50-Day Moving Average Crossover a Reliable Source of Sell Signals

Wednesday, September 26th, 2012

Upcoming US Events for Today:

1. New Home Sales for August will be released at 10:00am. The market expects 380K versus 372K previous.
2. Weekly Crude Inventories will be released at 10:30am.

Upcoming International Events for Today:

1. German Consumer Price Index for September will be released at 8:00am EST. The market expects a year-over-year increase of 1.9% versus 2.1% previous.
2. China Industrial Profits for August will be released at 9:30pm EST.

The Markets

Markets traded sharply lower on Tuesday as doubts over the efficacy of QE3 began to flourish following comments from Federal Reserve Bank of Philadelphia president Charles Plosser who indicated that “we are unlikely to see much benefit to growth or to employment from further asset purchases.” Cyclical stocks saw the greatest declines, led by Caterpillar, which cut its earnings forecast for the next few years. Shares of Caterpillar were the worst performer in the Dow, falling 4.25% during the session. Seasonal tendencies for the industrial titan remain flat to negative into the month of October, leading into the period of seasonal strength that kicks off in full force in November and December.

Prior to Tuesday, the S&P 500 Index had not seen a declining session exceed 1% since July 20th. Investors would have to look all the way back to June 25th, shortly after the summer rally began, to find a decline in the S&P 500 index larger than the one realized on Tuesday. Still, after seven days of negative pressures within equity markets, benchmarks, such as the S&P 500, have yet to get back to levels last seen prior to the September 13th Fed announcement, the last definitive up-tick day. Equity benchmarks are now looking to initial support at 20-day moving average levels, a dividing line between short-term strength and weakness.

This intermediate average has shown to be a launching point for this rally ever since the beginning of August. However, positive catalysts have also solidified this average as a point of support as optimism pertaining to central bank intervention propels equities higher. A positive catalyst might not materialize in order to save the market this time around with news pertaining to earnings and economic concerns seeming to take the steam out of what was a powerful rally within stock and commodity markets. Commodities have corrected rather sharply over the past few days and equity markets are seeming to follow. The current pullback has the potential to be a multi-week event, but, following this correction, the positive trend is expected to resume as the period of seasonal strength for equity markets begins into October and November.

Yesterday we showed you an indication of volatility and how it typically coincided to significant peaks in equity markets whenever the range of activity was substantially low. Another indicator provides similar hints of market peaks. The percent of stocks in the S&P 500 trading above 50-day moving averages has itself fallen below its 50-day moving average line. Crossovers such as this have typically preceded further declines within the S&P 500, implying that weakness has just begun to influence markets lower. Given the volatility of this indicator, it is also prudent to monitor the percent of stocks in the S&P 500 Index trading above 200-day moving averages, which provides similar buy and sell indicators based on 50-day moving average crossovers. As of yet, a crossover has not been revealed, but the push in that direction is apparent. The theory behind the indicator is that as more and more stocks within the S&P 500 give up levels of support presented by significant moving averages, selling pressures then escalate, leading markets lower until equilibrium is once again attained.

Gauges of risk sentiment are also showing that investors are once again starting to become risk averse. Defensive sectors, such as Staples and Health Care have been outperforming the market over the past few sessions. Even Utilities, the recent market laggard, is starting to show signs of rebounding from a bottom, also outperforming the market over the last few days. A ratio of Consumer Discretionary to Consumer Staples is showing signs of decline, indicating investor hesitation with holding higher beta, cyclically sensitive equities. Even fixed income investors are choosing safer alternatives, opting for investment grade bonds over high yield. Risk aversion is a typical characteristic within a declining trend, suggesting concern for risk assets, at least for the short-term.

Sentiment on Tuesday, as gauged by the put-call ratio, ended bullish at 0.93. The ratio has come well off of the lows recorded last week of 0.68, the lowest level in over a year. Investors had increasingly become bullish during recent weeks, shedding negative equity bets and tilting the market bias too far in one direction. A correction in equities and sentiment was/is inevitable.

S&P 500 Index

Chart Courtesy of StockCharts.com

TSE Composite

Chart Courtesy of StockCharts.com

Horizons Seasonal Rotation ETF (TSX:HAC)

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Tags: China, Commodities, ETF, ETFs, Qe, Quantitative Easing, TechTalk
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For China Size, Not Quality, Matters As First Aircraft Carrier Launched

Wednesday, September 26th, 2012

In what is likely the biggest sabre being rattled this week in the war-of-words that is occurring in the Pacific, China announced today the launch of its first aircraft carrier. China bought the 300-meter Soviet-built vessel in 1998 from Ukraine and had it refitted at Dalian. It is named Liaoning (which looks almost too much like ‘leaning’) after China’s northeast province where the port is located. The defense ministry said the aircraft carrier, is an important step in “raising the overall fighting capacity” of its naval forces.

Rear Admiral Yang Yi noted that “it is natural that China should have its own aircraft carrier,” arguing that all major world powers already own similar vessels. Of course, the coincidental timing is no surprise as Reuters notes “China will never tolerate any bilateral actions by Japan that harm Chinese territorial sovereignty,” Vice Foreign Minister Zhang Zhijun told his Japanese counterpart on Tuesday as the two met in a bid to ease tensions.

“Japan must banish illusions, undertake searching reflection and use concrete actions to amend its errors, returning to the consensus and understandings reached between our two countries’ leaders.”

Stratfor provides some more color on the current state-of-play (and some history)… as Taiwanese water-squirting was underway (no, seriously!!)

[AA's note] If you’ve read Jeff Rubin’s ‘The End of Growth,’ then you know all about how this aircraft carrier, the Varyag, came in to China’s possession. China surreptitiously bought this (then rusting hulk of a) vessel from the Ukraine, following the economic breakup of Russia CIS (the reason this carrier’s construction was halted) under the false pretense of using it as a research vessel or perhaps a floating casino, and promised the vendor that it would not be fitted for its original intended use. The rest is academic, as China has flexed its muscle, with its announcement.

China’s imperative to protect its own economic interests, as well as its access to resources, is becoming more apparent, and transparently obvious. [AA]

Tags: China, Russia
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Toronto New Home Sales Plunge 64 Percent; Lowest August on Record

Wednesday, September 26th, 2012

New home sales in Toronto plunged 64% in the wake of government’s changes to insured mortgages (30yr to 25yr) and home equity line of credit restrictions (80% max to 65% max) which took effect in July.

Lowest August on Record

Reader Corey emailed the above comments and a news link from the Canada BILD Association: New Home Sales Slip in August.

According to RealNet Canada Inc., BILD’s official source of new home market intelligence, the 1,242 homes sold in August 2012 add up to the lowest monthly sales since 2009 and the lowest August on record. Year-to-date sales have remained on par with 2010 but below its record-breaking 2011 predecessor.

“The federal government has been working on reducing household debt levels and recently adjusted mortgage lending rules. August was the first full month with the new rules in place and it appears these regulations have affected consumer confidence, resulting in significantly reduced sales of new homes,” explained BILD President and CEO Bryan Tuckey. “BILD will be carefully monitoring new home sales during the next three months to see if this decline becomes a trend.”

“Slip” hardly seems the operative word. Crash is more like it.

Also consider Bernanke Declares War on Canadian Economy (Rest of the World Too)

Addendum:

I said Canada previously but those sales are specifically the Toronto region.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Canadian, Canadian Market
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Investing Brief: The Stock Market, Housing and Washington

Wednesday, September 26th, 2012

September 24, 2012

by Mark W. Riepe, CFA, Senior Vice President, Schwab Center for Financial Research

Updated weekly, Schwab Investing Brief™ tackles questions about today’s markets and investing environment including the latest stock market trends.

Does the stock market have potential to go even higher? What’s the latest on the housing market? And what’s going on in Washington with the “fiscal cliff,” taxes and the debt ceiling? Liz Ann Sonders, Schwab’s chief investment strategist, and Michael Townsend, vice president of legislative and regulatory affairs, shared their thoughts with Mark Riepe.

The stock market and (lack of) volatility
The housing market
The “fiscal cliff” and US debt ceiling
Tax changes in the New Year
High-frequency trading and the SEC

The stock market and (lack of) volatility

Mark Riepe: Does the current stock-market rally have potential to go even higher? If so, what are the driving factors other than the Federal Reserve’s latest stimulus measures?

Liz Ann Sonders: Without trying to time the market, which we never recommend, it’s presently a mixed picture and sentiment alone suggests a breather in the market wouldn’t be surprising. Many short-term sentiment measurements show rising levels of optimism, a contrarian indicator; however, some sentiment measures—specifically the latest (September 20) American Association of Individual Investors Sentiment Poll—show a very high level of uncertainty.

As for driving factors other than the Fed’s moves, corporate earnings have been the biggest support, and estimates are trending back up after dropping sharply the past two quarters. A wide variety of investors have been taking less risk and are generally defensively positioned, possibly providing ample fuel for rallies when the news hasn’t been as dire as the consensus opinion.

MR: Why is the VIX [the CBOE Volatility Index, designed to measure the market's expectation of volatility over the next 30-day period] currently so low—and what might that indicate?

LAS: The VIX index has recently been in the mid-teens, which many view as a sign of investor complacency, since that’s the lower end of the range it’s been in over the past three years. Too many VIX watchers use time frames of analysis that only include the post-2008 financial crisis, and the VIX was around well before then. During the 2003–2007 bull market the VIX ranged between 12 and 20, and during the six best years of the 1990s bull market the VIX ranged between 10 and 20 most of the time, according to Bloomberg. A mid-teens VIX is not extreme when measured against other bull markets.

The housing market

MR: The Federal Reserve’s third round of stimulus measures includes a commitment to buy mortgage-backed securities and a promise to keep interest rates down. Could this cause a jump in the housing market?

LAS: The jump in the housing market already began earlier this year, not solely as a result of the Federal Reserve’s previous easing measures. The past five quarters of residential investment (housing) have added to GDP, after six years of losses, according to the Bureau of Economic Analysis. “Real” mortgage rates (nominal rates minus home-price appreciation/depreciation) have dropped back into negative territory, thanks to rising house prices, and this—along with low nominal mortgage rates—is driving improved demand.

Ostensibly, the focus on mortgage-backed securities in this round of quantitative easing could help the housing market even more. Although spreads between US Treasuries and mortgage rates did narrow sharply after the announcement, the 10-year Treasury yield also moved higher, meaning the net effect on nominal mortgage rates has been minimal for now, according to Bloomberg. The more important factor has been and will be home prices, given the help they provide for not only real mortgage rates, but also for household net worth and in lifting many homeowners out of underwater status with their present mortgages.

MR: Could you explain the recent housing-market data? How solid is the housing recovery and when might it have a meaningful effect on the overall economy?

LAS: As the largest component of household net worth, housing’s recovery has provided a nice boost to the economy, according to the Federal Reserve. Housing should continue to support gross domestic product by 0.5% to 1% into next year as housing grows again as percentage of overall GDP. Housing has a very strong jobs multiplier and the recent surge in the National Association of Home Builders (NAHB) housing index bodes well for a more accelerated move down in the unemployment rate.

The latest good news in the housing market was driven by several factors, including a three-point jump in an already improving NAHB housing market index, a nearly 8% rise is existing home sales (to the highest level in two and a half years) and the fact that median home prices are now nearly 10% higher than a year ago. Other contributing factors include an 8% jump in single-family home sales (which account for 90% of total sales), inventories of new and existing homes relative to working population decreasing to near-all-time lows, and housing completions now well-undershooting the recent surge in household formations, according to the most recent figures from Bloomberg.

MR: It appears as if every business sector other than construction is on the rise, yet it’s not showing in the labor market—so why aren’t businesses hiring? Is there any unmeasured pressure to hire developing in the labor markets?

LAS: Everything I’ve read and seen, and heard in conversations with leaders of both small and large businesses, suggests that the election and related “fiscal cliff” implications represent a level of uncertainty too great for them to increase either capital investment or hiring until at least some of it is settled. Businesses generally don’t feel a short-term pressure to hire if their competitors aren’t. So we’re likely at a standstill until at least after the election and there’s more clarity regarding the tax and regulatory playing field.

Most business leaders say they can suit up and play on any field as long as they know the rules, but with so much current uncertainty about the rules of the game, businesses are staying off the field. In our opinion, fundamental pressure to hire has been building, given that productivity is starting to slip from its recession-era highs.

The “fiscal cliff” and US debt ceiling

MR: There are a lot of pieces of the so-called “fiscal cliff” looming at the end of the year, but which are the most important that are driving the need to reach an agreement in Washington?

Michael Townsend: The expiration of the Bush-era tax cuts gets the most attention, but they could be allowed to expire and then be reinstated retroactively without too much disruption in early 2013 by the new Congress. So we believe the most important drivers will be the Alternative Minimum Tax (AMT), the federal debt ceiling and the automatic spending cuts that are set to go into effect January 1.

The latest “patch” for the AMT expired at the end of 2011. Because the AMT was never linked to inflation, it captures more middle-class taxpayers every year. For the past decade or more, Congress has approved “patches” that increase the amount of income exempt from the AMT. Without a patch, the number of taxpayers hit by the AMT would jump from around five million to more than 30 million. Trying to fix the AMT retroactively in 2013 would be very complicated—a big incentive, we believe, for a post-election compromise.

It’s likely the debt ceiling of $16.4 trillion will be reached before the end of the year, and no one wants a repeat of what happened in the summer of 2011. Look for a compromise package at the end of this year that includes a relatively small increase in the debt ceiling—something that will ensure the issue won’t come up again until well into 2013.

With regard to the automatic spending cuts, $55 billion in defense cuts and $55 billion in non-defense cuts will kick in come January. The defense cuts are particularly worrisome to both Democratic and Republican members of Congress—many have defense installations or big defense contractors in their districts, and they don’t want to see jobs lost as a result of these cuts. So that’s another piece of the puzzle that many lawmakers from both parties want to solve.

MR: Congress raised the debt ceiling last year. How close are we now to hitting that higher limit, and will the ceiling need to be raised again after all this added borrowing? If so, when might that happen?

MT: The current debt ceiling is $16.4 trillion, and reports are we’ve already passed the $16 trillion point. So it’s very likely we’ll hit the ceiling before the end of the year. The Treasury Department has a number of ways it can delay a US default—that’s what happened in the summer of 2011, when Treasury extended the deadline for a couple of months. But probably no one in Washington wants a repeat of that scenario, so we think there will be a strong push for a modest increase before the end of the year.

Raising the debt ceiling doesn’t do anything to slow the debt itself, and doing things like postponing the scheduled January 1 automatic spending cuts will only add to the debt. So we wouldn’t be at all surprised to see Congress have to raise the debt ceiling again sometime in 2013.

Tax changes in the New Year

MR: If no compromise is reached in Washington before the end of the year, what happens on January 1 to various taxes rates for investors?

MT: It will depend greatly on which party controls Congress and the presidency after the fall election; for details on all of the tax issues, you can read Are Taxes Headed Higher? and Health Care Taxes, recent articles by Schwab’s Vice President of Financial Planning Rande Spiegelman.

MR: How might taxes on dividends change depending on the outcome of the election?

MT: It’s an interesting situation in Washington. President Obama believes dividends should be treated as ordinary income for taxpayers in higher income brackets (individuals earning more than $200,000 and couples earning more than $250,000). The Republican-controlled Congress approved a bill this past summer that would extend all Bush-era tax cuts for one year, which would keep the dividend tax rate at 15% for all filers for another year. The Democrat-controlled Senate approved a bill that broke with President Obama, setting a top rate of 20% for both capital gains and dividends for higher-income filers, while keeping the rate at 15% for filers below the $200,000 level.

As a result of this split, it’s not clear how things will play out after the election. The President has said he wants to let the Bush tax cuts expire for higher-income taxpayers, and if he’s re-elected, he’ll probably get his way. However, Senate Democrats may push back on the issue of letting dividends be taxed as ordinary income.

High-frequency trading and the SEC

MR: What’s the latest on the Securities and Exchange Commission’s (SEC) probe into whether stock exchanges sometimes allow high-speed trading firms to trade ahead of other investors?

MT: Earlier this month, the SEC announced a $5 million penalty assessed to the New York Stock Exchange for sending market data to certain clients ahead of the consolidated feed that makes the data available to the public—the first-ever SEC penalty against an exchange. We wouldn’t be surprised to see rules proposed, perhaps next year, on high-frequency trading.

The fine is the latest in a growing list of problems undermining the confidence of individual investors in the integrity of our capital markets. It follows the “flash crash” of 2010, problems in the Facebook IPO, the Knight Capital glitch this summer that resulted in losses of more than $400 million and a host of other incidents. The growing presence of high-frequency traders and “dark pools” are a huge part of the debate over whether the playing field is level for all investors.

Next week, the SEC is hosting a daylong roundtable on technology issues, which will focus both on how to prevent glitches and how to respond when they do happen. An SEC roundtable is usually a first step in the process that leads to a regulatory proposal. Congress can also be expected to pay more attention to this issue in the coming months—Chairman of the Subcommittee on Securities, Insurance and Investment Jack Reed (D-Rhode Island) said he would hold additional hearings on this complex issue.

Copyright © Schwab Center for Financial Research

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Bernanke Put: Beware of Easy Money

Wednesday, September 26th, 2012

by Axel Merk & Kieran Osborne, CFA, Merk Funds

September 26, 2012

Central bankers around the world may be providing a backstop to the financial markets in much the same way Greenspan did during the “Goldilocks” years, but when the short-term euphoria wears off, will the negative repercussions be even more severe? Bernanke’s Federal Reserve (Fed) appears to specifically target equity market appreciation as part of its offensive in bringing down the unemployment rate; expectations are high: every time the market sells off, the Fed might simply print more money. We fear central bankers have overstepped their reach, and the implications of their actions may be much worse than the anticipated benefits.

To an extent, the effects of today’s monetary policies resemble the “Greenspan Put” (named after former Fed Chair Alan Greenspan) in the years leading up to the crisis. Today’s central bankers have been quite straight forward in communicating their stance: they appear willing to step in with evermore liquidity should the global economy show any signs of further weakness. Bernanke’s Fed has gone even further: the Fed has stated it’s accommodative policies will “remain appropriate for a considerable time after the economic recovery strengthens”. In other words, financial markets will be awash with liquidity for an extended period, even if we see signs of a sustainable economic recovery.

At first glance, this may appear a positive development for investors holding stocks and other risky assets. After all, Bernanke appears willing to underwrite your investments over the foreseeable future. Indeed, Bernanke appears to specifically target equity market appreciation, on many occasions noting one of the key benefits of quantitative easing (QE) has been to increase stock prices. Notably, while he believes the Fed’s QE policies have had a positive impact on stock prices, he considers it has not caused increases to inflation expectations or commodity prices. We disagree, which we elaborate below. Ultimately, the Fed may have reached too far, bringing risks to economic stability and elevated levels of volatility; the full implications of its actions may be somewhat dire down the road.

From the Bank of Japan and the People’s Bank of China to the European Central Bank (ECB), the Bank of England (BoE) and the Fed, central bankers are either putting their money where their mouth is (quite literally) or strongly insinuating that continued, ongoing easing policies are needed to prevent another significant downturn in global economic activity. While all the excess printed money may or may not have the desired effect of stimulating the global economy, the money does find its way somewhere; unfortunately, most central bankers appear to fail to realize that they simply cannot control where that money ends up.

Fed Chair Bernanke’s Achilles’ heel since the onset of the financial crisis has been the housing sector. It’s no surprise why the Fed bought over a trillion dollars worth of mortgage backed securities (MBS) since 2009: to re-inflate home prices and in so doing, bail out all those underwater with their mortgages. The problem was, it didn’t work – house prices continued to weaken across the nation, and have stagnated to this day. Now, the Fed has announced another MBS purchase program, this time open-ended, under the auspices of “QE3”. Do they believe the time is now ripe for MBS purchases to positively impact the housing market and thus the economy? Unfortunately, the first MBS purchase program failed to have its desired effect; we do not foresee how QE3 will be any better at stimulating house price appreciation.

One of the things we believe such actions do stimulate are inflation expectations. Indeed, the jump in market-implied future inflationary expectations in reaction to the Fed’s QE3 decision was quite remarkable:

In contrast to Bernanke’s views that QE does not cause commodity price appreciation, in our assessment, much of the freshly printed money only serves to inflate the value of assets that exhibit the greatest level of monetary sensitivity: commodities and natural resources. These are essential in the manufacture and production of goods and services purchased by U.S. consumers on a daily basis. As such, inflated commodity and resources prices ultimately pressure consumer price inflation, as the consumer’s “everyday basket of goods” becomes evermore expensive. The ongoing weakness in the U.S. dollar only serves to compound these inflationary pressures. A weak dollar, we believe, is part of Bernanke’s strategy to stimulate the U.S. economy through stimulating exports. While we fundamentally disagree that this is sound monetary policy for the U.S. to pursue, the inflationary ramifications are clear: the U.S. imports a great deal from abroad; every time the dollar depreciates against a currency of a country from which the U.S. imports, the price of those imports rises.

Not only have the Fed’s actions heightened inflationary risks, but we also believe it implicitly heightens the risk that the Fed gets monetary policy wrong. For instance, Fed Chair Bernanke believes that the Fed’s non-standard policies since 2008 may have helped lower 10-year Treasury yields by over 1.5%¹. In so doing, the Fed has taken away a key metric used to gauge the economy and thus set appropriate monetary policy: free market interest rates. The Fed has historically relied on long-term yields, such as the 10-year and 30-year Treasury yield, as part of its assessment of the overall health of the economy. In manipulating those same yields, the Fed can no longer rely upon them to provide valuable information on the health and trajectory of the economy. In other words, the more the Fed meddles in the market through non-standard measures, the more the Fed is in the dark regarding the appropriateness of monetary policy. Such a situation inherently creates an additional level of uncertainty over the U.S. economy, U.S. monetary policy, and may continue to underpin weakness in the U.S. dollar.

The vast amounts of liquidity provided via the Fed’s quantitative easing programs will, at some point, have to be reined in. Whether due to inflationary pressures or a sustainable recovery, only time will tell, but the need to rein in liquidity may create massive headaches down the road. Given the ongoing high level of leverage employed in the economy, such monetary tightening runs the risk of undermining any economic recovery and potentially causing it to crash back down, as the likelihood of it negatively affecting consumer spending is high. With a still-leveraged consumer, rising rates may be overly painful, dramatically slowing consumer spending and, in turn, the economy. Such dynamics may have an outsized impact on the U.S. economy, given consumer spending makes up approximately 70% of U.S. GDP.

All of which underpins our view that there is a significant risk that the Fed has gotten monetary policy wrong. We consider the Fed’s actions have not only heightened inflationary risks, but have also inherently created risks to appropriate monetary policy going forward. Both of which will likely contribute to ongoing high levels of market volatility over the foreseeable future.

With so many dynamics yet to be played out globally, and with central bankers becoming evermore active in meddling with economic dynamics around the world, investors may want to consider preparing for the potential ramifications of such policies. While we may disagree with the policies being pursued, central bankers appear to be at least predictable in their decisions. We believe the currency market provides the most effective way to position oneself to protect and profit from the implications of such monetary policies.

In the current environment, the general equity market seems to be moving on the back of the next anticipated move of policy makers, and less so on fundamentals, but company-specific risks remain. With the outlook for the economy still on tenterhooks, many companies have been missing earnings forecasts. Currencies don’t have this additional layer of risk. As a result, currencies may be the “cleanest” way of positioning oneself for the next policy move. Historically, currencies have also exhibited much lower levels of volatility relative to equities, when no leverage is employed. As such, investors may want to consider adding a professionally managed basket of currencies to their existing portfolios.

Please sign up to our newsletter to be informed as we discuss global dynamics and their impact on gold and currencies. Engage with me directly at Twitter.com/AxelMerk to comment on Merk Insights and to receive provide real-time updates on the economy, currencies, and global dynamics.

Axel Merk & Kieran Osborne, CFA

Axel Merk is President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds.
Kieran Osborne is Senior Analyst at Merk.

Copyright © Merk Funds

Tags: China, Commodities, Gold, Qe, Quantitative Easing
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Quantifying The 6 Downside And 2 Upside Risks To Global Markets

Wednesday, September 26th, 2012

While much attention has been paid to what Draghi has ‘talked’ about doing, what Bernanke ‘is’ doing, what EU Leaders ‘are not’ doing, and what US politicians ‘will not’ do – the world’s risk markets remain on edge. Admittedly, for now, that edge seems biased to the ‘we-believe’ side of the fence. However, as Deutsche Bank notes, in their wonderfully succinct chart comparing the impact and probability of potential upside and downside risks to global markets, it is economic (or real!) data that should worry investors the most – though we still fear the Kubler-Ross ‘denial’ stage that in which Spain/Italy/Portugal/Greece remain mired.

Risk Matrix:

the shift in (1) is over the past month

Downside Risks:

Upside Risks:

Source: Deutsche Bank

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S&P 500 Works Off Overbought Levels (Bespoke)

Wednesday, September 26th, 2012

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Look Back. Now A Little Further.

Wednesday, September 26th, 2012

by Steven Visscher, Mawer Investment Management

Recency Bias – the tendency to use our recent experience as the baseline for what will likely happen in the future, despite historical information that argues to the contrary.

As humans, we often invent a skewed view of reality by overemphasizing recent events. Even if we don’t intend to, it’s natural to allow past information to fade and allow newer information to garner more attention.

Investors do this too. One of the more memorable examples comes from examining equity returns across different regions of the world. When we look at very long-term returns (i.e. 50+ years), there is not a dramatic difference between equity returns across regions. But they can vary much more so in shorter timeframes.

During the 1990s, the S&P 500 (C$) had an average annual return of 20.8%. What a decade! In this same time period, Canada’s TSX index earned only 10.6%. After seeing this decade of U.S. outperformance, many investors fell prey to recency bias and shifted their investments more heavily into the U.S. market. But 10 years later they were in for a serious disappointment because in that decade, it was Canada that led the way with an average annual return of 5.6% while the S&P 500 (C$) lost 4.1% per year.

We believe some investors are now making this same behavioural error again. With the memory of Canada’s recent market dominance fresh in our minds, it’s easy to forget about the 1990s when Canada lagged. And there appears to be several reasons why Canada’s good fortune could continue. For example, Canada has a much healthier fiscal situation than the U.S. or Europe. Their debts have been downgraded while we remain one of the few countries to boast a AAA credit rating. We have fewer unemployed, a stronger banking sector, a more stable political and regulatory framework, and an abundance of commodities that the rest of the world craves. Canada’s markets must be reining supreme right? Not so fast.

In 2011, Canada’s S&P/TSX lost 8.7% while U.S. equities gained 4.4%. Thus far in 2012, Canada continues to lag. Our S&P/TSX has gained approximately 2%, while U.S. equities have gained approximately 10%. Even Europe, amidst all of its challenges, has gained over 5% so far in 2012. So much for all our advantages noted above. This may be happening because markets are forward looking beasts, and if a drawn-out global economic slowdown were to occur due to difficulties in China, Europe and the US, then Canada and its commodity sensitive economy may suffer more than these other economies. But our point is not to try to analyze the future – it is to caution about the shortcomings of the human mind.

As investors it’s easy to fall into the recency bias trap. To help avoid this pitfall, it’s important to take a long-term view, stay disciplined, stay diversified, and don’t forget the past.

Steven Visscher

Copyright © Mawer Investment Management

Tags: China, Commodities
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QE Forever?

Wednesday, September 26th, 2012

by Ed Ylagan, Mawer Investment Management

This past week I have been battling a cold which has, as many of you can imagine, turned my daily routine into a bit of a grind. Despite the fits of coughing, sneezing, and lack of sleep, I have generally been of the opinion that one is best served by allowing their body to recover from a cold on its own accord. That being said, this particular cold packed enough punch to break my resolve and I have since undertaken some “easing” measures to hasten my recovery.

The first round of my treatment program was the deployment of lozenges to combat my irritated throat. Although tasty and mildly soothing, I soon realized that throat lozenges were pitifully inadequate to deal with the problem. As such, I launched round two and turned to Lemon Neo Citran coupled with early bedtimes. After a brief period of temporary relief, I am unhappy to report that this combination also proved unsuccessful. As I enter the third round of my coughing and sneezing easing armed with a particularly potent brand of cough syrup, I can’t help but observe parallels between my own treatment tactics and the Quantitative Easing (QE) measures of the U.S. Federal Reserve.

Last week Ben Bernanke, the Chairman of the Federal Reserve, announced that the U.S. Central Bank would engage in a third round of QE in order to hasten the recovery of the U.S. Economy. In particular, Mr. Bernanke alluded to the persistent high unemployment rate as a “grave concern”. Now, the good news is the Federal Reserve recognizes that the pain caused by high unemployment is intolerable and thus, requires treatment. The bad news is that the QE measures taken by the Federal Reserve may be likened to my throat lozenges, Neo Citran, and cough syrup in that although each initiative offered temporary relief, all may prove to be disappointingly ineffective in the long-run. And worse, there could be unintended consequences.

Ed Ylagan

Copyright © Mawer Investment Management

Tags: Qe, Quantitative Easing
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