“There is only one side of the market and it is not the bull side or the bear side, but the right side.”
- Jesse Livermore
I guess it is no different this time. There are always more questions than answers. I guess the first question is: Are we finally seeing a change to the “all one market” liquidity-driven correlations in global markets?
For about seven years running, maybe more, it seemed there was only one market (and that market did the funding). Of course this period was qualified by the terms “risk on” or “risk off” … and still is. In effect, the ebb and flow of growth expectations, reinforced by market liquidity, drove risk assets. Risk assets are now considered a broad bundle including: stocks, commodities, and currencies (except for the US dollar, which was the major funding currency for this all-one-market move) which moved sharply higher in lock-step correlation.
This tightly correlated bundle of assets seems no longer to be acting as one big market, as you can see clearly in the chart below:
Dow Jones Industrial Average vs. Euro Stoxx 50 Index vs. CRB (commodities) index vs. EUR/USD Weekly:
Why has this changed? Why the divergence? Theories seem to abound; here are a few we think about … and then some reasons why we are skeptical:
I. Money is flowing out of Asia on decelerating Chinese growth and out of Europe on structural risk and must hide in the US market.
A. If money is flowing that freely into the US, why has the US dollar been such a dog? Shouldn’t it benefit from that flow? It hasn’t, at least not much.
B. If money is flowing from Europe on structural risk, why is the Euro supported?
1. And if long-term structural portfolio positions were that afraid of the euro, why is gold lagging, i.e. why isn’t it getting some of that haven flow?
C. If stock buyers site US economic growth momentum as their primary rationale, why are commodities prices not ticking higher accordingly?
D. If US economic growth is the driver, why are US bonds in the ozone still?
E. If the US stock move higher is based in large part to the rising probability the Fed gives us QE3, which makes sense, why isn’t the dollar in a tail spin, and why aren’t other risk assets following stocks?
I think the consensus view on US stocks is this (though it doesn’t answer all the questions):
The best place to put money to work is in US stocks on the back of relatively positive US growth, because stocks are getting no real competition from such low bond yields or gold’s non-yield. China has engineered a soft landing, and they will likely provide a lot more stimuli if needed. Plus, if the US economy stumbles we have a Bernanke put option in our back pocket, and we know that has been a big winner in the past. And despite the cat-calls from the euro demise crowd, the ECB has proven it can play the QE game as well as anyone despite those single currency rules.
I think the consensus view makes a lot of sense. But …
… what if the rest of the asset classes in the chart are telling a story of falling global liquidity and falling growth and what we are seeing now is simply a near-term divergence that will be closed with DJIA coming down to meet the rest of the bundled risk assets?
… or what if the US stocks are a true US global economic indicator and the US is now the only game in town, i.e. “the money has to go somewhere” theme?
Could it be we are heading back to old school, when each investment class and region needs to be evaluated on its own merits, instead of one big liquidity bid?
… and …
I guess it doesn’t matter, as we will likely never know. Once again Jesse Livermore likely nailed it: just get on the “right.”