Risk Assets Defy Bearish Sentiment

Includes: DBV, JNK, PCY
by: Daily Trading

The beginning of another collapse? Well, reading through blog sites (the best means by which to gauge the mood of the market) would have us believe that it is a foregone conclusion that it is about to happen... Equity markets have peaked out, gold is about to go to the stratosphere along with U.S. treasuries, the Eurozone is on the verge of breaking up, and the USD is going much higher!

The level of bearish commentary is rather intriguing in that it is reminiscent of the depths of 2008! I really struggle to find any commentary that is remotely bullish! It is very bizarre because this level of bearish sentiment is usually found after a dramatic move to the downside not before.......that is, material falls in equity markets are usually preceded by a high degree of complacency.

OK so equity markets have yet to break down (we have yet to see the major market indices close anywhere near multi-week lows, most are only a few percent away from multi-week highs). But what are leading indicators doing, do we see any evidence of breakdowns? Again prior to material downside in equity markets we usually see risk assets lead the bearish charge. Let's have a look at a few indicators outside of the equity market for bearish confirmation.

First let us look at the spread between emerging market sovereign debt and U.S. treasuries. Historically, blow outs in equity markets have been preceded by investors running to the relative "safe haven" of U.S. treasuries. From the graph below we did have a blow out last week. But by hook or crook, the spreads have since come back down... No multi-week high here (a multi-week high would be bearish for equity markets).

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Secondly, has the cost of insuring junk grade debt from default increased relative to investment grade corporate debt? The graph below is a custom index of the U.S. CDS index of investment grade relative to the CDS Index of Junk grade debt. A rising index indicates that it is costing relatively less to insure junk grade debt from default relative to investment grade debt. Accordingly, a rising index is bullish for equity markets. Yes, you could argue that it is topping but as yet there is no breakout. We will believe the breakout when (if) we see it.

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Thirdly, problems in equity markets are usually preceded by a breakdown in the so-called carry trade. The graph below is the DB Currency Harvest Index, the index on which the ETF DBV is based. No breakdown yet, in fact just two weeks ago it was trading at a multi-week high.

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So for the time being at least we have yet to see breakdowns in the very asset classes/securities/indicators that usually precede a general breakdown in the equity market. Given the level of bearish sentiment out there one could argue that if they haven't broken down now they are unlikely to breakdown anytime soon.

A bull market is a bull market until proven otherwise. Yes it is lonely out there being a bull in a sea of bears!

Disclosure: Long JNK, PCY DBV