Will Ukraine be the “Trigger” for the Next Risk-Off Phase?

In a continuation of the rebound that began in early February, the S&P500 climbed another 1.3% last week. Volume was fairly light, so there was again no huge rush of new buyers coming into the equity markets. And volatility barely changed, again suggesting that buying was done with only tentative conviction.

Technically, the S&P500 is now firmly over-bought. Prices have jumped right back up to the upper Bollinger bands on both the daily and weekly charts. Interestingly, however, several breadth indicators were turning bearish. For example, the difference between new highs and new lows plunged last week. This is not something you would expect to see in a market that’s surging to new all-time highs. The same conclusion can be drawn from the percent of stocks above their 50 day moving average; while this gauge rose, it hasn’t recovered to the peaks it reached in 2013, so this is another negative divergence…..also known as a warning sign.

Meanwhile, in the real economy, things are still fairly grim. Last week, a slew of reports missed expectations, starting with the Chicago Fed National Activity Index, which turned negative last month. Flash PMI missed, and the Dallas Fed manufacturing survey plunged to register its worst reading in 9 months. Consumer confidence missed, as did the Richmond Fed survey. Initial jobless claims were worse than expected. US GDP results for Q4 of 2013 were weaker than experts had predicted. And finally, the pending home sales index also missed. On the positive side, new home sales, durable goods, and the Chicago PMI all beat expectations.

Now that the crisis in Ukraine is growing—-the UK Telegraph called it the worst crisis in Europe in the 21st century—investors around the world are asking the obvious question: could this crisis be the trigger that finally causes global (and especially US) risk assets to sell off meaningfully, not necessarily crash, but correct by 10-20%?

The answer is nobody knows for sure. We will only know the answer with the benefit of hindsight.

But the more important answer is that it really doesn’t matter if Ukraine is THE actual trigger. Why? Because asset prices (stocks, bonds, and real estate for example) are so over-priced relative to their long-term historical benchmarks (thanks to the perceived benefit of central bank intervention), that it really doesn’t matter WHAT the trigger is.

Prices are ripe for a correction, a big correction. Whether or not the crisis in Ukraine triggers the correction is less important than the fact that prices are extremely vulnerable to suffer a meaningful drop. And investors would be far more successful, in the long-run, if they focused on long-term valuations not short-term events and their potential impact on risk asset prices in the short run.

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