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Equities Soar, Volatility Drops and Fundamental Questions Deepen

Equities Soar, Volatility Drops and Fundamental Questions Deepen

2017-01-26 05:17:00
John Kicklighter, Chief Strategist
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Talking Points:

  • S&P 500 gaps to a fresh record high while the VIX volatility index drops below 11 - the lowest level since July 2014
  • Emerging markets (EEM) and Mexican Peso jump despite US President Trump's progress on trade boundaries
  • Event risk over the next 48 hours includes US and UK 4Q GDP, Trump and May's first meeting and a list of data reports

Sign up for the live UK or US 4Q GDP coverage and see what other live coverage is scheduled to cover key event risk for the FX and capital markets on the DailyFX Webinar Calendar.

What is the market's tolerance for speculative irrationality? Risk trends soared this past session with the S&P 500 gapping to a fresh record high and the Dow Jones Industrial Average symbolically surpassing the 20,000 mark. The reach for returns grows increasingly dependent on momentum to keep markets stable. Should the trance break, it could easily expose the lack of speculative and fundamental support necessary to fortify a market against serious scrutiny. There is little income, dividend or yield to be had in these markets. Returns are therefore found through capital gains (buy high, sell higher) and fueling this late-in-game run are increasingly dependent on a persistent extension. Yet, there isn't much discount, few dips and no risk premium (VIX hit a 2.5 year low and is near a record) for the short-term speculator to mop up.

Regardless of whether we are evaluating the fundamental drivers that motivate or the market movements that result, it should all be evaluated against the backdrop of speculative reach. A swell in speculative exposure from the likes of US equities, emerging market assets, Yen crosses or high-yield carry currencies will be throttled by the already stretched assumptions of how much exposure the markets already carry. In contrast, there lingers an asymmetrical risk that a crack in speculative confidence can readily turn into an implosion that spreads across the market and drives the markets much further. This imbalance will also warp the catalysts. Trade policies, fourth quarter GDP figures, reports of Chinese financial strain and any number of developments will readily be interpreted for how it was influence by sentiment and how it will in turn drive speculative development.

Speaking of fundamental development, this past week saw impressive moves by both the Dollar and Pound in the FX market. The Greenback's performance was uneven, but President Trump's executive order on his long-avowed wall along the Mexican border solidifies the rise of trade boundaries. The Sterling's climb was more robust - with GBP/USD experiencing its strongest two-week advance since August 2010. This dynamic will be put to the test over the next 48 hours with the UK 4Q GDP due and Brexit Minister set to answer questions in Parliament. Friday, US 4Q GDP is scheduled for release and a planned meeting between the UK Prime Minister May and US President Trump will bring the two most prominent anti-trade candidates together. We discuss the building tension, high profile event risk and trade opportunities in today's Trading Video.

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