Every week we sit down and look at the markets from a high level. It’s a discipline that we go through without fail. It helps to remove ourselves from the day to day analysis detail and see the bigger picture.
For those unfamiliar with our weekly analysis, we are not trying to pick stocks or sectors here. Rather we are trying to “listen” to what the markets are telling us; by looking at the major equity, bond, commodity, and foreign exchange market indicies. In doing so we attempt to measure the markets appetite for risk.
Basics are basics. We think of markets as pure supply and demand. If risky assets are in demand, their price will rise and similar to the “less risky” assets. From this we draw conclusions as to how we should allocate assets across our portfolio.
We have a much more detailed process than we show here and have our own proprietary appetite for risk index; perhaps we’ll release that publicly sometime.
And so down to business. Let us first focus on the equity markets, by looking at the Dow Jones World and World Small Caps Index. Keep in mind that we see small caps as riskier assets and so are firstly interested in any divergence between the two markets; of which, at the moment, there is nothing of significance.
Secondly, what does the price movements tell us? Well, it appears that equity market investors across the globe have regained confidence in their markets and are prepared to purchase equity assets again.
The price performance of gold is more than a little interesting. It has managed to maintain its value in USD terms whilst the USD has appreciated significantly against the all major currencies.
We could all argue for hours about the role gold plays in the financial markets, but all we can do at the moment is take note that there is still significant demand for gold in-conjunction with rising equity markets and an increasing USD.
Moving onto the bond markets we now look for signs of confidence in the riskier assets, corporate debt, as measured by JNK , and the “safer” government debt of US Treasuries as measured by TLT .
Clearly US Treasuries are continuing their downward momentum, unsurprisingly so. Much more interesting, to us at least, is the price momentum of corporate debt. This is a vote of confidence in business and is also complemented by reducing credit swap premiums.
We can only take this as a positive sign for risk appetite.
The euro effect is being felt. We are wondering if perhaps it is becoming oversold. With so many short sellers this has become one of the most crowded trades that we have ever seen. Having seen some violent reversals in the past, we are sitting out this one.
In commodity and high yield currency terms, the USD has not appreciated as the above graph would suggest.
Despite the recent price movements of the USD, we still have troubles with the euro, Dubai, and a whole lot more. We believe that the underlying reasons for the USD weakness of last year still exist and expect downward momentum to reassert itself over the oncoming year.
We’ve now taken a very high level look at the equity, bond, commodity and foreign exchange markets. Our interest is what, collectively, can we learn about general appetite for risk and thus the most likely medium term direction of the markets.
Nothing is ever certain, and as traders, we have to make decisions and live with the consequences. This week we have decided to maintain our long equity and commodity positions, and our short US Treasury positions.
