Thursday, June 30, 2011
In the previous post cornering fund flows found here, I reported how US mutual fund flows experienced a very large outflow of 16.6 billion dollars over the last three weeks. It is obvious from these numbers that investors hate US equities.
It shouldn't be hard to figure out where investors have been fleeing towards - bonds of course. In the chart above, we can see that after a strong sell off in November 2010 to March 2011, investors are once again piling into Emerging Markets Bonds amongst others. The chart of the Emerging Market Bond ETF (EMB) can be found here over the same timeframe.
One type of bonds that have neglected have been High Yield Junk Bonds in the US, which I recommended to short in the middle of May - post found here. However, after substantial fall and good profits, this trade should have been closed as recently as 25th of June, when I wrote about huge outflow panic by retail investors - post found here. The fund flow chart above confirms this, but so does the recent price action in the High Yield Junk Bond ETF (HYG) - chart below.
Junk Bonds are risk assets, so a continued recovery rally in this asset class, show let us know that credit spreads will most likely not blow out any further that they already have against equivalent Treasuries. This obviously means that the state of economic recovery could still be on track, so equities and commodities should keep doing well for awhile at least. Speaking of Treasuries, readers of this blog should already know that I am short this asset class since middle of June. My view on Treasuries and the reason why I think they are a good short can be found here.
This is part two section on Crude Oil. The first part can be read in the post here. Please review the charts below:
We are now approaching 92 million barrels a day in demand as of next year. Majority of the growth is coming from Emerging Markets. If the world economy keeps growing and recovering, than the supply side is going to experience huge shortages, worst than the one currently in Libya. Oil will keep moving up.
And what about if the world economy does not recover and the Chinese credit bubble bursts tomorrow? There are so many bears out there saying that Crude Oil is going to collapse towards $30 again if this happens.
I have a different view. I do think Oil could collapse and overshoot in the short term, the bear market will not last. The exploration break even point is now at around $75 a barrel, Middle East production break even point is around $80 a barrel, Saudi Arabian production break even point is $84 a barrel and the worlds Oil Reserves running out at 6% per annum according to the IEA. Therefore, keeping all this in mind, I just wonder who will supply Oil for the world at $30 a barrel?
I guess these doom-sayers are now planning on swimming from London to New York or from Hong Kong to Sydney, because there will be no Oil at that price to fly a plane. I also guess these same guys plan to walk or cycle to work, even if they live on the other side of city. Its plain and simple: If Crude Oil goes below $70 a barrel, the whole of the worlds production will just be shut off, until price recovers.
Source: Nomura Newsletter
Retail investors took 16.6 billion dollars out of US equity mutual fund flows in the first three weeks of June. As a matter of fact, they took over 17 billion dollars out of all equity mutual funds. You should remember that, we've had one of the largest put buying streaks in over 5 years in the month of June. I have been covering this in previous posts over the last few weeks.
Therefore, is it a surprise to anyone that the S&P 500 is now powering towards 1,310 in just a few days? Is it a surprise to anyone that Nasdaq 100 and Russell 2000 have already retraced 50% of their drop since the 02nd of May top?
Obviously, as soon as the stocks have started to rally, perma-bears have come out saying that the current rally is just based on temporary short covering. I say disbelief, is the perfect fuel for more gains. Bespoke Investment Group also disagrees with the short covering "excuse" and actually did some research on this subject. They wrote an excellent article on their website about this topic - read it here.
Finally, for those who have missed it before, my article on Japanese stocks would have come in handy with this topic as well. I showed how retail investors remained heavily short equities on the Nikkei. As a matter of fact, bearish readings were higher than in March 2009, bull market lows. Within the next 48 hours, Nikkei put in a bottom and took off like a rocket! Now, I'm not sure about you, but to me when a price retraces almost all of the previous two month losses within 9 days, it is a very bullish sign. This is a powerful reversal indeed.
Also for those contrarians out there, do not forget that the reason Japanese equities are outperforming the world at the current time is because majority are underweight this region as of early June 2011. And just like always, I bet fund managers are now chasing the price as well as the momentum.
Wednesday, June 29, 2011
There are a lot of bears in the Crude Oil market currently. They argue that Oil, as well as other commodities are in a bubble, and that Crude Oil is a good short. They point to bullish sentiment and say that the rally is over. They also point towards Cushing in Oklahoma, noting that stocks of Crude Oil and Petroleum Products in at very high levels.
What these bears fail to understand is that their US-centric view and thinking process is outdated. The Great Empire (US) is not the only important player within the Oil demand market anymore. What smart money commodity bulls keep pointing towards is the New World, the BRICs as well as the E7: Brazil, Russia, India, China, Mexico, Turkey and Indonesia. These countries are eating up an insane amount of Crude Oil and their per-capita usage is so much smaller than developed countries, that their growth potential is mind boggling.
Crude Oil bulls should also be happy to see divisions and cheating within the OPEC, from the supply side of things. While Saudi's have turned on the spigots, Iran and Venezuela is turning them off. Bulls should also be happy with the IEA panic release of emergency supplies - however, to be brutally honest, 60 million barrels released by IEA is 2/3rds of the daily demand... a drop in the ocean. At 2 million barrels a day, this will be eaten up in 60 days! The most important aspect of the Supply is the current increase in the Saudi Arabian production capacity. This is a critical chess move, that has placed Saudi's production capacity to levels not seen since 2008. Market will be testing the countries capabilities and a slight disruption to supply will once again lead to Crude Oil spike.
Tuesday, June 28, 2011
Pretty much Federal Reserve with General Bernanke in charge is now financing almost the whole United States deficit by creating money out of thin air and than swapping that phoney paper for Treasury Bonds, removing supply out of the market, while increase the cash supply. By leaving rates at 0.25%, the Federal Reserve is then forcing this money into speculation chasing risk assets, instead of savings. If you do not speculate, inflation eats up all of your phoney paper savings. I guess the US Dollar as well as the Treasury Bonds really do have much better fundamentals than some commodities like Silver, which investors are so desperately trying to short since April of this year.
Source: Nomura Newsletter
S&P 500 still stands firmly in a bull market territory. We are currently in a 9th correction, which is down 7.2% and has so far lasted 39 trading days. Note: According to the Dow Theory, primary uptrend support remains at 1,250. If the prices breaks below that, we will enter a downtrend. Technical threshold for a bear market is 20%, which means the S&P 500 has to decline to 1091 to achieve that.
While that is the short term picture, it is also important to look at the history of not just the last decade, but the last century.
Since the cyclical bull market began on 09th of March 2009, it has lasted over 121 weeks and so far has gained 87.5%. As you may remember, the gain was 100% plus at one point before the May and June correction started. While an average cyclical bull market tends to last 155 weeks with an average gain of 100%, the cyclical bull markets within a secular bear market tend to last only 126 weeks with gains of about 100% plus. So therefore by all definitions, we have achieved that average.
I went back into history and looked at every secular bear market in the last 110 years. These include the 1901 to 1920, 1929 to 1949, and 1966 to 1982. The chart above shows the average performance of these secular bear markets as they are inflation adjusted and it than compares that average against the current S&P 500 since the year 2000. The model above, on its own, suggests that the cyclical bull market could be coming close to an end. Obviously, that is not the only thing an investor should look at, but nonetheless, it is an important clue when investing into stocks.
Both Shanghai Composite as well as Bombay Sensex have bounced of their supports and daily oversold levels late last week and early this week. At the current time, the rallies look very powerful, which makes me think all of the speculators shorting in the last few weeks just got their fingers burned...
Monday, June 27, 2011
According to Merrill Lynch Fund Managers Survey, one of my favourite sentiment indicators, the current portfolio asset allocations are skewed towards Equities at 27% overweight (down from 67% in Feb 2011) and Cash at 18% overweight (up from -9% underweight in Feb 2011). Commodities are now third on the preference list out of four main asset classes sitting at only 6% overweight (down from 28% overweight in Feb 2011) while Bonds, which have been the most hated asset class out of the four, have improved somewhat to -35% underweight (from -66% underweight in Feb 2011).
Note: A total of 282 fund managers with $828 billion of assets under management participated in the survey from June 3 to June 9. The next survey update will be in the middle of July.
Where to from here? If you are feeling somewhat similar to the picture above, you are probably not alone. No one is Nostradamus to get everything right. What I try to do with this blog is put forward my own thinking process as a trading dairy, which also helps me think more clearly. The way I see things is sort of like this - majority of fund managers do not count commodities as an asset class, so they either allocate their portfolio funds between equities, bonds or cash. Lets run through them to see what would be the smartest investment option right now, after a 8% correction on S&P 500 and a 10% rally in Treasuries...
Cash - in the US you have 0.25% on the Fed Target Rate, which means you barley get anything extra on bank term deposits or short term Treasury Bills or Notes. The 1 Month Treasury Bill was yielding negative 0.005% on Friday, while the 2 Year Note yield is approaching record lows. You are barley going to make any money here, so the best you can do is use this vehicle as a safe haven when other asset classes are correcting. Obviously, you allocate money out of Cash or Bills as soon as you think the correction is over, because if you stay here for too long, your money will be eaten up by inflation.
Bonds - the current inflation rate in the US is slowing edging towards 4%. Shadow Stats reports the old method of calculating inflation from the Jimi Carter era, which shows that inflation is actually running above 11%. But even if you do not believe those numbers and would rather side with Chairman Bernanke's "freshly altered" numbers, you should notice that the majority of the Treasury yield curve in now returning negative real interest rates. The yield on the 10 Year Note is currently at 2.84%, meaning that as an investor right here you will be receiving a whole 75 basis points of negative returns. As a matter of fact, the 20 Year Bond yield is barley above water compared to inflation. Therefore, if you are a buyer of Treasuries at the current levels, you have to be ultra bearish on the economy, expecting a huge deflation in prices all across the board. That means agreeing with what The Bernank recently stated, believing that the current inflation is only "transitory" (Note: never got anything right... ever... in his career).
Equities - the current state of economy is not impressive at all. I do admit that. Any one of these soft patches could lead to an actual double dip recession. Greece could default tomorrow if the vote austerity does not pass. There is obviously plenty of reasons to be bearish. And a bearish stance has usually meant that an asset class like equities is dropped in favour of either cash or bonds. But when I look at the options fund managers have between either equities, cash or bonds with inflation on the rise, and than I also look at what the current retail investors views on equities are, with the likes of huge mutual fund outflows, insane level of put buying, bearish readings on sentiment surveys - I come to the conclusion, that this is the best financial asset compared to the other options.
Summary - my view is that the current slowdown is linked more towards the Japanese earthquake that anything else. Therefore, I think the slowdown is temporary. However, a lot of comments on this blog sound like the following:
What about the housing market? And what about the huge unemployment level? And what about tight lending and non-existant credit growth? And what about de-leveraging which will create deflation?
If you believe that these events have not already been priced in with a 60% crash in 2008 as well as sharp spike in Treasury prices, you must have been living under a rock. That was one of the worst stock market crashes in the last 100 years. A crash like that does not occur every few years, but more so every few decades, but the problem is that fear remains fresh in investors minds, to the point where any after shocks tend to be perceived as a potential repeat of that event. But say that I am wrong and the current economic situation is about to get even worse. Well if one must be bearish, than the following might not make sense to you, due to conventional wisdom.
Precisely because one must be bearish, one should therefore sell bonds or cash. Authorities are going to keep printing money at any sign of a slowdown, which will totally murder returns in cash, as well as bonds. Basically, the worse the economy gets, the worse safe haven assets like cash or bonds will perform.
Now... if the economy recovers here, due to an overly bearish stance by US economists as we can see from the Citigroup Economic Surprise Index above, than Treasuries will sell off. On the other hand, if the economy does not recover here, President Obama, General Bernanke and Sergeant Geithner will print more money than QE 1 and 2 put together. Therefore, if you must be bearish on something, be bearish on Treasuries, unlike the majority of retail investors out there. If the economy recovers, bonds will perform badly; and if the economy doesn't recover, further stimulus will lead to even higher inflation, and bonds will once again perform badly. Either way you look at it, Treasury Bonds are not going to be a good investment from here on. If you disagree with this view, the other option you have is to buy puts on the S&P 500 just like every other retail investor...
Sentiment and risk appetite on equities is now lower than during last years 16% correction sell off, which ended on 02nd of July 2010, and as a matter of fact, it is at the lowest levels since February / March of 2009. On the other hand, the overall investor mood is not as bad, but nonetheless has recently turned negative.
Source: Credit Suisse Newsletter
Since the secular bear market in US equities started around 1999/2000, we can see a substantial improvement of balance sheets of corporations. Earnings as well as profits continue to grow, debt to equity levels keep being reduces and the cash levels keep rising. Balance sheets are in a very good position, setting us up for an eventually secular bull market in several years from now.
Credit markets seem to be pricing in a 25 basis point movement in the US, about a 75 basis point movement in the Eurozone, about 25 basis point movement in the UK and about the same for Australia. Apart from the Eurozone's hawkish outlook, interest rate swap traders are not very upbeat on future monetary tightening prospects. It most likely has something to do with the current "soft patch"!
Source: Credit Suisse Newsletter
Saturday, June 25, 2011
Chart above shows the spread between Junk Bond and Treasury Bond yields. Credit spreads haven't really blown out that much, so I was very surprised to see that Lipper reported that high yield funds saw its largest weekly outflow EVER. The record outflow was $3.4 billion. To put it in context, here is the updated Top 5 weeks of all times in terms of outflows:
- 6/22/2011: $3.4 billion of outflows
- 8/6/2003: $2.6 billion of outflows
- 5/12/2004: $2.2 billion of outflows
- 5/12/2010: $1.7 billion of outflows
- 6/15/2011: $1.6 billion of outflows
I took this chart on my iPhone during the CNBC show, so I apologise for the bad quality. So I am thinking, why so much fear, when the price barley moved. Are investors over-panicking everywhere, be it in the equities, bonds or commodities markets?
Well, before you answer that question, another thousand did answer a similar one on CNBC last (same time I took the photo above. The Poll question during the show was: "How are you reacting to this market?" 49% said they are in Cash, 36% said they are buying and 15% said they are shorting. That means half of the investors have sold out and have not bought back in, and a further 15% are ultra bearish, fighting the Fed. If we add these two groups up, we can conclude that 64% or two thirds of those surveyed, are currently not bullish on stocks right now. I take it they are even less bullish on Crude Oil, Silver or Wheat, which are all down over 20 to 30 percent!