Bad night for markets…risk off?

Risk off is an overused term that I’m never comfortable with day-to-day. Just because the market goes up or down on any given day or week doesn’t mean that risk is off it just means that traders pushed the markets one way or the other and because of high correlation in markets these days things moved together.

When we do see a risk off move it is usually persistent and grounded in real fears about the outlook. Then we see risk assets really move lower, usually they get thumped, as safe havens like US Treasuries while assets like the AUD (world’s favourite currency punt) get sold.

So I don’t want to overplay one night’s move but last night could be the start of something bigger.  Because last night’s move seems to me to be better grounded in economic fundamentals as the weakness is being fed as data from the US and Europe continues to weaken. Indeed it was enough to unwind yesterday’s silly rise in the AUD and swap rates on the back of weak data in the first quarter GDP.

While markets have been thoroughly distorted by the Fed’s quantitative easing program the linkage has been both through free money but also an expectation that Chairman Bernanke’s stated goal of hold the markets up until main street comes on-line would be achieved.

That is simply not happening and markets are waking up to it and equity prices by necessity need to readjust for the weaker economic outlook in the US and beyond – remember it’s still the worlds largest economy. Indeed the bit that is just US consumers is still the world’s largest economy on its own.

Ben Graham said that the stock market is a voting machine in the short-term and a weighing machine in the long-term. Markets voted that they thought QE2 would work but they are now weighing up the impact, on prices, now that the evidence that the US economy is sliding again.

Last week the OECD put out its voluminous outlook for its member economies and it is not a pretty read for the developed world. Australia gets of lightly because of where we sit in the world in terms of both our proximity and trade links but overall it feels like pre-Lehman 2008.

Here is a list that highlights the key risks to the up and down side from the OECD last week. It’s clear where the risks lie.

  • Upside Risks
    • Stronger than projected final demand momentum
    • Additional short-term impacts from structural reform
  • Downside risks
    • Renewed increases in commodity prices
    • Deeper than projected slowdown in China
    • Continued concern about public debt sustainability in some OECD countries
    • Lingering weakness in property market
    • Ongoing financial fragility in the euro area
  • If downside risks interact, their cumulative impact could weaken the recovery significantly.

So one swallow doesn’t make a summer. but the summer holidays have started in the US and a chart from Doug Short at dshort.com is instructive on where we sit relative to the lows in 2009 and the highs back in ’07. Doug says,

The S&P 500 closed the day down 2.28%, just fractionally above the intraday low, for a worrisome June 1 selloff. The index is 94.3% above the March 2009 closing low but 16.0% below the nominal all-time high of October 2007.

We just want to highlight the risks here at the present. With the global economy slowing it may not take Greece to see the market swoon over the Northern Hemisphere summer.

We think it’s time for options cover to protect positions. We always say that but it seems more pertinent now. Oh and when you hear that QE3 is coming as a saviour to the markets ask yourself one question. If QE1 and 2 didn’t work why will 3. Whatever answer you get others probably will too.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

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One Comment on “Bad night for markets…risk off?”

  1. Tristen Cosgrove Says:

    I was thinking pretty much the same thing, well done Greg. Bloomberg last night had a headline that “Australia GDP Falls Most Since 1991”. While we in Australia know about the floods, overseas investors might only pay attention to the snapshop considering they may already have concerns about China such as another article on Bloomberg last night “Willard Concerned About S. China Sea Tensions” (the US Navy Admiral Willard). The US Dow Jones was down 2.2% overnight and there seems to be more problems than solutions, globally, bubbling to the surface at present. Great Post Greg!

    Reply

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