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Stock Market Investors Are Last to Get the Return of Risk Aversion

Stock-Markets / Stock Markets 2010 Jan 31, 2010 - 02:40 AM GMT

By: Graham_Summers


Best Financial Markets Analysis ArticleI’ve been pounding the table about what I think is coming down the pike for months now. Rather than producing another editorial heavy essay, I thought today we’d let the market dictate what’s going on.

First off, we need to examine the currency markets. With over $3 trillion traded daily, this market is the largest most liquid market in the world. As such it’s the fastest moving market, the proverbial “smartest” money that often signals what will soon hit bonds and then stocks.

So what do the currency markets tell us?

The above chart shows the Dollar’s performance of the last year. A lot of commentators like to talk about how the Dollar is doomed and worthless, but they are misguided and wrong. ALL currencies are PAPER currencies (doomed and worthless). And the Dollar, no matter how much you hate it, remains the reserve currency right this minute. As such, today it’s THE most important asset class on the planet.

With that in mind, it’s important to note that the Dollar is flashing a “flight to safety” or risk aversion. We’ve seen a clean break above the 50-day moving average AND key resistance (78) in the last month and a half. The Greenback now appears to be taking a breather just below its 200-DMA. Any move above the 200-DMA would signal a MAJOR change in market climate with risk-aversion dominating the world’s markets.

On that note, I wanted to point out that despite stocks AND gold roaring higher over the weekend (I’ve detailed this weekly ramp job before), the Dollar only dipped a little. This is QUITE different from the usual weekend into Monday mania in which stocks erupt higher and the Dollar tanks. In light of this, we need to take the Dollar’s refusal to plunge over the weekend as a significant change, one that likely forecasts continued risk aversion in the markets.

Again, the currency markets are flashing “risk aversion” has returned.

Now let’s move on to bonds. At $72 trillion in size, the bond market is roughly twice as big as the stock market. As such it can be considered the “smarter” money (smarter than stocks, not quite as smart as currencies).

The above chart shows the iShares T-Bond 20+year ETF: a basic proxy for the long-end of the US Treasury market (bonds with maturities greater than 20 years). As you can see, the “risk aversion” trade began in mid-December here too with bonds rallying (yields falling as a result of this) into January.

Interestingly, the strength of this rally is not nearly that of the Dollar, failing to break above the 50-DMA. This isn’t surprising totally given that most investors want shorter term US Treasuries right now (the long end of the market has been suffering for months). However, despite this, “risk aversion” remains the name of the game.

This is even more obvious for 10-year Treasuries.

Look at the spike that started late December. Also notice that the 10-year broken overhead resistance at 117 with no difficulty at all. It’s now butting up against the 200-DMA and 50-DMA. Any break over these levels and the “risk aversion” trade should really catch fire.

Thus, we see the two largest, most liquid markets in the world flashing danger signals as early as mid-December. As usual, stocks were the last to “get it.”

As you can see, the S&P 500 continued its rally into mid-January (a full month AFTER the currency markets and bond markets began discounting trouble ahead). Stocks then made a gut-wrenching plunge breaking below their 50-DMA like a machete through a sheet of paper. The technical damage here is severe and we need to see a MAJOR reversal (stocks rallying hard back above the 50-DMA) for this not to signal that REAL fireworks are coming.

Given that both the Dollar AND Treasuries remain in uptrends, I expect we’ll soon see stocks breaking down to test the 200-DMA at 1,000. We won’t get there all at once mind you, given the rampant bullishness (2007 levels) the market won’t go down without a bounce or two. But overall, the market right now is flashing that “risk aversion” is the name of the game. This is bullish for the Dollar and bearish for stocks.

Good Investing!

Graham Summers

PS. I’ve put together a FREE Special Report detailing THREE investments that will explode when stocks start to collapse again. I call it Financial Crisis “Round Two” Survival Kit. These investments will not only help to protect your portfolio from the coming carnage, they’ll can also show you enormous profits.

Swing by to pick up a FREE copy today!

Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets. 

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

    © 2010 Copyright Graham Summers - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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