Equities plunged last night with the S&P 500 down by 4.8%. Commodities were down 2.8% while high yield bonds declined 2.9%. 10-yr Treasury yields fell 1.4% while the US dollar index rose 1.5%. Interestingly, considering the carnage done to risk assets, emerging market bonds fell only 0.5%.
The lack of a catalyst for yesterday’s selloff is a cause for concern. Both the global economic slowdown and the European debt crisis have been ongoing for a while, so markets would have discounted such issues. The risk is that these issues turn out to be worse than expected.
While we still think the probability of a US recession is low, a macro shock emanating from the EU could potentially send the American economy into a recession. The fact that Spanish and Italian yields have yet to come down after the announcement of greater lending capabilities of the EFSF is another source of concern for markets. This is why European financials continue to underperform the broad market and this debt issue has yet to be resolved.
The deterioration in equity markets is another source of concern. After yesterday’s selloff, cyclical sectors like Materials, Industrials and Consumer Discretionary are now below previous support levels (Figures 1, 2 and 3 below). The uptrend has been broken and this suggests a more cautious approach should be adopted by investors. Nonetheless, even defensive sectors like Consumer Staples and Utilities (Figures 4 and 5), safe havens in times of recessions, are also being sold off, suggesting that this is just a correction.
Looking at the S&P Large Cap Index (Figure 6), markets are now deeply oversold. Relative strength index, a measure of bullish/bearish momentum, is at its lowest since the depths of March 2009. Clearly there is a sense of fear in markets and a relief rally is likely to occur. Again, we shall see how the rally enfolds, which will give us insight into how investors are likely to position themselves over the next few months. Given the nature of how investors have fled risk assets, the bias is towards being defensive.
Figure 1: Materials Select Sector Index
Figure 2: Industrial Select Sector Index
Figure 3: Consumer Discretionary Select Sector Index
Figure 4: Consumer Staples Select Sector Index
Figure 5: Utilities Select Sector Index
Figure 6: S&P 500 Large Cap Index
At such oversold levels, there is possibility of a relief rebound. Nonetheless the markets are nervous and such drops could be self-fulfilling. We will continue to monitor the markets closely and will trim our overall portfolios further if necessary. Our United G Strategic Fund - the core fund within our cash portfolios, had been progressively trimming equity positions in the last few weeks. The fund currently has an exposure of 59% in equities as of 3 Aug, before the sharp drop in US markets on Thursday night (the balance being in bonds, cash and gold). The fund managers will also trim positions further if the markets continue to show weakness. This will help to protect our asset values within the overall portfolios.
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