If the weakness in the S&P 500 over the last two days was the start of a move that will take it below the key 1050 level and thereby confirm a highly bearish head and shoulders pattern wouldn’t we have seen confirmation from risk indicators? That is shouldn’t the proverbial canaries in the coal mine of each asset class be very close to breaking out/down or at least showing out of character behaviour? Yes logically you would think so, but that does not seem to the case. In any event let us have a look at the following measures of “risk”:
- Emerging market bond spreads relative to US treasuries,
- Spreads between high yield (junk) and investment grade corporate bonds,
- The number of corporate bonds trading in a distressed state (1000bpts over US treasury yields),
- The behaviour of emerging market small caps,
- The percentage of stocks in the S&P 100 trading above their 50 day moving average.
JP Morgan EMBI Sovereign Spread
Spread Between High Yield and Investment Grade Corp Bonds
TRACE Index (Number of corp bonds trading in a distressed state)
MSCI Emerging Market Small Cap Index in Local Currency
OK beauty is in the eye of the beholder and you may well differ in your interpretation of the charts above. From our perspective we have not seen the sort of behaviour that should occur if this was the start of a genuine move to the downside in the S&P, that is a move below 1000 and beyond. If the weakness we have witnessed over the last few days was the start of something big then shouldn’t we have already seen a significant blow out in the yields of emerging mkt bonds relative to US treasuries, junk grade bonds relative to investment grade, the number of bonds trading in a distressed state, and a general unwillingness of emerging market small cap equities to bounce back after the fall in May?
But wait there is just one other thing, you should only worry about significant downside in equity markets when there is a general complacency towards risk. With a mere 17% of stocks in the OEX trading above their 50 day moving average it does not appear that there is a general complacency. Furthermore, if we see the S&P fall back to the 1050 level we are likely to see less than 10% of OEX constituents trading above their 50 day moving average, and that would equate to the same oversold condition that prevailed on the 6th of March 2009! We need more upside before we have to worry about significant downside.
Until we see the risk indicators listed above roll over we continue to believe that the S&P 500 is hammering out a bottom from which a meaningful rally to new highs for the year will ensure. Believe it or not!
