The market gets a whiff of bullish news and stocks rocket like there is no tomorrow. We are now stating the somewhat obvious now that stock markets are looking bullish…..perhaps what is not obvious is that there is still considerable more upside in the offering before we have to worry about any bearish moves of significance.
We will be worried about bear moves if there is a divergence between the Value Line Index and the Dow, High yield corporate bonds underperforming investment grade, the USD Index and US Treasuries strengthening, and the ETF DBV falling. Let us have a look at these key indicators of risk:
It does not take a rocket scientist to figure out that the broad market is much stronger than the Dow. This suggests that the font-line troops are feeling much more confident than the generals (that is exactly the situation that we are after).
High yield bonds (junk bonds) continue to outperform investment grade bonds. You don’t buy illiquid junk bonds in preference to liquid investment grade bonds unless you are genuinely bullish (because of the illiquidity in junk grade bonds you don’t want to be selling in a down market because your sell orders will push prices down themselves). Perhaps that is why junk grade bonds turn down well before investment grade when problems in the equity market strike.
US Treasuries have clearly (at least from our perspective) entered a bear market, albeit reconfirmed the bear market that they have been in since the start of the year.
It now appears that the USD (as per the USD Index) is on the verge of breaking below the 83 level which would confirm a material bearish break down. We continue to believe that the USD Index will break below 83 over the coming days and then break below 78 over the coming weeks.
One of our favourite ETFs “DBV” which goes long high yield currencies (out of the G10 currency universe excluding the USD) and by default short low yielding currencies continues to appear as if it is in a bottom formation and that the next move of significance will be to the upside.
We include one more chart as well…….the performance of emerging market small cap stocks (we use the ETF “DGS” as a proxy for emerging market small cap stocks). If you are bearish on the prospects of world stock markets you don’t go and buy emerging market stocks and secondly you don’t go and buy even riskier emerging market small cap stocks – but look at what is happening here, emerging market small caps are taking off, in fact momentum to the upside is accelerating. In our experience one first picks up problems in world equity markets first in small cap stocks particularly in emerging market small caps.
From the charts above we conclude that there is no threat to the upside of the stock market…..everything is confirming each other and that rarely happens!
