Contagion exists

There was the belief that this time would be different, that the world economy has decoupled from the United States, and that the Asian flu we saw a decade ago was a thing of the past. Well, think again. It is unclear what will happen in the next few hours but we are seeing the continuation of the credit crisis in another form. So much for the optimistic equity traders who have not been able to utter the words recession versus the gloomy bond guys. So much for the ultimate circuit breaker – a holiday week-end.

A stock decline is justified if there is a recession but the real global move is being caused by a delivering of positions. Commodities, especially metals, are correlated with the equity move. Foreign exchange and bonds have both had good moves. A delevering of some positions has spilled over to what could be considered good positions as portfolios are rebalanced. Stronger performing markets are reduced in exposure to get them back in line with the poor performance in the United States. Again, this does not dismiss the fundamentals but explains why there is such high correlation across the board. Nevertheless, there is a sense of purpose with the sell-off. Look at the sectors that are being hit hardest, financials and cyclical in equities, high yielders in foreign exchange, and a flight to government bonds. The moves have a purpose to reduce risk and avoid those sectors which have the highest level of uncertainty.