Tuesday, December 25, 2012

Global Macro Update

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As we approach the festive season around the world, this is probably one of the last major blog updates for the year. With Christmas holidays tomorrow and new year celebrations next week, the up and coming week could be a quiet one in the financial world. Volumes and news headlines usually die down until early January. So with that in mind, I will do a little bit of a global macro summary in the current post, so let us begin.
Source: Short Side Of Long

When I look at the overall global macro picture for risk assets, I get a picture of an ending investment cycle. Let us understand that the majority of risk assets have bottomed between October 2008 and March 2009. What followed next was a dramatic reflationary bull market, which has lasted for some 4 years. The S&P 500 is the main poster child of this move, and one of the most followed assets in the world. Its bull market is still alive, but with a gain of 114% since the lows, most likely close to the end. The German DAX has approached a major resistance zone being up more than 50% since last year's October lows. With that in mind, I'd argue that the majority of the equity gains are now just about done.

Commodity currencies and Asian currencies are highly correlated with the S&P 500 and therefore will follow its leadership. Recent price action suggest a topping process too, especially with record high bullish bets on the Aussie Dollar. Commodities continue to under perform all other asset classes and look the weakest at present. Industrial commodities like Crude Oil and Copper have been struggling since the early parts of 2011, as China slowed down. Despite money printing, commodities have not been able to regain upward momentum, but in my opinion the secular bull market is still alive and well. Let us use the magnifying glass on some of these major assets.

Sunday, December 16, 2012

Precious Metals Summary

Market Notes
Source: Short Side Of Long
  • The recently published update of the OECD Leading Economic Indicators "point to diverging patterns across major economies." Eurozone growth rate continues to slow, with Japan joining the recession party. On the other hand, the US continues to grow above par, while China stabilises for now. Germany looks very disappointing while Canadian, Brazilian and Russia growth rates have also turned down. Finally, India is showing no signs of recovery just yet. OECD Total indicator is signalling anaemic global growth only three years into the recovery phase, despite the unprecedented global stimulus as mega trillion dollar cheques were written. In my opinion, since we are at stall speed, it is now only a matter of time until some-event, some-where in the world triggers a cascading slowdown that enters into a global recession, as we find ourselves in the very late cycle of the expansion.
Source: NFIB Small Business Survey
  • There has been a lot of discussions towards the Fiscal Cliff and how it is impacting the price of equities. The Media has attributed every sell off and every rally towards the political negotiations in Washington. However, in my opinion, behind the curtains the economic cycle is slowing and companies are now starting to struggle... but bullish investors are not paying attention. Bull market leaders like Apple, are not declining because of the Fiscal Cliff, but as investors forecast disappointment in sales & earnings. This is also evident  when we look at the health of small businesses in the US, the backbone of the private sector. In the charts above, we can see clear evidence that the majority of companies are entering a period of slowing sales (anaemic consumer demand) and therefore falling earnings. During the late stage of a business cycle, when earnings start to disappoint, companies start cutting capex plans and begin trimming expenses (including workforce). These factors are bound to contribute towards lower growth and higher unemployment in the coming quarters (lagging indicators). Of course, the US government could step in place of the private sector by increasing its spending deficit to even higher levels. However, with the public's eye on the US government budget thanks to the constant media attention, it seems that it is only a matter of time until the US also enters austerity. It is worth noting that previous rapid collapses in small business earnings lead to a recession in 1990, 2001 and 2008.
Source: Barry Bannister
  • Luxury art dealer Sotheby's has been a leveraged speculative play on asset booms during the reflationary phase of the current secular bear market in equities. While not perfect, the company price itself has also been a great indicator of bull market tops, including the previous peak in 2000 and 2007. It has been my view for awhile that a real equity market top already occurred in May of 2011, just as Sotheby's was peaking in its blow off top phase. After all, the broadest measures of stock prices such as the NYSE Composite, Russell 2000 and Broad Market Value Line have not exceeded their respective 2011 highs. Neither have any of the major global indices such as the STOXX Euro 50, Emerging Markets or Frontier Markets. Therefore, we can assume that the majority, if not all, of the gains have already been squeezed out of the March 2009 bull market. The bulls are being overly bullish for the sake of single digit percentage returns at best, while major downside risks are developing. I do admit that some of these global indices could outperform US equities in the coming quarters, but the question is - will they outperform during an uptrend or a downtrend?
Source: Short Side Of Long
  • In the recent weekly sentiment update, I've noticed that NAAIM (National Association of Active Investment Managers) showed extremely bullish exposure towards the stock market. Not only was the overall exposure the highest since the May 2011 market peak, but more importantly the number of managers positioned towards the short side was at 0%, indicating an overwhelming complacency. This is confirmed by the recent Investor Intelligence Survey, where bearish advisor readings have not ticked up since the October 2011 bottom. It seems to me that fund managers are all in, while advisors remain complacent.

      Thursday, December 13, 2012

      A Quick Update On QE4

      I thought that a quick update is appropriate post FOMC meeting. Just as expected, Federal Reserve has engaged into QE4 or as some call it extension of QE infinity. Regardless of what name you brand the "money printing" programs, more importantly here are the details:
      • Fed to buy $45 billion a month of Treasury from January 2013
      • Fed links 0.25% rates to 6.5% unemployment and 2.5% inflation
      • Fed will continue to buy $40 billion a month of MBS
      • Fed's Operation Twist program comes to an end in December
      • Fed's annualised purchases to reach $1.02 trillion per annum

      Watch the summary of Ben Bernanke explaining the change in Fed policy with all the important details. 

      My personal perspective is that this is nothing new to the markets from the short term. It has been telegraphed well in advance and various assets had the time to adjust and discount the up-and-coming program (to a certain degree). Majority of the risk assets like stocks and commodities put in late reversals and sold off their earlier gains. Not something you'd expect on such "favourable" news. While one day does not make a trend, let us see the broad macro picture for all major asset classes:
      Source: StockCharts

      With the Fed pledging Treasury purchases, the 30 Year Long Bond seems to be selling off right now. Let us remember that previous occasions where Fed engaged into Treasury purchases almost always pushed down Bond prices and pushed up interest rates. While many have opted to short Treasuries, I am personally not taking this trade just yet. While Bonds are extremely overvalued on historical basis, I believe the up-and-coming recessionary conditions in 2013/14 will be even worse for the stock market.

      Source: StockCharts

      S&P 500 has rallied from 1340s in middle of November all the way to 1430s - a move of 7% or so - which has nothing to do with Fiscal Cliff and just about everything to do with money printing. I know bulls aren't really paying any attention, but it is important to state the fact that S&P 500 has still not exceeded its QE3 announcement highs at 1465 in middle of September. More and more "favourable" news is coming at us, such as QE3 followed by QE4, and yet the market refuses to give us an overall net gain. If this was 2010, a back-to-back QE announcement would have moved the markets in a rapid fashion.
      Source: StockCharts

      I have to admit, despite being heavily long PMs, the same is true for Gold and the rest of the sector. Gold, Silver and Platinum experienced an initial rally followed by a big negative reversal as well. I do not want to judge the trend by one days action, but Gold bugs have received everything they wanted, plus more. Trillions of dollars will be printed into 2013 and beyond, yet the overall sector is not really excited about it. Disappointing price action is most likely linked to large amount of PMs stale longs via COT reports. I remain long and personally wouldn't short this sector. Furthermore, I do admit that Gold Miners look oversold right now. However, one would have thought that a back-to-back QE3 and QE4 would have ignited PMs towards new highs. Therefore, I remain cautious.
      Source: StockCharts

      Finally, just as described in the previous article, the Dollar seems to be stuck between a rock and a hard place. All central banks continue to pledge some type of stimulus, be it BoJ or RBA or PBoC, so the currency market is in a war right now. One CB stimulates, while another stimulates more, so currencies just whipsaw up and down. From a technical point of view, one could make an assumption that the Dollar has lost its uptrend momentum, but personally I do not like to guess future prices via a few squiggly lines on the chart.

      All in all, investors should pay attention to the post QE price action over the coming days and weeks, to see how the current "favourable" news impacts the markets.

      Monday, December 10, 2012

      Currency Market Positioning

      Market Notes
      Source: Nomura Research / Short Side Of Long
      • Wall Street analysts are quick to make an assumption that the US housing market is in recovery mode, which essentially will be good for economic growth, employment and therefore the stock market too. While I agree that the US housing market definitely offers fundamental value for long term investors, the story isn't that simple. Real estate prices do not necessarily correlate positively with stock prices, so if we were to assume that Wall Street analysts are right and money does flow into the beaten down housing market, the question we should be asking ourselves is where will this money be coming from? The chart above, via Nomura research, shows the US household asset ratio between real estate and all other assets, with overwhelming majority of the "other" being equities.  We can see that households are currently underexposed to real estate and therefore an assumption could be made that this asset will experience favourable attention in the future, relative to others. But, what does that mean for the stock market? Well, last time we saw a similar occurrence, stocks struggled. During 1966 to 1968 as well as during 1998 to 2000, the US equity market peaked out and entered a decade long sideways secular bear market range. Will this time be different? While I do not think US equities will move sideways for another decade, I definitely think we are approaching a major top and a bear market is just around the corner.
      Source: Deutsche Bank
      • A lot of investors claim that the US stock market dividend yield has now overtaken the Treasury yield, which should result in improved competitiveness for the stock market, in hopes of attracting more money to push it towards higher levels. While I do not want to get into the overall stock vs bond debate, I am not so sure about this theory. I do admit that government bonds aren't attractive at the current yield at all, especially after a prolonged 30 year Kondratiev bull market. However, just because stocks have a higher dividend yield relative to government bonds for the first time since the 1950s, it does not give us an automatic buy signal. As a matter of fact, dating back to the late 1800s, stocks almost always yielded more than government securities until the 1950s secular change. The truth is, while bond yields are very unattractive, the dividend yield on the stock market is also at historically low levels too. I am not sure if we will see a period of high dividend yields in the US equity space again (towards 5% or higher), but what is needed is one of three outcomes: companies increasing their dividends meaningfully, stock prices falling dramatically or a mixture of both.
      Source: Short Side Of Long
      • Global hedge funds, influenced by central bank monetary policy, continue to hold above average bullish bets on the overall commodity space. High exposure to any asset, just like the commodities in this example, usually signals that further upside tends to be limited the majority of the time (but not always). This is because the majority of buyers are already participating and stale longs are forced to sit patiently waiting for prices to rise - and if prices do not rise, a major shake out of weak hands occurs. The majority of technical analysts continue to see a head & shoulders bottom in the CC Index, with a break out above the 600 level signalling a new uptrend, the problem with this view, as we can see through the commitment of traders report, is that the majority of market participants (like hedge funds & other speculators) are expecting the same outcome. So caution should be applied. When we dissect the commodity exposure data into different sectors, we can see that despite a strong correction in price, hedge funds still hold a relatively decent exposure to Agriculture. Furthermore, while not overly bullish, hedge funds still hold modest bullish bets on energy and industrial metals too. Precious metals exposure is definitely more optimistic as well, relative to the summer doldrums experienced this year. While commodity bulls amongst us would prefer hedge funds to be under-exposed and in disbelief right now, which could potentially push prices to higher levels, sentiment isn't extremely optimistic either. There is no clear contrarian edge right now, as we wait for further Fed policy this week.
      Source: Short Side Of Long
      • The fight between bulls and bears continues, without a clear winner just yet. Bulls claim the global economy is recovering and finally EU stocks are starting to outperform, while Chinese manufacturing is expanding once again. They say that this is a very good sign. Bears claim that the recovery calls are premature and finally bull market leaders like Apple are breaking down, as earnings are set to disappoint in the not so distant future. One camp is calling for an inflationary growth outcome into 2013, while the other camp is calling for a deflationary recession as early as 2013. So who is right? Who better to ask than the doctor and Phd holder in economics - Dr Copper. It seems that the price has not decided just yet, as we remain in one of the closest and narrowest price ranges since at least 2004. With the majority of Copper demand coming out of Asia, a break out in price could signal a Chinese recovery. On the other hand, a breakdown in price will definitely signal a bulls worst nightmare - a hard landing in Chinese real estate. Keep an eye on the price very closely... as Copper tends to lead global growth.

          Sunday, December 2, 2012

          QE4 Rumours Start Circulating

          Market Notes
          Source: Short Side Of Long
          • Lets face it, sentiment surveys have not given investors an edge towards either the bullish or bearish side in recent months. When we look at the chart above, we can see that the AAII spread started to approach what one might call an extreme low reading or a contrarian buy signal. However, this was not confirmed by other surveys, especially the NAAIM, which was at the opposite spectrum of sentiment showing high optimism and therefore giving us contrarians a sell signal. Finally, Investor Intelligence remains around neutral readings, but here too advisors just move from bullish to neutral camps and back again. Not many are actually turning bearish. Furthermore, the market action has been one of sharp sell offs and just as sharp rallies, leaving behind weak bottoming phases without proper wash outs (also known as V reversals which are prone to failure). This can be seen in the June 2012 & November 2012 bottoms and is very much unlike the price action during the middle of 2010 & middle of 2011. Furthermore, at both the 2010 and 2011 sell offs, volatility spiked into what I call a "capitulation zone", whereas during recent sell offs the VIX has barley moved above 20 (historical average). The reason I was able to call a bottom in late September 2011 and early October of 2011, is because the majority entered total panic and expected a repeat of 2008. Back then, one prominent blogger wrote that "the cleansing process stocks should either test the March 09 lows, or if Bernanke tries to stop the bear market with another round of quantitative easing, we could see the March 09 lows breached." Today, the view of this same investor is to see all time new highs in the stock market and there are many like him. The market is up a lot since those days and the recent short term bottoms in June & November do not look like they were proper buying opportunities for longer term investors. The bull market that started in March 2009 is ageing and struggling to create any meaningful net gains. According to the historic data of the Presidential Cycle, the current rally is already one of the greatest ever. All of these are usually not good signs for the long run.
          Source: Short Side Of Long
          • While sentiment surveys are not giving us the edge when it comes to stock market sentiment, we have to remember that these surveys are more about who "said" what, instead of who "did" what.  In the previous post, I discussed how within the foreign exchange world, the Australian Dollar Japanese Yen cross pair is commonly known as the perfect example of the carry trade concept and also a great sentiment indicator for all risk assets. A follow up on the recent COT positioning data shows that hedge funds have engaged into very large bullish bets on the Aussie Dollar and at the same time very bearish bets on the Japanese Yen. Looking at the chart above, readings have now moved into an extreme territory of 2.5 standard deviations away from the mean. This is a contrarian sell signal and a major warning flag for those long any risk asset, including global equities. The correlation coefficient between the Aussie Yen cross and MSCI World Equity Index stands at 80% positive over the last 260 days (one trading year) and 85% positive over the last 520 days (two trading years). In other words, these two assets move in essentially the same direction.
          Source: BarChart / Short Side Of Long
          • I believe technical analysis is a useful tool when cross referencing fundamental conditions of an asset class. Price action on the chart can tell us what is currently happening, however in my opinion using technical analysis on its own to "predict" what will happen in the future is a recipe for disaster (many will disagree with me). The chart above shows Silver, the largest single holding investment in my fund. The goal of an investor like me is to buy low during panics, while the goal of a trader is to buy high with a break out in mind. Those who have been following the blog for a while would know of the major purchases in late December 2011, early July 2012 and again a technical breakout out of a small triangle in August 2012. There have been other minor positions through the last 12 months, but their NAV % is very small in comparison. The point is that I am not a buyer right now, while the majority of traders are ready to play the breakout on the upside with many positioning themselves to the long side as Silver's Open Interest explodes. Silver now approaches a major decision point, with fundamental conditions possibly improving further. The Federal Reserve could embark on another round of quantitative easing called QE4, where they buy Treasuries. If implemented as Operation Twist ends, this action could finally start pushing up the Fed's balance sheet and should be beneficial to precious metals. At the same time, Silver's price action has been stuck between a $26 support and $35 resistance without a clear break in either direction, indicating neither bulls nor bears dominate the trend. I am not into short term predictions, but one thing is certain - both the Gold and Silver price action has been rather weak in the last few days despite rumours of QE4 in circulation. Failure by these assets to break out on the upside and clear major resistance levels ($35 for Silver) despite favourable QE conditions, will signal that not all is well within the Precious Metals sector. Furthermore, Gold Miners have already broken down and have yet to confirm their recovery above 200 MA. With Gold up for the 12th annual year in the row, PMs bulls should carefully watch the price action in coming weeks as we await the Fed decision and the follow through price reaction (don't turn bearish in a secular bull market, just be cautious)!
           Source: Short Side Of Long
          • Investors continue to ignore Soft commodities like Sugar, Cotton, Coffee and Orange Juice - all which have been awful performers over the last 12 months. If an investors job is to buy fundamentally strong value at cheap prices, then it does not get any better than these assets right now. Sugar, in particular is my favourite agricultural commodity due to the demand and supply problems I see developing in the coming quarters and years. On the other hand, hedge funds do not seem to hold the same amount of optimism as I do, as they hold the lowest net long position in 5 years. Furthermore, small speculators which are also known as dumb money, continue to hold net short positions in Sugar. The price of this commodity is down 17% this year, down 47% since the February 2011 top and furthermore down over 66% from its all time highs. Finally, the Sugar price action shows that we have spent a very large amount of time trading below the 200 MA, usually a signal that a major bull market is just around the corner. I am looking forward to engaging further into the Sugar market in the coming weeks and months ahead, as I believe it offers great long term prospects.