Market Psychology began to go “risk off” the first week of September as capital retreated from the periphery to the center…but the Big Cap stock indices continued higher until September 19…the day of the Alibaba debut…and then the major American stock indices, the bond market and several lesser markets all registered a Key Turn Date (KTD.) Since September 19th “risk off” psychology has intensified across markets…we anticipate more to come. (Note: This blog was written Oct 11/12 but all charts below were created Oct 13 as posting was delayed by the Canadian Holiday.)

Stocks: The DJIA is down nearly 900 points (~5%) from its September 19th All Time High (ATH) and is negative YTD. The TSE has fallen nearly 1500 points (~9.5%) from its September 2nd ATH…the German DAX is down ~11% from Sept 19…while the Emerging Markets index is down ~12%.

We have been skeptical of the stock market for most of 2104…preferring to trade it from the short side…while respecting the huge upside momentum created by 5 years of global money printing (and corporate share buy backs!) We bought S+P puts on Sept 19 as the market broke from ATH but covered them (too early!) after 2 weeks on the expectation of another “buy the dip” rally…which never really came…unless you count last Wednesday when the DJIA soared nearly 350 points on the Fed minutes. We did not expect the stock market to “turn on a dime” at ATH…rather we expected “topping” price action…which would include price breaks and recovery rallies…but no new highs…to eventually  “break the spirit” of bullish Market Psychology.  

Volatility: We had ultra-low volatility across asset classes this summer…that has changed dramatically since the Sept 19 KTD with the VIX hitting 2 year highs last week…almost a double from the Sept 19 lows.

Credit markets: Top quality bond yields have dropped like a stone since the Sept 19 KTD with US 10 year Treasury yields near 2.25%…their lowest in over a year…while junk bond yields have risen to their HIGHEST in over a year as credit spreads have widen dramatically. Euro Area Sovereign bond yields have dropped to new All Time Record lows…German 5 year bunds are now on par with Japanese 5 year bonds.

The falling stock markets are the lead story on the nightly news…but the changes in the credit markets may be much more important as weaker borrowers suddenly find it harder to raise money after years of feasting on capital provided by “yield hungry” investors.

Currencies: We’ve been relentlessly bullish the US Dollar for months…but we thought it was overdone in late September (up 12 weeks in a row) and we stood aside the currency markets looking for a correction to re-establish long US Dollar positions. We do NOT want to be short the US Dollar. The Dollar Index closed lower last week for the first time since early July.

The Russian Rouble closed last week at All Time Lows…down ~20% since June (a huge move in FX)…tracking almost perfectly with the 20% tumble in crude oil.

Crude Oil: WTI has fallen ~20% from its June highs…registering its lowest weekly close in 2 years. WTI is down ~11% in just the last 2 weeks!  Western Canada Select (the Canadian Benchmark) traded just above $70 last week as global energy markets struggle with rising supply and falling demand. Crude looks extremely over-sold short term…skyrocketing volatility has us considering short puts.

Commodity Indices: The CRB commodity index is down ~30% from its 2011 ATH…now at 4 year lows. Slow global growth, disinflationary pressures and a strong US Dollar have been “bad news” for commodity prices after a decade long surge…when Market Psychology assumed that China would buy everything that wasn’t nailed down…

It’s a deflationary world: The Fed is concerned that slow global growth and a strong dollar will make it harder for them to reach their goal of 2% domestic inflation. (US Import prices have fallen in each of the last 3 months.) The Fed is expected to end their current “Q” program…and had been expected to start raising interest rates early next year…especially given the improvement in their “employment” mandate…but…if inflation stays stubbornly low…because it’s a deflationary world outside the USA…the Fed may drag their feet on raising interest rates. (Treasury Secretary Lew has also spoken out against countries using currency devaluation for competitive advantage…however…we maintain our macro view that capital will “come to America” seeking safety and opportunity.)  

Short term trading: Markets were not prepared for the Fed’s concern about slow global growth and a strong Dollar. The DJIA rallied ~350 points and the US Dollar tumbled as Market Psychology suddenly shifted to thinking (hoping) that the Fed might delay raising interest rates…BUT…the fact that there was absolutely no follow-through to Wednesday’s stock market rally highlights the intensity of the prevailing “risk off” tone. We look for lower prices ahead.

We had a good run with our bullish US Dollar positions then stood aside…waiting for a correction to re-establish long positions. We are still waiting. We bought S+P puts on September 19…but in hindsight we exited that position WAY too early! We are currently flat in our short term trading accounts…looking for opportunities…and VERY aware that trading is not a “game of perfect”!