Axel Merk: U.S. Dollar and Euro – Review and Outlook

Thursday, May 31st, 2012

by Axel Merk, Merk Funds

May 30, 2012

The analysis below is based on our letter to shareholders in the annual report of the Merk Funds*.

The 12-month period ended March 31, 2012 (the “Period”) could be described as one of contrasting halves. The first half of the Period was marked by increased pessimism and concern regarding Europe, particularly the periphery nations. In contrast, market sentiment was more optimistic through the second six-months of the Period, and markets exhibited significant strength. During the first six-months ending September 30, 2011, the market – as measured by the S&P 500 Index – returned -13.78%, while the market returned 25.89% during the second six-months ending March 31, 3012.

News emanating from Europe dominated market gyrations for the majority of the Period. Specifically, the periphery nation sovereign debt crisis and concerns surrounding its global contagion effects – particularly on countries previously considered immune to the fallout, like China – held the market’s attention. Concerns appeared more acute through the first half of the Period, where we witnessed heightened levels of market volatility and general selling of perceived risky assets. The VIX index – widely followed as a bellwether for market volatility – reached a high of 48 in August 2011, as concerns mounted regarding the Greek debt situation and focus shifted to the larger European countries, particularly Italy and Spain, where political upheaval only muddied the waters. Policy makers on this side of the Atlantic compounded the problem, with Washington leaving the decision to raise the U.S. Government’s debt ceiling to the last minute causing further market distress.

During the second half of the Period, the market appeared to ascribe a more optimistic assessment to the European situation and the global economy. Particularly in the U.S., we saw the release of many economic data points that beat consensus expectations, including notable improvements to the unemployment rate. European policy makers also appeared to alleviate the market’s concerns regarding Italy and Spain, where austerity measures were finally agreed to and put in place, while much needed clarity was provided surrounding the Greek situation when bondholders agreed to participate in a debt swap. At the same time, we witnessed a number of central banks following much easier policies through the second half of the Period. The U.S. Federal Reserve (Fed) became evermore dovish in its rhetoric regarding easing measures and extended the calendar date that low rates are anticipated to be kept in effect, moving it out to the end of 2014 from mid-2013 previously. The Bank of England expanded its quantitative easing program by £50 billion pounds and the Bank of Japan also increased its expansionary asset purchases by ¥10 trillion and concurrently set an inflation target. Additionally, the ECB expanded its balance sheet via two long-term refinancing operations (LTRO’s), together totaling over €1 trillion. All of which helped alleviate market concerns and underpinned significant strength in equity markets, as indicated above, and a substantial reduction in the VIX index, which fell to a low below 14 in March of 2012.

Going forward, we consider that central banks around the world are likely to err on the side of further monetary policy easing. Our analysis finds that the composition of voting members on the Fed’s Federal Open Market Committee (FOMC) is more dovish in 2012 compared to 2011 and is set to become even more dovish in 2013¹. We therefore consider it very likely that rates will be kept low for an extended period of time in the U.S. and, should economic fundamentals deteriorate, further easing policies may be put in place. Elsewhere, the Bank of Japan appears committed to generating inflation via easing policies, while the Bank of England appears to be more concerned about deflation despite the existence of what we deem to be elevated inflationary pressures (as measured by the consumer price index). We consider it likely that the Bank of England announces further stimulus measures should economic growth in the United Kingdom disappoint. At the same time, there is renewed pressure on the ECB to purchase periphery nation debt to stave off further fiscal deterioration in the region. While ECB President Draghi appears committed to provide the banking system with unlimited levels of liquidity (through the two three-year LTRO facilities), pressure is mounting to intervene directly through the Securities Market Program (SMP) and buy the likes of Spanish debt. Notwithstanding, the ECB is likely to do everything in its power to stop the financial industry from collapsing, which may mean further liquidity provisions, such as the LTRO’s already seen.

All of which should serve to underpin those currencies most correlated with the outlook for economic growth and of countries set to benefit from increases in the price of commodities and precious metals. We believe as central banks continue to follow expansionary, inflationary policies, that those assets exhibiting the greatest monetary sensitivity should benefit – such as commodities, natural resources and precious metals. As such, we favor the currencies of commodity producing nations, such as Australia, Canada and New Zealand. In particular, we do not consider that China will experience too severe a slowdown in economic growth – the recent announcement to expand the trading band of its currency should be seen as a signal that policy makers there believe the risks to the economy have satisfactorily abated. We think Australia and New Zealand are well situated to benefit from ongoing Asian economic strength, while both countries’ fiscal positions are in stark contrast to the U.S. and Europe, for all the right reasons. Canada, too, should benefit from ongoing commodity price appreciation, and is well placed should the U.S. economy continue to pick up steam ahead of consensus forecasts.

In Asia, we continue to favor the currencies of nations who are producing more value-added goods and services while concurrently focusing on the development of the domestic economy as a source of long-term sustainable economic growth. China in particular checks these boxes. We consider building inflationary pressures brought about by increases in global commodities and a tightly managed currency, may ultimately force the Chinese into allowing the currency to float more freely². While there have been recent hiccups regarding China’s upcoming leadership transition, the ultimate goal of the Communist Party remains intact: to maintain social stability, so as to remain in power. We believe there are several aspects to this notion, none the least being the support of strong, sustainable economic growth and the containment of inflationary pressures. Regarding the latter: should inflation get out of hand, the risk of social upheaval may become elevated. China’s close management of the dissemination of any news discussing the “Arab Spring” uprisings is indicative of the strength of its resolve in maintaining social stability. One of the contributing factors causing the “Arab Spring” was runaway inflation.

In China and other Asian nations, allowing the respective currencies to float more freely may act as a natural valve in alleviating the inflationary pressures being experienced. Moreover, we consider China and countries such as Malaysia, Singapore, South Korea and Taiwan to have the pricing power to allow their currencies to appreciate. These countries now produce relatively higher value-add goods and services compared to other Asian nations; therefore we believe they have the ability to pass on price pressures to the end consumer – Western consumers. With a concurrent focus on the development of their domestic economies, we believe Asian nations will eventually be less reliant on exports to the West, with a renewed focus on domestic demand, as well as demand within Asia, as a source of future growth. The result may be stronger Asian currencies over the medium to long-term, while western nations may experience increases in import prices going forward.

Regarding the U.S. dollar, we consider the more dovish FOMC voting member composition to be a negative for the currency, as it will likely lead to more expansionary policies relative to global central bank counterparts. In our view, the aforementioned debt ceiling debacle is just one increment in the ongoing marginal deterioration of the U.S.’s safe haven status; concurrent degradation to the long-term sustainability of the U.S.’s fiscal situation may ultimately erode confidence that the U.S. will honor its future obligations. Importantly, we do not doubt these obligations will be fulfilled, but the manner in which they are likely to be fulfilled gives us grave cause for concern. In our assessment, future obligations are unlikely to be met through much needed austerity measures, either from spending cuts or revenue increases, as neither side of the political aisle has shown a willingness to comprehensively and satisfactorily address the issues. Rather, future obligations are likely to be met through the path of least resistance: inflation. Said another way, devaluation of the currency.

We continue to believe the currency asset class may provide investors with the opportunity to access enhanced risk-adjusted returns and valuable diversification benefits. We are excited about the outlook for the asset class and believe many investment opportunities continue to exist in the space.

Please make sure to sign up to our newsletter to be informed as we discuss global dynamics and their impact on currencies. Please also register for our upcoming Webinar on June 13 where we will discuss the investment strategy and objectives of the Merk Absolute Return Currency Fund. We manage the Merk Funds, including the Merk Hard Currency Fund. To learn more about the Funds, please visit www.merkfunds.com.

Axel Merk

Manager of the Merk Hard Currency Fund, Asian Currency Fund, Absolute Return Currency Fund, and Currency Enhanced U.S. Equity Fund, www.merkfunds.com

Tags: Bellwether, Contagion Effects, Debt Ceiling, Debt Crisis, Debt Situation, Economic Data, ETF, ETFs, European Situation, Global Contagion, Global Economy, India, Letter To Shareholders, Market Gyrations, Market Sentiment, Market Volatility, Merk, Optimistic Assessment, Periphery, Pessimism, Political Upheaval, Risky Assets, Sovereign Debt, Vix Index
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Dr. Copper, the Economics Ph.D.

Wednesday, April 18th, 2012

It is often stated that copper is the metal with a Ph.D. in economics, and the data for the most part bears this out.

Figure 1 is a monthly chart of copper (cash data) with NBER dated recessions noted by the indicator in the lower panel.  With the indicator in the down position, the US economy is in recession; when the indicator is up, the US economy is expanding.  As can be appreciated, copper does better during economic expansions.  The metal typically peaks during recessions before heading into a down trend (see vertical gray bars).

Figure 1. Copper v. NBER recessions/ monthly

Presently, copper is under performing the broader market, and as we can see from the weekly chart (see figure 2, cash data), copper gap below its 40 week moving average last week, and it is making a lower high.  The weakness in copper should be respected, but there is more to the story.

Figure 2. Copper/ weekly

The next graph (figure 3) is a weekly chart of copper (cash data).  In the lower panel, is the “Bullish Consensus” data  for copper from MarketVane.  According to the MarketVane website, “the Bullish Consensus measures the futures market sentiment each day by following the trading recommendations of leading Commodity Trading Advisors.”  Many investors view the MarketVane data (and sentiment data in general) as helpful in identifying market turning points.  For the most part, this is true as we have seen many times how too many investors on one side of a trade often leads to a strong reaction in the opposite direction.  But sentient data also has other uses that few rarely speak of, and this has to do with trend following.  In essence, as prices of an asset rise so does the degree of bullishness, and as prices fall, investors become more bearish.  So what good is following investor sentiment if it just tracks price?  My research shows that investor sentiment leads price by about a week or two, so investor sentiment is a good tool at identifying changes in a trend that do not occur at the extremes.  Let me give some examples.

Figure 3. Copper v. MarketVane Bullish Consensus/ weekly

Figure 4 shows how investor sentiment leads price.  Once again, this is a weekly chart of copper (cash data) with the Bullish Consensus for copper in the lower panel.  The black dots represent swing pivot points.  Now if we look at the current Bullish Consensus value and compare this value to past swing pivot points, we can make the statement that a close below three swing pivot points is bearish.  As you can see, this was the the case in 2006 and in 2008.  (This also happens to be the case across time and other asset classes.)  When the Bullish Consensus value closed below 3 prior swing pivot points, copper dropped rather precipitously.  (As an aside, I am drawing upon my research with pivot points, and I have previously presented similar findings in a SP500 trend following strategy; click HERE to go to that article.)  So a close below 3 pivot points is generally bearish, and since sentiment tracks price and as sentiment often precedes price in time, this is an ominous sign.

Figure 4. Copper/ weekly

Now let’s move our chart forward in time and look at the past 2 years.  See figure 5.  At point #1, the Bullish Consensus value closed below 3 swing pivot points.  Rather than sell off, this marked the low point for copper before it reversed strongly higher.  8 weeks later, Federal Reserve Chairman Bernanke mentioned QE2 at his speech at Jackson Hole.  At point #2, this breakdown nearly marked the high point for copper back in April, 2011.  Point #3 was the break down back in September, 2011.  Rather than lead to a break down in price, this also marked a bottom.  This also happened to coincide with the Federal Reserve’s Operation Twist and with the European Central Bank’s LTRO.  Lastly, turn your attention to the “?????”.  The Bullish Consensus has closed below 3 swing pivot points.  While this normally would be interpreted bearishly, one could easily speculate, based upon the recent past, that central bank intervention is imminent.

Figure 5. Copper/ weekly

So what have we learned from Dr. Copper today?

One.  Copper generally peaks during recessions.

Two.  Copper is currently putting in a lower high and is trading below its 40 week moving average; copper peaked over 1 year ago.

Three.  Investor sentiment not only tracks price but it often precedes it by a couple of weeks.  The current price structure for the Bullish Consensus is bearish.

Four.  Recent bearish patterns in the price structure of the Bullish Consensus have been bullish owing to central bank intervention.  In essence, central banks have prevented a recession from unfolding.

Five.  It should noted that each central bank intervention has provided less and less benefit to the markets.  When looking at copper, we see that Operation Twist did not produce gains that were seen during QE2.  It’s as though the markets have become resistant to the effects of monetary stimulation.

Lastly and most importantly.  What’s next for copper and the markets?  The breakdown in the price structure of the Bullish Consensus for copper strongly suggests lower prices for copper, which in all likelihood implies a recession.  Central bankers have been timely in their implementation of recent quantitative easing, and we could easily make the case that their interventions have thwarted the onset of a recession on more than one occasion.  Copper will need to reverse from the current levels and investors will need to embrace that risk.  This will be heralded by a reversal in the Bullish Consensus.  Will central bankers be able to save the day again?

Tags: Bullish Consensus, Commodity Trading Advisors, Copper Gap, Copper Metal, Down Position, Down Trend, Economic Expansions, Figure 3, Futures Market, Gap, Gray Bars, Investor Sentiment, Market Sentiment, Market Turning Points, Marketvane, Nber, Recession, Recessions, Sentiment Data, Strong Reaction
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The Hazard of Second Best

Monday, April 2nd, 2012

by Mohamed El-Erian, PIMCO, via Project Syndicate

NEWPORT BEACH – The international community risks settling for second best on two key issues to be discussed this month at global meetings in Washington, DC: the lingering (if currently somewhat dormant) European debt crisis, and the selection of the World Bank’s next president. It is not too late to change course, but doing so will require the United States and governments in Europe to resist harmful habits, and emerging countries to follow up effectively on recent initiatives. In the last few days, European leaders, including French President Nicolas Sarkozy and European Central Bank President Mario Draghi, have declared that the worst of the eurozone crisis is over. Others, like French Finance Minister Francois Baroin, have gone even further, claiming that Europe “has done its part,” and that it is now up to other countries to do theirs.

These announcements should come as no surprise. Having experienced prolonged turmoil, the eurozone is currently in a period of relative tranquility. The courageous reform measures implemented by Mario Monti, Italy’s technocratic prime minister, have eased immediate concerns that Greek dislocations might tip other European countries – much bigger and harder to rescue – into insolvency. Europe’s decision last week to bolster its internal financial firewalls has reinforced the resulting positive impact on market sentiment. But, as important as these steps are, the recent tranquility has been more borrowed than earned. Since December, the ECB has twice deployed long-term refinancing operations, which provide unlimited three-year financing to banks at 1% interest. This has given the banking system more time to increase capital and improve asset quality. It has also reduced several governments’ financing costs. What it does not do, and is not meant to do, is resolve Europe’s twin problems of too little growth and too much debt.

If it is not careful, Europe risks falling into the trap of trying to shift responsibility for its problems onto others, rather than building on recent progress. That temptation is partly reflected in efforts to press officials from around the world to agree this month to a major increase in the International Monetary Fund’s resources, with emerging economies footing a significant part of the bill. In pivoting from internal to externally-financed firewalls, Europe is pushing a political agenda that is not yet warranted by economic and financial realities. Europeans are about to embark on another round of elections, in both core and peripheral EU countries, as well as a referendum in Ireland. Recent history suggests that these votes are unlikely to favor ruling parties unless they can signal some progress in resolving the crisis.

Read Complete Article

Copyright © Project Syndicate

Illustration by Paul Lachine

Tags: Asset Quality, Bank President, Debt Crisis, Europe Risks, European Leaders, French Finance Minister, French President Nicolas, French President Nicolas Sarkozy, Global Meetings, Harmful Habits, Mario Monti, Market Sentiment, Mohamed El Erian, Newport Beach, Nicolas Sarkozy, PIMCO, President Nicolas Sarkozy, Project Syndicate, Reform Measures, Relative Tranquility
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The Demise of Risk-on / Risk-off and the Emergence of Heteroscedasticity

Wednesday, March 28th, 2012

by Jason Doiron
FRM, PRM, SVP – Head of Fixed Income & Derivatives
Sentinel Asset Management, Inc.

I estimate that I inadvertently watch 12 hours of financial news programming per day. Too much television? perhaps, but for a portfolio manager it has become an occupational necessity. One of the greatest benefits to watching this much television is that I can recite verbatim every commercial that plays on CNBC with no clue which company is sponsoring the ad – pig on a skateboard anyone? The other benefit is that I am provided with a front row seat to a rogues gallery of pundits who describe the complexities of the financial markets through sound bites.

After a close contest with “kick the can down the road” and “tail risk,” the undisputed champion of sound bites since 2008 has been “risk-on / risk-off.” Both terms accurately describe the market sentiment for certain periods over the past 3.5 years. But as with all good sound bites, the useful life span of these terms is quickly coming to an end. Before we bid farewell to these terms, let me explain my reasoning for predicting the demise of risk-on / risk-off.

1) Irrelevance:
No other term more accurately described the market sentiment in 4Q08 and 1Q09 than risk-off. During the summer of 2011, the term risk-off accurately described the sentiment in certain sectors of the fixed income market such as CMBS. But the term risk-off does not accurately describe a 2 point sell-off in the SPX [1] on a Thursday afternoon before a 3 day weekend in July. That is simply called a pull back.

2) Professional:
I can assure you that the terms risk-on and risk-off did not originate from anyone in the risk management profession. Risk management professionals do not reduce an opportunity set down to a binary outcome such as on/off. If a true risk management professional were trying to describe the risk on/off phenomenon, they would use a term like homoscedasticity.

3) Fundamentals:
The demise of the term risk-on / risk-off should be a welcomed event by investors. Over the past three years, the only question that investors have needed to get right is risk-on or risk-off. Investing became a binary outcome where the instruments that you utilized to express either of these views mattered little as long as you got the on / off call correct. This seems easy enough but in a homoscedastic world, the benefits of diversification will prove to be futile in your fight against the risk on / off mentality.

We are starting to see an investment landscape where fundamentals matter again. A landscape where securities derive their value from the fundamental underpinnings rather than from a headline on failed votes regarding debt ceiling limits or sovereign default write-downs. The pundits will need a new sound bite to succinctly describe this landscape so I offer up. Heteroscedasticity!

Sources: Sentinel Asset Management

[1] The Standard & Poor’s 500 Index is an unmanaged index of 500 widely held U.S. equity securities chosen for market size, liquidity, and industry group representation.

Copyright © Sentinel Asset Management, Inc.

Tags: Asset Management Inc, Binary Outcome, Cmbs, Cnbc, Complexities, Doiron, Fixed Income Market, Frm, Life Span, Market Sentiment, Portfolio Manager, Risk Management Profession, Risk Management Professional, Risk Management Professionals, Rogues Gallery, Row Seat, Sound Bites, Spx, Thursday Afternoon, Undisputed Champion
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Investor Sentiment: It Cuts Both Ways

Wednesday, December 28th, 2011

The article below is a guest contribution by Guy Lerner, writer of the Technical Take blog.

Most market participants use investor sentiment as a contrary tool. Gauge which direction the majority of investors are leaning and bet against them. But there are times when it doesn’t pay to bet against the herd. There are times when too many bulls is a good thing as in “it takes bulls to make a bull market”. So here we have the SP500 closing above the much watched 40 week moving average, and I am sure many an investor is trying to gauge the significance of such a milestone in this seasonally positive time of year when trading volumes have shrunk. So this technical event must mean something?

Yes, it means that the SP500 has now been above the 40 week moving average only twice in the past 20 weeks. Does it mean that the market is on the cusp of an explosive move higher? If the market is, don’t tell investors because they haven’t gotten the message yet. And that is really the trouble with this market – there are neither bears or bulls out there. If the market is really going to move higher in a meaningful way, I would think that we would begin to see the “it takes bulls to make a bull market” scenario (i.e, too many bulls) unfold as prices move higher. This is how new trends start, but instead we are just seeing ehhh.

So if this price move is for real and if the pending recession (see here) is going to be thwarted, then I would expect to see buyers. Sentiment cuts both ways sometimes; having a lot of bulls could be a good thing. For now, I remain bearish, and I gave my reasons nearly 4 weeks ago. Despite the passing of time and the expected holiday rally, little has happened to change that opinion.

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator shows neutral sentiment.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “As of 12/21/11 – Sentiment moved from a Sell Bias to Neutral as buyers outnumbered sellers – albeit by the slimmest of margins – for the first time in three weeks. The main sentiment driver was a decrease in selling, as the number of sellers fell nearly -23% week-over-week versus a 7% increase in the number of buyers. The Consumer Discretionary and Energy sectors showed the greatest improvement in sentiment, with a drop in selling again being the main cause. There continues to be a fair amount of actionable buying and actionable selling and with no sector showing a particularly strong signal in either direction we find company-level activity most compelling.”

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 58.72%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

Let me also remind readers that we are offering a one-month free trial to our Daily Sentiment Report, which focuses on daily market sentiment and the Rydex asset data. This is excellent data based upon real assets and not opinions.

Source: Guy Lerner, Technical Take, December 25, 2011.

Tags: Bulls, Cusp, Dumb Money, Explosive Move, Extremes, Figure 1, Guy Lerner, Individual Investor, Investor Sentiment, Market 1, Market Participants, Market Scenario, Market Sentiment, Marketvane, Moving Average, New Trends, Passing Of Time, Price Move, Recession, Time Of Year
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A Test of Fortitude & Discipline: 2011 in Review

Friday, December 23rd, 2011

Monthly Strategy Report December 2011

by Alfred Lee, CFA, DMS, Vice President & Investment Strategist,
BMO ETFs & Global Structured Investments
BMO Asset Management Inc., alfred.lee(@)bmo.com

Just when you thought financial markets couldn’t get any more extreme, they suddenly prove otherwise. Such was the theme over the course of 2011, a year where market volatility caused constant changes in sentiment and significantly frustrated many investors. Global equities fell 6.5% on the year, as indicated by the MSCI World Index (Total Return), which should actually be viewed as a positive given the macro-economic backdrop.

As the year progressed, the market was hit with an increasing number of negative headlines including: the unfortunate Japanese earthquake/tsunami; the downgrade of U.S. Treasuries by Standard & Poor’s; deteriorating sovereign debt issues in Europe; and growing concerns of a hard landing in China. As a result, most of the gains experienced in broad market equity indices during the first quarter of the year rapidly reversed course as sentiment became increasingly bearish from these news items during the last six months of the year. Moreover, since August, both realized and implied volatility have remained elevated, providing a serious test of discipline for investors.

We started the year with a more bullish tone as markets continued to enjoy the effects of “QE2” (the second instalment of quantitative easing by the U.S. Federal Reserve). However, as the year progressed and market sentiment soured, our Global Inter-Market Model showed developing trends in defensive-oriented assets. Consequently, and also considering the worsening macro-economic data, we issued a report on August 15, titled “Navigating Market Volatility” where we recommended a more defensiveoriented portfolio strategy. Given the rapidly changing market environment, our recommendations in 2011 were significantly more tactical than the previous year. Below, we highlight some of the recommended themes throughout the year.

Asset Allocation Themes:

1) “Overweight Equities Relative to Bonds:”

This asset allocation decision fared extremely well during the first quarter with the S&P/TSX Composite Index to DEX Universe ratio expanding until April 8, as Canadian equities outperformed bonds. Though we remained optimistic on equities through June, as the summer progressed, both macro-economic data and technical indicators suggested a greater emphasis to fixed income. We therefore recommended an overweighting in bonds in our previously mentioned August 15 report. That tactical shift to fixed income has served us well as our BMO Aggregate Bond Index ETF (ZAG) has gained 3.5% on a total return basis since that report, while the S&P/TSX Composite Index returned -6.7% on a total return basis from the same period. That tactical shift led to a difference of 10.2% in performance.

2) “Be Prepared for Sudden Upside Volatility:”

At the beginning of the year and a theme highlighted throughout 2011 was to prepare for constant shocks in volatility or what we noted as “volatility-squared,” as markets were becoming more behaviourally driven and increasingly reactive to negative headlines.

Tags: Alfred Lee, Asset Management Inc, BMO, Broad Market, Debt Issues, Economic Backdrop, Global Equities, Investment Strategist, Japanese Earthquake, Market Environment, Market Equity, Market Model, Market Sentiment, Market Volatility, Msci World Index, Negative Headlines, Portfolio Strategy, Sovereign Debt, Strategy Report, Structured Investments
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Contrarian Perspective to Market Sentiment Fear (Matt Lloyd)

Friday, December 2nd, 2011

We have long taken the contrarian perspective to the fear that dominates market sentiments.  Over night we have now seen the recognition that Europe is unable to fully solve this on their own and needed mediation in the form of a Federal Reserve lowering of the overnight swap rates to release the pressure cooker on European liquidity.  Though we have witnessed many interventions this year, this one is pronounced in what it says in a very subtle manner….if you could ever call an intervention like this as subtle.

• The move to lower swap rates for dollar rates basically pushes the valve on the pressure cooker that had seen increasing levels of anxiety push the pressure on nearly all aspects of the European economy.  By easing the rates with on dollars for loans to European banks, the Federal Reserve has come to the aid of a family member that has fallen on tough times.  This action also coincided with the European Central Banks move to increase funding to banks to its highest level in 2 years.
• Prior to this move, foreign bank deposits at the Federal Reserve had risen 104% to $715 billion.  This number will only swell which continues two important trends, one short and one long.  The short-term trend has now seen the Federal Reserve take over as the World’s Banker which had been held by Japan, China and Europe at some time over the last decade.  The longer-term trend is to see the U.S. dollar continue its depreciation but affirms its reserve status of the world’s economy.  Even in light of a credit downgrade, near 10% budget deficits and benign growth, when the world hits the panic button, it flocks to the dollar.
• Politically speaking, the Federal Reserves action coincides with President Obama’s call for a solution to the European situation in an accelerated manner.  It also opens up for more criticism from the masses who may not quite understand the symbioticness of the global economy and those who are seeking office next year.
• China also responded with a lowering of the amount of cash that needed as reserves by banks to the lowest level in three years.  Though it is lowered from its high of 21.5% to 21%, the size of the move is far less important than the trend of the move.

As such, the amount and number of participants involved in this move have caused a sense of relief in the markets which has seen several European equity markets surge over 4% for the day.  The opening of the domestic equity markets are following suit.

This move is also coinciding with continued strength in many economic statistics that we have noted over the last several weeks.  ADP employment change saw a surge of 206,000 jobs when the expectation was for 130,000.  Last months number was revised upward from 110,000 to 130,000.  There haven’t been many times when a large current number coincides with a revision upward of last month’s number.  Home sales also surprised on the upside coming in up 10.4% last month, which only affirms the ‘chutes-and-ladders’ metrics that dominates the housing market.

All the moves today affirm to us the tremendous potential opportunity in various asset classes.  Both Value and Growth investors should be fairly intrigued by the metrics of the S&P 500.  Cash flow on the S&P 500 stands at $169 per share, or 7 times, which is drastically below the average of 12 times normally seen over the last 15 years.  Book value multiple on the S&P 500 stands at 1.93 where the 10-year average has been 2.51 times.  For growth investors, earnings have come in strong once again and leave the index trading at a 12.60 multiple while the trailing 12-month average over the last 15 years has been over 16 times.

Though the move upward may not be a linear straight shot upwards, the disconnect between market fundamentals and the perception of their meaning has continued to create an opportunity that we have not seen in a very long time.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

Copyright © AAM

Tags: Bank Deposits, Benign Growth, Budget Deficits, Dollar Rates, European Banks, European Central Banks, European Economy, European Situation, Federal Reserves, Global Economy, Japan China, Last Decade, Levels Of Anxiety, Market Sentiment, Market Sentiments, Panic Button, Pressure Cooker, Subtle Manner, Swap Rates, Term Trend
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Investor Sentiment: Looking ahead (Lerner)

Monday, November 28th, 2011

The article below is a guest contribution by Guy Lerner, writer of the Technical Take blog.

The best way to get more investors to turn more bearish in their outlook is to have lower prices. The sentiment indicators are nowhere near the kinds of extremes seen at market bottoms, so it would be my expectation that we will see lower prices as market bottoms tend to coincide with bearish extremes in the sentiment indicators. If I were to guess, those extremes in bearish sentiment (i.e., bull signal) will likely be seen as prices approach the August, 2011 lows. Let’s call that level SP500 ~ 1100. Looking ahead, this area of support (i.e., prior buying area) will be our battleground.

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator shows neutral sentiment.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Market-wide sentiment improved, pushing further into neutral territory and away from bearish territory, as the number of buyers increased 72% week-over-week and the number of sellers fell -10% over the same period. Sentiment is very mixed overall, with a high number of positive and negative Unusual Events.”

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 58.93%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

Let me also remind readers that we are offering a one-month free trial to our Daily Sentiment Report, which focuses on daily market sentiment and the Rydex asset data. This is excellent data based upon real assets and not opinions.

Source: Guy Lerner, Technical Take, November 27, 2011.

Tags: American Association Of Individual Investors, Battleground, Bearish Sentiment, Dumb Money, Equity Funds, Extremes, Figure 1, Figure 3, Guy Lerner, Investor Sentiment, Lows, Market 1, Market Bottoms, Market Sentiment, Marketvane, Neutral Territory, Panel Measures, Put Call Ratio, S&P500, Sentiment Indicators
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Guest Post: Forget Gold—What Matters Is Copper

Saturday, September 24th, 2011

Forget Gold—What Matters Is Copper

Guest contribution by Gonzalo Lira

People are freaking out that gold has fallen to $1,650, from its lofty highs above $1,800—they are freaking out something awful. “Gold has fallen 10%! The world is coming to an end!!!” I myself took a shellacking in gold—

—but copper is what has me worried.

Copper fell from $4.20 to $3.25—close to 25%—in about three weeks. Most of that tumble has happened in the last ten days, and what’s worrisome is that, as I write these words over the weekend, there is every indication that copper will continue its free fall come Monday.

From the numbers that I’m seeing—and from the historical fact that copper tends to fall roughly 40% from peak to trough during an American recession—there is every indication that copper could reach $2.67 in short order. And even bottom out below that—say at $2.20—before stabilizing around the $2.67 level.

But we’ll see. The price of copper is not the point of this discussion. The point of this discussion is what the price of copper means.

What it means for monetary policy.

We all know the old saying: “Copper is the only commodity with a Ph.D. in economics”, or words to the effect.

The ongoing price collapse of copper signals that the markets have collectively decided that there is going to be no resurgence of the global economies—at least not for the next 9 to 18 months. Up until now, the economic data that has been coming out over the last couple of weeks seemed to indicate that there’s going to be a double-dip—but in my mind, this fall in the price of copper confirms this notion that the general economy is going down.

And remember: Market sentiment can not only be a predictor of future economic performance, but its determinant. If today the markets feel that the economy is going to suck tomorrow, often that very sentiment is what makes the economy suck canal water.

So if copper is falling like a mo-fo—which both signals and convinces the market that the economy is gonna suck—what does this mean for monetary policy?

Prima facie, the fall in the price of copper is deflationary: Less demand means that the prices fall—meaning the dollar acquires purchasing power.

What does it mean for monetary policy that copper has fallen so low?

It means that Bernanke will carry out more “non-traditional” Federal Reserve stimulus.

Ben Bernanke is famous for being terrified of deflation—and to his particular mindset, this is a reasonable fear. More to the point, Bernanke’s deflation-phobia actually matters—because after all, he is the Chairman of the Federal Reserve. He controls U.S. monetary policy.

Deflation is supposed to be bad because it shrinks an economy. (Personally, I am more afraid of inflation than deflation: The latter is self-correcting, while the former spirals out of control and into social chaos. But that’s for some other post.)

According to the deflationary world view, falling prices oblige producers to cut back on production—which means firing workers. These fired workers—husbanding their resources during their unemployment—spend less, further contracting demand, thus putting more downward pressure on prices, forcing more producers to cut back and fire even more workers, who thus spend less—

—you get the picture: A “deflationary death spiral”, in the Deflationistas’ parlance.

This is Bernanke’s fear—and he will do anything to alleviate it. Notice: It’s not that Bernanke will do anything to alleviate deflation—he will do anything to alleviate his fear of deflation.

As copper prices continue to tumble, signaling further economic contraction, there is no question in my mind that Ben Bernanke and his Fools of the Fed will view this as evidence of looming dollar deflation.

They will do everything to stop this looming deflation. But since the “traditional” Federal Reserve tools have been used up—that is, the Fed has its rate at zero, and for all intents and purposes all of its liquidity windows open—Bernanke will have no choice but to announce some new “non-traditional” liquidity injection scheme shortly.

Thus I expect some Banana Republic money-printing scheme to be announced by the Bernankster before the end of the year—perhaps as early as this coming October. The fall in the price of copper—more than anything else—is what Benny and his Fools will be looking at, to justify this new scheme.

And my bet is, this scheme they announce will be as big—and as controversial—as QE-II.

I am giving my people at The Strategic Planning Group a detailed analysis of what has happened over the past week, and what we can expect to happen in the markets over the coming weeks. You’ll have to pay to play for that.

But insofar as my overall view of the situation is concerned, this is what I think:

Bernanke will drive a schoolbus over small children, in order to prevent his notion of deflation from coming true. This fall in the price of copper is much more relevant to his course of action as Fed Chairman than the fall in the price of gold (which was just a combination of options expiration coming up, and gold positions being sold to cover losses in other asset classes).

This dramatic fall in the price of copper signals that the markets do not believe reactivation is anywhere near eminent—not for at least 9 to 18 months.

To the traditional twin Federal Reserve mandates of price stability and full employment, Bernanke has added a third mission: That of “growing the economy”—whatever it takes, however unorthodox or reckless the measures.

Therefore, it is my estimation that very soon now—end of this year at the latest—we will have QE-infinity—and beyond!

If you’re interested in SPG, check out a preview here.

Tags: Canal Water, Collapse, Commodity, Determinant, Double Dip, Economic Data, Economic Performance, Global Economies, Gold, Lira, Market Sentiment, Mo Fo, Monetary Policy, Notion, Price Copper, Price Of Copper, Recession, Resurgence, Shellacking, Signals, Trough
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Energy and Natural Resources Market Cheat Sheet (September 26, 2011)

Saturday, September 24th, 2011

Energy and Natural Resources Market Cheat Sheet (September 26, 2011)

Strengths

• The latest South Korean oil demand numbers released this week show the second straight month of year-over-year growth, following a weak second quarter. In August, Korean inland deliveries totaled 2.172 million barrels per day. In the year-to-date, South Korean demand growth has thus crept into positive territory, with the third quarter-to-date demand higher year-over-year by 4 percent.
• The American Institute of Architect’s Architecture Billings Index rebounded sharply in August to 51.4, shooting back above 50 (which indicates growth) for the first time since February.
• Despite a vicious bout of selling of stocks and commodities this week, the Global Resources Fund performed relatively compared to many of its peers over the past week as the fund management team has taken a more defensive position in the portfolio since early August.

Weaknesses

• Base metals prices fell sharply this week. The release of weak Euro area flash PMI data for September, suggesting a contraction is possible, combined with both a sub-50 China PMI reading for the same month and ill-received comments from the Fed on the state of the U.S. economy weighed heavily on broad market sentiment and drove risk aversion. Copper fell 17 percent this week to under $3.28 per pound, a 52-week low.
• The agriculture complex tumbled across the board as the downbeat economic outlook took its toll on market sentiment. Prices for corn futures fell 7 percent on the week.
• This week, metals giant Rio Tinto reported that some of its clients have begun asking to delay shipments of iron ore and other metals. Demand for coal is also decreasing, suggesting Asian activity could be waning.

Opportunities

• Peru’s government said it will not levy additional taxes on the country’s mining industry beyond those currently being debated in its Congress. Under the new law, mining companies will have to pay a sliding scale percentage of operating profits instead of the previous royalty system of 1 to 3 percent of revenue.
• At its Brazil Infrastructure Conference, Goldman Sachs estimated nearly R$85 billion of infrastructure projects will be executed over the next three to four years, including projects related to the 2014 FIFA World Cup, the 2016 Olympics in Rio de Janeiro, airports, subways, and highways.
• Oil supermajor Royal Dutch Shell’s CEO Peter Voser said in both the Financial Times and the Wall Street Journal that oil demand growth will outpace the growth in supply, so we should see “rising energy prices for the long-term.” Voser said that the reason for the shortage of supply was a lack of investment after the global financial crisis.
• Analysts at Macquarie noted the chance of another (albeit weaker) La Nina is starting to build in the Australian coal space. The latest median rainfall probability forecasts from the Bureau of Meteorology give a 65 to 70 percent chance of above average rainfall for the northern Bowen Basin between October and December 2011 versus a 70 to 75 percent probability for the same period last year. The probability of above median rainfall is lower in the Hunter Valley and Gunnedah Basin at 55 to 60 percent. The forecast raises the possibility that the Queensland met coal chain could again be disrupted by inclement weather, while steel mills’ inventories remain low.

Threats

• The IMF forecast a decline in commodity prices in the second half of 2011 and in 2012 based on bigger harvests of food crops and slower economic growth weighing on demand for base metals. The IMF’s index of non-fuel commodities is forecast to slip about 5.5 percent in the second half of 2011 on better harvests, while base metal prices are expected to decline “modestly” in 2012 on improved supply, the IMF said in its World Economic Outlook report. The world economy will expand 4 percent this year and the next, the IMF said, down from June forecasts of 4.3 percent in 2011 and 4.5 percent in 2012.

Tags: Base Metals, Brazil, Broad Market, Cheat Sheet, Commodities, Contraction, Corn Futures, Defensive Position, Early August, Economic Outlook, Fund Management, Giant Rio Tinto, Global Resources, Gold, Infrastructure, Iron Ore, Market Sentiment, Metals Prices, mining companies, Mining Industry, Oil Demand, Outlook, Resources Fund, Risk Aversion, Stocks And Commodities
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