ML Fund Managers Survey - Jan 2013

I have recently been quite busy with other matters and I am sure that my lack of presents has been noticed somewhat. However, my focus returns back towards the blog in February, so I will be doing quite a few more posts than I normally have done in recent months. Expect quite a lot of material in coming weeks and months. Today, we start of with a recent update from Merrill Lynch Fund Managers Survey. I will include just some of the more important charts, because it would take too long to go through the whole thing. If you have any questions about other specifics covered in the survey, while not on the blog, just drop a comment and ask - I will be glad to answer it!

Chart 1: Risk taking moves to extremely high levels

Source: Merrill Lynch

Merrill Lynch Fund Managers Survey, which surveyed an overall total of 254 panellists with $754bn AUM, in a period between 4th to 10th January 2013 showed that investors bullishness surged to extremes. The chart abodes shows that risk appetite is the second highest in surveys history. Current readings should be a worry for bulls, and they are just about everywhere these days. On previous two occasions of appetite reaching these extremes, in April 2010 and February 2011, the market eventually suffered a crash (flash crash and US debt downgrade respectively). Merrill Lynch summarises the mood by stating that:

"Investors enter 2013 as bullish as they have been in two years. Growth and risk metrics are at multi-year highs and, most glaringly, investors are OW bank stocks for the first time since 2007."

Chart 2: Managers see no need for market protection

Source: Merrill Lynch

Fund managers remain extremely bullish on the global economic prospects, especially when it comes to China. The survey writes:

"Growth optimism surged to a 33-month high. Optimism on Chinese growth remains robust. A net 63% expect a stronger Chinese economy over the next 12 months, the second highest reading on record."

On the other hand, fund managers are taking “larger-than-normal” risk (shown in the Chart 1), while the number “taking out market protection” fell to the lowest reading since the survey question was introduced. Once again, similar readings were wittiness in April 2010 and February 2011, and eventually markets corrected meaningfully. Bulls better hope that economy and earnings picture really picks up to justify this much greed, otherwise a lot of investors might be in for a disappointment. I hold my doubts.

Great Interviews From Market Masters

Entering Into 2013 - Part 4

In this series of articles called "Entering Into 2013", so far I've expressed my negativity towards the US equity market and as well as expressed my outright favouritism towards the Precious Metals sector as a long term investor - not just for 2013, but further along as the secular commodity bull matures. Let us now turn our attention to all commodities and not just the precious type. Once again, as stated previously, I will leave the fundamentals out of the current article, as they have been discussed many times in previous posts.

Anyone that has closely followed financial markets since 2008 understands the close relationship between commodities and equities. They both corrected sharply during the Global Financial Crisis and after the cleansing was done, both bottomed between late 2008 and early 2009. Eventually, they started rising together with a close correlation for the next several quarters.

Chart 1: Commodities are experiencing a cyclical correction within a long term bull market

Source: Short Side Of Long

Commodities managed to have a super run into early parts of 2011. While the correction in almost all risk assets followed in the fall of that year, commodities never really recovered unlike US equities. The breakdown in the correlation has become evident to even the most novice of investors over the last 12 months, as S&P 500 has managed to rally towards new bull market highs, while the Continuous Commodity Index (best way to track commodities) remained in a bear market correction.

There are many reasons why this occurred. Some investors link it to the end of QE2 in 2011, while others claim that the secular bull market in commodities most likely peaked out. In my opinion, the correction is mainly linked to weakening demand out of China as its quarterly GDP growth slumped in late parts of 2011 and into 2012. As for the end of the secular commodity bull market, I tend to disagree as I believe that we just witnessed a corrective phase within a major uptrend.

Chart 2: Chinese slowdown has been a major demand impact on commodities

Source: News.com.au

Long term secular bull markets tend to end in major oversupply. When one studies history one could easily conclude that great commodity bull markets of the past have always ended during the period of major oversupply. While supply has increased over the last decade, we have not seen anything even close to what historically occurs at the end of these great trends. The current conditions are not even remotely close to those of late 1940s and late 1970s, as two pervious secular commodity bulls came to a close.

Furthermore, and even more importantly, long term bull markets tend to end in speculation and mania. Today, commodities do not resemble either. The way gambling in Technology stocks became mainstream pass time during late 1990s, in the same fashion one day Precious Metals and maybe other sectors too, could experience a similar type of euphoria. During late stages of the secular bull markets, prices tend to go rapidly parabolic as public, usually clueless towards financial developments, becomes aware of certain assets and starts viewing them as a "sure bets".

Important Charts Updated!

December's and January's are always slow. Lot of time is spent with family and friends, which leaves less time for blogging. You have probably noticed that it has been overdue for awhile now, but I've finally updated the "Important Charts" section of the blog. While the page contains a lot of different indicators for a variety of asset classes I follow, a cupel that have grabbed my attention in recent months are connected to the US Treasury Bond market. Consider these two charts:

Are government bond yields finally starting to move upward?

The other side of the bond market that measures inflation expectations via TIP vs Treasury spread, also known as break evens, disagrees. We seem to be overheating and could be signalling a top for majority of risk assets including S&P 500.

Do you think bond yields have finally bottomed, after a long 31 year secular bull market? 

Please post your comments as to why you think or do not think so. I look forward to good debate and in the meantime, make sure you look at the rest of the charts at "Important Charts" section of the blog. Use the charts freely, as long as you source the blog. Enjoy!

p.s. Later on in the week I will continue with the Part IV update for 2013, focusing on Commodities.

Entering Into 2013 - Part 3

In this series of articles called "Entering Into 2013", so far I've covered my view on the US equity market, and highlighted scepticism towards the continuation of the bull market and the economic expansion. Let us now turn our attention to other asset classes and specifically focus on Precious Metals in this post. I will leave the fundamentals out of the current article, as they have been discussed many times in previous posts.

For long term investors like myself, the main goal is to participate in rising markets which will be making new highs as they progress forward. This means that I personally favour the secular bull markets in precious metals (and other commodities) relative to the sideways secular bear markets in equities. It is because of this view, and many other fundamental reasons, that I continue to believe in the precious metals story and anticipate substantial gains in the future quarters and years ahead.

Chart 1: During secular equity bear markets, Gold performs well

Source: Short Side Of Long

If we consider the chart above, we can see that Gold did remarkably well during the 1970s secular bear market in equities. Furthermore, even though equities went sideways from 1966 to 1982, during those 16 years, inflation was rampant eating away real inflation adjusted returns on capital. In other words, someone who bought the Dow Jones in 1960s around 800 points and sold in 1980 around 800 points did not break even in inflation adjusted terms. Meanwhile, someone who bought Gold in 1960s at $37 per ounce managed to return over 20 times by January 1980 as Gold touched the nominal value of Dow Jones.

If we overlap the last secular equity bear market with the current one, which started in 2000, we can see a lot of similarities. What seems to be happening is a sideways pattern in stocks, as valuations reached extreme levels during the late 1990s tech bubble. At the same time, on a relative basis precious metals are once again in a secular bull market. This is commonly known as the relativity between the Paper Asset Trade vs Hard Asset Trade. This type of a phenomena occurred during the 1930s depression, during the 1970s stagflation and once again during the 2000s as the economy swung between a depressive state (deflation with everything falling) and stagflation (inflation with weak growth and rising commodities).

A lot of investors seem to think that Gold is overvalued and the 13 year sideways action in stocks has brought them to levels which one would call "cheap". I tend to disagree as I believe the trend in the ratio between the Paper Asset Trade vs Hard Asset Trade has not yet run its course. Furthermore, I also believe that the last part of the trade should have some powerful movements in both asset classes.

Chart 2: Conservatively, Dow could be valued at 3 ounces of Gold or even less

Source: Macrotrends

As the economic troubles and high debt levels continue to push the global economy towards slow growth and de-leveraging, one theme remains constant: central bank currency devaluation. As we move into 2013 and 2014, I believe that economic activity will only get worse. Naturally, we should expect more money printing as presses keep running, I believe precious metals will benefit. After all, almost all great bull markets eventually end up in a gigantic bubble that reaches total frenzy and euphoria. Last time we saw something similar was in the late 1990s, as the Nasdaq Composite kept rising higher and higher... and even higher. By 1998, when the majority of us thought it was all over, Nasdaq went to double yet again from already incredibly overvalued levels.

Let us assume we run with that conservative ratio where the Dow Jones Industrial is at 13,400 and Gold is at 1,675 today. One could come up with a variety of figures that link prices to the 3:1 ratio, including stocks doubling from here while Gold touching the moon (and the sun); or stocks halving from here and Gold tripling from the current levels and so on. During the 1970s, the average price of the Dow Jones was about 850 points as Gold managed to almost reach that point. During the 2000s, the average price of Dow Jones is about 10,000 so could Gold once again touch that level?

Chart 3: Last stage of the secular bull tends to accelerate into a bubble

Source: Erste Group

I am not sure how far precious metals will run, but we are definitely in the long term uptrend. It all really depends on the action of central banks and governments, which will influence the behaviour of investors and more importantly the public. Since precious metals market is relatively small, even a slight shift by pension funds into this asset class could create huge price movements. One thing I do know is that the best is yet to come from Gold and especially Silver. 

Entering Into 2013 - Part 2

Before I move forward into summarising the outlook for other asset classes, I would like to further go into the US equity market outlook. My personal opinion is that there is too much complacency right now and this is usually how markets top out... especially after a four year super run like we've experienced since March 2009. Let me put forward 16 sentiment indicators I track to explain why I do not want to be anywhere near equities right now. Since there is a lot of charts to cover, I will keep it all in point form. Furthermore, apologies in advance if any of the material overlaps from the previous posts.

Chart 1: Low volume is usually a sign of distribution

Source: Short Side Of Long

• Low volume is usually a sign of distribution, where smart money is slowly selling into strength as retail money is buying. As long as the volatility is low, the media news is bullish and trend is upward - retail money is not spooked and keeps accumulating. In my opinion, distribution has been in progress since at least March 2012.

Chart 2: Low equity volatility is usually a sign of a top

Source: Short Side Of Long

• VIX is once again in the so called "danger zone", which usually indicates a top is either at hand or near. But it is not just equity volatility that remains very low. Consider the following chart:

Chart 3: Low global volatility is usually a sign of complacency

Source: Barry Ritholtz 

• Volatility is extremely low across all asset classes as investors hold high confidence that both the economy and financial markets will continue to deliver for quarters and years to come. JPMorgan’s G7 Volatility Index of currencies fell to a record low reading of 7 in late December. Furthermore, Merrill Lynch’s MOVE Index covering Treasuries fell almost 40 percent from its high last year. 

Chart 4: Low financial stress readings usually occur prior to a crisis

Source: Short Side Of Long

• Just like the VIX, the Fed's Financial Stress Index is at a very low level (inverse on the chart above). Last time we saw a similar reading was just prior to the 2010 flash crash and the 2011 sell off I believe something similar is in the cards once again.

Chart 5: Risk taking appetite and greed have prevailed since August 2012

Source: SentimenTrader

• During such low volatility, it is only natural that complacency and high risk taking appetite flourishes. If this was a solid economic expansion, like the business cycles we saw during the 1980s and 1990s, than one could make a point that usually these conditions could go on for a lot longer. However, we are currently in a secular equity bear market and in a period of de-leverging were constant shocks are very common. It is not wise to be bullish when the herd is in love with risk.

Chart 6: Hedge funds exposure to equity markets is now higher than in 2007

Source: Merrill Lynch Fund Managers Survey

• The Merrill Lynch research team writes: "Hedge fund net exposure to equities jumped to its highest level [in years] (net 45%). More broadly, the % of investors who say they are taking higher-than-normal risk in their portfolio is now highest since Apr’11." Exposure is as high as September 2007, while risk taking is as high as April 2011 - both of which marked very important equity tops over the last half decade.

Entering Into 2013 - Part 1

The global economy has been showing a bit of resilience as of late, with the manufacturing index recovering back towards 50.2 in December from 49.6 in November. Stabilisation is seen in US and China at present, while Eurozone and Japan continue to deteriorate. However, the question is weather or not the 2011/12 economic soft patch is a bottom from which another expansion period will re-start?

Chart 1: Recovery in global manufacturing, but for how long?

Source: markit / JP Morgan

Personally, I highly doubt it. When I watch Bloomberg or CNBC, I get the impression from various analysts, strategists and traders that this is a great time to buy into investment cycle. In my view, many market participants fail in understanding how to read the business cycles, as they are usually focused on short term trading and news headlines.

Chart 2: Global investors view the economy in a late cycle with 12% seeing a recession

Source: BofA Merrill Lynch

My personal view is that the current business expansion, as well as the investment cycle (bull market), both started in March 2009. As we approach the four year anniversary in March 2013, the bull market will be in very late stages of the investment cycle.

Chart 3: The four year old bull market has returned 120% from its lows

Source: Barchart

With the return of over 120% from its March 2009 lows, this has been one of the strongest rallies in the stock market post World War II era. Other higher beta indices have enjoyed similar or even more of a speculator runs. Consider that the German DAX is up 111%, Singapore's STI is up 113%, Mexican Bolsa is up 160%, Nasdaq 100 is up 168%, US Industrial sector is up 174%, US Discretionary sector is up 216%, Philippines Composite is up 236%, Thailand's SETI is up almost 260% and so on.

Off Topic: Happy New Year!

This update is late, but its better late than never! I want to wish all of my readers a very happy new year and all the best in 2013, including good health, family and friendship love, happiness and life satisfaction, goal achievements and of course.... prosperity too.

The photo was taken by my younger brother with the iPhone during the Sydney fireworks, as a group of six close friends and business partners (part of our fund) watched the mega fire works finale from the party at the Opera House that went for about 13 minutes. It was absolutely amazing and an experience of a life time! Big thanks goes to a friend who organised it all. Below is a better shot from the Sydney newspapers:

Regarding the markets, they have not been kind to me since middle of November with Silver correcting and US stocks recovering back towards new bull market highs. Also, my currency position in the Yen has suffered too. For me, what is more important is the exit of the positions in a few quarters or years from now, and not what has happened over the last few weeks. Nonetheless, not a good finish to the year in all honesty.

As always, I will be getting back to updating my view on the markets and the global economy throughout January.

Wishing all of you a very happy new year! ~ Tiho

p.s. Also... I am sorry if I haven't replied to your email regarding the markets. I always try and reply to everyones email as soon as possible, so I will get there in the coming days (or weeks hehe)!