The greatest crash in modern history is still way too vivid in people’s minds. Perhaps this is why with any sign of weakness that is vaguely out of the ordinary bulls quickly jump the fence to become raging bears. Of course once the weak hands are cleared out of the system the market continues to follow the path of least resistance. We have said many times before that this has been the most hated rally in market history and by the commentary continuing to come through on widely followed blog sites this certainly remains the case to this day.
We think that the big crack on Thursday and again on Friday last week (don’t forget the Russell fell almost 3% on Friday) was the best thing that could have happened to world financial markets. From equity markets, to treasuries, to currencies there were massive downward moves. Now picture this, anyone who had programmed orders to sell (closing longs or going short) on Thursday morning within 10% of Wednesday's close on the major market equity indices would have had their orders triggered. Now I sincerely doubt that the very people/traders/chip monks who had sell orders triggered would have bought back on the subsequent bounce later in the day. And given that the market was down again on Friday they would have remained on the sidelines. That means the market has effectively cleaned out most of the weak hands that entered long positions over the course of the last 6 months or so.
But there is more to it than that. Volatility was not unique to equity markets, it was also equally dramatic in currency and treasury markets. Now few speculative traders holding the AUDJPY will have a stoploss order more than 10% (actually probably not anymore than 5%) away from the level of its previous close. The AUDJPY plummeted some 10% intra-day on Friday which would have effectively wiped out anyone holding the AUDJPY from a short term speculative position at least. Of course the AUDJPY is not alone, dramatic moves in currency markets occurred across the board. We are certain that if the “carry trade” was a remotely crowded trade going into this month it certainly isn’t crowded now. In fact it is probably one of the most uncrowded trades. OK, add to this the volatility that occurred in the corporate bond and US treasury markets. If being short US treasuries was a crowded trade before (as indicated by hedge fund manager surveys) it is considerably less crowded now. Anyway, hopefully you will get my point......the market has effectively purged the weak and meek.
We have been rather bemused as to the proliferation of bearish commentary over the last few weeks. When bear markets are “officially” announced the broad market should have already sold off rather significantly over a multi-week period, or at least broken through key pricing levels. If we look at “pictorial representations” of the behaviour of key asset classes below you will notice a distinct absence of breakouts, in fact most markets (even as of the close on Friday) were less than 10% away from their recent high/low. So if this is the start of material downside in the equities, commodities, high yield currencies and US treasuries yields then it must be up there with the most heavily anticipated sell offs. As any seasoned trader will know, when it comes to financial markets the more something is anticipated the less likely it is to happen.
Any “excesses” that have built up in equities over the last few months have been quickly addressed.
It seems that everywhere that one looks globally signs of inflation are increasing. We have inflationary environments in a number of emerging markets now and perhaps more importantly in China. Just how the US can get away with no inflation for an extended period of time is beyond our simple comprehension.
If markets are genuinely bearish then why have highly risky junk grade bonds not sold off significantly already?
Bearish on commodities? Then what bearish activity are you seeing to justify your assertion? Most commodities are within a few percent of their recent highs - 2% upside in the CCI registers a short term breakout and 4% beyond that a multi-week high (which translates to confirmation of the bull trend).
Gold is at multi-week highs and look at how close silver is to closing above the key $19 level. Precious metals are usually leading indicators for the commodity group as a whole. Unless we need real strong glasses the next big move in precious metals appears to be up.
Bullish on the USD? Well, it has gone nowhere against emerging market currencies since October last year. Yes this could be the part of a topping action in emerging market currencies, but again usually at the first sign of trouble emerging market currencies get pummeled, yet they have held up remarkably well. If this is the start of material downside in emerging market currencies it is very uncharacteristic.
Closely related to the behaviour of emerging market currencies relative to the USD (CEW) is that of high yield currencies relative to low yield (the AUDJPY is part of this ETF). The carry trade is perhaps the best leading indicator of the crowd’s willingness to take risk and it does not look too bearish to us, in fact as of the start of last week DBV was trading at multi-week highs.
There are too many inconsistencies from an inter-market perspective to conclude that the volatile sell-off that beset world financial markets last week is the start of a material move to the downside in equities, commodities, high yield currencies and US treasury yields. We are of the belief that it is just part of a “back-filling” process in an ongoing bull market. Accordingly, any weakness should be seen as a buying opportunity rather than reason to sell.