What Kind of Company Do These Markets Keep?

Holmes is back in Europe this morning, enjoying a well-earned break. It seems as if Hank and his European counterparts were busy as Holmes and Watson traveled back to London, as the past 48 hours have seen a swathe of capital injections and deposit/debt guarantees on both sides of the pond. Macro Man will leave it to others to sift through the proposals; suffice to say that injecting equity capital directly into banks is a far more efficient solution to simply buying turds off of them.

The news has obviously had a beneficent impact on equity markets, and most major indices have put in a year's worth of rally in the span of two trading days. Such conditions are not, ahem, normal, and Macro Man is frankly pretty happy to have risk dialed right down at the moment.

It's said that you can tell a lot about someone by the company he keeps, and the same is true of financial markets. The extreme price moves of the last few days are fairly historic in nature; small wonder, given that a day's price action is what an index could reasonably be expected to gain or lose in a year. By way of perspective, yesterday's rally in the Dow would be in the top half of yearly performances since 1922, coming in 42nd place.

Drilling down into daily data, the recent extreme swings in US equities- both down and up days- are close to unique over the past 80-90 years.

There are essentially two kinds of markets that resemble the last month or two: 1987, and the stock markets of the Great Depression.

Judge for yourself which, if either, is the appropriate historical analogue. Certainly some aspects of the newsflow suggest the latter environment is closer to today. If that's the case, then we should probably expect the sky-high vol environment to continue.

More immediately, where to from here? Macro Man is left scratching his head. The Eurostoxx, for example, has already re-traced nearly 50% of its collapse since the beginning of September. 3 month Euribor, which fixed lower by 8 bps today, has retraced 38% of its move from the same period. Given that the latter has, ultimately, been the driver of the former, it's probably safe to say that equities are now pricing in a lot of the good news. There's still the small matter of a global recession to navigate in the quarters ahead....

Regardless of where equities go from here, it's safe to say that the stress of the past few weeks have created some strange bedfellows. The chart below shows the S&P 500 overlaid with the gold:oil ratio, which in normal may not mean very much but in times of stress represents some measure of the divide between fear and greed. As you can see, there has been a virtual 1:1 correlation between the two in recent weeks.

Frankly, Macro Man isn't sure what it means when equities and gold/oil keep such close company, other than "financial markets have been buggered". Anyone with a deeper insight is welcome to share it....as we begin the stretch run to the end of the year, Macro Man's mind is officially open to new trading ideas...

Comments

[Smarty_Pants:]

In the interests of full disclosure, those were AAA rated turds.

2008 Oct 14 02:48 PM

[Smarty_Pants:]

Fascinating comparisonn of gold:oil vs. spx. What it might mean is anybody's guess.

Is this something you track regularly or just a coincidental discovery?

2008 Oct 14 02:51 PM

[5kDow:]

I think it's always good to look at gold:oil and dow:gold for a long term valuation gage. We're gonna give back our wonderful gains from yesterday, this move was all mechanical and options expiration related.

2008 Oct 14 04:16 PM