Wednesday, August 18, 2010

Gauging Market Sentiment

The current equity market is a lethargic trade. The more I look into potential trades the more I find a lack of opportunity. Since The May 9, 2010 ‘Flash Crash’ markets adopted an elusive modus operandi. The European Sovereign Debt crisis waned in and out of news, a bubble in Gold prices tempted us, and economists argued the nuances of stimulus vs. austerity. I miss the ubiquitous uncertainty.

Over the last 10 days volume in the SPY SPDR ETF averaged almost 190 million shares per day. In contrast, over a 3-month span, the SPY averaged close to 252 million shares changing hands daily. Thus, volume decreased by 24.6%. In addition, The GLD SPDR Gold Trust averaged only 10.3 million shares traded in the most recent 10 days. Meanwhile, GLD volume averaged 14.2 million shares per day in the most recent 3 months. Hence, volume declined by 27.5%.

The SPY is the largest ETF by AUM with 66.8 Billion under management. StreetTracks Gold is the second largest with 51.2 Billion under control. What has cooled trading in the aforementioned derivative-like securities? For one, volume has decreased throughout equity markets for the better part of August. Though, with all the technological advances in High Frequency Trading, iPhone/BlackBerry trading apps, and trading robots, we live in an age were trading routinely flashes 24/7-365. Vacation time alone cannot explain the illustrious drop in volume.

Let’s skin this cat another way. What market has seen a consistent uptick in volume without decline? The bond market has. The iShares Investment Grade Corporate Bonds ETF, LQD, volume rallied 13.53% over the past 10 days in comparison to the prior 3 months. Additionally, the iShares TIPS Bond ETF, TIP, saw volume increase by 5.23% over the past 10 days in comparison to average 3-month volume. Now don’t let me get carried away with these statistical redundancies. Empirical reason suggests a normalcy in the gradual volume changes. Spreads continue to tighten as interest rates remain at near zero levels and inflation subsides. Yet, I’m not convinced investment grade debt is the correct safe haven.

Aside from bond prices and yield curves, what catalysts chauffeur equity prices? U.S. economic data often sits behind the wheel. Central Bankers remain the biggest elephants in the room, in particular the FED. The FOMC has found a way to implement a new Quantitative Easing program without calling it QE. The Fed will take proceeds from its MBS securities and buy U.S. Treasury Notes. Hence, U.S. notes continue to yield near-all-time-low interest rates. One thing the FED is clear on, the committee fears deflation. Thus, the committee led by Helicopter Ben will continue to shower the economy with liquidity. Until the day of reckoning comes, expect investment grade debt to rally. I also expect corporate debt issuance to exacerbate demand.

Remarkably, I managed to construct a top down argument that bottoms up. The FED’s decision making on monetary policy and QE will affect the bond market, which will drive equity prices. I surmise, global debt markets coalesced to form a bubble. Now that we know a bubble exists, we need to know how large it will grow and when it will pop. Although calling a top or bottom is dangerous, pointing out a bubble is reasonable and needs recognition. Undoubtedly, equities will benefit tremendously from the unwinding of the crowded debt trade. My suggestion is to short overbought bond ETFs and long growth/value equity ETFs. This may be a defensive play, but it will work in time.

Bond ETFs: iShares TIPS Bond Fund (TIP), , iBoxx $ Investment Grade Corporate Bond Fund (LQD), Vanguard Total Bond Market ETF (BND)

Equity ETFs: Russell 1000 Growth Index Fund(IWF), Vanguard Total Stock Market ETF (VTI), ELEMENTS Benjamin Graham Large Cap Value ETN

Patrick M. Ambrus
Analyze Capital LLC
Twitter: Analyze Capital

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