Sunday, April 29, 2012

Trouble In Stocks, Focus On Commodities

It is Sunday night, the 29th of April here in Asia. I have literally been working the whole weekend, reviewing the health of stocks, bonds, commodities, currencies and credit markets. From what I see right now, there are early warning signs of a trouble brewing in the stock market, which I will discuss in this post. But first let us get to the business cycle.

Early next week, we can expect the following data to greet our screens:
  • South Korean IP, HSBC PMI & CPI
  • German Retail Sales 
  • Canadian & Spanish GDP
  • Chinese Manufacturing PMI
  • US Chicago PMI & Dallas Fed Manufacturing
  • RBA Interest Rate Decision
  • US ISM Manufacturing PMI
  • Swedish, Norwegian & Spanish PMIs
Economic data from developed economies continued to disappoint in the week that ended, as can be seen from the group of Citigroup Economic Surprise Indices. Italian Business Confidence disappointed at the end of the week, just like Italian Consumer Confidence disappointed at the start of the week. European Manufacturing PMIs were very negative while French Consumer Spending fell off a cliff at -2.9% from previous month. Spanish Retail Sales didn't do too much better either, as they also disappointed at -3.7%. The BTP bond auctions in Italy send borrowing costs higher again. Certain parts of Europe are slipping into a stronger recession than earlier expected. 
We also received an onslaught of Japanese data this week, with Manufacturing PMI still expanding at 50.7, unemployment rate remaining unchanged at 4.5%, Core CPI coming in at 0.2%, Industrial Production disappointingly coming in at only 1.0% from expectations of 2.4% and finally Retail Sales (YonY) printing a 10.3% reading as Japanese consumer slowly recovers from earthquake disaster of last year. In the US, Michigan Consumer Sentiment beat expectations coming in at 76.4. We should all know that a rising stock market usually tends to create positive or rising consumer confidence, so this is not news. However, Initial Jobless Claims disappointed... yet again. This is now the fifth week in the row. United States employment picture, which is a part of Fed's mandate, is weakening without a doubt and the negative trend, even though mild currently, is establishing itself.
The US GDP also disappointed, which signals not only to the Fed - but to the rest of us, that current sluggish growth will not be strong enough to continue posting Non Farm Payrolls above 200,000 as economists have been expecting. On top of that, sluggish growth will most likely not push down the unemployment rate as the Fed would like to see. Unemployment rate currently stands at 8.2%, but the participation rate has been dropping since 2009 as well. Therefore, unemployment is not actually improving, it is just that people are giving up trying to get employed. This is also shown in the average unemployment during of 39.4 weeks. In my opinion, if the Fed wants to even try and achieve unemployment rate closer to 7%, which they are projecting in their latest Press Conference, they will have to bring QE3 or another form of easing / stimulus back onto the table without a doubt - a super bullish outcome for a secular commodity bull market.

With expectations of further Fed easing, that is precisely why I have been arguing for months that the US Dollar is about to break down. US Dollar bulls won't have any of it, but before you stay perma-bullish on the Dollar and of a view that the DXY Index is still in an uptrend - let me put forward some very interesting points I have noticed in the last couple of weeks in the currency markets:
It is very strange that the US Dollar is failing to rally with abundance of good news coming its way and the US economy outperforming its European counterparts. In my investment experience, I have learned that financial assets price in or discount news / data ahead of time. When an asset fails to perform positively on constant favourable news, than most likely that asset has discounted just about all of the good news and is ready to reverse the trend to start pricing in a changes in market conditions.
Certain currencies like the Pound have already left the Dollar in the dust. GBP is now up 10 days in the row and trading almost 3 standard deviations above the 50 day MA - the last time we saw such a winning streak was back in 1992. As we can see in the chart above, the Pound is approaching the upper end of its long term triangle consolidation, so I would be cautious buying the Pound right now. After being net short since August 2011, hedge funds have now turned net long as well. Public Opinion on the Pound is also quite high, signalling a potential correction could be in the cards. I would expect a consolidation or a pullback, but I wouldn't be overly bearish by buying the US Dollar. I think a major Dollar breakdown is coming up and the Pound could break out of its three year consolidation pattern to the upside, especially if Bernanke re-starts easing to improve the employment picture in the US.

Moving on to the stock market, as the post title states, I think there is trouble brewing in this asset class. Stock market bulls constantly point to strong earnings season and famous investors like Blackstone’s Byron Wien sees the S&P 500 reaching 1500 on strong earnings moving above $100 a share, coupled with expanding multiples towards 15 P/E. Personally, I think that there is a possibility of that occurring, especially if the Fed engages into further easingas discussed above.
On the other hand, stock market bears point to insanely high Corporate Profit Margins and believe that a mean reversion is in the cards eventually. During every investment cycle, bulls believe that corporate profits margins will never mean revert, just like they didn't in 2006/07 and 1998/99. Wise men like Jeremy Grantham have previously stated that “profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly.” So in my mind, it is only a matter of when (timing), not if. Speaking of timing, traders and investors should not use record margins as a timing tool, so lets dig dipper underneath the stock market to see where the trouble is brewing.

First of all, I do think that bull market leader stocks like Apple, Price-line, Starbucks, Hermes, Wynn Resorts, Ralph Lauren and many others have either started to top or are more than likely to top in coming weeks and months.
Looking at the sector breadth in the table above, at first glance we can conclude that breadth looks quite healthy for majority cyclical sectors and the overall stock market. First and foremost, early cyclical sectors like Semiconductors, that are very economy-sensative, are displaying very weak breadth and have failed to make a new bull market high giving us a S&P 500vs Semiconductor non-confirmation signal. We saw a similar type of a signal during the topping equity market phase in 2007 and also in early 2011 as well. Financial sector also falls into this category, having so far failed to make new bull market highs above May 2011.

On the other hand, short term breadth in the Utilities Sector (super defensive) is expanding in a bullish manner. We currently have over 96% of the sector above the 10 day MA and over 84% of the sector above the 50 day MA. Readings above 50 day MA at 84% is the highest Utilities breadth reading since late December 2012, when the S&P 500 started its runaway move from 1,250 towards 1,400. That means safety defensive sectors are now attracting inflows. There are several clues we can derive from this:
  • We are entering a late cycle of the equity rally, where defensives take lead from cyclicals
  • Utilities never rise strongly in an interest rate rising environment, but more so in an easing environment, so QE3 could be back on the table
  • There is a possibility of a current correction not being over just yet, so Utilities are being used as a hiding spot
Refocusing back on the overall equity market, we can see early breadth deterioration starting to show its ugly face, just like in early 2010 and early 2011. Consider the chart above and note that S&P 500 tends to cycle between breadth improvement and deterioration, when it comes to stocks making 50 day new lows. In recent times, during the current cyclical bull market, we tend to see two initial smaller corrections prior to a major sell off. The hints can be seen in the increasing  50 day new, as the chart above shows.

For example, we saw the number of stocks making new 50 day lows slowly increase leading into April 2010, just prior to the flash crash. Than, we saw a similar event occur in July 2011, lead into August 2011 crash. Currently, the number of stocks making new 50 day lows has started to rise above that of November / December 2011 correction. That signals to me that not all is well within the stock market and we could be at the start of the topping process, before a more meaningfully sell off occurs in up and coming months. Of course, in the meantime, stocks can and most likely will make a new bull market high.
I discussed non-confirmtions with the different sectors above, but there are also non-confirmations starting to pop up in the cross asset space. The chart above shows that we now have a US corporate CDS Index failing to make new lows despite S&P 500 making new highs - a similar type of an event to the topping process of 2007. Other non-confirmations and early warning signals include:
Furthermore, while the short term sentiment might be slightly bearish, these types of indicators are very volatile and more trader-related than anything else. Sentiment indicators that focus on the longer term view, like the Money Market Assets or cash levels as I like to call it, are flashing warning signals. There is currently just above $600 billion sitting in Money Market Funds which is the lowest reading since 1998. On percentage basis it is equivalent to about 5% of the S&P 500, which is the among the lowest readings in over 30 years and down by almost 10% from the early 2009 stock market bottom.

Bernanke has forced majority of investors out of cash due to ZIRP (zero interest rate policy), but from a contrarian point of view, do you really want to be buying equities for a longer term investment with cash levels so low? If the great stock market bottoms over the last 30 years occurred in 1982, 1991, 2002 and 2009, than today we are at the opposite side of the spectrum. Finally, seasonal weakness from May to October is now upon us, so do keep in mind that equity markets tend to under-perform during this time frame.
Having said all of that, I am not ready yet to short the stock market. While I see cracks appearing similar to that of 2007 and 2011, the internal breadth of the S&P 500 still remains quite strong with 81% of the S&P 500 above the 200 day MA and 73 out of 500 S&P stocks having made a new 52 week high this week. Cyclical sectors are still holding up decently as well. This leads me to think that we are now in the "Late Expansion" of the investment cycle, where the leadership assets become Commodities over Equities, and where late cyclical sectors like Energy & Materials outperform Semiconductor, Retail and Financial stocks. I have already discussed the commodity picture enough in recent posts, including PMs like Gold, Silver and Gold Miners. But, what I haven't talked about recently is Agriculture.
Rogers Agriculture is now on the verge of breaking out of its downtrend (chart above). Sentiment is extremely negative within the sector with Public Opinion reaching bearish extreme levels or close to extreme levels on Wheat, Corn, Sugar, Coffee, Cotton and Live Cattle amongst others. We are still sitting close to hedge fund record net short positions in the Wheat market. Price is in the prices soy making a first higher low, despite media news constantly telling us the globe is oversupplied with Wheat - nonsense! The longs have been cut considerably in the Corn market recently as well. Contrary to the rest of the grains sector, Soybeans are extremely overbought now.

However, sentiment is especially negative in the Soft complex side of Agriculture, where the Dow Jones Softs Index (JJS) posted a 52 week new low on Friday. Sugar has now crashed, due to expectations of Brazilian output recovery in 2013. Hedge funds are cutting their net long positions in a hurry. The price is down 5 weeks in the row and approaching the physiological 20 cent support level. Coffee is down more than 40% over the last year and is now finding support on a 10 year rising trend line. Hedge funds are net short the Coffee market for the first time since 2008. Finally, Cotton and Coco are now building bottoms after being slaughtered last year and will soon rally. For those that do not use the commodity futures, another way to participate in the Agricultural story is through fertiliser names like Mosaic. Consider the chart below and notice that there have been now new lows since the selling climax of September 2011. Mosaic is currently down 40% from its peak in February 2011 and offers great value for a longer term investor who believes in the Agriculture fundamentals.
Overall, I would expect the Agricultural sector - as well as all other commodities - to move up in coming weeks and re-enter a cyclical bull market. Commodities should be boasted by upside surprises in the Chinese economy, as infrastructure spending picks up in coming months. We could also see potential easing by the PBoC as inflation has now returned to more modest levels. Shanghai Composite could be discounting just that, as it flirts with the 200 day MA setting a stage for a break out higher. That too, would be very positive for commodities. Recent technical analysis newsletter I read from Jeffrey Zhang of Hong Kong based Trading Central Asia, suggested that "the index may be forming a so-called inverse head-and-shoulders pattern that could drive it [Shanghai Composite] up 17 percent should it break its 200-day moving average of 2,470."

We are in a "Late Expansion" of the investment cycle. I think there are cracks starting to show within the equity market, despite its potential to make new bull market highs above 1,420 in coming weeks. Therefore, I do not agree with Byron Wien's extremely bullish call. At the same time, stocks are not yet a short either, so I do not agree with Gary Shillings super bearish call either  right now (written about last week). 

As an investor, what I am interested in is late cyclical assets like Agriculture and Precious Metals that are oversold, Energy sector that is oversold relative to the rest of S&P 500, fertiliser stocks and finally in the breakdown of the US Dollar, where Commodity & Asian currencies should benefit. For more safer investors amongst us, purchasing high yield defensive sectors like Utilities, which have been out of favour for the last quarter, could also be a smart way to preserve capital and gain some modest returns. Defensive high yielders are currently a better play than the overpriced Treasury Bonds too.

Finally, for those that do not believe commodities can rally while stocks top out and decline, re-visit the recent events of 2007 and into middle of 2008, where the CRB Index went almost vertical and S&P 500 declined by 20%.

Thursday, April 26, 2012

All Eyes & Ears On Bernanke

[Quick Update]
It is Thursday the 26th of April. The US Dollar triangle seems to be breaking down despite FOMC not engaging into any further easing. The triangle is now breaking lower and short term support levels at 78.75 and 78.00 are the only major obstacles standing in the way of bears turning the US Dollar into a downtrend with lower lows and lower highs - chart below.

The Dollar bulls should be worried, because despite European recessionary news getting worse (Monday's PMI data) and no further Fed easing, the US Dollar is still acting weak. From my experience, whenever an asset acts weak during favourable news, something is not right.

As you might remember, back in middle of January 2012, our fund shorted the US Dollar via buying Swiss Franc exposure. Since than, we had to fight against amazingly strong consensus view favouring further US Dollar upside for variety of reasons. The amazing thing is, the US Dollar price has been telling us all along that it is in trouble, as it refused to make any new highs for months.

Having said all that, we are not yet certain the Dollar has started a downtrend, so a break below 78.00 on the DXY will definitely increase the probability substantially. As we always say... when it is obvious to the public, it is obviously wrong. There are no easy trades in the market, so you are always better off being a contrarian!


[Original Post]
It is Wednesday night, the 25th of April here in Asia. We are in the last trading week of April. The week started off on a bad note, with European Manufacturing PMIs disappointing to the downside. German Manufacturing PMI was a real worry, coming in at 46.3 while consensus expected a reading of 49.0. On top of that French Business Sentiment and Italian Consumer Confidence strongly disappointed to the downside too.

All this data has definitely removed hopes of a EU recession ending quickly and has pushed Citigroup Developed Markets Economic Surprise Index into negative territory. Australian PPI and CPI data also surprised to the downside, creating a scope for RBA to cut rates at the start of May from 4.25%. Australian Dollar is still struggling.

Recent data that is out while I write this article comes from the UK, where the GDP has now posted a first double dip recession since 1970s. On top of that, US Durable Goods Orders fell over 4%, which is the largest drop since 2008.

Important economic data for the rest of the week includes:
  • FOMC Statement & Interest Rate Decision
  • RBNZ Statement & Interest Rate Decision
  • UK Consumer Confidence & German CPI
  • Japanese IP & Japanese CPI
  • Italian 5 Yr & 10 Yr Bond Auctions
  • US GDP & Weekly Jobless Claims
  • US Michigan Consumer Sentiment 
It looks like it is a totally packed week of data, which provides a lot of clues on the state of global economy and creates catalysts to move prices in either directions for traders. One of the most important events is happening early morning in Asia (afternoon NY time) - chairman Ben Bernanke's speech, which in my opinion could finally trigger the US Dollar triangle movement as we can see in the chart above. I will refrain from discussing the Dollar any further, because the previous post covered the topic in-depth.

Looking at the recent sentiment surveys published today from SentimenTrader and Daily Sentiment Index, commodities sentiment has deteriorated further into bearish levels, which is contrarian bullish signal. Furthermore, sentiment on the following specific commodities is either close to or at bearish extremes:
  • Energy: Natural Gas
  • Grains: Corn & Wheat
  • Softs: Coffee, Sugar & OJ
  • Stock: Live Cattle & Hogs
  • Indu Metals: Copper
  • PMs: Gold, Silver & Platinum
I think opportunities exist in the whole commodity space or even in some of these specific asset classes as a trade. One particular area personally I am very excited about going forward is not the stock market, nor the bond market, but the Precious Metals market - especially Silver.
First of all, Silver's Public Opinion thanks to SentimenTrader website, is at very low levels of only 34% bulls. Historically, readings below 40% have been considered very extreme, where prices tend to make an intermediate bottom in coming days or weeks. Furthermore, this is the first time since May 2011 peak of $49 that Silver has an extreme amount of bears and yet the price has failed to make a lower low (below $26 in this case).

Finally, few other interesting fact regarding sentiment in the PMs market. First, Bloomberg recently reported that Silver's ETP holdings have fallen by most since 2008, which is great contrarian indicator. Second, visitor interest in Gold websites has fallen dramatically as prices stopped rising 7 months ago. The website is quite famous in the Precious Metals space, being full of historical charts and ratios. Nick Laird, who runs the site, recently stated in an interview the following:
"I have rarely seen my site so quiet. Normally I get at least a couple of visitors a day looking for a trail of my website. The last tend days, I've had two people asking."
The whole concept of investing is to participate in a secular bull market with an asset class that is showing strong fundamentals (e.g. like Silver) and constantly try to buy as low as possible while holding positions until the final bubble overvaluation. Remember, all secular bull markets end in bubbles and so will this commodity bull market. I do not know where Silver will go to eventually, but I do know the smartest thing one can do is accumulate when others are disinterested, bearish or selling out.
When we look at the performance of Silver over the last 12 months, we can notice that is has suffered with majority of other commodities like Natural Gas, Cotton, Coffee, Cocoa, Wheat and Corn in a cyclical downturn. Our fund is already overweight this metal, since it is one of the worst performers and we definitely plan to buy more in coming days or weeks, depending on the price action of the asset itself and the US Dollar triangle. For those that do not like Silver, Gold Miners look very attractive at current oversold levels.
Moving onto the stock market, Apple has been a poster boy of the cyclical bull market since March 2009 lows. In recent earnings results, Apple beat expectations by a staggering amount on stronger revenues and iPhone sales - especially in China. It seems that the recent parabolic correction has now ended in one single days of trading, with Apple shares jumping over 10% at the open. That has obviously pushed up the Technology sector higher today.

The most oversold sectors within the S&P 500 remain Energy and Materials, connected to the commodity price slump. The most overbought are Utilities, Telecom and Health Care - all on the defensive side of things. Risk off trade is still dominating for now. Currently 33.6% of the stocks within the S&P 500 are trading in an oversold position with one standard deviation below the 50 day MA, while 19.6% of the stock are trading in an overbought position with one standard deviation above the 50 day MA. These readings are now as oversold as November & December of 2011. I am not so sure if the current correction has now finished or not, but that is more of a concern to a trader, who has much better short term timing skills than I do. Readers tend to email me and ask why won't I buy any stocks?
For an investor like myself, I focus on the fundamental side of things and long term entry points, not so much the short term rallies. Looking at the chart above, I am definitely not interest to own equities with profit margins and earnings at record highs. I would much rather buy equities when earnings are depressed, which usually occurs during the bottom of recessions, similar to what we saw between November 2008 and March 2009.

Furthermore, the current business cycle is becoming over-stretched. Recessions tend to occur every 5 years on average, so if the last recession in the US started around December 2007, five year average period comes due around December 2012. That doesn't mean recession needs to starts straight away, and nothing might happen until 2013 or even 2014, but it is important to note that risks are constantly increasing as this bull market and the current business cycle ages. Awful fundamentals for the stock market are waiting in the not so distant future, so the last thing I want to do is buy and hold at elevated prices with record high earnings. What I might eventually do is short the stock market later down the track and therefore hedge my commodity longs.

All eyes will be on Bernanke's speech today. Disappointing the investment participants will most likely send stocks, currencies and commodities lower, while the Dollar goes up. Bonds could sell off if Fed does not engage in more easing too. However, sentiment on commodities and specifically Silver & Gold Mining stocks is quite bearish, as already discussed above. Any further panic selling will probably mark the final panic low where the smart money jumps in and starts to accumulate in a big way.

Those invested in Nikkei 225 or the Yen should be following onslaught of Japanese data coming out in the next day or two including Industrial Production and CPI readings. Finally, US Jobless Claims should give us further clues as to the way employment picture in the US is developing, while the Italian Bond auctions should give us a sense of credit risks within the Eurozone.

Monday, April 23, 2012

Is The Dollar Breaking Down?

It is Sunday night, the 22nd of April here in Asia. We are about to enter the last trading week of April. The week finished of with positive market movement in the risk on space, while the US Dollar sold off by about half a percent. Spanish & French Bond auctions went by pretty smoothly, but majority of market participants believe it was only an ECB smoke-screen. US Initial Jobless Claims once again disappointed to the upside and quite strongly too. Philadelphia Fed Manufacturing also disappointed while the German Ifo Business Climate surprised to the upside. 

Early next week we can expect the following important economic data releases:
  • EU, German & French PMIs
  • Italian & French Consumer Confidence
  • Taiwanese IP
  • Australian CPI
All in all, US economic data keeps surprising to the downside, according to the Citigroup Economic Surprise Index. Since the US Banking Crisis unfolded in 2008 and Lehman Brothers went bust, no other major bank or financial institution carrying large debt holdings has been allowed to file for bankruptcy. Each slowdown in economic activity since than, has increased the risk of another systemic failure and put pressure on global central banks to maintain the recovery on life-support. 
So far Fed has engaged into QE2 as well as Operation Twist programs as the economic data disappointed in middle of 2010 as well as middle of 2011. As we can see in the chart above, so far we are in a 2011 replay. Is it too early to think that the Fed will ease yet again or extend the current OT program? There are now certain market price hints that traders and investors are on the verge of discounting further Fed easing. These hints come to us via currency markets and especially the US Dollar. Let us quickly review the state of the Dollar.
Technically, the price action has been locked inside the triangle for months now. The Dollar has not been able to make any new highs, despite still remaining in an uptrend and making higher lows on its bullish trend line. Friday's price action is moving to the bottom part of the triangle, looking like this last week of April could set us up for a breakdown. Obviously, we have to be aware of any false or fake movements.
Furthermore, the price broke down on Friday from a compression of short and medium term moving averages. Whenever moving averages of all types compress, it lets us know that there is an agreement of price at that current level between bulls and bears. However, markets are naturally volatile and these agreements never last for long. Breakouts or breakdowns from MA compressions tend to be signals of trend changes.
My personal Asian Currency Index is signalling that the correction, which occurred in August & September of 2011 has been basing and building a bottom for the last few months. There is an above average chance that Asian currencies (high yield) will lead the charge higher against the US Dollar. Technically, we are now in a coil between support line and 200 MA, and a break out in either direction should occur soon. Obviously, as stated before, we have to be aware of any false or fake movements.
Sentiment wise, investors remain extremely bullish the Dollar. What has been very interesting to me is that the Trade Weighted Dollar Index (as well as the DXY) have failed to make new highs above the January peak, and yet investors continue to hold very large US Dollar positions on the futures market. This type of non-confirmation is definitely a warning signal for greenback bulls.
Finally, seasonality for the US Dollar tends to be below average during second half of the year. As we enter May, according to seasonal strengths and weaknesses, we could maybe expect a last burst of buying, before the Dollar eases into a downtrend for the last two quarters. Keep in mind that seasonality is not a holy grail and just a statistical probability.

FOMC meeting starts Tuesday and its a two day affair. I believe, Bernanke's comments could be a trigger for the Dollar's triangle, which is now on the verge of breaking down. As the economy keeps slowing, Bernanke could hint at further easing or at least warn the markets that if economy does slow down more, further easing will be guaranteed. Technically, the USD looks weak while sentiment is extremely bullish. Obviously, as stated before (once more), we have to be aware of any false or fake movements or Bernanke's comments refusing to ease, which would send the Dollar in the opposite direction. The triangle has not broken just yet...

Thursday, April 19, 2012

Still All About The Dollar

It is Thursday morning the 19th of April during Asian trade. It has been an interesting week so far. Looking at the business cycle - Russian, Japanese & US IP disappointed all around, while the US retail sales showed positive growth. Indian Central Bank cut interest rates for the first time since 2009, while inflation in the UK was above expectations, giving the Pound some strength. German investor sentiment (ZEW) was positive for the third straight month.

Important economic data releases for the rest of the week include:
  • Spanish 2 Yr & 10 Yr Bond auctions
  • French 2 Yr, 3 Yr & 5 Yr Bond auctions
  • US Initial Jobless Claims
  • Philadelphia Fed Manufacturing
  • German Ifo Business Climate
  • UK Retail Sales & Canadian CPI
Global manufacturing business cycle is in the 4th year of the expansion mode and continuously prepped up by global central bank intervention. However, European countries are being a drag on global GDP, with contracting PMIs and mild recessions. Confidence has taken a hit on the continent. The on-going debt crisis, harsh austerity and increase in taxes has completely removed growth from the current expansion in the EU business cycle. The stock market in Europe is no higher than where it was in August of last year. Spanish IBEX has declined below the previous major bottom of March 2009, while Italy is not too far away either.
Meanwhile, the rest of the word is still growing, with US holding its own too. The Restaurant Performance Index is a great barometer of US consumer spending (more than two thirds of the economy) and it shows no signs of a slowdown or recession. It is also not showing any signs that the current Gasoline prices are impacting the US consumer. Retail Sector ETF (XRT) seems to be confirming this outlook at the present time. 
I think all eyes will be on the EU Bond auctions during European trade today with both Spain and France selling short, medium and long term debt. The US Dollar triangle, as seen in the chart above, is now running out of room and will soon break in either direction (great news for traders). This could be a perfect catalyst to trigger a major movement. The uptrend which started in May 2011 has now lasted for almost 12 months with higher lows, but at the same time since January 2012, the Dollar has failed to progress upward in any meaningful manner and continues to make lower highs as well. 

Regarding the triangle price above, a trader emailed me yesterday and told me that currency investors are torn between focusing towards further Fed easing on the one hand and EU debt problems on the other. I disagreed. I agree that the price action itself is actually focusing on those two issues, hence the triangle, but the traders and investors are herding in one direction only.
According to the data I follow, and as shown in the chart above, investors are happily holding the largest US Dollar net long position since June 2010 at over 2 standard deviations away from the mean. It is pure US Dollar love affair. Furthermore, being long the Dollar has become a favourite trade of some large pension funds, who are usually the last guys to join the party. 

Financial Times reported that PIMCO shifted gears in recent weeks to bet the dollar will rally against some major currencies. Standard Life Investments Ltd is buying the dollar and selling the euro, reversing last year’s strategy (note: where were they last year?). Franklin Templeton Investments also has thrown some of its $700 billion behind the greenback. They join Jim O’Neill, chairman of Goldman Sachs Asset Management, who also is calling for a stronger dollar. Nouriel Roubini has expressed that the Euro would have to decline to parity to give the Europeans their competitive edge once more, while John Taylor of FX Concepts, is super bearish on the Euro. 

To summarise, long Dollar is a major consensus trade right now. Having said that, do keep in mind that, despite high bullish sentiment, the US Dollar could move higher out of the triangle in coming days or weeks. I have a feeling that any move higher will be short lived and most likely a head fake from which a major reversal will occur.
While the love affair with the Dollar is quite obvious, the same cannot be said about commodities. The chart above shows that CRB Index is currently near its support of 295 and at the same time it is oversold as its trading 2SDs away from its 50 day MA. Equal weighted CRB Index known as Continuous Commodity Index, is now down for the 8th straight week.
Sentiment on majority of the commodities remains very negative (opposite of the US Dollar). Daily Sentiment Index on Coffee stands at only 7% bulls, on Sugar at 9% bulls, on Cotton at 13% bulls and finally on Wheat at only 15% bulls. Public Opinion thanks to SentimenTrader website is quite low on commodities like Copper, Silver, Platinum, Cattle, Coffee, Lean Hogs, Corn, Wheat, Cotton, Sugar and finally at super bearish extremes on Natural Gas (which is probably at a lifetime buying opportunity). In the chart above, we can see that the overall CRB Index sentiment is also very low. Are we close to the bottom or will commodities break down even lower? I guess it rests in the hands of the Dollars movements in coming weeks.
Super bears over at Elliot Wave International think that Silver looks "heavy" around here and could drop "rapidly" towards $26 support in coming days and weeks. While I am not so sure if we will drop towards $26 per ounce, I think a rapid fall of 5% towards $30 per ounce in coming days could be possible, especially if it is caused by the weak Euro / strong Dollar combination.
Strong Dollar is not the only issue weighting on commodity prices right now either. Chinese GDP continues to slow too, as we can see in the chart above. Every single GDP quarter since early 2010 has been slower than the previous. At the same time Shanghai Composite has been in a bear market since early 2010 as well, reflecting the Chinese slowdown. However, from the contrarian point of view, the market action shows we have recently refused to make a lower low and are moving towards the 200 day MA with a potential break out. If the bullish outcome in the Chinese stocks was to occur in 2012, contrary to majority expecting a hard landing, it would also prop up commodity prices. Shanghai Composite & CRB Index have high correlation to one another.
Moving towards equities, the recent survey of hedge fund managers by Merrill Lynch, showed that equity positions were cut while cash positions were increased substantially (chart above), despite a minimal correction. US equities remain the most favourite of all the regions for global managers, while the Eurozone risks are biggest worry going forward. This doesn't give us any edge to be quite honest, as global fund managers seem to be quite neutral at present, unlike their extreme bullish positioning in Feb 2011 or their extreme bearish positioning August 2011.
Chris Puplava's recent equity market breadth article puts forward evidence that the current price action in the S&P 500 was just a correction. As we can see in the table above, top two sectors that are making the most 52 week new highs have been cyclicals, which are very economically sensitive. If the economy was about to slow down meaningfully, the markets action would be negative in the process of discounting this event. Furthermore, if is very interesting to note that commodity related sectors seem to be struggling the most in the current environment. This is obviously due to lower commodity prices (CRB chart above) and would improve very quickly if the US Dollar was to break down.
Moving onto the Bond market, I think we are slowing building a top in price / bottom in yields around these levels. Whenever money supply levels grow year over year, inflation in the cycle tends to rise and interest rate expectations move upward. On top of that, we can say that more bond purchases will definitely trigger yields to rise as well. Technically, the 200 day MA has finally caught up to the super sharp move we saw in August of last year. Furthermore, Long Bond is now up six weeks in the row, which is quite overbought. A failed new high above 145 for the Treasury market might signal a first major LOWER HIGH in coming days and weeks and than a break below the 200 day moving average is possible.
Finally, credit markets still give me no signals in either US nor Europe that anything major is on horizon. As we can see in the chart above Euro Dollar Basis Swaps over 3 months continue to improve since December of 2011 while the EU Libor OIS rate keeps falling. iTraxx CDS Index has risen as stocks have corrected, which is to be expected, but one sign of worry is that banks are still hoarding all the LTRO money at the ECB overnight deposit facilities. This fear amongst European banks lets us know that a real systemic problem is still alive and well within the EU banking sector and eventually the chickens will come home to roost. For the time being that is not a worry, but when we see Financial sector heavily under-performing S&P 500, the issue will most likely become front page once again.

It is all still about the US Dollar triangle. There has been a lot of calmness in the currency markets for the last few days as we await a catalyst to trigger a Dollar move in either direction. Watching the investor demand for Spanish debt could be critical for the way rest of the week plays out. Next weeks Fed meeting could also be a major market mover too.

Sentiment on the Dollar is way too bullish for me to chase prices higher, so instead I will be waiting for commodities to bottom (whenever that is) and slowly start to buy in. As already discussed before, with decently strong breadth and improving credit markets, I don't expect an equity bear market right now. Instead, there is a possibility bonds yields might rise soon.

Monday, April 16, 2012

Waiting For The Dollar Top

It is Monday the 16th of April here in Asia. I managed to get out of my Silver / Silver Wheaton trades for break even (very very small profit) as the prices reversed. Bernanke's speech was a complete non event as he did not mention anything to do with further stimulus, nor did he talk about jobs progress within the economy. Out of all the global economic data on Friday, the stand out was Italian IP disappointment - signalling that Peripheral Europe is sinking further into recession. European equity markets and peripheral bond markets sold off hard, with Spanish IBEX and Italian MIB down over 3.5% each.

Important economic data releases for early in the week include:
  • Japanese IP & Consumer Confidence
  • British CPI & Eurozone CPI
  • US IP & Capacity Utilisation
Despite below average economic performance of Europe, last weeks Chinese data was decent and the US economy is still not showing any signs of a recession according to the chart above by Chris Puplava. Having said that, the growth is quite anaemic, so we can easily suffer a set back if Eurozone crisis was to flare up again. Likewise, majority expect a soft landing in China, but the property sector is continuously worsening as months ago by.
Citigroup Economic Surprise Indices across the globe show that data keeps on disappointing economists expectations, especially in the US and other Developed Economies. It seems to be a reply of early 2011 and quite similar to early 2010 as well. As we can see from the chart above, whenever the economic data under-performs, Fed seems to step in. More on that later.

Earnings so far have been mixed. Alcoa beat estimates, while Wells Fargo, JP Morgan and Google missed. This week is going to be a big one for the earnings front. Following companies are going to report: Citigroup, Goldman Sachs, Johnson & Johnson, Coca Cola, IBM, Intel, Yahoo, Freeport-McMoRan, eBay, Yum! Brands, Bank of America, El du Pont, Morgan Stanley, Nokia, Philip Morris, Verizon, Microsoft, Wynn Resorts, GE, Honeywell Int, McDonald's and the list goes on.

Moving onto the markets, equity market correction is still in progress. On friday I said that "oversold equity readings from the short term perspective are creating a bounce, but I am not so sure that the correction is finished". In my opinion the VIX hasn't jumped enough just yet to wash us out. A move towards mid-20s could do that. Since the peak on 02nd of April, Energy and Financials are down the most, each more than 5%. Consumer Discretionary sector is down the least, only about 1.5%.
Certain parts of Consumer Discretionary sector are reassembling parabolic like behaviours that we tend to see at the end of a bull market. The same could be said about the Tech sector too (e.g. Apple). This is why it is difficult for me to get excited about the equity asset space. Unless you are a trader, who can successfully buy low end of the correction range and sell the high end of the correction range, I think the stock market is becoming overvalued by looking at Shiller's P/E10 or when we look at the age as well as the gains since March 2009.
Historically bullish sentiment readings across all surveys usually signal that stocks are either going to struggle in coming weeks / months or even correct, sometimes considerably. Two exceptions to this rule in the chart above, because no indicator is perfect: first, during the final bubble phase of the secular equity bull in 1997 sentiment meant nothing as stocks went into euphoria; and second, during the start of a fresh new cyclical bull in 2003 stocks rallied hard from oversold readings despite high bullish sentiment. Today, we are neither in the secular bull phase for stocks nor the bubble phase and we are definitely not coming out of a bear market where a new cyclical bull is fresh. That was March 2009… today is more than three years later!
So what to do? I do not want to short equities, as I think the stock market breadth indicators show no major warning signals just yet, even though medium term breadth is starting to weaken signalling the end of an uptrend (for now). We could make marginal new highs, without a doubt, but we could also correct sharply if the economy disappoints as well. In any case, top is a process - not an event, as we saw in late 1999, early 2007 and early 2011. Currently long term breadth still looks healthy enough to keep this cyclical bull alive.

While stocks show bullish sentiment and overbought readings, commodities show bearish sentiment and oversold readings with Continuous Commodity Index down 7 weeks in the row. From a contrarian point of view, this is what an investor wants to buy as we eventually bottom out. The question is when will that bottom occur? While I would love to know the answer myself, the probability would favour commodities to rally when the Dollar shows signs of topping and that sort of links to economic data and further Fed easing or money printing.

Master bond investors Bill Gross and Jeffrey Gundlach see the Fed engaging into the third round of bond purchases. Bill Gross has been cutting Treasury holdings and switching over to Mortgage securities instead. Both of the investors think further economic weakness and a more meaningful decline in the stock market will force Bernanke, Yellen and Dudley to reconsider another round of QE. As already stated above, economic data is weakening across the board.
As of this mornings Asian trade, almost all currencies are declining against the US Dollar once again. Euro went as low as $1.30 support level. The question on every traders mind is which way will the Dollar triangle break? Looking at the chart above, the answer should not be very far away as the triangle pretty much runs out of room. A breakout could send commodities even lower into a final wash out phase of the current two month correction, while a breakdown should bottom commodities almost instantly.
Positioning on the US Dollar is very bullish, which in my opinion remains a contrarian signal not to chase the prices higher. Euro has been in a bear market for almost a year now, so I think it is a bit late to be extremely negative here. It is not about great Euro fundamentals, but more about up-and-coming QE which will weaken the Dollar. We can see that huge short positions still remain and further selling most likely will not go below $1.26 bottom in middle of January. In other words, I see the Euro building a bottom here and creating a first HIGHER LOW and when the Fed does eventually act, a huge short squeeze will occur. Investors are very bullish on the Dollar across the board, not just against the Euro. Short positioning is present on the Pound, the Yen, the Franc and very reduced net long positions on the Aussie as well as the Kiwi Dollars.
I do favour the Agricultural space as well as the Precious Metals out of the commodity complex when the Dollar does show signs of topping once again. While I talked about Sugar on Friday, I would also like to note that investors remain extremely bearish on Wheat as well. We have been hearing about negative fundamentals and record high supply levels for months on end now... and yet Wheat prices refuse to make a lower low. In my opinion, that is very bullish as it seems that huge net short positions have already discounted majority of the bad news we hear and read from day to day.
Comex open interest on the Gold continues to drop, which is a very good contrarian indicator. Readings now sit at a two and half year low. Silver's open interest is close to very extreme lows last seen during the   2008 crash. Speculative activity is really not that present in the PMs market anymore. Gold Miners are becoming quite oversold from a longer term perspective. Furthermore, in recent weeks, Put Call ratios reached extremely bearish levels for both Gold and Silver and still remain at high levels in the Silver market. Short Interest ratios on GLD & SLV increased considerably over the last month, while sentiment surveys on both of these Precious Metals is now at levels where previous intermediate bottoms occur.
Corrections do not just occur in price, but in both price and time. Prices can consolidate sideways and work of previous gains too. When we run an analogue of all the Gold's major corrections since the beginning of this secular bull market, we can see that price wise the recent correction was as bad as 2006, but not close to the panic of 2008. Time wise, the current price is entering a phase where all other corrections have ended. This stands at about 170 days out from the intermediate peak. Therefore, this makes me think that the PMs market should bottom soon. Keep your eye out on the Dollar for the signal.
Moving onto the credit markets we can see in the chart above that LIBOR OIS rates remain quiet and continue to improve for the time being. That is a positive signal for the banking industry at present. Furthermore, the recent equity rally has been accompanied by out-perofrmance of Financials stocks, and if the banks were in trouble, we would not be seeing their shares bid up that quickly.

On the negative side of things. US corporate CDS have started to rise, both US & EU junk bond credit spreads have also started to rise and finally even corporate grade credit spreads have risen recently too, but these seem minor for the time being.
PIIGS continue to be the centre of attention in the current de-leverging crisis that the world faces. Main two countries that have taken front stage seats are now Italy and Spain. Italy was worse off last year during the Fall months, as its yields on the 10 Yr Bond went as high as 7.4%, while Spain seems to be the focus in early 2012 as its CDS reach a all time new high of 502 basis points. Spanish 10 Yr Bond is now approaching yields of 6%, while Italy trails behind at 5.5%. Rumours are now circulating that ECB could engage into more bond buying once again.

Overly bullish sentiment and short to medium term deterioration in breadth personally prevent me from investing in the stock market. Traders will of course find interest here and play the bounce, as the correction runs into more oversold levels. On the other hand, I'm waiting for the commodities to show signs of a bottom and the US Dollar to show signs of a top. When we do get the hint of Dollars top, be it from the technical side of things or from the Fed itself, I favour further investments into Agriculture due to supply & demand constraints; and into Precious Metals due to further currency diluting. Silver remains one of my favourite asset classes for this decade... not just for the next few months!

Friday, April 13, 2012

Risk On Rally

There is a bit of a change on the blog. In recent times I've been posting topic related articles regarding either equities, bonds, commodities or currencies, plus an occasional focus on credit markets, property markets as well as business & economic cycles. This type of posts are very specific and in-depth regarding the actual topic itself, but at the same time, do not cover anything else happening within the broad financial market space. Therefore, what I will be doing from now on is putting it all together in one post, similar to a traders diary entry. I hope it will be a great summary, which will be posted several times per week depending on the action of the market. So I hope you enjoy the new format of the blog!

It is Friday the 13th of April. Bernanke is scheduled to talk today 1pm New York time. That is very late for some of us that live in Asia, but it might be worth staying up for. Operation Twist program is now three quarters complete and we seem to have a deja vu occurring similar to April 2010 and April 2011. Other important economic data releases for Friday include:
  • German CPI
  • Italian Industrial Production
  • Brazilian Retail Sales
  • United States CPI
  • Michigan Consumer Sentiment
Yesterdays summary showed that Indian IP disappointed, while the Chinese IP as well as Retail Sales beat expectations. Also Chinese M2 broadest money supply measure grew above expectations. Italian 3 Yr bond auction printed a yield of 3.89%, which is quite high compare to the last auction ay 2.76%. South Korea kept its interest rates the same as before, at 3.25%. North Korean launched its rocket, but it failed. The Korean Won appreciated against the US Dollar. Aussie Dollar jumped a lot on the back of improved employment figures out of Australia. Finally, everyone is talking about the jump in Jobless Claims to 380,000 while consensus expected 355,000. The question on everyones mind is weather or not we have a real deterioration in the jobs market once again.
Onto the equity markets. S&P 500 staged a second day of its rally. As previously mentioned, price polarity should be in play, if this is a cyclical bull market break out to new highs. That means previous resistance between 1,350 to 1,370 should now act as a support within the context of a mild correction. If not, we will break down lower towards 1,300 support. Uptrend is still intact with higher lows occurring since 04th of October 2011.
Short term sentiment soured within the equity space as we saw bull readings enter negative 1SD, while bears entered positive 1SD readings. What is even more interesting is the speed that the bulls have scattered. One quarter of retail investors flipped out of the bullish side in just one week as S&P 500 fell only 4%.
Chris Puplava's recent breadth update shows that despite a stock market correction, two thirds of the S&P 500 is in an uptrend. Furthermore, it is also positive to see the Financial sector leading the way. It is a basic fact that in a de-leverging environment Financials will not lead the way higher if the bear market was due around the corner. If this was a top, we would see the current bull market experience sector rotation from cyclicals towards defensive sectors.

Over the last two days Materials, Industrials and Financials have rallied the most, with each sector gaining more than 3%. Having said that, these sector were also hit the hardest during the correction as well. What is important to note is that Utilities, Staples and Health Care have barley managed a 0.5% gain over the last 2 days, which indicates relatively weak demand for defensive sectors on behalf of investors.

Having said all that, I cannot get excited about investing in stocks at these levels. Sure, trading them for the next 3 hours or the next 3 days or the next 3 weeks is fine, but to invest for the longer term I think not. Moving onto commodities I think that is very opportunities lay going forward.
CRB Index was trading 2 standard deviations away from the 50 day MA as of yesterday. Oversold readings like that usually signal that an intermediate bottom is close. A strong reversal took place in yesterdays trade.

Commodities sentiment soured across the board in recent days, prior to the rally last night. Public Opinion on CRB Index got to the levels where we usually see a rally occur. Same is true for commodities like Natural Gas, Copper, Gold, Silver, Live Cattle, Cocoa, Coffee, Orange Juice, Sugar and Wheat.
I think Wheat, Coffee and Sugar look especially good here. Bloomberg article last night reported that "...sugar traders are bearish for a seventh consecutive week, the longest stretch since at least 2007, on prospects for the first supply glut in four years." We should all know what happened in 2007, when all the "gurus" were forecasting a huge Sugar oversupply (if you don't look at the chart above thanks to website).
Intra day chart of Silver showed a break out from relatively quiet price action. I added to my position and also bought some Silver Wheaton Corp shares too - both through some CFDs on a  tight stop. They had a terrific move last night. I wouldn't take too much from this right now, because the last time Bernanke spoke, he manage to reverse the rally in both Gold and Silver. The market price has been flip flopping up and down on the prospects of further stimulus from the Fed & ECB. It is also worth noting that Gold Miners, Gold Mining Juniors as well as Silver Miners all had a great rally last night too, with strong volume backing.
Crude Oil has had two strong days of rallying just like the stock market, while Natural Gas hit levels not seen in at least a decade as it went into a $1 handle. Palladium also seems to be oversold, while traders have a great opportunity in buying Rough Rice as it broke out from a great rounding base formation above $15. Commercial COT positions, aka Smart Money, have been heavy buyers for months so it was only obvious that we were building a low from which a rally will take place.
Moving onto the currency markets, I have already mentioned the powerful move by the Aussie Dollar. What is even more encouraging for the risk on assets is the breakdown of the US Dollar against the SIngapore Dollar. Triangle inflection points within this currency are very helpful, because when they break in a certain direction we tend to get a powerful risk on / risk off move as can be seen in the chart above. Sing Dollar tends to be a great leading indicator of what the US Dollar will do across the board. Funny enough, while I have been a US Dollar bear since January of this year, majority are still expecting a spike in the USD to a new 52 week high.

Moving onto safe havens, Japanese Yen as well as Treasury Long Bond did not sell off despite a risk on rally. The prospects for a weak Dollar have turned carry traders back into the Yen, while bond investors seems to be bidding up the price of Treasuries yet again hoping for another round of QE. Others are buying Treasuries as they expect a recession.

Gary Shilling was on Bloomberg TV saying that S&P 500 will drop 43% this year as the global recession unfolds. To summarise, he thinks that a recession in Europe, stronger dollar and a slowing Chinese economy will tank earnings back to $80. On a multiply of 10 times, S&P 500 should be trading around 800 ($80 x 10). He is currently long treasuries, short stocks, short commodities and long the dollar.
Moving onto the Credit Markets LIBOR OIS rates continue to fall. Three month Euro Dollar Basis Swap rates also keep normalising since the trough in December 2011. Both the USD and EUR currency swap rates over 2 years (bank funding) slightly spiked in recent days as the stock market correction unfolded. While the USD swap rates are at solid readings of 28.4 basis points, European counterpart remains very elevated at 89.9 basis points.
While it is not here right now, trouble is coming down the road, as the European Crisis enters its final phase in my opinion. We also had the 2 Yr Yields on both Spanish and Italian government bonds rise over the last few trading days. They are still a far cry from the levels seen in late November, early December of 2011.

Oversold equity readings from the short term perspective are creating a bounce. I am not so sure that the correction is finished. Having said that, I have no position in the equity markets and remain neutral. Best opportunities lay in the commodity markets, most likely with PMs and Agriculture. Chinese economic data has been decent and the credit markets are still not signalling any major worries, despite their negative upticks in recent days and weeks. Singapore Dollar break could be the leading signal for the risk on trade, but I think Bernanke will have the final word tonight. Stay tuned!

I hope you enjoy the new dairy entry posts and enjoy your weekend!