If the equity market was really bearish then we would expect to have seen a period of weakness in three key “risky” areas of currencies, corporate bonds, and emerging market sovereign bonds. This is because the behavior of these “big three” has a respectable record of leading the behavior of major market equity indices like the Dow and Nasdaq. Let’s have a look to see if there is any credible weakness showing up in these markets”
Emerging Market Sovereign bonds (PCY). Experience tells us that at the first sign of trouble capital flies out of emerging market bonds quicker than one can mutter “here come the bears”. Capital then moves into the relative “safety” of developed market bonds such as US Treasuries. This is a function of the illiquidity of emerging market govt bonds relative to JGBs, Bunds or US 10 yrs. From the charts below there does not seem to be a problem with the ETF PCY or its performance relative to US 10 yrs (IEF). So the bulls are not running from risky emerging market bonds (yet):
Junk Grade Bonds Junk grade bonds are even more illiquid than emerging market sovereign debt and we have found that risk aversion shows up in junk grade bonds before it does in emerging market sovereign debt. We see the weakness that beset the junk grade bond ETF JNK last night however, for the time being at least it is not anything out of the ordinary. We really need to see junk grade bonds below the 33 level before we become concerned of a flight to “safe haven” securities:
High Yield Currencies relative to Low Yield Currencies (excluding the USD) and the Aussie Dollar against the USD Again high yield currencies and the Aussie dollar tend to weaken well before equity markets do. Yes last night did see some weakness in DBV and FXA, however, the up trends have not been broken and furthermore there does not seem to be any breakdown in upward momentum. So for the time being there does not appear to be any change in behavior on the currency front (i.e. the risk trade is still on).
So there is not enough evidence from leading indicators to suggest that equity markets are about to topple over. Yes there is nothing to stop these leading indicators discussed above from falling over from this point forward. However, we don’t like to forecast the market, we don’t know what the future holds….but we do know that markets move in trends and a trend is a trend until proven otherwise. We also know that once macro trends are in place (like what we have now) they last for months rather than weeks which would suggest that we have got quite some time to go.
Until proven otherwise we see the last night’s weakness as a buying opportunity for our favorite trades…..which subscribers can see in our portfolio.
