Contrary to what we have been led to believe by the press of popular opinion and the recent behavior of major market indices like the Nikkei and S&P 500, the average listed stock in the world is trading well above its early July lows. To add a positive spin, many sentiment indicators suggest that the crowd is as fearful as it was in March 2009. Evidence suggests that the next move of significance will be to the upside rather than downside.
Yes it is more than just a little bit scary out there if you are long equities. The constant barrage of doom and gloom commentary by bloggers and the press of popular opinion is starting to give me shell shock, and I thought I always had a strong constitution. Well, strong enough to resist the plight of attention seeking bloggers and journalists. It is times like this the emotional human spirit in me suggests that one take to the hills, no further analysis required. But I have been around long enough now to know that running with the crowd is the wrong thing to do (at extremes at least).
How bad is it out there on the front lines, is there evidence of the bulls' defensive line breaking? Let's have a quick look at the Bloomberg World Equity Index. It is a market cap weighted index of some 4500 stocks. It is currently trading some 4.5% above its July lows. It is interesting to note that sentiment indicators are registering the same oversold condition that existed at the end of June. OK, how bad would sentiment get if we saw the Bloomberg World index fall by another 4%? As bad as it ever was in late 2008/early 2009?
They say that you should only worry about significant moves to the downside when there is complacency towards risk. I don't sense much in the way of complacency around here.
Bloomberg World Index
Now what if I took all the components of the Bloomberg World Index and equally weighted them. In a sense, what if I produced an equivalent of the Value Line Index but for the world stock market not just the US. Well, that is exactly what I did and the index looks rather interesting because it looks a lot healthier than the mkt cap weighted Bloomberg World Index (which wasn't looking so bad itself). The "average listed stock" in the world is currently trading above its June high and has a long way to fall before registering a multi-week low. This action is more befitting of a consolidation of previous gains rather than the start of a new prolonged bearish phase.
Bloomberg World Index Equally Weighted
Now let me add some "fundamental" beef. The press of popular opinion is doing its utmost at convincing us that "here we go again" in a repeat of what happened in 2008. Yes, we are off to "re-test" the lows of March 2009. Well not so fast. In 2008 we had a complete breakdown in liquidity/credit conditions. We also had a shock contraction in liquidity (or deterioration in financial conditions) in May. But look at what has happened since the start of July. Financial conditions/liquidity has improved dramatically. I would be very worried about a big move to the downside in equity markets if the chart below was at or very near to its May/June/July lows - of course it isn't.
Bloomberg Financial Conditions Index
But the world economy is slowing down. Yes, well, that is what we are being led to believe with almighty buzz-phrases line "double-dip" and "deflation" being bantered about by anyone and everyone. OK, so if this was what was happening in reality then wouldn't we expect hides, tallow, copper scrap, lead scrap, steel scrap, zinc, tin, burlap, cotton, print cloth, wool tops, rosin, and rubber (to name a few) to be decreasing in value not increasing? Yet they are - the CRB Spot Raw Industrials Index is just a few percentages away from a multi-month high and is absolutely nowhere near a multi-week low. So much for deflation and a double-dip.
So the average equity in the world is trading well above its 3 month low but sentiment is as bad as it was at the lows of May/June; financial conditions are reasonably healthy, certainly a lot healthier than they were two months ago, and industrial commodities are a few percentages away from multi-month highs. This does not look like the start of a retest of the March 2009 lows to me, in fact quite the contrary, this looks like a market setting itself up for a big move to the upside. We can think of no better time to be greedy when others are so fearful.