Maalox Markets

When nearly all asset classes move (down) together, leaving little place to hide other than long-dated U.S. debt and crude oil, you know that something is not quite right.

The week is not yet complete but much damage has already been done to equity markets around the world with shares for smaller, more adventurous companies faring the worst.

Oil stocks (^XOI) and gold (AMEX: GLD) have followed the Dow down 3 percent so far on the week, gold mining stocks (AMEX: GDX) have fallen by twice that amount, while the price of crude oil (AMEX: USO) has risen.


Continuing objections to Iran's nuclear development program and shrinking fuel inventory levels are surely lending support to the oil price at this point, but oil is right there with U.S. Treasuries as the "safe haven" du jour as gold is beaten back.

The 12 percent price increase for the metal over the last seven weeks makes it less attractive than it would otherwise be and its growing acceptance as an investment class causes it to move with other investment classes in the global economy. The Wall Street Journal commented the other day that individuals should have no more than five or ten percent of their portfolio in gold - that's actually quite a bit if you think about it.

In the scheme of things, equity markets were clearly due for a pullback along with most other asset classes in this over-liquified investment world. Broad equity markets have had a ball since last summer when the Federal Reserve stopped raising interest rates and they were certainly due for a correction of more than one percent.

Now it's a question of what happens next - don't look for a definitive answer today.


In the current issue of The Economist, there are a few thoughts to share:

A fall of 8.8% in China's main stockmarket index on February 27th rumbled around the world, clobbering share prices just about everywhere. And when American traders looked at the news about their own economy—companies' weak orders for durable goods, worries about “subprime” mortgages, and Alan Greenspan, no less, musing about the possibility of recession—they took fright.
...
No one yet knows whether this week's shudders mark a pause before prices glide serenely upwards again or the start of a proper tumble.
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One sign that things are slowing down came in the form of those disappointing orders for durable goods, which fell by 7.8% in January, far more than expected even after stripping out surprisingly poor demand for aircraft.
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A second and perhaps bigger source of concern is the housing market. The commonest view runs something like this. Yes, the housing market has slowed. Yes, the fall in residential investment has whacked the GDP figures, but the market seems to be settling down again. And consumer spending has gone along merrily. Just look at the fourth-quarter accounts: consumption was strong enough to explain the whole of the addition to GDP and more. This week the Conference Board's measure of consumer confidence hit a five-year high. So there is probably nothing to worry about.

Well, perhaps. The stock of existing homes, relative to monthly demand, remains high and the backlog of new homes is rising. The housing glut is likely to weigh on prices and on building—and hence on the economy—for a while. It is hard to believe that consumer spending will be unaffected, once homeowners realise that their houses are no longer doing their saving for them simply by going up in price. At the risky, subprime end of the mortgage market, there are already signs of distress: defaults and foreclosures have been soaring.
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In any case, an American slowdown is only to be expected. The markets (and perhaps Mr Bernanke) may have cursed Mr Greenspan for mentioning recession. In fact, he spoke a lot of sense. He did not say recession was likely. He merely noted the truth: that corporate America's profit margins “have begun to stabilise”, a sign that the economic cycle is entering its later stages. The cycle, in other words, has not been abolished.

If this week has served as a reminder of that, so much the better. So much the better, too, if it has made investors stop and ask whether, at the returns on offer, it is wise to run after emerging-market shares, virtually any sort of corporate bond and the privilege of insuring lenders against the risk that goodness knows who will default on a loan. And if not? Then the next slip on the tightrope could be much nastier.

The economic reports took on a decidedly negative tone about two weeks ago, perhaps foreshadowing the events this week in equity markets. Further, this morning's University of Michigan Consumer Sentiment report was down sharply, coming in a bit below the average of the last few years - squarely at odds with the Conference Board's measure.

It is shaping up to be another very interesting year in the investment world - keep the Maalox handy.

Full Disclosure: No position in GLD, GDX, or USO.