Humble Student of the Markets

Commodities poised to rally?

2013-05-20T00:25:00.000-07:00

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

2013-05-15T00:24:00.000-07:00

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

2013-05-13T00:26:00.000-07:00

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

2013-05-08T00:02:00.000-07:00

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?

2013-05-06T00:14:00.000-07:00

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

2013-05-03T07:55:00.000-07:00

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

2013-05-03T00:18:00.000-07:00

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

2013-05-01T00:50:00.000-07:00

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?

2013-04-29T00:07:00.000-07:00

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

2013-04-25T00:42:00.000-07:00

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

2013-04-23T00:47:00.000-07:00

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

2013-04-22T00:24:00.000-07:00

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?

2013-04-17T00:35:00.000-07:00

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.

Short France?

2013-04-15T00:13:00.000-07:00

I have found that the best trades are ones based on a well-defined fundamental reason combined with a market catalyst. Investors who put on a trade based purely on fundamentals run the risk of being early - and Value investors are a classic example of this tendency. Fundamentals have a way of not mattering to the market until it matters. A much better way to position your portfolio is to wait for the market catalyst by watching the technical conditions of the trade.

A bearish call on France
Consider this article from Charles Gave of Gavekal (via ZeroHedge): France Is On The Brink of A Secondary Depression:

France is engulfed by a political, economic and moral paralysis. The president has record low popularity, unemployment is making new highs and the tax czar of a supposedly left wing government just quit after repeatedly lying about a pile of cash he had stashed in a Swiss bank account. From such a sorry state of affairs, you might think that things could only get only get better. Unfortunately, economic cycles do not work this way and it is my contention that France is about to enter what was known during the gold standard era as a “secondary depression.” The rigid design of the euro system means the whole eurozone is prone to the kind of brutal cyclical adjustments seen in that hard money era of the 19th and early 20th centuries. But having reached the logical limits of its decades long experiment in state-run welfare-capitalism France is far more exposed than even its struggling neighbors.

The article is well worth reading in its entirety, because it lays out the bearish divergence for France against the rest of Europe. There is a French elephant in the eurozone room that no one dares to speak about. While Brussels can manage crisis after crisis in peripheral countries, a blowup in France is too big to contain as the French-German relationship lies at the political heart of the European Union.

Hale Stewart at the Bonddad Blog jumped on the same theme last week when he wrote:

The French ETF is looking more and more like a great short opportunity. As I first noted a little over a week ago, the French economy is in terrible shape: GDP has barely grown for the last 7 quarters, unemployment is rising, industrial production is dropping and the budget and current account deficits are increasing.

Too early to short France
What has been described so far is best characterized as a "trade setup". This is a trade with a strong fundamental backdrop. My inner investor tells me to be wary of France and its effects on Europe, but my inner trader tells me, "Not yet."

These fundamentals have a way of not mattering to the market until it matters. Right now, the market is shrugging off the warning signs. Consider this chart of the relative performance of French equities to eurozone equities below. Relative support seems to have held despite the potential negative news and the CAC is actually rally on a relative basis in the short term.

This may be a case of when it rains, it pours, but you have to wait for the rain. The "rain" to which I refer to is the emergence of a risk-off trade. Right now, there is no sign of that happening. Look at the relative strength of Greek stock to eurozone stocks - it's signaling a risk-on market.

The same could be said of Italy. Look at the relative performance of the MIB against the Euro STOXX 50:

In short, this is a trade setup to be watched. Watch how the fundamentals develop, because you have the time. Should the technicals deteriorate, then you have a great trade with tremendous upside potential - but not today.

Later this week, I will write about another potential trade setup in a hot topic - gold.

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.

Why this isn't investment advice

2013-04-09T00:44:00.000-07:00

Recently, I have gotten a number of comments like this one from my post You just don't understand Europe:

Cam you were wrong about Europe outperformance relative to US in your prediction for 2013.I am European I know Europe. Don't make mistake of doubling up on your losses.

Some of my readers mistake this blog as investment advice. I draw everyone's attention to the disclaimer that is at the bottom of every blog post, which reads in part [emphasis added]:
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 is an investment process?
You shouldn't use this blog for investment advice. Let me explain. Most investment processes consist of at least the following three steps:

Decide on what to buy and sell.
Decide on how much to buy and sell.
Timing the trade.

As an investment manager, I would add a four step of "review and control", which consists of analyzing past decisions and understanding what went wrong and what went right in order to improve future decisions.

I write this blog as my way of thinking out loud and inviting feedback. Most of what I write relates to step 1. There is little or no discussion of steps 2 or 3. Even if we both agreed that security XYZ is a good idea, I have no idea about your circumstances or your portfolio. I can't tell you how much to buy or whether it is appropriate for you at all.

Moreover, if I advocate entering a position, don't be assured that I will write about my decision to exit the position. Consider this post where I wrote in early December about the market leadership of European stocks and homebuilders (see Some surprising market leaders). Even though I had identified European stocks as market leaders, it didn't mean that I don't have a risk control discipline. The chart below shows the relative performance of the ETFs for Euro STOXX 60 (FEZ) against MSCI All-Country World Index (ACWI):

When the relative trend break occurred in early February, we were out of the trade. I didn't write about it on this blog, nor did I feel any obligation to write about it on this blog.

You can see a similar pattern in the homebuilders of when we exited the position at the relative trend break.

You get what you pay for
The best way to use the content in this investment blog as a source for ideas. But understand that you get what you pay for - and it's not investment advice.

If you do want investment advice, then I need to have an up close and personal relationship with you, where I am getting paid a fee. If you believe, for example, that the fund that I manage is appropriate for you, then I will undergo the four steps that I outlined above.

Otherwise, use my ideas at your own peril.

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.

A Value rally, or defensive sector rally?

2013-04-08T00:15:00.000-07:00

Despite Friday's disappointing Non-Farm Payroll release, I remain relatively constructive on the stock market's outlook for several reasons. First, the market sold off on the open, but rallied into the close - a positive sign.

Second, higher beta parts of the market have been outperforming in spite of the negative news. Consider this chart of the relative performance of small caps against the large caps indicating that the risk-on trade may not be done yet.

The risk-on rebound isn't just confined to the United States. Here is the performance of Greece compared to Europe, which is a key measure of risk aversion:

Here is the relative performance of Italy:

You get the idea.

What about the defensive stock leadership?
The one cautionary sign that I had mentioned last week was the leadership of defensive sectors (see Something's not right about this rally). I was not the only one to notice this effect. David Rosenberg mentioned it last Thursday and the WSJ featured a comment from UBS on the curious leadership behavior:

As the chart from UBS strategist Jonathan Golub shows, the classic defensive sectors, such as health care and consumer staples, led the way during the first three months of the year, while some of the more cyclical sectors, such as energy and tech, lagged near the bottom of the pack.

Defensive leadership or Value leadership?
There may be a more benign explanation for the leadership of defensive sectors. Value stocks have been outperforming Growth stocks since last June. The chart below of the relative performance of the Russell 1000 Value Index against the Russell 1000 Growth Index tells the story.

It just so happens that the Russell 1000 Value Index is overweight the kinds of sectors that have been outperforming, such as Financials and Utilities and the Russell 1000 Growth Index is overweight the sectors that have been lagging, such as the cyclically sensitive Industrials and Technology.

What's more, leadership in Value isn't just a sector effect. A contact of mine at MSCI Barra indicated to me that their factor analysis shows the performance of Value factors like Book to Price and Dividend yield to be outperforming as well. That outperformance was net of industry effects.

Bottom line: The upcoming Earnings Season will give us the best answer to the question of whether the real leadership is defensive stocks, which suggests caution, or Value stocks, which could be neutral to bullish.

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.

A time bomb in the Canadian financials?

2013-04-03T00:03:00.000-07:00

In my recent post about the Vancouver property market (see Is the secular bull market in Vancouver RE over?), I speculated out loud that a couple with 200K in annual income and 20% down payment could afford a house in the $1.0-1.2 million range, when Vancouver westside houses that aren't falling apart are trading at $2 million and up. These calculations suggested that the clearing price, in the absence of foreign buyers, would be substantially lower from current levels.

I have since had various discussions with mortgage brokers and realtors that indicated that my $1.0-1.2 million estimate is too low. It was suggested to me that a couple with 200K in annual income and 20% down could afford a $2.0 million home.

At first I couldn't figure out how this could happen. Using a standard mortgage calculator, assuming a 3% mortgage rate for mortgage with a 25 year amortization, I got a monthly payment of $7571, or roughly 91K a year. How could a couple with 200K pre-tax income manage with those kinds of numbers? How would they eat? Even assuming a 2% mortgage rate, I got mortgage payment of 81K a year - still a bit of a stretch for our hypothetical couple with 200K pretax income.

HELOCs to the rescue
After chatting with a couple of realtors, they revealed to me the answer: These people aren't financing their purchases with mortgages. They are financing their entire debt load with Home Equity Lines of Credits (HELOCs), which offer the "flexibility" of being secured, floating rate, interest-only loans!

With an interest only loan, a couple with 200K pretax income and a $1.6 million ~~mortgage~~ HELOC has payments of only $56K a year - which is well within the guideline of 40% of pretax income for housing related costs. Of course, the homeowner has the "flexibility" of paying more than the minimum interest payment each month in order to reduce principal. This financing "innovation" not only gets around the federal government's rules around mortgages, but creates a entire new profit opportunity for lenders.

Also consider the attractiveness of the HELOC business for the lender. These are secured, floating rate demand loans. Current HELOC rates are about 3.5%. Given their near-zero cost of funding, it's a great business (until it isn't). Now lever up those spreads up a "conservative" 20 to 1, imagine the profit potential!

It's a can't lose proposition, right?

For lenders, the HELOC business offers some degree of protection because the lines are secured (depends on your loan-to-asset ratio and how "real" your asset estimates are), floating rate (offloads interest rate risk to the borrower) and because of the demand loan nature of the credit line (just don't shout fire in a crowded theatre). Should the Canadian RE market tank, what happens to these "lucrative" lines of businesses and the "geniuses" who allowed the lending institution to plunge headlong into HELOCs?

An accident waiting to happen
I don't need to go on and on about moral hazard, but Canadians have been taking too much and too long a victory lap about the stability of their financial system. It's little things like the HELOC business in this country that scare me and suggests that there is a time bomb waiting to go off in the Canadian financial system.

For investors, think about the following: Should the Canadian financial system suffer a major hiccup because of a collapse in property prices, what happens to all that money that was chasing dividend yielding stocks, as the common shares of the major banks form a significant portion of the "blue chip" dividend yield universe?

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.

Something's not right about this rally

2013-04-01T00:38:00.000-07:00

OK, so the SPX made a new high. Many of my momentum models are bullish, but my relative strength work (see my previous post on combining momentum with trend following techniques) is making me scratch my head.

To explain, my work based on a paper by a team of researchers at Cass Business School entitled The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation suggests that when the market is experiencing an uptrend, you should go for broke and buy the "hot" sectors of the day. On the other hand, when the market is falling, buying the "hot" sectors is a recipe for disaster.

A risk friendly market trend
First of all, my trend following and momentum models is pointing to a risk-on market. Consider the relative returns of SPY (stocks) against IEF (7-10 year Treasuries) below. Unquestionably, we are seeing an uptrend in the risk trade:

The risk-on trade isn't just restricted to stocks vs. bonds. The same effect could be seen in the credit market, where junk bonds are outperforming:

Defensive leadership
Here is what's bothering me. We are obviously seeing an uptrend in the stock market, as evidenced by the new highs. However, sector leadership is gradually shifting away cyclical sectors to defensive sectors and industries. Take a look at what the leadership is today.

The chart below shows the relative returns of Financials (XLF) against the market (SPY). Financials are in a well-defined relative uptrend against the market.

Here are the Transportation stocks, which is a small cyclically oriented industry. These stocks are also in a well-defined relative uptrend.

OK. So far so good. Now here comes the surprises. Look at the relative strength in Healthcare:

...and the turnaround in the relative strength of Utilities:

Commodity cyclicals lagging
I have written that cyclical sectors are displaying a pattern of relative sideways consolidation after an uptrend (see An uncomfortable bull). I won't repeat myself, but you can click on the link and see the charts there.

What's bothering me is that commodity related sectors are lagging badly. Consider the equal-weighted Continuous Commodity Index, which is in a minor downtrend. Though it doesn't seem disastrous and commodity prices have firmed somewhat in the past three weeks, the price action of the commodity complex is not exactly signaling a robust global recovery.

On the other hand, the price action of industrial metals look downright ugly.

Here are some price relative charts of commodity sensitive stock markets against ACWI, or the MSCI All-Country World Index. Australia looks ok, but it's the exception.

Canada, on the other hand, is in a relative downtrend and has been underperforming since last November.

Here is Brazil. Enough said here:

Here is the relative chart of South Africa (in black), though its relative performance may be linked to the relative performance of gold stocks (in orange):

The relative performance of the cyclically sensitive South Korean market is not exactly inspiring either. South Korea remains in a relative downtrend, though it has staged a relative rally in the last week or so.

What's going on?
Frankly, I am puzzled by the nature of the sector leadership when the market is making new highs. My momentum and trend following models are telling to stay long. My relative strength models are telling me to rotate into defensive sectors like Utilities and Healthcare. When I net this all out, I wind up in a fairly neutral position.

Something's not right about this rally. Mohamed El-Arian of Pimco pretty much said the same thing when he indicated that the Markets are sending unusual signals [emphasis added]:

The rally reflects slowly-improving economic conditions, relatively robust corporate profitability and anticipation of stronger domestic and foreign inflows into the equity market. Yet this is far from the whole story.

Investors need only look at where some other benchmarks ended the quarter to get a feel for the unprecedented and artificial nature of today's capital markets.

Few would have predicted that the impressive equity performance would be accompanied by a 10-year U.S. Treasury rate as low as 1.85 percent, a 10-year German government bond (bund) rate as low as 1.29 percent and gold as high as $1,596 an ounce. Think of this as the markets' way to signal to investors some key issues for the quarters ahead.

More on this topic in subsequent posts.

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.

You just don't understand Europe...

2013-03-28T00:53:00.000-07:00

In the wake of the disappointing market reaction to the Cyprus deal, I just want to repeat the comment I hear from some of my European contacts: "You just don't understand Europe."

Don't be fooled by the theatre
Europeans elites do their deals behind closed doors and what we see in the headlines is mostly theatre. By contrast, Americans focus much more on process and headlines - and that's where they go off the tracks when analyzing the eurozone crisis. That's why we get alarmist comments, like John Mauldin's Thoughts from the Frontline: You can't be serious in which he worried about the precedences set by the Cyprus deal and the effects on European banks:

Basel III standards require European banks to increase their deposit ratios. This European response to Cyprus is going to make that harder for banks in smaller European countries to accomplish. Very tiny Luxembourg has banking assets 13 times the country’s GDP. Yes, I know that Luxembourg’s banks are the very epitome of solid banking and that the majority of those assets are loans to central banks and other credit institutions, but there is no way on God’s green earth that Luxembourg as a country could even begin to think about backing its banks. Of course, everyone knew that before this crisis, but if you are the treasurer of a large corporation, how soundly do you sleep at night after Cyprus? And God forbid you have an account in one of the peripheral countries. In the case of Ireland, the lesson was that the money would be found to back the banks, even if taxpayers suffered. But now? New rules for new times. And then you open The Financial Tim es this weekend and read (emphasis mine):

The chairman of the group of eurozone finance ministers warned that the bailout marked a watershed in how the eurozone dealt with failing banks, with European leaders now committed to “pushing back the risks” of paying for bank bailouts from taxpayers to private investors.

Jeroen Dijsselbloem, president of the eurogroup, was speaking after Cyprus reached its 11th-hour bailout deal with international lenders that avoids a controversial levy on bank accounts but will force large losses on big deposits in the island’s top two lenders.

By contrast, I was recently relatively sanguine about Cyprus (see Don't get too excited about Cyprus and More of the usual Eurocrisis drama). I wrote that a Cypriot solution is specific to Cyprus:

I believe that bailouts of other eurozone countries, should they be necessary, will conform to a different template of conditionality other than the imposition of a tax on bank deposits. For example, the ECB has made it clear that it will backstop Spain, but on condition that the government undertake structural reforms and austerity. In the case of Spain, Rajoy has yet to swallow the bitter pill that comes with an OMT bailout.

Don't forget Draghi's Grand Plan
To explain, the real agenda of the European elites consists of three components:

Push for structural reform long term;
Austerity in the short-term; and
The ECB stands by to hold everything together if the above two steps are taken.

Mario Draghi revealed this Grand Plan in February 2012 (see Mario Draghi reveals the Grand Plan) in a WSJ interview. Here are the key quotes from that interview [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.

He went on to say that the European social model was dead:

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.

Unlike Dijsselbloem, who is a rookie, Draghi is an experienced central banker who chooses his words carefully and he reveal his agenda in February 2012. Investors looking at Europe should remember that.

If you understand the Draghi Grand Plan, then you will understand how the eurocrats are likely to react when the next sovereign crisis occurs. First, the ECB will "do whatever it takes" to save the eurozone, but help from Frankfurt (the ECB) and Brussels (EU) comes with strings. In all likelihood, the eurocrats will believe that the country seeking help needs austerity and structural reform. In such a case, be the price to be paid will be paid is austerity and structural reform and the solution will not to stiff bank depositors (think Spain as an example as Rajoy's reluctance to embrace Draghi's "conditionality").

The kind of "conditionality" demanded by the ECB and is therefore highly situation specific. Cyprus was truly a unique case. Don't expect the same template to be used for Spain or Portugal. That's where outsiders make the mistake.

Investment implicationsLast week, I wrote that I was watching the relative returns of Greek stocks to eurozone stocks as a barometer of the level of stress in Europe, largely because of the Greek-Cypriot link and because Greece is the high beta play in Europe. When I looked last night, GREK had tanked relative to FEZ and had violated an important level of relative support.

The Athens Index had also dived relative to eurozone stocks. Though the degree of relative performance was not as bad, it is nevertheless a cautionary signal for the risk trade in Europe.

The French elephant in the room
The negative market reaction over Cyprus suggests to me that we are going to go through a "the glass is half empty" cycle in Europe and traders should be prepared accordingly. The key indicators to watch is the performance of France. France is the elephant in the room. The French economy is suffering a negative divergence with Germany. Consider this graph of French and German PMI (via Business Insider).

The eurocrats can deal with Italy, Spain and Ireland, but France is at the core of the EU and impossible to save. The Economist described France as the time bomb at the heart of Europe:

European governments that have undertaken big reforms have done so because there was a deep sense of crisis, because voters believed there was no alternative and because political leaders had the conviction that change was unavoidable. None of this describes Mr Hollande or France. During the election campaign, Mr Hollande barely mentioned the need for business-friendly reform, focusing instead on ending austerity. His Socialist Party remains unmodernised and hostile to capitalism: since he began to warn about France’s competitiveness, his approval rating has plunged. Worse, France is aiming at a moving target. All euro-zone countries are making structural reforms, and mostly faster and more extensively than France is doing (see article). The IMF recently warned that France risks being left behind by Italy and Spain.

At stake is not just the future of France, but that of the euro. Mr Hollande has correctly badgered Angela Merkel for pushing austerity too hard. But he has hidden behind his napkin when it comes to the political integration needed to solve the euro crisis. There has to be greater European-level control over national economic policies. France has reluctantly ratified the recent fiscal compact, which gives Brussels extra budgetary powers. But neither the elite nor the voters are yet prepared to transfer more sovereignty, just as they are unprepared for deep structural reforms. While most countries discuss how much sovereignty they will have to give up, France is resolutely avoiding any debate on the future of Europe. Mr Hollande was badly burned in 2005 when voters rejected the EU constitutional treaty after his party split down the middle. A repeat of that would pitch the single currency into chaos.

The lines in the sand
I am watching closely this ratio of the CAC 40 to Euro STOXX 60 to see which way it breaks out of the relative consolidation range.

If it rallies through upside relative resistance, then any crisis is just more theatre and can be regarded as a buying. On the other hand, if it breaks to the downside, there's going to be 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.

An uncomfortable bull

2013-03-24T18:25:00.000-07:00

I suppose that I should be happy. I correctly turned bullish on a tactical basis (see Give in to the Dark Side). I correctly called the Cyprus mini-crisis (see Don't get too excited about Cyprus and More of the usual Eurocrisis drama). As I write these words, the news of the Cyprus deal is sparking a modest risk-on rally.

Over here on this side of the Atlantic, the American economy continues to chug along, despite the sequester and payroll tax hike. I agree with Tim Duy when he writes that the recovery is real.

Sector performance signal caution
When I reviewed my charts on the weekend, I came away vaguely dissatisfied. The relative performance of industries and sectors reveal a market whose leadership that is increasingly turning away from cyclical groups and toward defensive sectors and a "negative beta" group.

If we are seeing such a bullish outlook (Europe, US economy), why are cyclically sensitive sectors not doing better. Consider the relative performance of Consumer Discretionary stocks against the market. This sector is currently seeing a sideways consolidation after stalling out of a relative uptrend that began last August.

Industrials are also displaying a similar pattern as Consumer Discretionary stocks: Stalling out of a relative uptrend followed by sideways consolidation:

The same could be said of homebuilding stocks:

The only cyclically sensitive group that I could find that is still in a relative uptrend against the market are the transportation stocks, which is a relatively narrow group:

Defensive sectors taking the lead
On the other hand, defensive sectors are starting to take the leadership position. Why are they outperforming when the stock market is advancing?

Consider, as an example, the relative performance of Consumer Staples, which is staging a relative strength rally:

Health Care, another sector thought to be defensive in nature, is already in a shallow, but well-defined relative uptrend after staging an upside breakout through relative resistance:

Utilities are forming a relative saucer bottom against the market:

Golds: The negative beta play
What's more, gold stocks are showing signs of revival. The Amex Gold Bugs Index has rallied through a relative downtrend line against the market, though the longer term relative downtrend (dotted line) remains intact:

HUI has already staged a relative turnaround against bullion as it has strengthened through the relative downtrend against gold.

Gold and gold stocks have somewhat defensive characteristics as they have had a zero or negative correlation against the SPX in recent weeks. Their revival could be a warning sign for stock bulls.

Be very, very careful out there
As I wrote in my recent post Give in to the Dark Side, my inner investor was already skeptical about this most recent rally:

My inner investor continues to be concerned about this market advance. He believes that the prudent course of action would be to move his portfolio asset allocation to its policy weight, i.e. if the policy weight is 60% stocks and 40% bonds, then the portfolio should be at 60/40.

At the time, my inner trader wanted to throw caution to the winds and get long the market. Now, my inner investor is telling him, "I told you so." Under these circumstances, my inner trader is getting very, very nervous and he is tightening up his trailing stops. The behavior of these sectors is flashing warning signals that if even if this market were to rally further, the advance could be very choppy.

Until we see some evidence of upside relative breakouts of consolidation ranges in cyclical sectors and industries, these market internals should make anyone who is bullish an uncomfortable bull.

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.

More of the usual Eurocrisis drama

2013-03-21T00:48:00.000-07:00

So the Cypriot parliament has rejected the terms of the Troika's rescue deal. Their finance minister is in Moscow and there were stories floating about that the quid pro quo for a Russian rescue of Cyprus would be a Russian naval base (via Business Insider). Should the EU and NATO be concerned?

I don't think so. The Russians had a chance to expand their geopolitical footprint in November but they passed. Here is what I wrote back then (see Europe dodges another bullet (Not the Catalan election)) [emphasis added]:

The wild card that I had been watching for is for Greece to turn to Russia instead of the Troika for financing. What if the Greeks got tired of the pain and turned to Putin for relief? Moscow has long had a historical desires for the warm waters of the Mediterranean for centuries. A financing deal could have shook up NATO and significantly shifted the geopolitical balance in the Eastern Med.

The test case was Cyprus. Russian nationals have a large presence on that island. As its banks got into trouble because they were stuffed full of Greek debt, the Cyprus economy was in peril. As the New York Times reported in June:

The Russian government last year gave Cyprus a three-year loan of 2.5 billion euros, or $3.1 billion at the current exchange rate, at a below-market rate of 4.5 percent to help it service its debt. Cyprus now needs at least 1.8 billion euros, or $2.3 billion, by the end of this month to buttress its ailing banking sector.
Instead of turning to the EU, they turned to Russia [emphasis added]:

Now many on this tiny island nation, whose banks and government are facing economic insolvency, are hoping for financial salvation from Russia rather than Germany and the European Union.

“I would much rather be saved by Moscow,” said Elena Tsolia, 30, an attendant at the department store Debenhams, where Russian shoppers snap up bottles of Dior and Chanel perfume. “We are a small island and we don’t want to be owned by Germany.”

I speculated that Russia could have not only rescued Cyprus, but Greece in return for naval basing rights:

Cyprus would have been the test case of Russia flexing its financial and geopolitical muscle in the Eastern Med.

Today Nicosia, tomorrow Athens? Can you say "Russian Black Sea fleet base in Athens, or Crete"?

So what happened? Cyprus turned back to the Troika instead of Moscow:

A little noticed announcement came across my desk. The headline was CYPRUS Government - Troika reach agreement:

The Government of the Republic of Cyprus informed on the 25th of June 2012 the appropriate European Authorities of its decision to submit to euro area Member States a request of financial assistance from the EFSF/ESM.

Any talk of a rescue from Moscow is likely just that - talk. The Russians demonstrated their lack of interest in November when they had the chance.

Cypriot crisis tripwires
Here is what I am watching for as signs that the markets believe that the Cyprus crisis is getting out of hand. The chart below shows the relative return of the ETF of Greek stocks (GREK) against large cap eurozone stocks (FEZ). The GREK/FEZ ratio has declined and it is testing a relative support zone. Should it break support, then it's time to get more cautious.

I use this ratio for two reasons. Cypriot banks are highly exposed to Greek debt. As well, the Greek stock market is the high beta "canary in the coalmine" of risk in the eurozone.

Looking at a similar ratio of the Athens Index to the Euro STOXX 50, it gives me further comfort that the market isn't overly concerned about the Cyprus situation. This ratio isn't even testing the relative support level yet:

So take a deep breath and relax. The headlines represent the usual European negotiation drama in a crisis, with one or both sides leaking stories of catastrophe should there be no agreement.

On the other hand, the message from the markets is that this crisis will be resolve in a relatively benign manner. Listen to the markets. Calm down.

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.

Don't get too excited about Cyprus

2013-03-18T09:59:00.000-07:00

The financial markets sold off early Monday on the news of the weekend bailout of Cyprus, but while the risks of a financial meltdown, while real, they are overly exaggerated. As I write these words, US equities have recovered most of their losses and shrugged off the Cyprus news.

What happened?
To explain what happened, Cypriot banks got in over the heads with too much Greek debt and had to be rescued. The EU stepped in with a €10 billion rescue package, but with the conditionality that the government impose a 6.75% one-time levy on bank deposits under €100,000 and 10% for deposits over €100,000. The deal has yet to be ratified by the Cypriot parliament. If it isn’t, banks in Cyprus are certain to collapse and there are reports about how the deal is going to get modified.

The knee-jerk reaction was instantly negative. The fear is that if this can happen in Cyprus, it could happen elsewhere. What if Portugal, Spain or Ireland had to get bailed out, would depositor funds be at risk there too? What’s to stop the Portuguese, Spanish and Irish from pulling their euros out of their banks and putting into Deutschebank in Frankfurt, thus sparking an enormous bank run and threatening the health of the European banking system?

Bank run fears are overblown
I believe that any panic over a possible bank run in the eurozone is exaggerated. Wolfgang Münchau (see Europe is risking a bank run in the FT) highlighted the risks of a bank run but admitted that there are institutional barriers to a bank run on retail deposits:

There are some institutional impediments against bank runs within the eurozone. Some countries impose daily withdrawal limits, ostensibly as a measure against money laundering. Nor is it easy to open a bank account in a foreign country. In many cases, you need to have residency. You may need to travel there in person, and you need to speak the local language – or at least English.

While it is possible to get around these rules, the risks of a bank run that threatens the health of the banking system are low.

In addition, ECB head Mario Draghi has said in the past that he would do “whatever it takes” to save the eurozone. However, he has also made it clear that rescues come at a price. The Cypriot rescue conforms with the EU and ECB principle of the imposition of “conditionality” on rescues. In the case of Cyprus, the banks had insufficient equity to withstand the shock of a write-down of Greek debt and it didn’t have enough senior bond holders to cushion the pain without rendering the banking system insolvent. The only ones left to take the hit were the depositors. It didn’t hurt politically that Cyprus was known as an offshore banking haven, mainly for Russian oligarchs. So it was easy for Angela Merkel to sell a bailout involving shared pain to the German people.

I believe that bailouts of other eurozone countries, should they be necessary, will conform to a different template of conditionality other than the imposition of a tax on bank deposits. For example, the ECB has made it clear that it will backstop Spain, but on condition that the government undertake structural reforms and austerity. In the case of Spain, Rajoy has yet to swallow the bitter pill that comes with an OMT bailout.

Based on my analysis, the worst fear of the pessimists, which is a bank run in the eurozone, will not materialize.

Key risks
However, there are two key risks to this forecast. First, I am assuming that the Cypriot parliament will approve the rescue package and approval isn’t fully assured. If the deal were not to be ratified, it would likely introduce a new element of risk to the eurozone banking system and possible contagion into the global banking system. In that case, all bets are all.

The second is the French elephant in the room. The French economy is negatively diverging from Germany and France needs to take steps to align itself with Germany and the core eurozone economies. While the EU can rescue Greek and Cyprus, France is at the heart of the EU and much too big to save.

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.

Will Cyprus spark a turnaround in metals and mining?

2013-03-18T00:24:00.000-07:00

The blogosphere is full of comments about the Cypriot bailout on the weekend (for examples, see How to start a banking crisis, Cyprus edition and The Cyprus conspiracy II). Instead of writing about Cyprus, a topic that I have no special expertise in, I thought that it would be timely to write an update to my blog post on February 19 about the resource-based sectors (see Time to buy gold and commodity stocks?).

Since I wrote that post, the metals and mining stocks have begun to stage a turnaround. To recap, the mining group is showing signs of being overly beaten up and washed out. This chart of XME, the mining ETF, against the market shows that it is trading at or near investor capitulation levels relative to its long-term history.

Take a look at the shorter term one-year relative chart of XME vs. SPY. The miners are starting to show some positive relative strength against SPY. Is that the sign of a nascent recovery?

Similarly, gold stocks are highly unloved against bullion. I have not been a big fan of buying gold stocks for gold bulls (see Where is the leverage to gold?), but in this case a long gold stock/short bullion position is likely to have much better risk/return profile than any time in the recent past.

Shorter term, however, my inner trader is still watching this pair of a relative turnaround as the HUI/Gold pair remains in a relative downtrend.

On the other hand, I can't say I am overly bullish on gold itself. The silver/gold ratio, which is a measure of the speculative interest in precious metals, is stuck in the middle of its historical band indicating neither excessive bullishness nor excessive bearishness on the PM complex.

Nevertheless, I am seeing signs of a capitulation, or washout, in investor sentiment. Here in Canada, the chart of the junior Venture Exchange Index against the more senior TSX Index shows that the ratio is at or near levels indicating investor capitulation in the juniors, which are mostly junior resource companies.

Not enough energy in Energy?
In my last post on this topic, I was more constructive on the energy sector as the sector was showing signs of a relative strength turnaround. Since then, the sector remains range-bound against the market and appears to be consolidating sideways on a relative basis.

The price of Brent crude confirms my observation about the range bound, or sideways consolidation pattern shown by energy stocks.

At this point in time, the energy sector may not have enough energy, or momentum, to present itself as the new emerging leadership sector.

As I write these word, the markets have a risk-off reaction over the Cyprus news. EUR is plummeting against all currencies and against JPY in particular; USD is up: ES is falling and gold is up marginally but a base metal like copper is down. While the initial market reaction isn't necessary the sustainable reaction, the Cypriot event may serve as a catalyst for the resource sectors (and the metals in particular) to stage a turnaround and present themselves as the new market leadership. It will also prove to be an important market test for the price of gold (and the gold bugs), to see whether investors flock to USD assets or to gold in this instance of an unexpected eurozone ~~confiscation~~ tax of banking depositor assets.

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 secular bull market in Vancouver RE over?

2013-03-16T00:19:00.000-07:00

I don't generally comment on the local residential real estate scene, largely because the topic isn't within the scope of this blog and I don't have much in the way of unique insights. However, I have a personal interest since I live here. In addition, several items came across my desk that piqued my interest.

First, the Conference Board of Canada recently unveiled some research indicating a statistical link between Chinese GDP growth and Vancouver property prices:

Statistical analysis confirms the importance of China’s economic health to Vancouver’s housing markets. Standard tests find significant correlations between the country’s real GDP growth and three important market yardsticks: existing home sales, existing home price growth and total housing starts. By contrast, local employment growth is significantly correlated to none of these and the five-year rate related to only the resale variables. This could mean that a substantial proportion of Vancouver real estate purchasers do not need local jobs to buy any home (new or existing) and that many do not need a mortgage to buy a new home. On the other hand, better economic health in China gives its residents wealth to spend on Vancouver housing.

While statistical relationships do not indicate causality, anecdotal evidence suggests that Vancouver property prices have been buoyed over the last couple of decades by several waves overseas buyers. The first was from Hong Kong, followed by the Taiwanese and now the Mainland Chinese.

The future of foreign demand
I came across an item Friday in the WSJ indicating that the older generation of Mainlanders looked to North America if they intend to emigrate (or at least to get a foreign passport), but the new generation is considering other alternatives such as Singapore, Hong Kong and Cyprus (see video and article). In particular, this wave of "economic refugees" ~~seeking foreign passports as a safety valve should things turn south at home~~ are looking to troubled eurozone jurisdictions such as Cyprus, where you can get a residency permit if you buy property there (and apply for Cypriot, and therefore EU, citizenship after five years). Other eurozone countries like Spain, which saw the collapse of a property bubble, also has a residency for house purchase program.

Yes, I have heard the local real estate boosters. Vancouver is a "world class" city (yes, as "world class" as other Winter Olympics sites like Salt Lake City, Lillehammer, Turin and Sarajevo - can you find them all on a map?). It has a mild climate (as mild as Cyprus or southern Spain?)

So what happens if Mainland Chinese demand starts to decline?

What's the downside risk?
The Conference Board study indicated that the health of the local economy had little or no effect on local property prices. In other words, the locals have been priced out of the market. At what price does local demand start to put a floor on the market?

Here are some back of the envelope numbers. A typical single-detached house on upscale neighborhoods on Vancouver's westside goes for about $2 million, give or take. If you were to open up the career section of the local paper, a good paying job is roughly 50-80K a year. Let's assume that you have a couple with a combined household income of 200K a year - which would roughly puts them in the top 2% in Canada. Assume that they have no other equity from an existing home but have the 20% down payment, they can afford a house of $1.0-1.2 million range based on current interest rates.

That's where local demand starts to kick in.

With the news that Vancouver real estate market slump is continuing:

Sales recorded through the Multiple Listing Service dropped 24 per cent in February to 4,501 transactions compared with 5,895 a year ago, the report said. The provincial average price was $529,922 in February, down 8.1 per cent from February 2012.

...the concern is that the overseas buyer is looking elsewhere is a threat to the secular bull market in Vancouver residential property prices. Should that happen, market price trends will transform itself from a series of higher lows and higher highs to a more cyclically driven market where prices move up and down with the economic cycle.

Right now, I am watching China (for cyclical effects on Vancouver RE prices, as per the Conference Board study) and emigration preferences (for the secular effects).

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.

Signs of global healing

2013-03-14T00:47:00.000-07:00

In addition to the upside surprise shown by US February retail sales yesterday, I am seeing additional signs of global economic healing. South Korean exports, which are highly cyclically sensitive, are turning up (via Business Insider):

As well, the OECD reported on Monday that it was seeing signs of emerging growth in the eurozone, with (surprise!) Germany as the engine:

Economic growth was beginning to re-emerge in the 17-nation euro currency area, the Organization for Economic Cooperation and Development (OECD) said as it released key economic indicators Monday.

The recovery in Europe's biggest economy, Germany, had pushed up an OECD indicator for the eurozone designed to identify turning points in the business cycle, said the organization, which represents senior Western industrialized nations.

The economic clouds are lifting and such an environment is supportive of further gains in equities (see my last post Give in to the Dark Side).

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.