Correction Has Gotten To Extreme Levels

Review of the ‘risk off’ trade in the past few days has been interesting because it has gotten remarkably extreme in some ways for such a normal correction. I remain in the camp that believes the fundamentals are sound. Growth is slowing, but that only justifies a correction opposed to a bear market. Since the correction has occurred, it’s time to be a bull.

Your perspective is dependent on your time horizon. If you’re a short term investor, I think you should’ve went short the market in January and should be heavily long now. If you’re a long term investor, then you recognize this is the 4th slowdown in this expansion. None of the previous slowdowns justified making a big move. Long term investors have enjoyed riding the bull wave instead of trying to time each movement. There will be a time to lighten up the long positioning in a long term portfolio, but we’re not there yet. The economy hasn’t fallen off a cliff and earnings growth is amazing.

Excessive Buying In Short Term Treasuries

The most interesting charts are the ones which show extreme movements despite the fact that this has been a normal correction. The vacillations have been excessive this year, but a 10.5% decline isn’t out of the ordinary. The chart below is an example of one which is at record levels. As you can see, it shows the z-score of the ‘risk off’ trade as investors sell stocks and buy short term treasuries. The difference is 4.7 which is by far the biggest difference since 2007. The decline in stocks is similar to other selloffs, but the buying of short term U.S. treasuries is the most in this period. It might be because investors are betting that the short term yields will fall because the Fed will slow down its rate hikes since the economy is slowing. I still think the Fed will raise rates 2-3 times, but the expectations for rate hikes have shifted to the downside. This is a chart you want to fade since the action is probably unsustainable.