QE Rumours Spreading

Topics Covered

• Philly Fed & ECRI predict weaker growth ahead
• Fed to the rescues, but will another mild program work
• Despite constant oversupply news, Wheat takes off
• Sugar, Coffee & Cotton are the forgotten asset class

Overview

The selling pressure intensified in certain risk assets, while others staged a recovery rally. It seems that the US equities are now playing catch up as S&P 500 fell hard every single day this week. Commodities were mixed this week, with economically sensitive industrials like Copper and Crude Oil selling off, while Gold rallied. Wheat exploded higher as record net shorts got squeezed. Treasury Bond prices hit another record this week. Japanese Bond yields approached 2003 lows, while German Bunds hit another record low yield. The US Dollar finally posted a reversal candle on Friday after a historical run.  The bottom line still remains the same: investors are selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino.

Economic Data

There was a lot of news, noise and data on the economic front this week. One that really stood out for me was the release of the Philly Fed Index. Economist expectations for the survey were at positive 10, but the actually number surprised everyone by a mile, coming in at negative 5.8. Business activity is contracting again, by the looks of things. While not perfect, Philly Fed is a decent leading indicator in predicting potential recession ahead.

As we can see in the chart above, last year the signal gave us a warning, but Central Bank intervention with a lot of Twisting & LTROing postponed the outcome. While the stock market made new bull market highs into April of 2012 (on very skeptical internal breadth strength as reported many times on this blog), many economic indicators including the Philly Fed Index, have not confirmed the advance with fundamental data, and instead posting negative divergences. Current setup between Business Activity and the stock market resembles those of late 1999 and early 2007, just before the recession.

Philly Fed Index is not the only leading indicator that signals warning flags ahead. ECRI Weekly Leading Index continues to show a major negative divergence between Main Street (economy) and Wall Street (stock market). On top of that, despite a recent pop several weeks ago, ECRI also continues to post readings below its 2 year moving average. This lets us know that the economy has been decelerating since April of 2010, while the central bankers have extended this recovery beyond its actual fundamentals. How long can money printing keep the floor under stock prices?

I am afraid that the stock market has been rising on "thin money-printing air" for awhile now, so a reversion to the mean could be a seriously bad outcome, as it might overshoot to the downside in quarters and years ahead. It is not only Philly Fed or the ECRI indices that signal weakness ahead - broad economic data figures have collapsed compared to their expectations in recent weeks all across the world from the US, to the EU and GEMs. Citigroup Economic Surprise Index in the chart above, instates this perfectly. Naturally, bonds are outperforming equities again, but more importantly the Stock / Bond ratio has not confirmed S&Ps new highs either.

Not to worry, say a lot of investors. Money printing is in fashion, as we can see in the chart above. Every investor out there has been trained to follow central bankers to figure out if a risk off trade will be supported by more stimulus. Investors I speak to, majority of whom I respect a lot for their very good market skills, seem to think that the Fed is about to engage into another program of some type. Sure, why not! Operation Twist is ending anyway. But my question to you is, will another program similar to what we have seen since late 2008 (chart above), actually help the stock market and the economy?

The recent Fed and ECB programs have not helped the MSCI World Equity Index, which has failed to make a new high for the first time since March 2009 and has not confirmed S&P 500's new high into April 2012 - not confirmations are everywhere! What I am trying to say is that the investors are becoming immune to small doses of sugar highs in the proximity of half a trillion dollars or euros per junkie hit, while the real economy keeps drifting lower. Therefore, I am now turning bearish on the economy, the stock market and majority of risk assets, as I am becoming very worried that we have approached a major top since the cyclical bull market began in March 2009.

One would ask, what would turn me bullish on the economic cycle and the risk assets again? A massive money printing exercise by world's leading central banks (Fed, ECB, BoE, BoJ, SNB etc) with mutli-trillion dollar scale, but unfortunately, that might only come after a major shock occurs. I asked myself 3 simple questions, from which I gauge macro investment opportunities and risks in coming months and quarters:

1. Do you think the Fed will act since S&P 500 has come off by only 10% in the last 2 months?
2. What amount would be enough in a Fed / ECB program to restore confidence properly? 
3. Do you think Greece will default in coming months and shock the system like Lehman in '08?

Answer those questions for yourself and/or answer them in the comment section of the blog.

Equity Markets
Nothing new to report.

Bond Markets

Nothing new to report.

Currency Markets
Nothing new to report.

Commodity Markets

I still remain super bullish on Agriculture, however. Agriculture is not really a risk on asset majority of the time and moves a lot more on supply and demand news. Regular readers of this blog should know that I have been EXTREMELY bullish on Wheat especially, predicting prices as high as $9 per bushel even this year, if not by next. And of course this is all despite constant oversupply news. I have argued for months that Wheat does have short term oversupply, but that the news has already been discounted due to record net short positions. The whole time Wheat failed to make new lows and trend down lower, despite bad news - which from a contrarian point of view tends to be very bullish!

In my opinion, eventually we are moving towards another major shortage of Agricultural supplies similar to 2008. Constant crisis periods from Lehman Brothers to Greece have created an under-investment environment in all commodities, but especially Agriculture. Even with falling demand due to average economic activity, supply across the board is falling much quicker on the historical basis looking back to 1960s, creating shortages. We have a shortage of equipment, shortages of farmers, shortage of supplies and shortage of just about anything Agri-related. It is becoming ever harder to feed Chin-dia and its 4 billion people population, which is slowly becoming a net importer of global grains and softs. 

Moving along, I remain neutral on the Soybean sector, due to a very powerful rally in recent months. However, I think the Soft complex is now a completely forgotten asset class and this is why I am turning my focus towards it. Let us look at the three main components in a quick summary - Sugar, Coffee and Cotton:

• Sugar peaked in February 2011. From 37 cents towards 20 cents, the price of Sugar has now lost 44% in the space of 16 months. Public Opinion has collapsed in recent weeks. Daily Sentiment Index stands at single digit readings, while hedge funds have reduces net long positions substantially in recent weeks, according to the COT report. Furthermore, Small traders are now shorting Sugar again. Technically, Sugar got extremely oversold in recent weeks with RSI dipping very low for extend periods of time. We could be bottoming out soon enough.

• Coffee was the last to peak in May 2011. From $3.10 towards $1.72 cents, the price of Coffee has now lost 44% in the space of 14 months. Public Opinion has collapsed in recent months, to much lower levels than 2008 bottom. Daily Sentiment Index stands at single digit readings for weeks on end, while hedge funds are now shorting Coffee for the fist time since late 2008 bottom, according to the COT report. Technically, Coffee is extremely oversold on the weekly chart, with a potential of an MACD buy signal developing. 

• Cotton peaked in March 2011. From $2.25 towards 78 cents, the price of Cotton has now lost 65% in the space of 16 months. Public Opinion has completely collapsed this week. Daily Sentiment Index stands at 5% bulls, while hedge funds are now shorting Cotton for the fist time since late 2008 bottom, according to the COT report. Technically, Cotton just collapsed hard this last two weeks during the market panic with daily RSI at ridiculously low levels. The price is extremely oversold from all perspectives and all time frames. pretty much, Cotton has been  totally murdered!

Credit Markets
Nothing new to report.

Recommandations

• I want to buy S&P 500 Calls soon. I am still waiting for signs of a bottom in the equity market sell off. Short term capitulation could be near, followed by a rally - even a very powerful one. Eventually, as we recover weeks or months from now, I want to short stocks.
• I have recently bought Silver Calls on Wednesday, so I will not be doing anything in the PMs market for now. My further action depends on Feds and ECBs further actions. Weak action will make me reduce my core holdings and close out Calls.
• Soft commodity ETFs (Sugar, Coffee & Cotton) are also on my watch list. Finally, in Agriculture, I am also looking at buying long dated OTM Calls on Wheat too. Prices in Grains and Softs can go higher despite risk off environment, if supply concerns elevate further.