What Financial Markets Are Telling Us: The Chinese Holiday Is Over And That Will Worry Investors

The market looks set to rally this morning and I expect this leg up will be short-lived, followed by another leg down in the ongoing consolidation that began in early September following the summer rally to new highs. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), but my technical reading of key stocks in the S&P 500 is neutral. There is one negative factor across global asset classes. The action in currencies signifies $US strength. Expect the S&P 500 to be range-bound over the next few days.

While some famous strategists see a bear market in the making the derivatives markets don’t seem to agree. They are showing that hedging has actually reduced to normal levels, reflecting a consolidation and modest correction rather than forecasts of a bear market. And while implied volatility (VIX) has risen so has actual volatility in the S&P 500 (measured by 1-month volatility): the VIX is above its norm and thus is expected to mean revert rather than rise further. The flatness of bond volatility (TYVIX) suggests interest rates continue to trade within their summer range rather than busting out to new highs, key for the resumption of the bull market.

Commodities except oil have been stalled due to $US strength, a reflection of fears regarding global growth, which itself reflects China’s brutish treatment of its private sector of late. With China returning from holiday expect more bluster which will fuel bearish fantasies and take the market down a leg. $US strength is key, and when we see a reversal against majors like the € and EM (e.g., the Mexican Peso), it will be a good signal to go long again.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), Apple (AAPL), Gibraltar Industries (ROCK), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and a hedged position in the S&P 500 (UPRO and SPXU).