** THOUGHTS ON EQUITIES **

Day traders in equities must either have had one of their best weeks of the year or were slapped all over the place by the market. Volatility looks to have returned, bringing opportunity as well as increased risk. Now that the dust has settled, the picture still remains rather cloudy. Most U.S. equity benchmarks are down for the week and appear to have set “lower tops” which is a typical technical sign of trouble down the road. To blame for all this were some weak reports from the macro front (most notably: a much weaker than expected 4Q GDP number, ISM Manufacturing & Non-Manufacturing indices moving slowly to the 50 danger mark and weak non-farm payrolls). Earnings reports on the other hand remain good: 345 companies within the S&P 500 have reported so far, posting an average EPS growth of 14%(YoY) in the fourth quarter and 64% of them surprising positively (source: Bloomberg). Despite all this, European equities closed about unchanged for the week and Japan even managed to squeeze out a small gain.

 

 

Over here at dealingfloor.com we believe that the rally in world wide equities which basically started in October last year and hasn’t looked back since is losing steam. We wouldn’t be surprised to see investors take money off the table and lock in some of the stellar profits that were accumulated last four months. Especially financials look vulnerable in our view now that the U.S. yield curve (10-2yr) has clearly inverted. As of Friday’s close the two year yield was 4 basis points higher than the ten year yield and this should typically hurt the financial sector’s P&L. The yield curve inversion will undoubtedly attract commentator’s attention next week with some pointing to its impressive track record in forecasting recessions and others claiming that this time will be different. We abide by the saying: “What you can learn from history is that people don’t learn from history”.

 

As we said in the introduction of this post, markets are getting more volatile. This is underlined by the increase we saw last week in popular implied volatility benchmarks like the VIX and VDAX. Despite last week’s gains, these indicators are still very low from an historical perspective. Sure, they have been historically low for quite some time now and therefore could remain low for some time to come. However, history hasn’t been nice to prolonged periods of low risk premiums. We therefore think it’s prudent to be on guard once these risk premiums start turning higher, as they are doing now.