Archive for September 10th, 2012
Monday, September 10th, 2012
Weighing the Week Ahead: Will the Fed Disappoint the Markets?
Guest Contribution by Jeff Miller, A Dash of Insight
After weeks of buildup, culminating with Fed Chair Bernanke’s Jackson Hole speech, the time for decision has arrived. While some of the economic data is better, the jobs picture remains poor. Friday’s employment report has raised expectations for some aggressive action. Are these hopes justified, or will the Fed disappoint the markets?
I was very accurate last week in predicting that the story would be all about jobs. The Democratic Convention, the pundit commentary, the GOP response, the media focus, and the Thursday and Friday data all followed this theme. Given Friday’s disappointing employment situation report, the question became, What now? I suggested in my employment preview that reaction would be dampened by the expectation of more aggressive Fed action. This is exactly what we saw from Friday’s trading.
The general expectations have shifted, setting the bar higher. Here is the take from Jon Hilsenrath, who seems to have the pulse of the Fed:
“Officials have been leaning toward an open-ended bond-buying program in which the Fed holds open the possibility that it will continue to buy bonds after an initial allotment is purchased if the economy doesn’t pick up. They also have been leaning toward purchasing mortgage backed securities.”
Michael Derby at the WSJ Real Time Economics Blog notes that the expectation is now “QE3 and more.”
The expectations from these sources are at odds with the investment posture of both the Street, and the public. Check out two of my favorite sources.
Barry Ritholtz has tracked the “most hated rally” so check out his article for the history. Here is the chart that shows why this is important — the underinvestment of some big firms.
Josh Brown shows the same psychology on the part of average investors, explaining that they have left $65 billion on the table through recent decisions to bail out of stocks.
I’ll offer some of my own expectations in the conclusion, but first let us do our regular review of last week’s news.
Background on “Weighing the Week Ahead”
There are many good sources for a list of upcoming events. One source I especially like is the weekly post from the WSJ’s Market Beat blog. Ben Fox Rubin and Steven Russolillo go beyond the formal list of economic releases by mentioning major earnings reports, speeches, and even conferences.
In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
This is unlike my other articles at “A Dash” where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!
Last Week’s Data
Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
- It is better than expectations.
There was a fair amount of good news last week.
- The ISM services index provided an upside surprise. The employment component is especially encouraging. Bespoke has a comprehensive look with the components individually listed and charted. Here is the overall history, but the full article is worth a look.
- Home prices continue to rise as measured by CoreLogic. Global Economic Intersection has an excellent discussion and charts comparing different approaches. Here is a sample:
- Productivity was up 2.2%, handily beating expectations. Productivity gains have come from corporations doing more with fewer workers. At some point they will need to add workers to meet growing demand. Meanwhile, this is good news for profits.
- Job creation was strong, according to ADP and various other analysts, as I described in my monthly employment report preview. I understand the need for some “official” result, and the BLS method is very good. Alternative approaches are also very good. In the richness of time, these estimates often prove to be more accurate.
- Auto sales are rebounding smartly (via Scott Grannis).
- The ECB delivered on promises. Unlike many of the past incremental steps in Europe, this one did not generate a “sell the news” reaction. The potential open-ended nature, the willingness to take equal status with private investment, and the assertion of power to act independently from government decisions were all factors. The one downside element was that the purchases will be “sterilized” so that the overall balance sheet does not expand. This is not the all-out money printing that some craved. The overall effect was rather amazing, stretching into the 10-year yield for Spain and Italy, even though that is not where the ECB proposed to buy. Attitudes seem to be changing, as reflected in market prices.
There was negative news, lesser in quantity but greater in importance.
- Earnings forecasts drift lower. Brian Gilmartin, an expert on earnings both for individual companies and the overall market, tracks these trends very closely. (Similarly, Dr. Ed Yardeni) He notes the recent weakness and acknowledges the debate about what is already priced into the market. On his excellent new blog he writes as follows:
“…(A)ccording to ThomsonReuters – 2nd quarter, 2012 earnings are still expected to grow at 1.3% ( ex Bank of America and the financial sector) and 3rd quarter, 2012 earnings, which we continue to think will be the bottom for this cycle in terms of the earnings slowdown, are expected to decline year-over-year at a -2.1% rate.The forward 4-quarter estimate for the S&P 500 estimate as of late last week was $108.02, exactly where it was 1 week ago.”
- Economic confidence remains weak (via Gallup). This measure is off the lows from last year, but still very weak — a bad sign for consumer spending.
- Foreign economic indicators (Europe and China) all declined last week. I always watch these — always. It is how I start my day, and I often comment on them in my daily diary at Wall Street All Stars. I understand that we have a global economy, and I want to put it in perspective. Offsetting some of the decline, China will do more stimulus. Analyzing the impact on US stocks is a challenge.
- The official jobs numbers reflected a weak economy, worse than expected and worse than needed. Discussing this objectively is nearly impossible for most, since the issue is so salient for voters. There was nothing good about this report. The net job gain of 96,000 is less than needed to keep up with the growth in population (perhaps 125k, although the target changes with trends in retirement and immigration). Downward revisions for the last two months subtracted another 40K jobs, half of which were in government. The household survey also showed a decline in jobs, although this series has fluctuated wildly. The decline in the unemployment rate was not statistically significant (after rounding) and mostly reflected a reduction in the labor force.
The official employment data is roughly consistent with the rest of what we see — growth of 2% or so. Putting aside the political rhetoric, everyone realizes that more economic growth and a greater increase in net jobs is needed.
The ugly award goes to the rather surprising result of diversification into commodities. Tom Brakke always combines clear-headed analysis with great charts. He analyzes the concepts behind the chart below. Check out the full discussion, but this point describes investor behavior: “Investors have embraced these alternatives, only to find that they don’t really know much about them other than they’re not stocks or bonds.”
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
- The St. Louis Financial Stress Index.
- The key measures from our “Felix” ETF model.
- An updated analysis of recession probability.
The SLFSI reports with a one-week lag. This means that the reported values do not include last week’s market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a “warning range” that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli’s “aggregate spread.”
Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.
The evidence against the ECRI recession forecast continues to mount. It is disappointing that those with the best forecasting records get so much less media attention. The idea that a recession has already started is losing credibility with most observers. I urge readers to check out the list of excellent updates from prior posts.
Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.
The single best resource for the ECRI call and the ongoing debate is Doug Short. This week’s article describes the complete history, the critics, and how it has played out. The article highlights the most important economic indicators used in identifying recessions, showing that none have rolled over. Doug updates the recession debate every week and includes a great chart of the “big four” indicators used by the NBER in recession dating.
Meanwhile, the ECRI story continues to change. The latest variation is that the data will eventually be revised lower to show that we are already in recession.
Note on the Fiscal Cliff — A thoughtful reader asks whether our recession forecasts include the fiscal cliff, a good question. Methods derived from historical experience are not helpful on issues like the cliff, so the general answer is “no,” but some of the market-based methods will capture this as the time comes closer. I treat factors like the fiscal cliff, the collapse of Europe, the collapse of China, an attack on Iran, and similar factors as relevant elements of “tail risk.” There is no good way to incorporate these into standard recession forecasting methods, so no one even tries. (I am ignoring those with a semi-permanent recession forecast!)
I frequently cite and monitor these factors in the weekly commentary, especially in “the ugly” section. If you insist on waiting for a time when there are no low-probability risks, you are a spectator, not an investor.
Our “Felix” model is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we continued with our recent switch to neutral. We have been bullish since June 23rd, with a one-week move to neutral a month ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings have moved lower, and the confidence has deteriorated from last week.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
There is plenty of data coming this week, but two events loom large:
- The German Constitutional Court ruling (W, before US markets open). The feeling is that the Court will accept an increased German role — -perhaps 80%. If not, there will be a scramble to figure out what portion of current plans may still be feasible.
- The FOMC announcement and Bernanke’s press conference (Th afternoon)
The “A List” includes the following:
- Trade balance (T) with implications for GDP.
- Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.
The “B List” includes several reports:
- Industrial production (F).
- Michigan consumer sentiment (F) which has implications for consumer spending and employment.
- PPI (Th) and CPI (F) are sometimes important, but only if we get a few scary reports. That would create a dilemma for the Fed.
The time from the market opening on Wednesday through the FOMC announcement on Thursday will be the most crucial hours of the week.
Trading Time Frame
Despite Felix’s overall “neutral” posture, our trading positions continued in fully invested mode last week. Felix became more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the “bull market somewhere” even when the overall picture is neutral. The ratings have been getting a little weaker, but the trade continues to be profitable.
Felix does not try to call tops and bottoms, but instead keeps us on the right side of major moves, either up or down.
Investor Time Frame
Long-term investing is an objective for many of my clients, so I give it a lot of thought. Each week I try to provide an idea or two that will be useful for those sharing this perspective. Here are two new ones.
How much risk to take. The right answer is different for everyone, but too many people choose “zero.” These investors do not follow the Buffett advice of buying when others are fearful. Then, when the market rallies, they are afraid that they are “too late.” I wrote a new article, Stock Prices and the Fundamentals: Don’t be Fooled, showing how to avoid this trap.
How to pick dividend stocks. Regular readers know that I am fussy about my choice of dividend stocks and I like to enhance yield by selling near-term calls against the position. Carla Pasternak explains why it is important to look beyond the yield, finding companies that also represent good value. This is a fine article, combining both a great approach with some specific ideas.
If you have been following our regular advice, you have done the following:
- Replaced your bond mutual funds with individual bonds;
- Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
- Added some octane with a reasonable allocation of good stocks.
There is nothing more satisfying than collecting good returns in a sideways market.
If you have not done so, it is certainly not too late. We have collected some of our recent recommendations in a new investor resource page– a starting point for the long-term investor. (Comments welcome!)Final Thoughts on the Fed
Before this week I was not expecting an aggressive action by the Fed, but my own opinion changes with the data.
The mistake made by most is a collection of dangerous ideas — OK for politics, but risky for trading and investing. In the absence of a better term, I’m going to call it the Fed Skeptic Syndrome.
The Fed Skeptic has the following collection of beliefs:
- QE has no positive economic effect. It has not helped employment and has boosted stocks only because the Fed bond buys act like direct purchases of stocks and commodities — in addition to pushing conservative savers into tech stocks and soybeans. Fed action has artificially kept stock prices and the economy higher, but is ineffective. You can see this because things are worse than they were a few years ago. It is all a sugar high, and it will end badly either through deflation, or hyperinflation, or both. These forecasts are certified by an array of “chief investment strategists” whose credentials do not include economic education but do include frequent media appearances. The most popular are “self-taught in Austrian economics.”
The FOMC has the opposite viewpoint:
- QE has lowered interest rates by a few bps and generated a gain of about 2 million jobs over what otherwise would have happened. There was no direct effect on commodity prices. Misguided speculators drove these prices higher. Stock price increases reflected the improved economic prospects from the program, and also created a virtuous cycle of confidence and wealth effects. The proponents are all credentialed mainstream economists of both political parties.
As a voter, feel free to take whatever perspective you want.
As an investor, it is wise to understand those who actually have power, and predict what they will do. Most of those who are missing the rally do not have sufficient respect for the determination and power of government officials.
Monday, September 10th, 2012
by James Bianco. Bianco Research
The most hated stock market rally in years continues. S&P 500 hits multiyear high — anger and frustration hit multiyear highs. (Read more: Stocks Near Highs, Nasdaq Up 2%; Vix Near 16) S&P 500 at 4.5-year high, Healthcare and Consumer Discretionary (mostly retail and home builders) at historic highs. Markets led by Financials, Materials, Energy, and Industrials. How can this be, my trading friends keep asking me? The economy is mired in sub-2 percent GDP growth. Mario Draghi downgraded the GDP outlook for Europe, not just for 2012, but also for 2013. How can the markets be at new highs? It will still be two steps forward, one step back. Ultimately you still have to make a decision: are you in or out of the market based on Europe?Right now, the market is saying that Europe is turning from a headwind to a potential tailwind. By the way: we are in a strange position. Right now strategists expect the S&P to be LOWER at the end of the year than it is now. The consolidated strategist forecast for the S&P 500 is 1,425, according to S&P Capital IQ. The S&P is at 1,430 midday. Even the strategists have been too conservative.
Click to enlarge:
Many assume this is a hated rally because so many managers have underperformed, as shown below. As we noted last January (here and here), 2011 was an unchanged year for the S&P (no price change with a total return of 2.1% thanks to dividends). However, it was a terrible year for money mangers beating this benchmark. 84% of managers did not beat the S&P 500.
This underperformance by most managers is nothing new. It is a continuation of a trend that started in 2010. As we wrote last January:
When told of the bad performance detailed above, market pros instinctively assume these managers made a bad market call. They were too bearish as the market rallied or too bullish as it declined. However, the data does not support this theory. First, there was no market call to miss this year. The stock market is essentially unchanged, so neither the market bears nor bulls made a bad call. Second, in looking at the data day by day, there is no relationship between the direction of the market and these funds’ performance. Quite simply, they performed poorly in both rallying and declining markets. Finally, this poor performance extends beyond equity managers. As a group, macro managers, fixed-income managers, commodity managers and international managers also had a sub-par year. Not everyone can be right, but it is unusual to see so many be wrong.
In a free market system, money is supposed to be efficiently allocated to good ideas or companies while being denied to poor ideas or companies. Most money managers are not concerned with the overall trend of the market or macro themes. Instead, they are focused on each company’s fundamentals. Both long-only and long/short managers will construct their portfolios via an exhaustive company-by-company selection process.
In today’s highly correlated world, company specifics take a back seat to macro considerations. All that matters is risk-on and/or risk-off. Unfortunately this makes the capital allocation process inefficient. If the average stock is 80% correlated to the S&P 500, then bad ideas rally on risk-on days while good ideas suffer on risk-off days, causing a mispricing of assets. If the capital allocation process is inefficient, then the financial sector will suffer and the economy will struggle. That is exactly what is happening as the last six quarters have seen real GDP grow less than the economy’s perceived “potential” of 2.5% and financial firms have struggled to the point that they continue to seek out Warren Buffett for capital injections.
Statisticians like to say that correlation does not imply causation. So what is the cause of this high correlation? In short, the extreme moves of central banks and governments are being done on a scale unprecedented in modern financial history. It is not central bank/government intervention that is new, but rather its pure scope and size.
James Grant of Grant’s Interest Rate Observer calculates that the total fiscal and monetary intervention during the Great Depression (September 1929 to July 1933) was equal to 8.3% of GDP. That was enough to pay for the indelible images in our memories of WPA work camps, FDIC insurance to stop bank runs and government-run soup lines. During the Great Recession (December 2007 to June 2009) government intervention was 29.9% of GDP – three times larger than the stimulus seen during the Great Depression when taken as a percentage of GDP.
Simply, the actions of people like Ben Bernanke or Mario Draghi matter far more than any specific fundamental of a company. It’s as if every S&P 500 company has the same Chairman of the Board that only knows one strategy, resulting in a high degree of correlation between seemingly unrelated companies.
Massive central bank/government involvement in markets risks returning us to a de facto centrally planned economy. Every time the Federal Reserve opens a swap line, the ECB hints at another program to stem the crisis, or successful American money managers wonder if the Federal Reserve could directly buy Italian bonds, the central banks/governments are trading a short-term fix that raises all boats, even the bad ones, for an even more inefficient capital allocation process. Winners must be rewarded and losers must fail. High correlations among markets leading to poor performance are an indication that this is not happening today and it is hurting the economy.
The Wall Street Journal – More Gains, Even More Pain
Summer Rally Puts the Hurt on Defensive Hedge- and Mutual-Fund Managers
It was the rally that left many fund managers behind. Stocks jumped nearly 10% over the summer, defying the expectations of many hedge- and mutual-fund managers who had bet on a decline. They saw a multitude of headwinds from Europe’s woes to the slowing U.S. economy and sluggish corporate earnings. Now, those defensive fund managers are facing what’s known in Wall Street lingo as the “pain trade”: having to buy stocks just to avoid being left in the dust. The longer stocks hold the summer’s gains, the more deeply the pain could be felt, forcing fund managers to start buying. That, in turn, could give stock prices another leg up and potentially generate a virtuous circle for the stock market and even more pain for those on the defensive.
Source: Arbor Research
For more information on this institutional research, please contact:
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Monday, September 10th, 2012
The “Bond King” – Pimco boss Bill Gross – says:
[There's] a diminished or dying cult of both bonds and stocks from the standpoint of a belief that they can return 10% ….
Gold can’t be reproduced. It could certainly be taken out of the ground in an increasing rate but there’s a limiting amount of gold.
And there has been an unlimited amount of paper money over the past 20 to 30 years and now – in this period of central bank expansion where it’s QE1 or QE2, or whether it’s the LTROs of the ECB or this potential new program … then central banks are at their leisure to basically print money.
Gold is a fixed commodity that has a considerable store of value that paper money has not….
When a central bank starts writing checks and printing money in the trillions of dollars, it’s best to have something tangible that can’t be reproduced, such as gold.
Gold … is a better investment than a bond or a stock, which probably will only return a 3 to 4 percent return over the next 5 to 10 years.
Gross doesn’t believe that gold is a crowded trade at this point.
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Monday, September 10th, 2012
Via Mark J. Grant, author of Out of the Box,
“There must be some way out of here,” said the joker to the thief,
“There’s too much confusion, I can’t get no relief”
-Bob Dylan, All Along the Watchtower
Debunking Some Myths
First let me state , with a certain calmness, that there is a Transfer Union underway in Europe. This is the subject, you may recall, that Germany has tried to avoid at all costs which is why Eurobonds and other similar schemes have not been implemented. Europe, however, has found a clever way of implementing such a program and keeping it under the radar from the German citizens. I will explain:
In Greece, Spain, Portugal and Italy the ECB has implemented a program where the sovereign guarantees some bank’s bonds. The bank then pledges them as collateral at the ECB and gets cash. The bank then turns around and lends the money back to the sovereign nation and provides liquidity and economic sustenance. The Transfer Union is completed as Germany guarantees 22% of the ECB and the European Central Bank is nothing more than a conduit to lend money to the various nations. This contrivance is also not sterilized so that the ECB is, in fact, printing money which is another part of this subterfuge that no one in Europe wants you to know anything about. This strategy is what has kept all of these various countries alive while the political entity, the European Union, tries to decide what to do about the future of the troubled nations. In a very real sense the ECB is the only fully operational part of the European construct at present as the European Union does not have the “political will” to carry out its mandate.
“The tears I have cried over Germany have dried. I have washed my face.”
Given what is happening, it then must be declared that the ECB is the lender of last resort and that they are printing money on a daily basis. Sterilization may take place in some instances and for some programs but it is not universally applied or even discussed. The program also gives the ECB tremendous leverage because any threat to turn off the spigot will force any of these troubled nations to turn to the Troika and ask for aid. The assistance does come with a price tag though and it is costly; the nation is audited, reality arrives, and the country gives up the total control of their finances and their budget to the EU/ECB/IMF. In effect, the nation no longer governs itself. The IMF, of course, is nothing more really than a cover for some kind of legitimacy beyond the politics of Europe and it has become the arm piece of the Continent so that Europe can point to them and say, “it is them; not us.”
It turns out that Jens Weidemann, chief of the Bundesbank, is a huge fan of Greta Garbo. Apparently he got to use her famous line recently at the ECB meeting:
“I want to be alone.”
He got his wish.
The total paid-in capital of the ECB at the end of 2011 was $13.7 billion. Currently the balance sheet of the ECB is $4 trillion. The leverage then is 292 times paid-in capital and the other assets must then be assessed as to their solvency. This is one reason why a default by Greece, or any other nation, would be so devastating to the ECB as it would wipe out their entire capital base in a heartbeat requiring re-capitalization immediately which would be politically challenging these days. Now the ECB is thought to be a riskless proposition because, in the last instance, it can print money but this is not a correct viewpoint. There are a number of circumstances that can destroy a Central Bank, any Central Bank, and the first would be the loss of confidence in the institution or the nation (s) guaranteeing it. The second would be actual losses on their balance sheet and while no Central Bank must adhere to marks-to-market; real losses in their portfolio cannot be brushed under the rug forever. I would submit that the ECB, in particular, in having lowered and lowered their collateral requirements is putting itself in a position where their risk profile has increased dramatically. Then there is the risk of some large bank failure in Europe and while the Irish banks, Dexia and Bankia et al have been absorbed by their respective nations and so have had their balance sheets and ratings impacted; there may come a time when the European banks, already institutions with balance sheets three times larger than the sovereign nations where they are domiciled, cannot absorb without serious repercussions, the failure of some large European bank. Finally, in my mind, comes the greatest present risk and this is a run on the banks. This is a quite real present danger which is exemplified by Spain where almost 20% of the capital in the Spanish banks has fled. If the present trend and trajectory continues then we may see a systemic banking failure in Spain which would wipe out not only the banks in Spain but the ECB as the money lent to the Spanish banks goes into default.
Mervyn King, Governor of the Bank of England, once noted that it may not be rational to start a bank run, but it is rational to participate in one once it had started.
The price tag of cleaning up a systemic banking crisis is significant in its size and breadth. The fiscal costs average 13% of GDP and economic output losses average 20% of GDP for important crises from 1970 to 2007 according to data supplied by the International Monetary Fund. Consequently to stare at the ECB and declare it a “risk free proposition” is naïve at best and quite dangerous at the worst. You may think what you like but you must retain sound principles.
“Those are my principles and if you don’t like them—well, I have others.”
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Monday, September 10th, 2012
Market Update (September 2012)
Thackray Market Letter
by Brooke Thackray, alphaMountain Investments
Super Mario to the rescue! In August, the ECB President Mario Draghi stuck his neck out and claimed the everything possible would be done to save the Euro. Despite the absence of an agreement amongst the EMU countries and no supporting details, investors took him at his word and pushed the markets higher. On September 6th, he announced that the ECB was stepping up with an unlimited bond buying program in the secondary market to help the struggling countries. In addition he announced that the ECB would be pari passu with the private investors on new bond purchases, not have senior credit status over private investors. This is a big step, as previously when the government was seeking investor participation on bond purchases, the more the ECB bought, the worse off the private investors became. He also stated that the bond buys would be linked to “strict and effective conditionality” with the recipients of aid having to meet agreed austerity conditions. In addition, Draghi stated the ECB’s efforts would be focused on debt maturities up to three years. Investors should note that Draghi stated that he has support for his program, but it is not clear that he has full support of all the countries.
Although there is no doubt that this new program is a major step forward, it is not quite as good as first portrayed in the media…… Just like the cell phone companies that claim “unlimited this” and “unlimited that”, it is only when the bill comes in the mail that you realize that the plan you bought into…is not so unlimited.
By announcing an “unlimited” program Draghi is hoping to avoid the pitfalls of the previous programs where investors were able to see the inadequacies of the amounts and structure, and trade against the sovereigns. The word “unlimited” is meant to scare away any investors from betting against the sovereigns. The theory of the big unlimited bazooka is that it will not be seriously challenged because of its fire power, allowing for continued lower yields in the profligate countries.
There are two trading problems with the current “unlimited” program. First, the ECB buying is designed to focus on bonds with a range of one to three years in duration. Naturally, investors are going to see the Maginot Line and attack the sovereigns at the longer part of the curve. This is going to create a steep yield curve and force governments to operate at the short end of the curve.
Typically, and wisely, governments spread their debt out over the yield curve to diversify risk. The current rescue program is going to encourage governments to have a disproportionate amount of obligations at the short end of the curve. This is going to increase the risk of rising interest rates. If rates do increase in the future– a large amount of funds will have to be raised all at once. Oh well….who is worrying about the future, not the ECB, not yet.
Second, do you really think that the bond buying program is unlimited? In theory, the ECB could print as much money as they desire to buy the bonds, but practically this would have a detrimental effect on the Euro. Germany and other countries with strong balance sheets will not be supportive of such inflationary measures. The program will be unlimited up to the point where one or more countries start to realize how costly it has become on their economies and consider leaving voluntarily if the program remains unchecked. This applies to both the receiving and giving countries.
The receiving countries may reevaluate whether they can live with the continued austerity programs and whether it is worth the pain staying in the EU. Some of the giving countries may reconsider staying in the Euro, wondering whether over the long-term they will be slowly dragged down as the profligate countries suck more and more money out of them. It is very conceivable that eventually one or more strong countries leave the euro or perhaps even form their own regional currency. If this were to occur the Euro would still survive and Euro financial obligations could still be met. The profligate countries could then inflate their way into oblivion.
Although Merkel is making bold statements standing behind Draghi, all is not well in Germany. There is a rising number of German citizens and politicians against “unlimited” support – who can blame them. In addition the German courts announce their decision on the legality of Germany’s financial help to the EU. Legal experts have generally taken the stance that the courts will be supportive of the current programs, but with some modifications — but it is the courts after all, and no one really knows the outcome.
There is tough talk about how the countries receiving assistance will have to commit to austerity programs in order to receive support. The reality of the situation is that the current receiving countries have not met their austerity targets and are asking for extensions or more lenient terms. Greece is currently asking that their austerity timeline be bumped from two to four years. More than likely, they will be back later asking for another extension to six years. There is no red-line for the imposed austerity programs and all of the profligate countries know it. It is all a negotiation game.
Investing in an environment where political actions can easily drive the market one way or another is very difficult at best. So far, front running possible announcements has paid off, but as the programs become less effective in boosting he market and the increase in value gets baked into the price earlier and earlier, at some point front running will not pay off. It is difficult to say when this time will occur: it could be six months, or a year, or even later, but it will come.
The FMOC meets this week and a large portion of investors is expecting the Fed to announce another stimulus package. Another stimulus package is probably forthcoming in the near future, but it is difficult to determine if it is going to be this week, or after the election in November. There is no question that the economy has been sluggish in the US, but it has not been disastrous. Bernanke has held off on another QE package, knowing that if he announces too soon, investor expectations of following packages will occur much quicker next time the economy slows down.
Despite my negative comments on the European and US situation, the market can move independently from political events in the short and medium term. In other words investors should remain focused on other factors to make their investment choices, such as, seasonal trends, earnings and the economy.
The market has had a rare summer time rally, based mostly on the fact that the economy in Europe and the US is bad enough that stimulus would be forthcoming. As I have mentioned before, the market rises often enough into the middle of July, but less often from that point forward. The S&P 500 has just broken above its high of 1422 set in early April. Investors should remember that we still have not finished working our way through the most negative month of the year and risks to the downside remain.
Later this week, September 13th, the Federal Reserve could move the markets by either announcing, or not announcing, another stimulus program. If it does not announce a stimulus program then investors will probably have to wait until after the US election. Also, on September 12th, the German courts are expected to pass judgment on the constitutionality of Germany’s assistance to EMU through the European Stability Mechanism (ESM). The point is that there are two very large variables that could move the markets either way. Given that we are still in the weak seasonal month of September, caution is urged.
Even though the market has moved up from its lows in June, the time to enter into a more aggressive market position will soon be at hand. Despite October having the reputation as being a weak month, since 1950 it has produced an average return of 0.6%% and has been positive 59% of the time. Nevertheless, it does deserve the reputation as the most volatile month.
Volatility can provide opportunities. There are three possible buying zones in October. First, the beginning of October (start of the 18 day Earnings expectation cycle, Thackray’s 2012 Investor’s Guide, see page 43). Second, October 9th (actual buy date at close of market October 8th), is also another rally point as the market can often surge if it has corrected coming into this time period. Also, technology stocks tend to start their outperformance at this time. Third, October 28th (actual buy date at close of market October 27th), is the classic long-term buy date kicking of the favourable six month seasonal cycle.
There is no guarantee that any of these three dates will prove to be opportune, but the market often provides a good opportunity for increasing equities during October. Investors should be actively looking for entry points. Last year the beginning of October presented itself to be an opportune time for market entry, as the market started to rally on October 3rd. In the first week of October HAC started to commit more money to the markets. The market went on to reach a short-term peak on October 28th, before correcting in November and then rallying once again.
It is difficult to develop a strategy for the best entry point during the month of October. Nevertheless, seasonal investors should have a bias to increasing equity exposure in October. The beginning of October could present an attractive entry point if the market corrects severely during the rest of September, setting up for a bounce in October. If the market muddles through into October it will be more vulnerable to a pullback in the middle of October (19th to 27th), when the market often has large downdrafts. Although technical analysis can help fine tune the entry dates, investors should be disposed to enter the market before the end of the month.
Monday, September 10th, 2012
(Editor’s Note: Next Tech Talk report is available on Friday September 14th. Don Vialoux is presenting at the CSTA International Commodity Conference in Banff).
Economic News This Week
July U.S. Trade Deficit to be released at 8:30 AM EDT on Tuesday is expected to increase to $44.5 billion from $42.9 billion.
The FOMC Meeting rate decision is released at 12:30 PM EDT on Thursday. Press conference is held at 2:15 PM.
Weekly Initial Jobless Claims to be released at 8:30 AM EDT on Thursday is expected to increase to 370, 000 from 365,000 last week.
August Producer Prices to be released at 8:30 AM EDT on Thursday are expected to increase 1.0% versus a gain of 0.3% in July. Excluding food and energy, PPI is expected to increase 0.2% versus a gain of 0.4% in July.
August Retail Sales to be released at 8:30 AM EDT on Friday are expected to increase 0.6% versus a gain of 0.8% in July. Ex autos, Retail Sales are expected to increase 0.5% versus a gain of 0.8% in July.
August Consumer Prices to be released at 8:30 AM EDT on Friday are expected to increase 0.5% versus no change in July. Excluding food and energy, CPI is expected to increase 0.2% versus a gain of 0.1% in July.
August U.S. Industrial Production to be released at 9:15 AM EDT on Friday is expected to increase 0.2% from a gain of 0.7% in July. August Capacity Utilization is expected to remain the same at 79.3%.
September U.S. Michigan Consumer Sentiment Index to be released at 9:55 AM EDT on Friday is expected to slip to 74.0 from 74.3 in August.
July Business Inventories to be released at 10:00 AM EDT on Friday are expected to increase 0.3% versus a gain of 0.l% in June.
Earnings Reports This Week
No major companies are scheduled to release earnings.
The S&P 500 Index gained 26.79 points (1.90%) last week. Intermediate trend is up. The Index broke above resistance at 1,426.68 to reach a four year high. The Index remains above its 50 and 200 day moving averages and moved above its 20 day moving average. Short term momentum indicators have rebounded to overbought levels.
Percent of S&P 500 stocks trading above their 50 day moving average advanced to 84.00% last week from 71.60%. Percent has returned to an intermediate overbought level.
Percent of S&P 500 stocks trading above their 200 day moving average increased last week to 77.20% from 67.80%. Percent has returned to an intermediate overbought level.
The ratio of S&P 500 stocks in an uptrend to a downtrend (i.e. the Up/Down ratio) jumped last week to (328/96=) 3.42 from 2.26. The ratio remains intermediate overbought.
Bullish Percent Index for the S&P 500 Index increased last week to 74.80% from 71.20% and remained above its 15 day moving average. The Index remains intermediate overbought.
The Up/Down ratio for TSX Composite stocks increased last week to (155/65=) 2.36 from1.86. The ratio is intermediate overbought.
Bullish Percent Index for TSX Composite stocks increased last week to 65.85% from 62.20% and remained above its 15 day moving average. The Index remains intermediate overbought.
The TSX Composite Index added 185.78 points (1.54%) last week. Intermediate trend is up. The Index broke above resistance at 12,196.77 on Friday. The Index remains above its 50 day moving average and moved above its 20 and 200 day moving averages last week. Short term momentum indicators have recovered to overbought levels. Strength relative to the S&P 500 Index has changed from negative to at least neutral.
Percent of TSX stocks trading above their 50 day moving average increased last week to 70.73% from 61.38%. Percent has returned to an intermediate overbought level.
Percent of TSX stocks trading above their 200 day moving average increased last week to 56.10% from 45.53%. Percent has returned to an intermediate overbought level.
The Dow Jones Industrial Average gained 148.67 points (1.13%) last week. Intermediate trend is up. The Average is testing resistance at 13,330.76 and 13,306.64. The Average remains above its 50 and 200 day moving averages and moved above its 20 day moving average on Thursday. Short term momentum indicators have returned to overbought levels. Strength relative to the S&P 500 Index remains negative.
Bullish Percent Index for Dow Jones Industrial Average stocks slipped last week to 80.00% from 83.33% and remained below its 15 day moving average. The Index is intermediate overbought and showing early signs of rolling over.
Bullish Percent for NASDAQ Composite stocks increased last week to 55.58% from 53.94% and remained above its 15 day moving average. The Index remains intermediate overbought.
The NASDAQ Composite Index gained 66.63 points (2.17%) last week. Intermediate trend is up. The Index broke resistance at 3,134.17 on Friday to reach an 11 year high. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators have returned to overbought levels. Strength relative to the S&P 500 Index remains positive.
The Russell 2000 Index added 33.08 points (4.09%) last week. Intermediate trend is up. Resistance at 846.92 is being tested. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators have returned to overbought levels. Strength relative to the S&P 500 Index remains positive.
The Dow Jones Transportation Average fell 46.38 points (0.91%) last week. Intermediate trend is down. Resistance is at 5,223.98 and support is at 4,911.83 and 4,795.28. The Average remains below its 20, 50 and 200 day moving averages. Short term momentum indicators are neutral. Strength relative to the S&P 500 Index remains negative.
The Australia All Ordinaries Composite Index slipped 27.70 points (0.63%) last week. Intermediate trend is down. The Index remains below its 20 day moving average and above its 50 and 200 day moving averages. Short term momentum indicators are trending down. Strength relative to the S&P 500 Index has returned to negative from neutral.
The Nikkei Average fell 199.11 points (2.20%) last week. Intermediate trend is up. The Average fell below its 20 and 200 day moving averages, but recovered on Friday to above its 20 day moving averages. Short term momentum indicators are trending down. Strength relative to the S&P 500 Index has returned to negative.
The Shanghai Composite Index gained 35.66 points (1.70%) last week. Intermediate trend is down despite a 3.70% gain on Friday following announcement of a fiscal stimulation program. The Index remains below its 20, 50 and 200 day moving averages. Short term momentum indicators are recovering from oversold levels. Strength relative to the S&P 500 Index remains negative.
The London FT Index added 0.74 (0.01%) last week, the Frankfurt DAX Index gained 217.76 points (3.13%) and the Paris CAC Index added 77.32 points (2.25%) last week.
The Athens Index gained 49.45 points (7.68%) last week on hopes that Draghi’s plan to stabilize European sovereign debt rates will work. Intermediate trend changed from down to up on a break above resistance at 662.49/ The Index remained above its 20 and 50 day moving average and broke above its 200 day moving average last Thursday. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index has turned from neutral to positive.
The U.S. Dollar Index fell another 1.38 (1.37%) last week with most of the loss occurring on Friday following release of the August employment report. The Index remains below its 20 and 50 day moving averages and dropped below its 200 day moving average on Friday. Short term momentum indicators are oversold, but have yet to show signs of bottoming.
The Euro gained another 3.03 (2.42%) last week. Intermediate trend changed from down to neutral on a break above resistance at 126.93 on Friday. The Euro remains above its 20 and 50 day moving average and below its 200 day moving average. Short term momentum indicators are overbought, but have yet to show signs of peaking.
The Canadian Dollar gained another 1.38 cents U.S. (1.37%) last week. Intermediate trend changed from down to up on Friday when the Canuck buck broke above resistance at 102.05 cents to reach a 12 month high. Strength was notably stronger on Friday after an encouraging August employment report was released. The Dollar remains above its 20, 50 and 200 day moving averages. Short term momentum indicators have returned to an overbought level.
The Japanese Yen gained 0.70 (0.55%) last week. Intermediate trend is down. Short term trend is up. Resistance at 128.77 is being tested. The Yen remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are trending higher.
The CRB Index gained another 5.63 points (1.84%) last week. Most of the gains were recorded on Friday when the U.S. Dollar weakened. Intermediate trend is up. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are trending higher. Strength relative to the S&P 500 Index remains neutral.
Gasoline added $0.10 (3.42%) last week. Gasoline remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are trending higher. Strength relative to the S&P 500 Index remains positive.
Crude Oil added $0.13 per barrel (0.14%) last week with more than all of the gain occurring on Friday. Crude remains above its 20 and 50 day moving averages and below its 200 day moving average. Short term momentum indicators have rolled over from overbought levels. Strength relative to the S&P 500 Index is positive, but showing early signs of change. Seasonal influences normally turn negative at the end of September
Natural Gas added $0.01 (0.37%) last week. Intermediate trend is up. Gas remains above its 200 day moving average and below its 20 and 50 day moving averages. Short term momentum indicators are neutral. Strength relative to the S&P 500 Index has turned negative from positive.
The S&P Energy Index added 10.02 points (1.86%) last week. Intermediate trend is up. Resistance at 544.46 was broken on Friday. The Index remains above its 50 and 200 day moving averages and moved above its 20 day moving average on Thursday. Short term momentum indicators are trending higher. Strength relative to the S&P 500 Index is positive, but showing signs of change. Favourable seasonal influences peak in mid-September.
The Philadelphia Oil Services Index added 2.47 points (1.09%) last week. The Index remains above its 50 day moving average and moved above its 20 and 200 day moving averages on Friday. Short term momentum indicators are neutral. Strength relative to the S&P 500 Index has changed from up to at least neutral
Gold gained $64.20 per ounce (3.84%) last week on weakness in the U.S. Dollar. Intermediate trend is up. Gold remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains positive.
The AMEX Gold Bug Index added another 27.51 points (6.03%) last week. Intermediate trend changed from down to up when the Index broke resistance at 464.76. The Index remains above its 20 and 50 day moving averages and broke above its 200 day moving average on Friday. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to gold remains positive.
Silver gained another $3.10 per ounce (10.14%) last week. Intermediate trend is up. Silver remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to gold remains positive.
Platinum added $36.00 per ounce (2.32%) last week. Platinum remains above its 20, 50 and 200 day moving averages. Strength relative to gold is positive, but stalled.
Palladium added $33.40 per ounce (5.39%) last week. Palladium remains above its 20 and 50 day moving averages and moved above its 200 day moving average. Strength relative to gold remains slightly positive.
Copper gained $0.15 per lb. (4.30%) last week with almost all of the gain coming on Friday following news of China’s fiscal stimulation program. Intermediate trend changed from down to up on a break above resistance at $3.56 on Friday. Copper remains above its 20 and 50 day moving average and moved above its 200 day moving average on Friday. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index has turned from negative to positive.
The TSX Global Metals & Mining Index gained 60.73 points (7.07%) last week with more than the entire gain recorded on Friday following the news from China. Intermediate trend changed from down to up on a break above resistance at 889.40. The Index remains below its 200 day moving average and recovered above its 20 and 50 day moving averages on Friday. Strength relative to the S&P 500 Index changed from negative to at least neutral on Friday.
Lumber fell $12.32 (4.17%) last week. Intermediate trend is up. Lumber remains below its 20 day moving average and fell below its 50 day moving average last week. Strength relative to the S&P 500 Index has turned negative.
The Grain ETN slipped $0.09 (0.14%) last week. Units remain above their 20, 50 and 200 day moving averages. Strength relative to the S&P 500 Index remains neutral.
The Agriculture ETF added $0.95 (1.89%) last week. Intermediate trend is up. The ETF closed at a four month high on Friday. Units remain above their 20, 50 and 200 day moving average. Short term momentum indicators are trending higher. Strength relative to the S&P 500 Index remains negative.
The yield on 10 year Treasuries added 9.9 basis points (6.34%) last week. Yield moved above its 50 day moving average. Short term momentum indicators are neutral.
Conversely, price of the long term Treasury ETF fell $3.89 (2.89%) last week.
The VIX Index fell 0.80 (5.27%) last week. The Index fell below its 20 and 50 day moving averages on Friday.
Two unexpected events last week triggered a surprising upside move in equity markets last week, China’s $150 billion fiscal stimulus package announced on Thursday night and the ADP report showing a gain in U.S. private employment in August instead of a loss. Gains were muted on Friday when the less than expected U.S. employment report was released.
The economic focus this week is on the FOMC meeting. The Fed widely is expected to announce an additional monetary stimulus program that probably will include the purchase of mortgage backed securities by the Fed that effectively will replace Operation Twist that is expected to expire at the end of the month. However, the effectiveness of a new program is somewhat suspect. At best, it may reduce mortgage rates slightly, but mortgage rates already are near all-time lows. Importance of an additional monetary stimulus program is psychological (Investors relate monetary stimulus to higher equity prices). If the Fed chooses not to introduce another stimulus program, equity markets are vulnerable to significant short term downside risk. If the Fed chooses to go beyond a token purchase (or promise to purchase) mortgage backed securities, equity markets will move higher. The Fed in order to show political neutrality is unlikely to act beyond the September FOMC meeting until after the election.
U.S. economic news other than the FOMC meeting is expected to be neutral to slightly bearish for equity markets this week (higher trade deficit, higher inflation, higher inventories, lower consumer sentiment, but continuing strength in retail sales).
Macro events outside of the U.S. once again focuses on China this weekend and Europe later this week. Negotiations between ECB President Draghi and Greece continue on Tuesday. The German constitutional court rules on the eligibility of ECB lending on Wednesday. The Netherlands holds parliamentary elections on Wednesday.
Short and intermediate technical indicators for most equity markets and sectors improved last week but have returned to overbought levels.
North American equity markets have a history of moving lower from September to mid-October during a U.S. Presidential election year (particularly when polls show a tight race as indicated this year). Thereafter, equity markets move higher.
Cash on the sidelines on both sides of the border is substantial and growing. However, political uncertainties (including the Fiscal Cliff) preclude major commitments by investors and corporations before the Presidential election.
The Bottom Line
Downside risk exceeds upside potential in equity markets during the next six weeks. The breakout by the S&P 500 Index last week implies that depth of the downside risk is less than previous. Selected seasonal trades continue on the upside (gold, energy, software) and downside (transportation). However, many of these seasonal trades reach the end of their period of seasonal strength this month. September is a month of transition. Trade accordingly.
Keith Richards’ Blog
Gold bullion has been a great place to be lately, and I’ve had a position in the portfolios I run for about a month now. But gold stocks are lagging. So too is the materials sector. They may be ready for a breakout. Find out more on my blog at http://www.smartbounce.ca/?p=1407
Special Free Services available through www.equityclock.com
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Crude Oil Futures (CL) Seasonal Chart
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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 September 7th 2012