Crunch time perhaps? We are coming to a critical juncture in US financial markets and as strange as it may seem it appears that equity markets are leading the way. Equities, as per the Vanguard Total Market Index at least, are in a perfect up trend. In fact small caps as per the Russell 2000 are now trading at multi-week highs. This typically is not what you would expect if this was a false rally in equity markets.
We are still of the feeling that there are few genuine bulls of the equity market, let us not forget the total “stop-out” of bullish commentary in early – mid February! If you put a gun to investors heads and asked them if they thought equity markets would close the year 20% higher or 20% lower from current levels, the vast majority would say 20% lower (remember if they sit on the fence the trigger gets pulled). OK that is rather drastic but I hope you get the point – this still remains one of the most hated rallies in modern history…..perhaps that is why equities have advanced the degree to which they have over the last 18 months and why they are likely to continue to rally over the course of this year. Not until there is a general complacency towards risk or a universal belief in a bull market in equities will the rally run into genuine problems.
We think where equities go, so too will commodities. Yes commodities remain about 10% away from their highs reached at the start of the year but to expect the CRB to be at or close to multi-week highs given the recent strength of the USD Index is somewhat unreasonable. Perhaps the king-pin to commodity prices is US Treasuries (TLT). A breakdown in the US Treasury markets is liable to propel commodities higher to multi-week highs. One reason which few realise is that a rise in treasury yields would increase the carry costs of holding commodities for physical delivery and thereby dramatically reduce the contango condition of many commodity markets which have been effectively held down the near dated contracts (on which many ETFs are based). Whether or not a breakdown in US Treasuries pulls down the USD Index remains to be seen, but with record short positions against the Euro (long the USD) we don’t think that it would take much to trip the USD Index.
