Correction characterized by typical risk aversion patterns

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The past week’s performance of the major asset classes is summarized in the chart below – a set of numbers indicating heightened risk aversion on the back of growing concerns about sovereign debt issues, the longevity of the global economic recovery and Chinese policy tightening. The only asset classes to end the week in the black were the US dollar (+1.5%) and Treasury Inflation-Protected Securities (TIPS) (+0.3%).



The chart below, obtained from the Wall Street Journal Online, also includes the performance of a few other financial markets during the past week.


Source: Wall Street Journal Online, January 29, 2010.

On the topic of risk aversion, and more specifically as far as equity markets are concerned, a number of indicators make for interesting reading.

Stock market leadership

It is interesting that since the start of the nascent US stock market correction on January 20, cyclical sectors such as the Materials SPDR (XLB), Technology SPDR (XLI) and Energy SPDR (XLE) have been leading the market lower. Traditionally defensive sectors such as Consumer Staples SPDR (XLP), Health Care SPDR (XLV) and Utilities SPDR (XLU) also declined, but to a lesser extent than the S&P 500 Index as a whole (-6.6%) and the cyclical sectors.



Emerging markets

The chart below shows the relative performance of the MSCI Emerging Markets Index versus the Dow Jones World Index. After strong outperformance by emerging markets since November 2008, the relative performance has been moving sideways for the past three months, with emerging markets underperforming since early January.



Small caps

Small-cap stocks have strongly outperformed large caps since the start of the March rally (see chart below). The relative line has been volatile since October, but it would not come as a surprise if small caps are heading for a bout of underperformance (i.e. a declining line).



The above are some of the patterns one would expect typically to emerge during a correction phase. These will be on my radar screen in an attempt to assess the magnitude of the nascent correction.

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