Submitted by Nic Lenoir of ICAP
Risky assets are not having a very good day. In fact it's their worst day since March. Not losing 130 points on the Dow Jones is anything to write your relatives about, but there is definitively a combination of developments in the markets today that are worth noting.
The S&P 500 future has broken the overlap around 1,037/38 and is now well established below the trendline joining the lows. After attempting to retest the 1.6165 break out of the H&S neckline 2 days ago at 1.6125 and failing, GBPUSD is back down below 1.60. The Nikkei, after a failing to breakout higher out the wedge around the tops and also failing to fill the gap left open in October, is plunging quite abruptly. The Nasdaq future fell short of challenging the overlap with the lows of July 2008 at 1762, and came back to test 1670 this morning. This last level is quite pivotal, and we would use that as a good guidance for further acceleration lower or conversely a hold could mean we reached downside potential. Personally I remain convinced that medium term we are going a lot lower in equities, a break of 1670 would only make my view nearer term than I originally thought.
I saved the best for last: the LQD ETF which is basically a proxy for investment grade bonds which has been on a straight ramp up since October 08 seems to have broken its trend. Tha comes on the back of some observations over the last few weeks of some divergence between the CDS market which has made attempts to move wider while equities kept grinding up. This is by far the most important development. If the price action in the next 2/3 days confirms this break, then really it means the carry trade as a whole is starting to break down. It's one thing to have an equity correction, but with CIT possibly headed for bankruptcy, Saturn shut down, Ken Lewis resigning, regional banks closing faster than schools due to swine flue, and commercial real estate looming, there is enough smoke in credit space to reignite some fire. A lot of fast money moved into credit because it outperformed stocks even after a 60% rally, and that's a problem too if things deteriorate. People view leverage through short selling as evil because it is unpatriotic to bet on the market going down, but propping up the market through leverage beyond sustainable levels is just as good a catalyst for a sell-off... actually it's a better catalyst because it brings about people shorting based on valuation that would not get invlved otherwise.
Crude oil is attempting to defy gravity and fundamentals today. Interestingly natural gas is taking one on the chin, which is perfectly warranted given the level of inventories recorded. There is a story that has not made much noise on CNBC and in the news, but in my opinion sheds very insightful light on the commodity space. The Chinese government has announced they would not invest in aluminium for the next 3 years, nor would they develop any further production capacity, or build any shipyards. There are thousands of idle cargo ships around the globe, and chinese factories work at 60% capacity (that we know of, would not be unreasonable to assume it is in fact worst). Not being a nobel price in Economics, I would still have to think it's a fair bet that commodities could be under pressure here, especially if financially leveraged accounts stop propping the market and need to reverse engines.
So looking around asset classes there are clouds forming here. Keep an eye on credit and the LQD to see if the cracks are sign of a clean break. Fundamentals could well offset the pro-cyclical arguments... and then some.
Good luck trading,