Are Markets Looking Overextended?

It’s been a mixed start to trading again on Tuesday and US futures are pointing to similar moves ahead of the open, a sign that markets are starting to look a little overextended.

The rally in equity markets has been very gradual and relatively uninterrupted over the last couple of months, leading many to question whether a correction of some kind is both warranted and healthy. Despite another strong earnings season, the rally has stalled which suggest we may now be a levels again that investors can’t justify going far above, which may leave them susceptible to a pull back, even one that isn’t particularly large.

After getting off to another tough start on Tuesday, driven primarily by increased political risk and Brexit concerns, the pound suffered further losses as CPI data fell short of market expectations and those of the Bank of England. The central bank earlier this month raised interest rates after inflation – which it claimed would peak above 3% in October – rose above the level that policy makers would tolerate, even in these exceptional circumstances.

However, with inflation having not risen as much as anticipated, the question of whether the BoE acted prematurely will likely be raised given the uncertain economic backdrop and significant headwinds facing the economy. The pound slid further after the data showed inflation rising only 3% last month – 2.7% on a core basis – although interestingly, it still remains range-bound against the dollar, euro and yen, despite the political risk, dovish rate hike and the data.

Another event today that had the potential to rattle the pound, as well as the greenback, euro and yen, was the panel discussion that took place in Frankfurt involving Janet Yellen, Mario Draghi, Mark Carney and Haruhiko Kuroda, the heads of the Federal Reserve, European Central Bank, Bank of England and Bank of Japan, respectively.

While the participants did discuss aspects of monetary policy, they avoided saying anything that caused any shock moves in the currency markets, which was possibly aided by the fact that they all recently made policy announcements and any near-term changes – i.e. Fed rate hike in December – are almost entirely priced in. While more clarity is always sought on medium to long-term policy changes, there was clearly no need or desire to say anything on this, with the heads instead reflecting on the challenges and lessons from monetary policy having ventured repeatedly into uncharted territory since the financial crisis.

While there’s plenty of data coming from the US this week, Tuesday – as was the case on Monday – will be very quiet on this front. PPI data for October is the only notable release today and this typically doesn’t have a great impact on the markets. The most notable release today may be the crude inventory data from API which acts as a precursor to tomorrow’s EIA release and comes as oil prices trade around a more-than two year high. Further drawdowns may well continue to support the rally although having already risen significantly since the summer, I do wonder how much higher prices can go before output starts to rise again, particularly from US shale companies.