- New Science in old markets -

After the storm.

The large moves in markets yesterday seem to have resolved a number of compressions. The US bond market has been compressed at a weekly scale and the rise in price/drop in yields in yesterday’s session has broken that compression. This is the yield chart (don’t forget this is the inverse of the price chart) and reflects the renewed enthusiasm for these instruments that comes from Mr Bernanke’s probable continued job as Fed Chairman and the consequent continued existence of QE as a tool.

More bond buying can be expected and new analysis of this process shows that the Fed has now bought about 30% of all those bonds that are still outstanding at the longer maturities. The Bank of England has been even more aggressive and now owns about 40% of outstanding Gilts (the UK government bond) which means that the ‘easy buys’ have now been made. It may be quite hard to acquire significant further quantities on either side of the Atlantic as there are many who don’t wish to sell as they expect deflation soon. At the same steady pace of acquisition as now ($40bn per month in the US) this means that progressively higher prices will be needed to buy ever smaller amounts of bonds and gilts. Another bubble building?

US Stocks broke down through the most recent of the several daily-scale compressions after a brief ‘HEDfake’ up through the highs. This probably means that the Dow turn that we were expecting on the 5th came 2 days late and marked that brief high point. This was already a pretty useless signal but this extra volatility is worth noting as it often comes when a turn happens close to a compression, as here. It has the effect of turbo-charging the compression and big moves usually start at such moments.

There were also clear downward breaks in some European equity indices, but not all. Spain and Italy both slid well through their respective compressions, but the general weakness led only to new compressions in Germany and the UK. Regular readers will know that we like Germany in the longer term and we are also starting to like the UK. This does not mean that we advise buying these two here, but it does tend to confirm our view that Spain and Italy are the best short-sales candidates when weakness is due and that Germany and some others are the best to buy when we expect strength.

We added Greece to that ‘sell’ list again recently and it too has fallen sharply. We also added France, which still hasn’t dropped any more than Germany so we will watch it carefully to see what signals may alert us to its imminent demise. We will of course advise when we think it is the appropriate moment to start buying stocks in any part of the world and expect that it will again be Germany (and maybe the UK and perhaps Holland) that will be our preferred choices. 'Spread' trades, in which Germany is bought while Spain, Italy or one of the others are short-sold can be done at any time.

Still no 'China buy' and the latest rally in the indices we follow has failed up at the compression shown in the 28th October edition, as we said it should. Since then there has been another compression (shown in the last edition, 6th November) from which the price has now fallen. This is getting more interesting for potential buyers and it is possible that this current drop will end with the long awaited 'buy China' signal. Until then, traders should stay short. We will advise.