Is the rally the real deal? Watch the credit markets.
By Christine Hughes, Chief Investment Strategist, OtterWood Capital:
Since last Thursday’s intra-day low, the S&P rallied +6.6% in four days with the former laggards and most heavily shorted stocks leading the charge. This action is very typical of a bear market rally and should be viewed with skepticism. A great example of a laggard leading is Freeport McMoRan (FCX) which rallied +63% in four days before giving some back. Even with that huge surge, this stock is still down -66% the past year.
Given what was becoming a large short position in the market (see bottom of chart below), there has been what we call a “squaring of positions” the past week, driving global markets higher. Shorts have begun to cover which forces buyers into the market when they would really rather not be buyers.
If you want to know if a rally is the real deal, you must watch credit markets as credit leads equities – always. By looking at investment grade spreads below, credit has actually deteriorated during this rally, the opposite of what you’d want to see. When spreads widen out (line on chart goes up) this means the market is demanding a higher rate of interest for riskier corporate bonds vs governments. Markets only do this when conditions are getting worse/tighter. This line is going in the wrong direction.
Taken together, this tells me that although this ‘bounce’ in equities may have a bit more to go, we’re only talking days here, not weeks or months. It is my sense that March will not be a pretty month for risk assets. There is still a great deal of bad energy debt hanging over the global markets, a potential currency devaluation in China, and a crisis brewing in European financials. We remain cautious in our portfolios. By Christine Hughes, OtterWood Capital,
Desperate Measures for Desperate Times. Read… China’s Massive Debt Cram-Down