CEO in H&M but can gap be closed

H&M assigned a new CEO in the form long term employee Helena Helmersson. Previous CEO Karl-Johan Persson takes on the position as Chairman of the Board. Sustainability issues are likely to get even more attention from the retail giant from now on.

The H&M share gapped up on the news, but momentum is fading. EMA9 is keeping the stock up. A break on the downside and the probability for the gap to be closed increase significantly:

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This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capital protected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.


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