Signs of Market Recovery

Three crucial indicators will signal the worst is over for risky assets (such as equities) and these assets are ready to move higher in price. They will also signal the reverse for defensive assets.

S&P 500 Volatility Index: needs to move lower into the 15 to 25 range. This would indicate that investors expect the upper and lower trading range of the S&P 500 Index to remain relatively modest over the next 12 months.

As at end December was at 45 and now fallen to 39.

Ted-Spread: the difference between the three-month sovereign Treasury bill yield and the London Interbank Offered Rate for US Dollars, (LIBOR). A narrowing of the spread will be a good indicator that Interbank counter-party risk aversion is abating.

The spread was around 1.46 (23 Dec) and now 1.33 and just above where the rate differential was just before Lehman Bros collapsed. (click below to enlarge)

Yield on the short-dated Treasury bills: watch for an indication that the yield of these instruments is heading closer to the official cash rate, rather than at yields last seen around the time of World War II. This would be a good indicator that investor risk aversion is gradually abating.

• US Treasury yields across the board were generally higher through late Dec to 2 January.
• UST 90 day ranged between 0.0% and 0.04% (peaks on 23 Dec and 2 Jan).
• UST 2s steady at 0.82% (0.9% pre Christmas, Dec range was 0.64% – 0.94%) and UST 10s up 20bps to 2.37% (2.17% pre Christmas, Dec range was 2.05% – 2.70%).
• US 30 Yr is offering virtually nil return at 0.01% compared to the cash rate of 0.0% - 0.25%.

Given that cash rates are close to Zero, the Fed recently noted that it had “obviously limited” room to lower rates further, but that the US Fed might use unconventional policies, such as buying US Bonds, ie. keeping rates down, to revive the economy, thus this indicator may not be a trigger.

Investors have been focussed on ‘return OF capital rather than return ON capital’.