Investors who needed proof of China's increased importance in the post-financial-crisis world only have to look at the nervousness of recent weeks to get a glimpse of the future.
When U.S. stocks fell sharply late Friday, they capped off a harrowing 10-day span that has seen the broad U.S. market benchmarks drop by nearly 7%. Emerging markets are down 9%. Not surprisingly, investor fear has sent volatility rocketing 40% – the largest two-week increase since the global financial crisis went nuclear back in October 2008.
Complicating matters was the continued strengthening of the U.S. dollar – something we've been discussing and warning about for a few weeks. With fear on the rise among global investors, many are abandoning risky positions in emerging-market stocks and bonds and moving cash into the safety of U.S. Treasuries. This bolsters the dollar, which was up 4% in two weeks. That exerts a lot of pressure on commodities. Crude oil fell more than 7% during the week. Gold is down 5%.
The corporate bond market – which has been red hot lately, helping to underpin stock-market gains – continued to advance, but slipped relative to ultra-safe government debt. Tim Backshall of Credit Derivatives Research wrote in a note to clients that both high-yield and investment-grade credits have been making the longest and most consistent run of lower lows versus ultra-safe U.S. Treasuries since February 2008.
While government debt has the edge for the moment, the long-term corporate-credit bull market remains intact, according to WJB Capital Group Inc. strategist Brian Reynolds. He sees the credit bears making a run at credit-derivative products that insure against bond defaults, which are a cheap way to try to manipulate the market.
Indeed, the cost to protect against default at banks like JPMorgan Chase & Co. (NYSE: JPM) and Goldman Sachs Group Inc. (NYSE: GS), not to mention Greece, jumped noticeably last week. But the damage has been limited as bears have failed to get traction against the instruments that they used to catalyze the 2008 credit crisis.
This lays the groundwork for a powerful snapback rally for stocks.
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