This is one of those moments in history where you can see some weakness creeping into markets but you never know what sort of weakness will transpire! Will it be just a consolidation of the recent gains in equity, currency and corporate bond markets……given how far these markets have run we would not be surprised to see some “profit” taking. Or will it be the start of some significant downside which takes the major market indices down by more than 10% over the coming weeks – i.e. a tradable downtrend?
What do we know, and what don’t we know? We know that other investors are convinced that they can predict the future, and we believe that is where our source of profits comes from. Yes it is as simple as that. Because trend following is primarily based on a single piece of data – the price- it can be difficult to paint the true story of what the data really means. Anyway this is our interpretation of the current situation. The trends of equities, the USD Index, and corporate bonds remain clear. However, markets do not move in straight lines for extended periods of time, which is currently the case with the dollar, equities, and corporate bonds. So some correction should not be unexpected, perhaps it is occurring right now. In essence we do not think that this correction will transpire into anything dramatic because risk indicators have not already fallen. Usually prior to significant moves to the downside in equities there is a notable sell-off in:
- high yield currencies (DBV);
- junk bonds (JNK);
- small cap equities i.e. a deterioration in the underling breadth of the market (GWX);
- emerging market sovereign bonds (EMB).
To date there has not been any credible evidence of a flight to “safe haven” securities. OK so this is not to say that it will not happen, all we are saying is that the current behavior in the market is certainly not typical of that which precedes significant moves to safe haven securities.
We don’t know what the future holds but we do know that various inter-market behavioral relationships have been very consistent over time. Let’s hope they remain consistent. Yes we are human and we never lose hope!
This week watch closely the behavior of emerging market bonds (EMB & PCY), junk bonds (JNK & HYG), high yield currencies (DBV & CEW) and small cap equities (GWX & EWX). If there is a “wholesale” breakdown in these markets then we have something big on our hands……..seeing is believing!
Our wealth creation portfolio is up 17.06% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.
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