Posted by: Matthias Paul Kuhlmey
By popular demand, we are bringing back the music reference: Elephunk was a best-selling album by American hip hop band Black Eyed Peas, released in 2003. Funk, by strict definition, may refer in its origins to a french dialect, funquer, meaning “to give off smoke.” As the investment community tends to forget important lessons (quickly) by going “ga ga” over the most obvious and main stream media-proclaimed outcomes, we are convinced to do better: With the memory of an elephant, and definitely considering the common wisdom of “where there is smoke there is fire,” current market events need to be viewed with caution.
The global financial crisis, some years back, is engraved on most memories as an event spanning the years 2008-2009, mainly affecting equity markets. The schooled observer, however, would recall the situation differently, broadening the time frame to a starting point in 2006. That year, the U.S. Housing Bubble burst, fueled by cheap money and loose financing conditions, severely affecting securities tied to real estate as well as bank balance sheets. In 2007, warning signs became more obvious, but were still “localized,” with problems mainly affecting lower-quality U.S. mortgage lenders. In late 2007, several major global investment firms started to halt redemptions in mortgage-based investment funds.
With a perfect storm brewing, equity investments, for the most part, remained “constructive.” It took more than a year after the peak of the housing market to witness more severe losses in the S&P 500, which traded at 1447 in January 2008 (close to its historic all-time high of 1565, recorded in October 2007), before declining to 666 in March 2009. Most warning signs, such as multiple minus 300+ points down-days in the Dow Jones Industrial Index (in January, February and June 2008) were ignored; in fact, those were considered opportunities, as most losses were met with significant buying sprees in the aftermath of the sell-offs.
If we translate our historic observations to the current environment, we need to closely understand the NASDAQ Biotech Index (NBI). Market observers continue to see this market in a new paradigm, as a revolutionary “bull,” rather than a bubble. The formation of the NBI from a technical perspective, however, appears to be similar to every other bubble formation experienced throughout recent investment history. Further to consider: Year-to-date, the NBI has experienced 23 days with positive or negative advances/declines of 2% or more. To put this occurrence in perspective: During the entire course of 2013, only 35 such trading days were observed.
Volatility is picking up considerably, but so far in market segments that are not commonly watched by mainstream observers. With the risk of a “spillover” to major market indices, we consequently, need to stick with our music reference, broaden our focus, and beware of the potential “black eye.”