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Gl b l Tactical
T ti l
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Equities
Third Quarter
June 14th , 2010
Damien Cleusix
d i @ l 6
damien@clue6.com
Stocks
Investors surveys have moved from the complacency witnessed in April to more constructive levels. The Merrill Lynch
Fund Managerg Survey y is indicatingg a increased ppreference toward Japan p and the US and declining g interest toward
emerging markets, a trend which already started a couple of months ago. They are increasingly underweight Europe. While
usually wrong at extremes, the fund managers participating in the survey are right during trends. So accordingly one should be
long Japan and the US relative to emerging market and especially Europe.
Option
O ti activity
ti it has
h improved
i d andd some indicators
i di are in
i outright
i h bullish
b lli h configuration.
fi i W would
We ld prefer
f to see smallll traders
d
be more fearful and buying more puts to open instead of selling calls to open. The 3 months skews reached panic levels a week
ago.
Our preferred “market timers” continue to have different opinions. J.Hussman is bearish while S. Leuthold thinks that the
correction should be bought. The best value managers have continued to reduce their exposure to the market indicating that
the markets will have to fall more before we see fundamentalists buying from the technical traders.
Speculators
S l t remains
i long
l th Nasdaq
the N d 100 future
f t while
hil NYSE Specialists
S i li t have
h i
increased
d their
th i relative
l ti short
h t selling
lli
activity in the past days.
So sentiment is oversold but it has to be put in the context of the recent decline and market trend (lower highs and lower
lows) Sentiment in itself does not imply that the markets can not continue their descent in the medium-term but more that it
lows).
should at least consolidate in the short-term.
Breadth volatility is such that it is currently hard to give much weight to this area. The positives are that the various
advance decline lines have not diverged negatively in April and that we had a new cycle high in 52 weeks high at the same time.
Markets tends to at least retest the highs when this happen. Furthermore we did not get an Hindenburg Omen and the Fosback
High Low Logic Index did not indicate distribution.
High-Low distribution Shorter-term
Shorter term we are also seeing a positive divergence from the McClellan
ratio-adjusted oscillators and from the stocks above their 10 days moving average. The negative are that we have had a lots of
Lowry’s 90% down days, that the McClellan oscillators remained very oversold for a very long time (relatively speaking) and
our selling pressure indicator is behaving as it does at the onset of a cyclical bear market. Furthermore the Nasdaq New High-
New Lows model is on sell since the beginning
g g of May.
y
On the liquidity side, there were big outflows in equity funds around the world. In the US one has to keep in mind that the YTD
net inflows have not been homogenous between the various categories. While foreign funds, domestic mid cap and small caps
funds have seen big inflows (mid cap inflows are reminiscent of 2000 and 2007), large cap domestic funds have seen huge
outflows. The cash ratio has also declined everywhere and does not leaves much dry powder to managers. Net redemption will
have to be met with selling holdings. Buybacks have picked up slightly but not as much as during the January correction. The
US IPO and secondary offering market is almost closed while activity has declined markedly in emerging markets in general
and China/Hong Kong in particular. Don’t be fooled there are quite a few issues in the pipeline. Foreigners appetite for US
stocks remains high
Margin debt remains very high in the US when one look at its size relative to overall market capitalization.
On the monetary
y front,, real M2 and M1 g
growth is still negative
g on a y
year on yyear basis in the US and decelerating
g
markedly elsewhere. Emerging markets central banks reserve growth has been slowing rapidly which is a headwind for
risky assets.
Pension funds’ funding status has stabilized but imagine the what will happen if equity price falls while high quality
corporate bonds yields (used to discount liabilities to present value) do not rise as they did in 2008-2009.
Seasonals are supportive for the very short-term but August and September are not kind to the markets, on average. Our
mechanical seasonal model is on sell since the end of April. The 20 cycles low is due for now while the next low is expected
sometimes at the end of October (which could also be a four years presidential low).
Intermarket relationships have deteriorated. The equity market risk relationships like the Nasdaq, semiconductor or banks
relative performance are still supportive (at least for the US). The relative defensive sectors performance is a negative. What is
more worrying is the deterioration in the credit markets. Commercial papers yield are rising as is the Libor-OIS and Ted
Spreads Investment grade CDS indices are diverging negatively.
Spreads. negatively At the sovereign level the ebb and flows are influences by the
daily news flow but don’t be fooled the trend is clear. We have some surprise on the subject. Some forecast will be met with
incredulity.
The trends is down but markets are so oversold that a snap back rally is almost a certainty. The big problem is that it is
only ALMOST a certainty. Waterfall decline do not starts when the markets are overbought but when they are deeply oversold.
We covered our shorts and bought some in the past 10 days. We sold those position at a nice profit and are in sit and wait
position now. We are seller of strength. We expect to start building a new short position on a move above 1100 on the S&P
500 and to be fully short at 1140-1160. If the markets fail to reach those level we will take short position on lower short-
t
term l
lows AND a decline
d li below
b l the th currentt short-term
h tt up trend.
t d
The Hulbert Nasdaq and Dow newsletter exposure surveys are clearly showing a lot of anxiety in this space with net short position being
recommended on average.
The Investor Intelligence (Chart 1) and American Association of Individual Investors (Chart 2) surveys have improved but are not yet in
screaming buy territory,
territory especially if the cyclical bull market is dying.
dying
The National Association of Active Investment Managers allocation survey has declined markedly to the low 30
30’ss (Chart 3)
The TSP Bull/Bear Survey (Chart 4) is neutral but gave a buy signal 2 weeks ago when it fell below 0.5.
The crash confidence index (Chart 5) measures the percent of the population who attach little probability to a stock market crash in the next-six months.
After having reached its lowest level at the end of 2008-beginning of 2009, the index has been steadily rising since. The analysis of this index is tricky…
Low levels occurring after prolonged decline are bullish, but you want the index to rise strongly along the markets (remember the crowd is wrong at the
end of the trend not during a trend).
The buy-on-dips index (the percent of the population expecting a rebound the next day should the market ever drop 3% in one day) (Chart 6) is indicating
that institutions are very comfortable buying the dips while individuals are nervous…
Last quarter we said : “So, maybe small declines will be bought, as they have in the past 9 months but if the selling pressure is strong enough to push the market lower, the
move could start to cascade downward” Well, here we are judgment day is coming… soon.
Clue6 Third Quarter 2010
Equities: Sentiment – Surveys 7
Chart 7 ML Fund Managers Survey Percentage Chart 8 ML Fund Managers Survey Percentage Net
Net Overweight Japan Overweight Emerging markets
On a Country/Region basis we identified two stands out for 2010 in the Q1 presentation.
Everybody “hated”
hated Japanese stocks (Chart 7) while Emerging Markets were everyone
everyone’ss darling (Chart 8)
So far so good… Japan has outperformed Emerging Markets. There are now more managers overweight Japan than at anytime in the past two and an
half years but Emerging Markets are still the most loved region but its popularity is rapidly falling.
g g market is p
The fate of emerging paramount to the bulls as theyy think EM will decouple
p and be the engine
g of the world. Theyy are pprobablyy right
g on
a 25 years basis but for the medium-term they might be disappointed. Especially when a big part of its outside financing needs have been coming
from… European financial companies.
Managers are warming up to the US (Chart 9). We think they are right. With all its ills and disequilibrium, the US are the more flexible among
major regions (a subject we have written a lot about in our past macro quarterlies).
quarterlies) Once they understand that big financial institutions are not too
big too fail if they are allowed to be reorganized or liquidated on an orderly fashion, the US will move from outperformer to super-outperformer.
In the meantime managers are now underweight Europe (Chart 10). We never understood why they wanted to be overweight in 2009 in the first
palce but…
The OEX put call ratio (Chart 12) is currently very low after the 2 as usual timely “above 2” warnings it kindly gave at the end of April.
The equity put call ratio (Chart 13) has corrected from the extreme bullishness of the end of April. The moving average is now declining which is a
positive. We would have preferred this decline to start from a higher level but…
The option skew is the shape of an asset option implied volatility along the strike for a given maturity. In the above charts we are looking at the
absolute difference of the implied volatility of 3 months put options with a strike at 90% of the current price and 3 months call options with a strike
at 110% of the current price.
price The higher the level the more expensive puts are relative to calls i.e.
i e the more nervous investors are.
are
The S&P 500 skews has surpassed the levels reached during the aftermath of Lehman Brothers bankruptcy (Chart 13). The same is true for
the EuroStoxx skew (Chart 14).
This is bullish at first sight but such a high skew so early in a correction might indicate a change of character in the market and might
actually be bearish longer-term.
The Japanese
Th J andd Emerging
E i Markets
M k t skew
k proxies,
i while
hil moving
i sharply
h l higher,
hi h did nott indicate
i di t the
th same level
l l off panic
i as the
th US andd European
E
Markets (Chart 15 and 16).
Small traders (up to 10 contracts traded) puts buy to open activity represents 18% of their total activity which is low given the recent markets
volatility while their call buy to open activity now represent less that 30% of total activity. Their favorite strategy is currently to sell calls (Chart 17).
Bullish strategies now represents less than 50% of the total which is much better that the 60% of 6 weeks ago.
The buy to open put call ratio is above 0.5, still shy of the 0.6 levels where markets have usually bottomed (Chart 18).
The Russell 3000 sell/buy ratio has now corrected from the extremely high levels reached in April (Chart 19). We almost even had some net buying
10 days ago.
ago What we do not like is that we saw increased selling in the first phase of the correction which is a bad omen longer-term.
longer term
In the UK, the buy/sell ratio has improved somewhat too (Chart 20).
Remember, insiders activity is especially useful in 2 configurations: lots of relative buying or increased selling when the markets decline…
Source: DB Source: DB
Europe experienced some short-term net buying at the transactions level (Chart 21) but…
… has seen increased selling activity at a company level in the past 6 months (Chart 22). This is not good and indicating that the cycle has
probably moved from bull to bear. Once more you do not want insiders selling a falling market.
In Canada, insiders buying has peaked up slightly but remains lower than selling (Chart 23). Historically, as in the UK, buying has outpaced selling
in Canada, not like in the US.
In Singapore, the buy/sell ratio has moved sharply higher in the past few weeks (Chart 24). This is a positive.
J. Hussman strategy has changed since the start of April He is not buying small on weakness and re-hedging completely on strength, at least not to
the extend it did it in the past 12 months. According to our calculation he is currently fully hedged (Chart 25). He remains very concerned that the
market decline could accelerate after a short-term relief rally.
S. Leuthold, who has been bullish and right since early in 2009, is back to the bull camps after having expressed some short-term concerns in
April (Chart 26)…
Source: Clue6
Looking at the median exposure of a subset of successful value managers, one can see that they have dramatically reduced their exposure
recently.
It usually pays to buy when their daily exposure shoots higher for a couple of days and you should move out if their exposure decline (couple of days
with very low exposure) in a declining markets as the risk of a waterfall decline increase exponentially.
Non-Commercial are net long Nasdaq future which is worrying (Chart 27).
Wall Street Strategists are still recommending investors to allocate approximately 60% of their assets to stocks (Chart 28). While it remains
lower than the average of the past 12 years this would probably not be the case if a longer history was available.
NYSE Specialists (to be considered as smart money) have been heavy relative short sellers in the past 2 days (Chart 29).
29)
In the meantime, odd lots short selling relative activity has decreased (Chart 30).
Source: G.Lerner
The percentage of Rydex assets in bull strategies has declined from the highs reached in April (Chart 31).
31)
Proshare short ETF total assets have risen markedly in the past few weeks (Chart 32).
US analysts recommendations momentum is not very informative at the moment with both buy and sell recommendations being only slightly
higher than 3 months ago (Chart 33)
In Japan both buy and sell recommendations are only slightly lower than 3 months ago (Chart 34).
In Japan analysts have access to the performance of the margin buyers and sellers.
O Chart
On Ch t 35 one can see that
th t when
h investors
i t are starting
t ti to t make
k money on the th stocks
t k bought
b ht on margin
i (or
( even losing
l i less
l th 5%),
than 5%) the
th rally
ll is
i
usually very near a reversal. They are not yet losing enough for the odds of a rebound to be strongly positive.
The same is true on stocks sold short on margin (Chart 436) when they start to make a profit, a reversal to the upside is not very far. Close to
positive territory.
Margin traders are currently losing both way… the winner? Brokers we guess.
Non-commercials have a net short position in the VIX future (Chart 38). Remember that they are the smart-money here (but note that they were
dead wrong with their highest net long position in December so…)
Source: Clue6
The sentiment Composite is oversold. If we are just experiencing a correction in a bull market, you should be buying aggressively if not we
should/could rebound but the rebound should be used to sell.
Why breadth and volume can help us gauge the future prospective risk/reward ratio of the market. We have tried for 10 years to explain it… Well
J.Hussman explains it brilliantly… as always
“A good way to think about prices and trading volume is to abandon the idea that money goes in or out, and to think instead about the market as
a collection of various groups. Imagine there being fundamental investors, who are interested primarily in value (buying on weakness and selling
on strength), and technical investors, who are interested primarily in trends (selling on weakness and buying on strength). These people also trade
on different horizons and base their trading on different extent of movement.
In this sort of equilibrium, trading volume is a measure of strong views and disagreement. As the market turns weaker, trend-following investors
typically abandon stocks, while fundamental investors accumulate. The reverse is true on significant strength. So spikes in trading volume tend to
occur primarily at extremes relative to the target prices of fundamental investors. Volume spikes also tend to be correlated with a series of positive or
negative shocks that then abate. In contrast, dull volume is a measure of low sponsorship, strong agreement, and lack of external shocks.
Equally important is that net incipient buying from both technical and fundamental investors cannot exist, so large price movements are typically
required to relieve the disequilibrium. If you've got an overvalued market which then loses technical support, the outcome can be extremely
negative, because technical investors are prompted to sell, but fundamental investors have weak sponsorship at that point, so large price declines
are required to induce the fundamental investors to absorb the supply.
In contrast, if you've got an undervalued market where fundamental investors raise their outlook, the demand from fundamental investors is not
typically provided by technical investors (who would tend instead to buy on advances in price), so the price must increase enough to induce
fundamental investors with shorter horizons to supply the stock.
All of these dynamics have been active in the market over the past two years, but the most significant outlier has clearly been the past few months,
where
h volume
l b h
behavior h demonstrated
has d d muchh weaker
k sponsorship h than
h we would ld have
h expectedd for
f an advance
d off this
h size. Normally,
ll the
h volume
l
characteristics we've seen have been much more typical of short-squeezes and less durable advances.”
J.Hussman
The S&P 1500 Composite Index cumulative advance decline line is still in synch with the markets after having displayed a lot of strength at
the last peak (Chart 39).
39) Combined with the fact that we had a new cyclical peak in new highs at the same time it makes the probability of the
current correction being something else than a simple correction in a cyclical bull market very low. This is one of the rare element in our
overall analysis that points clearly that way. This is the fly in the ointment.
Our selling Pressure indicator has spiked higher recently (Chart 40). Usually when it is above 0.7 and the market is making new 52 weeks high, a
cycle trend is ahead…This
ahead This was the case in 1962,
1962 1968,
1968 1972 and 2007…
2007
The Nasdaq New High-Low Model is on sell (Chart 41). It is in sell the rallies mode.
We have documented the rapid increase in breadth volatility in the past few years and the same is true for Lowry’s 90% days (to have an 90%
up days, >90% of the volume should be in rising stocks, >90% of the issues should be rising and >90% of the points moves should be made by rising
stocks). The past 6 weeks have seen the highest concentration in history (Chart 42)…
Source: Clue6
We have had 11 90% Lowry’s down days (7 where both the Nasdaq 100 and S&P 1500 had one the same day) and 5 90% up days.
The last one was a 90% up day for the S&P 1500 on the 10th .
Such a high concentration of down days when the market has only corrected a bit more than 10% is worrying.
worrying The fundamental buyers are not
here yet (which is understandable, see the equity valuation presentation).
Source: N. Bulkowski
A buying climaxes occurs when a stock is closing a week where it reaches a 52 weeks high with a loss. The selling climaxes is the reverse (close
higher a week where it made a 52 weeks low. Back at the end of May we had a record in the number of buying climaxes. We are now having the
highest number of selling climaxes since the March 2009 bottom (Chart 43).
Looking at the percentage of stocks forming bullish/bearish pattern, N.Bulkovski has created an indicator which has been pretty accurate in the
past few months (Chart 44). The model is on sell now.
We have been waiting for a positive divergence between the NYSE and Nasdaq McClellan Oscillators in the past few weeks (Chart 46 and 47).
We ggot one this week when the markets made new low but the oscillator did not.
Markets usually only makes the low on a divergence and when the oscillator is very oversold for 5-6 days, the risk of an acceleration to the downside
are high.
The oscillator stayed deeply oversold so long that it increases the risk of the April highs to be the highs of the bull cycle which started in
March 2009.
Short-term
Short term breadth has diverged positively with price around the world during the last couple of days (Chart 47 and 48).
48)
In the past we have used the following 2 studies to warn of impeding cyclical trend change.
On chart 49, one can see that the Fosback High Low Index remains low, indicating a lack of distribution. We are now moving away from the 1
year anniversary of the Marc 2009 bottom and the behavior of the indicator will be very informative in the weeks/months to come…
As for the “Hindenburg Omen” none has been triggered since the 2007 peak on the major indices (Chart 50)…
There were huge outflows from equity mutual funds in May after the big inflows in April. Note that not all categories are behaving similarly.
Since the start of the year, foreign equity funds have continued to see inflow as have domestic mid cap (inflow similar to the 2000 and 2007 peak)
andd small
ll caps. The
Th big
bi losers
l h
have b
been d
domestic
ti large
l cap funds.
f d Large
L cap quality
lit where
h you should
h ld invest
i t your money to t show
h your true
t
contrarian mentality.
Mutual fund cash reserve is historically low and net mutual fund selling will have to be met with manager selling. If we adjust the cash level
taking into account the short-term interest rate level (a higher risk free rate imply a higher cash ratio, ceteris paribus) using Jason Goepfert
Mutual Fund Cash Reserve,
“Mutual Reserve the Risk-Free
Risk Free Rate and Stock Market Performance
Performance“ paper,
paper one can see that we have yet to reach dangerous low levels,
levels
but note that with the current short-term rate even 1% cash ratio would not be sufficient to make the model bearish so…
Source: MS Source: MS
Equity allocation remains below the 2000 and 2007 highs but not as much as one would think (Chart 53 and 54).
Bond allocation is rising in the US but isn’t in Europe. A big share of the increase has been toward corporate bonds while foreign bonds have seen
big relative inflows from a low bas (notably in Emerging market bonds). In the next few years, money will pour into treasury bond funds in the US.
The mountain of cash in the sideline has decreased sharply since March 2009. Note you should not really care has this cash on the sideline
argument if a fallacy.
fallacy
Buybacks have picked up modestly in the US in the past 6-7 months but remains at relatively low level (Chart 55)… It was encouraging to see
the number of buybacks announcement to rise to around 100 a month in January (with a big increase a the end of the month) and February (at the
beginning of the month) but unfortunately we are not seeing the same increase in May despite the market decline.
decline
In Japan, the beginning of the year increase as petered out (Chart 56), we hope we will soon be convinced that managements are more interested
in the well-being of their shareholders.
Note that we remain wary of too much buybacks which, in aggregate, still remains a sign of management “short-terminism”
short terminism (especially when
management (insiders)is selling their own shares… and in Japan we would prefer to see stocks bought back than new unproductive capital
expenditures.
Clue6 Third Quarter 2010
Equities: Liquidity 36
Chart 57 US IPOs and Secondaries (US mio.) Chart 58 China + Hong Kong IPOs and Secondaries (US mio.)
Secondaries picked up in the US in April but the market is quasi closed for now (Chart 57).
Remember that management sell stocks mainly for 2 reasons. First when they have to in order for the company to survive (what happened in the US
during the first 4 months of 2009) or when they would be stupid not to (like Blackstone in July 2007, China and Hong Kong at the end of 2007 and
potentially now, KKR,…)
As an aside, we were choked by the level of optimism toward China expressed by Hong Kong investors. See it for yourself here:
http://insider.thomsonreuters.com/link.html?ctype=groupchannel&chid=3&cid=111042&start=0&end=2382&shareToken=Mzo0MzJmNWY2ZC1kZmU0LTQ0MjgtYjE1Yy1jZWU3ZjFmYjU5MDM%3D
Hedge funds net long exposure has increased a lot since its September 2008 lows and was 43% at the end of March (Chart 59).
59)
They have been actively decreasing their exposure to small caps in the past few months (Chart 60) and this does not bode well for them.
Foreigners like to bash the US but they have an incredible propensity to buy US equities near cyclical tops (Chart 61).
With regard to short interest, we have long said that while large cap shorts tend to be “dumb money” on aggregate, small caps shorts tend to be
better informed… The spreads between small and large cap short interest as a percentage of float is rising again (Chart 62)
The NYSE margin debt has now exceeded the 2000 levels on a % of market cap basis and is not far away from the 2007 highs (Chart 63). It
remains well below the 1929 highs but those levels will probably never be seen again.
Japan short selling activity has picked up markedly recently and is at levels were the market usually find some footings (Chart 64).
Source: ICI, Census Bureau, Clue6 Source: BOJ, Japanese National Institute of Population and Social Security Research, Clue6
The above 2 graphs are well-known for those who have been reading our research for a long-time.
We believe that the long-term flows into and out of assets (the relative buying/selling urgency to be more precise as they are no money getting in
or out of the market… for each buyer there is a seller and vice-versa) have a demographic root… It affects the assets relative value and can be best
seen on the secular trends in normalized valuation ratios.
In the US, one should not be surprised by the net outflows from equities into bonds, this is what should happen (Chart 65) while in Japan we should
see the
h reverse (Chart
(Ch 66)…
66)
On chart 67 you can see the countries which have the most positive demographic dynamic according to the Middle to Young Cohort hypothesis…
But should not only the “Middle to Young Cohort” but the absolute growth of the middle age population (Chart 68).
Combining both, one see that the picture is somewhat less bullish than it seems for Japan, Spain, Poland, Portugal and Greece
On chart 69 one can see the countries with the most bearish demographic configuration according to the Middle to Young Cohort hypothesis.
Change)
Stocks Price (% C
Bonds Yields (Bps Change)
g, Clue6
Source: Bloomberg,
In the US, listed corporate programs are underfunded by almost 30% (Chart 71). This represents more than US bn. 300 or almost 60% of ttm
net earnings.
On the chart 72 and 73 you will find rough estimates of the impact on markets movement on the assets and liability side… The 2008-2009 carnage
was avoided by the big increase in the liability side discount rate (highly rated corporate bonds).
bonds) This might not be the case during the next
downturn.
And let’s not forget the poor state of many public pension schemes… Future retirees will not get what they were promised… when they will
realize, they will see that they have massively under saved (and we would say that the situation is dearest in many European countries…). This will
serve as a wake up call for younger generations.
Liquidity momentum has a slight tendency to lead markets, and this should be especially true given in the current environment…
M2 momentum
t i supportive
is ti when
h using
i a 8 weeks
k rate
t off change
h b t on a year on year basis
but b i the
th picture
i t d
does nott look
l k goodd (Chart
(Ch t 77).
77)
EM foreign reserve holding have started to decline and this has historically coincided with volatile equity markets (Chart 78).
Note that emerging markets foreign reserve holding have been increasing much more rapidly than what the US current account deficit would have
implied This means that massive short USD position are being build through the speculative inflows.
implied. inflows Demand for USD will return with a
vengeance when it is least expected.
The market has a tendency to perform well in July but then you’d better be on holiday (Chart 80).
Source: The Halloween Indicator, S. Bouman Source: The Halloween Indicator, S. Bouman
We are now in the negative half of the year (Chart 81 and 82) and our “sell in may” seasonal quant models (where the switch is not based solely
on a date but we want a technical confirmation during a given time-window) has been on sell since late April.
In the US the first day of the month remains the stand-out winner
while in Japan, the 8 positive days continue to display an outstanding
performance
performance.
Source: Macquarie
The next 20 and weeks cycles low are expected for now with the next 20 weeks cycle low in October (Chart 85).
Chart 86,
86 courtesy of B. B Bronson,
Bronson has been used in the past to depict the relative assets movement during the Long Cycle (Kondratiev wave). wave) Many
analysts have tried to define this cycle by applying a fixed number of years but, as we have long said, we think that this is more of a generational cycle of
leveraging and deleveraging (was visible on price up to the creation of the Fed and on money velocity since then…). People who were young in the 30’s
were allergic to borrowing during all their life, organizing parties to celebrate their final mortgage payment… The same is slowly happening now in the
developed world (it will likely accelerate in the coming years when the weak foundation of the current upswing will become clear to all…)
The Autumn Season is the harbor of the biggest bubbles (1929 and 2007), stocks valuation are rising while interest rates falls from a high level. What
could we ask for more… It is followed by the Winter where interest rates and stocks valuations become highly correlated, both falling…
Commercial papers yield have been rising recently (Chart 87). Norman Fosback in the 70’s and M. Zweig in the 80’s showed that it was not a
good omen for the markets. Our own experience and derived models are confirming their findings.
The US and Euro Libor-OIS Spreads have also risen rapidly in the past few weeks (Chart 88).
Note that the US movements have been sharper and are probably a better reflection of the current stress and demand for cash USD.
In our macro presentations we have spent a lot of ink explaining why we believe that the stock markets will move along the ebb and flows of leading indicators.
They might even be lagging somewhat. They won’t profit from a valuation ratio expansion to save their day in downturn.
The ECRI weekly leading indicator year on year rate of change is now negative and the fact that austerity is in every politicians mouth won’t help (R.Koo
and M.Keynes are trembling but this will be a fertile ground for future financial historian).
J.Hussman
J H recession
i prediction
di ti model
d l would
ld be
b flashing
fl hi a warning
i signal
i l if the
th manufacturing
f t i ISM declines
d li b l
below 54 with
ith the
th S&P 500 remaining
i i
lower than 6 month ago and credit spreads higher than 6 months ago. The model has a perfect track record and the last 2 “live” warnings were on the
mark. So ignore at your own risk.
Global defensives have performed well recently and are in a clear up trend (they are even at the top of their rising relative channel and are
due for a consolidation (Chart 89).
The same is true for the Philadelphia Semiconductor index (Chart 92).
Banks have been performing relatively well in the US (was a bloodbath in Europe as expected) given the circumstances (Chart 93). The sector
relative performance will be a key to understand how the new wave of mortgages reset, the end of central bank accommodation and new accounting
rules will affect the rest of the market but let’s not forget that they are in the portfolio of quite a lot of the smart money managers we follow so…
High yield bonds are now in sync with the equity markets (Chart 94). Investment grade 5 years CDS indices have failed to confirm the April
highs and are currently weaker than equities. Check those graphs daily they will lead, this time again.
Two years treasuries above 1% have been associated with struggling market in the past 18 months (Chart 95). This won’t last but spike-like
movement have always been a warning worth listening to. This worked again in April.
We also like to look at the relative behavior of the equity markets and the Eurodollar future. On chart 96 you can see what happen to the market
when the eurodollar falls (higher rate expected) 2 days in a row and the market falls at the same time… We had an episode mid October… Another
one could mark an peak of significance…
We have long argued that one the characteristics of the current structural bear market (and we are talking US, Europe and Japan here...) was
the positive correlation between stocks and government bond yields.
But one has also to take into account the fact that while they are positively correlated, when yields have risen too much too quickly the stocks will
struggle. The sequence is usually rising rate, acceleration to the upside, yield starting to fall just before stocks do it to…
A rising USD has rarely been a positive for emerging markets (Chart 99). Funding of emerging markets dependant of European financial
institution, US investor obsessed, rightly, by the prospect of EM growth should start to get more interested by the European problems. They won’t
b contained
be t i d despite
d it T.T Geithner
G ith promised.
i d
2010 or 2011 could be years of major sovereign negative surprises… on the next page one will find the countries to have especially an eye on…
On Chart 100 you will find the usual suspects… Spain, we repeat is AN ACCIDENT IN THE MAKING as is HUNGARY. Spain will be the
domino which will set the rest into motion and the consequences are such that they are seen as impossible today (you know one of this black swan
in the making). We have been warning for some time and as we said in a recent update:”You ain’t seen nothing yet”
Source: RBS
Canaries in the coal mine candidates… To observe attentively in the coming months…
Candidates have been selected using the methodology of “Rules of Thumb' for Sovereign Debt Crises” by P. Manasse and N. Roubini, 2005
We are now in an environment where the S&P 500 will struggle to stay 4-5% above its 50 days moving average (Chart 101 and 102)…
A move above this threshold will likely be followed by a close more than 4% below the moving average later…
So do not accept any deterioration in other factors when the market is over-extended…
When the cycle is up the market usually does not fall so much below the 50 days MA has it has recently. Another sign that the cycle has
turned?
The S&P 500 is hovering around the October and February lows and is approaching the lower end of its declining trend channel. We took a
opportunistic position near the 1150 level less than a week ago. The position has now been exited.
The rebound could continue up to the 1150-1160 area but is not expected to move above. The first real test will be the 40 weeks moving average
which
hi h is
i now at 1100, andd falling.
f lli
Megaphone
Top
Europe has performed relatively better than the rest in the past 2 weeks as it did not makes new lows last week. A retest of the 2700-2750 area
before a new down wave is a distinct possibility.
Head
Head Shoulder
Shoulder
Shoulder
Shoulder
We are still observing.
g
Shoulder
Shoulder
We will start to buy
methodically on Head
Japan has always been a nightmare for technician. You have pattern all over the place and price are very noisy.
The Topix is sitting at support and should rebound along with the other markets. We won’t short it on rebound because it is cheap (maybe
justifiably) and there are better shorts elsewhere
Megaphone
Top
We will be shorting
again on a move above
400-410 or on a move to
new lows.
The index has continued to move inside the megaphone top pattern identified in March. The 40 weeks moving average is now at 390 and
declining.
We will be shorting
again on a move above
3900-4000 or on a move
to new lows.
In a configuration very similar to Asia ex-Japan. Has been relatively stronger in the during the past two weeks.
Megaphone
Top
Haven’t bought
on weakness last
week and won’t
until we move to
less than 0.5-0.6
times book value.
Much weaker than the rest. Still far away from its declining 40 weeks moving average. Would start to short on a move above 190 or on new
lows. We have insisted in the past that Europe would be the epicenter of the second leg of the great unwind.
There is no way Easter Europe would not be the main victim of what is happening now in the Euro zone. If the guy who finance you and who
yyou sell what yyou pproduce too is having
g a rough
g time,, yyou will too,, especially
p y if yyou have lived above yyour means thanks to bigg loans.
Do not forget to pick some of the dominoes falling by contagion… there are plenty of good things in the Czech Republic for example…
We are short.
Eastern Europe still remains one of the least discounted "unavoidable accident" in the market today (it is was mostly discounted in
the Eastern European markets last year but the second round effects toward other part of the world are not…… The stronger IMF has
voided the "end of their world" scenario, but…)
Investors surveys have moved from the complacency witnessed in April to more constructive levels. The Merrill Lynch Fund Manager Survey is
indicating a increased preference toward Japan and the US and declining interest toward emerging markets, a trend which already started a
couple of months ago. They are increasingly underweight Europe. While usually wrong at extremes, the fund managers participating in the survey
are right during trends. So accordingly one should be long Japan and the US relative to emerging market and especially Europe.
Option activity has improved and some indicators are in outright bullish configuration. We would prefer to see small traders be more fearful and
buying more puts to open instead of selling calls to open. The 3 months skews reached panic levels a week ago.
Insiders activity has moved away from heavy selling. Buying in the US remains subdued as it is in Canada. In Asia and Singapore in particular,
we have
h seen a notable
t bl pick
i k up in
i nett buying.
b i E
Europe remains
i the
th exception.
ti S
Some nett buying
b i in i the
th very short-term
h tt b t a lots
but l t off nett selling
lli ini the
th
past 100 days despite the market plunge. Selling while the markets decline is rarely a positive combination.
Our preferred “market timers” continue to have different opinions. J.Hussman is bearish while S. Leuthold thinks that the correction should be
bought. The best value managers have continued to reduce their exposure to the market indicating that the markets will have to fall more before
we see fundamentalists
f d t li t buying
b i from
f th technical
the t h i l traders.
t d
Speculators remains long the Nasdaq 100 future while NYSE Specialists have increased their relative short selling activity in the past days.
So sentiment is oversold but it has to be put in the context of the recent decline and market trend (lower highs and lower lows). Sentiment in
itself does not imply that the markets can not continue their descent in the medium-term
medium term but more that it should at least consolidate in the short-term.
short term
Breadth volatility is such that it is currently hard to give much weight to this area. The positives are that the various advance decline lines have
not diverged negatively in April and that we had a new cycle high in 52 weeks high at the same time. Markets tends to at least retest the highs when
this happen. Furthermore we did not get an Hindenburg Omen and the Fosback High-Low Logic Index did not indicate distribution. Shorter-term we
are also seeing a positive divergence from the McClellan ratio-adjusted
ratio adjusted oscillators and from the stocks above their 10 days moving average.
average The
negative are that we have had a lots of Lowry’s 90% down days, that the McClellan oscillators remained very oversold for a very long time
(relatively speaking) and our selling pressure indicator is behaving as it does at the onset of a cyclical bear market. Furthermore the Nasdaq New
High-New Lows model is on sell since the beginning of May.
inflows are reminiscent of 2000 and 2007), large cap domestic funds have seen huge outflows. The cash ratio has also declined everywhere and does
not leaves much dry powder to managers. Net redemption will have to be met with selling holdings. Buybacks have picked up slightly but not as
much as during the January correction. The US IPO and secondary offering market is almost closed while activity has declined markedly in emerging
markets in general and China/Hong Kong in particular. Don’t be fooled there are quite a few issues in the pipeline. Foreigners appetite for US stocks
remains high
Margin debt remains very high in the US when one look at its size relative to overall market capitalization.
On the monetary front, real M2 and M1 growth is still negative on a year on year basis in the US and decelerating markedly elsewhere.
E
Emerging
i markets
k centrall banks
b k reserve growth
h has
h been
b slowing
l i rapidly
idl which
hi h is
i a headwind
h d i d for
f risky
i k assets.
Pension funds’ funding status has stabilized but imagine the what will happen if equity price falls while high quality corporate bonds yields
(used to discount liabilities to present value) do not rise as they did in 2008-2009.
Seasonals
S l are supportive
ti for
f the
th very short-term
h tt b t August
but A t andd September
S t b are nott kind
ki d to
t the
th markets,
k t on average. Our
O mechanical
h i l seasonall model
d l
is on sell since the end of April. The 20 cycles low is due for now while the next low is expected sometimes at the end of October (which could also
be a four years presidential low).
Intermarket relationships have deteriorated. The equity market risk relationships like the Nasdaq, semiconductor or banks relative performance are
still
till supportive
ti (at
( t least
l t for
f the
th US).
US) The
Th relative
l ti defensive
d f i sectors
t performance
f i a negative.
is ti Wh t is
What i more worrying
i isi the
th deterioration
d t i ti in i the
th
credit markets. Commercial papers yield are rising as is the Libor-OIS and Ted Spreads. Investment grade CDS indices are diverging negatively. At
the sovereign level the ebb and flows are influences by the daily news flow but don’t be fooled the trend is clear. We have some surprise on the
subject. Some forecast will be met with incredulity.
The trends is down but markets are so oversold that a snap back rally is almost a certainty.
certainty The big problem is that it is only ALMOST a
certainty. Waterfall decline do not starts when the markets are overbought but when they are deeply oversold. We covered our shorts and bought
some in the past 10 days. We sold those position at a nice profit and are in sit and wait position now. We are seller of strength. We expect to
start building a new short position on a move above 1100 on the S&P 500 and to be fully short at 1140-1160. If the markets fail to reach those
level we will take short position on lower short-term lows AND a decline below the current short-term up trend.