The market tranquility is over
Poor economic data and volatility shake investors out of their complacency.
For months, financial markets have been quiet. Almost too quiet. A flood of cheap money from the major central banks had squeezed volatility and risk aversion out, creating the conditions for a slow-motion grind higher in the Dow Jones Industrial Average ($INDU).
Sure, there were blemishes including narrowing participation and pitiful volume. But investors didn't care, preferring instead the lull into a dreamy state of complacency. Measures of market risk, from the CBOE Volatility Index to the credit-default swaps on eurozone bonds, suggested all was well.
That's ending now. And it's not pretty.
For weeks, I've been saying that reality didn't match what the markets were pricing in. Economic data was disappointing. Big structural issues, from the budget situation in Washington to the eurozone debt crisis and Japan's efforts to escape decades of deflation, remained unresolved.
Emerging market stocks have been underperforming for months. And beneath the surface, there was evidence professional traders were already heading for the exits with cyclical, economically-sensitive stocks lagging behind defensive, non-cyclical issues.
Monday, the logjam appears to have been broken.
It seems to have started because of the intense volatility in Japanese government bonds (JGBs) -- in the wake of an unprecedented decision by the Bank of Japan to double its monetary base over the next two years. That, accompanied by recent weakness in the yen, looks to have resulted in forced selling of JGBs.
We're also seeing intense volatility in precious metals. Some of this could be connected to the JGB selloff, as banks and other institutions are selling gold and silver to shore up their JGB positions. And some of this is related to chatter that Cyprus could be required to sell its sovereign gold reserves to fund the ballooning cost of its bailout program.
Now, the selling pressure has finally hit the once sheltered U.S. equity trade, with small cap stocks in particular receiving the brunt of the damage. The Russell 2000 Small Cap Index has fallen below its early April lows and is trading below both its 50-day moving average and its lower Bollinger Band. The CBOE Volatility Index is spiking over its 50-day moving average, a precondition for market downtrends. And the selling is concentrated in cyclical areas like energy and materials stocks, suggestive of eroding economic growth expectations.
Disclosure: Anthony has recommended SMN and HLF short to his clients.
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