Vertigo: Why Not to Fear Dow’s String of New Highs

Wednesday, March 20th, 2013

March 19, 2013

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• The Dow Jones Industrial Average surpassed its all-time high in a series of record-breaking closes.
• However, new highs bring new worries about whether the market’s come too far, too fast.
• We believe there’s enough support under the market and economy to keep us on the side of the bulls.

Since my last report, the Dow Jones Industrial Average has surpassed its prior all-time high. Actually, it has managed a feat of nine consecutive new all-time highs since its first crossing on March 5. The S&P 500 Index came close, but has been held back to a significant degree by weakness in Apple (AAPL), which is not a component of the Dow.

Let’s start with a comparison of a variety of metrics (both market and economic) between today and the last time the Dow traded at these levels, in October 2007. I split the indicators into “good” and “bad” categories. We’ll get the bad out of the way first:

Then and Now: The Bad

Source: Bloomberg, FactSet, Federal Reserve, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2013 © Ned Davis Research, Inc. All rights reserved.), Standard & Poor’s, as of March 15, 2013.

As you can see, it’s the more macro/economic-oriented statistics that have worsened over the past 5½ years; notably the deficit and debt, as well as jobs and confidence. We’ve written extensively about the burden of debt and the deleveraging cycle that began in the private sector in 2008 but is only just now being addressed by the public sector.

But then there’s the good news:

Then and Now: The Good

Source: Bloomberg, FactSet, Federal Reserve, NDR, Inc. (Further distribution prohibited without prior permission. Copyright 2013 © Ned Davis Research, Inc. All rights reserved.), Standard & Poor’s, as of March 15, 2013. AAII=American Association of Individual Investors.

Notice that most of the better comparisons are many of the traditional stock market barometers, including earnings, valuation, technical conditions and inflation. Also better is the household sector’s balance sheet, thanks to the aforementioned private-sector deleveraging that was forced upon it after the financial crisis erupted more than four years ago.

Benign pullbacks are more likely

But along with new highs have come concerns about whether the market’s come too far too fast. We remain optimistic, but have consistently expressed the view that a pullback could occur at any time, especially in light of much higher levels of investor optimism, a contrarian indicator.

The news out of Cyprus was the trigger for the slight pullback the market’s experiencing as I write this report. The story will have to play out, but we don’t feel this represents the type of exogenous shock that could undermine the US stock market for any extended period of time.

US offsets

Although the eurozone crisis keeps policy uncertainty elevated, US policy uncertainty has been coming down sharply of late.

Less US Policy Uncertainty

Source: Scott Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com, as of February 28, 2013. Index measures policy uncertainty and tests its relation with output, investment and employment.

New highs, new worries

In the meantime, I’ve been traveling all over the country and have been getting many questions about whether all-time highs are typically indicators of impending doom for the market. The answer, in short, is no.

Until the Dow’s record on March 5 this year, it had gone 1,973 days without hitting an all-time high. According to Bespoke Investment Group (BIG), that’s the sixth-longest stretch the Dow has ever gone without closing at a new all-time high. It’s also the second time in the past decade that the Dow has gone more than two years without closing at a new all-time high.

These periods of “drought” are very rare. As you can see in the table below, going back to 1900, there have only been 10 periods when the Dow went two or more years without closing at a new all-time high. For each period, also shown is how the index performed over the following one, three, six and 12 months.

New All-Time Highs in the Dow: 1900-2013

Source: Bespoke Investment Group, LLC (B.I.G.), as of March 15, 2013.

Looking at the average returns, there isn’t much credence to the argument that you shouldn’t be buying stocks when the Dow is trading at an all-time high. Over the following one, six and 12 months, the Dow saw better-than-average returns. Furthermore, while the average maximum drawdown (loss) was a decline of 8.5% over the following 12 months, the magnitude of the average maximum gain was more than twice that at over 20%.

Bullish case has plenty of supports
But history is never a perfect guide, and one can only rely on momentum so much. There have to be fundamental underpinnings to a market rally, so let’s review the supports to the bullish case:

• Thanks to better economic readings lately, many economists are upping first-quarter real gross domestic product (GDP) estimates; some as high as 3%.
• “Don’t fight the Fed” (or most other global central banks).
• Housing is firing on nearly all cylinders
• Unemployment claims (a fellow leading indicator with the stock market) are at a five-year low.
• Household net worth is on track to take out its prior all-time high this quarter.
• Industrial production and retail sales have been particularly strong (primary source of higher GDP forecasts for first quarter).
• Small business confidence is ticking up.
• Earnings revisions turning higher.
• Moderate, but persistent employment gains.
• Consumer financial obligations (mortgage/credit card payments, etc.) relative to disposable personal income are near record lows.
• The credit-card delinquency rate is at record low by wide margin.
• Highest year-to-date stock mutual fund inflows in seven years.
• About 90% of S&P 500 stocks are above their 200-day moving averages.

Demand versus supply

Let’s dwell on the last bullet above for a moment. We’re seeing an acceleration in demand for stocks, and it clearly relates to the market’s momentum, but likely also fatigue by investors in cash investments earning nearly nothing. NDR has done extensive work on the relationship between supply of and demand for stocks as it relates to market tops and bottoms.

NDR’s Demand Index crossed above its Supply Index last November and has continued to improve since that bullish sign. The lead times of a peak in demand to a peak in the stock market were quite variable going back to the early 1980s, but averaged 242 market days. This suggests a rather long period before we have to worry about a longer-term market peak. You can see the details below.

NDR Peak Demand Lead Times During NDR-Defined Bull Markets

Source: Ned Davis Research NDR, Inc. (Further distribution prohibited without prior permission. Copyright 2013 © Ned Davis Research, Inc. All rights reserved), as of March 11, 2013.

Shorter-term, the next worry for investors is whether we’re going to see a fourth consecutive mid-year slowdown in the economy. As most investors probably recall, the US economy slowed meaningfully in 2010, 2011 and 2012, and as such, many are on high alert for yet another dip.

There are some reasons to hope for a break in that cycle given many of the factors noted in the bulleted list above. But meaningful weakness the past three years didn’t rear itself until the April-May time frame (as you can see below via the Citi Economic Surprise Index comparisons), so we’ll have to wait and see.

No Sign of Weakness Yet This Year

Source: FactSet, High Frequency Economics, as of March 15, 2013.

Not handing in the horns

In sum, the events in Cyprus put eurozone risks back in the spotlight and could lead to additional market volatility. But neither the stock nor credit markets have set off any longer-term alarm bells, and we think any near-term weakness is more likely than not a buying opportunity for stock investors.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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Tags: Dow, New Highs, sonders
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Wanted: More New Highs

Monday, August 20th, 2012

by Bespoke Investment Group

The fact that the S&P 500 is back near multi-year highs is certainly enough to make bulls happy.  That being said, the rally has hardly been broad.  As one example, the Utilities sector, which is comprised of 31 stocks in the S&P 500, was down every day this week.  Earlier in the week, we also noted that in the most recent leg higher, the Russell 2000 has been underperforming the S&P 500.

In terms of new highs, we have also seen a narrowing of the rally.  Back in late March and early April when the S&P 500 made a new bull market high, the number of stocks in the S&P 500 hitting new highs got as high as 78, or 15.6% of the index.  Today, however, the number of new highs was just a little more than half the peak reading we saw in the Spring.  Of the 500 stocks in the S&P 500, there were 42 stocks that hit a new high (8.4% of the index).

The reason for the smaller number of new highs stems from the fact that the rally is being led by megacaps (like AAPL), which stocks with smaller market caps have lagged.  This doesn’t necessarily mean that the rally is doomed.  Rather, the less broad based nature of the rally means that it is imperative for investors to be in the right stocks.  For a lot of us, just summoning up the courage to get into the market is hard enough.  Now, we also have to worry about picking the right stocks!

Copyright © Bespoke Investment Group

Tags: Aapl, Amp, Bespoke Investment Group, Bulls, Courage, Investors, Market Caps, New Highs, Rally, Russell 2000, Stocks
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Francois Trahan: Expect Stocks to Hit New Highs in the Coming Months

Saturday, August 18th, 2012

Leading investment strategist, Francois Trahan takes on the naysayers and explains why he expects stocks to reach new highs in the coming months.

Tags: Francois Trahan, Investment Strategist, Naysayers, New Highs, Stocks
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The Economy and Bond Market Radar (July 23, 2012)

Saturday, July 21st, 2012

The Economy and Bond Market Radar (July 23, 2012)

Treasury yields headed modestly lower again this week. Retail sales were much weaker than expected. Inflation and manufacturing data were more or less in line with expectations, while housing data was mixed. By Friday, European financial concerns had resurfaced as Spanish 10-year bond yields spiked above 7 percent and hit new highs. Spain indicated its recession will likely continue into next year. U.S. treasuries remain a safe haven for global investors, pushing yields lower this week.

Strengths

• Industrial production rose 0.4 percent, ahead of expectations and a bright spot in an otherwise lackluster week for economic data.
• Real estate lending in China jumped 20 percent year-over-year in the second quarter and already shows Chinese policy-makers are taking aggressive action to combat the ongoing global slowdown.
• Housing starts rose 6.9 percent in June and the National Association of Home Builders confidence index had its biggest increase since September 2002.

Weaknesses

• Retail sales fell 0.5 percent and have now fallen for three months in a row, which bodes very poorly for second-quarter GDP growth.
• The Conference Board’s Leading Index fell 0.3 percent in June, also indicating lackluster growth.
• Auto sales in the European Union fell 2.8 percent in June for the ninth consecutive monthly drop.

Opportunity

• With growth tepid, the Federal Reserve will not only remain accommodative, it may increase accommodation in the next few months.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

Tags: Aggressive Action, Auto Sales, Bond Market, Bond Yields, Chinese Policy, Confidence Index, Economic Data, Financial Concerns, GDP Growth, Global Investors, Global Slowdown, Housing Starts, Market Radar, National Association Of Home Builders, New Highs, Quarter Gdp, Safe Haven, Shifting Focus, Treasuries, Treasury Yields
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Treasuries Currently Overbought: Relative Performance of Stocks vs. Bonds

Thursday, June 7th, 2012

by Tiho Brkan, The Short Side of Long

Topics Covered

• Global economic data worsening towards a recession
• Treasury Bond sentiment is extremely optimistic

Overview

The selling pressure has stopped. It seems that the S&P 500, Crude Oil and Gold are now recovering somewhat. Sentiment reached extreme negative levels on all of these asset classes over the last couple of weeks. 30 Yr Long Bond has paused its vertical rise on top of extreme bullish sentiment, while the US Dollar posted a reversal also due to extremely bullish sentiment. It seems we are entering a period of mean reversion but the bottom line still remains the same: investors have been selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino. At the same time, Asia and especially China is slowing down meaningfully. Nothing has been done, announced or hinted by authorities yet and risk off trades are very crowded.

Economic Data

Last week was one of the worst ever data release weeks for the US economy. Out of 21 releases throughout the week only 1 was better than expected, 2 came in at their estimates and a staggering 18 releases (including the important employment figures) all came in below economist expectations. I am pretty sure that the authorises, politicians and central bankers around the world are watching this with a magnifying lens right now. The question is what will they do next and will it even matter?

The overall Developed Markets Citigroup Economic Surprise Index has completely collapsed in recent weeks, so it should not be surprising at all that Bonds have outperformed Stocks again in the first half of 2012. While majority of analysts, economists and investors continue to put all of their faith towards the Federal Reserves ability to re-stimulate the economy through further QE, contrary to that I personally think it will not have too much of an effect, apart from a short to medium term sugar high rally without any new highs. In other words – a bear market rally!

Economic data is negatively surprising economists, not just in the US, but all over the world including the darling favourite of the investment world – Emerging Markets. As we can see in the chart above, the Emerging Market Citigroup Economic Surprise Index has completely collapsed for the first time since 2008 and with it GEM equities plus the global economic barometer – Dr Copper. This leads me to believe that not all is well in Asia and especially China.

While I believe all risk assets are currently oversold and due for a rebound, if the weakness continues again in repaid fashion, it will most likely lead me to a conclusion that we are entering a global recession. Chinese equity market, the Shanghai Composite, is still struggling to break upward. While this is a very bad sign, I am still willing to give it a bit more time to prove itself, as it struggles with a cluster of resistance points around 2,400 to 2,450 level. However, a proper breakdown will most likely signal a hard landing scenario for the Chinese economy. The crisis started in the US in 2007 and spread to the EU, but if we move towards a Chinese hard landing scenario, the final economic crash will most likely occur in Asia, where the boom has created over capacities in all economies from Indonesia to Korea and Australia.

Equity Markets
Nothing new to report.

Bond Markets
The second part of an article is a slight conundrum to the first part above. Here I focus on overbought Bond prices and extremely bullish sentiment that accompanies this assets. Therefore, one major problem when discussing a possibility of a recession, from a contrarian point of view, is that majority of market participants are already overweight Bonds as a fear trade. So the question is, if things get worse, will these safe havens go even higher?

Focusing on the current outlook, be it German Bunds or US Treasuries, prices have gone almost vertical in recent weeks and yields have dropped to 200 year plus record lows. While the uptrend is still intact for the 30 Yr Long Bond and the bull market is still posting new highs, currently the Daily Sentiment Index is showing readings of 97% bulls as of Friday last week. These types of readings usually do not offer too much further gains and most likely signal that we could at least suffer a correction / pullback from current levels.

This view is also confirmed by the Mark Hulbert service of tracking Bond newsletter exposure recommendations. Consider that at present, Bond newsletters are recommending 40% plus long exposure towards this asset class. This a very dramatic switch from March 2012, where these same “gurus” were recommending 40% net short exposure (and got it completely wrong). Historically, readings of 40% plus on each side have been very extreme and usually signalled that Bond prices reversed in some type of a counter trend rally.

Personally, I do not own any bonds in my fund, because I think they are a major major major major bubble! To led money to the US government at 1.5% over the next ten years is a total robbery when adjusted for true inflation figures, in my opinion. Therefore, I am waiting to short these assets, together with the Japanese Yen, at some time in the future.

Having said that, that does not mean prices cannot go higher from these levels, as overvalued bubbles can turn into manias and totally insane buying frenzies. Remember Nasdaq in 1999? Therefore, I am still reluctant to call a final top on the Treasury bull market, until the final EU crisis resolution and some type of a major default occurs to create a capitulation.
Currency Markets
Nothing new to report.

Commodity Markets
Nothing new to report.

Credit Markets
Nothing new to report.

Recommandations

• Summary: my further action depends on political and central bank intervention. During market panics, authorises also panic. It is not until they start to panic, that they actually do something about current problems, which usually take form of some type of reflation policy. However, weak action will make me reduce my longs substantially and rebalance my portfolio towards net short exposure. Italy and Spain are once again moving towards the edge of the cliff, which is a real worry while Asia is now in a meaningful slowdown.
• I still own SPY Calls purchased in middle of May, and today I purchased some more Calls on the SPY ETF. I do not own any other equity positions in my portfolio.
• I also still own SLV Calls purchased in middle of May, and I also added to that by buying some more SLV ETF positions today (only a small trade). I am also still holding onto that core Silver position from late December 2011 bottom at $26.
• I bought a very small position in Agricultural commodities through RJA ETF today. I’m expecting the Agricultural bull market to resume eventually (best fundamentals of any asset class right now). But, I haven’t done anything major just yet.
• Other assets on my watch list for some shorter term bullish rebound trades include Australian Dollar (FXA), Russian / Brazilian equities (RSX & EWZ) and Continuous Commodity Index (GCC).
• It is too early to talk about shorting anything yet, as I am waiting for a market rebound first.

Tags: agricultural, Asset Classes, Brazil, Bullish Sentiment, China, Citigroup, Crude Oil, Economic Data, Economists, Employment Figures, energy, ETF, ETFs, Eurozone, Federal Reserves, Gold, Magnifying Lens, Mean Reversion, New Highs, Qe, Recession, Relative Performance, Stocks Bonds, Tiho, Time Asia, Treasuries, Treasury Bond, Vertical Rise
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Gold Equities – Insider Buying Has Recently Soared – Time to Buy? (May 28, 2012)

Sunday, May 27th, 2012

Gold Market Radar (May 28, 2012)

For the week, spot gold closed at $1,573.03 down $19.96 per ounce, or 1.3 percent.  Gold stocks, as measured by the NYSE Arca Gold Miners Index, surged 7.88 percent. The U.S. Trade-Weighted Dollar Index gained 1.37 percent for the week.

Strengths

• Gold stocks strongly outperformed gold bullion this week.  As we have highlighted in the past there has been a significant disconnect between the price of gold and equity share prices.  The latest Canaccord Genuity Junior Mining Weekly highlights that one year ago, bullion was making new highs week-over-week with the price of gold rising up to $1,508 per ounce.  Based on Canaccord’s in-situ gold database, the market was valuing gold held by non-producers at about $129 per ounce.  One year later, while the price of gold is trading higher at $1,590 (5.4 percent higher than one year ago); the average in-situ value per ounce has dropped to $62 (52 percent lower than one year ago).  The junior miners have been put in the penalty box as capital markets have temporarily shut off the financing lifeline to these companies.
• With the S&P 500 now giving up more than half its gains for the year, much of the surge in gold stock buying over the past week came from generalist funds that may be diversifying in an uncertain market.  Another factor driving this buying may have been insider buying at the gold mining companies, which has recently soared according to the Market Ink Report.  The Market Ink Report notes that the stars may indeed be aligning for gold stocks as the eurozone faces the prospect of a full-blown banking crisis potentially taking hold over the next few weeks.  That would force the European Central Bank to provide further monetary easing.
• Despite gold being down this week it did get a lift in value as the International Monetary Fund (IMF) reported that central bank buying in gold was still proceeding at a brisk pace in April.  Turkey raised its reserves by 29.7 tons and Ukraine, Mexico and Kazakhstan also increased their holdings.  The Philippines, whose purchases actually date back to March but were slow in being reported to the IMF, reported gold purchases amounting to 32 tons of bullion–the biggest volume since Mexico bought around 78 tons a little over a year ago.

Weaknesses

• Feedback from the recent Bank of America Merrill Lynch 29th Global Metals, Mining and Steel conference in Miami showed there was very little interest in attending a gold company presentation, which could in itself, be interpreted as a buy signal.  Michael Jalonen, of BofA/ML noted he came to the conference with high hopes for news flow on capex reduction and a focus on capital returns but ultimately left feeling a little disappointed.
• Before a mining company has even applied for a permit for the Pebble Project Assessment in Alaska, the EPA stepped in and released its own report.  The EPA issued a heavy three-volume report on the possible impact of mining projects on the Bristol Bay watershed system but the agency insisted, “the draft study in no way prejudges future consideration of proposed mining activities.”  The U.S. Corps of Engineers is the primary permitting authority for dredging and filing permits for mining projects.  However, Senate Energy and Resources Committee Member Lisa Murkowski, R-Alaska, and others noted the EPA is determined to wrestle the mining permitting authority for itself, using the power it believes was granted by the Clean Water Act.
• Indian retail gold demand has been poor as the rupee has fallen significantly in value due to inflation and this has made gold more expensive in local currency terms.

Opportunities

• Ray Dalio was interviewed by Barron’s recently.  Dalio is one of the most successful hedge fund managers in the world, overseeing $120 billion in assets.  Dalio was asked if he is still a fan of gold.  Dalio noted it could be a bumpy ride temporarily because Europeans will have to sell gold in order to raise funds because they are squeezed but recommended that most people should have in the vicinity of 10 percent of their assets in gold, not only because he thinks it will be a good investment longer term, but because he thinks it is a very effective diversifier against the other 90 percent.  He also explained that he is viewing gold as an alternative currency.  “The big issue is debtor-developed countries, the U.S., Europe and Japan, all have a lot of debt and will have to print money or they will have credit problems.  I don’t want to have all of my money in those currencies.”
• Technical studies by Institutional Advisors show that the Philadelphia Stock Exchange Gold and Silver Index (XAU)/Gold Ratio has hit an extreme reading of less than 25 and such lows have only been seen around the important lows of September-October 2008, October-November 1948, the double bottom of March and October 1942 and June 1924.  Their work indicates these types of readings have historically marked turning points in the relative performance of gold versus the gold stocks and the current readings support stronger gold stock prices.
• Chris Wood, in his latest Fear and Greed report, said that gold has been acting like a risky asset lately, and it is only a matter of time before it resumes its safe haven status.  In the near term, so long as there are investors who own gold on leverage via ETFs or futures, there is always the risk of gold correcting further in a classic deleveraging trade.  But in the long run, gold is the only real hedge against both deflation and hyperinflation.  The ongoing experiment in unorthodox monetary policy from Western central banks will not end well.  While rising energy costs have hurt gold companies’ profit markets, CLSA says that with U.S. crude oil inventories rising, rising gold and falling oil prices are “a perfect ‘combo’ for gold-mining shares.”

Threats

• Don Coxe noted there is essentially a backroom political ban on investing in companies deemed impure by environmental NGOs and this is unfairly depressing the prices of some of the leading gold mining stocks, and hurting pension funds.  Coxe says pension funds are succumbing to political pressure, resulting in “more and more corporate pension funds…being impaled on their own funding swords due to inadequate investment returns.”  Coxe suggests that commodity stocks are “victims of a new form of persecution from two groups–those with contempt for capitalism, along with those who resent what mining and oil and gas companies do for a living.”
• To stop the development of several new mines that are being contemplated in Minnesota, a couple of NGOs recently went on the offensive to highlight that sulfide mining presents many more risks to their environment than traditional iron ore mining that has taken place in their state and the citizens need a broad conversation about this issue.
• The Canadian mining industry is seeing a couple of headline risks this week with the Teamsters strike, which shut down Canadian Pacific Railway freight lines early Wednesday with no end in sight.  This leaves mining and other resource companies in Canada faced with supply and fuel disruptions.  Also, forest fires in Canada have surfaced as a problem as some power lines to the mines have been damaged while other areas are shutting in to make sure air quality underground is free of smoke.

Tags: Banking Crisis, Brisk Pace, Dollar Index, energy, Equity Share, ETF, ETFs, Eurozone, Gold Bullion, Gold Database, Gold Equities, Gold Market, Gold Miners, Gold Mining Companies, Gold Stock, gold stocks, India, International Monetary Fund, International Monetary Fund Imf, Market Radar, New Highs, Nyse Arca, Penalty Box, Price Of Gold, Spot Gold
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Scratching My Head Till it Bleeds & The 5 classes of Corporate Bonds

Tuesday, March 27th, 2012

by Peter Tchir, TF Market Advisors

The market has rallied more than 2% since the lows on Friday morning.  The rally has been almost exclusively central bank and government driven.

On Friday the rally started with rumors of ECB bond purchases, it continued Monday morning with Merkel softening her stance on how much Germany is willing to risk, and momentum accelerated to a crescendo once Bernanke made it clear that not only is QE not off the table, but he is dying to do more QE ASAP.

Equities seem to have completely accepted that central banks and governments can only be good for the market.  That is what has me scratching my head so hard.  Does nothing other than central bank policy make a difference?  Anyone who nailed the economic data last week has to feel like an idiot. The Chinese landing question has not been answered, but there is growing evidence that it could be the hard sort.  The European economy deteriorated and some of the weaker countries did the worst – Spain as a not so shining example.  Housing data in the US missed across the board, and generally the data was weak.  Yet here we are, back to new highs in equities.

So it is true that flooding the world with money has helped stocks, there have also been periods where stocks did poorly in spite of all these programs being in place.  Are we now supposed to believe that we can never go down again while central bankers are at work? That doesn’t match with history, yet yesterday seems to have convinced many that the only direction for stocks is up with Bendraghi in charge.  The S&P is trading at 14.7x earnings.  Maybe not overvalued, but also hard to argue that they are extremely cheap – especially with economic indicators not only a little weaker than expected, but showing signs that a lot of the strong data early this year truly was a function of weather, and rather than being able to jumpstart the economy, merely pulled activity forward and we are now seeing the impact of that.

While equities and commodities (except for natural gas) knew exactly what to do with the Ben’s statement, treasuries had more difficulty figuring it out. They seemed to be left scratching their heads and were torn between the desire to rally on the back of more government support, or selling off as part of a “risk on” rally.  Treasuries seem to be caught in no man’s land.  Fed purchases keep them artificially low, but with any potential for stability in the world, any signs of inflation, and a stock market this high, it is hard to be an “investor” in treasuries here.  There is real fear that you do not want to be the one left holding treasuries once the QE game is over.  It is a bit surprising that Ben wasn’t able to do more for treasuries yesterday.  The long bond is actually 2 bps higher than it was on Friday.

Corporate bonds were okay.  Not as enthusiastic as stocks and commodities, but more excited by the prospects of additional QE than treasuries.  On the credit ETF side, it looks like most of the appreciation went into increasing the premium as the NAV didn’t move as quickly.

Mortgages should do best on any QE as it seems that will be the primary beneficiary.  In the meantime, corporate bonds seem to be 5 distinct assets classes:

Investment Grade Corporate: These are already trading tight, but should have little volatility.  I would want to own them on a hedged basis, if at all.  Nothing wrong with the bonds, but little upside left.

Financial Bonds: Bonds issued by banks still have the most spread and best chance of appreciation.  They also clearly have the most risk.  I prefer bonds of the biggest European banks (DB and SG), but would want to avoid or be short the banks that have used LTRO the most aggressively.

“Short Dated” HY Bonds: There are a lot of high coupon hy bonds trading to call dates within the next two years.  Normally these offer limited upside, but it might be worth buying some.  Retail investors seem to have their eyes on these bonds, and there is now at least one ETF specifically targeting these bonds.  There isn’t much value here, but retail is likely to drive these bonds up a couple points higher than institutional investors ever would – especially with the economy being stable.  Decent carry and real chance that retail chases these bonds higher than they should be.

“Story Credit” HY Bonds: These have rallied but still have some potential.  It really is a “close your eyes” and hope for the best at this stage as the downside is probably greater than the upside, but if you truly believe in QE and its ability to make things good, you are supposed to close your eyes and buy these.  Not a strategy I like right now as I believe that in spite of (or because of) all the government and central bank intervention we are a long way from having resolved anything.

“high quality non-callable” HY Bonds: These are potentially the most dangerous.  These are typically BB companies with bonds that have good call protection for at least 5 years.  Spreads are relatively tight, though have room to move tighter, but in spite of many articles saying that HY doesn’t move with rates, these will.  We are in a pretty unique situation in the credit markets.  Treasury yields are very low.  Spreads on these bonds are okay, and could tighten, but the yields are very low.  The ability for this class of bonds to rally in a rising rate environment is low.  On a spread basis, they could tighten as they should outperform treasuries, but they can still go down on price.  They will be squeezed out by BBB bonds in a rising rate environment.  The analysis of HY correlation to treasuries that I have seen is too simplistic.  The first two categories of hy bonds that I mention do not have much rate risk.  This category does.

Tags: 7x, Asap, Central Banks, Chinese Landing, Commodities, Commodity, Corporate Bonds, Crescendo, Economic Data, Economic Indicators, European Economy, Friday Morning, Lows, Match, Merkel, Momentum, Monday Morning, New Highs, Qe, Spite, Tf, Weather
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What’s Next For Gold?

Wednesday, March 14th, 2012

by Dominic Frisby, Moneyweek.com

I’m not unduly worried about the gold price.

But when I saw it had dropped $40 yesterday from $1,700 an ounce to almost $1,660 in the space of just a few hours, I’ll admit a concerned eyebrow was raised.

So I suppose a bit of hand-holding is in order in today’s Money Morning – even if it’s only my own.

Gold may not see fresh highs for at least another year

Let me start by re-visiting my forecast of several months back. By my reckoning, we wouldn’t see new highs in gold for at least another year, ie not before autumn 2012, if not later.

I based this forecast on a simple, repeating pattern that gold makes when it gets ahead of itself. In the chart below, you can see gold’s action since 2001. It’s plotted on a logarithmic chart, as the pattern is clearer that way. (A logarithmic chart, by the way, measures percentage gain on the y-axis as opposed to an arithmetic chart which measures price. So on a logarithmic chart, a move from 200 to 400 looks the same as 400 to 800 and so on).

You can see what a lovely consistent ascent it’s been.

But even within this steady uptrend there are times when it’s got a little ahead of itself and then pulled back as I have indicated in yellow on the above chart. One example is in early 2003, another is in May 2006, another February 2008, and of course the same thing happened again in September 2011.

Each time it’s done so, it’s had a nasty fall, followed by a period of consolidation and digestion. And the more it’s got ahead of itself, the bigger the fall and the longer the subsequent consolidation phase. I’m thinking in particular about the 18 months or so that followed the highs of May 2006 and February 2008.

On both occasions it was well over a year before gold made new highs. I believe we’re in just such a period now. The high gold made last September at $1,920 was a typical example of gold going too far too fast. Now we have the consequent period of digestion.

So that’s how I’m interpreting the big picture.

Gold measured in sterling is far less smooth

Out of interest, I present to you now the same chart, but of gold measured in pounds. The graceful ascendency is gone. This chart is hiccuping its way higher in steady, annual burps.

The inverse of this chart – which shows just how much the pound has fallen against gold – has the look of a geriatric stumbling blindly to his coffin.

The short-term outlook for gold

Now let’s zoom in and take a look at the nearer term. Here is a one-year chart of gold.

My famed 144-day moving average (blue line) has now become resistance, unfortunately. I see good support in the $1,550 zone, where I have drawn the light blue band. And I see resistance at $1,800 where I have drawn the red band.

These will be, I suspect, the two lines in the sand for the time being, probably until the autumn. Of course, these are just guesses – I know no more than you.

But again, staring at the chart and guessing, I suggest a retest of at least $1,600 looks to be on the cards before gold’s normal, upwardly-mobile business can resume. But such a re-test, should it occur, would give a nice symmetry to the chart and add to that decent-looking base at $1,550.

Could the miners finally start to outperform?

As for silver, I see a similar picture with strong support at $26, but resistance at $38. Silver does seem to be displaying some relative strength, which is positive.

Also on the positive side of things, I am seeing some buying coming in to the junior resource sector. This is probably because of broader stock market strength, but I’m hoping we’re in the early stages of one of those periods when the stocks outperform the metals. Not before time, that’s all I can say.

I’ve just come back from the PDAC in Toronto, which is the world’s biggest mining conference. I must have spoken to over a hundred different companies while I was there. I’ll be publishing my notes from the conference, as well as my pick of the PDAC in a new report, so watch this space.

And, finally, I’ve banished my inner Luddite and signed up for Twitter. I have 136 subscribers so far, so plenty of room for upside. If you’re on Twitter, please follow me @dominicfrisby.

Tags: Arithmetic, Ascent, Autumn, Axis, Consolidation Phase, Digestion, Dominic, Eyebrow, Frisby, Gold Price, Last September, Measures, Money, Nasty Fall, Nbsp, New Highs, Occasions, Ounce, Percentage Gain, Typical Example, Uptrend
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The Emotions of Fear and Apathy Create Good Buying Opportunities

Sunday, February 26th, 2012

The Emotions of Fear and Apathy Create Good Buying Opportunities

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

One of the most debilitating forms of human emotion isn’t anger, fear or sadness, it is apathy. Apathy can be defined by an “I don’t care” attitude, an indifference to events and the world around them. Helen Keller once said: “We may have found a cure for most evils; but we have found no remedy for the worst of them all, the apathy of human beings.”

Over the past few years, an onslaught of onerous regulations, market volatility and a lack of political leadership has pushed investor apathy to new highs.

Many of the new, “one size fits all” regulations are poorly thought out and haven’t received sufficient cost-benefit analysis. I’ve been discussing this theme for several years and now it’s on the cover of The Economist magazine this week. From the Patriot Act to Sarbanes-Oxley to Dodd-Frank, it appears we have wrapped a suffocating amount of red tape around American business over the past decade, according to the magazine.

Even with good intentions—we need checks in place to prevent the next Enron or Bernie Madoff—the faulty design of some regulations has resulted in several unintended consequences. Money is the lifeblood of the American economy. A healthy economy is dependent on money flowing freely. Business, like life, needs to cycle and circulate, or it declines. However, the cost of compliance, in terms of dollars, time and resources, has clogged the arteries of American enterprise. Excessive regulation is an injection of cholesterol when the economy needs a dose of Lipitor to heal and grow stronger.

The Economist uses the Volcker Rule as an example of unhealthy regulation. The rule, which is intended to limit proprietary trading by banks, includes more than 1,400 questions banks must answer in order to verify compliance. This means that it would take one full year to assure compliance if a firm answered 27 of these questions (four a day) each week. Instead of beefing up business, finance and research & development (R&D) departments, business leaders are hesitant to commit capital because of uncertainty about how much they’ll need to allocate toward compliance.

If burdensome regulations are the bad cholesterol in the system, then tax breaks have acted as a stent, keeping the economy alive. Removing these stents and raising taxes could spell cardiac arrest for the recovery.

Business owners aren’t the only ones feeling out of sorts; uncertainty surrounding economic policy has dispirited the general public. According to a recent Barron’s article, an index measuring economic-policy uncertainty from Stanford and the University of Chicago jumped to an all-time high toward the end of last year.

Investors need hope and a vision of cooperation and building together. This is what we experienced during the 1990s when President Clinton streamlined and deregulated industries such as telecommunications and financial services. Add in the Internet, a public gateway to the world, and you had an economy that boomed.

Today, a lack of faith and trust has driven investors to the sidelines and halted the flow of capital in the U.S. According to the Investment Company Institute (ICI), investors pulled more than $130 billion from equity mutual funds during 2011. This represents the second-largest withdrawal of funds in the past 25 years and is four times the amount withdrawn in 2010. The Barron’s article cites an Investment News survey that found just 43.6 percent of financial advisors planned to increase their stock allocations in 2012.

Finding a Solution

The article offers a solution: The Economist says “rules need to be much simpler” because “all-purpose instruction manuals” get lost in an “ocean of verbiage.” I agree. What makes the U.S. special is our entrepreneurial spirit, and we must adopt policies that promote prosperity and efficiency in order to empower the world’s most innovative companies.

This discussion is not intended to condemn either political party or claim that all regulation is bad. Business, just like sports, needs rational refereeing in order to ensure a fair game is played. However, we need to be careful that we don’t put more referees on the court than players.

Rays of Sunshine in the Market

Just like you wouldn’t spend a day on the golf course without sunblock, investors need to protect themselves. Think of these observations as your sunblock and don’t step foot into global markets without it.

Now that you’ve got some sunblock on, it’s time to go searching for rays of sunshine in the marketplace. All great bull markets climb a wall of worry and one of today’s brightest spots is the “American Dream Trade,” which can be found in emerging economies. Designed to inject liquidity into the system and stimulate economic growth, a global liquidity boom that began in December has initiated the resurgence of markets around the globe. In total, 77 countries have instituted stimulative measures since late last year. With per capita GDP increasing and local markets rising, it is shaping up to look like a strong year for natural resources.

A second driver could be the recent improvement in investor attitudes, which can have a significant effect on market performance. Back in early October, we discussed how Citigroup’s Panic/Euphoria model, which measures a combination of nine facets of investor beliefs and fund managers’ actions, had been stuck in panic mode for months.

This was a signal to us that market sentiment was destined to improve and lift share prices with it. Since then, the S&P 500 has jumped 18 percent and is currently at levels not seen since before the credit crisis. Small caps have felt an even greater lift, rising 26 percent over the same time period.

One of the reasons money has found its way back to the market is that low interest rates and a bubble in bonds have upped the attractiveness of equities relative to other asset classes. In fact, many large-cap equities come with a higher yield. Currently, 222 companies (roughly 44 percent) of the S&P 500 are paying dividends at an annualized rate of at least 2 percent. This is greater than the yield on a 10-year government note. This means that investors can wait for the growth, while receiving the income.

Overall, it looks like the market’s dark clouds are lifting and we could be in for a period of sunny skies in the months ahead.

Tags: American Economy, Apathy, Bernie Madoff, Care Attitude, Chief Investment Officer, Cost Benefit Analysis, Economist Magazine, Excessive Regulation, Faulty Design, Frank Holmes, Helen Keller, Human Emotion, I Don T Care, Lifeblood, Market Volatility, New Highs, Political Leadership, Proprietary Trading, U S Global Investors, Unintended Consequences
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Gold Shares Would Soon Play Catch Up

Monday, December 12th, 2011

In a recent research note, BCA Research argues that it is too soon to give up on gold shares – a sector that has underperformed gold bullion and liquidity plays over the past few years.

The report says: “Gold miner profits track gold prices and this has not changed in the past few years, although the tracking is far from perfect. What has changed is the traditional 2:1 relationship between changes in gold shares and underlying prices. Global gold shares are flat year-on-year in dollar terms, yet the dollar price of gold is up 22%. This is despite the fact that gold company hedge books are leaner than they have been in years.

“One possible explanation is that commodity-sensitive currencies have been strong in recent years. This places a wedge between revenues and costs for many gold producers. Put another way, gold in C$, A$ and SA rand terms has been weaker than in U.S. dollar terms. However, that has not been the case in recent months as the commodity currencies have dropped in the face of investor risk aversion.

“A more likely explanation relates to the ETF phenomenon. Gold company multiple compression accelerated as ETF holdings hit successive new highs in 2010 and 2011.

“While the divergence is unsustainable, it is difficult to tell when it will end. Even if gold shares are in a bear market versus gold prices, they are stretched relative to the downtrend in place since 2006. Perhaps global reflation and a softer dollar will spur a “broadening” of interest in lagging liquidity plays, such as gold shares.”

I am in agreement with BCA’s recommendation that one should continue to hold strategic positions in both gold and gold shares.

Source: BCA – Daily Insights Service, December 8, 2011.

Tags: Bear Market, Commodity, December 8, Divergence, Dollar Price, Dollar Terms, Gold Bullion, Gold Company, Gold Miner, Gold Prices, Gold Producers, Gold Shares, Investor Risk, liquidity, New Highs, Phenomenon, Price Of Gold, Rand Terms, Reflation, Risk Aversion
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