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Strategy Video: The Risk of Deleveraging Through Year's End

Strategy Video: The Risk of Deleveraging Through Year's End

2016-10-22 02:42:00
John Kicklighter, Chief Strategist
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Talking Points:

  • Complacency is exceptional when comparing S&P 500's smallest 14-week range since 1994 and wide value gap
  • Tempered speculative activity in volatility products and capital outflows from equity ETFs should be monitored
  • Events to keep track of for risk winds include US and UK GDP(11/27,28); Quarterly BoE(11/8); US Election(11/8); more

See the DailyFX Analysts' 4Q forecasts for the Dollar, Euro, Pound, Equities and Gold in the DailyFX Trading Guides page.

A watched pot never boils. The same lesson seems to apply to the markets. The remarkably complacent conditions through all corners of the financial system seem to suggest that low returns and high asset prices is sustainable. Yet, a logical assessment of the situation would dictate that revived activity is just a matter of time. Therefore, the virtue that we traders must prize most is patience. However, that doesn't mean we shouldn't keep track of the pressure and the undercurrents of this volcanic landscape. The past three months of extraordinary consolidation from the S&P 500 draws a dichotomy of a record high versus the smallest range in 22 years.

Most market participations would agree that current market levels are rich - the debate is in the degree. Yet, the characteristic of the backdrop that defines direction and momentum in his value discourse is exposure. A prodigious use of leverage and a penchant for riskier asset types are trademarks for our current market cycle. In spite of that, volume has faded and raised the stakes for walking that far out on a limb. While the benchmarks for trouble - like equity index and volatility levels themselves - may not signal any issues just yet; there are certainly underlying capital flows that should be monitored. Speculative appetite for volatility products - particularly appealing these past few years given the appeal of time decay in complacency - has notably dropped. Meanwhile, despite the seemingly steadfast S&P 500; there has been a consistent 31 weeks of capital outflow from equity ETFs.

While there is uneasiness over extended and exaggerated complacency as well as some unfavorable winds in risk allocation, we have yet to see the wave build to the mainstream assets. Yet, the thin liquidity could quickly escalated isolated issues into systemic ones. There are plenty of milestones to disrupt peace before year's end including: the UK and US GDP releases due this week; US Presidential Election (November 8); an ECB Taper announcement (likely December 8); Fed rate hike (likely December 14); or year-end capital rebalancing. In this weekend Strategy Video, we discuss preparedness while take a 30,000-foot view of what the financial landscape looks like.

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