April 17, 2013 | By Scott Minerd
Market internals are eroding and volatility is increasing. From the deterioration of the situation in Europe to slower growth and bird flu in China, there are several major risks on the global macro landscape. At some point, these foreign storms will reach our shores. Recent downturns in the markets have demonstrated how vulnerable asset prices have become to the arrival of bad news and data that does not meet expectations. Adding all of this up, it appears we are in the early stages of a broad consolidation.
Equities are priced for perfection. We don’t need the end of the world for a correction, just something less than perfection.
Recent data on the transport sector confirms the view that the equity market has gotten ahead of itself. A divergence of transport stocks against major averages, such as that which we are currently seeing, usually signals a changing trend in the near-term. This probably means equities will be 5% to 10% lower by the summer, and we will see some modest spread widening in credit, perhaps 10% to 15% wider than today’s levels. There is less risk for Treasuries because any perceived slowdown in economic expansion will be interpreted as increasing the likelihood of extending quantitative easing.
Dow theory posits that the strength of the transportation sector indicates the direction of the broader economic trend and overall market. Over the past 12 months, weakness in the transportation index has consistently been followed by corrections in the industrial index. With the divergence between the transportation index and the industrial index increasing again, the possibility of a near-term correction is rising.
Source: Bloomberg, Guggenheim Investments. Data as of 4/16/2013.
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