Investors begin taking more risks
At the time of writing, the equity markets are only fractionally up from last week's close. They traded very strongly in the first couple of days of the week, but as the Dow Jones reached 10,400, and indeed broke a little higher, it found it difficult to hold onto its gains.
On Thursday we witnessed a particularly large sell-off, with the Dow Jones losing more than 1.5% early in US trading. The price movement has been very similar to the end of last month when the Dow was struggling around the 10,000 level.
There has been plenty of talk about the dangers facing the global economy and whether or not the rally will last. This seems somewhat premature given the fact that we are still positive on the week.
Traders looking back a few weeks will be feeling a slight sense of déjà vu. The fears on economic prospects are justified and we believe time will prove them correct, but that does not translate to 'sell equities' right now.
When a market moves up sharply, it rarely sticks to a steady path. Some profit-taking usually occurs along the way, with shorter-term traders, who were long, booking their profits. Indeed those with longer-term views would also understandably be taking some profits off the table given the enormous (nearly 60% rally in US equities) returns achieved over the past eight months. Some traders will also start to go short after prolonged periods of upward momentum, either in anticipation of this profit-taking or because they feel that the market has become overpriced.
There is a saying that financial markets tend to "take the stairs up... and the elevator down". For an illustration of this you need only look at a 10-year chart of the Dow Jones. At the moment it doesn't feel like we need to start queuing for the elevator just yet, but when the time comes we will do our best not to get caught in the stairwell.
Over the past eight months the dollar has been under sustained selling pressure, with investors moving their capital out of safe-haven dollar investments and into riskier asset classes. The emerging markets index is up 75% since mid-March, which represents a significant outperformance on its Western counterparts. Emerging markets are considered a riskier asset set than the likes of the Dow Jones or the German Dax, and the outperformance is a clear indication that investors have been adding more risk to their portfolios.
At the moment, cheap credit and government stimuli are supporting the rally. When this dries up, consumers will most likely still be paying off debt and saving. They will not be spending like they did before the bubble burst. To claw back massive exchequer debt, governments around the world will have to take a bigger chunk of people's disposable incomes, further crippling their spending power. This will inevitably lead to depressed corporate earnings for longer than many are pricing in.
This is our admittedly depressing outlook for the economy, but don't worry about all of this just yet as it looks like the momentum for the time being is still up, and if and when markets do turn south, we will try to make money going short.
Commodity prices continue to surge
This past week there has been a continuation of the persistent rise in commodity prices. At the time of writing, gold, after reaching another all-time high above $1,150, was up 2%. Silver was the standout commodity, gaining 5.7%. Soft commodities such as wheat and soybeans were up over 3% and platinum made a rare appearance in the financial press as it made a yearly high and was up over 3% on the week.
Investors' continued concerns about inflation were the main reason for these moves. Economic data from the US and UK supported this premise as both CPI figures came in higher than expected.
Given the amount of cash that has been pumped into the system via quantitative easing, these rises in CPI are to be expected in the short term, but in the long term we feel the risk to inflation is not as high as is currently being priced in. In the medium to long term, we foresee these commodity prices reversing quite sharply.
Despite the broad-based rise in commodities markets over the past few weeks, oil has still struggled to make any headway. At the beginning of the week, US light crude prices once again found support at the $77/bbl level and oil prices moved higher. After a bullish oil inventory report on Wednesday, which showed a drop in crude supplies, oil once again rose above $80/bbl. However, as has been the case for the past few weeks, oil couldn't rise above the $81 resistance level. By Thursday afternoon oil had fallen back to $78/bbl, as the market continues to trade this range.
Vinay Sharma and Paddy Haran, Delta Index