For the week ending March 15, 2013, the SPX was up 0.6%, the Russell small caps were up 1.1% and the COMP was up 0.2%.
All indices remain flat and in a confluence zone with no clear trend. Though equity prices may push higher, the question of trend sustainability grows as momentum is weakening and foreign exchange markets indicate a risk off environment is developing.
Supporting the thesis of declining momentum is found with position data (COT) which shows over the past three weeks commercial has increased their net short position to a multi-year high, while non-commercial (large speculators) are at a multi-year net long position. The opposite is true in Treasury futures. So market participants are at an extreme in terms of short Treasury and long equity.
The model also confirms these extreme conditions based on price action across multiple time frames. And lastly, though JPY remains flat both pairs and futures, it has begun to show growing signs of a trend reversal short (pairs), long futures. Should this continue it will further limit upside in equity markets.
Though the environment supports a major reversal, the model remains flat and in a confluence zone. Any directional trades are viewed purely as a trade. Any long trades should use extremely tight and trailing stops as intraday reversals are highly probable.
Asset Class Correlations
For the week ending March 15, 2013, the DXY was down 0.7%, 30 year yield was down 3bp and the USD/JPY was down 0.7%.
The commodity sector, after a period of heavy selling continues to bounce with DBC up 0.7%, oil up 1.7% and copper up 0.2%. The model had been short oil, copper and DBC but was stopped out this week and is now flat.
The model remains flat USD/JPY, long DXY and short EUR/USD. The current DXY profile remains bullish with this week's pullback a simple test of support.
The multi-month divergence with equity and the EUR, copper and 30 year yield remains. As a result equity may show greater relative weakness as part of any future asset class convergence. Using any of these asset classes as a directional indicator may likely produce false signals. Our preference is to use JPY pairs.
This week saw a continuation of the divergence with 5 year Treasury break evens which were up 12bp on the week.
Volatility disappeared with the VIX down 10.3% on the week. This is now the second breakout in volatility only to fail to sustain the trend. The prior being the end of 2012. Implied volatility skew remains high, averaging 127.80 for the week and closing at 129.12, a very elevated level.
Skew is a measure of how implied volatility is distributed. The lower the reading the less skewed the curve, indicating a normalized distribution.
For the period ending March 7, 2013, $0.6 billion flowed out of domestic equity funds while $6.4 billion flowed in to both municipal and taxable bonds. This ends the previous seven consecutive week of inflows to domestic equity funds as is now the second consecutive outflow.
For the month of February, domestic equity funds had a net inflow of $1.3 billion while bond funds had a net inflow of $20.7 billion. For 2012, domestic equity funds had a net outflow of $149.3 billion while bonds funds had a net inflow of $295.4 billion.
All equity indices are now flat and have entered a period of confluence. Any directional trades are viewed purely as a trade and not a sustainable trend. Equity markets have become extremely volatile and additional upside cannot be ruled out. Therefore it is advised that stops be honored, regardless of one's qualitative view. It is also important to watch the JPY, both futures and pairs to gauge overall risk sentiment.
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