Riskier assets have taken a pounding in the last month or so as investors calibrate the extent of the damage in Europe. Whether a Greek default will happen is almost irrelevant at this point because almost three quarters of investors think that a Greek default is highly likely. That is why Developed Europe is at or near the bottom of all the representative portfolios that we monitor. In the ETF Long/Short Portfolio, the Short EAFE ETF (Europe, Australasia, Far East or EFZ) is now joined by the Short Commodity ETF (DDP) at the top of the list. Please note that the readings for short products can change quickly so unless you are willing to follow those trades closely, the Long/Short Portfolio may not be for you.

However, the implications are important for all investors. As we have mentioned in the past few newsletters, the global “liquidity bathtub” has been tilted towards the US dollar. Most of the new money flooding into the US dollar is going into short term US Treasuries rather than equity, property or other assets, so it is short term in nature. On the equity side, money is flowing from the Big Caps to Small Caps. The reason for the small caps preference can be traced to the relatively large proportion of earnings that come from overseas in indices like the S&P500.

A strong US dollar does not bode well for export-led recoveries in the US or in most of Asia (where currencies show a “high correlation” to the US dollar). Copper prices had a bit of a bounce (an important leading indicator for construction and manufacturing in China), but commodities are generally still soft across the board. The only exception is Natural Gas (UNG) which is probably due to the continuing disaster in the Gulf of Mexico.

All of these developments send us scrambling to our favorite economic indicator, the ECRI Weekly Leading Index. A critical question in investors’ minds is the likelihood of a second dip into recession. Although the WLI has not signaled an upcoming recession yet, the trend is definitely not comforting. Like any leading indicator, major equity indices are going to have a weighting and certainly much of the drop from 12% in May to -3.5% in June is due to the sharp correction in major market indices. We will have to wait a few weeks to see how much a market bottoming will impact upon the numbers.
ECRI Weekly Leading Indicator
Source : ECRI

Will we go into a double dip recession? There is no doubt that GDP growth rates and corporate profits will slow for the rest of the year. Looking at a new set of indicators developed by Richard Davies at Consumer Metrics Institute, which uses a modern, updated approach to gathering sales data from the US economy, consumer demand is turning negative. Although these data series have not been around as long as ECRI, the approach is very interesting, the series leads GDP figures and the conclusions are also not positive.
Consumer Index Chart
Source: ConsumerIndex.com

So, what is the answer? Bear or just a correction?

Unfortunately, the jury is still deliberating. The System is designed to favor cash and cash equivalent asset classes when everything else is falling. We are not there yet and the risk of getting out of the market at a short term bottom is high when sentiment is as negative as it is now. Overall, our system is still showing a preference for some classes of equity over money market related investments although the readings are approaching a turning point. One sector which has fallen out of favor is the Biotechnology both in our mutual fund and ETF portfolios. But US stocks remain at the top of the portfolios with a skew towards small caps.

New research tool

For intrepid readers who are interested in seeing how some of our numbers are put together, we have developed an application which is still in the testing stage. Try it out here. For now, it only works with US equities, ETFs and Mutual Funds and you need to know the ticker (which can be found on Yahoo Finance). We would appreciate any feedback might have; please that you send it here.


Filed under: CommodityCurrencyDeveloped MarketsMarket CommentMarket Psychology

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