Investors still nervous from the wealth destroying effects of the 2007-2009 Credit Crisis have placed a high value on “safety” in their investment approach. Unfortunately, many of the traditional sectors of perceived safety have proven to be more dangerous than perceived “risky” investments. In many investors’ minds, the safest of all assets is gold. Many believe gold retains value even in the worst of economic circumstances and will serve as a workable currency when paper currencies become devalued by excessive quantitative easing.
The chart below show what has happened to gold this year as measured by the gold ETF (GLD).
While the numbers are small and hard to read on this chart, the trend is clear. Gold has fallen by about 20% year-to-date which places it in the category of bear market. Gold remains below where it peaked in 1980. It is the only major asset class we are aware of that is below where it was 32 years ago.
Nervous investors also migrated into defensive stocks that pay high dividends to increase the “safety” of their portfolios. The S&P 500 is up over 3.6% in May. With the overall market higher, the utility sector declined by 9.0% and the telecom services sector was down by 6.1% during May. These are two of the highest dividend paying sectors. Shown below are charts of the S&P 500 utility sector ETF (XLU) and the telecommunications sector measured by the ETF (IXP).
The demise of these two stock sectors during May strongly suggests that investors are moving away from safety and towards risk. When sector rotations occur, there is no safety in places from which the money is being taken.
U.S. Treasuries (UST) are perhaps the ultimate safety trade. When institutions require a large, liquid and safe place to store money, they buy U.S. Treasuries. As we saw in the Credit Crisis, the demand for safety can become so high that investors are willing to accept a negative real rate of return as long as they can be certain they will not lose principal.
The chart below shows what has happened to U.S. Treasuries in May measured by the iShares Barclays 20+ Year Treasury Bond ETF (TLT).
Clearly, the safety of U.S. Treasuries is not in high demand currently. If the recent collapse of the long-term UST is similar to the gold decline in April, the equity market could see further appreciation. In April, the S&P 500 dropped -4% from high to low initially when Gold suffered its worst single trading day in 30 years and then moved +9% as people realized the world was not falling into a deflationary trap. Now we have UST yields moving higher (UST down) and although it is placing bearish pressure on equities currently, it is a sign that the market is beginning to transition from Fed controlled rates to market controlled rates.
The moral of the story is there is no special asset class that can be bought and held that will provide both safety and returns at all times. What is required to achieve safety is a system for avoiding major bearish moves and participating in major bullish moves.
The Delta Market Sentiment Indicator declined this week from 73.3% to 70.5% indicating the market got slightly weaker on a technical basis. Friday’s market retreat was blamed on an MSCI index rebalance away from U.S. stocks and towards foreign stocks and profit taking on a month when the S&P 500 advanced by 2.1%. Today, we will watch the market close carefully to gauge how large institutions are positioning their portfolios for June. A strong positive close would suggest there is continued institutional buy-on-the-dips pricing pressure that will continue to provide a spring board for equities.
The other driving force on market pricing currently is speculation on the winding down of quantitative easing. Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, made comments today saying the Fed is essentially unlikely to pull back on QE during its June meeting. His comments have helped the market lift off its lows intraday.
Over the past three weeks, the Delta MSI indicator has stabilized in the low 70% range. We remain bullish.
Review of Positions
Parting Shot: Market Sentiment Indicator
Shown below is our MSI (blue line) superimposed on the equal weighted S&P 500 measured by the ETF (RSP). We are bullish on the stock market when the MSI is above the 50% mark and bearish when it is below.
The scale for the MSI is on the left hand y-axis. The MSI decreased from 73.3% to 70.5% last week. With the MSI bullish in the intermediate term, we will look to increase long exposure on pullbacks.
Have a great week trading,
Nick Atkeson and Andrew Houghton
Big Money Options