Closer Look At Long Term Trends

Topics Covered

• Global equity indices performance over the last year
• Treasury Long Bond is most likely in a blow off bubble
• Dollar is now everyones favourite currency of choice
• Gold's record performance could signal a correction ahead

Weekly Overview

The mean reversion rally has stalled. Major commodities have found resistance levels with Crude at $90, Gold at $1640. Agricultrue has been a superb performer with Wheat above $8, despite abundance of bears calling for new lows. US Dollar is closing onto a new 52 week high, while the Long Bond is not too far off either. The bottom line still remains the same: investors are fearful of a disorderly default in the Eurozone and intense funding pressure on large economies like Spain and Italy. At the same time, Asia and especially China is slowing down meaningfully. Global economy is edging closer towards a recession.

Global Macro

Nothing new to report. Refer to the side menu for previous articles.

Economic Data

Nothing new to report. Refer to the side menu for previous articles.

Equity Markets

S&P 500 is the most followed equity index in the world. Great buying opportunities in S&P 500 usually occur as the price slumps 30% or more - your typical run of a mill bear market territory. Currently, year on year performance is yet to go negative and stands at 0%. Europe is already in a recession and China is slowing down meaningfully. Majority of the equity markets in the world are already in bear downtrends (see below), so can the S&P 500 hold out on its own? My view is most likely not, despite its impressive outperformance.

DAX 30, an index tracking the German manufacturing powerhouse economy, is a barometer of global export trade. Great buying opportunities in DAX 30 usually occur as the price slumps 40% or more. Currently, year on year performance stands at negative 13%. Europe is already in a recession and now Germany is getting affected too. DAX 30 has not confirm new highs, like the S&P 500 has, which is a negative non-confirming signal.

Hang Seng is a great proxy for Chinese mainland economy, since Shanghai Composite is not an open market to foreign investment just yet. Great buying opportunities in Hang Seng usually occur as the price slumps 40% or more. Currently, year on year performance stands at negative 13%. With Chinese hard landing a decent probability and huge property bubbles in Hong Kong, one could expect more correcting to come.

Bovespa is a great proxy for commodity producing companies, which have benefited over the last decade due to development and industrialisation of Asia, especially China. Great buying opportunities in Bovespa usually occur as the price slumps 40% to 50% or more, as Bovespa is a very high beta equity index. Currently, year on year performance stands at negative 10%. With Chinese hard landing a decent probability, one could expect more correcting to come.

Bond Markets

US Treasury Long Bond prices have gone parabolic in recent quarters due to the flight of capital out of Eurozone into safe havens like the United States, amongst other countries. Currently, year on year performance has been too good to be true - 20% plus gains on consistent basis. Similar gains occurred during the 2003 (World.com bankruptcy) and 2008 (Lehman Brothers bankruptcy). I assume that the bond market is discounting a default out of Eurozone this time around again. 

Possibility of more gains are not to be ruled out, especially if the Eurozone crisis enters its final stage. However, be warned that this asset class is now in a major mania bubble, created by panic (instead of greed). There is always a "hook" in every bubble and currently majority of people on CNBC and Bloomberg can be quoted saying that bonds offer "return of capital, instead of return on capital". I am not so sure that majority of these investors will actually "get return of their capital" once the bubble bursts...

Currency Markets

US Dollar Trade Weighted Index follows a group of G10 currencies against the greenback. It is by far the best gage of Dollar's performance, unlike the very popular Dollar Index, that is the heavily weighted towards the Euro. Great buying opportunities in Dollar usually occurr as the price slumps 15% or more. Recent one came 12 months ago when the QE2 finished and the Dollar bottomed. Currently, year on year performance has been very good for the greenback, especially considering that only a year ago it was the most hated asset in the world. Possibility of more gains are not to be ruled out, especially if the Eurozone crisis flares up again. On the other hand, Bernanke could stop the Dollar's rise with another QE program, but the news might get a lot worse before another QE...

Commodity currencies have benefited over the last decade due to commodity exports to developing Asia, especially China. Great buying opportunities in Commodity currencies usually occur as the price slumps 20% to 30% or even more like in 2008. These currencies are very volatile indeed. Currently, year on year performance stands at negative 5%. With Chinese hard landing a decent probability, and huge property bubbles in both Canada and Australia, one could expect more correcting is definitely a possibility.

Asian currencies became completely slaughtered in 1997, during the Asian Financial Crisis. This forced the Asian tigers to deal with excesses of the previous boom and reform their economic houses back in order. Fifteen years on, Asia is experiencing a great boom that puts Developed World growth rates to shame. Great buying opportunities in Asian currencies usually occur as the price slumps 10% to 15% or even more. Currently, year on year performance stands at negative 4%. With Chinese hard landing a decent probability affecting trading partners like Korea and Japan; and huge property bubbles in both Hong Kong and Singapore, one could expect more correcting to come.

Commodity Markets

Finally, let us move onto commodities, which remain in a strong fundamental secular bull market, but at present are caught up in a middle of a cyclical downturn. The chart above shows that year over year performance on the CC Index is currently at negative 15%, but it got as low as negative 25% recently. This is currently the second worst bear market since the major secular bull began in 1998. Let us focus on economically sensitive industrial commodities within the index:

Crude Oil is bar far the best barometer of global economic health, especially in Emerging World like Asia, which have become new marginal buyer of commodities. Whenever Crude Oil spikes and gains more than 100% within a single year, majority of the time a recession tends to follow. This occurred prior to 2001 recession and prior to 2008 recession. Great buying opportunities in Crude Oil usually occurr as the price slumps 40% or even more, as Crude is a very volatile asset. Currently, year on year performance stands at negative 12%. Possibility is that more correcting could come, especially if the global economy enters another recession.

Just like Crude, Copper is also a great barometer of global economic health, especially in China, which has become a major consumer of the industrial metal. Great buying opportunities in Copper usually occur as the price slumps 40% or even more. Currently, year on year performance stands at negative 22%. With Chinese hard landing a decent probability, one could expect more correcting, similar to Crude Oil discussed above.

Finally we look at Gold, which in my opinion is more of a currency than a commodity. The most surprising thing to see is what while all other asset classes have moved from strong positive returns to large negative losses over the decade, Gold has been a bulls best friend. It has managed to achieve a record breaking run of 11 annual gains in the row. Furthermore, since 2001, it has barley dipped into the negative return performance over any rolling 12 month period. This type of price action makes me very cautious, very nervous and very hesitant to buy more - until it goes down further of course.

Credit Markets

Nothing new to report. Refer to the side menu for previous articles.

Trading Dairy Update

• Fundamental Outlook: I believe that we approaching another bear market as the recovery loses steam. I am not sure if politicians can hold it off until elections in both US and Germany pass, but 2013 and 2014 will most likely be bad years. US GDP has grown 5 quarters at around 2% or lower which is stall speed. Over the last 60 years, whenever the economy grows at subpar levels it has always entered a recession. At the same time earnings and margins are at record highs, so I expect that they will mean revert. During recessions since the 1950s, earnings tend to fall on average by 25%, so a drop to $70 from current levels in earnings could take the S&P 500 down below 1,000 points (P/E = 12 * $70).  Cash levels in money market funds are as low as 1998/99 and 2006/07, so I believe investors are extremely exposed to equities. Corporate credit spreads are very narrow relative to economic fundamentals, so I expect they will widen dramatically in due time. Recessions occur every 3 to 4 years of expansion during secular bear markets, so in 2013 or 2014 we are overdue for a slowdown (but it could be much earlier).

• Current Positioning: I've positioned myself towards long PMs especially Silver (large position in my fund) and have recently just accumulated more, because I believe central banks will continue to print money and devalue currencies whenever the economy gets worse. Furthermore, investors were recently heavily exposed to US Dollar, so from a contrarian point it also makes sense. On the other side of my book, I have recent opened a very large position relative to NAV by shorting Junk Bonds (HYG), as I believe credit spreads will spike into the future, similar to the VIX. Further to that, I have also opened a few small short positions against various individual stocks. Finally, I eventually want to short US equity sectors, especially the much loved Consumer Discretionary and Technology sectors.

• Asset Watch-list: On the long side, commodities still remain on my watch list. These include Commodity Indices (GCC / RJI), Brent Crude (BNO), Precious Metals (CEF, SLV, PSLV) and Agriculture (RJA / MOS). I believe commodities are very oversold right now especially Crude Oil's and Silver's sentiment. As already mentioned, I've recently bought more Silver on the long side, but will not do anything more until I hear stronger action response from the Fed or until European crisis plays out its final leg. On the short side, Tech sector (XLK) & Discretionary sector (XLY) are on my list of stock shorts. I am also looking at Emerging Market bonds (EMB) and have already engaged into shorting high yielding Junk bonds (HYG). Finally, a major short in due time will be US Treasury long bonds (TLT), but I believe we are just not there yet.

What I Am Watching