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Peak optimism in risk assets? Maybe not yet.

Most of the US stock indices took a day of breather yesterday after six days of winning streaks. The S&P 500 and Nasdaq 100 recorded modest losses of -0.1% and -0.06% respectively. On the other hand, the Russell 2000, the barometer for smaller caps stocks powered on with a gain of +0.40% to post another fresh all-time high record close of 2299.

Market breadth has remained healthy where the number of advancing stocks in NYSE and NASDAQ outpaced declining stocks by a ratio of almost 1.4. In addition, performances seen in the 11 S&P sectors are not indicating a clear start of a potential medium-term bearish reversal at this juncture. Even though, the Energy sector took a hit of -1.52%, the worst sector performer but yesterday’s dismal performance may just be a blip after it saw an accumulated gain of +10.8% in the past four days.

Given the on-going risk-on behavioural traits seen among market participants and even corporates where Tesla (its CEO being the richest man in the world now) has announced via a SEC filing on Tuesday that it invested in US$1.5 billion in Bitcoin and would soon accept it as a form of payment for its electric cars. Hence there is a heightened debate there is going now whether we have reached peak optimism for risk assets or “this time round is different and there is no alternative” narrative continues to plough on.

There are two key factors right now that are supporting the risk-on narrative. Firstly, even the US Treasury 10-year yield has been rising since December 2020 to a hit a high of 1.17% on February 8, a level not seen since 19 March 2020, but global liquidity has remained abundant. As seen from the BofA/Merrill Global Financial Stress Index that measures cross market risks, hedging demand and investors flows has continued to inch lower below the zero level and a median level of 0.26 which indicates stress in the financial system has not reached an elevated level that may derail the current bullish tone see in risk assets.

The second factor will be the potential start of another impulsive down move sequence within a major downtrend phase of the US dollar in place since March 2020. The corrective rebound seen in the USD against other major currencies since January 6 is likely to be over. From a technical analysis perspective, the US Dollar Index has broken and recorded a daily close of 90.43 in yesterday’s US session below the 90.70 ascending trendline support that has connected a series of “higher lows” since January 6 low of 89.20. In addition, the USD/CNH (offshore Yuan) has declined for three consecutive sessions since February 5 and right now it is attempting to retest the 6.40 major support where downside momentum has revived. Thus, the USD/CNH may soon stage a bearish breakdown below 6.40 to open up scope for further USD weakness ahead. Since Q4 2020 the movement of the USD has a high indirectly correlation of around -0.90 in comparison with global stock markets and if the USD continues to weaken and kick-start another impulsive down movement, it is likely to support the current bullish tone seen in global stock markets.

Hence, we may not have reach peak optimism yet, enjoy the ride till it lasts but with proper risk management techniques.

Chart of the day – USD/CNH

Looks vulnerable for a bearish break below 6.40 major support

Source: CMC Markets