Humble Student of the Markets

Passing the generational torch

noreply@blogger.com (Humble Student of the Markets) — Thu, 20 Jun 2013 07:57:00 +0000

As I watched the Audi commercial of Zachary Quinto (new Spock) vs. Leonard Nimoy (old Spock) (via Barry Ritholz), I am reminded of the issues surrounding the process of passing on the torch from one generation to the next and how it affects the financial services business. A research report from Pershing LLC showed that financial advisors are potentially leaving a lot of money on the table by ignoring their clients' children:

Some $30 trillion in assets is expected to be shifted to younger generations over the next 30 years, according to Pershing LLC, a subsidiary of Bank of New York Mellon. And advisers typically lose half of the assets they manage when those assets are passed from one generation to the next, a 2011 study by consulting firm PriceWaterhouse Coopers found.

In a survey of 317 advisers conducted in February and March, Pershing found that more than half of their affluent clients had adult children, but advisers had talked about finances with only about a third of those children.

Advisers who don't want to lose those assets should get up to speed on how to win the next generation. The basics: Attract them with engaging events and modern practice-management methods, then retain them with solid financial planning.

The suggested solution is to spend time wooing the kids:

You can start by coordinating a family meeting so your clients can introduce you to their children. Make estate planning the focus so you can explore the family's expectations for their wealth - and try to ferret out situations where the parents and the children might have different financial objectives that could complicate your serving both of them at the same time.

Offer to provide complimentary financial planning to your clients' children. These accounts won't pay big, but the parents will appreciate it. Then hand off those accounts to younger advisers in your office. Not only will this be good practice for them, they'll probably be better at relating to the younger clients.

Focus more on the needs of Gen X and Millennials by "Remodeling for a hipper look":

Consider making over your office to make it more appealing to the next generation, said Wayne Badorf of Wells Fargo Asset Management, a practice-management expert. Put a few magazine-loaded iPads in the lobby, install Wifi and add energy drinks to your complimentary beverages.

You may need to revamp your online image. As long as your compliance officer approves, use your site to link to financial podcasts and interesting websites. And make it a portal for clients to access their statements and make updates to accounts.

Overly conventional thinking
I believe that such approaches are likely to yield disappointing results. When I speak to affluent Baby Boomers, their fears are that their children will not have the tools to properly manage their wealth. Their darkest fear is their kids acquire the Paris Hilton syndrome. A common refrain is, "What happens when my twentysomething son/daughter gets this [six or seven figure] windfall drop in their laps?"

Indeed, the SEC found that financial literacy is a serious issue amongst Americans. A Dodd-Frank-mandated study of financial literacy and concluded that Americans have a low level of financial literacy:

Studies reviewed by the Library of Congress indicate that U.S. retail investors lack basic financial literacy. The studies demonstrate that investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.

A 2009 FINRA study found that investors way over-estimated their own financial knowledge. They were fairly confident about their own abilities, but when asked some basic financial concepts, their understanding was appalling lacking. Here are the questions, which shouldn't be that difficult for anyone who has some basic financial understanding:

Imagine that the interest rate on your savings account was 1% a year and inflation was 2% a year. After one year, how much would be able to buy with the money in this account? [More|Less] (64% correct)
If interest rates rise, what will typically happen to bond prices? (21% correct)
Supposing that you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow? [More than $102|Less than $102] (65% correct)
A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less. [True|False] (70% correct)
Buying a single company's stock usually provides a safer return than a stock mutual fund. [True|False] (52% correct)

Financial literacy + Instilling passion = Value creation
There is a silver lining in this dark cloud. The FINRA study showed that higher income groups were more financially literate than the general population. Nevertheless, I believe that the road to recruiting the next generation of clients is involves a dual-track approach of financial education and instilling a passion for creating wealth. The latter is important because it shifts the attitude of the next generation from viewing the inheritance as consumption (the Paris Hilton symdrome) to wealth generation.

Katherine Lintz of Financial Management Partners seems to have hit the right notes in her approach, according to this Bloomberg report:

They call it “money camp.” Twice a week, 6- to 11-year-old scions of wealthy families take classes on being rich. They compete to corner commodities markets in Pit, the raucous Parker Brothers card game, and take part in a workshop called “business in a box,” examining products that aren’t obvious gold mines, such as the packaging on Apple Inc.’s iPhone rather than the phone itself.

The results have been astounding:

Lintz, 58, is on to something. Her 22-year-old firm was No. 2 among the fastest-growing multifamily offices in the second annual Bloomberg Markets ranking of companies that manage affairs for dynastic clans, Bloomberg Markets magazine reports in its September issue. The assets that FMP supervises grew 30 percent to $2.6 billion as of Dec. 31, just behind Signature, a Norfolk, Virginia-based family office that expanded 36 percent in 2011 to $3.6 billion.

I believe that Lintz has found a formula that many financial advisory firms catering to the HNW market has ignored or didn't know how to approach - the issue of how to recruit the next generation of clients. By combining financial literacy education and an approach that instills a passion for creating wealth, her firm has made its AUM much stickier and fashioned an important tool to recruit older clients who are concerned about these issues of how to pass the family torch.

Investment firms, analysts and advisors spend a lot of time talking and thinking about how companies create value. This is one way of how investment firms can create values for themselves.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

An EM yellow flag

noreply@blogger.com (Humble Student of the Markets) — Wed, 19 Jun 2013 03:49:00 +0000

I wrote last week that I was closely watching the behavior of emerging market bonds to see if we are experiencing just a minor market correction or if this is the start of something worse (see The bear case for equities). EM bonds had stabilized late last week and my inner bull breathed a sigh of relief. Then today(Tuesday), which was a risk-on day for global equity markets, EM bonds took a nasty tumble and set off alarm bells again.

Consider this chart of the relative performance of EMB (emerging market bonds ETF) against HYG (US high yield ETF). EMB successfully tested a key relative support level and rallied. Just as I started to get constructive on the risk-on trade, EMB reversed itself and went south again.

Here is a close-up look of the same chart with a one-year history:

Unlike emerging market bonds, emerging market equities never bounced. Here is the chart of the relative performance of EM equities (EEM) against the MSCI All-Country World Index (ACWI):

What was unsettling was that this EM selloff occurred on a global equity risk-on day when the Dow Jones Industrials was up over 100 points. While the selloff is not terribly surprising as we saw hot money rush into EM as the Fed and other global central banks engaged in repeated rounds of quantitative easing. Most recently, SocGen analyst Kit Juckes wrote that we are seeing the down slope of an emerging markets bubble.

The most likely priximate source of the Tuesday's EM weakness was a reaction to the spike in the Shanghai Inter-bank Offered Rate (SHIBOR), which was an indication of tightening credit conditions in China:

David Keohane of FT Alphaville has an excellent discussion of the Chinese credit conditions and an assessment of the risks here. Walter Kurtz of Sober Look also pointed out that the SHIBOR curve is highly inverted and inverted yield curves are indications of tightening credit conditions and can be precursors to economic slowdowns and recessions.

At this point, the EMB/HYG ratio has not convincingly fallen through relative support. I regard this as a yellow flag and not a red flag. Nevertheless, these readings are indicative of how jittery the markets are.

All eyes are on the Fed. If the FOMC statement is not satisfactory to the markets and the markets sell off, it wouldn't take much to turn the yellow flag into a red flag.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Is the correction over?

noreply@blogger.com (Humble Student of the Markets) — Mon, 17 Jun 2013 07:19:00 +0000

The recent bout of volatility in the capital markets owes much to the turmoil seen in the emerging markets. Both emerging market bonds and equities have recently been hammered on the basis of:

Slower growth in China; and
The whispers of Fed "tapering", which caused an unwind of the risk trade in EM bond and equities.

By the end of the week, it appeared that the storm that was battering the markets was abating. Breadth indicators had reached oversold levels and fear levels were starting to recede. Consider this chart of the NYSE New highs - New lows, which fell to levels consistent with the end of past minor corrections and saw a bounce late in the week.

Bill Luby at VIX and More suggested watching DBV, the currency carry trade ETF, as a measure of risk appetite. Look at the five year weekly chart, DBV fell to the bottom of its Bollinger Band, which is an indication of an oversold condition, and mean reverted late in the week. Such mean reversion rallies from oversold are classic buy signals.

The question then becomes one of whether this is just a minor correction of the start of a bigger bearish impulse in stock prices. As I mentioned earlier, the fear of Fed tapering threw a scare into emerging markets, largely because the QE promise of cheap money pushed a lot of "hot money" into EM and the prospect of an unwinding caused the "hot money" to rush for the exits.

The carnage is particularly acute in emerging market equities. The chart below shows the relative performance of emerging market stocks (EEM) to the MSCI All-Country World Index (ACWI). This longer term chart back to 2008 looks rather ugly. EM equities staged a relative rally in the wake of the Lehman Crisis but topped out in 2010 and they have been underperforming global equities ever since. Earlier this year, EEM broken an important relative support level against ACWI and has been plunging ever since. From a technical viewpoint, there is no bottom in sight.

Emerging market bonds, however, tell a different story. I wrote last week that I was worried about the signal from the EM bond market and to watch the relative performance of EM bonds relative to US high yield market for signs of a break (see The bear case for equities). Lo and behold, EM bond prices recovered strongly late in the week, not only against US high yield, but against 7-10 year Treasuries:

At a crossroads: The Fed, China and earnings
Which is giving us a better signal? EM bonds or equities?

My trader's instincts tell me that, in all likelihood, that the correction is over. The market saw oversold conditions on a number of indicators and the VIX Index hit levels that saw the end of past corrections. The key "tell" were the reversals in these short-term indicators

On the other hand, nagging doubts remain as the sources of volatility are still intact. First and foremost, the prospects of Fed tapering has heightened market volatility? Tim Duy believes that the September FOMC meeting is the most likely point at which the Fed announces that it would start to pull back on QE and his view is becoming the consensus one. He pointed to the likely trajectory of the unemployment rate as one of the key triggers of when the Fed would start to pull back.

On the other hand, Benn Steil and Dinah Walker indicated how difficult it is for the Fed to project unemployment rates by showing how the forecasts have changed over time and the likely effects on the timing of a change in policy.

Moreover, another debt ceiling fight is looming in September. The Hill reports:

A drawn-out debt ceiling fight in Congress could undermine the jobs growth that is expected later this year.

Economists argue that the nation's economic expansion is poised to accelerate in the fall once it weathers the headwinds of tax hikes and spending cuts.

While I recognize that any Fed action is highly "data dependent", would the FOMC move in the face of such fiscal uncertainties?

In all likelihood, Fed will probably calm market expectations about "tapering" in their FOMC statement on Wednesday, as signaled by the Jon Hilsenrath article. Nevertheless, sources of volatility remain as the markets are still highly jittery. Bloomberg reports that regardless of what the Fed has or hasn't done, it has managed expectations to such an extent that it has de facto tightened. Just look at the expectations for Fed Funds rates:

China and the EM contagion effect
In addition, the markets will stay jittery as signs of softness in China emerge, which they have as shown by Ed Yardeni's analysis:

The signals from commodity markets, a key indirect forward looking indicator of Chinese growth, have been mixed. While some key commodities like crude oil have seen prices stabilize and possibly stage upside breakouts...

On the whole, the entire commodity complex remains weak and the downtrend in prices remain intact.

The latest bout of turmoil in emerging market bonds and equities represent a cautionary tale for investors. If the mere whiff of Fed tapering of its QE program is throwing the EM capital markets into a tizzy, what happens if China hard lands if it is unable to successfully navigate its transition from a capital intensive economy to a consumer based economy? The World Bank recently issued a warning on the risks to the Chinese economy (via the BBC):

"The main risk related to China remains the possibility that high investment rates prove unsustainable, provoking a disorderly unwinding and sharp economic slowdown," it warned.

It further added that "should investments prove unprofitable, the servicing of existing loans could become problematic - potentially sparking a sharp uptick in non-performing loans that could require state intervention".

In addition, Fitch has warned that China credit bubble [is] unprecedented in modern world history:

The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.

"The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation," said Charlene Chu, the agency's senior director in Beijing.

"There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signalling," she told The Daily Telegraph.

If China were to slow dramatically, what about the contagion effect? While many global banks can claim that they have little or no direct exposure to China and its shadow banking system, which is a likely source of downside volatility, can the same banks say that they won't be exposed if a Chinese slowdown affects the risk premiums in EM bond and equities? Would these same global banks have the same level of minimal exposure to other EM markets like Poland, Turkey, India, Brazil, Malaysia and Indonesia (just to name a few?)

Sam Ro at Business Insider highlighted a Morgan Stanley research report that showed the history of past EM crises:

He went out to show the effects of the contagion effect on these markets [my emphasis]:

"Most shocks that have created sudden stops in the last 30 years have not been big enough to engulf all of EM, nor did they affect systematically important countries first," write the analysts. "Rather, it was the combination of a shock to a vulnerable economy and contagion that spread the shock to other economies sharing a common characteristic with the economy at the epicenter of the shock."

What about earnings?
As well, the outlook for US equity earnings estimates is a source of uncertainty. Ed Yardeni recently showed that Street estimates for revenues have ticked down, which is bearish:

On the other hand, earnings estimates continue to rise:

Can this be right? The top line estimates are falling but the bottom line estimates are rising? Margins would have to improve. By contrast to Yardeni's analysis, Thomson-Reuters showed that Q2 earnings guidance is the most negative on record:

Most of the negative guidance has been concentrated in the Healthcard, Consumer Discretionary and Technology sectors. We can interpret these readings in one of two ways. The most obvious is, "Wow! Earnings are going to be ugly and stocks are going to get hammered." The more nuanced take is that companies are guiding down expectations so that they can beat Street estimates, so most of the bad news is out already.

I have no idea which is the correct way of interpreting the deluge of negative guidance. Add in the uncertainty of the effects of sequestration, the wobbles last week in consumer confidence offset by the positive surprise in retail sales, you have the ingredients for more uncertainty and volatility.

Correction over?
Is the correction over? I honestly don't know. Last Monday, my Trend Model moved from a "risk-on" reading to "neutral", but my level of confidence in its forecast has fallen because macro uncertainty has risen substantially. We are at a crossroads in terms of market direction. My best forecast is that volatility is likely to continue.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Two view of income inequality

noreply@blogger.com (Humble Student of the Markets) — Wed, 12 Jun 2013 07:03:00 +0000

Recently, I have seen a number of blog posts and articles about the uneven nature of the US economic recovery. Zero Hedge documents how the number of households on food stamps have climbed to a new record.

Over at FT Alphaville, Cardiff Garcia has pointed out that most of benefits of the post-Lehman Crisis recovery have accrued to the wealthy.

You can see the disparity in the consumer confidence figures by breaking them down by income levels.

My inner investor is horrified by these statistics. He could go on and start railing about how rising income inequality will ultimate create social pressures, which will ultimately damage the social fabric of the nation and be very bearish for the US in the long run. As an illustration of this trend, the chart below shows corporate profits as a percentage of GDP (in blue), employee compensation as a percentage of GDP (in red) and the US Gini coefficient, which is a measure of inequality (in green).

Classic economic theory holds that the three factors of production are capital, labor and rents. As the above chart shows, the returns to capital (profitability) has been rising while returns to labor (compensation) has been falling for several decades. Moreover, a rising Gini coefficient indicates that income inequality has been rising. At some point, this will create social pressures that has the potential to tear society apart. The American Dream is about equality of opportunity, not equality of wealth. Any steps that erode the equality of opportunity erodes American competitiveness (see my previous post Another American step to Argentina).

My inner trader is more agnostic. He shrugs and tells my inner investor that these problems have a way of not mattering until they matter. The income inequality situation is exemplified by the Tiffany vs. Wal Mart pair*. As the 10-year chart of the pair shows, the TIF/WMT ratio is rising and is not at an extreme yet and it is exhibiting positive momentum. In fact, my inner trader is more inclined to go long this pair with an eye to the upper end of the band as a target.

The Great Gatsby lives!

* I am being metaphorical. I would not actually trade this pair as a way of playing the income inequality macro trade, as there are highly company specific issues that can affect both TIF and WMT.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Mystery chart leads to FX mystery

noreply@blogger.com (Humble Student of the Markets) — Mon, 10 Jun 2013 11:30:00 +0000

Further to my post Friday night (Would you short this?) From reading the comments, I can see that a lot of my readers got it. The chart is the AUDCAD currency cross. While this currency pair shows the Australian Dollar to be vulnerable to its Canadian cousin, the loonie, it brings up another mystery.

First of all, the pair may not be as technically vulnerable as it initially appeared because it hit a 50% retracement level on Friday despite breaking down from major multi-year support.

I understand how the hedge fund community seems to have piled into the AUDUSD short as the Aussie Dollar has gone into freefall for the last few weeks. The short position has been highly profitable in a very short time.

Here's the head scratcher. Why isn't its Canadian cousin similarly weak against the USD? The structure of the Australian and Canadian economies are very similar as they are both resource based and both about the same size.

Admittedly, Canada did see some surprisingly positive economic releases last Thursday (Ivey PMI) and Friday (employment). On the other hand, how long will it be before all the Aussie shorts pile into a loonie short position as an alternative, especially when the CADUSD remains in a long-term downtrend and it hit a Fibonacci retracement level Friday and backed off? For reference, see these bearish posts on the Canadian Dollar from Sober Look (Canada's latest job report is a mixed blessing) and FT Alphaville (Canada’s grizzly outlook).

Just asking.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The bear case for equities

noreply@blogger.com (Humble Student of the Markets) — Mon, 10 Jun 2013 07:28:00 +0000

I have been fairly bullish in these pages and I remain cautiously bullish today. However, successful investors and traders look at the other side of the coin to see what could go wrong with their thesis. Today, I write about the bear case, or what's keeping me up at night.

The signal from emerging market bonds
James Carville, former advisor to Bill Clinton, famously said that he wanted to be reincarnated as the bond market so that he could intimidate everyone. The message from the bond market is potentially worrying. In particular, emerging market bonds are selling off big time. The chart below of the emerging market bond ETF (EMB) against the 7-10 year Treasury ETF tells the story. The EMB/IEF ratio broke an important relative support level, with little signs of any further support below the break.

Technical breaks like these are sometime precursors of a catastrophic event, much like how the crisis in Thailand led to the Asian Crisis. For now, the concerns are somewhat "contained". Yes, junk bond yileds have spiked...

On the other hand, the relative performance of high yield, or junk, bonds against 7-10 year Treasuries remain in a relative uptrend, which indicates that the trouble remains isolated in emerging markets.

Here is the relative performance of emerging market bonds against junk bonds. They have been in a multi-year trading range. Should this ratio break to the downside, it would be an indication that something is seriously wrong in EM that smart investors would be well advised to sit up and take notice of.

For now, this is just something to watch.

Are European stocks keeling over?
The second area of concern is Europe. Despite my bullish call on Europe (see Europe healing?) European stocks have been performing poorly in this correction. As the chart below of the STOXX 600 shows, the index has fallen below its 50 day moving average, though the 200 day moving average has been a source of support in the past.

The 200 dma is my line in the sand.

Faltering sales and earnings momentum
In the US, high frequency macro indicators are showing a pattern of more misses than beats, as measured by the Citigroup Economic Surprise Index.

Ultimately, a declining macro outlook will feed into Street sales and earnings expectations for the stock market. Ed Yardeni documented the close correlation between the Purchasing Managers Index against revenue estimates.

Viewed in this context, the PMI "miss" last week is especially worrying. Indeed, Yardeni showed that the Street's forward 52-week revenue estimates are now ticking down. Unless margins were to expand, which is unlikely, earning estimates will follow a downward path and provide a headwind for equity prices.

As Zero Hedge aptly puts it, this is what you would believe if you were buying stocks right now:

My take is that the downturn in high frequency economic releases a concern, but it is something to watch and it's not quite time to hit the panic button yet. I agree with New deal democrat in his weekly review [emphasis added]:

After several weeks of more positive signs, last week we returned to the pattern of gradual deterioration that began in February. This week most indicators remain positive and there were fewer negatives...

Last week I said that for me to be sold that the data is actually rolling over, I would want to see a sustained increase in jobless claims and a sustained deterioration in consumer spending. That wasn't happening as of last week, and it certainly didn't happen this week either. The economy still seems to be moving forward - but in first gear.

In summary, most of these concerns are on the "something to watch" list to see if any of these risks turn out to be more serious. My base case, for now, is that the market is undergoing a typical rolling correction, with leadership shifting from interest sensitive issues to deep cyclicals (see my recent post Commodities poised for revival). Until the late cycle commodity stocks roll over, there is probably more upside to stocks from these levels, but I am still looking over my shoulder and defining my risk parameters carefully.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Would you short this?

noreply@blogger.com (Humble Student of the Markets) — Sat, 08 Jun 2013 03:27:00 +0000

Look at this four-year weekly chart. Would you buy, sell, or hold this?

I will write about what it is on Monday and discuss it further.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Commodities poised for revival

noreply@blogger.com (Humble Student of the Markets) — Thu, 06 Jun 2013 07:17:00 +0000

Yesterday's stock market selloff was an event that we haven't seen in some time, as major averages fell over 1% across the board - and globally. Nevertheless, I saw a glimmer of hope for the bulls, as commodities were performing well despite the carnage. If a deep cyclical sector like that is displaying rising relative strength, it suggests that the end of this correction may not be too far off.

Commodities unloved and washed out
Simply put, the commodities complex is unloved, washed out and showing signs of investor capitulation. The chart below from BoAML shows the aggregate large speculator (read: hedge fund) net position from the Commitment of Traders report in the CRB Index. Large speculators have liquidated their net long positions from a near crowded long level to net short. Moreover, readings are consistent where declines have halted in the past.

Here in Canada, the junior resource companies are beyond washed out. The chart below of the relative performance of the junior TSX Venture Index against the more senior TSX Composite is at all-time lows - and below the level of the capitulation lows seen following the Lehman Crisis.

Here in Vancouver, which is the heart of junior mining country, I personally know of scores of well-qualified people who are in the industry who are struggling with the difficult environment.

Green shoots
In the midst of this bleak landscape, I am seeing nascent signs of recovery for the sector. What is encouraging was the positive performance shown during yesterday's ugly selloff. One of the top recent performers has been industrial metals, which has:

Rallied through a downtrend;
Staged an upside breakout through a wedge; and
Staged an upside breakout through a resistance level yesterday - which was impressive given the headwinds provided by the risk trade.

At the same time, gold seems to have made a temporary bottom and it's starting to grind upwards as the precious metal is displaying nascent upside strength.

I am watching carefully the Brent price, which is a better proxy for world oil prices, for signs of an upside breakout through a downtrend. We almost achieved the breakout yesterday, but not quite.

The relative performance of energy stocks against the market is starting to show positive relative strength, which is another early warning of shifting leadership.

Macro and market implications
While I understand that commodities and commodity related stocks are unloved, washed out and poised to rally. These combination of sold-out sentiment and early signs of rising relative strength are pointing to a recovery in these sectors.

From a macro perspective, the recovery of deep cyclical sectors like these are consistent with a relatively upbeat outlook for growth economic growth. In that case, the environment for equities is encouraging and any correction should be relatively shallow - barring any macro surprises,

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Should you have sold in May?

noreply@blogger.com (Humble Student of the Markets) — Mon, 03 Jun 2013 07:19:00 +0000

All it took was someone to whisper "Fed tapering" and volatility has returned with a vengeance to the markets. I explored this topic in late April (see Sell in May?) and outlined various criteria for getting bearish. For now, most of them haven't been met, which means that I am still inclined to give the bull case the benefit of the doubt.

Surveying the Big Three global economies (US, Europe and China), I see signs of healing - which suggest that markets are likely to continue to grind higher, albeit in a volatile fashion. Let's take the regions one by one.

US: Muddling through
As I mentioned, I outlined a number of bearish tripwires in my previous post Sell in May?

Earnings getting revised downwards, or more misses in earnings reports;
More misses in the high frequency economic releases;
Major averages to decline below their 50 dma; and
Failure of cyclical sectors to regain their leadership and defensive sectors to outperform.

With the exception of high frequency economic release data, none of the aforementioned tripwires have been triggered. The chart below shows the decline in the Citigroup Economic Surprise Index, but my own personal impression of high frequency economic data is that the results have been mixed. Even then, bad news may be good news as a weakening economy may provide the impetus for the Federal Reserve to delay any tapering of QE-infinity.

We will have a major test of market psychology this Friday. Supposing that the Non-Farm Payroll misses expectations, will the markets react positively because it is another data point supportive of further QE, or negatively because employment isn't growing as expected?

In the meantime, the major market averages remain in a well-defined uptrend. So why are traders so skittish?

In fact, market participants have been so skittish that it only took a minor decline in the major averages for the percentage of bulls from the AAII survey to tank from a crowded long reading (chart via Bespoke). This kind of nervousness do not typically mark major market tops.

In late April, I also wrote that the bearish case also depended on the continued leadership of the defensive sectors and for cyclical sectors to continue to underperform. Well, those trends reversed themselves dramatically in the month of May. The relative performance chart below of Utilities (XLU) and REITs (VNQ) against the market shows that defensive and yield related sectors took a huge hit in the month:

Meanwhile, cyclical sectors as measured by the Morgan Stanley Cyclical Index have started to turn up against the market. What's more telling is the fact that cyclical sectors performed well in Friday's market selloff.

Europe: The next step in the Grand Plan
Across the Atlantic, I am seeing signs of healing in Europe (see Europe healing?) What's more important is the fact that eurozone leaders are taking steps beyond pure austerity measures to address their structural problems.

Recall during the eurozone crises, many analysts said that there were only two solutions to eurozone problems, which was a competitiveness gap between the North and South. Either Greece (or insert the peripheral country of your choice here) leaves the euro and devalues to regain competitiveness, or the North (read: Germany) makes an explicit political decision to subsidize the South. It appears that the latter is happening (from The Guardian) and the focus issue is youth unemployment:

The French, German and Italian governments joined forces to launch initiatives to "rescue an entire generation" who fear they will never find jobs. More than 7.5 million young Europeans aged between 15 and 24 are not in employment, education or training, according to EU data. The rate of youth unemployment is more than double that for adults, and more than half of young people in Greece (59%) and Spain (55%) are unemployed.

Der Spiegel echoed the German "party line" about youth unemployment:

But a new way of thinking has recently taken hold in the German capital. In light of record new unemployment figures among young people, even the intransigent Germans now realize that action is needed. "If we don't act now, we risk losing an entire generation in Southern Europe," say people close to Schäuble.

The new solution is now direct country-to-country assistance instead of assistance through the usual EU institutions [emphasis added]:

To come to grips with the problem, Merkel and Schäuble are willing to abandon ironclad tenets of their current bailout philosophy. In the future, they intend to provide direct assistance to select crisis-ridden countries instead of waiting for other countries to join in or for the European Commission to take the lead. To do so, they are even willing to send more money from Germany to the troubled regions and incorporate new guarantees into the federal budget. "We want to show that we're not just the world's best savers," says a Schäuble confidant.

The initial focus of the direct assistance is Spain:

Last Tuesday, Schäuble sent a letter to Economics Minister Philipp Rösler in which he proposed that the coalition partners act together. "I believe that we should also offer bilateral German aid," he wrote, noting that he hoped that this approach would result in "significant faster-acting support with visible and psychologically effective results within a foreseeable time period."

Schäuble needs Rösler's cooperation because the finance and economics ministries are jointly responsible for the government-owned KfW development bank. The Frankfurt-based institution is to play a key role in the German growth concept that experts from both ministries have started drafting for Spain. Spanish companies suffer from the fact that the country's banks are currently lending at only relatively high interest rates. But since it is owned by the German government, the KfW can borrow money at rates almost as low as the government itself. Under the Berlin plan, the KfW would pass on part of this benefit to the ailing Spanish economy.

This is how the plan is supposed to work: First, the KfW would issue a so-called global loan to its Spanish sister bank, the ICO. These funds would then enable the Spanish development bank to offer lower-interest loans to domestic companies. As a result, Spanish companies would be able to benefit from low interest rates available in Germany.

The concerns over youth unemployment isn't new. ECB head Mario Draghi spoke about the structural problems relating to youth unemployment in early 2012 (see Mario Draghi reveals the Grand Plan). In a WSJ interview, Draghi discussed what he believed it took to solve the youth unemployment problem [emphasis added]:

WSJ: Which do you think are the most important structural reforms?

Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.

The first step in the Grand Plan was to gradually go after all the entrenched interests of people with lifetime employment and their gold-plated pension plans, etc. In other words, get rid of the European social model:

WSJ: Do you think Europe will become less of the social model that has defined it?

Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.

WSJ: Job for life…

Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.

Now that they are taking steps to clean out the deadwood, the next thing to do is to plant, i.e. directly address the youth unemployment problem. These are all positive structural steps and, if properly implemented, result in a new sustainable growth model for Europe.

In the meantime, the Euro STOXX 50 staged an upside breakout in early May and, despite the recent pullback, the breakout is holding:

Stabilization in China
The bear case for China is this: The leadership recognizes that the model of relying on infrastructure spending and exports to fuel growth is unsustainable. It is trying to wean the economy off that growth path and shift it to one fueled by the Chinese consumer. Moreover, it has made it clear that given a choice between growth and financial stability, the government will choose the latter. This was a signal that we shouldn't expect a knee-jerk response of more stimulus programs should economic growth start to slow down.

Indeed, growth has slowed as a result. The non-consensus call I recently wrote about is that China seems to showing signs of stabilization (see Even China join the bulls' party). Since that post, further signs of stabilization is also coming from direct and indirect indicators of Chinese growth. First and foremost, China's PMI came out late Friday and it beat expectations (from Bloomberg):

China’s manufacturing unexpectedly accelerated in May, indicating that a slowdown in economic growth in the first quarter may be stabilizing.

The Purchasing Managers’ Index rose to 50.8 from 50.6 in April, the National Bureau of Statistics and China Federation of Logistics and Purchasing said in Beijing yesterday. That was higher than all estimates in a Bloomberg News survey of 30 analysts and compares with the median projection of 50, which marks the dividing line between expansion and contraction.

Moreover, the KOSPI in nearby South Korea, which exports much capital equipment into China, is behaving well. This is somewhat surprising as South Korea competes directly with Japan and the deflating Japanese Yen is undoubtedly putting considerable pressure on the competitiveness of Korean exports:

Other indirect indicators of Chinese demand such as commodity prices are stabilizaing. Dr. Copper rallied out of a downtrend and appears to be undergoing a period of sideways consolidation.

A similar pattern can be seen in the industrial metal complex:

Oil prices, as measured by Brent (the real global price), is also trying to stabilize:

Key risks
In summary, the overall picture seems to be one of stabilization and recovery around the world. In such an environment, stock prices can continue to move higher in a choppy fashion. There are, however, a number of key risks to my outlook:

US macro surprise: If we get an ugly NFP this Friday and further signs that US macro picture is slowing, it will negatively affect the earnings outlook and deflate stock prices.
Japan: John Mauldin has a succinct summary of the issues facing Japan that I won't repeat but you should read (see Central Bankers gone wild). The issue of a blowup seems to be one of timing and a catastrophic outcome could be close at hand. With bond yields spiking, how will the economy adjust to rising rates? Already, Toyota has pulled a bond issue because of rising rates. Zero Hedge pointed out how JPM has postulated that "a 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan's banks":

The rise in JGB volatility is raising concerns about a volatility-induced selloff similar to the so called “VaR shock” of the summer of 2003. At the time, the 10y JGB yield tripled from 0.5% in June 2003 to 1.6% in September 2003. The 60-day standard deviation of the daily changes in the 10y JGB yield jumped from 2bp per day to more than 7bp per day over the same period.
As documented widely in the literature, the sharp rise in market volatility in the summer of 2003 induced Japanese banks to sell government bonds as the Value-at-Risk exceeded their limits. This volatility induced selloff became self-reinforcing until yields rose to a level that induced buying by VaR insensitive investors.

An emerging market blowup and subsequent financial contagion: The hints of Fed tapering have negatively affected the emerging market bond market and they are starting to roll over against Treasuries. I am monitoring this chart of emerging market bonds against 7-10 Treasuries carefully for signs of market stress and contagion.

The Short Side of Long has indicated that, in general, sentiment towards equities remain at frothy levels which suggests that a short-term pullback may be in order, However, I am still inclined to stay long equities on an intermediate term basis and give the bulls the benefit of the doubt, but at the same time watching over my shoulder for signs of trouble.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Even China joins the bulls' party

noreply@blogger.com (Humble Student of the Markets) — Wed, 29 May 2013 07:09:00 +0000

It can't be that easy, can it? Was that the correction? The markets melted up yesterday and upside momentum remains strong (though volume was a little lacking).

I wrote about two weeks ago that I was seeing strong upside momentum across the board (see Upside breakouts everywhere). SPY had staged a convincing relative breakout against IEF, the 7-10 year Treasury ETF, and the breakout has held despite last week's weakness:

...though the SPY to TLT ratio remains below a key relative resistance level and more work needs to be done by the bulls:

Last week, I wrote that I was willing to give the bull case the benefit of the doubt for now (see Giving the bulls the benefit of the doubt):

I am inclined to give the bull case the benefit of the doubt for now, though I am maintaining a risk control discipline of tight and trailing stops.

The US economy continues to muddle through without a slowdown and Europe seems to be turning around (see Europe healing?)

Now even China has joined the bulls party. Take a look at the Shanghai Composite, which rallied through a downtrend and is now showing a pattern of higher lows and higher highs:

Despite my worries about the sustainability of China's growth model, I have to listen to the message of the market. With the stock markets of all three global economic blocs exhibiting bullish technical patterns, I have to give in to the Dark Side yet one more time and temporarily set aside my concerns about these overbought and exuberant markets and stay long, albeit with tight stops.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Europe healing?

noreply@blogger.com (Humble Student of the Markets) — Mon, 27 May 2013 07:19:00 +0000

Sometimes things are so bad it can't get any worse. That seems to be case in the eurozone, which is mired in deep recession and possibly a multi-year depression.

Yet I am seeing signs of improvement. Mario Draghi's ECB has moved to take tail risk off the table. What's more, the periphery is starting to turn around. Walter Kurtz of Sober Look noted last week that peripheral Europe is starting to improve:

Today we got the latest PMI numbers from the Eurozone (see figure 2). France is clearly struggling and Germany’s growth has been slower than many had hoped – due primarily to global economic weakness. But take a look at the rest of the Eurozone. While still in contraction mode, it shows an improving trend.

Spain printed a trade surplus last month (surprising some commentators), which may be a signal to rethink how valid some of these forecasts really are. Nobody is suggesting we will see Spain or Portugal all of a sudden begin to grow at 5%. But given the extremely pessimistic sentiment of many economists (a contrarian indicator), it is highly possible we are at or near the bottom of the cycle. People should not be surprised if we start seeing some positive growth indicators – especially in the periphery nations – in the next few quarters.

Indeed, bond yields in the periphery have been showing a trend of steady improvement and "normalization". As an example, look at Italy:

Here is Spain:

Here is the real clincher. Greek 10-year yields have fallen from over 30% to under 10% today:

As a sign of how the bond markets have normalized and how risk appetite has returned to Europe, consider this account of what happened with Slovenia early this month. Slovenia was doing a bond financing, then Moody's downgraded them two notches to junk:

After several days of roadshowing, the troubled Slovenia decided to open books for 5 and 10y bonds on Tuesday (30 April). Given that in the previous weeks peripheral bond markets rallied like mad, it wasn’t too heroic to assume that the book-building would be quite quick. Indeed, in the early afternoon books exceeded USD10bn (I guess Slovenia wanted to sell something around 2-3bn) and then reached a quarter of what Apple managed to get in its book building. If I were to take a cheap shot I would say that Slovenia’s GDP is almost 10 times smaller than Apple’s market capitalisation* but I won’t.

And then the lightning struck. Moody’s informed the government of an impending downgrade, which has led to a subsequent suspension of the whole issuance process. I honesty can’t recall the last time a rating agency would do such a thing after the roadshow and during book-building but that’s beside the point. That evening, Moody’s (which already was the most bearish agency on Slovenia) downgraded the country by two notches to junk AND maintained the negative outlook. This created a whopping four-notch difference between them and both Fitch and S&P (A-). The justification of the decision was appalling. Particularly the point about “uncertain funding prospects”. I actually do understand why Moody’s did what it did – they must have assumed that the Dijsselbloem Rule (a.k.a. The Template) means that Slovenia will fall down at the first stumbling point. But they weren’t brave enough to put that in writing and instead chose a set of phony arguments.

Did the bond financing get pulled or re-priced? Did bond investors run for the hills and scream that Slovenia is the next Cyprus? Not a chance. In fact, the issue sold out and traded above par despite the downgrade:

Then the big day came – books reopened, bids were even stronger than during the first attempt and Slovenia sold 3.5bn worth of 5 and 10y bonds. On Friday, the new Sloven23s traded up by more than 4 points, which means yield fell by more than 50bp from the 6% the government paid. A fairy tale ending.

Key risk: France
From a longer term perspective, the elephant in the room continues to be France (see my previous post Short France?). French economic performance continues to negatively diverge with Germany. This isn't Greece or Ireland, whose troubles could be papered over. France is the at the heart of Europe and the Franco-German relationship is the political raison d'etre for the European Union. France cannot be saved. It can only save itself.

Despite these dark clouds, the markets are relatively calm over France. The CAC 30 is actually outperforming the Euro STOXX 50:

From a global perspective, European stocks are also showing a turnaround against the All-Country World Index (ACWI):

I am watching this carefully. European stocks could turn out to be the new emerging leadership and the source of outperformance.

Full disclosure: Long FEZ

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Giving the bulls the benefit of the doubt

noreply@blogger.com (Humble Student of the Markets) — Fri, 24 May 2013 07:12:00 +0000

OK, I was partially right. On Monday, I wrote that commodities were setting up for a rebound (see Commodities poised to rally?):

All of these conditions are lining up to suggest that commodities are poised to rebound. The euro, commodity sensitive currencies and gold are all at key technical support levels. As I write these words, precious metal prices are substantially in the red. Watch for signs of stabilization, or better yet, reversal on the day. If that were to happen, expect that the rotation back into cyclical sectors will continue and stock prices to continue to grind higher.

I was partly right. Gold appears to be turning around here, though it is more correlated with the safety trade than the risk trade. The chart of GLD below shows a constructive bottoming process, with overhead resistance at about the 150 level.

On the other hand, the rotation into deep cyclicals hasn't fully developed yet. Consider copper as an example. The red metal has rallied through a downtrend and seems to be consolidating sideways.

Other industrial metals remain in a downtrend, though.

And oil prices, as measured by Brent global oil price benchmark, are still in a downtrend and has not participated yet in a commodity upswing.

Though natural gas seems to march to beat of its own drummer as it staged an upside breakout, driven by positive fundamentals.

I remain constructive on the rotation into the deep cyclicals. Despite the market's freakout over Bernanke's off the cuff remarks* about the possibility that the pace of QE might be tapered, followed by a poor HSBC manufacturing PMI out of China and Japanese stocks cratering by 7% (though they are recovering as I write these words), the technicals for the cyclical trade looks intact. Consider this relative performance chart of the Morgan Stanley Cyclical Index (CYC) against the market. These stocks held up well in light of the mini-panic over the last couple of days.

Joe Fahny wrote that he is seeing very jittery traders and signs of panic, which suggests to me that any pullback is likely to be short-lived:

Today is May 22, 2013. The general market declined by less than 1% (0.82% to be exact) and my phone has been blowing up with panic by people who are IN the market!!! My trading friends are either calling or texting me with serious worry, and even a few stories of mini “blow-ups” today. I’ve never seen anything like this in my 17 year career! God help these people when (not if) we get a serious correction.

As well, Barry Ritholz pointed out this piece of analysis from Jeff deGraaf [emphasis added]:

Jeff deGraaf, technician extraordinaire (formerly of Lehman now at Renaissance Macro Research) makes an interesting observation about the heavily overbought markets.

Last week, the S&P500 had ~93% of all stocks trading over their 200 day moving average. Normally, this degree of overbought should lead to a correction. As you can see in the inset box, it sometimes does.

However, if you are looking out a year, we see that over the past 3 instances, markets have been higher.

Is the market overbought? Yes. But these conditions constitute what my former Merrill Lynch colleague Walter Murphy termed a "good overbought" condition.

I am inclined to give the bull case the benefit of the doubt for now, though I am maintaining a risk control discipline of tight and trailing stops.

* Paul Volcker once remarked that as Fed Chairman, he was so guarded about his public remarks that if he went to a restaurant, he would say, "I'll have the steak, but that doesn't mean that I don't like the chicken or the lobster."

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Commodities poised to rally?

noreply@blogger.com (Humble Student of the Markets) — Mon, 20 May 2013 07:25:00 +0000

Much has been made of the upside technical breakout experienced by the US Dollar last week, but when I dissect the components of USD strength, I found that much of the breakout was attributable to Yen weakness. In fact, the other components of USD are all testing support, which suggests that the euro and commodities are poised to rally here.

At first glance, the USD breakout looks impressive, especially on the weekly chart:

Now consider how weak the JPYUSD has been:

Now consider the EURUSD rate, which is testing technical support:

The commodity weakness story is well known. Disappointment over Chinese growth has been a principal driver, but the flip side of that coin has been USD strength. The commodity sensitive Aussie Dollar is also testing a key technical support zone:

So is its cousin, the Canadian Dollar.

In fact, if you were to consider the EURAUD cross as a measure of the strength of Europe, the euro is turning up against the commodity sensitive Aussie Dollar as it has staged an upside breakout through a resistance level. Viewed in that context, is the euro that weak or is it just weak against the USD?

As I have shown, most of the other components of the USD Index other than the Yen are sitting on technical support. I also wrote to watch for the re-test of the recent bottom in gold as a clue to market direction (see The golden canary in the coalmine). As the chart below shows, GLD hit that technical re-test level on Friday and the silver/gold ratio is stabilizing indicating that most of the blind panic selling of gold is over.

All of these conditions are lining up to suggest that commodities are poised to rebound. The euro, commodity sensitive currencies and gold are all at key technical support levels. As I write these words, precious metal prices are substantially in the red. Watch for signs of stabilization, or better yet, reversal on the day. If that were to happen, expect that the rotation back into cyclical sectors will continue and stock prices to continue to grind higher.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Upside breakouts everywhere

noreply@blogger.com (Humble Student of the Markets) — Wed, 15 May 2013 07:24:00 +0000

As the major US averages grind to more new highs, I am seeing signs of confirmed upside breakouts everywhere. Consider, for example, this relative performance chart of SPY against IEF, which is the ETF for 10-year Treasuries. The ratio staged an upside breakout on the weekly chart, with relative resistance a some distance away indicating considerable upside potential for stocks.

Across the Atlantic, the FTSE 100 staged an upside breakout:

The same could be said of large cap eurozone stocks, as represented by the Euro STOXX 50:

And then there's Greece. Yes, remember that Greece? The Greece whose rating that Fitch recently upgraded.

The European markets are healing, as the WSJ reports even Greek companies are now tapping the bond markets for financing:

Greek commercial refrigeration and glass bottle producer Frigoglass’s debut bond sale is the latest sign investors are growing more optimistic about Greece, the company’s chief executive said in an interview with Dow Jones Newswires Tuesday.

Frigoglass Monday sold a €250 million ($324.3 million) five-year bond–the second debt sale from a Greek company in as many weeks as the country’s corporate bond market emerges from a deep freeze.

The risk-on mood was also reflected in this account of Slovenia's successful bond financing, after Moody's downgraded the country to junk after its roadshow:

Then the big day came – books reopened, bids were even stronger than during the first attempt and Slovenia sold 3.5bn worth of 5 and 10y bonds. On Friday, the new Sloven23s traded up by more than 4 points, which means yield fell by more than 50bp from the 6% the government paid. A fairy tale ending.

Key risks
Though momentum is positive for stocks in most developed markets, it isn't necessarily all clear sailing ahead. My biggest concern is that China and China related plays look punk. Here is the Shanghai Composite in a well defined downtrend:

Industrial commodities are also exhibiting a similar downtrend pattern:

The AUDCAD currency cross, where Australia is more China sensitive and Canada more US sensitive, looks downright ugly.

In the US, Ed Yardeni pointed out that forward Street consensus earnings growth is showing signs of stalling. While this isn't a bearish signal yet, it does bear watching. Should forward estimates growth turn negative, it would create considerable headwinds for equities.

My takeaway from the current environment of powerful stock momentum is, "It's ok to get long, but don't forget to look over your shoulder and maintain a tight risk control discipline."

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The golden canary in the coalmine

noreply@blogger.com (Humble Student of the Markets) — Mon, 13 May 2013 07:26:00 +0000

Shortly after the market closed, the WSJ published Jon Hilsenrath's article Fed Maps Exit From Stimulus in which the Fed discusses a gradual withdrawal of QE:

Federal Reserve officials have mapped out a strategy for winding down an unprecedented $85 billion-a-month bond-buying program meant to spur the economy—an effort to preserve flexibility and manage highly unpredictable market expectations.

No doubt the markets will get spooked by this "leak" and as I write these words, ES futures are moderately in the red. The question is, "How much and how far?"

Watch gold for clues to market direction
For me, the canary in the coalmine is the gold price, which is highly sensitive to expectations of monetary stimulus. Gold has staged a tactical V-shaped bottom and the silver/gold ratio has stabilized, which is constructive (see Watching silver for the bottom in gold). Gold rallied to fill in the gap left by its free fall in April - so now what?

With the news that the Fed is starting to think about an exit from QE, the near term downside risk is evident. There are many opinions about the fallout of this "leak". Josh Brown has two sides of the story. On one hand, he believes that with sentiment excessively bullish, we are tactically headed for a hard correction. On the other hand, he seems more relaxed longer term.

As for myself, I am watching for a re-test of the April lows in gold to see if that low can hold as a sign for the risk-on trade. Longer term, the April decline caused considerable short-term technical damage, but the long-term uptrend remains intact. The other key issue is whether the uptrend can hold here.

A Lost Decade or a "beautiful deleveraging"?
Will this Fed action be a repeat of the Japanese experience where the authorities go through ease-tighten cycles that caused ups and downs in stock prices? This will be a test of Ray Dalio's beautiful deleveraging thesis where the United States has undertaken just the right mix of austerity, money printing and debt restructuring.

David Merkel wrote a timely post recently entitled Easy In, Hard Out (updated):

My view is that there is no such thing as a free lunch, not even for governments or central banks. Any action taken may have benefits, but also imposes costs, even if those costs are imposed upon others. So it is for the Fed. At the beginning of 2008, they had a small, clean, low duration (less than three years) balance sheet on assets. Today the asset side of their balance sheet is much larger, long duration (over 6 years), negatively convex, and modestly dirty as a result.

He went on to outline the risks [emphasis added]:

Fed tightening cycles often start with a small explosion where short-dated financing for thinly capitalized speculators evaporates, because of the anticipation of higher financing rates. Fed tightening cycles often end with a large explosion, where a large levered asset class that was better financed, was not financed well-enough. Think of commercial property in 1989, the stock market in 2000 (particularly the NASDAQ), or housing/banks in 2008. And yet, that is part of what Fed policy is supposed to do: reveal parts of the economy that are running too hot, so that capital can flow from misallocated areas to areas that are more sound. At present, my suspicion is that we still have more trouble to come in banking sector. Here’s why:

We’ve just been through 4.5 years of Fed funds / Interest on reserves being below 0.5% — this is a far greater period of loose policy than that of 1992-1993 and 2002 to mid-2004 together, and there is no apparent end in sight. This is why I believe that any removal of policy accommodation will prove very difficult. The greater the amount of policy accommodation, the greater the difficulties of removal. Watch the fireworks, if/when they try to remove it. And while you have the opportunity now, take some risk off the table.

Zero Hedge put it more forcefully:

It is possible a steep decline in financial assets would ensue with the lowest part of the capital structure being hurt the most. The Fed has chased investors all in the same direction; into risk-seeking securities. Few care about “right-tail” events, but should investors decide to pare risk in reaction to a hint of ‘tapering’, the overshoot to the downside may surprise many. The combination of too many sellers, too few buyers, and dreadful (and declining) liquidity means a down-side overshoot is highly likely. It would provide the Fed with their answer as to whether they have been creating market bubbles.

It appears that the Federal Reserve is well aware of these risks. In a speech last week, Ben Bernanke said that the Fed was closely monitoring the market for signs of excessive risk appetite, such as reaching for yield [emphasis added]:

We use a variety of models and methods; for example, we use empirical models of default risk and risk premiums to analyze credit spreads in corporate bond markets. These assessments are complemented by other information, including measures of volumes, liquidity, and market functioning, as well as intelligence gleaned from market participants and outside analysts. In light of the current low interest rate environment, we are watching particularly closely for instances of "reaching for yield" and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals. It is worth emphasizing that looking for historically unusual patterns or relationships in asset prices can be useful even if you believe that asset markets are generally efficient in setting prices. For the purpose of safeguarding financial stability, we are less concerned about whether a given asset price is justified in some average sense than in the possibility of a sharp move.

The Fed being aware of a problem is the first step. Whether they can either react, either preemptively or after the fact, in the correct manner is another problem.

I prefer to watch the golden canary in the coalmine to see how the markets react, or over-react to the news that the Fed is mapping out a plan to gradually withdraw from quantitative easing.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The 3rd Way in the cyclical/defensive debate

noreply@blogger.com (Humble Student of the Markets) — Wed, 08 May 2013 07:02:00 +0000

Here's a thought. About a month ago, I wondered out loud that whether the defensive sector rally could be better characterized as the outperformance of Value over Growth stocks (see A Value rally, or a defensive sector rally?)

Now that cyclical (and growth oriented) sectors have surged relative to the defensive sectors, the Value stocks have similarly pulled back against Growth stocks. The chart below of the Russell 1000 Value Index relative to the Russell 1000 Growth Index shows that the relative uptrend of Value vs. Growth is still intact.

If my analysis of Value vs. Growth is the more appropriate framework, then it may be time to start buying Value now (and it may represent the third way in the cyclical vs. defensive sector debate of whether the cyclical rebound is a fakeout or true revival).

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Secular bull or bear?

noreply@blogger.com (Humble Student of the Markets) — Mon, 06 May 2013 07:14:00 +0000

As US equities have rallied in the last couple of weeks, there has been much discussion about the rotation in sector leadership from defensively oriented sectors to the deep cyclical sectors. Does the rotation mean that this market is truly ready to take off to further new highs? What does it all mean?

I have spent a fair amount of time pondering that question (see my recent post Sell in May?). My conclusion is where you come down on the question of whether this is the start of a new secular bull market where stocks move to new highs or whether we are just seeing the top of a range-bound secular bear.

To explain, consider this long-term chart of the Dow, where the market has seen alternating secular bulls, where stocks rally to multi-decade highs, and secular bears, where the market remains range-bound for years.

Still a secular bear market
My main belief is that we remain in a secular bear for two main reasons: demographics and valuation. I have written about the demographics issue before (see Demographics and stock returns and A stock market bottom at the end of this decade). For stocks to go up, there has to be more buyers than sellers at a given price. The propensity of Baby Boomers, as they move into retirement, is to take money out of stocks. In order for equities to rise, those negative fund flows have to be met by the retirement savings of their children, the Echo Boomers. Two research groups looked into this topic (see papers here and here). Their conclusion - the inflection point at which the fund flows of Echo Boomers moving into stocks start to overwhelm the Baby Boomers taking money out is somewhere between 2017 and 2021.

In addition, long-term valuations don't appear compelling. I have long considered the market cap to GDP ratio as a proxy for an aggregate Price to Sales ratio for the stock market. The chart below from Bianco Research via Barry Ritholz, shows this metric, whose history goes all they way back to 1925, to be well above its long-term average. In addition, note that instances of falling market cap to GDP ratios correspond with secular range-bound bear markets.

Another reason for the long-term secular bear case comes from John Hussman, an investor for whom I have much respect. His latest 10-year return projections for the SPX is about 3.5% (see My answer to John Hussman). Even with bonds yields at microscope levels, a 3.5% return expectation for US equities is nothing to get overly excited about.

The bull case (and it's always important for investors to consider opinions contrary to his own) is represented by Ray Dalio's "beautiful deleveraging" concept (see my post Falling tail risk = new secular bull?). Dalio believes that the United States has undergone a "beautiful deleveraging" process in the wake of the financial crisis of 2008. A "beautiful deleveraging" involves just the right amount of austerity, debt restructuring and money printing. He went on to observe that, by contrast, Europe has gotten it all wrong and that region is likely to be mired in a Lost Decade.

If Dalio is correct, then the rotation that we are observing from defensive to cyclical sectors is another sign of a new upleg in equity prices and therefore the start of a new secular bull.

The intermediate term outlook
While my analysis of the secular bull vs. bear is based on a long-term multi-year investment time frame, what about the intermediate term time frame for the next several weeks to months?

Here's what's bothering me about the emergence of the cyclical leadership. First of all, commodities look positively sick. Here is a chart of the industrial metals. Does this look like the basis for a cyclical rebound?

In addition, the Citigroup Surprise Index has been turning down, both in the US and globally. Despite Friday's NFP upside surprise, the internals of the employment report appeared to be negative and it was before long that there were a cacophony of voices pointing out the weaknesses in the report (for examples, see here, here and here).

I agree with the blogger MicroFundy when he pointed out the divergences between the macro picture and US stocks:

I think we are getting real close to a major inflection point. It seems like every macro-economic data point I come across is saying one thing – the same thing. There is an extremely high correlation between all the varying data points and indicators. Data like the 10yr treasury yields, PMI manufacturing, durable goods orders, copper prices, international (ex Japan) stock markets, inflation expectation, margin levels etc – are all saying that the (global &) US economy is slowing, and that the risks of deflation/contraction/recession are growing.

The only thing diverging from this pattern in all of the charts below is the US equity markets.

His conclusion is "something's gotta give":

There are two extreme scenarios that can “correct” the above divergence, although I believe it will be a combination of the two.

1 – We could see a correction of 15-20% that would put the US equity markets back in line with most of the charts above. It would then be priced closer to fair value based on most of the recent economic data.

2 – The economic data can pop back up. Whether it was because of the payroll tax increase, sequestration, or some other seasonal event(s)… maybe this is/was just a blip on the radar these last few months, and the economic data will “catch up” to the US equity markets.
If these scenarios were mutually exclusive, I would bet the farm on #1. A realistic base case assumption though, is a combination of the two. I am anticipating a good 10% correction combined with a small pickup in some of the macro data.

Either way, something’s gotta give. The level of divergence here is bordering historical, and the relative and absolute over-valuation of some of these high-yield names are frightening.

With Europe mired in recession, commodity markets signaling that Chinese growth is stalling, the US is once again holding up the world. If the American economy is holding up the world, then why is US equity performance faltering against global equities? The chart below shows the relative performance of SPY against ACWI (All-Country World Index). If we are indeed seeing a launch of a new secular bull, shouldn't the US, which has been the beneficiary of the "beautiful deleveraging", be leading?

A bearish bias
While I have outlined my bias for the bear case, investing is about probabilities and I honestly don't know how this market is going to resolve itself. While the bear case is compelling, Street earnings and revenue estimates continue to get revised upwards (as per Ed Yardeni).

Until we see some sort of negative macro surprise that cause estimates to get revised downwards, the stock market is likely to grind higher. As I wrote last week, there is no catalyst yet for a bearish impulse for stocks yet.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Tech revival? Watch AAPL

noreply@blogger.com (Humble Student of the Markets) — Fri, 03 May 2013 14:55:00 +0000

There was some excitement this week about the relative breakout of the Technology sector against the market:

Given the dominant weight of Apple in the Technology sector, consider the relative performance of an equal weighted Tech index. the equal-weighted NASDAQ 100 (QQEW) against the SPX. While the XLK has rallied out of a relative downtrend against SPX, QQEW remains range-bound against the market. In other words, the average Tech stpcl has performed in line with the market in general.

The rally out of the downtrend is far more evident in AAPL:

So if you start to get excited about the potential rally in Technology stocks, pick the appropriate benchmark and know what you are betting on.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Technical analysis as behavioral finance

noreply@blogger.com (Humble Student of the Markets) — Fri, 03 May 2013 07:18:00 +0000

A couple of items came across my desk that, in combination, made me think about how we think about finance today. The first was Mark Buchanan's review of Gary Gorton's book Misunderstanding Financial Crises where the author took down the blindness of economists and, by extension, the theory of rational expectations [emphasis added]:

I think it's the most convincing book I've read so far that links the mechanisms of the recent crisis to crises in the past. In effect, he argues that the crisis was the direct result of the uncontrolled creation of money by the shadow banking sector, and ultimately took place as a classic bank run, no different from runs in the past, except that this run took place mostly out of public view because it didn't involve ordinary bank deposits. The new kind of money in this bank run was stuff such as repo agreements and commercial paper which played the role of money for financial institutions. In 2007-2008, when lenders lost confidence (for good reason) in the mortgage-backed collateral backing this money, they demanded that money back, and the financial system seized up.

The explanation is convincing and wholly natural. The argument is most convincing because Gorton does a masterful job of placing this bank run in the context of the long history of past runs. And also because Gorton, as an economist, places blame squarely on the economics profession (himself included) for being asleep at the wheel:

Think of economists and bank regulators looking out at the financial landscape prior to the financial crisis. What did they see? They did not see the possibility of a systemic crisis. Nor did they see how capital markets and the banking system had evolved in the last thirty years. They did not know of the existence of new financial instruments or the size of certain money markets. They did not know what "money" had become. They looked from a certain point of view, from a certain paradigm, and missed everything that was important... The blindness is astounding. That economists did not think such a crisis could happen in the United States was an intellectual failure.

It seems to me that there is a certain amount of denial among economists. I have noticed, in talking about the ideas in this book with my economist colleagues, that there is a fairly clear generational divide on this. To younger economists and graduate students, it is obvious that there was an intellectual failure. Some older economists are inclined to hem and haw, resorting to farfetched rebuttals. It is clear that this is a sensitive issue, as like banks no one wants to have to write down the value of their capital.

...One other thing of interest. Gorton in a late chapter, when discussing the spectacular failure of the rational expectations paradigm, quotes University of Chicago economist James Heckman, winner of the economics' Nobel Prize (yes, that's not its actual name) in 2000, from an interview he did with John Cassidy in 2010.

Why didn't economists saw the financial crisis coming? What happened to rational expectations?

In a recent interview, Nobel laureate Daniel Kahneman explained his problem with the rational agent and rational expectations hypothesis this way:

Think of the kind of market that Adam Smith described. You can get a lot of insight into how just the right amount of bread gets to London in the morning by assuming that the baker and the other participants in the market pursue their own interests in a sensible manner. The rational-agent model takes this idea to its logical extreme. If you want to predict the behavior of a market, you are best off assuming individual agents who act in a way that is predictable and fairly simple—for example by assuming that the participants are similarly motivated and exploit all their opportunities. I am not an economist, but I find it hard to imagine that they will ever give up the use of schematic individual agents, even if they endow these agents with a little more realistic psychology. And I see no reason why they should.

The rational agent model has more questionable consequences in the domain of policy because the assumption that individuals are rational in the pursuit of their interests has an ideological coloring and policy implications that many would view as unfortunate. If individuals are rational, there is no need to protect them against their own choices. At the extreme, no need for Social Security or for laws that compel motorcycle riders to wear helmets. It is not an accident that the department of economics at the University of Chicago, one of the most illustrious in the world, is known both for its adherence to a strict version of the rational actor model and for very conservative politics.

Rational expectations: Is this an anomaly?
The other item of note was a post at George Washington's blog (via Zero Hedge) showing how much more likely an American is to die from heart disease, car accidents and other common causes of death than from terrorism:

– You are 17,600 times more likely to die from heart disease than from a terrorist attack
– You are 12,571 times more likely to die from cancer than from a terrorist attack
— You are 11,000 times more likely to die in an airplane accident than from a terrorist plot involving an airplane
— You are 1048 times more likely to die from a car accident than from a terrorist attack

Now ask yourself, how much has the United States government spent on combating terrorism compared to heart disease, cancer and automobile accidents? If this had been academic finance literature, then these mis-pricing or mis-allocation of resources would be termed an anomaly, much like low P/E or small capitalization were deemed to be market anomalies in the 1970's.

Here's another thought from the Chicago school: If the world needed to be rid of terrorism, or __________ [insert the dictator of your choice], wouldn't the market have done it?

In praise of behavioral finance
Behavioral finance is the school of thought that tries to understand human behavior in the context of what "should" be rational expectations. I have long believed that technical analysis is a branch of behavioral finance.

I recently wrote an essay about the evolution of thinking about technical analysis and why it works. You can read it here.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Negative divergences

noreply@blogger.com (Humble Student of the Markets) — Wed, 01 May 2013 07:50:00 +0000

Further to my last post (see Sell in May?) I am seeing more negative divergences that create more concerns for the bull case. The recent rally, which has been led by the golds and deep cyclicals, have all the appearances of a dead cat bounce rather than the start of a sustainable advance.

Last week, I suggested that traders should watch the silver/gold ratio for signs of a sustainable rally (see Watch silver for the bottom in gold). The idea was that silver, being the more volatile poor man's gold, should display positive relative strength against gold and lead a precious metal rally if these metals are in the process of making a sustainable bottom. Look at what's happened to the silver/gold ratio since then:

We can see how the oversold rally developed by analyzing the price charts of the gold and silver ETFs. GLD has certainly staged a classic capitulation and rally pattern to fill in the gap left by its recent freefall:

But what about silver? Sure, this poor man's gold rallied, but the rebound has been weak and the gap was not filled, which suggests to me that this advance is an oversold rally and the next major move in precious metals is likely to be down.

As confirmation of the bearish commodity trend, the entire industrial metals complex remains weak despite the rebound in gold and oil:

In my previous post, I also wrote about watching the AUDCAD currency cross rate, with the premise that the Australian Dollar is more sensitive to growth in China and the Canadian Dollar is more sensitive to growth in the American economy. A breach of the uptrend in this cross rate would would be a signal that the market's belief that Chinese growth is slowing, which would be negative for the global growth outlook. The breakdown in this currency pair cannot be regarded as good news for the prospects of Chinese growth.

Another concern is the disappointing South Korean April exports, which were just released and missed expectations at 0.4% compared to estimates of 2.0%. The South Korean economy is regarded as cyclically sensitive as the country is highly exposed to trade with China and Japan.

In addition, Cullen Roche at Pragmatic Capitalism recently pointed out that the Citigroup Economic Surprise Index is turning down in every major region in the world. As a reminder, a economic surprise index reading below zero is indicative of more misses than beats on economic data. Falling surprise indices around the world suggests, therefore, that global economic growth is starting to stall.

As we wait for the decisions of the Federal Reserve and ECB this week, it will be a test of market psychology of whether bad news is good news, i.e. economic slowdown will lead to central bank stimulus, which is bullish, or bad news is bad news.

Non-confirmation of SPX new highs
Moreover, with the SPX making new marginal highs, I am not seeing the breadth confirmations from the 52-week highs and lows. While these kinds of breadth divergences can last for months, it nevertheless raises a red flag about the sustainability of this stock market rally.

Here's another puzzle. If the stock market is making new highs, why is the VIX/VXV ratio (which I described in a previous post here and first pioneered by Bill Luby, see his original post) sitting at only 0.91, which is barely below my "sell signal" mark of 0.92? What is the term structure of the option market telling us?

This is not investment advice
One final point. I have outlined a number of negative divergences that suggest a bearish tone for stocks, but I have not outlined the timing of any trades. In my last post entitled Sell in May? I sketched out a number of likely triggers for to get more defensive. Since then, I have had a number of emails and other responses asking if and when I would write about when those events are triggered and, by extension, when it's time to sell or short the market.

Let me make this very, very clear: Those triggers are just a set of suggested triggers. It will be up to each individual reader to make up his or her own mind as to what to do if and when each event is triggered. Don't expect me to hold your hand and shout "sell" for you. You are responsible for your own portfolio and your own profit and loss statement.

For the readers who are waiting for me to tell when to buy or sell, I strongly suggest that you re-read my previous post about why the contents of this blog does not represent investment advice. This blog is a forum for discourse, not pre-digested investment or trading advice.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Sell in May?

noreply@blogger.com (Humble Student of the Markets) — Mon, 29 Apr 2013 07:07:00 +0000

As we approach the end of April, the inevitable question of seasonality arises. Is it time to sell in May and go away?

While many of my intermediate and long term technical indicators are starting to line up, indicating that it may be prudent to start selling now, I am not seeing the bearish trigger yet. To review, let's consider the charts from the three major regions of the world, US, Europe and China.

What does defensive leadership mean?
In the US, the stock market remains in an uptrend. The SPX, as shown below, remains in an uptrend and it is above both its 50 and 200 day moving average. For traders, it may be premature to get overly bearish without some catalyst or trigger.

The warning signs are there. Defensive sectors have been leading the market. Analysis from Thomson-Reuters shows that the defensive sectors have fared the best in the May-October period during the 21st Century. Is the market is anticipating a downturn or correction?

Consider the chart below of the relative performance of Utilities against the market. The sector appears to be making a saucer shaped relative bottom, which is an indication that the intermediate term outlook for relative performance is positive.

Similarly, look at the relative performance of Consumer Staples. The sector staged a relative upside breakout in late March and remains in a relative uptrend, though it got over-extended and pulled back last week.

As well, take a look at the relative performance chart of Healthcare. Like Consumer Staples, this sector staged a relative upside breakout in March and has also pulled back recently, though the relative breakout remains intact.

Meanwhile, cyclical stocks appear to be rolling over against the market. The chart below of the Morgan Stanley Cyclical Index against the market shows CYC to be failing at a relative resistance level and starting to roll over in relative performance.

The defensive vs. cyclical theme has also played out in the real estate sector. Consider the relative performance of the cyclically oriented homebuilding group, which was on a tear for all of last year, but it is now consolidating sideways after violating a relative uptrend.

By contrast, the chart below of the relative performance of the more defensively and yield oriented REITs against the market shows that this group staged a relative upside breakout in early April, pulled back but the relative breakout remains intact.

Premature to go short
Is it time to get bearish and get short the market? Not yet. I consider the US market to be at a crossroad. The rally last week was led by an oversold bounce in gold and other resource sectors. As the chart below shows, gold has rallied to mostly fill the gap from its recent freefall. We now need to watch if there is any follow through or if gold (and the stock market/risk-on trade) can continue upwards from here.

Another bearish setup has been the relative performance of stocks to Treasuries. As the relative performance chart below shows, stocks remain in a minor relative downtrend to bonds after breaking down from a recent relative uptrend.

In addition, the longer term chart of the 10-year yield shows that bond yields remain in a downtrend and the recent uptick looks like a flag pattern, which is a continuation pattern indicating that bond yields are likely to fall further. As well, David Rosenberg (via Pragmatic Capitalism) indicated that recent sentiment polls showed that there were virtually no bond bulls around. If bond yields fall (and bonds therefore rally), it would likely be bearish for stocks.

However, stocks continue to grind upward because of its fundamental underpinnings of positive earnings momentum. Earnings Season is coming roughly in line with historical experience. Thomson-Reuters reports that with about 20% of the SPX companies reporting, 67% of the companies have beaten earnings expectations, which is in line with the historical experience, but only 44% have beaten on revnues. Nevertheless, Ed Yardeni pointed out that forward earnings estimates are still rising - which should support the bullish impulse in stocks.

To get more bearish on US equities, I would like to see some combination of:

Earnings getting revised downwards, or more misses in earnings reports;
More misses in the high frequency economic releases, e.g. New Deal Democrat pointed out that much of the miss in last Friday's GDP report was attributable to a fall in government spending;
Major averages to decline below their 50 dma; and
Failure of cyclical sectors to regain their leadership and defensive sectors to outperform.

Europe: Waiting for the ECB?
Moving across the Atlantic, the pattern of the European bourses bear an uncanny resemblance to the American one. Despite the well publicized problems in the eurozone, European stocks remain in an uptrend. The chart below of the STOXX 600 shows the index to be above its 50 and 200 day moving averages, though there is some work for the bulls to do as the index is approaching overhead resistance.

As well, I pointed out last week (see Commodity weakness is likely localized) that peripheral country markets were outperforming the core European markets even as stocks declined. This is evidence of rising risk appetites in Europe.

It appears that the market is expecting further stimulus from the European Central Bank this week. Recent economic releases have been so weak, so bad that they're good. Conditions have weakened to the extent that the ECB may be forced to take further action to stimulate the eurozone economies. As Benn Steill and Dinah Walker of the Council on Foreign Relations pointed out, a rate cut is not necessarily a done deal as it may run counter to the ECB's price stability mandate:

In those Eurozone countries where the monetary transmission mechanism is still working normally—Austria, Finland, France, Germany, and the Netherlands—the GDP-weighted-average inflation rate is 1.8%, right near the ECB’s target. France, with 1.1% inflation and 10.8% unemployment, would appear a strong candidate for a rate cut, but not the others. Germany has 1.8% inflation and only 5.4% unemployment. The other three all have above-target inflation rates: Austria at 2.4%, Finland 2.5%, and the Netherlands 3.2%. Austrian unemployment is low, at 4.8%. Dutch unemployment is a moderate 6.4% Only Finnish unemployment is high, at 8.2%.

Some will argue that a bout of robust inflation in the north is just what is needed to restore competitiveness in the south. But the ECB will have to willfully ignore its price-stability mandate if it is to justify a rate cut right now, and it will almost certainly need to apply more radical tools if it is to aid the south quickly. “The ECB is obviously in a difficult position,” German Chancellor Angela Merkel said on April 25. “For Germany, it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing.”

In Europe, my bearish triggers are a combination of watching for:

Peripheral market underperformance
A possible negative reaction to ECB action. Assuming that there is a rate cut, could the market buying the rumor and selling the news?

China: Markets shrugging off weakness
In China, most of the recent economic releases have been below Street expectations. What's more worrying are indications that the new leadership is more concerned about financial system stabililty than growth (via Kate Mackenzie of FT Alphaville):

The official Xinhua report is here and its headline suggests some worry at the economic growth rate. “China needs to cement its domestic economic growth momentum and guard against potential risks in financial sectors,” seems to be the key line, from the third paragraph, although it goes on to point out that Q1′s 7.7 per cent growth that had many China watchers worried was in fact higher than the 7.5 per cent official target.

Then there’s this:

While focusing on improving the quality and efficiency of economic development, the country should keep a proactive fiscal policy and prudent monetary policy while making them more targeted, it said.
Hmm… more targeted…

Bloomberg’s take is here and they’ve also noted that the official statement focused on risks despite the slowdown; they also point out the emphasis on boosting the consumption (ie, rebalancing the economy; which as we’ve outlined before, can’t really happen unless growth slows).

Translation: Don't expect more stimulus measures if the economy slows further. Despite these concerns, the markets have shrugged off signs of Chinese weakness. A good measure is the relative performance of the Australian stock market (EWA) to MSCI All-Country World Index (ACWI) as most of Australia's raw material exports go to China. EWA remains in a relative uptrend against ACWI, though there was a recent minor violation of the relative uptrend:

Another key indicator that I have been watching is the AUDCAD currency cross. Both Australia and Canada are resource-based economies, but Australia is more sensitive to Chinese growth while Canada is more sensitive to American growth. The AUDCAD violated an uptrend that began last October on Friday, but I would like to see some further weakness to confirm that this trend violation is not a minor one as we saw in the above chart of EWA against ACWI.

Investor or trader?
Let's go back to the original question, is it time to sell in May?

My inner investor thinks that it may be prudent to trim back some equity holdings, but my inner trader says, "Not yet." He is still waiting for a bearish trigger. I became a reluctant bull in late March (see An uncomfortable bull). Even though my Trend Model turned neutral briefly two weeks ago, it flipped back to risk-on last week and I am still inclined to give the bull case the benefit of the doubt - for now.

My inner trader is still waiting for the aforementioned bearish triggers before getting more defensive.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Watching silver for the bottom in gold

noreply@blogger.com (Humble Student of the Markets) — Thu, 25 Apr 2013 07:42:00 +0000

In a recent post (see What to do about gold?) I suggested that a tradable bottom for gold may be near, but to wait for some signs of price stabilization:

Personally, I would be inclined to step aside for now and watch how this trade develops. Gold could have great upside potential once it bottoms, but prudence calls for waiting for some signs of stabilization before getting long. I would rather miss the first 10-20% move than lose another 50% should I get long prematurely.

It appears that we are seeing signs of a panic bottom and some signs of stability. The chart of GLD is showing the classic signs of a capitulation bottom:

The same goes for GDX:

As much as my inner trader is itching to jump onto the long side with both feet, a falling silver/gold ratio is flashing a caution signal. The chart below shows the silver/gold ratio as the solid line and the gold price as the candlestick chart. If silver is the high-beta version of gold, i.e. the poor man's gold, why is the silver/gold ratio continuing to fall here?

In the last couple of instances where gold had bottomed, the silver/gold ratio bottomed at about the same time. Here is the 2008 bottom:

Here is 2004:

The most charitable explanation that 2013 corresponds to the 2001 gold bottom, where the silver/gold ratio continued to fall. As the gold price stabilized, rallied and then fell back to test the bottom, the silver/gold ratio stabilized, though it was several months late in confirming the start of the secular gold bull.

The markets in 2011 and 2013 may not be directly comparable. 2001 was the end of a multi-decade secular gold bear market. Today, the price of gold peaked out in late 2012 and fell back below important technical levels after a long bull market.

Bottom line: We are likely seeing a short-term bottom for gold here. On the other hand, don't be so sure about the intermediate term trend. There may be more downside to come. We'll just have to watch and wait to see how some of these technical patterns resolve themselves.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Commodity weakness is likely localized

noreply@blogger.com (Humble Student of the Markets) — Tue, 23 Apr 2013 07:47:00 +0000

The old Cam would have been freaking out. The first version of my Inflation-Deflation Trend Allocation Model depended solely on commodity prices as the canaries in the coalmine of global growth and inflationary expectations. The chart below of the equal-weighte Continuous Commodity Index is in a well-defined downtrend. The weakness isn't just restricted to gold, but other commodities like oil and copper are all falling.

However, we found with further research that adding global stock prices to commodity prices as indicators gave us a better signal, in addition to giving us a more stable signal.

Equities not confirming weakness
The three axis of global growth are the US, Europe and China. I am finding that signals from all three regions are not really confirming the signals of weakness given by falling commodity prices. Consider, for example, Caterpillar's earnings report yesterday. The company, which is a cyclically sensitive bellwether, reported punk sales, earnings before the opening bell and revised their outlook downwards [emphasis added]:

We have revised our outlook for 2013 to reflect sales and revenues in a range of $57 to $61 billion, with profit per share of about $7.00 at the middle of the sales and revenues outlook range. The previous outlook for 2013 sales and revenues was a range of $60 to $68 billion and profit per share of $7.00 to $9.00.

“What’s happening in our business and in the economy overall is a mixed picture. Conditions in the world economy seem relatively stable, and we continue to expect slow growth in 2013,” said Oberhelman.

“As we began 2013, we were concerned about economic growth in the United States and China and are pleased with the relative stability we have seen so far this year. In the United States, we are encouraged by progress so far and are becoming more optimistic on the housing sector in particular. In China, first quarter economic growth was slightly less than many expected, but in our view, remains consistent with slow growth in the world economy. In fact, our sales in China were higher in the first quarter of 2013 than they were in the first quarter of 2012, and machine inventories in China have declined substantially from a year ago,” said Oberhelman.

“We have three large segments: Construction Industries; Power Systems; and Resource Industries, which is mostly mining. While expectations for Construction Industriesand Power Systems are similar to our previous outlook, our expectations for mining have decreased significantly. Our revised 2013 outlook reflects a sales decline of about 50 percent from 2012 for traditional Cat machines used in mining and a decline of about 15 percent for sales of machines from our Bucyrus acquisition,” said Oberhelman.

In other words, CAT remains upbeat on US housing. China is weak-ish and mining is in the tank. It seems that much of this negative outlook has been discounted by the market. While the stock fell initially, it rallied to finish positively on the day on heavy volume.

For now, the US economy look OK. I agree with New Deal Democrat when he characterized the high frequency economic releases as "lukewarm". We are not seeing gangbusters growth, but there is no indication that the economy is keeling over into recession either. The preliminary scorecard from the current Earnings Season is telling a similar story. The earnings beat rate is roughly in line with the historical average, although the sales beat rate has been somewhat disappointing.

Risk appetite rising in Europe
Across the Atlantic, Europe is mired in recession. However, there is little sign that tail-risk is rising. I have been watching the relative performance of the peripheral markets in the last few days as stocks have weakened. To my surprise, European peripheral markets have been outperforming core Europe, indicating that risk appetite is rising. Here is the relative performance of Greece against the Euro STOXX 50:

Here is Italy:

...and Spain:

Well, you get the idea.

Weakness in China?
What about China? Chinese growth has been a little bit below expectations, such as the March Flash PMI released overnight. Shouldn't weakness in Chinese infrastructure growth would be negative for commodity prices? Isn't that what the commodity price decline is signaling?

Well, sort of. Maybe. We have seen a great deal of financialization of commodities as an asset class. An alternate explanation of commodity weakness is the unwind of the long positions of financial players . Indeed, analysis from Mary Ann Bartels of BoAML shows that large speculators have moved from a net long to a net short position in the components of the CRB Index:

One key gauge I watch of Chinese demand is the Australian/Canadian Dollar cross rate. Both countries are similar in size and both are commodity producers. Australia is more sensitive to Chines growth while Canada is more sensitive to American growth. As the chart below shows, the AUDCAD cross remains in an uptrend in favor of the Aussie Dollar, though it is testing a support region.

In conclusion, the preliminary verdict from the market is that commodity weakness is localized - for now. Barring further weakness in commodity prices and the other indicators that I mentioned, the implication is that US stock market action will be choppy because of the uncertainty caused by commodity weakness and Earnings Season, but any downside will be limited. As the point and figure chart of the SPX below shows, the S+P 500 remains in an uptrend and I am inclined to give the bull case the benefit of the doubt for now.

So relax and chill out.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

My answer to John Hussman

noreply@blogger.com (Humble Student of the Markets) — Mon, 22 Apr 2013 07:24:00 +0000

I have the greatest of respect for John Hussman. His weekly commentary has always a must-read for me. So it was with much interest that I watched the video of his speech from the Wine Country Conference (via Mebane Faber).

I came away thinking that while I agree with Hussman's analysis on many fronts, we came away with some very different conclusions - a result that I will explain.

Where I agree with Hussman
If you watch the video, you will see that at the beginning, John Hussman states that he believes that much scarce savings has been squandered. Instead of directing savings towards productive innovation, e.g. robotics, etc., it has gone into financial manipulation (my words, not his) in trying to save the current system.

I completely agree.

Hussman went on to say that QE doesn't work to stimulate long-term sustainable growth. It only serves to drive down interest rates and lower the risk premium, which results in a speculative reach for yield.

I agree.

He went on to outline his 10-year return expectations for stocks. Based on various approaches, he gets an expected return of roughly 3.5%. Indeed, Mark Hulbert highlighted a similar conclusion based on the 3-5 year appreciation potential of stocks from the Value Line Investment Survey.

Hussman 10-year equity return expectations

Unfortunately for the investor, there are no good alternatives in the current QE environment. Expected returns are low for all asset classes.

Hussman called the current environment "An Unstable Equilibrium". In other words, the markets are an accident waiting to happen.

I agree with his analysis. While stocks returns can be relatively benign in the short to medium term, there are at least two major macro tail risks that we have to be concerned about: France (see Short France?) and China (see The canaries in the Chinese coalmine and An update on my Chinese canaries). In other words, the markets can behave for a while and then the roof could suddenly cave in. That's why we have an unstable equilibrium.

Same analysis, different conclusions
What can an investor do under these circumstances? That's where I differ from John Hussman. It appears that Hussman manages his fund primarily based on his 10-year rate of return outlook expectation. If return expectations for all asset classes are low, it makes sense to focus on capital preservation and to go long opportunistically. It's a long-term investment viewpoint, much like the sort adopted by pension fund committees and fiduciaries that I used to speak to in my previous life as an institutional money manager. I understand that point of view completely.

Today, I, along with people like Mebane Faber, believe that we have models that can trade the swings in this market - and there are plenty of swings. In effect, Hussman is saying that we are in a modern day depression - sort of a Japanese Lost Decades-like environment. The economies of the developed world is likely to go through cycles of upswings caused by fiscal and monetary stimulus and declines as the stimulus is withdrawn, largely scarce savings is not being directed at productive investments.

My principal approach is to use my Inflation-Deflation Trend Allocation Model, supplemented by price momentum at the appropriate times. While Hussman's time horizon is measured in years, my time horizon is measured in weeks and months. That's why, despite the poor long-term return expectations, I can be relatively sanguine on the outlook for the stock market. (More on that in a future post.)

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

What to do about gold?

noreply@blogger.com (Humble Student of the Markets) — Wed, 17 Apr 2013 07:35:00 +0000

As gold continues to melt down, I have had a number of discussions with both individual and professional investors about the outlook for the shiny precious metal. Notwithstanding the global conspiracy to suppress the gold price*, here is my view on gold.

First of all, I am relatively agnostic on gold. I am no gold bug, nor am I a permabear on bullion. I do believe that the financialization of gold and other commodity prices has made the precious metal more volatile. No one complained when money poured into GLD and the price was rising, but as Josh Brown aptly put it:

Personally, I think that Bitcoin caused the crash in gold. When Bitcoin, another alternative currency crashed, it created so many margin calls that the effects spilled over into gold**.

The bull and bear case for gold
There is no question that what happened to gold on Monday was what Dennis Gartman termed "a margin clerk market". We saw a disorderly liquidation. Tuesday saw some stabilization. Gold tried to rally but ended up only up slightly on the day - not good.

On a longer term basis, the chart below of the gold to SPX ratio shows that this relationship is testing a long-term relative support zone. Under such panic conditions, we may see a decent bounce.

In addition, there may be some fundamental underpinings for a bottom in gold equities. The dividend yield on the junior gold miner ETF GDXJ is 4.5% according to Yahoo! Finance and 6.2% according to Bloomberg. (Given how quickly the dividend has fallen, I am not sure how real that yield is, though.)

The bear case
While I recognize that gold is off-the-charts oversold, I worry that a significant bottom may not be in place because investor psychology hasn't gotten bearish enough. I have heard anecdotal evidence that people are lined up at the local bullion dealer to buy gold bullion and bars - which is contrarian bearish and an indication that Joe Public hasn't given up on the precious metal yet. ~~(Can anyone else confirm that?~~ Addendum: ZeroHedge reports that physical buyers are out in droves in Australia, China and Japan.)

As well, Bloomberg reports that Indians, who are a large source of physical demand, are still buying:

Gold buyers in India, the world’s biggest consumer, are flocking to stores to buy jewelry and coins, betting a selloff that plunged bullion to a two-year low may be overdone.

“My daughter is just six months old, but I think it is never too early to buy gold,” said Sharmila Shirodkar, a 28- year-old housewife, while displaying a new pair of earrings she bought from a store in Mumbai’s Zaveri Bazaar. “I had been asking my husband every day if prices will go down more. I couldn’t wait anymore.”

A durable bottom will not be in place until the small retail buyer capitulates - and these are not signs of capitulation.

As well, I watch the Silver/Gold ratio to measure the level of speculative activity in precious metals. Silver, another precious metal, is considered to be the poor man's gold and the relative Silver/Gold ratio is an important indicator of precious metal risk appetite. As the chart below indicates, this ratio remains in the middle of its historical range and is showing no signs of a washout yet.

Personally, I would be inclined to step aside for now and watch how this trade develops. Gold could have great upside potential once it bottoms, but prudence calls for waiting for some signs of stabilization before getting long. I would rather miss the first 10-20% move than lose another 50% should I get long prematurely.

* Relax! That's a joke
** Don't take everything I say so seriously!

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.