In double-dip territory?

There is ongoing debate as to whether the economies of both the U.S. and Europe have re-entered a recession, but the real question should be whether it ever got out of one! We unfortunately will not know for sure for at least a couple of years to come because of the tremendous adjustments lag between the initial data collecting and the final official figure. There are, however, strong clues that the recession that began soon after the sub-prime crisis erupted in 2007 is still around. The only reason why markets were rallying in 2009 and 2010 were because of the massive concerted government efforts to keep their respective economies afloat. A bull in a bear market if you will but, as the ammunition is being rapidly depleted, the effects of this are reverberated across the financial spectrum. Volatility is rising sharply, commodity prices are dropping and treasury yields, the ultimate safe haven investment (despite the downgrade), is at record lows. So from a technical standpoint, there is growing evidence to suggest that what we are experiencing is not a double-dip or "W" type of recession but more like a very extended "U" type. The rally in 2009 and 10 were just smokescreens and the markets are just discovering that now.

What the sectors are telling us...

A cursory look at stock market sector performances can provide a good sense of the current market sentiment. The graph above measures the year to date performances of the major sectors of the world economy and is not distorted by currency fluctuations.

As a first observation, it is interesting to note the wide performance divergences between the various sectors. There is, for example, more than a 20% difference between the best (health care) and worst (financials) performing sectors. This tends to occur in periods of uncertainty.

The next interesting observation would be the divergence between cyclical and defensive sectors. The better performers (health care, consumer staples) tend to be the defensive sectors which would indicated very bearish sentiment in the markets.

It should come as no surprise that financials are suffering the most considering the uncertainty facing European banks exposed to the sovereign debt of troubled euro zone peripheral countries. What is more curious, however, is the relatively strong positioning of sectors like information technology or energy. For the tech sector, it reflects the boom in technology stocks. Some pundits are drawing parallels with the nineties, arguing that the market may actually be in a bubble.

For energy, however, it is a bit more baffling, markets are clearly pricing a high probability for recession (the negative ranking of materials and industrials clearly show this) but oil prices do not seem to reflect this! Pressure from proponents of peak oil and the continued strength of emerging market economies may go some way to explain this, but who knows? Sentiment can sometimes be finicky.