MorningWord 6/5/15: The path of least resistance may no longer be higher $SPY

by Dan June 5, 2015 9:52 am • Commentary

In my almost 20 years in the business, I have never seen a sustained period of volatility in most major asset classes outside of equities (currencies, bonds and commodities) that did not correspond with some sort of looming financial crisis and equity sell-off.

At the onset of my career there was no shortage of debt/currency crises (Asian and Russian) and of course Long Term Capital. Those all resulted in massive macro moves that despite a sustained uptrend in U.S. equities throughout caused wild volatility and massive swings during. Then it was the crash and the sustained bear market that was then worsened by the events of 9/11.  And then of course the financial crisis, followed by the Great Recession and the European Sovereign Debt Crisis which may or may not be still be around.

The recent move in the U.S. dollar since the end of the Fed’s QE, has caused reverberations in asset classes the world over, but little impact on the S&P500 (SPX) which is up 9% since last June. That’s despite the 20% surge in the Dollar Index (DXY) that’s provided the single largest headwind to U.S. corporate profits.  The one year chart of the DXY vs the SPX shows the happy correlation of both. Equity investors have not been bothered:

DXY vs SPX 1yr chart from Bloomberg
DXY vs SPX 1yr chart from Bloomberg

Why the lack of worry?  Interest rates, until recently have made equities the only game in town. But in case you missed it, the yield on the 10 year yield has risen 70 bps off of the 2015 lows, and it appears that with the SPX only 2% from the all time highs, equity investors may start to take notice:


And of course the crash in commodities, specifically Crude oil, which despite a very healthy 35% bounce off of the March lows, still sits in crash territory down 45% from the 52 week highs.

Crude 1yr chart from Bloomberg
Crude 1yr chart from Bloomberg

Bizarre times. I would add that the breadth in the equity markets has been weakening for months. There appears to be little leadership and the inability for stocks to breakout to new highs (they’ve been trying for months) suggests the path of least resistance may no longer be higher.  We have positioned for a move in the SPX back to 2000 in the coming weeks (read here) as we expect volatility to start to creep into equities.

But I also suspect that some decent word-smithing by the Fed in two weeks at their next meeting and an near term resolution to Greece’s month end debt obligations could make for some sharp reversals off of any selling. The first major technical support in the SPX is just 5% from the highs, which is also a reflection of jst how complacent the trading has been up to this point.

As we head into quarter end, the focus will quickly turn to U.S. corporate profits. July will bring Q2 reporting season and if we see poor forward guidance (at a time where most economists/strategist expect a meaningful pick up in the second half) that could be the catalyst for US stocks to finally catch up in volatility terms to most other major asset classes.