Friday, November 23, 2012

Business Cycle Warning Signs

Market Notes
Source: Short Side Of Long
  • If you haven't heard the news already, the bulls have declared victory. Various bloggers around the internet have posted articles titled "The bottom is in", "Waiting for Santa Claus rally" and "Major buying opportunity" (plus many others). The first note in Saturday's post warned that "all in all, one could make an argument that a bounce or relief rally might be in store soon" and that is what we have gotten so far. However, I'm personally not expecting anything remotely close to "a major buying opportunity"... just yet. While there are many reasons for this, the chart above which tracks short term market breadth internals, shows that the market didn't really experience a proper oversold condition. We only became slightly oversold with Net New Highs, while the AD Line & Volume as well as the Stocks Above 50 MA never really washed out properly. Many will ask, why is it import to get oversold? Extreme oversold conditions create panic selling and re-build the wall of worry by removing weak hands from the market. These occurrences are necessary to forge longer term lasting supports as anything less usually fails.
Source: Short Side Of Long
  • Within the foreign exchange world, the Australian Dollar Japanese Yen cross pair is commonly known as the risk barometer or a perfect example of the carry trade concept. In recent years, this trade has been a great signal of market sentiment as it ebbs and flows from pessimism to optimism and back to pessimism again. As of last Friday, the CFTC commitment of traders report showed that hedge funds are currently extremely long the Aussie and extremely short the Yen. Furthermore, since that report was complied two Tuesdays ago, on the 13th of November, the recent price action has been very negative on the Japanese Yen. Therefore, one could assume that hedge funds have increased their bearish Yen bets and pushed the Carry Trade COT towards further extremes. Similar events occurred in April 2010, May 2011 and March 2012 with a result of a sharp and swift sell off (in all risk assets). I eagerly await the new CFTC report today to see further hedge fund positioning developments in both the Aussie and the Yen.
  • Gold Volatility measured by the GLD CBOE VIX is at record lows (video above). As a matter of fact, volatility all around the world has fallen dramatically. The S&P 500 VIX is around 2007 lows, the DAX 30 volatility is amazingly low, Hang Seng Volatility is also at multi year lows and finally the JP Morgan G7 currency volatility is as low as 2007 as well. Implied volatility for stocks, corporate bonds, junk bonds, currencies and commodities is just dead quiet. Skew indices for various currency crosses shows that bulls are paying premium costs for Calls. The Euro Dollar option skew is very elevated with Calls almost as cheap as Puts. In similar fashion, the Dollar Yen option skew is actually showing record premium being paid for the US Dollar rising. With volatility dramatically low on almost all risky asset classes and bulls paying premium for Calls in the options market, one should apply a lot of caution moving forward.
Source: markit / HSBC
  • As far as I am concerned, one of the major conundrums in the market today is the so called Chinese economic recovery we are constantly being bombard with by various media outlets. This morning in Asia during work, I noticed Bloomberg reported that "Chinese manufacturing index signaled the first expansion in 13 months, adding to signs that economic growth is rebounding after a seven-quarter slowdown" (chart above and link here). Poking further in-depth I checked out the report and read Mr Qu's comments (Chief Economist at HSBC): “As November’s flash reading of HSBC manufacturing PMI bounced back to the expansionary territory for the first time in 13 months, this confirms that the economic recovery continues to gain momentum towards the year end." The conundrum occurs with the lack of enthusiasm out of the financial markets. Just think about the conditions for a second. Chinese manufacturing expands for the first time in 13 months and Shanghai Composite continues its selling for yet another day? Whether we look at the price of Copper or the current level of the Korean KOSPI or the Shanghai Composite itself, it is impossible to see a Chinese recovery in the price. Let us remember that the majority of the time, markets act as a discount mechanism as they price in events up to 6 months ahead, therefore these markets should have front run todays data well in advance. During a real recovery in 2009, prices of Copper and KOSPI were rising rapidly, almost without a pullback. So why is there a lack of enthusiasm today? You will notice that the KOSPI and Copper both reversed all of their recent gains. Is the market doubting the Chinese recovery? One thing is for certain, while not perfect by all means, I rather trust the market than Chinese official statistics.
Source: Morgan Stanley
  • It has been my view for awhile now that global economies continue to slow as we are moving toward another recession. First it was the peripheral Eurozone countries (PIGS) that started slowing due to the financial crisis in 2010/11 and it wasn't long before the majority of the EU became affected in later parts of 2011. Afterwards it was Europe's largest trading partner China that started feeling the effects of a slowdown in 2012 and as China slowed the majority of Asia followed. One of China's biggest trading partners and the world's third largest economy - Japan - has now experienced a dramatic five month decline in exports and has become the latest economy edging toward a recession as we start 2013. The chart above, thanks to Morgan Stanley Research shows that German Business Confidence is now in free fall (something we have been covering here on the blog for awhile). MS research writes: "Germany might not be able to avoid a recession either - While we continue to expect the German economy to outperform the euro area as whole and expand by an average 0.3% in 2013, we worry that economic activity might contract over the winter. Not only is export demand (notably from the euro area) deteriorating sharply, but German companies are also embarking on large-scale cost-cutting programmes. Alas, consumer spending is not dynamic enough yet to compensate for the shortfall in external demand and investment spending." I also eagerly await the new Ifo Institute report today, which should give us further clues on what 7,000 German CEOs are currently experiencing.

Saturday, November 17, 2012

Summary Of Recent Events (Updated)

Market Notes
Source: Short Side Of Long
  • We are starting to see some signs of the equity market becoming oversold from a short term perspective. The chart above shows that we are approaching internal breadth capitulation in the near term, especially thanks to Wednesday's strong selling pressure resulting in a 90% down day. The basic 10 day Advance Decline Line is also signalling oversold levels. The percentage of stocks within the S&P 500 above the 10 MA & 50 MA also hit a low reading, regularly associated with short term bounces (chart here & chart here). According to Tom McCellan, a well respected technical analyst, his own Summation Index is now also oversold. Furthermore, more than one fifth of the S&P 500's components now show an oversold RSI reading of 30 or below, while the index itself has also become oversold too. Finally, the Bespoke website reported that 27 out of 30 Dow Jones components are now oversold. All in all, one could make an argument that a bounce or relief rally might be in store soon. However, be warned that markets remained overbought for a prolonged period of time in an uptrend, so they can just as easily remain oversold for prolonged periods during a downtrend. Also be warned that oversold readings work better when the price is above 200 MA, like we saw in June. All major indices are now below the 200 MA. Having said all that, you won't see me buying equities.
Source:  Market Anthropology
  • The current secular bear market in the Western World began in the year 2000 and has so far progressed in a sideways trading range for the last 12 years. I believe we are now approaching a peak in the current cyclical bull market, as investors should get ready for one last major bear market. This week I came across an interesting chart, which showed how each one of the major S&P 500 peaks was marked by a market capitulation bubble in a company which became the daring of the investment world. In 2000 it was Microsoft leading the way, in 2007 it was Petrochina leading the way, and today it is Apple. As you probably already know, CNBC has a special section on the morning Squawk Box called "iEconomy". This segment tracks... you guessed it... everything Apple related. After all somewhere between stocks, bonds, currencies, commodities, real estate and alternatives, Apple has become its own asset class.
Source: Short Side Of Long
  • The bull market that started on the 06th of March 2009 is aged, tired and exhausted. It is either ending or close to its final top. Bob Farrell, a legendary investor, used to say that "markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names." The chart above shows the internal strength of the NY stock exchange components making 52 week new highs has been narrowing with every new rally to the upside. The most likely reason we have constant re-occurrences of false breakouts (aka bull traps) is because each time the index breaks out to a new bull market high, it is accomplished with fewer and fewer individual names participating. As already discussed above, I assume that we might soon bounce from oversold conditions, but I hardly doubt there is a possibility of new highs. Having said that, anything is possible with the right amount of QE, according to Helicopter Ben!
Source: Short Side Of Long
  • As we can see in the chart above, the majority of gains in the current cyclical bull market occurred at the beginning of the recovery, from March 2009 towards April 2010. One might ask, why is April 2010 an important measuring point? Because in my opinion, that was the end of the natural economic rebound, post the 2008 rescission. Everything else was mainly driven by constant intervention by global central banks. Another reason why I measure performance from that period is because that was the first major peak in the current bull market and what most investors call a mid cycle slowdown. Therefore, personally for me, it is important to measure the true net gain as the bull market progressed onwards. The verdict is out: despite all the hustle & bustle, all of the fiscal & monetary stimulus (over 5 trillion in the US), despite global central bank rate cuts, despite record high earnings, and despite constant positive news flow from various media outlets (you know the ones) - the S&P 500 has managed to gain only 11% from its April 2010 peak. Comparing that to it's initial phase, where gains exceeded 80% in the space of 12 months, one has to ask themselves, is the equity market really worthy of your money this late in the business cycle?
Source: Short Side Of Long
  • The recent monthly issue of the BofA Merill Lynch Global Fund Manager Survey showed that investors continued to sell down Bond exposure while bidding up Equity exposure for the fifth month in a row. Despite falling prices and deteriorating fundamentals, global fund managers are now more bullish on equities than they were in March 2012, prior to an intermediate top. Interestingly as the chart above shows, managers are not as optimistic on commodities with exposure remaining at neutral levels. Regionally, global fund managers are once again falling in love with Emerging Markets, while shying away from Japan. A case could be made that Japan is a steal at current prices. Also to note, the Consumer Discretionary sector stands at an all time record high overweight. Finally, global hedge fund exposure is now around 40% net long on average. That reading is the highest during the current cyclical bull market - higher than in April 2010 prior to the Flash Crash, May 2011 prior to the Debt Ceiling sell off and March 2012 prior to the Greek election panic. The Merrill Lynch team writes: "Since 2007, whenever HF exposure has exceeded 35% SPX has underperformed Treasuries by 700bps in the following month."

Source: BarChart
  • The talking point in the Precious Metals sector this week is the huge decline experienced by the Gold Bugs Index (HUI) or the Gold Mining ETF (GDX). It seems that the declines took quite a few traders by surprise, especially as prices declined rapidly over the last two days. Personally, I had no interest in buying PMs in recent times, as quite a lot of PMs blogs, forums and newsletter writers expect "imminent upside break outs to test record highs". Many that claimed miners were a great entry two weeks ago still claim that miners are a great entry today, however a lot has changed in the last few weeks. First of all, the short term breadth has turned oversold, as the percentage of stocks above the 10 MA & 50 MA has now flatlined to 0%. The rise in volume over the last two days during panic selling can also be linked to a short term capitulation, as many retail trader's stops got triggered with prices falling below the 200 MA (chart above). There is now a possibility of a short term bounce, but personally, I am not playing this sector nor am I investing more capital into PMs just yet. I like to buy when real liquidation is evident and there are still way too many traders holding their position (with large drawdowns in hand), claiming that prices will recover in coming months. If their stops get triggered and they panic, it will be the time to buy!
Source: Citigroup
  • As the majority of you already know, we are in a very rare period in financial history. Once or twice a century the world economy tends to reach its limit on the amount of leverage it can take up. At that point in time, be it 1929 or 2007, various sectors of the economy start to de-leverage. According to the Citigroup chart above, the de-leveraging period is still in its early days compared to the last cycle we saw in 1930s. Households are leading the way, which is a very good sign, but there is still a lot more pain to go through. According to Gary Shilling, one of the smartest investors out there, the de-leverging could go on for another 5 to 7 years. I assume that the up-and-coming recession and a bear market will really speed up that process. Buckle up!
Source: Albert Edwards / SocGen
  • In his recent newsletter written on the 14th of November, Albert Edwards goes on to say that the equity market is not falling due to the fiscal cliff, but because future prospects of economic activity and earnings will most likely disappoint - something I have been warning about for months already. Mr Edwards says that: "the bottom line is: despite the upside economic surprises, profits have been spiralling downwards. It’s not the impending fiscal cliff the market is worrying about, it’s the actual profits cliff we have already fallen off." You will notice that in early 2008, Citigroup Economic Surprise Index was rising but the equity market was falling (circled). We have a similar picture today, were data continues to improve against economists expectations, but the equity markets aren't buying it. A lot of bulls have been tricked recently with this indicator. As Mr Edwards's prior boss, Roger Palmer used to say: "if the market can’t go up on ‘good’ news it will fall very sharply on ‘bad’ news.” Another great quote I also tend to use from time to time is from the wisdom of Marc Faber, who frequently says 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 also true for an asset that fails to make a new high, under very favourable conditions." So you might be wondering when will the bad news start to appear in the press? Well, according to Mr Edwards it's just about... now.

Sunday, November 11, 2012

Are We Already In A Recession?

Market Notes
Source: StockCharts / Short Side Of Long
  • I have been a Treasury bear for a long time and will remain so, because I do not see much value in the Treasury market as a long term investment. After all, Treasuries are nearing the end of their 30 year grand bull market. Having said that, I am not short Treasuries just yet. I believe that the current cyclical bull market in government bond prices might have a little bit of juice left, because EU problems have not been resolved and the up-and-coming recession has yet to play out. This week the Long Bond ETF (TLT) broke out between its tight range between the 50 MA resistance on the upside and the 200 MA support on the downside. The majority were caught off guard yet again (including Bill Gross), as expectations for rising yields due to QE3 reflation was a major consensus trade, already signalled with break evens overheating. This shouldn't have been a surprise to readers of this blog, because whenever traders turn extremely bearish on the Japanese Yen, Bonds also tend to rally due to their close correlative relationship. Furthermore, I have also outlined that global funds have been net sellers of Treasury Bonds since June, when the S&P 500 bottomed, and it seems that the trade is now reversing. I hope I am smart enough to short Treasuries over the coming months and quarters, if they spike to a new high as risk assets sell off in a panic.
Source: Nomura Research / Short Side Of Long
  • Japanese individuals have amassed one of the largest levels of private household wealth in any country around the world. But with local interest rates so low for so long, Japanese money tends to search for investments abroad and retail investment always has the same mentality everywhere - that is why we call them dumb money. The chart above shows that when Japanese households become net buyers of foreign equities, price usually tends to sell off rather sharply. On the other hand, when Japanese households become net sellers of foreign equities, the opposite happens as the price usually tends to rally. To explain this contrarian indicator better, consider this chart linking those important dates to the price of the S&P 500. We can see that Japanese retail money was euphorically buying foreign equities coming into August and September. Most likely, Draghi & Bernanke's one-two punch sucked in the rest of the retail crowd from there onwards, so the chances are high regarding a major top in stock prices, all while fundamental conditions were deteriorating.
Source: Short Side Of Long
  • Following on from the previous post written in late October and titled "Which Assets Will Benefit From QE?", I argued that certain assets will benefit much more in an up-and-coming currency devaluation period than others. While further QE might not increase corporate profits, it might actually increase the price of food and precious metals (currencies in their own right for over 5,000 years). The chart above shows the analogue of Silver I have been tracking with the recent rally comparable to those in late 2007 and early 2008. Both bottoms occurred from depressed sentiment readings and within the good seasonal time period. Finally, both rallies ignited as Ben Bernanke started to ease monetary policy to combat economic slowdown - in 2007 Bernanke was cutting interest rates, while in 2012 QE infinity was launched. While I do not believe in plain technical analysis too much, this analogue continues to work and implies Silver to reach $45 to $47 by April 2013. Disclosure: I personally remain long the PMs sector with the largest holding in Silver, but without any targets.
Source: Short Side Of Long
  • Even though the Federal Reserve has announced QE3 or as some call it QE infinity, most have now noticed that the Fed's balance sheet is actually not expanding. The Fed's balance sheet will naturally shrink as various bonds mature, so the Fed has to be active and aggressive to increase the size of its balance sheet. As the news came out that QE3 will be $40 billion per month, I've stated many times on this blog that it only adds up to $240 billion over the next 6 months (much smaller than QE2) and it will not be enough. With that in mind, the Federal Reserve will most likely engage into further QE expansions as soon as they can, as the top ten global economies have over 15 trillion dollars maturing into 2015. Chris Puplava recently wrote that: "...there is just too much debt maturing over the next couple of years for capital markets to absorb and it is highly likely we will see global quantitative easing occur as central banks step in to be buyers of last resort to help suppress interest rates and keep debt servicing costs low."
Source: StockCharts
  • There is an above average probability that Apple's stock price has topped as its parabolic trend starts breaking down. As we can see from the chart above, the orthodox top most likely occurred into March 2012 with a huge vertical parabolic rise. A follow through into September did manage to break above previous resistance and make a new high into $700 area, but has now reversed, creating a huge bull trap aka 2B pattern. Apple's 200 day moving average has also been broken for the first time since 2008. Whenever bull market leaders and darlings of the investment world start to under-perform and disappoint, the bull market itself has most likely come to an end. You might remember my real time post and short position disclosure from 23rd of September 2012 (the day of the record high) that was titled "Is Apple The Biggest Mania  Of Our Lifetime?" With so many investors on CNBC and Bloomberg defending the stocks decline, we are now watching a classic "slope of hope" emotional reaction to the reversal of a parabolic.

Tuesday, November 6, 2012

Sign Of Capitulation: Are We There Yet?

Market Notes
Source: Merrill Lynch
 Source: Skandinaviska Enskilda Banken (SEB)
Source: Short Side Of Long
  • The latest CFTC Commitment of Traders report showed that Small Speculators, also known as Dumb Money, are shorting Sugar as of Tuesday of last week. At the same time, the Daily Sentiment Index (DSI), a measure of optimism from futures traders, is approaching single digit readings. From a contrarian point of view, these sentiment readings indicate that Sugar could be close to an intermediate bottom. Furthermore, as already discussed in a recent in-depth article, Sugar's prolonged bear market, which  is currently almost two years old, is creating a good demand & supply equation as farmers cut production, while demand returns with price down more than 45% from the February 2011 peak.
Source: HSBC