Bad Bear Tells – VIX, Volume, High Yield, Spanish 10yr

Wednesday, August 22nd, 2012

by Peter Tchir, TF Market Advisors

Nervous Short

I remain short. I am flat Spain, Italy, and banks. I am short U.S. stocks here. I like CDS, but think IG18 will drift back to over 100 before it can take another leg tighter.

I think so much has been priced in from the ECB, that we face some disappointment as more plans get leaked or opposition becomes more vocal. I believe the ECB will do something that is sufficient to change the dynamics in Europe for a period of time, but think they are constrained enough, that the market may underestimate their plan. The market will view it as insufficient. LTRO1 remains a prime example. Everyone bought the rumor, sold the news, and then decided they better actually buy the news.

What concerns me most about being short, is that it seems very crowded. Not only is it crowded, but many bears (or underweight bulls) are pointing to the same things as reasons to be short, and some of those reasons don’t seem right to me. Here are 4 things too many people seem to be focused on and drawing potentially the wrong conclusions from, and why I don’t think any pullback at this stage will be meaningful and why I will be looking to cover and get long again on a relatively minor move.

VIX

It is impossible to read or listen to financial commentary without someone mentioning VIX and what a sign of complacency it is. Try it if you don’t believe me. Spend 1 hour paying close attention to the media and see how often VIX is cited and how it is universally accepted that this is a sign the market is due for a correction.

The following chart looks at the implied volatility of 30 day at the money S&P 500 options versus the last 10 days of realized vol. Implied volatility is much higher than realized volatility here. People are willing to pay up a little in expectations that volatility will increase. How much more than realized vol would you expect someone to pay? At some level, there are options traders who make a living trading the gamma. How much do you expect them to pay for that? They just won’t bid up option prices when realized volatility is low.

So yes, there are a variety of indicators from options that hint at complacency, but it isn’t horribly obvious to me that VIX is complacent relative to movement, and I am yet to see a study showing VIX is a leading indicator of anything.

I could see traders getting caught short gamma in a big move, causing the price move to become amplified, but I am becoming just as concerned about that in an up more as in a down move.

Volumes

Another thing many bears are pointing to is the lack of volume. The rally is not being “confirmed” by volume. I think volume is useful, but we have gone through other extended periods where volume didn’t confirm a trend, yet the trend continued.

Volume, to be important, in my opinion, must represent actual flows of people buying and selling shares to change their risk position. For better or worse, that represents only a fraction of the volumes in high frequency, sub-penny, rebated, etf arbitrage, etf creation, etf redemption, dark-pool, cross exchange arbitrage, sub-penny, and algorithmic trading driven world.

We can pretend that daily volumes are driven by customer buy and sell orders, but that just isn’t the case. So much volume is driven around the ETF products and replication that any change there filters through the system.

We can also ignore the fact that most volume indicators are based on number of shares rather than market value, but I’m not sure why we can ignore that. If stocks traded X shares when the S&P was at 1275, why would we expect X shares to trade when it is at 1425? From a “value” traded, the drop-off isn’t as bad. Most investors think in terms of money at risk, not number of shares at risk, so why is all the focus on volume in terms of number of shares?

And finally, what about Knight? Here is a nice chart of the S&P e-minis. While not a stock, I find it useful as one of the cleanest ways to trade the market. Look at the drop-off post Knight. Maybe they and other dealers decided to dial back some elements of their programs? Maybe it is a total co-incidence, but somehow, I doubt it.

High Yield Bonds

Another area of “weakness” or at least lack of “confirmation” has been the performance of the junk bond market. For many, this now means the ETF market. It is unrealistic to assume that high yield can perform in line with equities. High yield is almost a hybrid where it can exhibit bond like performance or equity like performance and we are in the stage where high yield looks more like a bond and less like an equity proxy.

The market has done so well that many of the bonds now have a lot of rate risk and just cannot rise with stocks, because the move in yields is a drag. Another category of bonds are the high dollar price yield to call bonds. They just have limited upside from here, so also cannot move in line. Rather than looking at the ETF’s which are price based products, it is probably more useful to look at the CDS market. Love or hate CDS, at least it is a spread product with a fixed duration. Look at HY18 vs HYG since June 12^th (after the ResCap settlement). While HYG hasn’t confirmed the rally, HY18 has, at least to some extent. The blue line is HY18 and it does show continued spread tightening.

2 of the largest holdings of HYG are the HCA 6.5% of 2020 bonds and the CIT 5.5% 2019 bonds. These trade sub 5%. The bonds have declined in price, while the spreads have narrowed. These bonds now trade far more like investment grade than traditional high yield. The rate risk is as important as the spread risk for their price. So these bonds sold off in price terms (while improving in spread terms) making it look like the high yield market wasn’t participating in the rally. More and more, you need to strip out some element of rate risk when analyzing how high yield did on a day, and it isn’t easy because too many of the other bonds have horrible convexity, and figuring out a “spread” is difficult too.

Still picking from HYG’s top 5 holdings, the INTEL 11.25% bonds of 2017 are an example. At a price of 105 they are trading to their 2015 par call, but it doesn’t take much of a move higher to push them to their 102.813 2014 call. At 105, the yield to maturity is 9.83% but the yield to call is 8.94%. That convexity definitely caps the potential for these bonds to appreciate.

So, a combination of bad convexity and rate risk means that just looking at the price of the HY ETF’s doesn’t give a true sense of how that market is doing. It isn’t as rate sensitive as LQD or MUB, but it cannot be ignored. The HY CDS market is confirming the rally if things like that are important, though to me it is just another risk on trade, one that I’ve particularly liked.

Spanish and Italian 10 Year Yields

In golf they say, drive for show, putt for dough. Well, in times of a credit crunch, which we are in, the 10 year is the drive. It is fun and exciting but the reality is the battle will be fought at the short end of the curve. The 2 year is boring, especially when not inverting, but that is more important to watch than the 10 year. The ECB may implement plans that help the front end more than the back end. They may even implement plans that hurt the back end, so watching that as a measure of the ECB’s “success” could lead to wrong conclusions. I wouldn’t ignore it, but anyone who tells you “the most important chart is the 10 year” is simply wrong. The 2 year will be the best indicator of what the ECB has accomplished, especially, if as I suspect, they limit their risk by focusing on that part of the curve.

E-mail: tchir@tfmarketadvisors.com

Twitter: @TFMkts

Copyright © TF Market Advisors

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Relative Value (Smead)

Wednesday, August 22nd, 2012

by William Smead, Smead Capital Management

Everyone wants to wait for the perfect time to buy into the stock market or into any major investment market. They want to enter at historically cheap prices or at “absolute values”. We at Smead Capital Management believe that these people are kidding themselves and everybody else. At the time of historical lows and “absolute value” those same folks are too mortified to pull the trigger (think March of 2009) and always come up with the reason that “it’s different this time”. Inertia rules the day.

Therefore, we have to deal in the world of “relative value”. Thanks to a recent article in the Financial Times by Peter Tasker, we have access to some terrific long-term graphs on the value of a wide variety of investments and products priced in gold. In fact, Tasker references the website, http://pricedingold.com/, which has a treasure trove of information about where things are priced currently compared to history in the form of ounces or grams of gold.

This got me thinking a great deal about pricing common stocks today by various popular measures. For example, if you prefer to be bearish on US stocks, you whip out the ten-year Schiller numbers and compute the S&P 500 Index PE ratio on a “smoothed” basis. Since we’ve had the deepest recession since the 1930’s, one of the slowest recoveries ever and a housing depression, the ten-year Schiller PE ratio is higher than the historical average at 18.8 PE. On that basis, you’d want to be extremely cautious with US common stocks.

On a consensus estimate basis, stocks look historically under-priced at around 13 times earnings. This compares to a multiple of 15-16 PE over the last 50-100 years. The bearish argument to that positive is that S&P profit margins are the highest they’ve ever been and must revert to the mean. When the reversion happens, earnings will be far lower and stocks will go nowhere or so say market bears. To get our opinion on this subject refer to our missive entitled “Stock Picking in a World of Profit Margin Mean Reversion”.

However, thanks to Peter Tasker’s thoughts, we need to have a discussion about the places that money is currently stored and compare them to the S&P 500 Index from a long-term standpoint. In the article, “Cash Out of Gold and Send Your Kids to College” here is how he got my thoughts and shopping comparisons started:

This makes sense. For most of human history, gold existed as an alternative to conventional finance, a “store of value” that could be relied on in times of distress and crisis. Gold bugs may hate to admit it, but those days are long gone. Gold has become just another financial asset, as vulnerable to the shifts of investor sentiment as an emerging market.

It is symbolic of today’s world that one of the largest exchange traded funds is invested in gold bullion, not equities.

Tasker pointed out that gold has always been a place that folks store some of their assets. Unfortunately for gold bugs, we believe it is getting severely out of whack with the price of important assets and goods which gold can be traded for. Its relative value is out of line.

The current bull market saw the gold price rise from $280 an ounce to $1,900 in 10 years. This is a rate of ascent comparable to some of the great historical bubbles, such as Japanese stocks in the 1980s, Nasdaq in the 1990s and Chinese stocks more recently.

In inflation-adjusted terms, gold remains within spitting distance of the all-time high it reached in 1981. After that it embarked on a 20-year bear market, which delivered a loss of 80 per cent in real terms and a far greater opportunity cost as other financial assets soared in price.

Even now the total market value of all the gold in existence – which, remember, generates a return of precisely zero – exceeds the combined capitalization of the German, Chinese and Japanese stock markets, with all the productive capacity they represent.

Then Tasker got me really excited and my economic academic discipline began boiling up inside of me with this paragraph:

According to the website pricedingold.com, gold is at a 120-year high (at least) relative to U.S. house prices. Likewise, it is at a 74-year high relative to U.S. wages, at multi-generation highs relative to wheat, coffee and cocoa and at the same price relative to the cost of a Yale education as in the first decade of the 20th century.

He didn’t include the S&P 500 Index, but at pricedingold.com you’ll find it is at the lower end of the last 60 years when priced in gold.

My mind quickly moved to the other liquid asset classes where folks store their money beside gold and US common stocks. This would include US Treasury Bonds, Bills and Notes, Certificates of Deposit (CDs) and other longer-term bank savings deposits, money market funds, corporate bonds (both high-grade and junk), commodities/commodity indexes, foreign bonds and international common stocks. Many of these are owned through mutual funds or ETFs, but for the sake of our discussion, they will be lumped together.

For the purpose of this missive, we will frame our relative value view of what Warren Buffett calls “currency investments” to the income they provide currently compared to the income they have provided historically. On both an absolute basis (interest rates lower than any time in the last 50 years) and a relative basis (as compared to the dividend yield on the S&P 500 Index) earning interest through the vehicles listed above is at an extreme. The opportunity cost of not owning interest-bearing securities is the lowest in US history. Ironically, both institutional and individual investors have poured money into these categories over the last five years.

It is even more exciting to compare US large cap common stocks to interest bearing securities if you normalize dividend payout ratios for the S&P 500 Index. In 2011, the payout ratio was 26%. Howard Silverblatt, the historian for S&P, reports that the average payout ratio from 1990 to 2010 was 46% and the 75-year average was 52.3%. He also shared that the current payout ratio is close to what it was in 1936 during the Depression. You think people might have been scared then? At a 52.3% payout ratio, the S&P would yield over 4% today! If something happens to cause leaders of the S&P 500 Index companies to normalize payout ratios in the next ten years, stocks could be attractive on an income basis for years. And they could be very competitive on an opportunity cost basis with “currency investments” as interest rates rise.

We have shared how over-priced we believe commodities are on a long-term basis in previous missives, so we won’t belabor the point. We also believe the international stock market won’t be good competition to the US large cap stocks until lower commodity prices have been priced into all the BRIC and BRIC-related equity markets around the world.

In summary, most of the places to put money among the liquid asset categories are very expensive relative to US large cap stock ownership at this time. It could be that US large cap stocks are incredibly undervalued and/or some combination of both. If the long-term charts at pricedingold.com are any indication and these historically low interest rates end, these next ten years could be a great deal of fun for common stock investors in the US on a “relative” basis.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities we recommend will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

Copyright © Smead Capital Management

Tags: Bullion, ETF, ETFs
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Eric Sprott: Investment Outlook (August 22, 2012)

Wednesday, August 22nd, 2012

NIRP: The Financial System’s Death Knell?

by Eric Sprott & David Baker, Sprott Asset Management

August 22, 2012

On July 18th, 2012, the German government sold US$5.13 billion worth of 2-year bonds at an average yield of -0.06%. Please note the negative symbol in front of that yield number. What this means is that the German government was able to borrow money for less than nothing. When those specific bonds expire in two years’ time, the German government will pay back the original $5.13 billion minus 0.06%. Expressed another way, investors knowingly and willingly bid the German government $5.13 billion in exchange for bonds that will pay no interest and are guaranteed to lose them money on expiration.¹ Welcome to the new status quo.

Germany is not alone. Over the past six months, the countries of Netherlands, Switzerland and France have also issued short-term government debt at negative yields. Like Germany, they’ve been able to do this because European bond investors are so shell shocked that they’d rather park money in a bond that’s guaranteed to only lose a miniscule amount rather than risk losing more in a PIIGS bond that actually pays some interest. In addition, many investors view German, French and Dutch bonds to be cheap options on the break-up of the Eurozone. If the EU currency union collapses, euro-denominated bonds issued by those specific countries may be paid back in re-issued deutschmarks, francs or guilders, which will be far more valuable than the euros that were spent to buy the bonds in the first place… or at least that’s the idea. As a result of this thinking, the bond market auctions for these select countries have seen overwhelming demand, making NIRP (Negative Interest Rate Policy) the new ZIRP (Zero Interest Rate Policy).

The NIRP acronym is misleading, however, because unlike ZIRP, NIRP isn’t actually an official “policy” per se, but rather a symptom of a broken financial system increasingly starved for good ‘collateral’. Aside from those speculating on a Eurozone currency collapse, a large portion of the bond investors participating in NIRP bond auctions are the banks. As the euro crisis has dragged on, banks in perceived “strong” countries like Germany and Switzerland have seen record inflows of deposits from banks in peripheral EU countries, like Spain. As most of these “strong country” banks have been hesitant to lend those deposits out (for obvious reasons), they are forced to park them in short-term government bonds. Moreover, new rules imposed by various regulators such as Basel III have forced all banks to hold a larger percentage of their balance sheet in government bonds, regardless of their country of domicile. The result has been a mad dash into the bond auctions of select “safe” countries just as the pool of available AAA-bonds has been drastically reduced. Banks are piling into NIRP bond auctions today because they have nowhere else to go. This is why nobody seems to be alarmed by the recent ubiquity of NIRP bond auctions – they are merely thought to be a short term phenomenon that will pass in time… just like zero-percent interest rates were supposed to be when they were widely introduced four years ago (sigh).

NIRP is different than ZIRP, however. NIRP causes outright financial destruction. Economies can hardly survive extended periods of ZIRP rates, let alone survive a long-term NIRP environment. It just doesn’t work. Institutional investors like pension plans and life insurance companies cannot earn enough “spread” to function properly. And many aren’t allowed to buy different asset classes that might produce a better “spread”, even if they wanted to. They are stuck holding the AAA government debt issuers – positive-yield, or not.

Negative rates also punish the individual investor. Try going online and using one of the banks’ retirement savings simulators and plugging in a negative expected return – you’ll break the program. The same also goes for the investment advisory business. When so-called safe-haven bonds start to consistently produce a negative return, try charging advisory fees to clients while recommending a 50% allocation to negative-yielding government debt. Advisors can try it for a while, but investors won’t put up with it for long.

The recent emergence of NIRP auctions are a signal that the relationship between governments, banks and investors has broken down. While the market still presumes that NIRP is a short-term phenomenon confined primarily to Europe, the dearth of AAA-assets coupled with banks’ captive bond purchasing suggests it may be structurally enforced for a long time to come. There’s even the potential for NIRP to emerge in the US bond market. As Bloomberg reports, the gap between US bank deposits and loans hit a record $1.77 trillion at the end of July 2012, representing an expansion of 15% since May.² “Banks have already bought $136.4 billion in Treasury and government agency debt this year, more than double the $62.6 billion purchased in all of 2011, pushing their holdings to an all-time high of $1.84 trillion.”³ The current 2-year US Treasury bill is yielding a paltry 0.29%. If something exciting happens in Europe, what’s to stop the bond market’s typical knee-jerk move into US Treasuries from pushing that yield down past zero? Not much. We could be there before the end of the year, especially if the banks continue to gorge on ongoing US Treasury auctions in the meantime.

The question now is how well the financial system can cope in a relentless low-to-no yield environment for bonds. The last four years of low rates have already wreaked much damage to ‘spread’-dependent industries. One need only look at the insurers: In its latest Q2 report, after reporting an 88% drop in Q2 year-over-year earnings, Sun Life Financial stated that if current interest rates persist its profits for the period from 2013 to 2015 could be hurt by up to CAD$500 million.⁴ Manulife recently reported a Q2 loss of CAD$300 million, which was mainly attributed to a CAD$677 million charge it took to revalue long-term investment assumptions to account for falling bond yields.⁵

The pension plans are also deteriorating: According to recent reports from BNY Mellon and Mercer, the funded status of US corporate pension plans hit a record low in July 2012. Benefits Canada writes, “The average funded status dropped 2.9 percentage points to 68.7%… while the latest figures from Mercer show that the aggregate deficit in pension plans sponsored by S&P 1500 companies grew US$146 billion during July, to a record high of US$689 billion.”⁶ That’s a one-month increase of 27%.⁷ In the pension business, lower yields on long-term AAA bonds results in higher plan liabilities, plain and simple. As Reuters reporter Jim Saft writes, “To give an idea of exactly how powerful the effect of falling rates is on pension liabilities, consider that, according to Mercer, though US shares rose 1.4 percent in July, the 30-55 basis point fall in discount rates drove an increase in liability of between 3 and 11 percent. In a single month.”⁸

It’s even worse for the public pensions. According to the Washington Post, new pension accounting rules imposed by bond-rating firm Moody’s are expected to “triple the gap between what states and municipalities report they have in their funds and what they have promised to pay out retirees.”⁹ If implemented, that new public pension gap will balloon to $2.2 trillion. Michael Fletcher from the Washington Post writes, “Among other things, the new accounting rules from Moody’s and the Governmental Accounting Standards Board (GASB) limit the rate of return on future investments that pension funds can assume for accounting purposes. Most government pension funds assume a 7 percent to 8 percent return, which critics say overstates future investment income.”¹⁰ With the US 10-year bond now paying less than 2% a year, assuming a 7-8% return isn’t an overstatement, it’s a fantasy. Chart 1 shows how the last four years of low-to-no rates has impacted the average Canadian pension plan. Extend that trend another four years and we might as well redefine the entire purpose of pensions altogether.

CHART 1: THE SOLVENCY POSITION OF DEFINED-BENEFIT PENSION FUNDS IN CANADA IS AT AN ALL-TIME LOW Indexes (December 1998 = 100)

a. Solvency position is equal to assets divided by liabilities.
Source: Mercer (Canada) Limited. Last observation: May 2012.

Banks are also suffering from NIRP and ZIRP, as evidenced by the performance of Wall Street’s five biggest banks thus far in 2012. Bloomberg writes, “JPMorgan Chase & Co. (JPM), Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley had combined first-half revenue of $161 billion, down 4.5 percent from 2011 and the lowest since $135 billion in 2008. The firms blamed the decline on low interest rates and a drop in trading and deal-making.”11 (Emphasis ours.) Banks make money on the spread between the interest they charge on loans and the interest they pay on our deposits (this is called the net-interest margin). Chart 2 shows the impact low rates have had on the net-interest margin for the Big 6 Canadian banks, and how tightly correlated their profits are to bond yields themselves. The average net-interest margin for the Big 6 was 2.55% in fiscal Q2 2012, while the average yield on the Canadian 5-year Treasury bond was 1.54%. According to our calculations, for every 100 basis point decline in the 5-year Treasury yield, the Banks’ net-interest margin will fall roughly 20 basis points. All else equal, a 1% drop in 5-year bond yields will result in a -15.6% impact on the banks’ net income. Like the insurers, the persistence of low bond yields hurts their profit margins… and the more deposits the banks take on, the more they are inadvertently forced to participate in short-term bond auctions – thereby supporting the very market causing the margin compression in the first place. It’s a vicious catch-22.

CHART 2: CANADIAN BANKS’ NET-INTEREST MARGINS TRENDING DOWN Correlation: 87%

Source: Bloomberg, Big 6 Canadian Banks’ Financial Reports.

From a government perspective – especially governments like Germany who currently issue short-term debt for less than nothing, the current abundance of NIRP and ZIRP bond auctions represent a sweet irony. Here we are, on the interminable verge of collapse in Europe, and at a time when Western governments have never been more indebted, and bond investors are lining up to pay for the pleasure of owning their bond paper! It’s actually quite ridiculous. But no matter how much pain the current low-to-no yield environment causes the rest of the financial industry, governments will not do anything to change their current set-up. No government is incentivized to proactively raise their bond auction yields for the sake of savers, and barring the surprise emergence of major inflation, no central bank would ever raise interest rates and risk curtailing their expensive efforts to foster growth through money-printing. The banks’ continuing need for safe “collateral” means they’ll buy government bonds at virtually any price, leaving the governments with a “captive” buyer for their bonds. It’s almost perfect for the governments… and as it now stands, unless the banking system diversifies into different forms of AAA-collateral (like gold), or until we experience a default or major inflation – both clearly negative events, investors will be forced to survive with a AAA-bond market that pays absolutely nothing, just like Japanese investors have suffered through for the past twenty years.

Under widespread NIRP, pensions, annuities, insurers, banks and ultimately all savers will suffer a slow but steady decline in real wealth over time. Just as ZIRP has stuck around since the early 2000’s, NIRP may be here to stay for many years to come. Looking back at how much widespread damage ZIRP has caused since its introduction back in 2002, it’s hard not to expect that negative interest rates will cause even more harm, and at a faster clip. In our view, NIRP represents the death knell for the financial system as we know it today. There are simply too many working parts of the financial industry that are directly impacted by negative rates, and as long as NIRP persists, they will be helplessly stuck suffering from its ill-effects.

Although it’s been a quiet summer for “hard assets” like gold and silver, this low-to-no rate environment should prove to be beneficial for them over time. The tide is definitely turning in their favour. Various bond commentators have recently come out in support of hard assets, including PIMCO’s Bill Gross, who opined in his August month-end letter that, “Unfair as it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.”12 NIRP and ZIRP are critical components of that solution, and are here to stay until something unpredictable disrupts the current relationship between the banks and government bond auctions. In our view, the factors that have led to the emergence of NIRP bond auctions are the same factors that will drive demand for physical gold in the coming months: savers have nowhere to go for a “safe” return. It’s only a matter of time before they realize they’ve overlooked a unique financial asset that would perfectly suit their needs. When they do, we would strongly advise them to take delivery.

a. Solvency position is equal to assets divided by liabilities.
Source: Mercer (Canada) Limited. Last observation: May 2012.

Footnotes:

1. Bartha, Emese and Chaturvedi, Neelabh (July 18, 2012) “Negative Yield on German 2-Year Note”. Wall Street Journal. Retrieved on August 8, 2012 from: http://online.wsj.com/article/SB10000872396390444330904577535102520070554.html?mod=googlenews_wsj.

2. Eddings, Cordell and Kruger, Daniel (August 20, 2012) “Banks Use $1.77 Trillion to Double Treasury Purchases”. Bloomberg. Retrieved on August 20, 2012 from: http://www.bloomberg.com/news/2012-08-20/banks-use-1-77-trillion-to-double-treasury-purchases.html.

3. Ibid..

4. Perkins, Tara (August 8, 2012) “Sun Life hammered by markets, low rates”. The Globe and Mail. Retrieved on August 10, 2012 from: http://www.theglobeandmail.com/globe-investor/sun-life-hammered-by-markets-low-rates/article4470289/.

5. Reuters (August 10, 2012) “Manulife takes loss, to revisit profit target”. Reuters. Retrieved on August 12, 2012 from: http://in.reuters.com/article/2012/08/09/manulife-results-idINL2E8J90LV20120809.

6. Benefits Canada (August 3, 2012) “U.S. pensions hit all-time funding low”. Benefits Canada. Retrieved August 5, 2012 from: http://www.benefitscanada.com/pensions/other-pensions/u-s-pensions-hit-all-time-funding-low-31130.

7. Mercer (August 3, 2012) “US Corporate Pension Plans’ Funding Deficit Reaches All-Time High”. Mercer. Retrieved on August 21, 2012 from: http://www.mercer.com/press-releases/funding-deficit-reaches-all-time-high.

8. Saft, Jim (August 14, 2012) “Negative rates and pension pain”. Reuters. Retrieved August 14, 2012 from: http://www.reuters.com/article/2012/08/14/us-column-saft-idUSBRE87D03U20120814.

9. Fletcher, Michael (August 16, 2012) “New rules expose bigger funding gaps for public pensions”. The Washington Post. Retrieved on August 16, 2012 from: http://www.washingtonpost.com/business/economy/new-rules-expose-bigger-funding-gaps-for-public-pensions/2012/08/16/c183fe1a-d507-11e1-b2d5-2419d227d8b0_story.html.

10. Ibid..

11. Eddings, Cordell and Kruger, Daniel (August 20, 2012) “Banks Use $1.77 Trillion to Double Treasury Purchases”. Bloomberg. Retrieved on August 20, 2012 from: http://www.bloomberg.com/news/2012-08-20/banks-use-1-77-trillion-to-double-treasury-purchases.html.

Tags: Canadian, Canadian Market, Sprott
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Sector Relative Strength: Industrials Improve, Utilities Dive (Bespoke)

Wednesday, August 22nd, 2012

by Bespoke Investment Group

The charts below show the relative strength of the ten S&P 500 sectors as well as the Dow Jones Transports and the Russell 2000 relative to the S&P 500 over the last year.  When the line is rising it indicates that the sector is outperforming the S&P 500, while a falling line indicates underperformance.  We have also shaded each sector in red or green to indicate whether the sector has outperformed (green) or underperformed (red) the S&P 500 over the last year.

As shown in the top two charts, both consumer sectors have seen their relative strength trend lower in recent weeks.  The recent performance of these two sectors has provided a mixed message.  While the underperformance of a defensive sector like Consumer Staples is encouraging for the bulls, the underperformance of the more cyclical Consumer Discretionary sector is a negative divergence.

Staying on the theme of underperformance, we have also seen a notable decline in the relative strength of other notoriously defensive sectors.  Health Care’s relative performance has been notable over the last few months.  While the sector outperformed leading up to the Supreme Court’s ruling on the Affordable Care Act (Obamacare), its relative strength peaked within two weeks of the ruling on June 28th.  Along with Health Care, other defensive sectors such as Telecom Services and Utilities have both seen sharp declines in their performance relative to the S&P 500.

On the positive side, bulls should be encouraged to see the relative strength of Industrials and Technology reverse higher in recent weeks.  Even Financials have been getting in on the act, as the sector’s relative strength has been drifting higher since making a low for the year back in late May.

Outside of the performance of individual sectors, we also included the relative strength of the DJ Transports and the Russell 2000 small cap index.  During market rallies, many investors like to watch these sectors for confirmation of the rally.  In the case of both of these sectors, the overall market rally started without them, and it wasn’t until just recently that they started to join the party.  Better late than never!

Copyright © Bespoke Investment Group

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Drudge Headline Indicator Surges to New High Then Pulls Back

Wednesday, August 22nd, 2012

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Japanese Trade Implosion Sends Futures To Lows

Wednesday, August 22nd, 2012

Somewhat disastrous trade balance data from Japan – with exports dramatically worse-than-expected (EU exports -25.1% YoY) and imports worse-than-expected (which will come as no surprise to any ZH reader given Europe’s depression and our discussion of world trade here) – has crushed JPY crosses overnight (especially AUDJPY) which is exactly what we said at the close today was required to extend today’s equity weakness. Sure enough, S&P 500 futures are down over 6 points from the close now – and trading below day-session lows.

For those too lazy to click on the hyperlink above, here again is the chart we showed earlier in the year when we gloated over the now rotting carcasses of decouplers everywhere (looks like decoupling has been “greenshot” again, hopefully this time for good), which explains why without a healthy Europe there can never be a global recovery:

Japan Exports missed by the most in a year – pretty much to their lowest since 2009. Stunningly, European exports are -25.1% YoY!

which sparked AUDJPY (and carry FX in general) to slump…

which is implictly dragging S&P futures down – below day-session lows (on decent overnight volume)…

Charts: Bloomberg

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60 Minutes Does Not Understand Lehman Brothers or The Financial Crisis

Wednesday, August 22nd, 2012

via Barry Ritholt, The Big Picture

WRONG:

Steve Kroft seems to think the collapse of Lehman Brothers was a trigger, and had it not fallen, we would not have had a financial crisis.

Thats simply wrong.

No, it was not the cause of the crisis — it was merely one of the first trailer homes in the park to get blown away by the tornado.

The rest about the non prosecution is worth watching:

Source: 60 Minutes

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Spiegel: ECB Plans to Set Yield Targets for Sovereign Debt

Wednesday, August 22nd, 2012

by Mark Hanna, Market Montage

Spanish and Italian bond yields have fallen significantly this morning as a news item in Spiegel that the ECB is considering a plan to set a limit for sovereign yields.  This would be a big change in strategy and more along the lines of bazooka.  In fact, this is the type of thing Hank Paulson meant when he said if you set a clear signal to markets you really don’t have to take the bazooka out of the pocket.  If the ECB said Spanish yields won’t be allowed to go over X, who is going to bet against them?  Interesting development but the political implications are interesting as this would signal (in theory) the potential for unlimited bond buying which the Germans are against.  Whatever happens, it is clear the ECB is turning much more similar to the Bernank in policies…

• As part of its efforts to fight the euro crisis, the European Central Bank (ECB) is considering establishing caps on interest rates for government bonds in individual countries as part of its future bond-buying program. Under the plan, the ECB would begin purchasing government bonds from crisis-hit countries if yields for those bonds exceeded the interest rates for benchmark German sovereign bonds by a predetermined amount. This would signal to investors which interest rate levels the ECB believes to be appropriate.
• Given that it can print money itself, the central bank has access to unlimited funds, which could make it extremely difficult for speculators to continue driving yields up beyond the amount stipulated by the ECB. By engaging in bond buying, the ECB not only wants to get the financing costs of crisis-plagued countries under control — it also wants to ensure that the general interest-rate levels across the euro zone do not drift too far apart.
• During its next meeting at the beginning of September, the ECB’s Governing Council is expected to decide on whether the interest-rate goal will actually be implemented. However, it has already been decided that the ECB will be more transparent in the future about its bond purchases. Looking ahead, the ECB plans to publicly state the volume of bonds it has purchased from each country. This information is to be published immediately after the purchase takes place. Under current practice, the ECB announces on Mondays how much, in total, it spent on buying bonds the previous week.
• Calls for such action are growing. In an interview with state-owned news agency EFE, Spanish Economics Minister Luis de Guindos called for the ECB to purchase unlimited amounts of Spanish sovereign bonds on the capital markets. He argued that that would be the only way to effectively reduce interest rate pressure on Spanish sovereign bonds and to eliminate doubts about the euro.
• ECB President Mario Draghi has signaled the prospect of the ECB undertaking that kind of step, but only under the precondition that countries such as Spain or Italy first make a formal request for EU aid, which would involve agreeing to the conditions attached to that assistance. The question of what a country would have to do in return for the ECB buying its bonds is expected to be discussed at a meeting of Euro Group finance and economics ministers that is scheduled for the second week of September, de Guindos said.

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Catching The Invisible Hand Pushing On The VIX In Action

Wednesday, August 22nd, 2012

Every now and again the coincidences (or some might call them conspiracies) become too much to bear. We have noted the incessant deep-pocketed use of volatility as a levered way to manage equities up (or down we suppose should the need arise from a centrally-planned banking institution that does not feel the incumbent is in his court). Today was a great example of the desperate interaction of the world’s most over-owned (and biggest) company and selling pressure over-whelming the VWAP algos. As the chart below shows, the early selling pressure in AAPL smashed prices down to yesterday’s close and closing VWAP; volumes surged as algos piled institutions out but they soon got overhwhelmed as the price fell through their VWAP level (which means the costs start to pile up to the market-maker’s algo which promised VWAP execution). Immediately Plan B comes into play – Sell Vol Hard! which implicitly lifts the stock in a ‘bullish’ index-signaling way and enables the algos to offload the overwhelmed volume to unsuspecting nibblers. Once stable and flat again – business can continue and the selling commenced as they bought back the vol they sold. Conspiracy or coincidence? If you know how VWAP algos work – there is no doubt.

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Early Signs: Start of a Short Term Correction?

Wednesday, August 22nd, 2012

by Don Vialoux, Timingthemarket.ca

Interesting Charts

Early signs of start of at least a short term correction in U.S. equity markets have appeared. Interesting technical action by the S&P 500 Index yesterday! According to Mark Leibovit, “We’re experiencing a ‘Key Reversal Day’ today – higher high, followed by a lower low (as compared to the previous trading session in both cases) accompanied by a slight increase in volume. Not a good sign”. The reversal comes at a critical time. The S&P 500 Index briefly broke above its four year high at 1,422.38, but was not able to attract buying interest.

The VIX Index spiked from deeply oversold levels.

Currency moves had a significant impact on commodity markets. The Euro broke above its 50 day moving average and short term resistance at 124.42.

Conversely, the U.S. Dollar broke short term support at 82.04.

Commodity prices responded to weakness in the U.S. Dollar. Gold broke above resistance at $1,642.40 on higher volume. Intermediate trend changed from down to up.

Gold stocks and related ETFs moved higher and are outperforming gold.

Grain prices reached new highs.

Uranium stocks and their related ETF continue to move higher on increasing volume.

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FP Trading Desk Headline

FP Trading Desk headline reads, “Forget the fiscal cliff. Food is the real crisis”. Following is a link to the report:

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Disclaimer: Comments and opinions offered in this report at www.timingthemarket.ca are for information only. They should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.

Don and Jon Vialoux are research analysts for Horizons Investment Management Inc. All of the views expressed herein are the personal views of the authors and are not necessarily the views of Horizons Investment Management Inc., although any of the recommendations found herein may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management Inc

Horizons Seasonal Rotation ETF HAC August 21^st 2012

Tags: ETF, ETFs, Seasonal, Seasonal Trades, Seasonality
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