Head Scratching Stuff

The dichotomy in asset markets has many, myself included, scratching their heads. Whilst the last four months have seen falls in the European and US high yield bond markets of approximately 1.3% and 2.9% respectively, equity markets have continued their upward trend. In fact, over the same time period the DAX has returned circa 0.8%, the S&P 0.9%, the DOW 3% and the MSCI Emerging Markets Index a whopping 20%. All are at, or near, their all time highs.

It would seem unlikely that both markets can ultimately be proven right. Whilst the equity market is no doubt aware that there are real pitfalls ahead, it appears supremely confident that central banks will be willing and able to reinflate their economies. I’m not so sure.

As an aside I spent a few days in the US last week trying to gauge the tone in the US bond market. The mood it must be said was somewhat mixed. Some argued that what we are seeing is more a mid cycle slowdown and were hesitant to talk too much about the dreaded ‘R’ word. Readers of this blog will be acutely aware of our bearish thoughts and I must admit the bulls failed to convince me otherwise.

Since Jim’s teleconference (see here) the asset backed and interbank markets have so far failed to normalise and US housing data has continued to come in below consensus (August pending home sales fell -6.5% yesterday). I fail to see how this withdrawal of liquidity and continued poor housing data won’t have wider implications for the US economy.

Finally the technical picture continues to look unappealing – several hundred billion dollars worth of pre-committed leveraged loans have yet to be sold, there is a risk of various structured vehicles having to unwind, and new issuers need to come to market.