If US goes into recession, risky assets face abrupt sell-off
Updated: 2012-10-20 07:56
(HK Edition)
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Wall Street is in correction mode and a number of the leading growth stocks have weakened over the past week. It is notable that the technology sector is coming under intense selling pressure and this implies that businesses are cutting back on spending. At this stage, it is too early to tell why this is happening but it is conceivable that corporations are preparing for a slowdown in business activity or an outright recession.
There can be no doubt that some of the world's biggest economies are struggling and the ongoing private-sector deleveraging is a profound deflationary force. However, the central banks and governments are desperately trying to save the banking system and ignite another credit cycle. Thus, rather than deflate, asset prices are gyrating wildly and policy intervention is creating huge volatility and distortions within the asset markets.
It is no secret that the three and half year old rally in risky assets is primarily due to policy intervention. However, I suspect that if the world's largest economy slides into recession, we may witness a big sell off in stocks, commodities and high yield credit. Up until now, the benign economic environment in the US has allowed risky assets to appreciate, but if the American economy weakens, Wall Street may feel the heat. It is worth noting that many European nations are already in recession and if the US joins the party, risky assets may face an abrupt sell-off. Unfortunately, nobody knows when the US economy will contract, so it is best to monitor the price action with an open mind.
In terms of the technicals, it is noteworthy that the major US indices are currently showing signs of distribution. Thus, unless the price action improves on heavy volume, this is the time to defend capital. In my view, as long as the stock market is in correction mode, investors should raise cash and refrain from establishing new 'long' positions.
Turning to commodities, the CCI Index is still trading above its 200-day moving average. However, despite the ongoing tensions in the Middle-East, the price of crude is struggling to rally and this is a sign of weakness. As you know, given the state of the world's economy and the looming bust in Chinese real-estate, I remain skeptical about industrial commodities. Already, the prices of various base metals have declined quite sharply and this is a clear indication that not all is well in the Chinese economy.
Looking at precious metals, it is interesting to note that both gold and silver have recently sliced through their recent lows and this is a bearish omen. Given the fact that QE-ternity is already in force, precious metals should have appreciated in value. Instead, the recent consolidation has ended with a downside breakout. In any event, I do not think this is a suitable time to invest additional capital in this sector.
Over in the commodities arena, the US Dollar Index is currently fluctuating within a tight trading range. If it closes above 80.21, a new uptrend will be confirmed and a break below 78.60 will be negative for the greenback. QE-ternity is negative for the US Dollar but if the economic outlook worsens, the world's fever chart may rally.
Finally, over in the fixed income space, US Treasuries have declined over the past week and yields have risen. If the rally in risky assets continues, US Treasury securities will probably face additional selling pressure. Elsewhere, high yield corporate bonds are performing well and in this yield starved world, investors are bidding up their prices. I continue to believe that high yield corporate credit will probably continue to do well, so income seeking investors should focus on this sector.
Finally, over the past week, US mortgage REITS have faced intense selling pressure and these high yield securities should now be avoided.
(HK Edition 10/20/2012 page2)