A week is a long time in pico-second land – so it has been nigh on an eternity since we last spoke for some of our high frequency friends.
The resilience of markets to the steady stream of seemingly bad news has been surprising though perhaps not entirely unexpected given that governments globally remained committed to supporting equity prices. (Just how the short term performance of equity markets became a benchmark for the success of monetary policy is a question for another time.)
In any event, the strength in markets gives us reason to test our assumptions – cause based on these, our expectation is that we will experience a reasonable correction as we head into the end of QE2. Last weeks selloff did not tick this box.
So how to characterise the information flow over recent weeks:
1) The economic growth cycle looks to be peaking – per OECD leading indicators (here) – this is consistent with a tightening of money in China and the final wave of stimulatory action in the US.
2) But, more importantly, monetary stimulus stepped up a notch with the response of the Japanese authorities. Perhaps there is a growing consensus that more monetary stimulus is inevitable – whether as part of the refinancing of the European periphery or by the US itself.
If it is expectations about more monetary stimulus driving the recent price action, then this should be reflected in a relative outperformance of real assets – think precious metals, energy and commodities in general – versus financial assets – bonds of all ilks and defensive equities. As a quick proxy consider the outperformance of the CRB against LQD since the Jackson Hole speech:
The CRB has certainly bounced hard over the last week and may yet retest its highs. And while we are here, we can push a little further down the risk curve via the relative performance of JNK as against LQD:
On the face of it, JNK does seem to do pretty well for itself when the Fed is actively buying securities. It too has enjoyed a steepling bounce recently though is short of its highs.
Also, those currencies that are home to the QE stimulus efforts should underperform.
It’s clear that Gold, as measured against US dollars, has barely stopped for breath as it has ridden the easy money train. The ‘hard asset’ Australian dollar may not have kept pace, but has certainly benefited from trade. While the carry trade pair of choice, borrowing in Japanese Yen to buy the AUD has been flatlining since the risk selloff last April.
Zooming in to the period since Bernanke visited Jackson hole the same trends prevail – XAUUSD beats AUDUSD that beats AUDJPY. And on even closer inspection, the same trends are replicated over the recent bounce. These charts seem to indicate that it is the US in particular that is driving the appreciation of real assets.
Recent price action suggests that capital flows have taken on some of the character of a flight from easy money – and particularly the US variety. Whether this is the moment when the ‘governments are debasing our currencies’ meme goes mainstream is beyond my reckoning. If it is, then we can expect gold to lead real assets in a substantial spike higher.
Probably more likely though is that this thesis needs further testing – for example, as the expiry date for QE2 draws closer and the debate about further QE rises to the fore, then uncertainty should creep into the equation. It is for this reason that we remain under our target weighting in gold and energy in particular. We continue to expect volatility across risk markets as the first half of 2011 draws to a close. Hang tight.
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