For the past 3 months, equity markets have continued to forge ahead unabated. The magnificent 7 are telling us that there is no reason for the markets to pause beyond short term overstretched valuations (I recommend the reader to go to the GTI web site for their monthly newsletter, one of the best available).
S&P 500 Banks index: the index has now been consolidating for 2 months around the 130 level. The index continues trading over the 200 days moving average which in turn is near its inflection point and on the brink of becoming positive. Results fro banks should be positive for Q3 and any disappointment should be limited around the 200 days moving average. The new support at 128-130 is holding very well. Positive.
Global 1200 financial index: The world financial sector broke through the 800 cap mid-July to gain +/- 25% since. The new cap/consolidating zone is around 1000. The index looks more over-extended than the S&P 500 Bank index (but also with better fundamentals due to emerging markets not plagued by the sub-prime and the-likes debacle), standing well above its 200 days moving average; the latter is however firmly on a positive slope, technically favorable. Positive.
TED spread (LIBOR USD 3 mth - US 3 mth T-bills): The spread is back to normal - no stress showing at +/- 20 basis points (0.20%). Positive.
USD bank BBB 10 yr - US 10 yr yield: Whilst still high and above historical average, the spread has decreased by 1.5% since our last review in August, and now stands at 5.4%. Positive.
OEX volatility: OEX volatility is now hovering around 25% well below the stress times of Q4 2008 and Q1 2009. Ideally, I would like to see it at 20% or below. Positive.
S&P Case Shiller house price index (source: S&P): The latest data (July) published in September show the 6th consecutive month of yoy decrease in the rate of decline. More importantly, the index continued to increased:
Composite-10: July 2009: +1,7%, y/y: -12,8%
Composite-20: July 2009: +1,6%, y/y: -13,3%
Signs are becoming more positive. Slightly positive.
Oil price: For nearly 3 months, oil prices have been trading in a narrow $65-75/b band , the latter seeming to be the resistance. This range will last as long as the economy in the US is not decisively improving (watch retail sales numbers). When it breaks upwards, it will rally very sharply. Positive for the time being.
Conclusion: All these indicators are now positive for the first time since 2006. I am not (yet) in the camp of the commentators that see a bear market rally. I however expect a 20-25% correction in equity markets by 2010 Q1.
In my last review (11th August), I advised to relax and wait for the next move, expecting a consolidation that did not occur beyond a few percentages in July. Liquidity and strong anticipations are very forceful factors that have driven markets higher. I still believe that they went ahead of themselves and will very carefully watch retail numbers as well as the employment situation (whilst a lagging indicator, in the current crisis, I think it is important to follow it due to its strong psychological effect on consumers).
I however do not forget that banks' balance sheets are still fragile (look at all the capital increase announcements in Europe for example) and may be hit by commercial real estate write-downs. In that case I would change my view and become bearish. I will watch the bank index regularly for any clue about a possible repeat (whilst not as large) of last year collapse.