We have been hearing a lot about “buying the dip” lately. It has largely worked, but it didn’t work on Friday, and didn’t work yesterday, and today we are looking at the weakest overnight futures performance of the year. Is this an opportunity to buy the dip, or the start of a bigger decline? I think we are at the start of decent move to the downside. The market feels very long and had become very complacent with the view that Greece would be resolved once and for all, that China would have a “soft” landing, and that the central banks of the world would continue to flood the markets with liquidity.
As I wrote on Friday, the market felt extremely confident on Thursday. The rally in Italian bonds was enough to provide stocks with strength in spite of some weaker than expected data. Friday saw renewed weakness, nothing major, but just like Wednesday, it felt like all the LTRO money had been priced in.
This week has started weak so far. China had weak PMI over the weekend and came out with a lowered growth target 7.5% and a higher inflation target 4% (indicating only 3.5% real growth?). Not impressive.
Economic data in Europe remains weak, the Greek “bailout” is muddling along at best – PSI looks like it will struggle, there isn’t complete agreement within the EU that Greece is doing enough even if it gets PSI done, and finally there is growing “nationalism” within Europe. So nothing out of Europe is helping the market.
In the US, the Fed remains dovish, but is having difficulty finding a good excuse to unload another round of QE on the markets. Away from the Fed, there is growing resistance to more QE as more people question whether a policy that has demonstrated the ability to increase the stock market without helping the economy should continue to be repeated. The headline ISM yesterday was okay, but employment declined and prices paid popped up. There is a lot of hope for a strong NFP on Friday. We may well get it, because not only was January an exceptional month for weather, February seemed pretty darn good as well. Those of us looking for a giveback on the economic data due to good weather in January may need to wait another month since the good weather really continued into February and we got an extra day on top of it.
The S&P 500 has still not had a down 1% day this year (it has had 4 days where it was up 1%). Will we have our first down 1% day? It is a very distinct possibility. The market seems as though it has attracted about as much cash as it can, and there are a lot of nervous longs. Remember, hedge funds always act as though they are leveraged up, because they have minimal tolerance for pain. Anyone who was reluctant to be fully invested early in the year, is now behind, but the last thing they can afford is to get fully invested just as the market takes a leg lower. With AAPL now over 4% of the S&P 500, it is impossible not to pay close attention to it. Yesterday’s sudden decline took a lot of people by surprise. It didn’t reverse, it actually leaked into the close. A great company without a doubt, but it is far from clear if it is still a cheap stock. Watch it closely.
JNK attracted some new money yesterday, but HYG didn’t add any new shares, and LQD actually saw the number of shares decline. DTV came out with a new issues yesterday. Both the 10 year and 30 year are 10 bps wider on the bid side. Nothing too traumatic, but with so many investors, hedge funds in particular, playing the new issue game rather than chasing the secondary market, this is an important change. Even in the high yield space, the new FIS issue that came out yesterday at 100 is down a point on the bid side, but new PNK is up a touch. It is only one day so far, but with such a big new issue calendar out there, any weakness on the break for new issues will put big pressure on the market.
The CDS indices are underperforming. IG17 is 2 wider today and finished on the wides yesterday and seemed weaker than stocks. Individual bonds are doing better as the weakness is too recent and the difficulty investors had sourcing bonds is still too fresh in their minds. Continued weakness in CDS will soon translate to the “most liquid” bonds. Investors will start tapping bids on names like HCA if the weakness persists and we will see how quickly that liquidity turns out to be a curse as those go-go bonds underperform. We aren’t there yet, but it could happen quickly, and HYG and JNK have been weak and closed with “premiums” to NAV near the lowest of the year. To the extent investors are taking advantage of the liquidity of the ETF’s to reduce positions, this could be a good leading indicator for the broader market. All of the CDS indices seem to be trading near their “intrinsic” value, so they are okay shorts since that indicates positioning is fairly balanced right now.
Again, buy the dip has worked so well, that we will likely see some bounces, but with so much uncertainty out there, and such high valuations, a continuation of the declines seems more likely than a big bounce.
So I would NOT be buying this dip.