Risk Aversion sends Global Equity Markets lower, Bonds higher

One never knows what the markets are going to focus on any given day ( which is the reason this never gets boring) but today seemed to be one of those days in which investors/traders were given to experiencing a sudden case of "risk aversion".

News out of the Eurozone set the mood with Euro-area growth up a mere 0.2% for Q1 when market expectations had been for a 0.4% increase. While hardly the stuff of legend at 0.4%, at least the estimate was up slightly. When the actual number came out and investors realized that the Eurozone was barely avoiding an overall contraction, equity bulls got nervous. Heck, it seemed as the entire world was suddenly itching to get out of stocks and into bonds.

Ever since China news has been less than stellar there have been concerns about a slowdown in global growth.

Even here in the US, players seemed to hone in on the Industrial Production number, which was down as they overlooked a friendly Initial Jobless Claims number.

The lousy Euro-area number increases the pressure on the ECB to "do something" at their next meeting in June. Already talk is ramping up of their own version of QE to stave off deflation. Keep in mind that in the past the ECB has surprised the markets by announcing an interest rate reduction apart from their actual meeting. It could happen again if we get any further unexpectedly weak numbers out of that region.

No matter the reason, most global equity markets were weaker today. Bonds, on the other hand, here in the US, were higher with interest rates falling below the 2.5% level at one point on the Ten Year Treasury. There remain an awful lot of speculative shorts in the bond markets and it appears that they are getting squeezed in a big way right now. When that many bets are all on one side of a market, it does not take much to get the ball rolling in the opposite direction. These things tend to feed on themselves as short covering begets more short covering until all that is left is the strongest of hands.

To illustrate why I believe we currently have a risk off trade occurring in the markets, take a look at a rather simplistic, but helpful, comparison chart I use to gauge investor demand for risk. It is essentially comparing the Russell 2000 index to the S&P 500 index.

The Russell 2000 is comprised of small cap stocks and by its nature, tends to be much more sensitive to sentiment in regards to risk than its bigger cousin, the S&P 500. This can be seen in the chart.

Notice how the two indices can practically be laid directly over the top of the other and the pattern is almost identical. Both tended to rise and fall in harmony beginning at the date shown on this chart all the way up until this month.

Can you see how recently, the Russell 2000 has been underperforming its larger cousin in a very big way? Look at the February low for the Russell 2000 and you can see that the index actually fell to that level today before it rebounded. Compare that to the S&P 500 which remains well off its February low.

If we take the high point of the Russell 2000 back in March of this year which was up near 1212 ( the best close was near 1208) and compare that to its current level, near 1096, the index has fallen some 9.3% from its best CLOSING LEVEL. The S&P 500 on the other hand closed today near 1867, down 25 points from its best CLOSING LEVEL near 1892. That is off a mere 1.3%. Another way of saying this is that the Russell 2000 is very close to achieving an official "correction". That requires a drop of 10% off the best close.

The lesson? Investors appear to be nervous right now and seem to be fearing SLOWDOWN fears at the moment. This is one of the causes of the big rush into bonds. We are apparently back to caution as the name of the game. I think many are wanting to see confirmation of an improving economy here in the US, especially in the employment area, before getting too aggressive on the buy side in stocks again.

Along this line, the VIX or volatility index rose today. It still remains quite tame however.

There is also a bit of chatter out there that holders of European-based bonds are jettisoning them in favor of US Treasuries. That talk has picked up as sentiment increases that the ECB is going to act on the stimulus front next month. If they do, and if the Euro weakens as a result, some of those bond holders would prefer to own US Treasuries as they expect the Dollar to strengthen against the Euro. We'll see about that but it is a plausible theory.

One last thing, I do not currently have the time to do this, but some of you more enterprising readers out there might be able to do some research to see if you can track money flows INTO TREASURY ONLY FUNDS. It would help to confirm that we are seeing a shift out of stocks temporarily into the safety of bonds. Demand for bonds is very strong right now. I continue to marvel how the Fed has been able to reduce their bond buying and not upset the interest rate market. First they get a geopolitical event to induce safe haven buying into bonds and now they get some fears over slowing global growth. Boy howdy are these guys good! Their reduced buying has been more than offset by investor demand.

Keep in mind that the nature of today's markets is that all it will take to completely turn this sentiment around is a piece or two of solid economic news. Again, I want to caution you traders out there, do not overtrade right now and watch your position size closely. You can have your trading career end very quickly if you become foolish right now.