Sentiment Update For All Assets

Topics Covered

• Equity sentiment shows majority are not bearish enough yet
• Barron's asks which bond fund is the best for you?
• Dollar sentiment is extremely optimistic... once again
• Very large fund outflow leave commodity markets in May

Weekly Overview

The mean reversion rally has stalled. Major commodities have found resistance levels with Crude at $90 and Gold at $1640, however Crude Oil has be bucking the higher Dollar rise. 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. Sentiment is extreme on these safe haven assets. 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

It has been awhile since I've update sentiment on majority of the asset classes, so let us look at various surveys, money flows and positioning by market participants across the global macro environment - starting with equities.

The chart above is the AAII bull readings averaged over three months or one quarter. It is giving us a very rare buy signal that has only been witnessed four other times over the space of sixteen years. Furthermore, this signal has picked a perfect major bottom three out of the last four times, including the October 1998 low, March 2003 low and finally the famous March 2009. In March 2008, which was an intermediate low during a bear market rally, the index still managed to achieve a 15% gain before rolling over. However, do keep in mind that during all of those dates equity market experienced a large bear market decline prior to negative sentiment, while today the market is only about 5% from its peak.

Furthermore there is a bit of a conundrum in the equity sentiment readings, with other popular measures giving us different signals. Investor Intelligence survey, which I recently posted last week, shows that II Bear reading are resembling complacency as the name of the game within the market environment. Majority of investors are either bullish or neutral, but most importantly hardly any are outright bearish. This is also confirmed by very low VIX readings too.

On top of that, a great blog over at TechnicalTake.com, run by Guy who is a very good trader, shows a composite sentiment indicator that he developed. According to Guy, the indicator has 10 different variables from sentiment surveys to fund flows and insider buying. In other words, it is well balanced. As we can see from the chart above, the indicator gave correct buy signals in June 2006, March 2008, November 2008, March 2009, June 2010 and August 2011. All of those dates marked an intermediate low of some kind and produced at least a tradable rally. Currently, we do not have any signs of capitulation whatsoever, so one could make a case that lower prices are needed, before dumb money panics and smart money becomes interested again.

Finally, a word or two on other indicators:

• Options activity in the equity market is quite neutral. One slight concern I have is that OEX options, usually used by smart money institutions for hedging purposes, have show several large Put spikes since May of this year. This could be telling us that smart money is hedging their underlying equity longs in anticipation of further declines.

• Rydex fund flows are showing decently large money moving back into equity funds. Rydex money market cash levels are very very low right now, resembling the conditions when equities peaked in 2011 and earlier this year. Strongest inflows are in defensive sectors and Biotech, which has recently gone vertical.

• Hulbert Newsletter Sentiment readings show that the bulls are back with haste. As of one week ago, the overall exposure to equities recommended by newsletter advisors was 47% net long. To compare this with various other peaks, in April 2012 readings were 41% net long, in May 2011 readings were 67% net long and in April 2010 readings were 63% net long. On the opposite side of the spectrum, recently June low saw 20% net short exposure.

Bond Markets

Treasury Bond prices continue to rise, pricing in variety of events in my opinion. First of all, majority know that Bernanke will eventually do a QE3, if not next month then in few quarters time. So buying these bonds and driving prices into a bubble makes complete rational sense, especially when you know that Ben will guarantee to buy them back from you. So in other words, we really have a Bernanke Put on the Treasury market, not the equity market. Second, I think Treasuries are discounting Eurozone default of some type. Treasury prices spiked in 2003 due to World.com default and in 2008 due to Lehman default. Who will it be this time around?

Having said all that, sentiment readings are once again bullishly extreme according to SentimenTrader composite indicator for Bonds. The indicator have various variables including options ratios, fund flows, sentiment surveys and COT data. All in all, consensus is usually wrong at turning points and buying at overbought levels when extreme euphoria is present does not make any sense for an investment. But, depending on how bad things get in Europe, maybe Bonds could go up for a trade in the next 3 days or 3 weeks or even 3 months. But be warned - the bubble will eventually burst and most likely sooner rather than later...

Benefiting from the rise in Treasuries, is the ever going bull market in Corporate Bonds. Since Treasury yields have dropped to dramatically low levels, majority of retail investors including mums and dads, are moving into Corporate Bonds instead. Obviously, money trail shows that majority of retail investors are leaving the stock market to join the fixed income game. ICI reports that since the start of '07, over 350 billion dollars has left the equity funds while over 1 trillion dollars has flown into fixed income.

Seen above is the cover of Barron's magazine this week and it comes as LQD (Corporate Bond ETF) records the highest ever quarterly inflow. These types of magazines covers make me very nervous to invest into bonds after such a great run-up and record inflows by retail / foreign hot money. Obviously, all bonds still remain in a bull market and Bernanke insists that the short term rates will stay at 0.25% until 2014. But... how many of us truly believe that bonds can continue rising higher for years to come?

Currency Markets

Since majority of the currencies trade against the greenback in a risk on / risk off movement, Dollar's sentiment is the primary barometer of the mood in this correlation concept. In the chart above, we can see that Dollar optimism is once again close to all time record highs set only several weeks ago. This is nose-bleed type of optimism, which has always signalled an imminent intermediate top of some kind. Word of cautious however, during bull markets, bulls tend to be right and therefore bullish sentiment can remain elevated for extended periods prior to mean reverting.

However, sentiment alone is not enough to sell off the Dollar. What we need is some type of a catalyst, most likely from either the US or Europe. The strongest type of a catalyst could come from Bernanke and the FOMC, if they were to engage in a new round of money printing, therefore devaluing the Dollar. Fed rate decision and Jacksons Hole meeting is in August, so it is a wait and see approach.

Moving along, sentiment on the Euro is below 30% bulls... again. We are now entering extreme levels only seen during 2008 and 2010 panic attacks. It seems that the $1.20 area is now a magnate for the prices and we could fall towards that level very shortly (only a cent or two away as I write this). A strong rally is to be expect from this support level in my opinion. However, from the longer term aspect, despite current negative sentiment conditions, Euro could be signalling even more downward pressure after a relief rally takes place. The fact that the Euro has retraced 100% of its gains from June 2010, is a very negative signal and one that could have negative implications in 2013!

As a side note, if the Euro breaches $1.20 I will formally lose my bet with a close friend who has been laughing at me all along.

Commodity Markets

Coming into June of this year, commodities experienced one of the largest ever outflows. Panic really hit the market as majority of the bulls hit the sell button. Since than, the prices have recovered somewhat, but still remain quite oversold from the longer term perspective. As already mentioned in the article I wrote on Thursday, this is now the 2nd worst bear market in the last two decades for the overall commodity complex.

Gold bulls have completely disappeared out of the market, and I must admit I have also been sounding like one of them too. Technical action is edging toward a downside break and Gold is up 11 years in the row, both of which make me believe lower prices are to come. However, my view has nothing to do with what the market will actually do, so I would not be surprised at all if Gold moves higher out of a triangle from a contrarian viewpoint.

As we can see from the chart above, Gold bulls have been trending lower and we know have a huge wall of worry, which usually can re-start a bull market. Furthermore, Silver's sentiment is even worse, sinking to lower levels than at any point in time during Global Financial Crisis of 2008. However, since  Gold is in a downtrend, it is possible for sentiment to remain negative for a prolonged period of time. There is an old saying with sentiment:

"In a bear  market, bears are right!"

Finally, a word or two on other indicators:

• Grains has performed remarkably well despite stronger Dollar and the overall complex is showing very high Public Opinion readings. Extreme DSI readings on are also seen on the Grains with Soybeans at 93% bulls, Corn at 94% bulls and Wheat at 85% bulls. Possibility of a pullback or a correction is high right now. Soft commodities have not recovered as well and therefore sentiment remains quite muted.

• Industrial commodities that are highly sensitive to economic growth, are bucking the trend against rising Dollar and remain quite stable for the time being. Public Sentiment has recovered from very low levels seen a couple of weeks ago on both Crude Oil and Copper, while DSI on Crude Oil currently reads 24% bulls and 34% bulls on Copper. Single digits were seen for both commodities in late June.

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