Agricultural Commodities Sentiment

From the recent peak to current trough, speculators have cut all major agricultural commodity bets by 33% or one third. These include Corn, Wheat, Soybeans, Rice, Cotton, Sugar, Cocoa and Coffee.

Cotton Update

• May 23: Official customs data from China showed that the country’s cotton imports in the first four months of the year totalled 1.062 Mt, a drop of just over 9% compared to the previous year.

• May 12: Cotton Australia, an industry association, forecast total Australian production in 2010-2011 of 4m 480-pound bales, 600,000 bales higher than the previous record in 2000-2001. The cotton crop has shrugged off the Queensland floods of January; next year’s crop is also expected to be substantial, given the incentive of high international prices and very good water storage levels.

• May 11: China’s National Cotton Exchange said the country’s cotton plantings this year could rise to 5.43m hectares, almost 6% higher year-on-year, due to higher prices. Planting was mostly finished by the end of April. This is slightly higher than other agencies forecast; in February, the Chinese Academy of Agricultural Sciences forecast a 4.1% rise of cotton plantings in China, to 5.17m hectares.

Sugar Update

• May 26: In its latest fortnightly update Unica, the sugarcane industry association, said that sugar output up to 16 May so far this season totalled 2.36 Mt, almost 47% lower than the same period last season. The total crush was 56.7 Mt, down almost 40%. The figures are however somewhat skewed – the crush started early last season and this time round it was delayed by heavy rainfall from February to mid-April.

• May 13: The director general of the Indian Sugar Mills Association (ISMA) said that India would produce a total of 24.2 Mt of sugar in the 2010-2011 season, an 800,000 tonnes reduction from the association’s previous estimate.

• May 10: China’s white sugar production during January-April was 7.82 Mt, 1.4% higher than the same period of the previous year, according to the National Bureau of Statistics.

• May 10: Conab, the Brazilian state-run crop supply agency, estimated that sugar production in the centre-south region would be a record 35.9 Mt in 2011-2012, against a (revised) output of 33.6 Mt in 2010-2011. It put the cane crush in the region at a record 573.1 Mt.

• May 4: Indonesia’s forestry ministry has offered 2m hectares of “degraded land” and forest which was previously allocated to palm oil production to be used as sugar plantations. The government is keen to reduce its dependency on imports, officially running at about 3 Mt/year.

Market Sentiment

So remember... buy low and sell high!

Thinking Process: Euro, Pound Sickness Masks Board Dollar Weakness

The guy in the picture above is a critical piece of the puzzle for many asset classes today. Since it is linked to a safe haven trade, it is said that Financial Crisis brought about two simple trades: Risk On / Risk Off. Risk on means that asset classes like equities, junk bonds, emerging market bonds, commodities and higher yielding currencies out-perform, while risk off means that the money tends to flow back towards developed markets government and solid corporate bonds, and safe haven currencies like the US Dollar. US Dollar itself has a very negative correlation with many risk assets like commodities and equities, which means that tracking the next move of the guy in the picture above, can give us many clues about how to position our portfolio.

The widely followed US Dollar Index still remains above its 2008 "panic low", fooling many into believing that the current negative sentiment together with a failure to make these new lows, is a bullish sign for the Dollar.

The chart above could explain why. My old man always taught me to compare myself with "the best" and strive for that level. I guess a same metaphor could be applied with the US Dollar Index, which compares itself with the Euro and the Pound, amongst others - another two sick currencies, that seem to be struggling just as much as the US Dollar.

So... what I've done is developed two of my own indices, which track the currencies that are not so sick. In the chart below (red) I overlapped the US Dollar Index (DXY) with the Commodity Currency Index (CCI) - an equal weighted index consisting of the Australian Dollar, Canadian Dollar and the New Zealand Dollar. These economies have been growing at a strong pace, fuelled by exporting commodities to Asia. Their interest rates have also been moving north and increasing yield, which makes the currencies appreciate.

We can see that the US Dollar Index (DXY) bear market, which started in early 2002, has been tracked perfectly by the CCI up to 2009. However, since the late 2009, the Euro started to be plagued by a serious sovereign debt crisis in peripheral countries (PIIGS). This affected the neighbouring Pound as well and gave the investment community a perfect incentive to weaken these countries against all other majors, including the US Dollar. However this strength was masking the actual broader US Dollar weakness, where commodity currencies continued appreciating in a secular bull market. Currently, the CCI is making all time new lows, breaking US Dollars support below the "panic low" of 2008 and confirming that the US Dollar remains in a downtrend.

The other index I want to show in the chart below (blue) is the same process of overlapping the US Dollar Index (DXY) with the Asian Exporter Currency Index (AECI) - an equal weighted index consisting of the Japanese Yen, Taiwan Dollar and the Korean Won. These economies have been growing at a strong pace as well, fuelled by exporting goods to both developed and emerging economies, especially China, since the Global Financial Crisis. Their interest rates, too, have also been moving north and increasing yield, which makes the currencies appreciate.

And just like with the CCI, the US Dollar Index strength is also masking broader weakness, where Asian export currencies continued appreciating in a secular bull market, that started in 2002. Currently, the AECI is making all time new lows, breaking US Dollars support below the "panic low" of 2008 and confirming the CCI and that the US Dollar remains in a downtrend.

Therefore, this trend should also continue with the US Dollar weakening against precious metals like Gold and Silver, commodities, and could reignite a risk on trade! However, apart from commodities - which are in a secular bull market, I remain wary about purchasing equities this high up, as they are in a secular bear market. Obviously, that does not mean they will not go up more, but this is just my own risk tolerance. And... on a final note of caution, from a contrarian point of view, it should be quite obvious that both CCI and AECI are very much dependant on Chinese growth engine. Therefore, if and when the Chinese property bubble bursts (fuelled by huge amounts of credit), these economies and their respective currencies will get an absolute beating, similar to that of 2008 - if not WORSE!

Jim Rogers Interview

S&P 500 YTD Heat Map

Biggest large cap winners and losers in 2011...

Crude Oil Supplies

There is constant bearish talk that US Crude inventories are at very high levels. What majority of these bears have missed, is that there is actually a world outside of the US, and believe it or not... they are eating Crude Oil supplies at an amazingly rapid pace.

In fact, they are consuming excess levels of Crude so fast, that almost all of the global build up inventory, that occurred during the 2008 recession, has now been used. Why the hell have all the bears out there been trying to short Crude, in the first place?

No wonder Crude is back in the $100 range, from the depths of $30 a barrel not so long ago. Since markets always look to the future, instead of the past or even present, the question is what next?

Jim Chanos Interview On Bloomberg

Stocks: Hedge Funds Winning Streak Indicates Caution!

The chart above shows monthly hedge fund performance from January 1996 to April 2010, thanks to the Hennessee Group LLC. As a contrarian indicator, the above chart shows that when hedge funds lose serious money and go through periods of forced liquidation, it tends to be close to or perfectly at an intermediate bottom of the S&P 500. Periods like these were seen during the LTCM crisis in 1998 when on average hedge funds lost over 7% in just three months; tech bubble burst during 2001 & 2002; and finally the crash of 2008, where hedge funds got completely slaughtered and were down almost 20% for the overall year.

On the other hand, when hedge funds enter periods of easy money through long periods of winning streaks (blue highlights in the chart above), tend to be an indication that the trade has become extreme overcrowded and majority are complacent. Just around the corner, market surprises to the downside, and usually in an abrupt and violent manner.

We have now entered one of these famous streaks seen in the last 15 years or so. Monthly hedge fund performance since August has been a perfect winning streak of return, which means eight months of solid returns without a dollar lost to the market. To be honest, the S&P 500 did move in a single line straight up, without a pause. These same managers are using low volatility (VIX @ 16) to leverage themselves up and try to increase returns. To say that we are once again entering a speculative bubble in equity markets might be an understatement, as the NYSE Margin Debt hits $320 billion in April and starts approaching those frothy 2007 levels.

Simple conclusions could be something along these lines... easy money, huge winning streaks, very low volatility and increasing leverage, usually does not equal strong future returns. It actually sounds to good to be true and eventually somebody will get hurt... very badly! Even tough retail investors are currently bearish, which could send the market higher by a margin or two, I would still stay very cautious as we could see some nasty surprises around the corner.

Goldman Sachs Values S&P 500

Source: Goldman Sachs Strategy Research Newsletter

Thinking Process: Another Look At Sentiment

This morning (Australian Time), the S&P 500 futures are sitting at 1,330 flat, which is about 40 points or about 3%, from the bull market high, registered on 01st of May 2011. And yet market participants are starting to become more and more pessimistic. I wrote about this a week ago, as it became quite obvious from the survey of retail investors (AAII). However, now it seems like other investors, like advisors and money managers, are also slowly letting their worries overcome their confidence. AAII Survey shows the reading of bullish retail investors approaching the lows of August, which is mid to low 20s. Investor Intelligence Survey also shows the reading of financial advisors dropping back to low 40s and approaching levels last seen in September 2010. Finally, money managers, which are tracked by the NAAIM Survey, aren't that optimistic either, sitting somewhere on the fence, when it comes to equity exposure.

Retail option traders, who's sentiment is well represented by the CBOE Equity Only Put to Call Ratio, currently shows that there is more pessimism than optimism within the market mood. Since the bull market started from the 666 lows on 06th of March 2009, the smart thing to do was to buy when majority where buying puts, and stay cautious (not short), when majority were buying calls. This is a bull market after all, so there is no need to become a bear, until the market changes directions. As we can see from the chart above, the majority of retail investors are buying puts. We are now in the upper trading range of the PC Ratio, which indicates, that now is not the time to sell or short, buy to actually buy or at worst... just hold.

Now, obviously there is a reason for this pessimism. According to the Citigroup Economic Surprise Index, which tracks deviations of economic data surprises (actual releases vs Bloomberg survey median forecasts), the economy has been under-performing in recent months. This is obviously music to the Treasury market, which in the contrarian manner, bottomed and rallied ever since the economic momentum peaked in late January.

Therefore, if you are of the view that the economy is now about to improve again; that end of QE 2 fears are overdone; and that the global economic expansion will continue; than as a contrarian, you would take on the opposite position to majority of market participants, who are currently cautious at best or bearish at worst. On the other hand, sentiment could get a lot more bearish and the economy could really disappoint during the European summer months, but... would you want to be betting on that with the majority?

Jim Rogers Interview On BBC HardTalk

You'll notice he said "America is in deep shi.."

Deviating From Long Term Trends

S&P 500

S&P 500 is currently in a secular bear market, which means a trading range as inflation adjustment occurs towards the downside. However, in saying that, one of the great buying opportunities in our lifetime occurred with S&P 500's crash during the Global Financial Crisis, when the index traded over 35% away from its 200 day moving average. This point was one of the most oversold events since the 1929 crash, within the equity market. Currently, S&P 500 is still trading above its 200 day moving average, and therefore no buying opportunities are currently present. Since the market price has doubled since March 2009, even if the price was to trade below the 200 day moving average, I would not see it as a buying opportunity, as a believe the next cyclical move will be to the downside.

10 Yr Treasury Note

Interest rates on the 10Yr Treasury Note have been in a secular bull market since 1981. However, with the Global Financial Crisis of 2008, government bonds in the US stages a secular panic low, where interest rates on the 10 Year Note fell to a low of almost 2.0%. Obviously this is my opinion, as the market itself has not started an interest rate rise. However, in saying that, if one is willing to speculate that we are at the end of the 30 year Kondratieff Wave, than we are fast approaching that point now, where the 10 Year Yield relative to its 200 day moving average is becoming quite neutral. Bull or bear, what is your view?

Crude Oil

Long term for Crude Oil prices remain towards the upward bias. One of the great buying opportunities in our lifetime occurred with Crude Oil's crash during the Global Financial Crisis, when Oil traded almost 70% away from its 200 day moving average. This point was one of the most oversold events that ever occurred within the financial markets for a major asset class. Currently, Oil is still trading above its 200 day moving average, and therefore no buying opportunities are currently present.

Gold

Gold remains in a secular rising bull market. In recent months however, there hasn't been a proper buying opportunity. As a matter of fact, this is quite true since the Global Financial Crisis, when Gold traded almost 20% away from its 200 day moving average. This point was one of the most oversold in the last 15 years and therefore a great entry point. Currently, Gold still resumes it "parabolic" looking move, and therefore no buying opportunities are currently present, as the price keeps persisting upwards, always staying above the 200 day moving average.

US Dollar Trade Weighted Index

Long term trend remains down for the US Dollar, however it is not very wise to short the US Dollar at the current time, because the price is still a few percent away from the 200 day moving average. Good short opportunities occur, as we can see from the chart above, when the price rallies above the 200 day moving average and it becomes overbought in a major secular downtrend.

Euro Crisis Update

Greek default coming up?

S&P 500 Technicals

Marc Faber Interview On Bloomberg

Sugar Update

Sugar price is now testing the 20 day moving average, and despite a bad commodity sell off over the last week, the prices have not made new lows. Can we take out th 20 day moving average (green line) and stage some sort of a rally?

Commodities Update

The secular bull market in commodities is alive and well. Two asset classes that tend to move in opposite directions during a 17 year cycle. As equities started their secular bull market from inflation adjusted lows in 1982, commodities peaked. The chart above is a comparison of the way stocks started their bull run, compared to the way commodities have started theirs up to to the current time frame.

In my opinion, the 1987 crash in the stock market, which was due to forced liquidation, reassembles the 2008 crash in commodities, which was also due to forced liquidation. As stocks rallied into the bubble parabola of 2000s, the 1987 crash looked just like a little blip. I assume that the same outcome will occur to commodities within the next 5 to 10 years.

The chart above shows the return for various commodities, which are part of the CRB Index, since June 2010 lows. Agriculture had the most powerful move since those lows, and still remains very depressed from historical perspective.

Global Economic Sentiment Update

• Both the Kospi and the S&P 500 remain in an uptrend mode, as both market indices sit comfortably above their trend lines. Kospi has been in the process of making new record highs in recent months, above the psychological 2000 point resistance, which at the current time, signals positive global economic momentum.

• Currently we have Dr Copper giving us some warning signs, as it recently hit its bull market trend-line at $3.85 per pound. A break of this line could be an early warning signal, just like the one we got in 2008.

• German business confidence, shown above thanks to Ifo, is currently sitting at record high readings. We do not yet know if we have peaked here, like in early 2000 and early 2007. Keep an eye out on this sentiment survey in future months.

• Also giving us a strong warning signal is the current ECRI reading which is rolling over, as well as the divergence between the April 2010 peak and the current peak, with the S&P 500. In other words, the real main street economy is not doing as well as the financial market Wall Street economy.

About the indicators

The chart above incorporates some of my favourite leading indicators for the state of the current global economic activity, market liquidity and possible future outlook. In the first section I use the S&P 500 (black) because this still tends to be the main barometer of the world economy, which tracks some of the biggest companies in the world.

I overlay US equity index with the Korean equity index (red), also known as KOSPI Composite or Dr Kospi as some call it. Korean economy is highly cyclical and export driven, and therefore very depended on the state of global economy, especially China, where majority of Korean business find exports customers.

Following Dr Kospi, we have Dr Copper (blue), a high grade industrial metal, that is used in so much infrastructure and so many products that surround us every single day. It is because of this mutli-purpose use that Copper tends to be a good barometer of the world economy.

The next chart below Copper is Ifo German Business Confidence Index (green), which tracks the sentiment of CEO of some of the worlds greatest manufacturing and cyclically export dependant companies that, just like Korean companies, tend to be very dependant on the health of the global economy.

And finally, we have the ECRI Weekly Leading Index (purple), which tends to have a very good track record (minus the 2010 saga), of predicting future economic activity in the US, including possibility of a rescission.

Global Equity Indices Breadth Update 22-05-2011

Developed Markets

S&P 500 (United States) has been moving sideways since the 18th of February of this year. The rally that started at 1040 after the Jacksons Hole speech by The Bernank at the end of August, is currently looking tired and over-stretched. May's price action has been quite average, but the index still holds both the 50 day as well as the 200 day moving average, and has yet to make any lower lows, which tend to signal a downtrend. The index currently trades more than 6% above its 200 day moving average.

DAX 30 (Germany) has also been moving sideways since the 18th of February of this year. May's price action has been quite average, but just like the S&P 500, the index still holds both the 50 day as well as the 200 day moving average, and has yet to make any lower lows, which tend to signal a downtrend. The index currently trades about 5.5% above its 200 day moving average. Friday's reversal candle is quite worrying, from the short term perspective. German equities have been under-performing United States equities since early December of 2010.

Nikkei 225 (Japan) topped on 18th of February of this year and than entered a full crash mode during the earthquake crisis in March of 2011. May's price action has been a continuation of a sideways move since middle of March. The index is yet to break above any of the moving averages. The index currently trades more than 3% below its 200 day moving average. Japanese equities have been under-performing United States equities since early December of 2010.

FTSE 100 (England) has also been moving sideways since the 18th of February of this year. May's price action has been very average, as the index barley holds its 50 day moving average. Unlike the S&P 500 as well as the DAX 30, the FTSE has failed to make a new high during the April rally. The index currently trades about 2.5% above its 200 day moving average. Friday's grave stone candle is quite worrying, from the short term perspective. English equities have been under-performing United States equities for over 8 months (this chart).

CAC 40 (France) has also been moving sideways since the 18th of February of this year. May's price action has been very average, just like the FTSE 100, as the index barley holds its 50 day moving average. Another similarity to the FTSE, is that the CAC 40 also failed to make a new high during the April rally. The index currently trades about 2% above its 200 day moving average. Friday's outside day reversal candle is quite worrying, from the short term perspective. French equities have been under-performing United States equities for over 8 months (this chart).

Emerging Markets (BRIC)

Bovespa (Brazil) has also been moving in a downtrend since the 05th of November of last year (Feds QE II meeting). May's price action has been a disaster, as the index continues to make lower lows, also known as a downtrend. The index currently trade below all of its main moving averages and currently is below its 200 day moving average by over 6%. Brazilian equities have been under-performing United States equities since October 2010.

Russian Exchange (Russian) has also been in a strong correction mode since early April 2011. May's price action has been a continued selling pressure that we saw in April, as the index continues to move towards its 200 day moving average. The index currently trades more than 2.5% above its 200 day moving average. Russian equities have been out-performing United States equities until April, when the story switched.

Bombay 30 (India) has also been moving in a downtrend since the 05th of November of last year (Feds QE II meeting). May's price action has been continuous selling pressure. Unlike the Bovespa however, Bombay 30 has yet to make a new lower low. The index currently trade below all of its main moving averages and currently is below its 200 day moving average by over 2%. Indian equities have been under-performing United States equities since October 2010.

Shanghai Composite (China) has also been moving in a triangular pattern of lower highs and higher lows since 05th of November of last year (Feds QE II meeting). May's price action has been quite average, as the index still holds the 200 day moving average, and has yet to make any lower lows, which tend to signal a downtrend. However, the index is still below the 50 day moving average. Chinese equities have been under-performing United States equities since November 2010.

Thinking Process: Secular View Of Stocks Vs. Bonds

The chart above shows a long term, secular, 140 year perspective between one of the two main rival asset classes - stocks and bonds. Bonds are presented as a 10 Yr Yield and the stocks are presented as S&P 500, adjusted for inflation. Here are some interest points to note:

Bonds

When one looks at the long term interest rate picture, it should become quite obvious that there have so far been five cycles known as Kondratieff Waves. These secular cycles are inflationary and deflationary in nature, and tend to last anywhere between 20 to 30 years. The two most recent ones have been an inflation cycle, where interest rates rise, which started in 1950s and ended in early 1980s. The other is the current deflationary cycle, where interest rates fall, which started in early 1980s and still seems to be in progress. Another obvious point is that weather the current deflationary cycle has already ended in 2008, or will end soon, one thing is for sure, next few generations will once again experience rising interest rates in a inflationary cycle.

Stocks

Share prices, on the other hand, tend to under-perform when interest rates are rising during an inflationary Kondratieff Wave. This was obvious during the early 1900s up to early 1920s, as well as during late 1960s up to early 1980s. Since the equity market (inflation adjusted) trades in the opposite direction to the commodities, it is therefore important to understand that during high inflation periods, where interest rates are on a rise, commodities tend to out-perfprom stocks. Consider that when equities enter secular inflation adjusted bear markets, commodities tend to enter powerful bull market rallies. As we can see from the chart below, when equities were depressed during 1860s, 1910s, 1940s, 1970s and 2000s, it was commodities climbing in an almost vertical line upwards.

Long term equity market moves are also very much connected towards valuations. The chart below shows the long term CAPE valuation method averaged over 10 years for the S&P 500. Therefore, the S&P 500's value based on decade of earnings, currently stands at a price to earnings ratio of 23.52. This reading is much lower than a ratio of 44.20, which was recorded in December 1999, just as the equity market bubble popped. This obviously tells us that the market is not extremely overvalued, compared to where it was.

However, it is important to realise that this reading is on par with the ratio of 24.06, which was recorded in January 1966, just as the equity market topped after a merger and takeover conglomerate boom came to an end. It is also worth noting that during the last 1890s equity market boom, by June of 1901, the market valuation based on this ratio was 25.24. Therefore both of these examples throughout history show that the current reading is on the overvalued side, where two previous secular equity market bull came to an end (1901 & 1966).

Conclusion

My long term outlook based on historical cycles (Kondratieff Wave) leads me to conclude that, over a secular long term view, the government bonds are currently the most overpriced asset class. Contrary to all the gloom and doom coverage, deflation talk comparing the United States to Japan, and constant double dip worries, I would stay away from any purchases of government fixed income, which is branded "flight to quality / flight to safety / risk off" asset.

The stock market, on the other hand is not extremely overvalued (bubble) and just like in early 2009, has the ability to produce strong cyclical returns, however over the long term, I think that the stock market still has several years of this secular bear market to go, where it will move south in both the inflation adjusted price, when compared to the 2000 top, as well as in valuation terms, when compared to the CAPE10 ratio. Most secular bear markets bottom with single digit CAPE10 ratios, instead of the ones in mid-20s. As commodities tend to move in an opposite direction to equities and also benefit from an inflationary rise in interest rates (Kondratieff Wave), that still looks like the most attractive investment asset class. That does not mean you run out and buy commodities tomorrow, but time your entry on any major correction or consolidation.

Long Term Investment Summary: Sell/Short the 30 Year Long Bond for years and years to come, own real assets like Commodities or Commodity Producing Equities due to up-and-coming inflationary cycle which should last for decades to come. Instead of doing business degrees in university, consider working in farming or mining sectors of the economy. Do not work on Wall Street as a Bond Trader / Manager. Stay away from debt as rising interest rates will become a huge headwind. Equities could become cheap once again within a several year time frame, if and when the CAPE10 enters single digits.

S&P 500 Technicals

Source: Normura Technical Analysis Newsletter

US Dollar Update

We got a rally in form of a short squeeze. Will it be more sustainable or not?

Thinking Process: Current Pessimism Signals End Of Correction

Greek default concerns, sharp Euro sell-off, slowing global economy including US and China, a new recession in Japan, commodities mini-crash, "sell in May and go away" and US default concerns, plus many other problems seem to be weighing heavily on investors.

After looking at the current survey readings from the American Association of Individual Investors (AAII), I've noticed that there were hardly any bulls. The readings stand at 26.7% Bulls, 41.3% Bears and 32.0% Neutral. Since March 2009, when the bull market in equities started, we have only seen bullish readings this low or lower, four other times. All four presented buying opportunities. The last time bearish sentiment outnumbered bullish sentiment by this amount or more, was back in June and August 2010, when S&P 500 stood between 1010 and 1100. We all know what followed thereafter.

What is very strange however is that usually these type of sentiment readings occur as the market sell offs, just like in during May - August of 2010. This time around, the market has just moved sideways since early April and yet bullish sentiment is approaching levels which usually present a good buying opportunity, if history is any guide.

History shows that as bullish sentiment decreases, returns tend to increase, while overly optimistic and extremely bullish readings, on the other hand, do not necessarily forecast losses. The chart above shows that a bullish reading of 28% or lower tends to create returns in excess of 3% over the next three months, which in this case could mean that the S&P 500 could be destined towards new bull market highs, above 1,380.

However, there are those, known as smart money, which tend to disagree with very strong S&P 500 performance from here on. These including Marc Faber, Jeremy Grantham, Jim Rogers, Robert Prechter etc. These market veterans think that the stock market is overbought from the longer term cyclical perspective, so therefore my view is that the current short term pessimism might be an opportunity to look at other asset classes, such as shorting US Government Bonds on the long side of the curve, which have benefited with a 10% rally as February 2011.

As we can see from the chart above, the best time to buy government bonds from the contrary point of view, is when the economy is performing well, because we know that the next cycle will be down. Current pessimism, therefore signals that the economy might actually surprise to the upside during European summer months. Citigroup's Economic Surprise Index, as shown above, is one of the best ways to track economies momentum. Government bonds tend to rally as economic momentum peaks and than thereafter surprises to the downside. The opposite is also true, because when there is too much pessimism around and economies weak momentum becomes quite recognised, than one should sell government bonds, and enter the risk trade again. So therefore, shorting US Government Bonds, which have been in a 30 year secular bull market, might just be a smarter move than buying stocks right here, after a 100% gain since March 2009.

BofA Merrill Lynch Fund Managers Survey - May 2011

The potential summer surprises The May FMS sees investors questioning global growth (in a re-run of summer 2010) but enjoying ample liquidity that keeps risk appetite high. A stand-off has ensued with little change in allocation across asset classes but some switching within asset classes, typified by defensive rotation within equities. The summer surprises are either growth to the upside or liquidity disappointing as QE2 ends.

Only a net 10% of investors expect stronger global economic growth in the next 12m, down from 58% in Feb. This is easing inflation concerns, albeit marginally, with a net 61% seeing higher inflation down from 75% in March.

Three-quarters of the panel expect no Fed rate rise before 2012 and so risk appetite remains firm. Hedge funds are risk-on with 1.53x gearing the highest since Nov-07.

Mean cash balances rose to 3.9% up from 3.7%, but remain low. Our risk appetite indicator eased to 43 but is well above the average of 40.

Growth fears see EU debt issues again ranking as the main investment risk. A slightly lower EU growth outlook (49 vs. 52) is being offset by US resilience and a rebound in Japan sentiment (74 vs. 42). A bigger concern is the deeper decline in China optimism with a net 28% seeing weaker growth compared to 15% in March.

Asset allocation saw modest rotation into bonds (48% UW from 58%) funded by lower commodities (12% OW vs. 24%) and equities (41% OW vs. 50%). GEM regains its position of most preferred region (29% OW vs. 22%) replacing US (26% OW). Consensus is UW Europe (-1%) and Japan (-17%). USD sentiment (48% undervalued) is one of the highest readings since 2002.

Sharp falls in energy (to 19% OW from 40%) and materials (2% UW from 17% OW) accompanied a sharp defensive rotation into staples (8% OW from 6% UW), pharma and telecoms. Banks are once again the most unpopular sector (26% UW down from 15%) with technology by far the most popular (35% OW).

A very sharp deterioration in sentiment sees the EUR as the most overvalued reading since Dec-09, while the USD is seen the most undervalued since Aug-08. A net 60% regard the EUR as overvalued while a net 48% see USD as undervalued – both of these readings are not far off their all-time peaks.