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USD is tracing out a potential larger corrective rally

A rather sidesway and lacklustre performance seen in the major US stock indices overnight except for small caps stocks where the Russell 2000 staged a bounce of +1.72% to 2,195 due to short-term oversold conditions from momentum technical indicators. Modest losses were seen for the rest; S&P 500 -0.32%, Nasdaq 100 -0.53% and Dow Jones Industrial Average -0.31%.

On a broader perspective, market breadth on the NYSE has improved from yesterday levels where advancing stocks outpaced declining stocks by a ratio of 1.72 versus 0.50 seen yesterday. In addition, a positive observation was seen in the performances of the financials stocks where they recovered from yesterday’s sell-off triggered by the fear of a contagion melt-down in the financial system due to the massive $20 billon margin call triggered by several major investment banks to close the leveraged equities positions of Archegos Capital. The S&P Financials sector was one of the outperformer that recorded a gain of +0.72% and the more narrower focus SPDR S&P Bank rose by +2.19% versus yesterday’s losses of -0.93% and -2.59% seen respectively. Hence, the expectation of a systemic risk posed by Archegos Capital’s losses on its leveraged positions has been negated for now.

From its current all-time high of 2,360 printed on 15 March, the Russell 2000 has staged a decline of -11% to hit a low of 2,100 on 25 March, the worst performer versus the rest (Nasdaq 100 S&P 500 & Dow Jones Industrial Average) as compared over a similar period.

2 possible explanations for its on-going weak performance; firstly, due to end of Q1 portfolio flows adjustments as prior winning stocks positions tend to be trimmed down ahead of quarter closure. The Russell 2000 is the star performer if we take into account its accumulative performance since start of Q4 2020 where it has recorded a stunning gain of +43.3% and a peak of +53.6% (on its current all-time high close printed on 15 March. Secondly, most firms that formed the component stocks of the Russell 2000 have high gearing ratios which indicates that their respective debt servicing burden will be higher if cost of funding increases that can erode earnings. Hence given the long-term risk-free rate (the US 10-year Treasury yield) has jumped significantly since the start of 2021 from 0.91% to a high of 1.77% seen on 30 March. Therefore, it implies that future cost of funding will increase significantly for these component firms of Russell 2000 that lead to lower expectations on their share prices to stage a similar magnificent rally of +50% in the next six months.

Moving on to the foreign exchange market, the US dollar has continued to gain strength against the major currencies where the US Dollar Index rose by +0.38% to close yesterday’s US session at 93.30 that has surpassed close to a 3-month high of 93.20 printed on 11 November 2020. The current up move seen in the US dollar has been supported by yield spreads expansions where the 10-year US Treasury yield over the 10-year Japan government bond has increased to 1.64%, a pre-COVID level not seen since early February 2020. Similar observation can also be seen in the yield spread over the 10-year German Bund where it rallied to 2%. Technically speaking, the US Dollar Index still has leg for further potential upside as its price action has evolved into a larger corrective rally to retrace the entire major downtrend phase from its 20 March 2020 high of 102.99 to its 6 January 2021 low of 89.20; the next resistance to watch will be at 94.50/70.

Over to Asia, we have a double dose of positive economic data out from China. NBS Manufacturing PMI for March increased to 51.9 from 50.6 (February) versus 51.1 (consensus). In addition, NBS Non-Manufacturing PMI for March increased to 56.3 from 51.4 (February) vs 51.9 (consensus).Growth in China’s manufacturing sector for March surpassed the previous two months while the services sector growth for March grew at its highest pace in the past three months. Therefore, the weak seasonality factor from January to February has abated.


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