Think about it. We have a gagiillion of money going into fixed income over the past three months. A big chunk of that comes from equity mutual fund redemptions. Seventeen weeks of outflows. What happens? Stocks catch a bid and bonds take a tumble. Two observations come to mind. (1) Retail is dumb money and (2) the buy and hold is just a dead concept.
The “Risk On” trade was a convergence of a number of forces. Stocks were oversold, bonds overbought and as it turns out the economy was doing a tad better in August than was expected on a number of fronts. So once again the market flushes out weak hands. It must be tough on the folks managing their own 401k’s. No sooner than they get invested in long term fixed income (at the lowest yield in 40 years) it starts to look like a bad idea. A lot of money is now tied up in yields that after taxes and inflation are just going to produce losses. Oh well. That is the ‘In your face’ market (AKA the FU market) we have.
For me this could be just a head fake. So what if the odds for a double dip have fallen from 40% to 30% in the last month? That whole debate has been a waste of time. That may be a good excuse for a snap back reaction to an oversold/bought market. But it is a dumb reason to get excited that stocks will never have another down day for the rest of the year. There are plenty of down days in front of us.
Absent something very big from DC the economy is going to slow. We are going to see GDP in Q3 at around 1.5% it will be lower than that in Q4. That is a given folks. And that is the good news. All of 2011 will be a struggle to get GDP over 1.5% on average. That forecast assumes there are no downside shocks or upside surprises. As it stacks up I think the bet is better for downside news than upside. We shall see.
I look at a number of barometers for evaluating where we are in the risk on/risk off cycle. I like the DLR/YEN and the EUR/CHF. When they are trading lower I am very suspicious of the Risk On trade. Both those rates are down big from Friday’s close.
As I write the DLR/YEN is breaking down based on some political news. If Mr. Kan is the winner tonight then the Yen has to be stronger. The EUR/CHF is going to take a dip should the Yen break to new to new highs.
My secondary sources to confirm Risk Off are the DLR/CHF, Gold and of course the bonds. To me it looks like a sure thing that $/Swissie is going to break par some day soon. That will make for negative headlines. Gold swooned a bit as the Risk On appetite rose. But have you noticed that for all of the “noise” from the pundits we are only $10 bucks under an all time high? That is nothing if we get a hiccup in DLR/YEN. More headlines.
I am not sure that watching the bond market for correlation trades is such a wise thing to do any longer. The question I have been pondering is, “When does the current correlation (Weak Bonds – Strong Equities) change to Weak Bonds – Weak Equities?” If the pendulum of the correlation is to swing, it is likely to produce some bad “reads” along the way. “Old Reliable” may not be so relevant.
So If you believe in the FU market theory watch for the next leg to be ‘risk off’ for equities for a bit and we could still see bonds pushing against the critical 2.85 level. DLR/CHF could break below parity. We could see new lows for DLR/YEN and EUR/CHF. The one thing I would not expect? That the market(s) close where they were in NY today on this Friday. Vol up, belts on.
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