What a week of extremes. At the start of the week, the Russian Grizzly Bear was showing his teeth as the worst case scenario of conflict could not be ruled out when Russian troops moved into the Crimea. European equity markets declined by nearly 3%, Russia by 12% with the US outperforming, down by less than 1% on the S&P 500.
As it became clear on Tuesday that neither side wanted even a small skirmish, European markets recouped their Monday losses and the US closed at a new record high. Trading these Geopolitical events is never easy, and with the Ukrainian situation far from resolved, we were surprised by the ease with which equity markets and emerging market assets were able to shrug off the events in Ukraine. That said, by Friday, markets were under a bit of pressure again. It was a scrappy week in what has so far been an up and down year for a number of markets, although most balanced portfolios should still be ahead year to date.
The pull back on Friday developed despite a healthy US employment report (especially considering how downbeat expectations had become after private sector indicators deteriorated during the week), this could simply be blamed on profit taking as headlines from Ukraine illustrate that the situation is far from resolved. Or, the weakness on Friday may indicate that risk assets are more vulnerable than the bullish crowd would admit.
In particular, European equities have failed again at resistance and have now made no headway for four months. The chart below illustrates this, and with the Ukrainian situation on Europe's doorstep, and the ECB unwilling (so far) to ramp up stimulus, perhaps it's not surprising that European equities are failing to make headway. We would also point out that earnings and economic growth have been (and we believe will continue to be) lacklustre, and without growth or central bank liquidity, we see no generic reason to be bullish of European equities.
As noted above, US equities were able to reach new highs this past week, but there may well be signs of vulnerability. Some of the traditional indicators that we use to confirm trends are not confirming the new highs in US equities. The chart below shows the New York Stock Exchange Index together with new 52 week highs less new 52 week lows in the bottom panel. What is clear is that while the index has been making new highs in the last few months, there are fewer stocks making new highs. This is a sign that participation in the bull market is declining and the index is being pushed up by fewer stocks. This is an unhealthy development, and nearly every notable market high in history will have a similar set up. Although we will keenly admit that these sorts of non confirmations do not guarantee a market high around here, the greater the non confirmation, the more seriously we have to take the signal, and with the recent peak in the New High minus New Low Index some 10 months ago, this is an increasingly important non confirmation.
We believe that the underperformance of the Nasdaq 100 Index this week is also a worrying development. Nasdaq been the centre of some speculative forces in recent months, and signs of weakness must be taken seriously. Several high profile names such as Apple and Amazon have not hit new highs during this last up move and are beginning to look vulnerable. Furthermore, Biotech which has been showing bubble like tendencies suddenly came under pressure and closed 2% down on the week. It is quite possible that with the collective weight of these stocks within the Nasdaq, further weakness in Biotech along with say Apple and a few others will be sufficient to drag the Nasdaq index down, possibly quite sharply.
We have been highlighting for some time now that as the FED and the PBoC reduce the amount of liquidity they are pumping into the global system, financial markets will have to find a more natural equilibrium - a lower one in our opinion. As well as liquidity risks, the next few months may throw up further challenges such as the European Parliament elections, a possible wave of defaults in China, risks to the Japanese recovery as they raise consumption tax, possible US economic slowdown and a possible emerging market crisis. Now, it could be that everything settles down, and perhaps if one or more event upsets markets, the FED will halt or reverse their tightening. The point here is that the risks are growing and markets are priced for perfection and so are increasingly vulnerable if something goes wrong; and especially so if the FED decides to ignore a market event and end QE regardless.
To wrap up this week, European equities are really beginning to have the feel of a (potentially major) top forming and the Nasdaq Index appears to be the most vulnerable in the US. Emerging market assets could be especially vulnerable if a new global bear market resumes. The next few months will be especially important and it is easy to highlight a growing list of risks. We absolutely believe that investors should be cautiously positioned during what could be a tricky period.