Bear Market Talking Points:
- Sentiment is an innate element of the market whose influence can overwhelm all other fundamental or technical concerns if provoked
- Correlation along 'risk' lines is intensifying as fear rises despite an expected, seasonal liquidity drain
- US equities may suffer more under further risk aversion owing to its latent premium, meanwhile gold and the Franc are better havens
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As Risk Aversion Builds a Dominant Fundamental Force Takes Over
Up until a few months ago, risk trends were relatively unmotivated. Sure, 2018 has seen a few unmistakably terrible moves (such as the slide from the EEM emerging market ETF or the Shanghai Composite), but there was a notable lack of paired correlation and intensity from the broader spectrum of speculative assets. In the rally through 2017, there was a more overt reach for yield wherever it could be found, but the momentum was uneven as the fundamentals backing the charge. There is a significant discrepancy in sentiment-sourced risk trends when it comes to bullish speculative build up versus fear driven deleveraging. Greed carries rather little urgency and typically holds only when the ideal conditions back the market - whether traditional growth-based valuation metrics or through extraordinary stimulus measures. Alternatively, panic sets the terms for the market, frequently facilitating the catalyst as much as the outcome. What is important to recognize is that risk never loses its place in establishing our course. That seemed to be the belief for many up until recently as traditionally disappointing data was ignored and bullish interests seemed to cherry-pick catalysts to justify buying any dip. There reflects an underlying bias that can selectively favor positive news while minimizing the negative - or visa versa - as suits the prevailing current. That can make conditions difficult, but it does not argue defy the logic of sentiment. That course heading has clearly shifted with clear commitment to correlation and intensity as of late. Adding to the charge was US President Donald Trump's decision to defy reports that he was willing to compromise on a stop-gap funding bill to keep the US government open through the holiday. As troubling as this may seem, similar circumstances now long ago seemed to barely register in capital markets. This past session, however, the news helped drive benchmarks like the Nasdaq to the cusp of a true bear trend.
Market Performance Chart
High-Return, High-Risk Assets Have a Hierarchy Should the Tumble Continue
Through 2018, we have seen a range of traditionally risk-associated assets come under greater pressure, eventually finding their resistance to fundamental friction give way. Dependency on traditional growth as well as higher potential return earned through greater possible volatility are considered the hallmarks of those assets deemed 'risk-oriented'. Since the first, overwhelming convulsion of volatility back in February, the emerging markets (EEM ETF) have steadily lost altitude. In the uneven and selective period of risk aversion, investors were willing to consider specific assets' fundamental threats and seek out alternatives with a comparable balance of risk-reward. The growth-dependent, Dollar-sensitive and interest-rate exposed EM assets stood out more readily as skewed towards risk. As the intensity of deleveraging escalated, critical sentiment spread to more traditional assets like European equity indices. Though global shares still earned benefit as a favorite traditional asset class, inherent concerns surrounding the floundering Brexit situation drove the index to significant losses relative to its global counterparts. As speculative fear starts to seriously dig in, now we are finding one of the most consistently outperforming benchmark risk asset capsize faster than its less resilient counterparts. US indices were long the holdout as the likes of the S&P 500 (and its derivatives) stood as the simple exposure to the 'market'. This benchmark index has now fallen through the floor of a head-and-shoulders pattern - typically associated with reversals - that has developed over the entire course of 2018. Further concentration of performance within US equities, the tech-heavy Nasdaq 100 stretched beyond a 20 percent correction from the year's high on an intraday basis (qualification for a bear trend) while my FAANG index has collapsed nearly 30 percent in the span of a few months.
Risk Severity Curve Chart
Textbook Havens May Not Represent the Best Safety to More Troubling Conditions
Avoiding risk is only one leg of the effort. Finding safety for capital is arguably more important. However, establishing the best haven is not as easy to determining what speculative assets will come under pressure in genuine risk aversion. As volatility rises and liquidity freezes, selectivity rises. For FX traders, one familiar outlet for de-risking is a reversal in Yen crosses. These pairs traditionally slide during 'risk off' periods which leads to the assumption that the Japanese Yen is a safe haven. In reality, these pairs rise in risk appetite owing to their carry trade appeal - the Japanese unit is a long-standing funding currency owing to decades of near-zero rates. The first stage in seeing sentiment reverse course is to first remove risky exposure. This is an offsetting position rather than a genuine move in capital to an intended harbor. Escalating even further, a genuine need for liquidity raises the profile for the likes of the US Dollar and Treasuries. Typically at the extreme end of the spectrum, there are circumstances that these assets may fall short on. The threat of a US government shutdown draws attention back to the country's rapidly expanding deficit, its fading roll in the global financial system owing to trade wars and the lingering risk of further credit rating downgrades that could all permanently change the currency's place on the spectrum. If monetary policy continues to slide and the Trump-Congress battle tips the economy over the edge while absolute liquidity is still the priority, there are a few atypical havens that may gain greater prominence. The Swiss Franc has been overlooked owing to the SNB's unrelenting effort to devalue its currency, but it represents a long-standing haven that has a unique political withdrawal. And then there is gold. The precious metal has floundered the past few years but its performance between 2009 and 2011, when stimulus further undermined traditional assets, shows its unique potential. We discuss the balance of risk and where key assets stand on the spectrum in today's Quick Take video.
Risk Impact Chart
