Coming to a Head

• Posted by Robert Sinn
• on July 24th, 2012

The tension is building, can you feel it?

Spanish bond yields are soaring to euro area all-time highs and CDS on Spanish debt is blowing out:

 

Sentiment is pervasively bearish and the guy who hasn’t been able to do much of anything right during the last two years says there is a 50% chance that the euro will unravel over the next two years: “John Paulson Said to See 50% Chance Euro Will Fail”

Ratios such as $DIA/$IWO, $SPY/$IWM, and $GLD/$SLV continue to point to widespread risk aversion and defensive positioning. Meanwhile, the Dow theorists continue to point to the weakness in the Transports ($IYT $TRAN) and the series of lower highs which offer a clear divergence from the series of higher highs in the S&P 500:

To top it all off (and trust that I could keep listing things but you get the point by now) yesterday we received an infamous confirmed “Hindenburg Omen”. So what does it all mean and what will happen next?

If we think back to the “Flash Crash” of May 2010 and the early August plunge of 2011 there were a few things in common with both events:

• Market participants were generally positioned fairly bullish with a general sense of complacency – the $VIX was relatively muted and rose rapidly as panic set in
• Both corrections occurred rapidly amid a “buy the dip” mentality which dealt out a great deal of punishment to the vast majority of market participants
• There were powerful catalysts which emerged suddenly and took the market by surprise (Greece in 2010, Italy yields skyrocketing, emerging US recession fears, and US downgrade in 2011)

There is no doubt that this market could crash given the right set of catalysts (Spain is certainly a powerful enough catalyst), however, the lead up to the current market situation has been far different from the prior two summers – markets are almost bracing for another large leg down, whereas, in 2010 and 2011 the vast majority were caught flat footed and unprepared when turmoil began to spread across markets. This does not mean that markets cannot go lower, it just means that the likelihood of a large downdraft is much less this time around. Remember that if everyone is expecting something to happen, when it happens it isn’t a surprise……

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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