A train wreck in slow motion? One cannot deny the weakness in equities and commodities and strength in US Treasuries over the last two weeks. But do we get bearish based on what we have seen over just two weeks? We are all too aware that the market will do its best to keep weak hands out of the game and to ensure that the average trader (the majority) loses money over the long term.
We can handle volatility, after all that is what trading is all about. What does concern us is if this short term volatility transpires into something a little more dramatic! Certainly at this stage no major levels have been broken across the major asset classes. Perhaps the exception to this is the behaviour of the USD Index but it must be noted that at this stage the strength is due more to the weakness in the Euro than anything else.
What has surprised us is the persistent strength in asset classes that should already have broken down, namely the junk bond market. Is this persistent strength in this market (albeit the fact that it has hardly moved) telling us the real story and that the weakness in equities and commodities is merely just a short term thing? Or will junk grade bonds play catch up to the weakness in commodities and equities? If history is anything to go by the junk grade market usually acts as a leading indicator to the equity market whether or not this time will be different of course remains to be seen but we will refrain from betting against it.
We have been somewhat surprised at the level of bearish sentiment that has crept into world financial markets at a mere 7% fall in the S&P 500. We can only imagine the heightened level of bearishness that would prevail if the S&P were to get down to the 1030 level (support) within the next few weeks? Something within us suggests that there are few genuine bulls out there who will keep their heads at even the slightest sign of a hiccup in the market. While this condition holds the path of least resistance for equities and commodities is up at least on a 6 month view.
