Signs Of The Times
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Our April 22nd edition observed that "The ladies are back. On the quest for Lady Bountiful, Rosie Scenario leads to Goldilocks – only to find Mother Nature waiting."
Often Mother Nature has something other than Lady Bountiful in mind. This time it was the revelation of a sudden loss of liquidity in stocks, corporate bonds and commodities.
That April 22nd edition also included our checklist for an important top in the stock markets and concluded it was at hand. This also reviewed the "helpers" such as crude oil and base metals had reached timing and momentum targets. The advice was that investors should increase the rate of selling and that traders could play the short side.
In facing a number of "discoveries" that Greece was "fixed" or not "fixed", that Thursday's conclusion was:
"Today's report 'Greek debt crisis gets worse as EU revises figures' reveals an ongoing problem that will 'suddenly' be viewed as really bad when the stock market rolls over."
The key paragraph was:
"This describes the condition of the stock market and the concluding event will be the senior indexes setting a lower low on a weekly basis."
That occurred on the Tuesday before the "Flash Crash" on May 6.
The slump has been driven by an impressive loss of liquidity, which has been more severe than we could have guessed. Nevertheless, and as noted by Ross in Friday's ChartWorks, the stock market became oversold enough to prompt a relief rally that could be short lived.
The ChartWorks will be watching for the next exit.
There are some measures on the degree of the hit.
The Ted Spread has increased from 1.06 in early March to 3.83 on Tuesday, which compares to the jump from 1.00 in June 2008 to 4.63 with the forced liquidation in 2008. By this indicator the distress has yet to match that of 2008.
Three-month Libor has increased from 0.252% in early March to 0.536% this week. This compares to the run from 2.75% in June 2008 to 4.82% in the panic that ended that November. On this liquidity problem the Libor rate has doubled, which since it broke out in April has had our attention. The "double" may have something to do with the exceptionally low rate, but the uptrend has been the warning. Probably has further to go before this return of trouble culminates.
The VIX got some headlines on its way from 15.23 in mid April to 48.2 last week. This compares to the exceptional high of 89.5 in late 2008. Highs with other problems in 2002 and with LTCM in 1998 were at the 45 level. The move has been dramatic, suggesting a rest in the stock markets for a while.
Can the VIX reach higher levels? Yes, and if it does it would be under very severe pressures.
Wednesday's ChartWorks Bonds-Technical Alert reviewed the pattern leading to an important top for the long bond future. This is a stand-alone study that does not relate to any setbacks with the rebound in stocks and commodities.
Our big picture view has been that a reversal in the treasury curve and credit spreads was possible in April-May and this worked out. The main thing is that the change would break rather intense speculation and end the big financial rebound out of March 2009.
For us, the curve was expected to run inverted until as late as June 2007 and in reversing to steepening would signal the end of the bubble. This began to change in that fateful May, and as with previous great bubbles signaled the collapse.
It took until the panic ended a year ago in March before the tout about steepening enhancing bank earnings. This was fully into bank stocks five weeks ago, when the sector became vulnerable to the potential change to flattening.
Beyond eventually assisting commercial and investment banks, steepening became one of the carry trade items and after 2.5 years "everyone" was aggressively positioned. The culmination of a one-way trade is always interesting and ultimately expensive to those offside.
The turn to steepening in 2007 was "bad" in marking the end of the bubble. This year’s turn to flattening will be "bad" in marking the end of the big rebound out of the initial crash. It will also take away the "positive" carry for most banks.
As with the change in 2007, the turn to widening credit spreads is extremely important. While not widely announced, the change in short-dated stuff in April was anticipating the hit to long corporate bonds.
The Ted Spread began to widen in late March and by early April it was moving fast enough to provide warning. Although not a spread, the rise in the Libor rate was another warning.
Corporate bond spreads, which had enjoyed outstanding speculative interest on the carry trade, narrowed into mid April. As an example the high-yield came into 336 bps, over treasuries and has widened to 526 bps. It took fourteen weeks to narrow from 526 bps and only five weeks to reverse it.
With the hit, the yield increased from 8.08% in mid April to 9.33%, which is also in the right direction. With some trading swings this can continue to dislocating conditions later in the year.
Late last week the Dollar Index registered a daily Upside Exhaustion as the euro registered the opposite. The high close for the DX was 87.3 yesterday and the correction could last for a week or so.
With the setback in commodities, the Canadian dollar was likely to decline to around 93. The low close was 93.4 yesterday and the rebound could make it to 97.
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