The traditionally quiet month of August, when all good city folk should be sunning themselves on the Riviera, has exploded into action Tuesday 01 Sep 2015

The traditionally quiet month of August, when all good city folk should be sunning themselves on the Riviera, has exploded into action

 

The traditionally quiet month of August, when all good city folk should be sunning themselves on the Riviera, has exploded into action. Now that we have high frequency traders running the show, allegedly supplying liquidity, which must be one of the biggest jokes perpetrated on a largely unsuspecting investment community, volatility has been eye watering. From the 23rd to the 28th the Dow Jones Industrial Average moved up and down by a total of 5,612 points! It has been the same story in commodities, notably oil where Brent crude started the week around $46 a barrel got down as low as $42 and then traded above $50. Bond markets usually the safe haven when “things go a bit awry” have also been in the eye of the volatility storm. The 10 year US Treasury yield fell below 2% to 1.9% on Monday morning, but by Friday it was as high as 2.2%.

What on Earth is going on? The explanations are legion; Chinese devaluation, Chinese economy, Chinese stock market, but not according to China. Oh no! As far as they were concerned it was about interest rate speculation in the US and the inability of the Fed to articulate their intentions without the customary obfuscation. Quite so… The commodity complex has been quietly imploding for some time. Punditry is of the opinion that lower commodity prices, notably oil and the industrial metals, would be good for increased economic growth, which of course it would be if there was any! Commodity prices rise as a result of growth, not the other way around, proven by the continuing decline of prices as news slowly leaks out of a slowing Chinese economy.

But this is all relatively old news so why the mayhem in the equity markets. Well as ever it seems that it is all down to the inability of homo sapiens to act rationally, which is a huge problem for economists as they assume rationality as a given; otherwise their models don’t work... Once the creeping doubt, of which we have had much to ponder, translates into a “significant market move”, the herd mentality kicks in and up and down we go. The press then goes on the rampage searching for “the trigger” when it was “us” all the time!
 
After a sharp fall, in four days the UK index went from 6,526 to 5,768 -11.6%, we can expect a rally; and we have had one + 8.3% since the low. What happens next is crucial. Are there still doubters out there? Or will “rationality” prevail? Is it rational to insist that “nothing has changed” so the bull market can continue? The topping action of the major indices, in particular the S&P500 and the UK, suggests otherwise. This distribution pattern when the market transfers stock from strong hands, who have ridden the bull for some time to the latecomers, who are now keen to get on board, is characterised by a rounded pattern that eventually gives way.

A second bearish signal is that the 50 day moving average has crossed below the 200 day moving average both of which are now falling. One swallow doesn’t make a summer (although we could do with one before September is out!) but without some more significant central bank manipulation, capitulation on interest rate rises through to more QE (the efficacy of which is very much open to question), we can, at best, expect markets to go nowhere with regular bouts of volatility to maintain the apprehension. A move below the recent low at 5,768 would suggest a lot more downside eventually testing 5,000.

We have been taking risk off the table for some time now with our portfolios well below their long term risk budget targets and we see no reason to change that stance yet. We will be watching how this corrective move unfolds.
 

From Clive Hale at Albemarle Street Partners - www.aspllp.com