“Bull markets are born in pessimism, grow on skepticism, mature on optimism, and die of euphoria”
These were the wise words of wisdom from Sir John Templeton. Think back to the extreme pessimism exhibited in global markets in the first quarter. Then the skepticism that prevails to this very day, over the sustainability of the “green shoots” rally, due to a fragile US-economy, beset by rising unemployment and sliding home prices. But now, skepticism is giving way to cautious optimism, with the Dow Industrials reaching for 9,000, up from a low of 6,500 three months ago.
The question remains…….how healthy is current advance in US equity markets (and by default world equity markets). Today we look at five indicators that give us an appreciation of the strength of the current up trend. Not all of these indicators relate to the equity market rather they relate to other markets which have tended to lead equity markets into bear trends/phases in recent months.
The TED spread continues to improve. This is essentially a measure of fear in inter-bank lending. As far as equity markets are concerned it is not the absolute level of the TED spread that is important rather the trend. Junk grade corporate bonds continue to outperform investment grade bonds. So as far as the corporate bond market is concerned a risk seeking (or yield seeking) condition is alive and kicking. We have found that problems in equity markets tend to show up in corporate bond markets well before that is why we pay particular attention to risky corporate bonds.
From an equity market perspective there has been no let up as far as market internals are concerned. Usually the advance decline line falls before the major market indices (like the S&P 500). On the international front, risk capital tends to fly from emerging markets and especially emerging market small caps well before it flies from large cap blue chip stocks. The emerging markets small cap ETF DGS remains in a bullish condition with no deterioration in momentum.
We have noticed that high yield currency markets have led equity markets into bearish phases over the last couple years……and we also know that problems in world financial markets often show up in high yield currency markets first. The charts below give no suggestion outside normal market noise of an impending change in trend.
If equity markets are getting ready to slip into a tradable bearish phase then they are doing a good job at disguising it…..because none of the indicators that have led equity markets into bearish phases over the last few years are giving any indication of a flight from risk capital (i.e. running to safe haven securities). So until we get evidence to the contrary we consider the current weakness as a buying opportunity.
