This Week in the Markets is a weekly series that describes, at a very high level, how we manage our long-term portfolio. We use John Murphy’s inter-market ideas, looking at the performance of equities, bonds, commodities and foreign exchange markets. We attempt to measure appetite for risk, and from that draw conclusions on whether to go long or short these asset classes.
We have various proprietary market algorithms, risk and commodity indicators that we use. But they are for another article. What we show here is intended to be understood and acted upon by investors of every level.
Before we begin let us just remind ourselves that the Euro has not broken down over the last few weeks, despite a backdrop of unprecedented bearish sentiment. Definitely where the action will be this week; more on this further down.
World Equity Markets
The Dow Jones World and Dow Jones World Small-Cap indices are as broad based as you can get. Over the last week investors have demonstrated that they feel equity markets are undervalued and that appetite for risk is back.
US Bond Markets
Here we look at US Government Debt (as measured by TLT – 20 Year Bonds) and US Corporate Debt (as measured by JNK – Corporate grade debt). We see this relationship as risk appetite indicator.
TLT appears to have resumed its downward momentum, whilst we see steady support for JNK. This tells us that investors are increasingly prefer corporate grade debt compared to government debt. In other words, investors are prepared to risk their capital on the higher, but riskier, returns of business.
From this we conclude that risk appetite is increasing, or at the very least not decreasing. Hence we will maintain our short TLT and long JNK positions.
Commodity Markets
We use commodity prices as indicators of supply and demand for physical things, be it food, railways, motor vehicles, electronic goods, etc. Increasing prices indicates increasing demand (it may indicate decreasing supply of course – but this is one reason why use such a broad index).
In our view all investors should be regularly reviewing commodity price trends across a range of currencies.
Gold has been in the news of late. With several notable fund fillings indicating that they have taken large positions, along with several government treasuries increasing their holdings.
We think that this indicates a long term lack of confidence in US Treasuries to hold their value. The key phrase here is “long term”.
We will stay long Commodities and Gold and are prepared to hold these positions for a number of years.
Foreign Exchange
We’ve mentioned previsously that shorting the EUR/USD was the single most crowded trade that we’ed ever seen and were going to sit this one out (actually, just to be contrarian, we took a small long option, that is now in the money!)
We suspect that there will be some disappointed EUR/USD speculators out there, and would not be surprised to see a short-covering bounce soon. Those who utilized long term options for their shorting should be fine. Those who traded spot may be re-thinking their positions right about now.
Also note the performance of DBV over the week. We expect an upwards movement as the carry trade makes a return.
As a trading outlook for the next weeks, we expect TLT and $USD to move downwards, pushing $CRB to a multi-week high.
We also think that markets have moved sideways for the last few months and pressure has been building up. Breakouts, if the come, are liable to be quite strong. We are reasonably confident of breakouts occurring over the next few weeks. Risk appetite appears to be back.
Hubris knows no bounds, and, we could be wrong.
