|
We have a short-term upward bias due to 1) generally favourable liquidity conditions with both decreases in RRP balances and increases in US Reserve balances, with the Fed supporting the market, 2) outsized downward earnings revisions for 4Q23 potentially setting a low bar for negative earnings surprises and 3) a continued “buy the dip mentality” particularly in the tech sector, and following the market’s rebound after a hot CPI print. Nevertheless, we expect returns in the short term to be capped by demanding tech valuations and investor positioning. Although both major US and European indices are trading at long-term resistance levels, it is hard to ignore the forces, namely liquidity, behind the market melt-up since the end of October 2023, even though rate cuts appear to be broadly reflected in investor expectations, both in US yield projections and stock market levels. However, in our view, the Fed’s actions point to its willingness to protect financial stability and in particular, to avoid strains to the Fed’s liquidity system that could emerge on the back of QT, and ahead of the election period, potentially at the expense of reaching its inflation targets. In addition, markets appear to be more focused on the Fed’s dovish turn rather than the macro environment, as seen from the rebound following weakness around the hot CPI print. This leads us to believe that further market upside could be warranted from current levels. Given the continued low-volatility environment and our short-term upward bias on the market’s direction, we see an attractive risk reward in buying Mar 24 calls on the SP500 and SX5E with strikes at 5100 and 4800 respectively costing only 0.14% and 0.18% respectively. |