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Five tips for traders in the second quarter

THE first quarter of 2010 was a rocky one. We had confirmation that the British economy exited recession in the last three months of 2009 but political polls increasingly pointed towards a hung parliament come the general election. The Eurozone suffered dreadfully from the Greek fiscal crisis and fears grew that its woes could spread to other Club Med countries.

Yet despite this poor macroeconomic backdrop, equities continued to march steadily higher with a number of developed market indices at or past pre-Lehman levels. As we progress through the second quarter of the year, the election in the UK, the success or otherwise of the Greek support scheme and, of course, policy moves in China should be watched by all contracts for difference (CFDs) traders. We look at what the next three months might hold for the macroeconomy, fixed income, commodities, equities and currencies.


BONDS:
Gary Jenkins, head of fixed income at Evolution Securities, says there are two main risks for the bond market in the next quarter: firstly, whether or not sovereign nations can fund themselves adequately, and secondly, the strength of the economic data.

The best environment for bonds to flourish is one of economic stability, says Jenkins. “If the economy starts to show signs of recovery and there is no rush to raise interest rates, then there are conditions for companies to recover and fixed income to do well.”

The corporate bond market has performed well over the past 12 months, and even though Jenkins expects demand for corporate bonds to ease, the sub-asset class should continue to do well this quarter. “The problems don’t lie with the companies – they lie with governments,” he says. Although Jenkins says that corporate bonds are a fashionable asset class at the moment, they are still affected by fears surrounding sovereign corporate risk: “When fears about Greece have hit the markets then credit has sold off across the board.” This quarter will herald more uncertainty for the sovereign debt markets: “The bond vigilantes are back and they are watching the markets very closely,” says Jenkins.


MACRO:
The second quarter will be pivotal for global growth. According to Saxo Bank’s leading economic indicators, signs of weakness are developing after a strong rebound in the past 12 months. Inventory building by US companies has contributed strongly to growth since the second half of 2009, however Saxo Bank argues that weak business activity will fail to ignite further re-stocking later this year. Coupled with a double dip in the housing market, the growth outlook for the US looks constrained in the coming months. Saxo Bank says that the signs point to weak but positive growth for the Eurozone and the UK as both regions start on the long road to fiscal recovery. In Japan domestic demand is likely to remain constrained, but deflation could be a boost to growth. “Deflation and Japan go together like ying and yang,” according to Saxo Bank. But lower prices make it less likely that the Bank of Japan will raise interest rates, keeping downward pressure on the yen, which should boost Japan’s exporters and feed into economic growth.

So far the strength of the markets are pointing to a continued recovery in the global economy, but there are some caveats to remember. Growth in the economic powerhouses of the US and China has supported the global economic recovery. But there are risks of a slip-up, especially if the Chinese authorities and the Federal Reserve in the US tighten monetary policy too far and choke off growth.


COMMODITIES:
The commodity markets have kicked off the second quarter with an inauspicious omen: a death cross on the Commodities Research Bureau (CRB) index. This happens when the 55-day moving average crosses below the 100-day moving average and suggests that the price will fall further. There are many factors that could hurt commodities this quarter.

Firstly, a hawkish Fed could put upward pressure on the US dollar, which often triggers a degree of weakness in commodities, says James Hughes, market analyst at CMC Markets. The inverse relationship between the dollar and the oil price means that when the dollar increases in value oil, which is priced in US dollars, tends to fall. So if dollar strength continues this is bad news for the oil price. Secondly, commodity markets will be sensitive to any signs that China’s growth is struggling, which would weigh on global demand for oil and gas.

Precious metals have underperformed in line with a stronger US dollar. The gold price has failed to break above its 2009 high of $1,200 per ounce. It has hovered around the $1,100 mark since the start of the year. Saxo Bank remains bullish on the gold price for the medium to long term, as central banks in China and India are buying up the precious metal, which should support its price during this quarter.


EQUITIES:
Equity investors have just enjoyed four straight quarters of gains but the question is now whether they can make it five. Momentum is certainly behind stocks right now – the Dow is currently trading near the 11,000 mark and the FTSE 100 has moved beyond 5,700.

Whether equity markets can continue to make further gains will depend partially on how governments move to tighten policy. If we see a hike in interest rates or a withdrawal of some quantitative easing, then this could reduce risk appetite and induce another leg lower in the equity markets over the next quarter. However, the second quarter earnings season will equally be a factor that contracts for difference (CFDs) traders need to be watching out for. The consensus forecast is currently for a 30 per cent increase in earnings-per-share in 2010, well above the historical average of 19 per cent growth following a cyclical trough in earnings.

Evolution Securities’ Philip Isherwood says: “Investors should be prepared to take on some forecast risk at this point in the earnings cycle. Yes, analysts may be too optimistic, but the earnings cycle is too powerful to ignore. Our strategic call is that the cycle will gain force, belief in it will build, and that investors should be looking through the macro-political noise and should be backing equities and cyclicals going forward.”


FOREIGN EXCHANGE:
Currency markets are notoriously reactive to macroeconomic events and there are plenty of those happening over the next quarter. The big event here in Britain is the general election, but sterling appears to have largely priced in the worst-case scenario, says Bank of New York Mellon’s Simon Derrick. As a result, he sees a distinct possibility that the pound will be significantly stronger against the euro by the end of June, although he reckons that it will be unchanged against the dollar.

And while some progress has been made towards a solution for Greece, Derrick is sceptical given the poor demand for the Greek bond auctions last week – the first was only covered 1.4 times and in a subsequent surprise auction some bonds remained unsold. The euro could therefore fall to as low as the mid to high $1.20s against the dollar.

But the biggest theme for the currency markets over the next three months lies slightly further afield. There has been renewed speculation that the Chinese will move to refloat the renminbi after keeping a de-facto peg with the US dollar. With US mid-term elections looming in November, the Chinese would want to move either before September to avoid currency policy becoming a US election issue or wait until the new year.