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Risk Aversion Returns

Posted by Larry Doyle on July 8, 2009 2:43 PM |

Risk aversion returns to the markets. Was the weakness in last week’s employment report so unexpected as to have investors running for the exits? Not in my opinion. I believe the equity markets got overdone to the upside and never truly belonged as high as they had gotten. The risk aversion is playing out in most, but not all, sectors of the market.  Let’s review . . .

1. Equities: down .5-1% on the day and down 4% on the month. Concerns about 2nd quarter earnings along with prospects for future economic growth are weighing on stocks. See my post from earlier today about revised IMF projections for GDP.

2. U.S. Treasuries: a real flight to safety bid has reemerged in this sector. The $19 billion 10yr auction today was extremely well bid. The note was awarded at 3.365%, while it had been trading at 3.4% just prior to the bidding. The bid-to-cover ratio of 3.28 is extremely high.

On the month, the 10yr Treasury rate is lower by .20 (20 basis points) as is the 2yr note, as well.

3. Commodities: have largely tracked the equity markets lower with certain commodities, such as oil, declining even more. Oil on the month is down approximately 12%. There is increasing noise about further regulation within the oil markets, as the Wall Street Journal reports, Oil Speculators Under Fire.

4. Currencies: the greenback is sliding sharply versus the Japanese yen (currently 92.50) versus a closing level at the end of June at 96.30. The dollar is slightly stronger versus the Euro, but within levels seen over the last few months.

5. Bonds: while virtually every other sector of the market is flashing warning signals on the horizon, the credit sensitive sectors of the bond market seem remarkably calm. I would certainly not look to add exposure in the corporate bond or high yield sectors, and if I had exposure there I would lighten up. High yield bonds on the year are up approximately 25% and despite the selloff in equities from the early June highs, this sector has given back very little. Morgan Stanley concurs as Bloomberg reports, Junk Bonds Are ‘Dangerous’ After Rally, Peters Says:

The rally in junk bonds of the most debt-laden companies makes the market “incredibly dangerous,” said Greg Peters, head of credit strategy at Morgan Stanley.

“I just don’t see the proper risk reward here,” said Peters, who is based in New York. “The bet that you’re making in high yield right now is that the consensus forecast for defaults is actually going to come in lower than anticipated.”

Be careful out there!!


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