Where Are The Bears?

Note: Market notes and leading economic data will not be not updated in this post. Since I am specifically updating equity sentiment in-depth, there is no real need to update other matters until the next post. Nothing dramatic will change from today until later on in the week.

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It has now been about a year since I did a major sentiment post on the equity market. Back in late September and early October of 2011, I was insisting that if I had to choose between equities, bonds or cash - I would have chosen to buy equities. While there was the possibility of a recession, personally I remained in the camp that we would not experience negative GDP quarters until later on in the cycle. It is very important to remember that back in late September 2011, market conditions were one of forced liquidation, very elevated volatility; extremely negative sentiment surveys; large hedge funds losses; very high levels of institutional cash; extreme put buying; total panic in fund outflows and finally corporate insiders who are considered to be smart money were scooping up bargains at the fastest pace since the March 2009 bottom.

Nothing stays the same for a long period of time and just as everything in life always changes, so do market conditions. It is amazing what a year can do. Fast forward to September of 2012 and the US equity market was recently up 30% on annualised basis, as we can see from the chart below. If you think that is quite an amazing performance within a 12 month period - mind you on the back of global economic deterioration - you should have a sneak peak at the German DAX 30. Within just 12 months, the DAX 30 has managed to rally from below 5,000 towards almost 7,500 - an astonishing 50% gain. The DAX 30 has only ever performed better coming out of a recession or during the stock mania of the late 1990s.

Both of these charts now signal that we are most likely at an intermediate top of some kind. Keep in mind that strong performance coming out of a recession, seen in 2003 and 2009, is quite normal post a major bear market. Having said that, when the bull market ages towards its 3rd or even 4th year, powerful performance like the one we have witnessed over the last 12 months - while fundamentals deteriorate - is more closely linked to speculation and signal that a more significant top could be in place. Away from the performance indicators, let me put forward a write up which paints the completely opposite picture to the one we saw in September and October of 2011.

Off Topic: Is Apple The Biggest Mania Of Our Lifetime?

I haven't done an Off Topic post in awhile, so I thought it might be appropriate to do one regarding what occurred in Australia this week. As you probably know by now, Apple launched its iPhone 5 globally and Australia was the first place to officially start selling it (due to the timezone). The video above is from George Street in Sydney, where I used to live several years ago. I am totally stunned at the whole footage.

The question I would like to discuss is whether or not you guys believe Apple is a real mania? To me, this whole thing is totally ludicrous. Absolutely absurd. Maybe it is just me, but when I view the way everyone has gone totally mad, with frenzy and euphoria, about these telephones... yes, that is all they are, just telephones (we haven't yet cured cancer or reached world peace)... I think that the obsession society currently has towards Apple, which is discussed daily on all news channels and hourly on fiannce news channels regarding where its share price trades, is similar to the obsession society once experienced back during the Tulip Bubble.

As a disclosure, I would like to inform all that I am short Apple stock with Out of Money (OTM) put options that are long dated quite a few quarters out from here. Majority of experts on financial networks like CNBC and Bloomberg have prices targets from $750 to $1650, so they clearly seems to think Apple is still amazingly cheap. After all, what do I know? I still own iPhone 4 and iPad 2...

Precious Metals Update - Part II

Market Notes

• SNB currency peg, Fed's ZIRP & Twist, ECB's LTRO, Chinese Repurchase Operations, ECB's "whatever it takes" Bond Plan and finally Bernanke's QE∞. These types of interventions have completely crushed the VIX since it's last spike in August 2011. With the VIX  left nowhere to go but up, Merrill Lynch claims that US Yield Curve tends to predict what it could do next.

• Various equity sentiment surveys continue to uptick towards extreme bullish levels. These include the Investor Intelligence survey, Consensus survey, NAAIM survey and Hulbert Stock survey. However, the one that really stands out from the bullish perspective is the Market Vane survey, which last week recorded the highest level of bullishness since the 2007 market peak.

• Even though I have updated it few times already, it is still important to follow the non-confirmtion coming from the Dow Theory, with the Transports currently down 5% this week despite QEuphoria. Major components of the Transports are breaking down in price action due to  deteriorating fundamentals. These include; FedEx, UPS, Norfolk Southern and CSX amongst others.

• While low Treasury yields are the main point of discussion these days, it is actually the riskier Emerging Market bonds that represent the dangerously overbought technical picture. GEM bonds have grossly outperformed their equity counter parts by a wide margin over the last two decades, while fund inflows are reaching record high exuberance. You've been warned!

• Draghi's "whatever it takes" bond buying plan, followed by Bernanke's QE∞ and ZIRP until mid 2015 was a one-two punch that knocked the wind out of the US Dollar uptrend. From a technical perspective, the uptrend line has been broken and the price has recently fallen to the major support level. With sentiment extremely low and the price levels oversold, a counter trend rally is in progress.

• Last Friday's Commitment of Traders report by CFTC showed that risk taking continues to stay at extreme levels. Hedge funds and other speculators are holding close to record net longs on high beta risk assets, with Crude Oil @ 250,000 net longs, Commodity Currencies @ $19 billion net longs and Nasdaq 100 (mini) @ 145,000 net longs. Crude has now began unwinding those bets!

Big Picture

The last few weeks has seen central bank intervention promises push risk assets out of oversold levels. The Euro has experienced a 10 cent rally from its previous bottom around $1.20 while Copper is attempting to break above its 200 MA on a sustainable basis. The Emerging Markets, saviour of global growth in the post Lehman recovery, continue to lag other equity indices indicating that not all is well with the BRICs. Currencies and precious metals have technically broken out to the upside on the news of QE∞, but the real test will come as volatility returns to global risk assets and whether the US Dollar starts to rally again. Most importantly, one major pocket of weakness is the Crude Oil correction unfolding this week, down by over 8%.

Leading Indicators

The trend with the Citigroup Economic Surprise Indices remains similar to previous weeks, as we continue to see a mean reversion. Essentially, the majority of global economic data continues to surprise economist's expectations to the upside, but the overall economic activity is nothing to write home about. Let us focus on the main three economies, as we always do: US, Eurozone and China.

Chinese Flash PMI numbers released this morning in Asia, continue to show that Asia's largest economy is still in a manufacturing contraction mode. One of the key takeaways from the preliminary reading is the fact that the Output Index came in at a 10 month low. Interestingly, all subcomponents are contracting apart from Finished Goods, which indicates inventories continue to build as exports weaken due to falling global demand. Commenting on the Flash China Manufacturing PMI survey, Hongbin Qu, Chief Economist said:

“China’s manufacturing growth is still slowing, but the pace of slowdown is stabilising. Manufacturing activities remain lacklustre, thanks to weak new business flows and a longer than expected destocking process. And this is adding more pressures to the labour market and has prompted Beijing to step up easing over the past weeks. The recent easing measures should be working to lead to a modest improvement from 4Q onwards.”

Sticking with China, it was interesting to see electricity output increased only slightly by 2.7% year on year in August. Thermal power output continued to contract as readings decreased by 6.3% year on year in August, worse than –4.5% yoy in July. Current weakness is offset by hydroelectric power output. The chart above, showing a 3 month moving averages, indicates that Chinese economy is at stall speed at present.

Eurozone Flash PMI numbers released today continue to show a deterioration in the manufacturing cycle, which does not bode well for the economy overall. PMI readings have now come in at their lowest levels since June 2009, with France and the Rest of the Eurozone leading the way lower. Commenting on the flash PMI data, Chris Williamson said:

“The Eurozone downturn gathered further momentum in September, suggesting that the region suffered the worst quarter for three years. The flash PMI is consistent with GDP contracting by 0.6% in the third quarter and sending the region back into a technical recession."

Continued weakness across Europe is being confirmed by other indicators, like ZEW German Investor Sentiment, which shows conditions are now reaching their lowest levels in two years. Interestingly enough, as central banks inject the heroin addicts with another dosage of stimulus, the DAX 30 has completely disconnected from fundamental reality.

Moving along to United States, last night's Philly Fed Index contracted for the fifth month in a row, but at a much slower pace of -1.9 from the previous months contraction of -7.1. The three month moving average seen in the chart above has made a lower low, while the S&P 500 has recently made another higher high. A disconnect between the price action and fundamentals like we can see in the chart above, tend to be warning signals many market participants disregard. In the meantime, it is also important to note that the Empire State Manufacturing Index disappointed earlier in the week and alongside the Philly Fed most likely confirms that US manufacturing will keep contracting for the fourth straight quarter in a row.

One of the better indicators tracking consumer spending is the US Restaurant Performance Index. As we can see in the chart above, recent data showed a huge drop in performance. It should be well noted that the Restaurant Performance Index has a high correlation with the US GDP readings. Having said that, consumer spending isn't the only indicator pointing to a weak GDP print. Economic bellwether companies like FedEx are in the midst of a serious slowdown, with a large contraction in its shipments also pointing to broad economic weakness.

It has been awhile since we had a look what the US Jobless Claims are doing. The recent two prints came in at 382,000 today and 385,000 last week. The four week moving average, which I prefer to use as it removes volatility, currently stands at 377,750 which is the highest reading since early July. The chart below shows that for months Jobless Claims have trended sideways, while the stock market has  moved towards higher highs. 

Finally, from the long term point of view, I constantly hear how the equity market is climbing a wall of worry. I would like to remind investors that the wall of worry existed in its full force around early 2009, when the Jobless Claims 4 week moving average was above 600,000. Today at 378,000 we have seen a dramatic improvement in Jobless Claims and investors are acting like there isn't too much to be worried about.

Precious Metals Update - Part I

Market Notes

• The Investor Intelligence survey tracking newsletter advisors, tends to be a good contrarian indicator. This week's readings came in at 51% bulls, 25% bears and 24% neutrals. We are witnessing a prolonged period of low bearish sentiment, that strikes high similarities leading up to the 2008 bear market, 2010 flash crash and 2011 stock market crash. Where are the bears?

• German retail exposure to equities is now at the highest level since 2007 (alarm bells). At the same time, the DAX 30 is rising vertically in recent weeks as performance reaches a remarkable return of 25% year to date and 45% annualised. If you consider that historically over the last 160 years, US equities have returned 6.2% annualised, you will realise the DAX is extremely overbought.

• Bill Gross of PIMCO, a well respected bond investor, last month cut his Treasury Bond holdings to 21 percent from 33 percent in expectation of further reflationary policies (QE) by the Federal Reserve. Mr Gross stated that “QEs lower real interest rates and raise nominal rates because their intent is to reflate.” Will Mr Gross be right in picking a Bond top?

• The US Dollar has been in an uptrend for more than a year, as it initially bottomed in early May 2011. Recent technical action shows that the bull market has weakened as the price broke below the trend line as well as the 200 MA. Having said that, sentiment on the Dollar has recently turned bearish and the price trades over 2 SDs into oversold territory. The Dollar could now rebound somewhat.

• Current Merrill Lynch Credit Spreads show remarkable calmness in the financial markets. However, it is important to note that spreads are at more elevated levels relative to the good old 2004 - 2007 days, when the global economy was in the midst of a credit boom. While many market pundits believe Europe has turned a corner, I believe it is the calm before the storm...

Big Picture

The last two weeks has seen central bank intervention promises pushing risk assets out of oversold levels. The Euro has experienced a 9 cent rally from its previous bottom around $1.20. Copper, which tends to be an industrial economic indicator, is attempting to break above its 200 MA. However, Copper is far away from confirming the S&P's new highs in 2012. The Emerging Markets, saviour of global growth in the post Lehman recovery, continue to lag other equity indices indicating that not all is well with the BRICs. Currencies and precious metals have technically broken out to the upside, but the real test will come as volatility returns to global risk assets and whether the US Dollar starts to rally again. Finally, the DAX is now moving almost vertically like a NASA rocket, which usually does not end well.

Leading Indicators

OECD's leading economic indicator data was released today. OCED press release writes that:

"...the loss of momentum is likely to persist in the coming quarters in most major OECD and non-OECD economies. In Italy, China, India and Russia the CLIs continue to point to a slowdown. For the Euro Area, France, and Germany the CLIs point to continued weak growth. The CLIs for Japan and the United States show signs of moderating growth above trend, while in Canada the CLI continues to point to growth moderating below trend. The CLIs for the United Kingdom and Brazil tentatively point to a pick-up in growth, but remain below trend. The OECD Development Centre's Asian Business Cycle Indicators (ABCIs) suggest that ASEAN economies show overall resilience, though some signs of weakening are observed."

Two out of the big three economies (EU and China) have already been in contraction mode and it seems to me that the US in now slowly being affected. Furthermore, the world's third largest economy, Japan, seems to be slowly rather rapidly, especially as its exports to China (largest export market) drop off rather aggressively. Germany is also another major worry, as the contraction accelerates. After looking at the recent OECD data, the million dollar question is - how long can the US economy de-couple for? Bulls say de-coupling is possible as long as the EU situation stays relatively calm, while bear say that de-coupling is wishful thinking, last heard in early 2008 prior to a global recession.

Moving along, Merrill Lynch's Global Wave indicator continues to contract, signalling that the global economy is headed for a contraction. For those not similar with the index, the components include Global Industrial Production, Global Consumer Confidence, Global Capacity Utilisation, Global Unemployment, Global Producer Prices, Global Credit Spreads and Global Earnings Revision Ratio (one of my favourite indicators). Merrill Lynch summarises the recent data by stating:

"The Global Wave fell again this month as macro data deteriorated globally. Six of the seven components are now weakening. The most significant moves were falls in the Global Earnings Revision Ratio and Global Industrial Confidence. It is an amalgamation of measures of output, demand, productivity, the labour market, manufacturing prices, credit spreads and earnings expectations."

Global Wave indicator tends to lead the unemployment picture by a few months, so the recent weakness in growth could eventually spill into corporate layoffs. If that was to occur in the coming quarters, consumer spending would diminish substantially and most likely send the global economy into a synchronised recession.

Finally, it has been awhile since we looked at the ECRI leading economic data (published last Friday). ECRI Growth Index has risen from -3.5% towards +1% over the last couple of months. 

While the short term trend still remains positive for now, the ECRI Weekly Index is failing to make new highs and rise above the 2 year moving average. Furthermore, the chart above speaks of a bearish divergence between new highs in stocks which has not yet been confirmed by the ECRI Growth Rate. This could signal trouble ahead.

Manufacturing Slowdown Intensifying

Market Notes

• S&P 500 has broken out to a 4 year high. Is it another trap? Dow Theory did not confirm the break out and neither did the Dow Jones on its own. The broadest measure of US stocks, the NYSE Composite Index, is quite far below its May 2011 high and also not confirming a breakout. All charts thanks to Acting Man blog.

• In 1982, a famous Time magazine cover titled "Interest Rate Anguish" portrayed the mood of the time. Paul Volcker was fighting rampant inflation with Long Bond rates as high as 14%. Over 30 years later (in sync with the Kondratiev Wave), the rates on the Long Bond are now down to 2.8% with a technical divergence giving us a sell signal. Is this the final bottom for rates?

• Euro has broken its technical downtrend this week and now finds itself testing the 200 day moving average. The move has been linked to Draghi's promises (without any action) that has driven a huge short covering rally for several weeks now. Bearish bets on the Euro have been reduced by over 50% from 214,418 contracts in June to 102,306 contracts as of Tuesday.

• Unlike the much loved US equities, one of the most hated and worst performing assets in the last 12 months has been Coffee (down over 40%). The recent COT report showed that hedge funds now hold the largest net short position in the Coffee market since 2004, when the price was below 70 cents. Bearish hedge fund positions usually present opportunities, so is this time different?

Big Picture

A week full of central bank intervention promises has pushed risk assets out of oversold levels. Euro has experienced a 7 cent rally from its previous bottom around $1.20. Copper, which tends to be an industrial economic indicator, is attempting to break above its 200 MA. However, Copper is far away from confirming the S&P's new highs in 2012. The Emerging Markets, saviour of global growth in the post Lehman recovery, continue to lag other equity indices indicating that not all is well with the BRICs. Currencies and precious metals have technically broken out to the upside, but the real test will come as volatility of global risk assets rise and if the US Dollar starts to rally again. Finally, the DAX is now moving almost vertically like a NASA rocket!

Checking The Pulse Of Mr Market

Market Notes

• As I write this, there is a major battle taking place between bulls and bears in the marketplace. Physiological resistance levels of the Dow @ 13,000 and S&P @ 1,400 are now critical areas of play. Both indices have failed to close above these important levels two times already, so the question is whether or not bulls can push higher for a third time or are we in for a bull trap?

• As the Dow Theory continues to diverge, yesterday we saw critical Transportation components break down (FedEx & UPS). Industrial stocks continue to outperform as the US remains a safe haven. On the other hand, Transportation stocks are suffering as the global economy weakens and earnings disappoint. Dow Transports is now approaching a technical make or break decision.

• A recent Bloomberg chart of the day portrayed the credit markets in relative calmness. The chart explains that "measures showing US financial market conditions have improved". A similar occurrence was seen last year, during the summer break, until credit risk started rising due to the European Crisis intensifying. With nothing solved in Europe, is this time different?

• The Australian Dollar, a great risk barometer and a Chinese proxy, finds itself at a six week low. Fundamentally, we should all know the story of a weakening Chinese economy and the falling demand in industrial metals, including Iron Ore. Technically, the Aussie is now below the 200 day moving average as it just printed the second lower high in a row.

• To say that industrial metals have been under-performing lately would be an understatement. The fact is that the majority of these economically sensitive commodities have been selling off as the  Chinese economy slows meaningfully. There is only one industrial metal that still holds its support, as it gets ready for a technical make or break decision, and that is Dr Copper. Keep your eye on this one!

Big Picture

A lot more of the same as major global assets remain in consolidation patterns. Industrial economic barometers like Copper and Crude Oil are failing to rise above their 200 day MA and more importantly are not confirming the S&P 500's new highs in 2012. The Emerging Markets, saviour of global growth in the post Lehman recovery, also continue to lag other equity indices indicating that not all is well with the BRICs (GEMs also below 200 MA). Finally, Gold, Silver and Platinum have technically broken out to the upside, but the real test will come as volatility of global risk assets rise and if the US Dollar starts to rally again.

Leading Indicators

Due to a short week, I'll be updating majority of economic data on the weekend, including the Global Manufacturing PMIs making headlines in recent days.