Is this a pivot/tipping point in world markets where there will be a reversal of what we have witnessed over the last 6 months? We don't know what the future holds but we do know that markets "themes" move in observable trends. Once in place a global theme tends to last for months if not years. For the last 10-11 months at least markets have embraced a "high yield" theme (call it what you will). What we will do now is look for evidence of "cracks" in this broad theme......for evidence that what we have observed over the last 6 months is about to come to a tragic end!
We will approach this question from a number of different angles to try and form an objective conclusion. Now first things first - has the crowd's appetite for risk changed? If the crowd was moving from a risk seeking to a risk averse condition we would see a stampede out of "risky" assets, namely:
- junk grade corporate bonds,
- emerging market bonds,
- junk grade relative to investment grade bonds,
- emerging market bonds relative to US Treasuries,
- emerging market and developed market small caps,
- high yield currencies,
- emerging market currencies,
From the 8 graphs below there is no evidence outside normal market "noise" that would suggest a turnaround in leading indicators of risk taking. Yes, if you are going to see a flight to "safety" you will pick it up first in these charts.
If money is coming out of risky assets it would have to find a home in "safe haven" assets namely:
- the USD
- the Yen
- US Treasuries
- Large cap equities at the expense of small caps
We did have a bounce in the USD Index yesterday and the day before, however that "bounce" was nothing out of the ordinary and perhaps more importantly did not occur at any support level. The next support level lies at the 72 level which is some way off. What relevance a weakening yen has got relative to the USD is open to debate and perhaps just a red herring. More important is the emerging breakout in US Treasuries, particularly the long dated. This behaviour is exciting (yes it is about time they fall over given the recent behaviour of commodity markets) and at the same time it is disturbing because goodness knows what will happen if the US 30 year really starts to crumble! Anyway all that being said there does not seem to be any evidence of a move to "traditional" safe haven markets/assets/securities.
And what about commodities? Is the deflationist camp about to get their day in the sun again anytime soon? Well before we could reasonably conclude that commodities are about to fall on their face/implode we would have to see evidence of the following:
- A breakdown in the CRB in both USD and non USD terms,
- Inflation linked bonds breaking down against non inflation linked,
- Abreakdown in Baltic Freight Rates.
For now at least there does not seem to be any break of the recent trends. Everything seems to suggest that the next big move for commodities will be to the upside not downside and that the 1.6% fall in the CRB last night was merely "profit" taking.
The only change in "trend" has been the breakdown in US Treasuries (although we need to see further downside before we get real excited).
The trade that seems to standout to us from all of this is long commodities and short US Treasuries. What about equities? We are not bearish (yet) but don't know the implications of a falling US Treasury market, so perhaps long stocks with long dated out of the money puts (because vols are cheap) to hedge against Nouriel Roubini being right - yes stranger things have happened!
Disclosure: Long EEM, DBC, TBT, DBV, SLV.
