Japanese Yen To Surprise Bears

Market Notes

Source: FinViz

• It is my opinion that there isn't much value anywhere in the financial market environment today. However, one asset class that remains out of favour with investors are Soft commodities such as Coffee, Cotton and Sugar with price currently down between 26% to 32% from a year ago. Furthermore, Soft prices are down even more from their peak in February and March of 2011. Most retail investors have given up on these assets, while technician traders are calling charts "ugly", "awful", "value traps" etc. This is all happening as investment banking analysts forecast large surpluses for 2013 and hedge funds continue to add short positions. When everyone is thinking the same way, the majority of the time no one is doing any thinking at all. My opinion is that those willing to go against the grain by investing today, will find handsome returns in their portfolios in a few quarters to a year or two.

Source: Morgan Stanley

• We are witnessing the first wave of meaningful earnings downgrades since the Financial Crisis as the slowdown starts affecting profit margins, revenues and earnings of global corporations. The Morgan Stanley research team forecasts a 14% drop in Shanghai Composite earnings, 12% drop in Euro Stoxx 50 earnings, 8% drop in MSCI Emerging Markets earnings and finally only a 1% drop in the S&P 500 earnings. Only a 1% drop in the US? Is this a 2008 deja vu moment with the famous buzz phrase "de-coupling" all over again? With the current disappointment mainly skewed towards China and Eurozone, it should come as no surprise that Shanghai Composite has had a disaster of a run, while US equities have significantly outperformed EU & GEMs over the last several quarters. My personal opinion is that US equities are overvalued right now (on both a nominal and relative basis) and even though the majority of hot-shot ace analysts state that the P/E multiple is historically low, where they will go wrong is with the "E" component. In other words, I expect US earnings to be downgraded rather swiftly in the up-and-coming 2013/14 rescission, bringing the "P" component down with it.

Source: Short Side Of Long

• Despite continuous selling of US equities over the last few weeks, especially in the Nasdaq index, it is very surprising to see only one major sector (Energy) currently oversold in the short term. No sectors are oversold in the medium or long term, but alarmingly we now have the majority of sectors in a downtrend from the medium term perspective. With the S&P only a few percent from the bull market highs, it is also worrying to see long term 200 day MA weak participation from leading cyclical sectors such as Semiconductors and Technology. Remember, it was Technology that led us out of the March 09 lows with a powerful performance, so could it lead us into 2013 with a bear market disappointment? Furthermore, economically sensitive small caps also look quite weak too. Finally, gold bugs should be pleased to see that PMs miners have the strongest long term participation, with 85% of stocks within the sector trading above the 200 day moving average. Those that follow the blog closely should remember that only several weeks ago, Gold Miners were largely out of favour with investors.

Sugar Bottom Is Approaching

Market Notes

Source: Short Side Of Long

• The Global economy continues to slow month after month and the corporate manufacturing powerhouses out of Germany are definitely feeling it with the deteriorating world trade market. Recent sentiment readings out of Germany, tracked by the Ifo Business Climate Index, show industry and trade fell for the sixth month in a row. The survey was quoted saying that "clouds over the German economy are darkening" as the majority of CEOs now think we are on the edge of a recession, according to the business cycle update. Interestingly, the business expectations sub index, which is a leading indicator of the survey, is now in contraction for the first time since September 2009. At the same time German manufacturing is already in a recession, while the services sector still holds the economy together (charts here). But for how long?

 Source: Short Side Of Long

• Financial stress, according to the St Louis Fed's Financial Stress Index, has now returned to calm neutral conditions (read more on the index here). While bulls are holding hands and singing "Kumbaya... Europe is saved," I personally disagree (it seems that I always disagree). During periods of turmoil and secular de-leverging, whenever financial stress conditions have returned back to neutral levels, this has almost always been a contrarian sell signal. To understand this indicator better, one has to grasp the underlying fundamental economic conditions, which were positive from 1995 to 1998 and from 2004 to 2007; the same conditions were negative between 1999-2002 and from 2008 to the present. In my opinion, can kicking has bought politicians enough time to get re-elected, but you cannot solve a debt crisis with more bailouts funded by debt. The climax of the EU crisis is still ahead...

Source: Short Side Of Long

• Recent data from the New York Stock Exchange showed that margin debt increased to $315.11 billion in the month of September, from the previous readings of $286.62 billion in August. In other words leveraged hedge fund exposure to the US stock market rose over 10% month on month and well over 20% year on year. This fact completely dismisses constant buzz-phrases like "head funds are extremely underinvested", "plenty of cash on the sidelines" and "the market is up this year, but no one is invested" used by perma-bulls everywhere, including CNBC's Bob Pisani, who has used those phrases well over a hundred times by my calculations between late August and early September. The reading above shows that hedge fund leveraged exposure and speculation within the stock market remains extremely high, only second to readings seen in 2007.

Which Assets Will Benefit From QE?

Market Notes

Source: StockCharts / Short Side Of Long

• Equity market internals continue to deteriorate, especially in the Technology sector, which transitionally has had leading characteristics. Last night we saw that Google broke down due to disappointment in revenues and earnings. Other major components that have been struggling as of late include all the big names like Apple, Microsoft, IBM, Intel, Amazon, AMD, HP, Dell and many others. Percentage of stocks within the Nasdaq 100 index that are above 50 MA stand at 42%, while those above 200 MA stand at 52%. Breadth has been narrowing at each intermediate peak, which is a major warning signal that the bull market end is very close. Furthermore, the economically sensitive Semiconductor sector has now broken below its 200 day MA once again.

Source: SentimenTrader / Short Side Of Long

• If it wasn't already bad enough that economic growth was at stall speed; margin & revenue conditions are starting to deteriorate; also volatility & sentiment is at very complacent levels, stock market investors have another headwind to deal with. Various sentiment surveys on safe haven currencies like the US Dollar (not shown here) and Japanese Yen (chart above) show high levels of pessimism. Historically, S&P 500 has struggled every time traders and investors turned negative on the Japanese Yen. Will this time be different? Disclosure: I've purchased long dated OTM calls on the Yen.

Source: Short Side Of Long

• Nymex heating Oil prices tend to hold a very close correlation relationship with North Sea Ice Brent Crude Oil prices. Therefore, it does make sense to track hedge fund positioning in the Heating Oil market to try and determine the confidence of investors. The chart above shows that hedge funds betting on energy, extended their bullish bets to the highest level since the February 2011 (Libyan Crisis), just as Heating Oil and Brent Crude were topping. Even more importantly, small speculative COT positions (not shown here), which tend to be known as Dumb Money, have now risen to the highest bullish level in at least a decade. Only a few weeks ago, I was warning about excessive speculation in the Nymex West Texas Crude Oil market. Price has lost over 10% since then.

Source: Financial Times

• If the Facebook Mania IPO wasn't enough of a signal that we are at the top of the bull market, consider the following. It has come to my attention that a plan to construct the world's tallest building will take place in China next year. Furthermore London is planning to construct Western Europe's tallest building around the same time. Those not familiar with the curse of skyscrapers and business cycles, should give it a read here. Basically, research has shown that the "world's tallest buildings have risen on the eve of economic downturns. Business cycles and skyscraper construction correlate in such a way that investment in skyscrapers peaks when cyclical growth is exhausted and the economy is ready for recession."

Understanding The Bond Bubble

Market Notes

Source: Short Side Of Long

• The chart above shows the S&P 500 together with an indicator I call Weekly Internals. Basically it tracks the direction of the NYSE breadth and volume readings over five trading days or one week. Readings above 70% (inverse on the chart) tend to signal short term wash out. With the recent S&P decline of about 3%, many have proclaimed that the correction is over. However, according to the Weekly Internals, the stock market is not even remotely close to being oversold over the short term, let alone long term oversold. While this does not tell us the future direction of the market, it disregards the notion that the market is ripe for a rebound based on technical merits alone, as many pundits on CNBC would have us believe.

Source: Short Side Of Long

• The recent consumer data from the University of Michigan showed that confidence has now reached a five year high. Economists, investment bankers, strategists and advisors all claim that this is a very bullish signal. I disagree. This is actually a contrarian signal to sell. First, I wouldn't invest in stocks when consumer confidence is at five year highs, but rather when it reaches five year lows. Second, one should notice that the public is almost always wrong near major stock market turning points. Third, the current secular trend for consumer confidence is still negative since the bear market started in March 2000 and it will most likely continue to trend downwards until the middle of the decade.

Source: Short Side Of Long

• The recent CFTC Commitment of Traders report showed that hedge funds and other speculators increased bearish bets against Cotton, with the largest net short positioning since the middle of 2007. Such bearish conditions must have at least something to do with Cotton world inventory estimates being raised yet again by the recent report by the USDA. As a matter of fact, Commonwealth Bank of Australia commodities analyst Luke Mathews termed Cotton's stocks-to-use ratio as "staggering". Another investment bank analyst stated that he was "amazed" with Cotton's price resilience, saying that: "I am perplexed. We keep thinking the market ought to take a tumble to about the low-50s cents a pound." Despite such negative supply news, the price is failing to make a new low. Why, when the conditions are so bad? It was Marc Faber who first taught me that when the price of an asset fails to make a new low on unfavourable news, it could be starting to price in more favourable conditions. The inverse is true for an asset that fails to make a new high, under very favourable conditions.

Source: Merrill Lynch Newsletter

• Many of you already know that I have shorted Apple with long dated Puts at the end of August as already disclosed here on the blog. Doing my regular four to five hours of reading per day, I came across an interesting chart from Merrill Lynch research department showing that as of late August, Apple's market cap was worth more than the whole of Italy, Portugal, Turkey, Chile, Peru, Austria, Egypt, Czech Republic, Philippines, Finland and Norway combined. That is right... combined! At its peak of $700, Apple was up more than 110 times since its 2003 lows. Regardless of any reasoning anyone comes up with (PE ratio, cashflow, market share, balance sheet, iPhone demand, etc etc etc), when an asset goes up 110 times in a space of less than a decade... I'm pretty sure it is in a MEGA MANIA!

Stock Market Troubles

Market Notes

Source: Short Side Of Long

• Industrial sector (XLI) within the S&P 500 tends to correlate with the main index the best. When we overlap the two, they seem almost identical at times and therefore this sector holds a strong "tell" on the overall market. Having failed at the 37 resistance three times over the last 16 months, the Industrial sector looks very vulnerable, especially because it tends to lead the S&P 500 at major turning points. Furthermore, the relative strength of Industrials is giving us a warning signal that the sector is losing its uptrend leadership role and may be ready for a break down. Disclosure: I have sold short the Industrial sector.

Source: Nordea Newsletter

• Euro currency skew risk, which is commonly used to derive the difference in price between Puts and Calls, is showing that complacency has once again returned to the currency options market. For what it's worth, the current market conditions are showing extremely cheap Put prices relative to the same strike / expiry Calls. Historically, this has indicated that the Euro is much closer to a top than a bottom. Furthermore, over the last few months Super Mario has managed to squeeze more than three quarters of all Euro bears that held short positions against the currency. Recommending to "short the Euro" is far from a consensus trade these days.

Source: Short Side Of Long

• The Australian economy has not suffered a recession in over 21 years. Unemployment rate has not risen meaningfully for a whole generation. Housing prices are some of the most overvalued in the Developed World largely due to incredible leveraging stemming from the country not experiencing a single day of hardship for more than two decades. Australians have now become the wealthiest individuals in the world. Too good to be true? That is because it is. The recent book published nationally was titled "The Australian Moment", describing how the fortunes of the "lucky country" will continue for a long time into the future. It was a fantastic read... for a contrarian. I am skeptic, with a view that the economy is on the edge of a rescission (finally) and that the currency is on the edge of a bear market.

Source: Merrill Lynch Newsletter

• Despite strong evidence supporting the fact that there is a very high probability of a global synchronised recession, the consensus outlook remains upbeat. Reading the recent Merrill Lynch newsletter, amongst others, it is becoming very clear that the consensus outlook is for a growth recovery in early 2013. As seen in the chart above, the main forecast is an Eurozone rescission to trough in early parts of 2013 and to regain growth by the third quarter, while the outlook for the United States is to miss a recession and continue to "muddle through". If you believe ML and many other investment banks, you have nothing to worry about in the coming 12 to 18 months. Once again, I am skeptic, with a view that: a) Chinese real estate will experience a hard landing; b) the Eurozone recession will intensify; c) EU Debt Crisis is heading for a final climax with an overdue default out of Greece and;  d) the US will once again enter a recession. 

Off Topic: A Letter To A Friend

A friend emailed me yesterday regarding the state of financial markets. He happens not to be a client of my fund, but nevertheless the advice and effort I give to him and his family is one similar to that of my clients too. I've attended university with his two older brothers, who happen to be very, very close friends of mine, but they do not share interest in the investment world as much as he does. His father has given him the responsibility of investing the family's capital, as they own a large consumer staples business in the Asia Pacific region and are very well off. The gentleman emailed me regarding stock prices, Australian real estate prices and Precious Metals. Today's post is a "one-off" where I will copy and paste a letter to a friend regarding investment advice. For obvious reasons, certain private parts, family discussions, names, greetings, side chat and other sensitive information has been removed / edited for the sake of privacy. Enjoy!

When it comes to advice for the financial markets, there is a reason why the majority of people in this business lose money consistently, while only a handful are successful and make a profit on a consistent basis. These clowns come on TV channels like Bloomberg and CNBC and they all sound the same. I think I always say this to you, but I'll repeat it again: when it comes to financial advice, the best thing to do is to do your own research and run your own investments. It is basic advice, but it is very, very important. That way you lose your own money if you make mistakes, or if you do your homework and have a little luck, you make your own profits. Listening to financial "gurus / bloggers / experts / traders" who think they know everything, for the majority of time is a complete waste, and this includes me too. 

I can be just as wrong as the common man on the street. As a matter of fact, because I spend a large amount of time in front of the computer reading, researching and studying all of this "stuff", the common man on the street probably knows a lot more about the economy than I do. I am talking about the common man that runs a business and isn't brainwashed by all these financial reports we read daily. That is because visiting local restaurants and night clubs, or just asking various taxi drivers how business is going can tell you a lot more than government statistics - which are all phoney anyway. And on that note, I can give you advice on what I see in the market place today and what I am doing with my money, but in the end I am no better than you or anyone else, so read as much as you can from as many people as you can and in the end, always think clearly by yourself. 

On The Edge Of A Recession

Market Notes

• Markets tend to ebb and flow between risk taking and risk aversion periods. As we all know, risk taking has been quite a strong theme since June 2012. However, for a while now I've discussed the non-confirmation signal from the Dow Theory. I have also discussed the S&P 500's bearish momentum divergence relative to its 200 day MA. On top of that, I've also covered how S&P 500's new highs have not been confirmed by other risk correlated assets such as the Aussie Dollar / Japanese Yen. Together with the chart above of The Risk Appetite, all of these signals indicate that risk aversion is slowly creeping in.

• According to various blogs and forums, the current Treasury Bond technical picture is one of a head & shoulders top. While I'm not an the world's greatest technician, I do know that down sloping necklines hardly ever work out, just like S&P's famous down-slopping neckline of 2010 - we all know which way the price went next. While I think Treasuries are extremely overbought, I am not ready to short them until a major fundamental catalyst triggers a reversal. As already outlined many times on this blog, Treasury Bonds tend to top during a major fundamental event like a bankruptcy or a default... and Greece is now well overdue!

• According to the latest CFTC Commitment of Trader report, which came out on Friday, hedge funds are now net long British Pound, despite continuous QE by the Bank of England as well as UK's economy contracting for the third month in the row. Since the start of the Global Financial Crisis in 2008, whenever hedge funds have built net long exposure towards the Pound, an intermediate top was almost always nearby. Furthermore, confirming the COT report, last time I've update Pound's sentiment survey we saw a lofty 62% of bullish readings. Those readings have now moved towards extreme levels of 70% bulls.

• Unlimited QE has been launched by Federal Reserve Chairman Ben "Helicopter" Bernanke. So what did everybody do? They piled into Gold via the GLD ETF. The chart above shows how GLD's Tonne Holdings has now jumped to all time record high levels. This indicator is also confirmed by the rapid rise in Comex Gold's Open Interest activity. Furthermore, in the mid September post I showed how PMs sentiment surveys were reaching short term extremes. From a contrarian perspective, speculative activity and hot money could now signal that a short term pullback / consolidation is on the cards. Regardless of "Unlimited QE", I'd advise holding back from adding positions in this sector for the time being.