EC The Illusion Of Stability

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U.S. equities continue to trade like a risk-free market. Over the past seven months, the range (from high to low) in the Dow Jones Industrial Average has been among the smallest in history.

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This behavior has been comforting to most investors as they tend to equate low volatility with low risk. Additionally, every time there is minor spike in volatility, it soon collapses. We saw this in extreme fashion this month after Greece agreed to yet another bailout. The news was followed by the largest 5-day decline in the history of the VIX Index.

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Behind this illusion of stability, though, are a number of signs pointing to increasing fragility…

1) S&P 500 earnings are likely to decline (year-over-year) for the third consecutive quarter.

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2) S&P 500 sales are likely to decline (year-over-year) for the second consecutive quarter.

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3) Credit risk is rising with U.S. Investment Grade spreads approaching multi-year wides.

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4) High Yield credit is also weakening, with spreads widening and negative total returns over the past year.

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5) Breadth within the equity market is deteriorating. While the S&P 500 is near all-time highs, only 42% of stocks in the NYSE are above their 200-day moving average.

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6) The yield curve is starting to flatten again, with long duration bonds outperforming shorter duration issues (for why this matters, see our research on Treasury Bonds).

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7) Breakeven inflation rates are falling again as commodities collapse and expectations for global growth are declining.

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8) Industrials, a key cyclical sector that typically correlates with the broad market, is showing extreme relative weakness.

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9) Emerging Market currencies are moving lower again, with many currencies like the Brazilian Real at multi-year lows. This is major issue for Emerging Market companies that issued a record-high $276 billion of dollar-denominated bonds in 2014.

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