Archive for October 22nd, 2012
Monday, October 22nd, 2012
by Don Vialoux, TechTalk
Upcoming US Events for Today:
- No Economic Events Scheduled
Upcoming International Events for Today:
- No Economic Events Scheduled
Markets sold off on Friday, producing the largest one day loss since the end of June as investors reacted to the reality of the earnings situation in the US. General Electric and McDonanlds were the latest companies to report earnings that missed expectations, pushing the stock values of these two bellwethers lower by 3.42% and 4.46%, respectively. As well, continued weakness in the Technology sector remains as a substantial burden on US benchmarks heavily weighted in the sector. Microsoft and Google continued on their recent path of declines following earnings, while Apple, which hasn’t even reported yet, continues to be on a slide that began shortly after their latest iPhone launch in September. Other companies have also traded sharply lower prior to reporting, such as Caterpillar, which reports today. With 98 S&P 500 companies having reported earnings thus far, only 42% have reported sales above estimates, causing concern for investors. The beat rate on earnings per share, however, has been a respectable 70%. Prior to Friday of last week, broad markets had been trading higher with weakness isolated to particular names that disappointed investors expectations following reports. Now investors are finally reflecting the expected weakness of the of the remainder of the earnings period on stock values, an event that is more typical than not at this point during third quarter earnings season. October is typically a volatile month as a result of the earning reports that are released and seasonal averages show gains through to mid-month followed by losses into October 28th, which has been identified as the average optimal date to enter broad market indices for the seasonally favorable six months of the year. Weakness in the short-term still presents a certain appeal to take advantage of long opportunities in the equity market for the period of seasonal strength ahead.
Despite the strong drop on Friday, equity benchmarks, such as the S&P 500 and the Dow Jones Industrial Average, still managed to finish marginally positive for the week. The price action of both the Dow and the S&P 500 finished precisely at 50-day moving averages, the level which these benchmarks started the week at. The S&P 500 continues to remain in this short-term negative trend channel that began mid-September. The lower limit of this channel sits around 1420, while the upper limit is now around 1460. Downside risks should the market break below this range fall to 1375 to 1400, which is approximately a 25-point band above the current level of the 200-day moving average, now at 1374. A catalyst would likely be required in order to break below the 200-day moving average, potentially putting the market into correction territory.
Overall, although Friday was a risk-off session, it did not suggest panic in equity markets. Treasury yields were only little changed, holding around the 200-day moving average line in the case of the 10-year. The US Dollar Index resisted at its 20-day moving average line, continuing to suggest short-term weakness. And equity benchmarks less weighted in Technology, such as the TSX, held up relatively well amidst the substantial weakness in the US, suggesting that present weakness is primarily related to the recent technology earnings events and not something more broad based. The bias for stocks between now until the end of the year is to the upside based on positive seasonal tendencies, improving economic data, and accommodative central bank policy. Should any of these factors come into doubt or a catalyst is realized that severely threatens the future outlook, our bias is likely to change, but for now respecting the risks is more important than speculating an outcome. A definitive breakout in treasury yields above 200-day moving averages and a breakdown in the US Dollar Index below support at 78.60 would likely trigger the next leg higher in risk assets, mainly in stocks and commodities.
Companies reporting earnings today include Caterpillar, Freeport-McMoRan, Hasbro, Peabody Energy, SunTrust Banks, VF Corp, Canadian National Railway, Texas Instruments, Western Digital, and Yahoo.
Sentiment on Friday, as gauged by the put-call ratio, ended bearish at 1.12. After trading outside of the recent rising channel mid last week, the put-call ratio swung back into range on Friday, continuing with the apparent bearish trend for equities that begun in the middle of September.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
- Closing Market Value: $12.56 (down 0.71%)
- Closing NAV/Unit: $12.55 (down 0.64%)
|2012 Year-to-Date||Since Inception (Nov 19, 2009)|
* performance calculated on Closing NAV/Unit as provided by custodian
Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.
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Monday, October 22nd, 2012
SIA Charts Daily Stock Report (siacharts.com)
Agnico-Eagle Mines (AEM.TO) $52.41 – On a day where 16 holdings in the SIA S&P/TSX 60 Report were positive, 8 of them were found in the Favored zone including all of the holdings that had more than 1% moves. Agnico-Eagle Mines (AEM.TO) was one of those moving up above the downward trend line and prior resistance. Resistance above is found at $56.96 and $61.65. Support is found below at $48.61 and $43.61.
Green – Favoured
Yellow – Neutral
Red – Out of favour
SIACharts.com specifically represents that it does not give investment advice or advocate the purchase or sale of any security or investment. None of the information contained in this website or document constitutes an offer to sell or the solicitation of an offer to buy any security or other investment or an offer to provide investment services of any kind. Neither SIACharts.com (FundCharts Inc.) nor its third party content providers shall be liable for any errors, inaccuracies or delays in content, or for any actions taken in reliance thereon.
Copyright © siacharts.com
Monday, October 22nd, 2012
A rare interview with Great Investor, Steven Romick of FPA Crescent Fund. Romick describes how he is keeping his five-star rated fund on top by balancing the forces of inflation and deflation and continuing his contrarian, value-oriented strategies.
Posted in Markets | Comments Off
Monday, October 22nd, 2012
by Tom Brakke, Research Puzzle
What are your investment beliefs?
Such a simple question — and so hard for most market participants to answer. Go ahead, take a shot at making a list of your beliefs and see what you end up with.
Perhaps you’ll start with your take on market efficiency and your thoughts about passive versus active management. That’s a logical place to begin, given how many decisions hinge on that one divide. Perhaps you see efficiency in some areas and the opportunity to add value in others. For the latter situations, how do you expect to add that value? On and on we could go with the questions, from the macro to the micro, sketching the framework upon which your choices will be made.
That framework will look different depending upon where you are in the investment ecosystem. A do-it-yourself investor is able to define his beliefs and act upon them directly, although most individuals are not adequately prepared to do so.
Those that work with financial advisors need to think about the interaction between an advisor’s belief system and their own — as well as the issues that can arise when one person is being paid for the advice and another is paying for it. Incentives can sometimes swamp beliefs and the fear of losing business (or losing face) can distort decision making.
Shifting gears, let’s say that you are an employee of an organization that manages hundreds of billions of dollars. What are the organization’s beliefs? What are yours? How temporal are they? Are they formed by the rapid growth in assets of the latest hot product — or the most recent area of strong relative performance — or are there more permanent underpinnings?
Perhaps you are a fiduciary that’s responsible for working with others to select firms to manage assets for a pension plan or an endowment. What are your beliefs (and those of the other decision makers individually and as a group) and how do they ultimately translate into the individual purchases and sales that determine performance?
As a consultant on investment process, it’s usually not too hard for me to locate a wedge issue that is evidence of a gap between stated beliefs and their application. I have also written about this topic in a variety of ways over the years. That’s why I was interested to see articles in Pensions & Investments about a survey it did in conjunction with Oxford University.
In the print edition of July 23, the article was titled, “Having belief set is the key to future returns.” The headline was not a statement of fact, but of the opinions (beliefs, if you will) of the survey respondents. There was no proof offered.
And in my consulting, I don’t offer one either. But I agree wholeheartedly that an exploration of beliefs is a necessary precursor to improving an investment decision process.
Notice that I used the word “exploration” rather than “statement.” It is the consideration of the key issues that should inform beliefs, not a statement of beliefs that should close off debate about them. Knowing where to stand your ground is important, but beliefs that are treated as immutable can sometimes lead to bad returns rather than good ones.
So, yes, it’s always good to hear a clear statement of beliefs and be able to see how they translate into specific decisions that resonate with them. But tell me about the ways in which your beliefs collide and intersect, how they migrate over time and why, and what circumstances would call for a change in those beliefs (or a diversification of them) rather than a rote affirmation of those of the past.
If you can do that, you’ll be better prepared for the inevitable tests ahead.
Copyright © Research Puzzle
Posted in Markets | Comments Off
Monday, October 22nd, 2012
U.S. economic data last week boosted expectations. Are U.S. markets now the place to be? What stocks should we watch? MaryAnn Devenny is joined by TD Waterhouse’s James Marple and Justin Flowerday to answer these questions.
In the interview Marple and Flowerday address the following:
- What’s the most important U.S. economic number that came out?
- Are the U.S. markets out of their slump?
- Let’s talk stocks: Tiffany
- Let’s talk stocks: Dr. Pepper Snapple
October 19, 2012 (9 minutes) Click here or on image for video
Copyright © TD Waterhouse
Posted in Markets | Comments Off
Monday, October 22nd, 2012
Earlier this week two former Merrill colleagues, since separated, were reunited on several media occasions, and allowed to spar over their conflicting views of the world. The two people in question, of course, are Gluskin Sheff’s David Rosenberg, best known during the past 3 years for not drinking the propaganda Kool-Aid, and systematically deconstructing every “bullish” macroeconomic datapoint into its far more downbeat constituent parts, and his ebullient ex-coworker, Richard Bernstein, formerly head of equity strategy at a firm that had to be rescued by none other than Bank of America and currently head of RBA advisors, who just happens to be bullish on, well, everything. Rosenberg decided to dedicate his entire letter to clients today to “providing a rebuttal” of the slate of reasons why according to Bernstein the “we are on the precipice of a 1982-2000 style of secular market.” What follows is one of the most comprehensive “white papers” debunking the bullish view we have seen in a while. Read on.
From Gluskin Sheff’s David Rosenberg
R AND B
It is music though not necessarily of the B.B. King variety. It’s the Rosenberg and Bernstein duet.
My good friend and former Merrill Lynch research colleague Richard Bernstein and yours truly duked it out at a business executive forum on Thursday over the market outlook.
It was like the good or days and felt really good.
I would say that over the long haul, Rich and I tend to share very similar philosophies regarding global events and how they will play out over time.
But when we differ, we differ big time.
That said, I have to tip my hat to Rich for having been earlier than I on the bull call for equities this cycle. At the same time, the bond-bullion barbell strategy and S.I.R.P. thematic has also managed to help generate decent risk-adjusted returns over the past three-plus years.
But kudos to Rich for the stock market view. That’s what the debate was (and is) about. He got it more right than wrong. Be that as it may. just as past returns are never a guarantee for future performance in the money management field, so it is true in the realm of forecasting that extrapolating your latest successful calls can often be a big mistake.
Rich has said verbally and in print that we are on the precipice of a 1982-2000 style of secular bull market and has listed a slate of reasons why, and I intend on providing a rebuttal to each.
First, Rich is excited about the fact that the total national debt (government, business and household combined) has come down to 340% from the record peak of 370% set in 2009 and as such the deleveraging phase is gathering apace. I agree that going on a debt diet is a good thing to do, but it also eats into domestic demand and is one of the reasons why this goes down as the weakest economic recovery on record. And at 340% on the aggregate debt/income ratio, we are merely back to the levels we were at the bubble highs five years ago.
I find it doubtful that the debt ratio has managed to find its way back to a sustainable level, and Rogoff and Reinhart did the hard research showing that post-bubble deleveraging cycles last at least ten years. So in baseball parlance, we’re probably no better than in the fourth or fifth inning. And don’t forget that the wonderful 1982-2000 secular bull run was caused in part from the multi-year run-up in the all-in deb/GDP ratio from 160% to 260% — the correlation with the S&P 500 was large at 82%. To be sure, correlation does not imply causation, but there can be little doubt that the proliferation of credit products and ever-greater accessibility to leverage contributed immensely to economic growth and corporate profits during that virtually non-stop two-decade period of unbridled prosperity. Today, and tomorrow, the movie is continuing to run backwards and will prove to be an enduring drag on the pace of economic activity, not just in the USA, but globally.
Three other critical differences worth mentioning before moving on. In 1982. at the start of the secular bull run, the median age of the 78 million pig-in-the-python otherwise known as the baby boomer, the group which controls most of the wealth and has had a big hand in influencing everything in the past six decades from capital markets to the economy to politics, was 25 years old, heading into their prime risk-taking years and as such ushering in the era of aggressive growth and capital appreciation strategies. Today the median age is 55 and going on 56 and the first of the boomers are now turning 65— 10,000 will be doing so each day for the next eighteen years. And their tolerance for risk and need for income is considerably different than it was three decades ago. That much is certain.
The expansion in credit and the favourable demographic trends in that 1982- 2000 period helped generate annual economic growth, in nominal terms, of nearly 6.5% on average, taking the trend in corporate profits along for the ride. Not even the most bullish prognosticators see growth coming in anywhere near that pace for the foreseeable future.
And of course, while Ronald Reagan was no fiscal conservative, his worst sin was a 6% deficit GDP ratio, much of it being cyclical by the way, and a 28% federal debt/GDP ratio. Today the deficit is closer to 8% (there is a much larger structural component) and the federal debt/GDP ratio is about to pierce the 70% threshold. Not to mention entitlements being a much more acute ticking time bomb as the ponzi schemes are that much closer to facing insolvency without some tinkering. Remember — fiscal policy in the U.S. in the go-go 1980s and 1990s was all about receding top marginal tax rates and greater deductions. Everybody liked this so much that many of the folks sitting across the aisle from the GOP were labeled “Reagan Democrats”.
No such bipartisanship exists today, nor is it likely to given the large degree of acrimony, so evident in the last presidential (and veep) debates. It may end up taking some sort of a crisis, in the end, to galvanize the two parties to work towards a resolution to the fiscal morass (as happened in Canada in the early 1990s). That Obama can never seem to get a budget passed or that Simpson-Bowles is collecting dust was not the politics of the Reagan-O’Neill accords of the 1980s. Even Clinton learnt how to compromise and work with the enemy (he was very good, by the way, at the Democrat convention — no doubt he would win another term running against either candidate, and it was so obvious that neither one really fully comprehends just how massive the fiscal problem is and the complexity and painful shared sacrifice that it will take as part of any viable solution).
The 1980s and 1990s were all about industry deregulation. That fostered a durable expansion of both the ‘E’ and the ‘P/E’ as far as equity market valuation was concerned. That is hardly the case today, is it? And the 1980s and 1990s were all about breaking down harriers to global trade, again allowing for greater multiple expansion. This cannot be emphasized enough, especially in lowering business costs. Today, trade tensions are growing and protectionism rearing its ugly head via surreptitious currency wars.
Sorry, but it ain’t the 1980s and 1990s all over again, by any stretch. What the stock market has really experienced is a classic reflexive rebound from a depressed oversold condition, aided and abetted by radical government intervention, not entirely unlike what we saw from 1932 to 1936.
As I said, in 1936, it would have been foolhardy to have overstayed the party by extrapolating a vigorous bounce off the trough into the future. I recommend that people don’t repeat that mistake. The reason why policy rates in most parts of the world are at or near zero percent is because risk is high. Especially political risk. Make sure this is acknowledged in every financial decision you make.
Moreover, in the 1980s and 1990s, the government was getting out of the way. Back then, if a publicly elected official asked “what can I do for you”, the answer by most was “nothing. Thanks”. Today, the same question is met with “where’s my cheque”? In the 1980s and 1990s, the Fed was ushering in an era of disinflation, again a powerful way to expand the market multiple — which it did — as it led to better business decision-making and more efficient resource allocation.
Now the Fed is covertly attempting to create inflation so as to monetize our debt morass. Not only was government getting out of our way in the 1980s and 1990s, but the Federal Reserve found its moorings under the legacy of Paul Volcker, and followed years of what can only be described as a sound money policy. We have on our hands today, not just the Fed but many major central banks manipulating interest rates and relative asset values. It is imperative to recognize that as the Fed and ECB act in a manner today that has investors convinced that “tail risks” are being reduced, the cost of these unconventional policy measures are both unknown but very likely far-reaching, and have thereby introduced “tail risks of their own, even if not realized for years down the road.
Anyone who does not recognize the extent of the Fed’s manipulation in order to generate a positive wealth effect on spending should not be in the wealth management business. Because managing wealth means managing risks… and the Fed and other central banks have merely papered over the debt overhang by printing vast amounts of paper money. Once the inflation does come back, believe me, all hell will break loose, and the law of unintended consequences will rear its head. At that point, the Fed will have no choice but to do some very heavy backtracking and the game will be over. This again is being very forward- looking, to a fault perhaps, but the Fed, once it gets the inflation it so desperately wants, will he slow to respond at first but will end up having to unwind its pregnant balance sheet. One reason why gold bullion and gold mining stocks will prove to have been very effective hedges down the road (but when buying the companies, be very selective).
If you are bullish on equities, at least he bullish for the right reason. For the here and now, the correlation is dominated by the size of the Fed balance sheet. From 2000 to 2007, the correlation between the Fed’s balance sheet and the direction of the S&P 500 was less than 20%. Since 2007, that correlation has swelled more than four-fold to 86%. This is the missing chapter in the classic Graham and Dodd textbook on value investing, published 80 years ago.
So no doubt, Ben Bernanke (as well as Mario Draghi have thought their balance sheet machinations have been able to engineer a buoyant stock market. This is the most crucial determinant of the positive sentiment underpinning valuations at the current time Lord knows, it’s not corporate earnings, which are now contracting. Now profits are an absolutely essential driver of the equity market and the downtrend may be one reason why the major averages have basically been range-bound since QE3+ was announced on September 13th (in fact, through the daily wiggles, the interim peak was September 14th). But as high as the historical 70% correlation is between corporate earnings and the equity market, it is still dwarfed by that 86% correlation with the Fed’s bloated balance sheet.
Call it the “new normal’ — a term hardly bandied about any more than “fat tall risks’ in those wonderfully prosperous 1980s and 1990s.
Just to reiterate — deleveraging, which is necessary and will inevitably blaze the trail for more sustainable organic economic growth in the future, is a dead-weight drag for the here-and-now. In fact, the total debt/GDP ratio, for the past 30 years, has a positive 82% correlation with the trend in equity values. Opinions are one thing, statistical analysis quite another. And common sense. Deleveraging is inherently deflationary. It’s a painful process that typically involves years of rising savings rates and depressed growth in domestic demand which then feeds right into the 70% that matters for the equity market which is corporate earnings.
The over-riding problem of excessive global indebtedness relative to the income-generating capacity to service the debt remains acute, notwithstanding the “don’t-worry-be-happy” market mindset This is why central banks remain in aggressive treatment mode.
Well, Rich lays his bullish claim on the classic contrarian signpost of there being rampant pessimism. But is that actually the case? No doubt the latest AAII survey does show that fewer than 30% of individual investors are bullish on the outlook for equities. As I have said time and again, this is not some sort of classic contrarian play It is a deliberate shift in investor attitudes towards how best to diversify the asset mix with an eye towards generating ‘risk-adjusted” returns. Meanwhile, many other survey measures actually point to a high level of optimism among those in the financial industry. Market Vane sentiment is 66% bullish, at the high end of the range. The Investor’s Intelligence survey shows 43% bulls but only 26% bears. The Rasmussen investor index at just under 100, much like Market Vane, currently sits at the high end of the range for much of this cycle.
Beyond the survey evidence, look at the market positioning. The ICI data show that equity mutual fund managers are sitting on 4% cash — the exact same ratio that prevailed at the market peak back in October 2007 (the cash ratio in aggressive growth funds is only 3.5%). Bond fund managers are sitting on 7.6% cash. Managers of hybrid funds have also boosted their cash ratios to 9%. Also look at how the hedge funds have re-positioned themselves in the wake of QE3+ … It is already evident that when the Fed tells the world that risk-free rates will remain at zero at least semi-permanently, capital will flow to risk assets. After a prolonged period of being cautious, the latest CFTC (Commodity Futures Trading Commission) data show that the net speculative long S&P 500 positions on the CME has swung violently since early September from a net short backdrop of 10,896 contracts to a net long position of a record 18,346 contracts (in both futures and options).
In other words, if you are bullish on equities, I wouldn’t exactly be using depressed investor sentiment or “money on the sideline” market positioning as a reason.
The counterpoint that Rich likes to make is that the cult of equities is dead and this extreme pessimism is a bullish signpost. Sort of like the “Death of Equities’ on the front page of BusinessWeek decades ago (though that front cover showed up in 1979, about three years prior to the market trough). There is this view promulgated that whatever the herd effect is in the retail investor space, you want to do the opposite. The problem with that is that in 2007, the individual investor began to pull out ahead of the institutional investor who was slow to raise cash (ostensibly buying into the consensus view of a 2008 “soft landing”… remember that one?).
First off, it is not clear when you look at ETF flows, that retail investors have totally abandoned the equity market or have completely shunned risk. For one, based on the numbers I have seen, the 42% weighting that U.S. households have as equities in their overall mix is smack-dab in the middle of the historical range. To be sure, outflows from strict capital appreciation/aggressive growth funds have been large and relentless, but a good part of that has reflected not just a shift towards ETFs but also “hybrid” or balanced funds that focus more on income orientation and less on generating alpha with beta. To be sure, and keep in mind the demographic overlay, there is a secular drive towards bond funds, but the vast majority of that (over $200 billion of net inflow in the past year) has been in “spread product”, mostly corporates. Less than $40 billion have actually flown into “safe” government bond funds. It’s not like households are hiding under the table in the fetal position — if that was the case, assets in money market funds would have expanded $90 billion in the past year instead of losing that exact amount What individual investors are doing is a deliberate asset mix shift towards more diversification, less risk, and cash flows.
Finally, in terms of valuation, I would agree with Rich that we are not at extremes. But from my lens, the market is fully priced and with earnings now contracting and record margins being squeezed, the reduced prospect of more multiple expansion is likely to leave the major averages range-bound at best over the near- and intermediate-term. When Rich was the equity strategist at Merrill, he always focused on GAAP reported earnings. I concur. And on that basis, the trailing P/E ratio is now 15.5x. No doubt that is far from the blowout peaks we saw in 2007-08 and in 2000-01, but those were the only two cycles which saw the multiple go to radical extreme nosebleed territory (and look at those two bear markets — one was double the usual decline and the other was more than triple a normal cyclical downturn). But looking at five decades of history, we see that the average multiple at the peak of the market is 16x — we are a half-point from that right now. Of course the average peak multiple is far higher than that (46x), but what should matter for investors is what the multiple normally looks like at the highs for the market. By the time the multiple actually hits its extreme peaks, the market had already rolled over for an average of eight months— because the ‘E’ falls faster than the ‘P’, at least initially as companies take the writedown hits early on.
So in a nutshell, I am sure that Rich and I will agree to disagree. From my perspective, there are slices of the stock market that I do like (even if I am not excited for the S&P 500 as a whole). And being a long-time bond hull, it is the part of the equity sphere that behaves like a bond: Dividend growth. Dividend yield (though avoiding traps). Dividend coverage. Corporate bonds. Muni’s. Canadian banks. Gold mining stocks (that now pay a dividend!). Energy and energy infrastructure. Consumer Staples. Discount retailers.
Beneath the veneer, there are opportunities. But I do not agree that the equity averages have more upside potential than downside risks from today’s levels. I do not buy into the view that the fundamentals, valuation metrics, market positioning and sentiment indices are wildly bullish. I do buy into the view that central bankers are your best friend if you are uber-bullish on risk assets, especially since the Fed has basically come right out and said that it is targeting stock prices. This limits the downside, to he sure. but as we have seen for the past five weeks, the earnings landscape will cap the upside. I also think that we have to take into consideration why the central banks are behaving the way they are, and that is the inherent ‘fat tail’ risks associated with deleveraging cycles that typically follow a global financial collapse. The next phase, despite all efforts to kick the can down the road, is deleveraging among sovereign governments, primarily in half the world’s GDP called Europe and the US. Understanding political risk in this environment is critical.
And that is my point. It is not about gross nominal returns as much as risk- adjusted returns — now more than ever. Getting it right for clients in the wealth management business means striving every single day to identify the risks, assess the risks, price the risks and then rigorously manage the risks. Having an appreciation of the risks doesn’t necessarily make you ultra risk-averse, but what it does is empower you and lead you on the path of making prudent decisions.
Richard Bernstein and I may differ on the optimal strategy at the current time to achieve risk-adjusted returns, but I am sure on that last comment we are on the same page.
I look forward to his rebuttal!
Monday, October 22nd, 2012
by Don Vialoux, TechTalk
Economic News This Week
Canada’s Overnight Lending Rate to be announced on Tuesday at 9:00 AM EDT is expected to remain unchanged at 1.00%.
September New Home Sales to be released on Wednesday at 10:00 AM EDT are expected to increase to 385,000 from 373,000 in August.
Results of the FOMC meeting to be released on Wednesday at 12:30 PM EDT are expected to hold the Fed Fund rate at 0%-0.25%.
Weekly Initial Jobless Claims to be released on Thursday at 8:30 AM EDT are expected to decline to 375,000 from 388,000 last week.
September Durable Goods Orders to be release on Thursday at 8:30 AM EDT are expected to increase 7.4% versus a decline of 13.2% in August. Excluding transportation, Orders are expected to increase 1.0% versus a decline of 1.6% in August.
The first estimate of third quarter real annualized GDP growth to be released on Friday at 8:30 AM EDT is expected to improve to 1.9% from 1.3% in the second quarter.
The final October Michigan Sentiment Index to be released on Friday at 9:55 AM EDT is expected to remain unchanged at 83.1.
Earnings News This Week
The S&P 500 Index added 4.60 points (0.32%) last week. Intermediate trend is down. The index fell below its 20 and 50 day moving averages on Friday. Short term support at 1,425.53 is being tested. Short term momentum indicators have recovered to neutral levels.
Percent of S&P 500 stocks trading above their 50 day moving average increased last week to 58.00% from 53.00% despite the decline in Friday. Percent remains intermediate overbought and trending down.
Percent of S&P 500 stocks trading above their 200 day moving average increased last week to 70.40% from 67.40%. Percent remains intermediate overbought and trending down.
The ratio of S&P stocks in an uptrend versus a downtrend (i.e. Up/Down ratio slipped last week to (305/108=) 2.82 from 3.05. Sixty nine S&P stocks broke resistance and 41 stocks broke support.
Bullish Percent Index for S&P 500 stocks slipped to 76.20% from 76.40% and remained below its 15 day moving average. The Index remains intermediate overbought and trending down.
The Up/Down ratio for TSX Composite stocks slipped last week to (144/69=)2.09 from 2.48. Nineteen stocks broke resistance and twenty stocks broke support.
Bullish Percent Index for TSX Composite stocks slipped last week to 68.27% from 67.89% and remained below its 15 day moving average. The Index remains overbought and showing signs of rolling over.
The TSX Composite Index gained 213.94 points (1.75%) last week. Intermediate trend is neutral. Short term support is forming at 12,137.18 and resistance exists at 12,529.77. The Index bounced nicely from near its 50 day moving average and moved above its 20 day moving average. Short term momentum indicators are trending higher despite the decline on Friday. Strength relative to the S&P 500 Index has changed from neutral to positive.
Percent of TSX stocks trading above their 50 day moving average increased last week to 57.83% from 55.69% despite the drop on Friday. Percent remains intermediate overbought and trending down.
Percent of TSX stocks trading above their 200 day moving average increased last week to 59.04% from 57.32%. Percent remains intermediate overbought and trending down.
The Dow Jones Industrial Average added 15.46 points (0.12%) last week despite the fall last week. Intermediate trend is neutral. Resistance is at 13,661.87 and short term support at 13,296.43 is being tested. The Average fell below its 20 and 50 day moving averages on Friday. Short term momentum indicators have recovered to neutral levels. Strength relative to the S&P 500 Index remains neutral.
Bullish Percent Index for Dow Jones Industrial Average stocks fell last week to 76.67% from 80.00% and remained below its 15 day moving average. The Index remains intermediate overbought and has started to trend down.
Bullish Percent Index for NASDAQ Composite stocks fell last week to 56.88% from 57.69% and remained below its 15 day moving average. The Index is intermediate overbought and trending down.
The NASDAQ Composite Index fell 38.49 points (1.26%) lasts week following release of a series of disappointing third quarter reports by companies in the technology sector. Intermediate trend is down. The Index remains below its 20 and 50 day moving averages. Short term momentum indicators are oversold, but have yet to show signs of recovery. Strength relative to the S&P 500 Index remains negative.
The Russell 2000 Index slipped 2.09 points (1.26%) last week. Intermediate trend is down. Resistance is at 868.50. The Index fell below its 20 and 50 day moving averages on Friday. Short term momentum indicators are neutral. Strength relative to the S&P 500 Index remains negative.
The Dow Jones Transportation Average added 37.53 points (0.74%) last week. Intermediate trend is neutral. Support is at 4,870.74 and resistance is at 5,231.15. The Average remains above its 20 and 50 day moving averages. Short term momentum indicators are trending up. Strength relative to the S&P 500 Index remains positive. Seasonal influences are positive.
The Australia All Ordinaries Composite Index gained 70.78 points (1.57%) last week. Intermediate trend is up. The Index 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 Nikkei Average added 468.56 points (5.49%) last week. Intermediate trend is neutral. Support is at 8,488.14 and resistance is at 9,288.53. The Average moved above its 20 and 50 day moving averages. Short term momentum indicators are trending up. Strength relative to the S&P 500 Index has been negative, but is showing signs of change.
The Shanghai Composite Index added 23.37 points (1.11%) last week. Intermediate trend is down. Support is at 1,999.48 and resistance is at 2,145.00. The Index remains above its 20 and 50 day moving averages. Short term momentum indicators are trending up. Strength relative to the S&P 500 Index remains positive. Seasonal influences are about to turn positive.
The Europe 350 ETF added 0.70 (1.90%) last week. Intermediate trend is up. Support is at 36.43 and resistance is at $38.55. Units remain above their 20, 50 and 200 day moving averages. Short term momentum indicators are trending up, but showing early signs of change. Strength relative to the S&P 500 Index remains positive.
The Athens Index gained another 45.78 points (5.54%) last week. Intermediate trend is up. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show significant signs of peaking. Strength relative to the S&P 500 Index remains positive.
The U.S. Dollar slipped 0.03 (0.04%) last week despite the strong gain on Friday. Intermediate trend is neutral. Support is at 78.60. The Dollar remains below its 20, 50 and 200 day moving averages. Short term momentum indicators are mixed.
The Euro added 0.69 (0.53%) last week despite the sharp drop on Friday. Intermediate trend is neutral. Resistance is at 131.72. Short term momentum indicators are mixed. The Euro remains above its 20, 50 and 200 day moving averages.
The Canadian Dollar dropped 1.43 cents U.S. (1.40%) last week. Intermediate trend changed from up to down. The Canuck Buck fell below its 20 and 50 day moving averages. Short term momentum indicators are trending down.
The Japanese Yen fell 1.41 (1.11%) last week. Intermediate trend changed from up to down on a break below support at 126.72. Short term momentum indicators are trending down. The Yen remains below its 20 and 50 day moving averages and fell below its 200 day moving average.
The CRB Index slipped $0.50 (0.16%) last week. Intermediate trend is up. Support is at $302.45 and resistance is at 321.36. The Index remains above its 200 day moving average and below its 20 and 50 day moving averages. Strength relative to the S&P 500 Index remains neutral/slightly negative.
Gasoline fell $0.22 (7.59%) last week. Intermediate downtrend was confirmed on a break below support at $2.703. Gasoline remains below its 50 and 200 day moving averages and fell below its 20 day moving average. Short term momentum indicators are trending down. Strength relative to the S&P 500 Index turned negative.
Crude Oil fell $0.92 (1.01%) last week. Intermediate trend is neutral. Support is indicated at $87.70. Crude remains below its 20, 50 and 200 day moving averages. Short term momentum indicators are mixed. Strength relative to the S&P 500 Index remains negative.
Natural Gas slipped $0.02 (0.56%) last week. Intermediate trend is up. Gas remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought and showing signs of peaking. Strength relative to the S&P 500 Index remains positive.
The S&P Energy Index slipped 10.48 points (1.93%) last week. Intermediate trend changed from down to up on a break above 558.74. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are mixed. Strength relative to the S&P 500 Index changed from negative to neutral.
The Philadelphia Oil Services Index added 8.14 points (3.68%) last week. Intermediate trend is neutral. The Index moved above its 20, 50 and 200 day moving averages. Short term momentum indicators are trending up. Strength relative to the S&P 500 Index has turned neutral.
Gold lost another $33.00 per ounce (1.88%) last week. Intermediate trend is up. Gold 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 changed from positive to at least neutral. Seasonal influences are negative in the month of October.
The AMEX Gold Bug Index added 0.16 (0.03%) last week. Intermediate trend changed from up to down on a break below support at $489.51. 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 gold remains slightly negative.
Silver fell $1.38 per ounce (4.12%) last week. Intermediate trend is up. Silver remains below its 20 day moving average and moved below its 50 day moving average. Short term momentum indicators are trending down. Strength relative to gold remains negative.
Platinum plunged $33.80 (2.04%) last week. Intermediate trend is up. Resistance is at $1,734.50. Platinum remains above its 50 and 200 day MAs and below its 20 day MA. Short term momentum indicators are trending down. Strength relative to gold remains positive.
Palladium fell $5.95 (1.80%) last week. Palladium remains below its 20, 50 and 200 day moving averages. Strength relative to gold remains neutral.
Copper fell $0.06 per lb. (1.62%) last week. Intermediate trend changed from up to down on a break below support at $3.681. Short term momentum indicators are trending down. Strength relative to the S&P 500 Index has changed from positive to neutral.
The TSX Global Metals and Mining Index gained 28.75 points (3.17%) last week. Intermediate trend is up. The Index remains above its 50 day moving average and moved above its 20 day moving average. Short term momentum indicators are trending up. Strength relative to the S&P 500 Index has turned positive.
Lumber gained $14.55 (4.95%) last week. Intermediate uptrend was confirmed on a move above $312.44. Lumber 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 is positive.
The Grain ETN added $0.68 (1.17%) last week. Intermediate downtrend was confirmed on a break below support at $57.52. Strength relative to the S&P 500 Index remains negative.
The Agriculture ETF was unchanged last week. Intermediate trend is up. Resistance is at $53.19. Units remain above their 50 and 200 day moving averages, but fell below its 20 day moving average on Friday. Short term momentum indicators are mixed. Strength relative to the S&P 500 Index remains neutral.
The yield on 10 year Treasuries increased 10.5 basis points (6.31%) last week. Intermediate trend is up. Support is at 1.599% and resistance is at 1.892%. Yield found resistance near its 200 day moving average. Short term momentum indicators are trending up.
Conversely, price of the long term Treasury ETF fell $2.23 (1.80%) last week.
The VIX Index added 0.92 (5.70%) last week. Intermediate trend changed from down to up on Friday on a break above resistance at 17.08.
Third quarter reports will dominate action in equity markets this week as they did last week. As of Friday, 116 S&P 500 companies had reported results. Earnings on a year-over-year basis were down 3.7%. Revenues were up 1.3%. Sixty companies reported higher than consensus earnings, 13% reported earnings in line with consensus and 26% reported less than consensus earnings. Responses to reports were significant in both directions. The focus this week moves from technology and financial service companies to consumer staples, industrial, materials and health care companies.
Intermediate technical indicators generally remain overbought. However, short term technical indicators (particularly Stochastics for broadly based equity indices and sectors recovered from oversold levels and recorded short term buy signals. Most broadly based equity indices and sectors with the exception of technology showed early signs of bottoming a week ago. Some had a rather severe test of their lows on Friday (e.g. Dow Jones Industrial Average). If the lows hold, the stage is set for a significant upside move between now and Inauguration Day in the third week in January. If the lows do not hold, downside risk is limited and will provide an opportunity to accumulate equities at slightly better prices.
Economic news this week generally is expected to be favourable. The focus is on the FOMC meeting. Bernanke will want to confirm that the Fed continues to provide monetary stimulus.
Macro events this week outside of North America will continue to impact equity markets. Weakness on Friday was attributed to failure of the European Union to reach a concrete agreement to resolve the sovereign debt crisis. More news on the topic is expected this week. Meanwhile, European economic data (e.g. Eurozone manufacturing PMI) is expected to show early signs of a bottom.
Cash positions held by corporations and individuals are huge and growing. Cash positions will start to be employed when the next President is determined and when the Fiscal Cliff is resolved (regardless of whom becomes President).
The Bottom Line
The entry point for the seasonal trade in North American equity markets (on Average during the past 61 years: October 28th) either was reached at the beginning of last week or will appear this week. Preferred strategy is to accumulate equities and Exchange Traded Funds with favourable seasonality at this time of year that already are showing technical signs of performing with or better than the market (i.e. S&P 500 for U.S. equity markets and TSX Composite for Canadian equity markets). Sectors include agriculture, forest products, transportation, industrials, steel consumer discretionary, China and Europe.
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Sugar Futures (SB) Seasonal Chart
The latest weekly update on ETFs in Canada to October 20th is available at
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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 October 19th 2012
Copyright © TechTalk
Monday, October 22nd, 2012
by John Hussman, Hussman Funds
For anyone who works to infer information from a broad range of evidence, one of the important aspects of the job is to think carefully about the structure of the data – what is sometimes called the “data-generating process.” Data doesn’t just drop from the sky or out of computer. It is generated by some process, and for any sort of data, it is critical to understand how that process works.
For example, one of the moments of market excitement last week was the reported jump in new housing starts for September. But later in the week, investors learned that there was a slump in existing home sales as well. If you just take those two data points as independent pieces of information, it’s not clear exactly what we should conclude about housing. But the story is clearer once we consider the process that generates that data.
One part of the process is purely statistical. The housing data that is reported each month actually uses monthly data at an annual rate, so the jump from 758,000 to 852,000 housing starts at an annual rate actually works out to a statement that “During September, in an economy of about 130 million homes, about 100 million which are single detached units, a total of 9,500 more homes were started than in August – a fluctuation that is actually in the range of month-to-month statistical noise, but does bring recent activity to a recovery high.” Now, in prior recessions, the absolute low was about 900,000 starts on an annual basis, rising toward 2 million annual starts over the course of the recovery. The historical peak occurred in 1972 near 2.5 million starts, but the period leading up to 2006 was the longest sustained increase without a major drop. In the recent recovery, housing starts bottomed at 478,000 in early 2009, so we’ve clearly seen a recovery in starts. But the present level is still so low that it has previously been observed only briefly at the troughs of prior recessions.
The second part of the process is the important to the question of what is sustainable. Here the question to ask is how and why does a decision to “start” a house occur? According to CoreLogic, about 22% of mortgages are underwater, with mortgage debt that exceeds the market value of the home. Likewise, banks have taken millions of homes into their own “real-estate owned” or REO portfolios, and have dribbled that inventory into the market at a very gradual rate. All of that means that the availability of existing homes for sale is far smaller than the actual inventory of homes that would be available if underwater homeowners were able, or banks were willing, to sell. Accordingly, much of the volume in “existing home sales” represents foreclosure sales, REO and short-sales (sales allowed by banks for less than the value of the outstanding mortgage). That constrained supply of homes available for sale is one reason why home prices have held up. At the same time, constrained supply means that new home buyers face higher prices and fewer choices for existing homes than they would if the market was actually clearing properly. Given those facts, buyers who are able to secure financing (or pay cash) often find it more desirable to build to their preference instead of buying an existing home. It’s not clear how many of these starts represent “spec” building by developers, but it’s interesting to note that the average time to sell a newly completed home has been rising, not falling, over the past year.
In the end, the data-generating process features millions of underwater homes, huge REO inventories, and yet constrained supply. The result is more stable home prices, but a misallocation of capital into new homes despite a glut of existing homes that cannot or will not be brought to market. So starts are up even though existing home sales are down. Inefficient or not, there’s no indication that inventory will be abruptly spilled into the market, so if the slow dribble continues, we’ll probably continue to see gradual growth in housing starts that competes with a gradual release of inventory. This isn’t an indication of economic resilience or housing “liftoff,” but is instead an indication of market distortion and misallocation of scarce capital. Housing starts increased off of a low base during the 1969-70 and 1981-82 recessions as well. Still, this is unlikely to materially affect the course of what we continue to believe is a new recession today.
In the financial markets, the data-generating process is often very misunderstood. Investors often seem to believe that prices go higher because money comes “into” the market like air filling a balloon. But the actual process is that every dollar that comes into the market in the hands of a buyer is a dollar that leaves a moment later in the hands of a seller. So the data-generating process is dominated not by money-flow but by subjective eagerness to own stocks. Regardless of whether stocks are highly desired or utterly loathed, every share of stock, once issued, has to be held by some investor until that share is somehow retired. Stocks can never be over-owned or under-owned.
On that subject, a number of Wall Street analysts have argued that the increasing amount of investor assets in bond funds, relative to stock funds, is an indication that stocks are under-owned and that investors are overly bearish about equities. If one believes that the data is generated by money just “flowing” into stocks versus bonds, that’s a tempting conclusion. But again, the actual data-generating process is that every share of stock has to be held by someone, as does every bond certificate. The large amount of money being held in the form of bonds says simply that a huge amount of debt has been issued by both corporations and governments, and somebody has to hold it. With yields at record lows, those bonds are being held at very high valuations with little prospective return for the risk involved. The enormous volume of debt being held at high valuations should be a red flag for bond market investors, but is it a green flag for stocks?
According to Ned Davis Research, stock market capitalization as a share of GDP is presently about 105%, versus a historical average of about 60% (and only about 50% if you exclude the bubble period since the mid-1990’s). Market cap as a fraction of GDP was about 80% before the 73-74 market plunge, and about 86% before the 1929 crash. 105% is not depressed. Presently, market cap is elevated because stocks seem reasonable as a multiple of recent earnings, but earnings themselves are at the highest share of GDP in history. Valuations are wicked once you normalize for profit margins. Given that stocks are very, very long-lived assets, it is the long-term stream of cash flows that matters most – not just next year’s earnings. Stock valuations are not depressed as a share of the economy. Rather, they are elevated because they assume that the highest profit margins in history will be sustained indefinitely (despite those profit margins being dependent on massive budget deficits – see Too Little to Lock In for the accounting relationships on this). In my view, there are red flags all around.
Ultimately, what benefits stocks is a movement from being utterly loathed to being highly desired. Once that has occurred – once stocks are overvalued, overbought, and investors are overbullish, one has to rely on the idea that even more eager investors will enter the fray, and take those shares off the hands of already speculative holders. In general, the data-generating process produces the extreme of an advance exactly at the same time that it produces the highest confidence about the continuation of the advance. It produces the extreme of a decline exactly at the same time that it produces the greatest fear about the continuation of the decline. As a result, the point that investors are most inclined to think about the market in terms of the “trend” is exactly when they should be thinking about the market in terms of the “cycle.”
Keep in mind that the bear-market portion of the market cycle typically wipes out more than half of the gains achieved during the bull-market portion. During “secular” bear market periods, the cyclical bear markets wipe out closer to 80% of the prior bull market advances. Risk-management is very forgiving of missed gains in late-stage bull markets. The lack of risk-management is equally punishing to investors who overstay.
The most recent cycle has been unique, from my perspective, because the point where one normally might accept the opportunity for an aggressive stance in post-war data (reasonable valuations coupled with a firming in various trends and technical data) was also the point where the relevance of post-war data came into question. Depression-era data became very relevant, and posed the risk of deep drawdown losses and costly whipsaws under the very same conditions. My own response was to ensure that our methods could navigate extreme market fluctuations regardless of which environment we were facing. That “two data sets” uncertainty is behind us – but the most constructive portion of the past market cycle is also behind us.
As a side note, I should emphasize that trend-following measures are an important and valuable component of the analysis of market action, but it’s important to consider a broad range of additional factors as well (breadth, leadership, overbought/oversold conditions, yield spreads, divergences, etc). It’s incorrect to believe that simple moving-average crossover methods have been wildly effective over the long-term; particularly since April 2010, which is the last time that our present methods would have indicated a favorable return/risk profile for the S&P 500. Notably, even the popular trend-following strategy of buying the S&P 500 when it is above its 200-day moving-average has had a net loss since April 2010, including dividends, and even ignoring transaction costs. Trading the 50-day moving-average broke even. The luckiest cross-over strategy turned out to be the 17-week moving-average, which would have gained about 14% since April 2010, ignoring transaction costs, but that same strategy would have historically lagged a buy-and-hold approach even before slippage, so there would have been no basis to prefer it in 2010.
At present, we have little reason to believe that the data-generating process we are observing here is anything “out-of-sample” from the standpoint of a century of historical evidence. We presently have an overvalued, overbought (intermediate-term), overbullish market featuring a variety of syndromes that have typically appeared in the “exhaustion” part of the market cycle: elevated valuation multiples on normalized earnings, emerging divergences in market internals, an increasingly tepid economic backdrop, market prices near the upper Bollinger bands at monthly and weekly resolutions, and other factors that – taken in aggregate – have historically been associated with very weak average market outcomes.
Yes, the Federal Reserve has continued its program of quantitative easing, but here, I am convinced that we understand the data-generating process by which QE has impacted stock prices – namely, by creating an ocean of zero-interest money that acts as a “hot potato,” encouraging investors to seek riskier securities until all assets are so overvalued that their prospective returns compete with zero-interest money. At that point, the zero-interest money (which has to be held by someone) is just passively held, and acts as no further stimulant to prices. QE has had its effects at points when prices have declined deeply over the prior 6-month period, and I suspect that any major future effort will work only until investors realize that this manipulation of their risk preferences is all that quantitative easing is capable of achieving. On this point, I fully agree with PIMCO’s Bill Gross, who tweeted last week “The crash on Oct 19 1987 showed that portfolio insurance puts were dangerous. R central bank ‘puts’ in the same category? Very likely.”
On the economic front, careful consideration of the data-generating process provides insight into how “surprises” can emerge in a very predictable way. For example, although short-term economic data isn’t particularly cyclical, the expectations of investors and economists typically swing too far in the direction of recent news, which in turn creates cycles in economic “surprises” because not many periods contain an utter preponderance of only-good or only-bad data. In modeling this process, the same behavior can be produced in random data. The length of the cycle appears to be proportional to the length of the “lookback” period used to determine whether the recent trend of the data is favorable or unfavorable.
Case in point, there’s a perception that the recent economic data has somehow changed the prospects for a U.S. recession. The idea is that while the data has remained generally weak, the latest reports have been better than expectations. However, it turns out that there is a fairly well-defined ebb-and-flow in “economic surprises” that typically runs over a cycle of roughly 44 weeks (which is by no means a magic number). The Citigroup Economic Surprises Index tracks the number of individual economic data points that come in above or below the consensus expectations of economists. I’ve updated a chart that I last presented in 2011, which brings that 44-week cycle up-to-date. Conspiracy theorists take note – the recent round of “surprises” follows the fairly regular pattern that we’ve observed in recent years. There’s no manipulation of the recent data that we can find – it just happens that the sine wave will reach its peak right about the week of the general election.
In short, it is not enough to examine data, even large volumes of it. In order to extract information and draw conclusions, it is crucial to think about the process that is involved in generating that data. In other words, it helps to think about the interactions between buyers and sellers, the effect of expectations and how they are formed, and – for physical and biological data – the actual systems that are operating to produce the facts and figures that are being analyzed.
If investors believe that the markets are simply balloons that increase as funds flow in and out, that stocks should be valued as a simple multiple of profits without concern for profit margins or the factors that drive those margins, that stocks are “under-owned” simply because an enormous volume of low-interest debt has been issued, that moderate growth in a distorted housing market representing a diminished fraction of economic activity will suddenly drive a robust recovery, and that central bank “puts” are a reliable defense against market losses – with no need to consider the mechanism by which those puts supposedly work – then the willingness to accept significant market risk is understandable. For my part, I am convinced that these beliefs are at odds with how the data are actually generated. The red flags are significant not only for the stock market, but for the bond market (particularly credit-sensitive debt) and the economy as well.
A final note regarding Europe. Last week’s 2-day EU summit had two results. First, Angela Merkel insisted that the European Stability Mechanism (ESM) should be used only for future banking crises, not to bail out past banking debts. Second, Merkel said that Germany would not support transfer payments to indebted countries without strict conditionality, refusing to consent to the more generous and less conditional proposals from France. In Merkel’s words, “As long as there are individual national budgets, I regard the assumption of joint liability as inappropriate, and from our point of view, this isn’t up for debate. The Spanish government will be liable for paying back the loans to recapitalize its banks.”
That effectively short-circuits June’s vague plan-for-a-plan to use the ESM to “break the link between the banks and the sovereigns.” Efforts to create a single bank supervisor for Europe were pushed off until the end of next year, and Merkel added the further stipulation that “When we have a bank supervisor and want a direct recapitalization, then one must naturally have a resolution fund for the banks that has contributions from banks.”
The upshot is that despite endless hopes to the contrary, Germany continues along the principle that “liability and control belong together,” and that there will be no open-ended bailouts funded by the German public, or through open-ended money creation, which even Draghi has said must be conditional despite his “believe me, it will be enough” rhetoric. To use Merkel’s phrase, which was recently misinterpreted as an endorsement of ECB money-printing, the insistence on strict conditionality is “completely in line with what Germany has said all along.”
We should not be at all surprised if the bids drop away from Spanish and Italian bonds in the weeks ahead. In my view, those bids were based on a misinterpretation of ECB policy and an overestimation of the prospect for large and unconditional bailouts. The reality is likely to be far more challenging.
The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.
As of last week, our estimates of prospective return/risk for stocks remained strongly unfavorable, holding us to a defensive stance. Strategic Growth Fund remains fully hedged, with a “staggered strike” position that places the strike prices of many of its index put options at a level that is now just a few percent below present market levels. We’re observing more internal turbulence in market action here, with many individual stocks experiencing steep losses on even modest earnings disappointments. Skittishness about earnings prospects can lead to indiscriminate selling, particularly in richly valued markets, but we would expect that staggered strike to provide a reasonable defense against that risk in the event the market declines by more than a few percent. Strategic International is also fully hedged here. Strategic Dividend Value is hedged at about 50% of the value of its stock holdings – its most defensive investment stance. Strategic Total Return continues to carry a duration of less than 2 years, meaning that a 100 basis point change in interest rates would be expected to impact the Fund by less than 2% on the basis of bond price fluctuations. The Fund also holds less than 5% of assets in precious metals shares.
Needless to say, these are very defensive positions for us, and reflect what we see as very weak prospective returns per unit of risk in stocks and bonds, and only a modest return/risk profile even in precious metals. This undesirable investment menu has emerged as the intentional result of repeated bouts of quantitative easing that have distorted asset prices and prospective returns. I strongly believe that more favorable return/risk prospects will emerge over the course of the coming market cycle, and that locking in elevated, distorted prices and depressed yields in the belief that “the Fed has our back” is a speculative mistake, a misguided superstition, and an analytical error. To embrace present market and economic data at face value – without recognizing that generating this data relies on enormous monetary distortions and government deficits – is like believing that you’re Louis XIV just because you’ve built a massive cardboard Palace of Versailles in your front yard.
Copyright © Hussman Funds