We receive a constant stream of questions pertaining to how much more upside is there left in equity markets. We probably don’t impress many by our response……in essence we have no idea (albeit no preconceived ideas as to how much more upside there is left). Too many times in the past (yes we learnt the hard way) we have had preconceived ideas, which we thought were great, but the market paid little attention to them. Now we listen to the market, in various ways and means, to try and understand its underlying mood and the dominant themes. As far as the equity market is concerned we try and look various indicators of risk. Specifically we look at the performance of risky equities (small caps), risky bonds (high yield corporate bonds) and high yield currencies (NZD, AUD, ZAR, NOK, BRL). When the market is in a risk seeking condition we tend to find small cap equities advancing, high yield bonds outperforming investment grade, and high yield currencies advancing. Let’s look at what the indicators are currently suggesting:
Dow Global Small Cap Developed Markets
Small Caps remain in a bullish condition, there appears to be no deterioration in upward momentum as yet.
Vanguard High Yield Fund (VWEAX) relative to iShares Aggregate Bond ETF (AGG)
High Yield (or Junk) Corporate bonds continue to outperform investment grade bonds. As with small cap equities upside momentum remains strong.
Powershares DB G10 Currency Harvest Fund (DBV)
This ETF is a very good indicator of the carry trade. It is not exactly the smoothest of charts so we put a 50 day moving average through it to smooth out the noise. The downward trend appears to have been broken. The weakness over the last couple of weeks is noted, but we are not too concerned at the weakness of high yield currencies at this stage. We are well aware that currencies do not move in straight lines for very long (unlike small cap equity and high yield bond indices). We would be concerned about the weakness in high yield currencies if junk bonds were beginning to underperform investment grade and small caps were rapidly losing momentum.
So at this stage it appears that the market remains in a high yield seeking state. While this condition holds we see continued upside in equities in general. How long will this condition hold? We don’t know when the trend will change but we do know that once a macro trend in the market takes hold it tends to last for some time (months rather than days). Ride the trend until there is enough evidence that it is about to come to an end.
