Markets Correlated Into ‘Risk On-Risk Off’ Dichotomy


Markets currently seem to be highly correlated into a simple “risk on / risk off” dichotomy, with the emini S+P futures leading the way while other markets follow. If the spuz is bid, then WTI catches a bid while the USD and bonds are offered – and vice versa. The tricky thing with trading off inter-market correlations is that the if-then relationship often ends suddenly and the secondary market reverts to trading on its own specific issues.

Inter-market relationships sometimes provide clues as to “why” a market is moving. For instance, when I interviewed Jimmy Rogers (NYSE:ROG) many years ago he asked me, “How can you trade wheat in Chicago if you don’t know what’s happening to iron ore in China?”

The CAD has had a strong positive correlation with the S+P this year. I think the rising American stock market the past few months has pulled CAD much higher than Canada specific fundamentals warrant. I’m shorting CAD in part because I think the spuz rally may be overdone but also because if the CAD/spuz correlation weakens and FX traders re-focus on Canada specific issues then those issues will weigh on CAD.

I could make a similar case for shorting WTI.

Gold has chopped back and forth within a $100 trading range for the past three months while gold ETF ownership has soared to all time highs. Gold has rallied ~$400 in the past year and has certainly benefited from the trend to low/negative real interest rates and the “idea” that massive stimulus will ultimately create inflation.

Final thoughts: I’ve thought that the “risk on” rally from the March lows was a bear market rally driven by irrational exuberance over the massive stimulus, short covering, TINA and FOMO. The rally persisted far longer than I thought, and the higher it went, the more aggressively I thought the first break would be bought. Last week, I wrote about the “Island Reversals” and how they might signal a top. So far, the bounce back from this week’s lows has been strongest in the “big name” stocks, while the broader market bounce has been so-so.

One of my favorite chart patterns is the “M” top with a lower second shoulder. The market closing weak today (below the Tuesday – Thursday lows) ahead of the weekend adds to negative market psychology.

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