non-synthetic futures and option strategies

stocks set to fall, but safe from 'flash'-type slide

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the relative calm in the credit markets indicates the stock market's recent pullback isn't a result of investors running from risk, like they did last summer. that may not be enough to stop stocks from declining further, on the back of slowing economic growth. but as of now, it at least suggests those declines won't be of the "flash" variety seen in early may 2010, as well as the tumble in late 2008.

the rate spread between three-month treasury bills and eurodollar futures, or the interbank lending rate, known as the ted spread, widens and narrows as the perception of counterparty risk increases and decreases. at the moment, the perception of that risk has declined even as stocks have weakened.

the ted spread was recently just about 20 basis points, or in the middle of the range it has been in so far this year. the spread has narrowed from a nine-month high of 25.45 basis points may 6 while the s&p 500 has declined 1.3% during that time.

in the same vane, the high-yield bond market, which tracks liquidity conditions in the financial market, has held up relatively well. the ishares iboxx high yield corporate bond exchange traded fund (hyg) was down just 1.1% since closing at a multiyear high on april 29, while the s&p 500 has lost 2.8% over the same time. creditsights said one of the reasons the outlook for the high-yield market remains positive is that default rates have been declining to well below historical averages. the hyg closed thursday at $91.87.

of course, that doesn't mean the perception of liquidity risk can't change. a key level in the hyg for equity investors to watch is the 200-day moving average, which currently comes in at $90.47. if the 200-day gives way, like it did last may, so might the "orderly"-decline scenario for stocks.

but in the meantime, wells fargo senior analyst gina martin adams said, the fact that broader risk tolerance measures have held up so well while commodities prices and treasury yields have declined suggests the primary reason for the recent weakness in equities is "a reset of economic expectations, not a generalized flight from risk."

the bad news for stocks is, the 10-year treasury yield's slide thursday below its 200-day simple moving average for the first time in 5 1/2 months means economic expectations need to be reset even more. and despite the s&p 500's bounce the last couple sessions, the index has been unable to clear close resistance at the 1328 to 1329 level, which is where the 50-day simple moving average and the extension of an uptrend line starting at the august lows currently come. on thursday, the 10-year yield fell to 3.061% vs. the 200-day moving average at 3.08%, and the s&p 500 rose 5 to 1325.

the good news is that so far the equity declines look like they will be part of a "normal" cyclical correction, rather than the run-from-risk, stuff-the-mattress type selloffs seen last year, and in late 2008.