Sunday, July 29, 2012

Summary Of Recent Events

Topics Covered
  • Global business cycle in US and Germany continues to slow
  • Equity defensives still keep outperforming cyclical sectors 
  • Bond market technicals reveal a potential bearish divergence
  • Central banks easing cycle will continue as economy slows
  • Gold's GLD ETF holdings reduced as retail investors sell
Big Picture
S&P 500 remains the only major risk asset that has made new highs in the cyclical bull market that started in March 2009. Both the DAX 30 and Emerging Markets ETF have registered a lower high in 2012. S&Ps new high is also not confirmed by various credit spreads, risk currencies or commodities. Global engine of growth, Asia, seems to be slowing down meaningfully. This is reflected by weakness in Commodity currencies and Asian currencies, as well as in industrial commodities like Oil and Copper. This is also reflected in the strength of Government Bonds (Treasuries, Bunds, Gilts, JGBs) and the Japanese Yen. Euro is bouncing of the June 2010 support around $1.20, while one major stand out in 2012 has been a huge movement on the upside in Agriculture prices.

Big Picture will now be updated during every post to give readers a clear understanding of global macro asset market price movements.

Leading Indicators
Citigroup Economic Surprise Indices, seen in the chart above, show that currently we have had an uptick in global economic data beating expectations. However, before you jump the gun and proclaim that another upturn is here, let me remind you that it has become easier and easier to beat economist forecasts. For example, only three or so weeks ago, US economists were expecting GDP numbers to come in at 1.9%. Suddenly, they realised the economy is slowing much faster so they quickly revised their forecast lower towards 1.4%. And than by some "amazing miracle" come this week, GDP data has beaten economists forecast by coming in at 1.5% (we all know it will be revised even lower later) and as the French would say "VoilĂ ". Quite a joke really...
ECRI Weekly Leading Index still remains below the 2 year moving average and has been trending with lower highs every since April 2010. Also worth noting is various swings in the ECRI since 2009, as this business cycle is a lot more volatile than the previous two. Do take note that each central bank program has bought less effect on the economy and has also bought less time. Finally, as one can already notice, there is a major bearish divergence between the US stock market and the leading economic indicators (Wall Street vs Main Street). Majority of the time, the stock market eventually plays catch up to economic fundamentals.

Leading Indicators will now be updated during every post to give readers a clear understanding of global economic activity / data from week to week.

Business Cycle
German business confidence continues to deteriorate, as we can see in the chart above, and has recently fallen to a two year low. Majority of contrarian investors would argue that business confidence is a contrarian tool, so when CEO confidence is depressed a new upturn is waiting around the corner. That is true, however we have not fallen anywhere near the low levels of confidence, like in 2001/02 and 2008/09, so in my opinion the prevail trend in global activity is still down.
In the US, the manufacturing cycle is stalling just like the GDP growth. The recent Richmond Fed regional survey was a total disaster, in my opinion. Nothing new obviously, as it confirmed what the Philly Fed told us several weeks ago. If we consider the chart above, we can see that there is a potential for the overall ISM Manufacturing to disappoint quite handsomely in coming months and if that was to occur...
...I am pretty sure the S&P 500 would follow the ISM down into negative return territory. It is quite easy to see that during a secular bull market in stocks, from 1982 to 2000, manufacturing contractions did not necessarily force the stocks on the downside every time. However, during secular bear market in stocks, which started in 2000 and has been ongoing, we can see that the correlation between the manufacturing business cycle and stock returns is very closely correlated. Therefore, if the economy does slide into another manufacturing contraction (ISM consistently below 50) over the coming months and quarters, hold onto your hats.

Pavlov's dogs will obviously argue that Mr Ben Bernanke and his printing press will stimulate the economy and fix the manufacturing slowdown, but than again that is nothing new. They start barking every time Helicopter Ben or Super Mario open their mouth. Investors should buy PMs to protect from currency devaluation, but not expect Renaissance in manufacturing from here onwards.

Furthermore, the whole world has gone mad with stimulus talk. Since the birth of United States republic, we have had 40 plus recession over the last 200 plus years. Every single president has tried to stop an economy from entering a recession through stimulates, but all have failed. Furthermore, the Federal Reserve was created in 1913 and since than, it has been trying to stop a recession every time it was obvious a slowdown was in progress through stimulus and they too have failed every time too. Let mother nature do its works, you damn Keynesians! 

Equity Markets
Let us focus on US equities by looking further into the index via the magnifying glass. S&P 500 index strength is a smoke screen facade in my opinion, because the underlying sectors show a totally different picture. Chart above shows that early and late cyclical sectors are no where near making new highs, as the overall market rally is running on defensive outperformance for the last three months. Defensive leadership is only common near downtrends or bear markets. Furthermore, out of the 9 major sectors, 4 have not made highs above the May 2011. These include Financials, Energy, Industrials and Materials.
Looking at the overall breadth, I find it very interesting to note that if the S&P 500 was to gain only 2.5% it would register a new bull market high and yet there are less then two third or 66% of stocks within the index above their respective 200 day moving averages. Furthermore, early cyclical sectors like Semiconductors and Technology show remarkably weak internal breadth dynamics with less than 50% of stocks above their 200 day moving averages. These tend to be leaders in a bull market and laggards n a bear market.
Finally, I would not be buying any equities right now as VIX is this low. During periods of high volatility, which is what we have seen since late 2007, whenever VIX enters a reading of 16 or lower, it has almost always signalled that a top is closer than a bottom. I definitely expect VIX to be much higher in coming months and quarters and prices of stocks most likely lower within the same timeframe.
In summary, the current indicators I follow have not changed the underlying conditions since the last few articles I have written. Defensives still lead the charge to new highs while cyclicals continue to under-perform, which is something that we saw during July and August 2007 and July and August of 2011. Both instances lead to a downtrend over the next few months, with serious loses.

Furthermore, there is a major divergence between MSCI World Equity Index and the S&P 500. This divergence will need to be resolved soon enough, so either the World Index will play catch up on the upside or the S&P 500 will play catch up on the downside. Considering that the US equity market is a lone wolf making new 2012 highs, while the rest of the world struggles, I believe the US economy and its equity market will eventually succumb to a global slowdown (EU and China) as there will be no de-coupling.

Bond Markets
There have been some technical developments in the Treasury market which are also worth reviewing this week. As we can see in the chart above, common technical indicators like RSI and MACD have registered negative divergences with the current price action of a marginal new highs also known as a potential bull trap breakout. One could make a strong argument that Treasuries are extremely overbought.
Furthermore, a longer term chart also reveals that the Long Bond's distance away from the 200 day moving average is diverging with the price action too. All in all, these indicators suggest that the parabolic rise in the bond market is running on lower momentum right now and that at best a correction is in progress, while at worst a major top could be here. Still, technicals aside, markets do not change major trends without a proper catalyst, so the current speculation is that Draghi is about to pull out a "bazooka" to save Spain from a potential default, as its yield curve inverted only recently.

Currency Markets
There has been a lot of talk about US Dollar topping and the Euro bottoming around current levels, especially because of Draghi's comments this week. In my opinion, what we are seeing a mean reversion as sentiment on both currencies has been at either side of extreme. Furthermore, Euro has landed around the $1.20 level, which is a strong support region - so it is quite possible for the currency to recover a bit and stabilise for awhile. This can also help PMs rally too (more on that below).
Having said that, if we were to focus on a longer term picture and analyse the fundamentals, than I would have argue that the current economic slowdown around the world has most likely not yet played out in full context and therefore I think that the global central bank easing cycle has also not yet fully played out either. As global central banks continue to ease instead of hike, we should see that action benefit safe haven currencies like the US Dollar and the Japanese Yen.

Obviously, it is not to say that the Dollar cannot correct when it becomes overbought from time to time, but as long as one holds a view that China, EU and US is still slowing - and there is nothing to suggest that is changing - one should be prepared to see further easing by global central banks. On the other hand, if you think there won't be a severe recession globally and central banks have done enough for growth to become self sustainable, you should short the Dollar first thing monday morning.

Commodity Markets
Another development I have found very interesting in recent days and weeks, is the retail investor actions in the Precious Metals ETF space. The chart above shows number of Gold tonnes held in GLD ETF, as reported by SPDR iShares Trust, compared to the actual price of GLD itself. What usually occurs that the bottoms, is retail investor paid selling as we can see in June 2011, October 2011 and December 2011. Furthermore, we can notice that in recent weeks retail investors have withdrawn about 50 tonnes of Gold out of the GLD vault and yet the price of Gold seems to be forming a base from which it is breaking out on the upside. Do keep in mind that PMs are now entering a period of strong seasonality and that recent sentiment readings have been extremely negative.

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

Trading Diary
  • Watch-list: A major short in due time will be US Treasury long bonds (TLT), as they are extremely overbought and in a mist of a huge bubble mania. Other than that, not too much is on my watch list right now.
What I Am Watching

Thursday, July 26, 2012

Bernanke's Dogs

Topics Covered
  • Pavlov trained dogs, just as well as Bernanke trained investors
Weekly Overview
Nothing new to report. Refer to the side menu for previous articles.

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

Economic Data
I am not actually sure if Mr Ben Bernanke, the chairman of FOMC, has any pets including dogs. However, this article has less to do with animals and more to do with psychology. In the late 1800s, a Russian Nobel prizing winning scientist and a psychologist by the name of Ivan Pavlov was experimenting with animals, specifically dogs, on basic reflexive conditioning. It might not sound all to fancy today, due to huge advancement in human knowledge and technology, but what Mr Pavlov discovered back in late 1800s was quite a break through for his day in age and it obviously still applies today, especially in fields like financial markets where human psychology tends to be the dominant factor.
Mr Pavlov knew that a common natural response for a dog that is about to be fed was to salivate, as we can see in Fig 1 in the chart above; and furthermore he also knew that various "stimulants" like ringing of the bell or blowing of a whistle did not create the same response (Fig 2). However, what Mr Pavlov discovered back in his day, was the fact that if a stimulant was constantly introduced while the dog was fed food (Fig 3), it would be conditioned to remember that specific stimulant (Fig 4) and start salivating even without the presence of food itself. It was a huge break through back in his day. Eventually, Mr Pavlov discovered that the dogs salivated as much to a stimulant (whistle, bell, noise) as to food itself, as they were trained and conditioned to do so. For further explanation, refer to this video.

So you are probably thinking, what does this have to do with investing and the current state of financial markets?

Good question. Let us assume for the sake of this write up that Ivan Pavlov is Ben Bernanke, Pavlov's dogs are global financial investors like you and I, the bell is quantitative easing also known as QE and finally, food is actual global growth. Can you see how all of it perfectly falls into place now, especially if you look at the chart above?

The basic concept of investment is that risk assets like equities need at least decent growth to perform well. All one needs to do is look at the performance of manufacturing against stock prices, to understand that economic expansions create positive returns and economic contractions create negative returns. This is because in a growth environment companies earn profits and therefore this becomes reflected in their share price / dividend payouts. Obviously, during periods of growth (food), investors (dogs) act bullishly and buy stocks (salivate).

However, since late 2008, dogs (global investors) have become reflexively conditioned by Ivan Pavlov (Ben Bernanke) through a stimulant of bell ringing (quantitative easing or QE). Whenever Mr Bernanke even mentions the fact that he will try and stimulate the economy, global investors start buying risk assets, front running the Fed prior to their official announcement. Now let me rephrase that in another way based on the concept in this article - whenever Mr Pavlov rings the bell and pretends he will bring food out, the dog starts salivating.

Unfortunately, the dog is not smart enough to realise that bell ringing alone will not feed his empty stomach. For that food is required. One would assume global investors are smarter than dogs, but it doesn't seem to be so. Majority should know by now that money printing programs do not stimulate the economy, but mainly stimulate financial markets for a short period of time. QE has not created sustainable growth in both employment and nominal GDP, both of which resemble the slowest recovery since World War II. Therefore, without food the dog will eventually starve, no matter how many times Mr Pavlov rings his bell, or to put in in financial terms - without growth company revenues and earnings will eventually fall and mean revert during a recession, no matter how many times Mr Bernanke does another round of QE.

The reason I bring this up is because Bernanke's dogs have been in salivation for weeks on end, as rumours circulate that Mr Bernanke is about to ring the bell on QE 3. Global investors are hanging onto  hope, which is quite a famous emotion present at the beginning of bear markets and prior to recessions. Further printing of money is not going to help company earnings rise, it is not going to help profit margins expand further, it is not going to help nominal GDP expand, it is not going to help global exports volumes increase, it is not going to help the unemployment fall, it is not going to help Greece from eventually defaulting and it is not going to help Spain with its borrowing costs. Printing money will only make prices of food, energy and metals (especially the precious type) rise dramatically.

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

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

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

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

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

Trading Diary
  • Watch-list: A major short in due time will be US Treasury long bonds (TLT), as they are extremely overbought and in a mist of a huge bubble mania. Other than that, not too much is on my watch list right now.

Tuesday, July 24, 2012

Blog Poll: Gold's Next Move?

Just a quick update for all the traders out there. Gold and Silver triangle setups are compressed and coiled up as they get ready to break in either direction. As you can all see, I've uploaded a basic chart below:
So I thought it would be interesting to see what the readers of the blog think over the next several hours or days (depending on how long it takes for the break to occur). So please take time and vote in the Blog Poll regarding technical price movement and thank you in advance.

Update: poll is now closed and the results can be seen below.

Sunday, July 22, 2012

Euro Moving Lower, But "Real Money" Isn't!

Topics Covered
  • Equity market breadth warns of possible weakness ahead
  • Euro is moving lower, but "real money" isn't following
  • Spain is moving towards the edge of the cliff... again!
Weekly Overview
S&P 500 remains in a rally mode, but the bounce from early June lows has been weak. Crude Oil's rally has been somewhat stronger as it moves above $90, while Gold still remains below $1640 level. Agriculture has been a superb performer with Corn and Soybeans at new record highs and Wheat at $9.40, despite abundance of bears calling for new lows. US Dollar remains close to its 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
S&P 500 remains the only major risk asset that has made new highs in the cyclical bull market that started in March 2009. Both the DAX 30 and GEMs ETF have registered a lower high in 2012. S&Ps new high is also not confirmed by various credit spreads, risk currencies or commodities either. Global engine of growth, Asia, seems to be slowing down meaningfully. This is reflected by weakness in Commodity currencies and Asian currencies, as well as in industrial commodities like Oil and Copper. Euro is approaching June 2010 lows around $1.20. One major stand out in 2012 has been a huge movement on the upside in Agriculture prices, with Corn and Soybeans making all time record highs.

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

Equity Markets
I recently focused on the US equity market with a post titled Equity Market Topping where I argued various points of why I think that we are approaching a bear market. I highly recommend reading that post, which was written close to the beginning of this month, before you continue with the current post. All I would like to do is offer an update on the equity market right now, especially the non-confirmations and the health of internals.
Firstly, I want to focus on the Dow Theory. I currently see a major non-confirmation between Dow Transports and Dow Industrials as well as a recent minor non-confirmation in the recent rally out of the June lows. While the minor divergence could be a reason to expect further short term selling, the major divergence could be a reason to expect the beginning of a new bear market. Since Dow Jones Transportation Index is more economically sensitive, I tend to always listen to its message much more. It is for this reason that I find it very interesting on how these economically sensitive stocks have not registered any new highs in 2012 relative to their price in June 2011. Technically speaking, Dow Transports could break down as early as next week, so do stay alert.
Secondly, the focus turns to internals of the S&P itself. The index finished the week higher and is now less than 4% below its bull market high. And yet, despite such "positive price action" as many media reports state, I look at the internals of the market in a very worrying way. The chart above shows that despite being close to new highs, less than 60% of the stocks within the S&P 500 are currently trading above their 200 day moving average. Furthermore, majority of those who are above their 200 MAs are of defensive nature and mainly in the Utilities, Telecom, Health Care or Staples sectors. On top of that, if you think this is the only indicator acting bearish, also consider the Bullish Percent Index. It is a completely different measure of internal breadth strength and yet it also tells a similar story.
Thirdly, internals through the individual sectors are also breaking down. There are now less and less sectors helping the S&P 500 reach new highs. Four out of the nine major S&P sectors have not made new 52 week highs in the current cyclical bull market since March 2009. These are Financials, Industrials, Energy & Materials. Even more important is the fact that other cyclical sectors like Technology and Discretionary have started under-performing S&P 500 in a serious manner. The honest truth is, majority of S&P's recent strength has come about from a super strong rise in the defensive sectors as investors chase risk averse high yielding assets (also seen in Treasuries, Corporate Bonds and Emerging Market Bonds).

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

Currency Markets
One price action that I have found very interesting as of late is the relationship between the Dollar, the Euro and PMs like Gold & Silver. The chart to the left shows exactly what I am talking about. Consider the following: Euro topped in May 2011 together with Silver, as both suffered their first major sell off. Afterwards, all three assets experienced an intermediate top again in early September 2011 and suffered another major sell off. Supports were reached, where Euro hit $1.32, Gold hit $1,530 and Silver hit $26. Moving along, we can see yet another intermediate top in early November 2011, followed by yet another major sell off into late December 2011 lows.

Once again supports were reached where Gold and Silver held their $1,530 and $26 lines in the sand. However, the Euro fell lower into $1.26. Relative strength was beginning to show, but it was still early days. LTRO #2 occurred at the end of February 2012 just as majority of risk assets topped. Gold, Silver and the Euro all sold off together. Support levels were reached once again with $1,530 and $26 still holding for Gold and Silver, while the Euro made yet another lower low into $1.23 by early June 2012. Majority of risk assets bottomed around this time, including the S&P 500. However, Euro is once again making more lower low into $1.21, while Gold and Silver still refuse to confirm the Dollar strength by holding major supports. Relative strength is definitely becoming more evident now.


So the question is, despite continuous Dollar strength against the Euro, can Gold and Silver reverse their recent misfortunes? While it is difficult to answer this question with a Yes or a No, as I personally do not have the skills to predict the future, what I see currently is the fact that investors are treating "real money" in a different manner relative to the relationship between the Euro and the Dollar. And considering that Euro sentiment is rather extremely negative and approaching major support level last seen in June 2010, a case could be made that as soon the EU currency stabilises even slightly, PMs could surprise on the upside. However, a major risk event, like a default coming out of the EU, will most likely render PMs outperformance useless as majority of assets tend to go down in a panic.

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

Credit Markets
This panic could definitely come out of the Eurozone, as the credit situation is not improving right now. Some quick charts on Spain revile that the 2 Yr yields are rising vertically again. Interest paid on short term notes is usually the best measure of countries ability to finance itself and a good measure of default risk. LTRO #1 calmed worries in November 2011 when Italy and Spain were falling of a cliff. The can was kicked down the road. However, here we are again, with Spain at the central focus. Spanish 10 Yr yields are also rising to new highs again, above the 7% line in the sand.
Furthermore, the spreads between those bonds and German Bunds of same maturity are also reaching Eurozone historical records as we can see in the chart above. Credit Default Swaps on Spanish debt aren't too far off their record highs either. Every can kicking event has not stopped the rise in government debt risk coming out of the EU, and in my opinion, has only post pond the inevitable: bond haircuts / defaults of some type. There is a real fear going on out there that Spain or Italy could turn into another Greece times ten. Further to that, capital outflows (bank run) are now in full flight out of Spain, which must be serious concern for the politicians and completely undermines confidence in the overall stability of the major Eurozone members.


Trading Diary Update
What I Am Watching

Wednesday, July 18, 2012

A Boy Who Cried Wolf

Topics Covered
  • Global economy seems to be playing "boy who cried wolf"
  • Fund manager try to predict further Fed stimulus measures
Weekly Overview
S&P 500 remains in a rally mode, but the bounce from early June lows has been very weak. Major commodities have found resistance levels with Crude at $90 and Gold at $1640. Agriculture has been a superb performer with Corn and Soybeans at new records and Wheat at $9, despite abundance of bears calling for new lows. US Dollar remains close to its 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
Global economy continues to slow. At the start of the month JP Morgan's Global Manufacturing PMI was sitting at 50.3 but I am pretty sure in a two weeks from now (when the new report comes) the reading will be showing a contraction for the first time since 2009. Furthermore, the Global PMI has now given us a negative signal with its 3 month moving average. This builds a case that the global economy is potentially entering a serious slowdown.
When we look at the Developed World economies, my main focus tends to be on the US and Germany. US leading indicator, constructed by the ECRI, remains below the 2 year moving average. The indicator also shows that the economic fundamentals are not confirming the new highs in the stock market earlier this year and furthermore, it is obvious that each central bank stimulus program has created less and less effect. This builds a case that the US economy is failing to reach "escape velocity" necessary to create a self-sustaining expansion.

In Germany, business conditions continue to deteriorate as ZEW report showed yesterday. On top of that, the awfully large Industrial Production drop within a single month, usually tends to signal the beginning of an economic contraction (unless caused by a natural disaster). Rest of the Eurozone is pretty much in a recession already, so no need for us to discuss that once again.

So why aren't investors in full panic mode?

Well majority are clinging onto Bernanke's every word in the hope of further stimulus and another short term sugar rush. More importantly, majority also do not believe we are actually sliding into a global recession, despite Europe. There seems to be optimism that de-coupling is possible. Many economists are constantly appearing on Bloomberg and CNBC telling us that current data does not point to a US recession. Many internet blogs are filled with articles of charts trying to explain why we aren't in a recession. This type of thinking approach is a trained habit thanks to the markets false scares of the past. It comes from the fact that this is now a third soft patch since the recession ended in 2009 and majority were wrong in predicting recessions in the first two. Let me explain.
As we can see in the chart above, the first one occurred in the summer of 2010. Majority feared a Double Dip was about to occur, Greece was front page news everywhere and the Euro was falling off a cliff. But eventually, EU bailed out Greece, Bernanke did a QE2 and all was well. The second soft patch occurred in the late summer months of 2011. Global manufacturing stalled due to the Japanese earthquake, US credit rating was downgraded, Italy was front page news everywhere and rumours were circulating that a major EU bank was about to default. Once again, we were saved by Mr Draghi and his LTRO banking program and Bernanke's Operation Twist.

It is important to note that investors realised the economic scares were just that and nothing more. Furthermore, majority understood that both of those short term panics were buying opportunity in the current cyclical bull market and personally, they have been shaken out. Fast forward to today's sell off. Presently investors seem complacent, as if they refuse to be shaken out again. They seem to be thinking we are repeating 2010 and 2011 buying opportunity. I would argue this is due to greed. I personally believe that majority missed entry points in August 2010 and October 2011 and are sick of the market's wolf cries. However, this time investors might just pay the price if the economy really turns for the worse. The third soft patch seems to be much worse than the first two and the reason why is Asia.
As Europe is already in a recession and US is just muddling long, Asia has been the main global growth engine since the recovery started in 2009. However, it seems now that China and Asia as a whole is slowing down meaningfully. The chart above shows that unlike previous soft patches, the current one has Asia participating too. Citigroup Economic Surprise Index for Emerging Markets  shows that Asian and Latin American economic data is surprising to the downside by the most since 2009. Furthermore, Industrial Production in the overall Emerging World has been slowing since the middle of 2011. It is worth stating that in recent months, Chinese IP has totally collapsed on relative basis towards similar levels last seen in 2008 and electricity production is also below average. Therefore, I am not so sure that this time around we will follow the same script as in 2010 and 2011. This time, the wolf could actually be around the corner.

Equity Markets
Merrill Lynch Global Fund Managers Survey was released yesterday. Apart from the regular data that it prints, this time around there was a heavy focus on central bank stimulus questions. In the first chart above, I found it interesting that over 50% or the majority of fund managers think Fed's next QE program will come in Q3 or Q4 of this year. Dead smack right in the middle of US elections? Hmmm... somehow I'm finding that hard to believe.
More importantly, the next question revolved around the price level of stock market and further stimulus measures. As we can see above, the average price level of S&P 500 that fund managers think needs to be reached before Fed starts QE again is around 1150. Considering that equity markets  are only about 4% away from their highs, we might be in store for a large capitulation drop, before Ben acts. Let us not fogey that the internal market breadth is remarkably weak for an index that is only a few percent away from its recent peak.

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

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

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

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

Trading Diary Update
  • Watch-list: On the long side, commodities still remain on my watch list as they are extremely oversold. At this point I see the most value in the Precious Metals (CEF, SLV, PSLV) and Agriculture (RJA / MOS) sectors. 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) as a potential short. Finally, a major short in due time will be US Treasury long bonds (TLT), as they are extremely overbought.
What I Am Watching

Tuesday, July 17, 2012

Off Topic

I've added a new page on the blog called Blog Charts. It is pretty much a basic selection of important indicators I tend to follow from week to week, and from month to month. Obviously there are many, but for now, I've just included these basic ones.

So far I've included charts that focus on sentiment, credit spreads, financial stress, volatility, asset performance, economic data, leading indicators, inflation, corporate profits etc. I will be updating the page few times a month, I guess. It all depends on my work load. All feedback is appreciated so leave some comments in regards to what else you want to see on the page (or what you want removed).

Finally, all eyes will be on Bernanke this morning in the US. I will be watching closely to see if the "money printing king" will give us any hints towards further stimulus in the shape of balance sheet expansion (QE3). In recent weeks retail sales have fallen once again (three straight months now), non-farm payrolls remain relatively weak month after month and manufacturing PMI has contracted for the first time since 2009.

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Furthermore, since Off Topic posts are meant to try and bring at least a bit of humour to this whole finance thing, let me post a video which was sent to me by a friend. It definitely made me laugh!

Friday, July 13, 2012

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).
  • 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

Thursday, July 12, 2012

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).
  • 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