The S&P500 dropped 2.2% last week, it’s largest weekly loss in 2012 since July. Volume did not surge, suggesting that this was not some sort of rush to sell by long-term holders of stocks. And volatility, while rising 12.6% (the VIX), remained at low–and therefore still complacent–levels.
Technically, there were more signs of a breakdown of the uptrend in price….which is still in effect. The new highs less the new lows in the NYSE tumbled badly, and are very close to entering levels associated with more severe corrections. The percent of stocks above the 50 day moving average (in the S&P) also broke down, yet still not to levels associated with bear markets. Finally, the NYSE Summation Index made a substantial turn for the worse and it’s pointing to more selling ahead.
In macro news, international trade disappointed, and that means that the US economic growth in the 3rd quarter is weakening even further from it’s already dismal performance in Q2. Producer prices surged last month, suggesting that corporate profits will be under pressure from rising input costs. That said, excluding food and energy, the core PPI did not rise at all, meaning that if you don’t eat or drive, you’re not feeling any negative effects from inflation.
Citigroup’s credit strategy team, via ZeroHedge, just released a paper in which they argue that the Fed’s liquidity injections have been the driving force behind the levitation in asset prices over the last three years.
But the argue that the prices have now reached levels that are so lofty that prospective returns are huge and prospective risk are also high.
In other words, by driving “market” interest rates down to zero, the Fed has been forcing investors to dump low risk securities such as money market funds, and Treasury bills and notes and reach for yield in far riskier assets such as junk bonds and equities.
And now that the prices of these risky securities have jumped so high, anyone buying them now—or just holding them—is looking at essentially minimal returns going forward, but with super high risk of capital loss.
What could cause these risky assets to lose a lot of value? Well, the same “tail risk” catalysts that we’ve been harping on for months: among others, these include a Greek exit from the euro, political crises in Spain or Italy, or social unrest in any number of states and regions.
According to Citi, these “tail risks” are “bound to resurface in our view”.
And in our view too.