Technical Talk: Upside breakout for S&P?

Sunday, August 5th, 2012

The comments below were provided by Kevin Lane of Fusion IQ.

As seen in the chart below the S&P 500 Index (SPX 1390.99 â†â€˜1.90%) held its 100-day moving average yesterday (green line) near 1,350 and today is bouncing on ECB news and better-than-expected-non-farm payrolls – does anyone smell election year mark-ups? That said, the Index is still setting higher lows since its June low, which is bullish; however it has also been capped near the 1,385 area (red line) for a while now. The Index continues to remain locked in a range, with resistance at 1,385, and near-term support at 1,350. [PduP: The closing level on Friday was 1,391.] Whichever way it breaks, momentum will surely follow. More meaningful support lies near the 1,330 – 1,325 band (purple-shaded lines and arrows) as this was the area where the S&P 500 double-bottomed recently. This is the area that is most critical in regard to keeping the market together.

There are conflicting data that could support a breakout (i.e. more consistent levels of news highs, low long exposure levels and low levels of bullish sentiment) or a breakdown (i.e. weak action in cyclicals and transports, especially truckers). However, if forced to choose, we are leaning towards an upside breakout. That said, we won’t be ashamed to pull the rip cord if key supports are broken as this would take the breakout call off the table. After all, being wrong once in a while is inevitable, however, ignoring an oncoming truck (i.e. a break of support) assuming you can swerve around it, is never a smart strategy!

This game is about knowing when to press forward, when to sit tight and watch, when to retreat and, most important, knowing when to change strategies if need be!

Source: Source: Kevin Lane, Fusion IQ, August 3, 2012.

Tags: Amp, Arrows, Bullish Sentiment, Consistent Levels, Cyclicals, Election Year, Exposure Levels, Iq, Lows, Mark Ups, Meaningful Support, Momentum, Non Farm Payrolls, Red Line, Rip Cord, Smart Strategy, Spx, Transports, Truckers, Ups
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David Rosenberg On A Modern Day Depression Vs Dow 20,000

Wednesday, July 25th, 2012

 
From David Rosenberg of Gluskin Sheff

The challenge ahead is one of expectations. I think we win be fortunate to see any GDP growth at all for Q3, and yet the consensus is at +2.2%. The consensus is at +97k on July non-farm payrolls whereas the claims data point to sub-80k. Among the analysts, hope springs eternal that expected revenue growth of +2.6% in Q4 will be enough to generate a +12.1% expansion in bottom-line performance.

To meet that profit forecast, even more cost-cutting will have to come our way (no sooner do we say that than we see this article on page 61 of the WSJ: Steelmaker Presses for 26% Pay Cut). This may be encouraging for profits, but will also come at the expense of labour income, and with that, a sluggish consumer. Concerns over the fiscal cliff have already led to a renewed uptrend in the personal savings rate. The worst drought in the U.S. in a half-century are sending food costs sharply higher, which will severely pinch discretionary outlays, and whatever respite there had been of late from relief at the gas pumps has come to an end (have a look at Price Check: Drought May Hit Grocery Tabs, also on page 61 of the weekend WSJ). Survey after survey shows a sharp turndown in hiring plans as well.

This is looking more and more like a modem-day depression. After all, last month alone, 85,000 Americans signed on for Social Security disability cheques, which exceeded the 80,000 net new jobs that were created: and a record 46 million Americans or 14.8% of the population (also a record) are in the Food Stamp program (participation averaged 7.9% from 1970 to 2000, by way of contrast) — enrollment has risen an average of over 400,000 per month over the past four years. A record share of 41% pay zero national incomes tax as well (58 million), a share that has doubled over the past two decades. Increasingly, the U.S. is following in the footsteps of Europe of becoming a nation of dependants.

Meanwhile, policy stimulus, whether traditional or non-conventional, are still falling well short of generating self-sustaining economic growth. Some investors see this deflationary trendline because it is they that have helped drive the S&P Dividend Aristocrats index (contains large-caps that have consistently raised their payouts over the past 25 years) up 10.5% in the past month and actually touched a new all-time high last week. The likes of Kraft, Wal-Mart, Verizon, Johnson & Johnson, Pfizer and Merck all managed to reach 52-week highs as well. So even in this tough macro and market environment, there are ways to put money to work — in areas of the market that generate a reliable dividend stream for investors and produce a product that people need, not what they want.

Investors must not only screen for earnings visibility, non-cyclicality, dividend payout potential, strong management and high quality balance sheets with a manageable debt maturity calendar, but also for fully-funded pension plans. The S&P 500 space, right now, contains 338 defined-benefit plans, with aggregate obligations of $1.68 trillion but assets of just $1.32 billion, for an unprecedented underfunded liability of $355 billion. So you know the record cash-stash on corporate balance sheets that are often cited as a prime reason to be bullish on Corporate America the real issue is the extent to which shoring up depleted pension funds will compete with stock buybacks and dividend growth in the future. One thing is for sure — a reversion back to the old defined-contribution pensions is clearly coming back into focus as company after company seek out ways to reduce their contribution rates.

DOW 20,000?

Well, this is perfect.

It is amazing how many pundits still believe in stocks for the long run. See The Long-Term Argument for Dow 20,000 on page 6 of the Sunday NYT Money & Business section. Shades of Jeremy Siegel.

So what are we left to conclude?

Last week, we saw the VIX index touch 15. The Investors’ Intelligence survey showed there to still be two bulls for every bear in the realm of market newsletters. The put-call ratio had fallen through 1:1 after a 20% decline since early June. The bottom-up consensus of equity analysts see global profit growth of 13.5% for 2013, which is more than a double from the 6.3% projection for this year. The S&P 500 is currently trading much closer to the top end of its year-long 1.100-1,400 band than the low end. And now we see headlines of Dow 20,000 (whatever happened to the other 15,000 points Dr. Siegel promised 13 years ago)? Where exactly is there any sign of capitulation beyond, say, the mutual fund flows data which are illustrating even to the most casual observer that what we are witnessing on this front is little more than a demographic-driven rebalancing of the baby boomer asset mix as the investment lifecycle continues along a secular shift towards capital and cash-flow preservation themes.

The bottom line is that from the spring of 2009 to the spring of 2011, the stock mark doubled, and it doubled principally because of a wild short-covering rally in the financials which were priced for insolvency at the lows. It was a classic 1933-1936 bounce that never saw a new high and never foreshadowed better times ahead. The Great Depression ended nearly a decade later and the next secular bull market did not begin until 1954. And from what history teaches us, secular bear phases do not typically end with headlines about Dow 20,000 but rather with contrarian news like The Death of Equities on the front cover of BusinessWeek back in 1979 (or Awash in Oil on the front cover of the Economist back in 1999, when crude prices were turning in their secular lows).

* * *

Of course, for the laugh track, here again is James Altucher from June of 2011, predicting Dow 20,000 as recently as a month ago.

Tags: Bottom Line Performance, Consumer Concerns, David Rosenberg, Discretionary Outlays, Food Costs, Food Stamp Program, Gas Pumps, GDP Growth, Gluskin Sheff, Labour Income, National Incomes, Non Farm Payrolls, Personal Savings Rate, Program Participation, Record Share, Social Security Disability, Steelmaker, Turndown, Uptrend, Wsj
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The Economy and Bond Market Radar (May 7, 2012)

Monday, May 7th, 2012

The Economy and Bond Market Radar (May 7, 2012)

Treasury yields have had a slight downward bias the past couple of weeks and that trend accelerated this week as yields fell across the board. U.S. economic data continues to be a mixed bag. The unemployment report was released on Friday which was lackluster at best with non-farm payrolls growing a modest 115,000. The recent trend does not inspire a lot of confidence as can be seen in the chart below. The Federal Reserve remains in play and may enact additional quantitative easing or other stimulative policy measures if the economy does not improve.

Strengths

• The ISM Manufacturing Index rose to 54.8 in April, showing surprising strength amid weakening manufacturing data in many parts of the globe.
• The HSBC Purchasing Managers Index (PMI), which is a gauge of China manufacturing, also improved but still indicated contraction.
• Australia cut interest rates by 50 basis points as inflation expectations moved lower.

Weaknesses

• Non-farm payrolls only rose a modest 115,000 and the recent trend has been disappointing.
• April same-store sales have disappointed as the consumer appears to have slowed down after a several months of beating expectations.
• The European Central Bank indicated that additional easing is not likely.

Opportunity

• Bonds continued to grind higher and appear to be forecasting a benign inflation and slow growth.

Threat

• Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.

Tags: Austerity Programs, Basis Points, Bias, Bond Market, Contraction, Economic Data, Federal Reserve, Gauge, Inflation Expectations, Ism Manufacturing Index, Market Radar, Non Farm Payrolls, Parts Of The Globe, Pmi, Policy Measures, Purchasing Managers Index, Quantitative Easing, Treasury Yields, Unemployment Report, Wildcard
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Is the Fed Promoting Recovery or Desperation? (Hussman)

Monday, April 9th, 2012

On Friday, the Department of Labor reported that March non-farm payrolls increased by 120,000, falling well short of consensus expectations in excess of 200,000. For our part, we continue to expect a deterioration in observable economic variables, with weakness that emerges gradually and then accelerates toward mid-year. On the payroll front, our present expectation is that April job creation will deteriorate toward zero or negative levels.

Immediately after the payroll number was released, CNBC shot out a news story titled “Disappointing Jobs Report Revives Talk of Fed Easing.” Of course it does, because this remains a market dependent on sugar. And with little doubt the Fed will eventually deliver it – perhaps following a market plunge of 25% or more – but with little doubt nonetheless, because like the indulgent parent of a spoiled toddler, the FOMC can’t stand to see Wall Street throw a tantrum without reaching for a lollipop.

If the Fed indeed steps in with an additional round of QE, a few distinctions may be helpful. First, regardless of Fed actions, and even in the past few years, the market has invariably suffered significant losses following the emergence of the “overvalued, overbought, overbullish, rising-yields” syndrome that we presently observe. In contrast, the main window where it has not paid to “fight the Fed,” so to speak, has been the period coming off of oversold lows. That’s primarily the window where financials, cyclicals, materials, and garbage stocks with highly leveraged balance sheets have outperformed. Regardless of the fact that QE has had no durable economic benefits (more on that below), and does little but to repeatedly lay fresh wallpaper over the rotting edifice that is the global banking system, the main effect of QE has been to provide temporary support for the most speculative corners of the financial market after they have been pummeled.

Strategically, then, we concede that there is some latitude to ease back on defensiveness between the point where QE induces an early improvement in market internals and an upturn in various trend-following indicators (coming off of a previously oversold condition), and the point where an “overvalued, overbought, overbullish, rising-yields” syndrome is established. But once that syndrome is established, it is unwise to ignore it, and a defensive stance becomes essential (as we saw separately in 2010 and 2011, not to mention at most major market tops over history). Meanwhile, it is unwise to believe that additional rounds of QE will do much to help the economy in any event, as its primary effect is merely to drive investors into speculative investments by starving them of safer yields.

There is a very well-defined theoretical and empirical relationship between the monetary base and targets like short-term interest rates and monetary velocity (see Sixteen Cents: Pushing the Unstable Limits of Monetary Policy), but investors should note that the response of the stock market and other financial assets to quantitative easing is far more based on superstition than on structure. We can observe, for example, that drowning the financial markets in zero-interest assets has tended to lower the yields (and therefore raise the prices) of higher-risk, longer-duration assets, but that response is dependent on a certain form of myopia. Specifically, investors either have to assume that they can safely speculate until some particular date arrives on the calendar and they can all take their profits simultaneously, or they have to ignore the tendency for low prospective long-term returns to go hand in hand with quite negative prospective intermediate-term returns. For that reason, any “QE indicator” we might develop (as several people have requested) would likely be spurious and not very robust going forward, even though one might be back-fitted to the data. A better approach, as noted above, is to take a signal from market action and trend-following measures, but emphatically to also impose several alternate exit criteria – including for example a deterioration of those measures, or the establishment of an overvalued, overbought, overbullish, rising-yields syndrome. I remain convinced that investors who simply have blind faith that QE is reliably bullish in and of itself, or can be trusted to limit losses, will have their heads handed to them.

How QE “works”

Keep in mind that the U.S. banking system has trillions of dollars sitting in idle deposits with the Fed already. Quantitative easing simply does not relieve any constraint that is binding on the economy. Rather, QE is a method by which the Fed hoards longer-duration, higher-yielding securities like U.S. Treasury bonds and replaces them with cash that bears zero interest. At every moment in time, somebody has to hold that paper. The only way for the holder to seek a higher return is to trade it for a more speculative asset, in which case whoever sells the speculative asset then has to hold the cash. The process stops when all speculative assets are finally priced so richly and precariously that the people holding the cash have no further incentive to chase the speculative assets, and are simply willing to hold idle, zero-interest cash balances.

Why does the Fed want this? Simple. Chairman Bernanke believes that by creating a bubble in speculative assets, people will “feel” wealthier and keep consuming – regardless of the fact that real incomes are stagnant and debt burdens are already intolerable, and despite the fact that there is extremely weak evidence for any such “wealth effect” in the historical record. Undoubtedly, it would be difficult for Bernanke to refrain from these reckless policies when everyone is crying “do something!” But the willingness to tolerate short-term criticism in the interest of long-term benefit is part of what separates leadership from cowardice.

Given the bubbling concerns among various FOMC members about inflation risk, the next round of QE is likely to be “sterilized.” Essentially, the Fed would buy Treasury bonds from banks, and would pay for them with newly created cash, but the Fed would then borrow those funds back from banks, holding them as idle deposits with the Federal Reserve. By definition, the additional “liquidity” created by a sterilized round of QE would not be available for new lending (as if there aren’t enough idle reserves in the banking system already). So again, the main goal is to increase the outstanding stock of zero- and low-interest assets in the economy, in order to lower the yields and increase the prices of more speculative investments.

Now, if you think carefully about this, you’ll recognize that the U.S. government is still running a deficit of more than 8% of GDP, so the Treasury will have to issue more than a trillion dollars of new debt in the coming year anyway. Given that banks already hold trillions of dollars in idle balances, the Treasury could have the identical effect of an additional round of QE simply by issuing a larger portion of the new debt as very short-term T-bills, which also yield next to nothing. So why bother doing this as “quantitative easing” when the Treasury could just change the maturity profile of the new debt all by itself?

Well, for one, the Treasury securities are issued on the open market. The Fed typically pre-announces which issues it will buy, allowing the banks that act as primary dealers to essentially front-run: buying the newly issued debt from the Treasury in expectation of getting a higher price from the Fed. So doing all of this as QE has the benefit of handing the banks a nice trading profit. Second, the Fed has an awful lot of Treasury debt on its balance sheet, which is leveraged about 50-to-1 against its own capital. By purchasing Treasury securities and creating zero-interest cash (or low-interest reserves), the Fed essentially earns a spread that can cover any shortfall it might experience if it is ever forced to unwind its position and sell any of those securities at a loss. It’s true that if the Fed earns any surplus interest, it has to go back to the Treasury, but the surplus rendered back to the Treasury is only what remains after a night on the town in the Fed’s balance sheet.

Finally, the reason for doing QE through the Fed (rather than simply changing the maturity profile of the new Treasury debt) is that Wall Street – at least – believes that the Emperor is actually wearing clothes. Despite the fact that the main effect of QE is to boost speculation and release brief bursts of pent-up demand, both which immediately soften when the policies are suspended, this recurring pattern is still unclear to many investors and analysts. As long as that delusion persists, we can expect the Fed to periodically exploit it.

Ignore that the side-effect of this delusion is the misallocation of capital toward speculative assets in the belief that the Fed has set a “put option” under the markets. Forget that savings are discouraged, bad lending decisions are rescued, incentives and economic signals are distorted, and the accumulation of productive capital is disabled. We have the most creative, entrepreneurial nation on the planet, but our policy makers are intent on preventing debt restructuring and misallocating scarce capital. As a result, they continue to compromise long-term growth in favor of temporary bouts of short-term speculation.

What about recent employment gains?

But wait. How can we say that quantitative easing has such weak effects on the economy when we’ve clearly enjoyed a significant amount of job creation since mid-2009? Isn’t that clear evidence that Fed policy is working?

Well, that depends on what one means by “working.”

Last week, we observed “Real income declined month-over-month in the latest report, which is very much at odds with the job creation figures unless that job creation reflects extraordinarily low-paying jobs. Real disposable income growth has now dropped to just 0.3% year-over-year, which is lower than the rate that is typically observed even in recessions.” It wasn’t quite clear what was going on until I read a comment by David Rosenberg, who noted that much of the recent growth in payrolls has been in “55 years and over” cohort. Suddenly, 2 and 2 became 4.

If you dig into the payroll data, the picture that emerges is breathtaking. Since the recession “ended” in June 2009, total non-farm payrolls in the U.S. have grown by 1.84 million jobs. However, if we look at workers 55 years of age and over, we find that employment in that group has increased by 2.96 million jobs. In contrast, employment among workers under age 55 has actually contracted by 1.12 million jobs. Even over the past year, the vast majority of job creation has been in the 55-and-over group, while employment has been sluggish for all other workers, and has already turned down.

For most of history prior to the late-1990′s, employment growth in the 55-and-over cohort was a fairly small and stable segment of total employment growth. Undoubtedly, part of the recent increase has simply been a change in the classification of existing workers as they’ve aged (1945 + 55 = 2000, so the we would have expected to see some gradual bulge in this bracket since 2000 due to aging baby boomers). But the shift is too large to be explained simply by reclassification. Something more troubling has been underway.

Beginning first with Alan Greenspan, and then with Ben Bernanke, the Fed has increasingly pursued policies of suppressing interest rates, even driving real interest rates to negative levels after inflation. Combine this with the bursting of two Fed-enabled (if not Fed-induced) bubbles – one in stocks and one in housing, and the over-55 cohort has suffered an assault on its financial security: a difficult trifecta that includes the loss of interest income, the loss of portfolio value, and the loss of home equity. All of these have combined to provoke a delay in retirement plans and a need for these individuals to re-enter the labor force.

In short, what we’ve observed in the employment figures is not recovery, but desperation. Having starved savers of interest income, and having repeatedly subjected investors to Fed-induced financial bubbles that create volatility without durable returns, the Fed has successfully provoked job growth of the obligatory, low-wage variety. Over the past year, the majority of this growth has been in the 55-and-over cohort, while growth has turned down among other workers. Meanwhile, overall labor force participation continues to fall as discouraged workers leave the labor force entirely, which is the primary reason the unemployment rate has declined. All of this reflects not health, but despair, and explains why real disposable income has grown by only 0.3% over the past year.

Economic Notes

It’s important to recognize that our concerns about the stock market here are independent of our economic concerns, in that the “Angry Army of Aunt Minnies” we’ve recently observed are associated with very negative average market outcomes regardless of economic conditions. Even in the past few years, the emergence of these conditions has invariably been followed by declines that have wiped out all of the intervening gains since the earliest signal was observed.

As noted above, even in the event of another round of quantitative easing, the particular window to ease back on a defensive position would be between the point where QE induces an improvement in market internals and an upturn in various trend-following indicators (coming off of a previously oversold condition), and the point where an “overvalued, overbought, overbullish, rising-yields” syndrome is established. To ignore the syndromes we observe at present, in the hope that the hope of QE will be sufficient to limit market risk, is a strategy that would not have been successful even in recent years.

Still, though our present market concerns are independent of economic concerns, they are also reinforced by those economic concerns. We’ve reviewed various lines of evidence, from leading indicators to “unobserved components models,” and I continue to view the coming weeks as a likely minefield of economic disappointments. The issue here remains the distinction between leading, coincident and lagging measures of the economy. As I’ve noted before, a tendency toward positive economic surprises over this period would improve the underlying economic state that we infer from observable data, but here and now, the most leading components remain clearly negative. The concerns are also clearly compounded by the uniform deterioration in economic measures in Europe, China and India, among other regions. The charts below convey the general situation.

Over the weekend, the New York Times published a good article (Some Dreary Forecasts from Recovery Skeptics) that summarized the concerns of a number of economic observers, placing Lakshman Achuthan of the ECRI and me into the classification of “perma-bears.” Actually, with respect to the economy, I’m pleased to be in good company, and don’t greatly object to the “perma-bear” label in that I continue to believe major underlying economic problems have merely been kicked down the road and remain unresolved (primarily an overhang of unserviceable debt, which continues to need restructuring, and which will leave the global economy prone to recurring crises until that happens).

I also periodically get the “perma-bear” label with respect to my views on the financial markets. While I do believe that stocks have been generally overvalued since the late-1990′s (a view that is supported by the predictably dismal overall total returns on stocks since that time), I do think that some observers misclassify the 2009-early 2010 period as being a reflection of our standard investment strategy instead of what it was – a period when we suspended risk taking until we were confident that we had adequately stress-tested our methods against Depression-era data. That may seem like a distinction without a difference, but the difference is that for most periods since 2000, our present investment methods would do very little differently than we actually did in practice (though there are of course a few moderate differences due to various refinements and ongoing research). The 2009-early 2010 period is distinct in that it is not at all indicative of the hedge position that can be expected of our strategy in future market cycles, even under identical conditions and evidence. The fact that we removed about 70% of our hedges in 2002 (when our projection for 10-year S&P 500 total returns was not much more compelling than what it is today), should be some evidence of that.

Financial markets fluctuate, and prospective returns change. We will undoubtedly have ample opportunities to accept financial risk in expectation of reasonable returns, and if history is any guide, those opportunities will emerge well before our economic problems are behind us. What concerns me here is the refusal of investors to even recognize those problems; the army of hostile syndromes we observe in both financial and economic data; the blind faith that simply changing the mix of Treasury debt and bank reserves can produce growth and put a floor under speculative assets; the near-complete denial of ongoing debt strains; and heavily bullish sentiment that Investors Intelligence correctly notes is now in “territory associated with market tops.”

Market Climate

As of last week, the Market Climate for stocks remained characterized by a hostile “overvalued, overbought, overbullish, rising-yields” syndrome, and a variety of other hostile syndromes that I’ve reviewed in recent comments. Strategic Growth and Strategic International Fund remain tightly hedged here. Strategic Dividend Value has a hedge equal to about 50% of the value of its holdings – its most hedged stance. Strategic Total Return continues to have a duration of just under 3 years, and a small percent of assets in utility shares and foreign currencies. We raised our exposure in precious metals shares to just over 4% on last week’s price weakness, but there too, our stance remains decidedly conservative at present.

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Tags: Balance Sheets, Banking System, Cnbc, Consensus Expectations, Cyclicals, Department Of Labor, Desperation, Economic Benefits, Economic Variables, Edifice, Fomc, Global Banking, Hussman, Job Creation, Lollipop, Lows, Market Plunge, Non Farm Payrolls, Payroll Number, Qe, Tantrum
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Sprott: Investment Outlook (April 2012)

Wednesday, March 28th, 2012

The [Recovery] Has No Clothes

By Eric Sprott & David Baker, Sprott Asset Management

“I believe that there have been repeated attempts to influence prices in the silver markets. There have been fraudulent efforts to persuade and deviously control that price. Based on what I have been told by members of the public, and reviewed in publicly available documents, I believe violations to the Commodity Exchange Act (CEA) have taken place in silver markets and that any such violation of the law in this regard should be prosecuted.”

- Bart Chilton, Commissioner, U.S. Commodity Futures Trading Commission (CFTC), October 26th, 2010¹

What a difference a month makes. Now that Greece has been papered over, the bulls are back in full force, pumping up the equity markets and celebrating every passing data point with positive exuberance. Let’s not get ahead of ourselves just yet, however. Very little has actually changed for the better, and it’s certainly too early to start cheerleading a new bull market.

Take the latest US unemployment numbers, for example. There was much excitement about the latest Bureau of Labor Statistics (BLS) report which announced that US unemployment remained unchanged at 8.3% during the month of February.² The market was particularly enamored by the BLS’s insistence that non-farm payrolls increased by 227,000 during the month, as well as its upward revision of the December 2011 and January 2012 jobs numbers. Lost in all the excitement was the Gallup unemployment report released the day before, which had February unemployment increasing to 9.1% in February from 8.6% in January and 8.5% in December.³ Granted, the Gallup methodology is slightly different than that used by the BLS, but even if Gallup had applied the BLS’s seasonal adjustment, they would have still come out with an unemployment rate of 8.6%, which is considerably higher than that produced by the BLS.⁴ We all know which number the pundits chose to champion, but the Gallup data may have been closer to the truth.

For every semi-positive data point the bulls have emphasized since the market rally began, there’s a counter-point that makes us question what all the fuss is about. The bulls will cite expanding US GDP in late 2011, while the bears can cite US food stamp participation reaching an all-time record of 46,514,238 in December 2011, up 227,922 participantsfrom the month before, and up 6% year-over-year.⁵ The bulls can praise February’s 15.7% year-over-year increase in US auto sales, while the bears can cite Europe’s 9.7% year-over-year decrease in auto sales, led by a 20.2% slump in France.^{6, 7} The bulls can exclaim somewhat firmer housing starts in February⁸ (as if the US needs more new houses), while the bears can cite the unexpected 100bp drop in the March consumer confidence index⁹, five consecutive months of manufacturing contraction in China¹⁰, and more recently, a 0.9% drop in US February existing home sales.¹¹ Give us a half-baked bullish indicator and we can provide at least two bearish indicators of equal or greater significance.

It has become fairly evident over the past several months that most new jobs created in the US tend to be low-paying, while the jobs lost are generally higher-paying. This seems to be confirmed by the monthly US Treasury Tax Receipts, which are lower so far this year despite the seeming improvement in unemployment. Take February 2012, for example, where the Treasury reported $103.4 billion in tax receipts, versus $110.6 billion in February 2011. BLS had unemployment running at 9% in February 2011, versus 8.3% in February 2012.¹² Barring some major tax break we’ve missed, the only way these numbers balance out is if the new jobs created produce less income to tax, because they’re lower paying, OR, if the unemployment numbers are wrong. The bulls won’t dwell on these details, but they cannot be ignored.

Then there are the banks, our favourite sector. Needless to say, the latest Federal Reserve’s bank stress test was a great success from a PR standpoint, convincing the market that the highly overleveraged banking system is perfectly capable of weathering another 2008 scenario. The test used an almost apocalyptic hypothetical 2013 scenario defined by 13% unemployment, a 50% decline in stock prices and a further 21% decline in US home prices. The stress tests tested where major US banks’ Tier 1 capital would be if such a scenario came to pass. Anyone who still had 5% Tier 1 capital and above was safe, anyone below would fail. So essentially, in a scenario where the stock market is cut in half, any bank who had 5 cents supporting their “dollar” worth of assets (which are not marked-to-market and therefore likely not worth anywhere close to $1), would somehow survive an otherwise miserable financial environment. The market clearly doesn’t see the ridiculousness of such a test, and the meaninglessness of having 5 cents of capital support $1 of assets in an environment where that $1 is likely to be almost completely illiquid.

That anyone still takes these tests seriously is somewhat of a mystery to us, and we all remember how Dexia fared a mere three months after it passed the European “stress tests” last October. There has since been some good analysis on the weaknesses of the US stress tests, including an excellent article by Bloomberg’s Jonathan Weil that explains the hypocrisy of the testing process.¹³ Weil points out that stress-test passing Regions Financial Corp. (RF), which has yet to pay back its TARP bailout money, has a tangible common equity of $7.6 billion, and admitted in disclosures that its balance sheet was worth $8.1 billion less than stated on its official balance sheet. An $8.1 billion write-down plus $7.6 billion in equity equals bankruptcy. But the Federal Reserve’s analysts didn’t seem to mind. It came as no surprise to see that Regions Financial took advantage of its passing “stress test” grade to raise $900 million in common equity on Wednesday, March 14, which it plans to put toward paying off the $3.5 billion it received in TARP money. Well played Regions Financial. Well played.

Our skepticism would be supported if not for one thing – the recent weakness in gold and silver prices. Given our view of the market, the recent sell-offs have not made sense given the considerable central bank intervention we highlighted in February. Although both metals have had a dismal March, we must point out that they were both performing extremely well going into February month-end. Gold had posted a return of 14.1% YTD as of February 28th, while silver had appreciated by 32.5% over the same period. And then what happened? Leap Day happened.

In addition to being Leap Day, February 29th also happened to be the day that the European Central Bank (ECB) completed its second tranche of the Long-Term Refinancing Operation (LTRO), which amounted to another €529.5 billion of printed money lent to roughly 800 European banks. February 29th also happened to be the day that Federal Reserve Chairman Ben Bernanke delivered his semi-annual Monetary Policy Report to Congress. Needless to say, during that day gold mysteriously plunged by over $100 at one point and closed the day down 5%. Silver was dragged down along with gold, dropping 6%. Any reasonably informed gold investor must have questioned how gold could drop by 5% on the same day that the European Central Bank unleashed another €530 billion of printed money into the EU banking system. But all eyes were on Bernanke, who managed to convince the market that QE3 was off the table for the indefinite future by simply not mentioning it explicitly in his Congress speech. Given that Treasury yields have recently started rising again and that US federal debt is now officially over $15 trillion, do you think QE3 is officially off the table? We don’t either. Just because Bernanke signals that the Fed is taking a month off doesn’t mean they’re done printing. It doesn’t mean they have suddenly become responsible. It’s simply a matter of timing.

Looking back at the trading data on February 29th, the sell-off in gold and silver appears to have been an exclusively paper-market affair. We were surprised, for example, to note that between the hours of 10:30 am and 11:30 am, the volume of the COMEX front month silver futures contracts equaled the paper equivalent of 173 million ounces of physical silver. Keep in mind that the world only produces 730 million ounces of physical silver PER YEAR. The problem from a pricing standpoint is the simple fact that the parties who were on the selling side of those 173 million paper ounces couldn’t possibly have had the physical silver to back-up their sell orders. And the way the futures markets are designed, they don’t have to. But if that’s the case, how can the silver price be smashed by sell orders that don’t involve any real physical?

Looking at this issue from a broader perspective, we’ve discovered that silver is indeed in a unique situation from a paper-market standpoint. We compared the daily paper-market futures volume of various commodities against their estimated daily physical production. We discovered that silver is disproportionately traded 143 times higher in the paper markets versus what is produced by mine supply. The next highest paper market commodity is copper, which is traded at roughly half that of silver on a paper market volume basis.

FIGURE 1: MULTIPLES OF DAILY PHYSICAL PRODUCTION TRADED IN FUTURES MARKETS
Source: Barclays, Sprott Research

We don’t know why the paper market for silver is so huge, but we have our suspicions. Silver is obviously a much, much smaller market than that for copper, gold or oil. It could very well be that paper market participants like silver because they don’t need as much capital to push it around. The prevalence of paper trading in the silver market is what makes the drastic price declines possible by allowing non-physical holders to sell massive size into a relatively small market. It’s not as if real owners of 160 million ounces of physical silver dumped it on the market on February 29th, and yet the futures market allows the silver spot price to respond as if they had.

Same goes for gold. Although gold paper-trading isn’t as lopsided as silver’s, it too suffers from the same paper-selling issue. Indeed, as we discovered for February 29th, it appears to be one large seller of gold that single handedly downticked the spot price by $40/oz in roughly ten minutes.¹⁴ The transaction represented approximately 1.8 million ounces, representing roughly $3 billion dollars’ worth of the metal. Who in their right mind would even contemplate dumping $3 billion of physical gold in so short a time span? Dennis Gartman’s Letter on March 2, 2012, also mentioned an unnamed source who described an order to sell 3 million ounces of gold that same day, with the explicit order to sell it “in just a few minutes”. As the Gartman Letter source states, “No investor or speculator would 1) handle it this way and 2) do it at the fixing only… This [has] happened this way three times in the last year, yesterday being the fourth time. Ben Bernanke had done nothing yesterday to trigger this the way it happened. I [have done] this now for 30 years and this was no free market yesterday.”¹⁵

The following three charts show the price action and volume for the February, March and April Comex Gold contracts. You’ll notice that the February contract stopped trading on February 27th to allow time for settlement between the buyers and sellers who intended on closing the contracts in physical. The March contract had hardly any volume at all, leaving the majority of gold futures that traded on February 29th taking place in the April contract. This speaks to our frustration with futures contracts. The majority of trading that produced the February 29th gold price decline took place in a contract month that won’t settle until April 26th at the earliest, giving plenty of time for the shorts to cover and exit without having to back their sales with physical delivery.

FIGURE 2: FEBRUARY COMEX GOLD CONTRACT Source: Bloomberg

FIGURE 3: MARCH COMEX GOLD CONTRACTSource: Bloomberg

FIGURE 4: APRIL COMEX GOLD CONTRACTSource: Bloomberg

All of this nonsense brings us to the crux of our point. If we are right about gold and silver as currencies, and if we are right about the continuation of central bank printing, both gold and silver will continue to appreciate in various fiat currencies over time. If there is indeed some sort of manipulation in the futures market that is designed to suppress the prices for both metals so as to detract from the mainstream investor’s interest in them as alternative currencies, then both metals are likely trading at suppressed prices today. This means that there is an opportunity for investors to continue accumulating both metals at much cheaper nominal prices than they would do otherwise. While the volatility of the price fluctuations may be unsettling, they ultimately won’t change the underlying fundamental direction of both metals, which is upwards.

The equity market rally that began in late December appears to be generated more by excess government-induced liquidity than it does by any raw fundamentals. We continue to scour the data for signs of a true recovery and we are simply not seeing it. Until those signs come through, we would be very wary of participating in the equity markets without a strong defensive stance. We would also expect the precious metals complex to enjoy renewed strength as the year continues. One bad month does not change a long-term trend that has been building over 10 years. Gold and silver will both have an important role to play as the central bank-induced printing continues, and we expect more on that front in short order.

PS – if there is any group that can effectively address silver’s continued paper market imbalance, it is the silver miners themselves. Despite the best efforts of a select few at the CFTC, it is unlikely that there will be any resolution to the CFTC’s investigation announced back in September 2008.¹⁶ Silver miners have the most to lose from the continued “fraudulent efforts” that Commissioner Bart Chilton refers to in the opening quote above. They also have the most to gain by confronting the continued paper charade head-on.

Copyright © Sprott Asset Management

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Notes on Risk Management – Warts and All (Hussman)

Monday, February 6th, 2012

by John Hussman, Hussman Funds

One of the great challenges of investing is the distinction between hindsight and foresight. Hindsight treats each major advance, each market crash, each recession and each expansion as if their turning points were obvious, and extrapolates prevailing trends as if their continuation is equally obvious. Foresight is much messier, because it deals with unknowns and unobservables. It recognizes that major financial and economic events are often hidden from view when they are actually already in motion. Foresight requires the willingness to rely on data that tends to precede important outcomes (recessions, market crashes, durable long-term returns), even when those outcomes can’t be observed in recent economic and market behavior that we can see and touch. Most importantly, hindsight creates the illusion that uncertainty is never very great, and risk management is never very challenging. Foresight demands a much greater appreciation for randomness, noise, uncertainty, risk management, and stress-testing.

Presently, there seems to be an unusually wide gap between hindsight and foresight, both in the financial markets and in the economy. In both cases, forward-looking evidence suggests weak outcomes, but recent trends encourage optimism and risk-taking. Rather than sugar-coat these uncertainties and minimize the messy divergences in the data, I think the best approach is to review the evidence, warts and all, including economic risks, market conditions, and the strengths and limitations of our own investment approach.

The economy: weak leading, lukewarm lagging

The most important news in the financial markets last week was undoubtedly the January employment report, which showed a 243,000 increase in non-farm payrolls, outstripping the 150,000 figure expected by a consensus of economists. Two questions immediately arise. What does this news do to change the likelihood of an oncoming economic recession? And what does this do to change the prospects for the returns and risks in the financial markets?

With regard to recession risks, the January employment report increases the divergence between leading evidence on one hand, where the broad set of data remains in a conformation that is almost exclusively associated with oncoming recession, and the more favorable, if lukewarm, signs from coincident indicators (e.g. employment, purchasing managers index, weekly unemployment claims) and lagging indicators (e.g. unemployment rate).

There is always some element of information when divergences and inconsistencies emerge in the data. But you can’t extract that information very well by throwing all the data in a high-speed blender and just taking the average. Rather, inferences should be based on which indicators are relevant in which contexts. Specifically, we know that leading indicators lead, lagging indicators lag, and coincident indicators are coincident. Given that coincident indicators have improved in recent months, we can easily conclude that economic activity has also improved in recent months. But to make a forward-looking statement, we can’t just extrapolate those improvements, because we know that coincident data doesn’t extrapolate reliably at all. So we have to focus primarily on leading indicators instead.

And that’s our dilemma here. It’s undeniable that coincident measures have improved in recent months, but we have not seen a convincing turn in the leading data. So either the leading data will uncharacteristically lag the recent improvements, or what remains more likely, the coincident data will taper off and deteriorate. I’ll reiterate that we aren’t table-pounders for recession, and that we certainly don’t hope for a recession (though we would welcome higher prospective investment returns that would be brought about by lower market valuations). Overall, an economic downturn remains the most likely prospect, and it’s not at all clear that the latest employment report changes that risk. I think the best way to see why, as always, is to show you the same things that I’m looking at.

To begin, it’s useful to understand how the Bureau of Labor Statistics calculated the 243,000 increase in employment that it reported for January. Total non-farm employment in the U.S., before seasonal adjustments, fell by 2,689,000 jobs in January. However, because it’s typical for the economy to lose a large number of jobs after the holidays, largely in retail trade, construction, and manufacturing, the BLS estimated that the “normal” seasonal decline in employment should have been 2,932,000 jobs in January. The difference between the two numbers, of course, was 243,000 jobs, which was reported as an increase in employment. The fact that the size of the seasonal adjustment was more than 12 times the number of reported jobs, and more than 30 times the “beat” in economists’ expectations, should provoke at least some hesitation in taking the number at face value.

Notably, the January 2011 and 2012 seasonal adjustment factors ( seasonally adjusted payrolls divided by unadjusted payrolls) have been the two largest factors used by the BLS since the 1960′s, at 1.0166 and 1.0165, respectively. This compares with a January seasonal factor of 1.0155 a decade ago, and a factor of 1.0152 as recently as 2009. Now, a range of 0.0014 in the seasonal factors for January may not seem like much, until you consider that non-seasonally adjusted payrolls are presently about 130 million jobs, so variation in the seasonal adjustment factor alone amounts to a difference of 182,000 reported jobs. I’m not suggesting there’s anything nefarious going on here, it’s just that part of what we’re seeing here is most likely a statistical artifact of the adjustment process.

Moreover, we’ve had a remarkably mild winter in the U.S, particularly in January, and it’s clear that this has favorably affected both construction and retail activity. Ironically, however, nothing in the seasonal adjustment actually adjusts for this purely seasonal effect. If the mild winter weather reduced the “normal” number of January layoffs by just 3-4%, that would account for the entire amount by which the January employment number “beat” economists’ expectations.

Our understanding is that most economic series are seasonally adjusted using the same algorithm from the Census Bureau, and indeed, we’ve been able to closely replicate the labor department’s adjustments to various data series using that software [Geek's note: take the option to log-transform the data]. One concern we are aware of is that some data providers such as the ISM use exceptionally short windows (such as 5 years) to estimate their adjustment factors, which appears to invite a large amount of statistical noise in these factors due to the deep and unusual weakness of the 2008-2009 period.

As a side note, because the ISM incorporated the newly released seasonal factors from the Department of Commerce, we saw some significant downward revisions in the December ISM figures that made the January figures appear stronger. For example, the January figure for new orders was 57.6, the same as the original December figure. But since the December figure was revised down to 54.8, the January report appeared to be an improvement. Compared with the original December figures, both production and employment actually dropped. The original December PMI was 53.9, inching higher to 54.1 in January, primarily due to higher inventories. The upshot is that the composite signal from Purchasing Managers Indices and regional Fed surveys has improved modestly, but the overall picture remains lukewarm.

I certainly don’t want to push that argument to the point of suggesting that recent reports are irrelevant, or that they don’t reflect actual improvements. There is enough conformity across multiple pieces of economic data to conclude that the positive economic performance of late is not purely statistical noise. The real issue is the extent, durability, and “leadingness” of those improvements, where we continue to be adamant that lagging data (such as the unemployment rate) should not be expected to lead. Indeed, job growth has typically been reasonably positive in the 1, 3, 6 and 12 months prior to a recession. Job growth was positive in the month prior to 8 of the past 10 recessions, and in the 3 months prior to 9 of the past 10 recessions. In other words, we shouldn’t expect weak job reports to lead recessions, though the year-over-year growth rate in payrolls invariably drops below 1.5% in the early months of a downturn (a level that we’re still below).

In any event, a reasonable interpretation of the January employment report is that fewer jobs were lost in January than the BLS estimated that the economy should have lost on the basis of seasonal patterns. The economy is essentially bouncing around the flatline, and the main question is how much longer we can avoid a negative shock of any kind.

On a related note, we’ve seen a few suggestions that because the latest Purchasing Managers Index came in above 54 (the January figure was 54.1) and the S&P 500 is now above where it was 6 months ago, any concern about a recession is now invalidated as two of the four components of our basic Recession Warning Composite (see Expecting A Recession ) are no longer active. Put simply, this is not how this particular “Aunt Minnie” works. At least one signal from the Recession Warning Composite has appeared either just before or during each of the past 8 recessions, without false signals (the PMI never hit that 54 level in 2010), but those signals are typically not “step” impulses that stay continuously active. Rather, the appearance of even one composite signal is, in and of itself, cause for some recession concern. But given the simplicity of the Recession Warning Composite, a much broader set of evidence is clearly preferable, much of which has been the subject of numerous recent weekly comments.

As it happens, I received identical criticism of my recession concerns in May 2008, when the S&P 500 briefly rose above its level of 6 months earlier, and credit spreads briefly retreated from their levels of 6 months earlier, leading to suggestions that even our own recession evidence had “turned.” At the time, the Fed was easing, Congress had passed an economic “stimulus” in the form of tax rebates, economic reports were coming in tepid but ahead of expectations, and any concern about recession was viewed with disdain. The S&P 500 had advanced about 12% over a period of about 10 weeks, and was only about 8% below its 2007 peak, having recovered much of what was (in hindsight) the initial bear market selloff. This was the most recent example of the “exhaustion syndrome” that emerged again last week (see Warning: Goat Rodeo ).

At the highs of that May 2008 advance, I observed “The reality is that as recessions develop (and I continue to believe the U.S. faces a much more significant downturn than we’ve observed to date), the data can take months to accumulate to a compelling verdict, and in the meantime, speculative pressures can remain alive” (see Poor Fundamentals with Borderline Market Action ). A few weeks later, the surreal calm in the face of seemingly obvious risks prompted the title of my June 2, 2008 weekly comment – Wall Street Decides to Close its Ears and Hum , where I noted “investors appear to be viewing the recent period of weak but not terrible economic news as a signal that the worst is behind us and that clear conditions are ahead.” Memorably, that was not the case.

Though I don’t expect a 2008-type collapse here, I would view a 25% market decline as only run-of-the-mill. I don’t view the probability of recession as 100%, but the leading evidence continues to indicate recession as the most likely probability. While we track a very broad set of data, a crude but useful rule of thumb is that the combination of a) an upturn in the OECD leading indicators (U.S. and total world), coupled with b) a turn to positive growth in the ECRI weekly leading index, has generally been a good sign that recession risk is receding. Those shifts can occur fairly quickly, but we don’t observe them at present.

We aren’t oblivious to the comfortable reports from indicators that typically lag the economy, but we also see disturbing recession risks in indicators that typically lead the economy. The problem is that even though investors know that lagging data lags, it deals with actual recent outcomes that can be “seen and touched.” In contrast, even though investors know that leading data leads, it deals with unobserved future prospects that have not yet been realized. It’s natural to focus attention of what can be seen and touched, even if it’s not indicative of the future.

An angry army of Aunt Minnies

From a stock market perspective, even if we zero-out the recession warnings we’ve been seeing from a broad range of leading indicators, we are still left with rich valuations (we estimate that the S&P 500 is likely to achieve a nominal total return averaging about 4.4% annually over the coming decade), and an increasing set of very hostile “Aunt Minnies.” These are indicator sets that regularly invite very skewed negative outcomes for the stock market (for examples, see Extreme Conditions and Typical Outcomes near the 2011 peak, Don’t Mess with Aunt Minnie before the 2010 market break, Expecting a Recession in late 2007, A Who’s Who of Awful Times to Invest at the 2007 market peak, and our shift from a modestly constructive investment position to a Crash Warning in October of 2000).

Last week, Treasury bill yields and 10-year Treasury yields both advanced, compounding the existing exhaustion syndrome with an overvalued, overbought, overbullish, rising yields syndrome, and not far from generating another rigidly hostile set of conditions outlined in the July 2007 comment A Who’s Who of Awful Times to Invest . The fact that numerous Aunt Minnies are converging here is indicative that market risks are unusually high even if we ignore concurrent economic risks.

Market conditions are emphatically not comparable to the 2009 low, nor to the less extreme intermediate lows we observed in the summer of 2010 and again in 2011. What we observe today are market conditions very similar to what we observed near the 2011 peak, the 2010 peak, the 2007 peak, and to a lesser magnitude, the 2000 peak. Whatever questions one may have about our decision to maintain hedges in 2009 and early 2010 (more on that below, because it’s an important discussion with shareholders), now is not then – not in terms of valuations, sentiment, overbought conditions, implied volatility, or measures or exhaustion. We know that the current “risk syndromes” can be associated with weeks and in some cases months of further progress and marginal new highs, but anyone who is has followed these conditions over the past decade with us has repeatedly seen those weeks or months of marginal gains erased in a handful of trading sessions. That is just how they work – they are not a forecast about market direction of the next few weeks. They are an indication of disproportionate downside risk on a larger and more extended scale.

Again, specific features, and in some cases failures, of our own hedging approach deserve a separate discussion (below). But we are presently observing market conditions that have regularly ended badly, and this can even be demonstrated over the past two years. However one wishes to deal with the extraordinary central bank can-kicking interventions that seem to regularly appear at the lows of those declines, it does not change the clearly negative outcomes that have regularly followed the overbought advances similar to what we observe today.

“Are the models working?”

We recently received an interesting and honest question from one of our shareholders in Strategic Growth Fund. Referring to the ensemble models that we introduced in 2010, the question was “Are the models working?”

The simple answer is that over portions of the past two years, our hedging approach has both “worked” and “missed,” depending on the specific segment of market action under evaluation. We’ve hedged downside risks well, but have not taken advantage of the intermittent periods of speculation that followed massive central bank interventions at the 2010 and 2011 lows. Moreover, our avoidance of financials and “tight” choice of defensive put option strikes has sometimes produced moderate losses during periods of aggressive “risk on” speculation. The result has been something of a “chump to champ, champ to chump” rotation between underperformance and outperformance since we altered our hedging methodology in 2010. For newer shareholders, and to provide a more complete performance review, the challenging period from 2009 to early-2010 is discussed separately below.

The majority of my personal assets are, and remain, invested in Strategic Growth Fund. This is because I expect it to have the highest long-term return of the funds we manage, despite more recent years where the Fund has essentially treaded water (albeit with a fraction of the volatility of the S&P 500, which has been a screaming and volatile roller-coaster to nowhere over the same period). Our hedging approach is intended to be applied over a complete market cycle – generally several years, but in any event comprising a complete bull and bear market. While that approach may lag during the overvalued, overextended portions of a given cycle, I strongly believe – for reasons below – that it is well-suited to perform well over future market cycles.

I’m sometimes characterized as a “perma-bear.” This is because the period since 2000 has been generally characterized by unusually rich valuations, which is duly reflected in the abysmal 0.80% average annual return, including dividends, that the S&P 500 has achieved from the 2000 peak through last week’s close. That is not an accident, but instead matches the total return that we projected more than a decade ago, based on our standard valuation methodology. Given that, it should be clear that my generally defensive stance during this period is not some fixed aspect of my personality or temperament, but instead owes far more to the repeatedly and predictably disastrous overvaluation of the stock market since the late 1990′s.

Such a richly overvalued period is unique in U.S. stock market history, and as a direct result, 12-year periods of virtually zero returns are also rare. Only two periods come close. The stock market suffered negative returns in the 12 years after the 1929 peak, which started at a Shiller P/E of about 22. Stocks also achieved an annual total return of just 3.7% in the 12 years between 1963 and 1975, owing to the unfortunate combination of a high starting valuation, with a Shiller P/E of about 21, and a low ending valuation, with a Shiller P/E below 9. As of last week, the Shiller P/E was again over 22. Regardless of economic prospects, this is a strong headwind.

Unfortunately, it is both dangerous to speculate, and utterly frustrating to remain defensive, in richly overvalued markets coupled with significant economic risks or strenuously overbought conditions. This is the environment we are presented with, and it is in no way typical of “standard” market conditions, despite its repetition in recent years.

I noted back in 2007, during a similar period of frustration, that less than half of the typical bull market gain is retained by the end of the subsequent bear market – “Once stocks become richly valued, the remaining gains achieved by the market are almost always purely speculative � they are generally erased over the remaining course of the market cycle. There are reasonably good tools, based on the quality of market action, that have historically allowed the capture of a substantial portion of those ‘speculative’ gains. But once the market becomes not only richly valued, but sentiment becomes broadly bullish and stocks become overbought on a shorter-term basis, the return/risk profile of the market becomes unfavorable even for speculation” (see Baron Rothschild ).

While our standard valuation methodology doesn’t use Shiller P/Es, it is related, in that it accounts for the very predictable tendency of profit margins to normalize in a competitive economy. That method has been quite accurate both historically and as recently as the 10-year period ended last week. Indeed, just 5-years ago, in May 2007, I noted “investors would be well advised to base their expectations for market returns in the next several years averaging somewhere in a 3-4% band around zero” (see An Optimistic Route to a Poor Market Outlook ). It should be clear that our valuation models are not broken, and that they continue to be accurate and reliable gauges of subsequent market prospects.

What should a valuation model do? It should indicate the appropriate price an investor should pay in order to achieve a particular expected long-term return. Or equivalently, it should indicate the likely long-term return an investor can expect to achieve given the price they are paying. An investment in the S&P 500 Index at present levels is likely to achieve a nominal total return of about 4.4% annually over the coming decade, and investors will have to tolerate a great deal of volatility in pursuit of that return. Market history leaves little doubt that any further advance from present levels will be surrendered over the completion of the current market cycle.

As a side note, the most frequent “valuation” approach that we hear from Wall Street analysts amounts to what we call “forward operating earnings times arbitrary multiple” and is embodied in statements like “we expect forward operating earnings next year to be so-and-so, and we’re also expecting a very modest increase in the multiple of about 2 points, which gives us a price target of such-and-such.” While this sounds reassuringly analytical and conservative, that particular model has almost always implied a one-year price gain of about 15-18%, regardless of the circumstances (you’ll find many analysts who projected just that even at the 2007 market peak). Valuation “targets” of this kind should not be taken as useful information, but instead as red flags.

On our response to the credit crisis – warts and all

Despite the weak 4.4% total return that our valuation models project for the S&P 500 over the coming decade, it is also clear that our projected returns advanced above 10% at the 2009 lows. Our relatively flat performance since early 2010 would not be nearly as uncomfortable had we removed a significant portion of our hedges in 2009. Indeed, from the inception of Strategic Growth to the point of that 2009 low, the Strategic Growth Fund had nearly doubled, while the S&P 500 had nearly dropped in half. At that time, the Fund was ahead of the S&P 500 for every performance horizon since inception.

Our shareholders generally have a clear understanding that we will tend to lag in overvalued markets that are overbought and overbullish, or where economic risks are high. So despite that “champ to chump, chump to champ” cycle we’ve experienced since 2010, my sense is that most shareholders understand our reasons for not speculating here, and have enough examples from our similar experience approaching the 2000 and 2007 peaks to recognize that we know what we’re doing.

The real issue, which I suspect bleeds into a general insecurity about our hedging approach for at least some of our shareholders, is that we didn’t remove our hedges in 2009. In general, our conversations with shareholders indicate that they understand this period, but since we continue to get that question periodically, it’s important to walk through that set of events again.

Prior to 2008 our hedging approach was based on the historical return/risk characteristics of nearly 70 years of post-war U.S. data. When I developed our Market Climate approach well over a decade ago (which evaluates the return/risk profile of the market by grouping present market conditions with the most similar historical instances), I had excluded Depression-era data, not only because of incomplete availability, but also because it seemed highly improbable that the U.S. would face similar conditions again.

Pursuing our hedging approach, based on post-war data, we correctly identified the steep market risks in 2000 and 2007, while also removing about 70% of our hedges in early 2002 as the intervening bull market was beginning. As is common during the higher-risk overvalued, overbought portions of the market cycle, our hedging missed some potential returns during the approach to both bull market highs, but the 2000-2002 and 2008-2009 plunges easily wiped out the gains that the market temporarily enjoyed during those periods.

The economy entered a recession and the stock market plunged in late-2008. Our initial response, based again on post-war U.S. data, was to soften our hedges as valuations improved. Though valuations weren’t anywhere close to normal pre-bubble bear market levels, we had also been willing to reduce our hedges in 2003, when valuations also weren’t terribly compelling. In the 2008, however, the market continued to plunge in a way that was out-of-context from a post-war standpoint, leaving us with a loss of about 9% for the year, though a fraction of the losses suffered by the major indices.

As the crisis deepened, we were forced to contemplate the possibility of Depression-era outcomes, at which point the question was this: how would our existing hedging methods have fared during that period? The answer was both comforting and disturbing. Applying our approach to Depression-era data (using proxied or estimated data where important series were unavailable) significantly reduced downside risk and was acceptable in terms of returns, there were still several intervening drawdowns that I viewed as intolerable, approaching a temporary 45% loss of capital in at least one instance. In fact, once the market had declined to the point where 10% returns were expected over the following decade, the stock market went on to lose two-thirds of its value before reaching its Depression-era low.

Admittedly, I should have done that evaluation a decade earlier, but I hadn’t contemplated the possibility of Depression-era conditions again. It was small consolation that many Wall Street analysts didn’t seem to have stress-tested their approaches in any historical data at all. Given the present rhetoric on Wall Street, it is clear that a large proportion of analysts still have not done so.

In any event, I suspended our risk-taking based on the conflict between the two data sets, because as I noted then, there was no way to “average in” Depression-era information without producing negative return/risk estimates, and I wasn’t willing to expose shareholders to such potentially deep losses. As I wrote at the time, my main concern was to ensure that our hedging methods would perform well both in post-war and Depression-era data, with tolerable volatility. More exactingly, I insisted that our approach should work in “holdout” data that it did not previously “see” (anyone can back-fit a model, but those models often fail miserably in out-of-sample data). I called this our “two data sets” problem, which I wrote about repeatedly during 2009 and early 2010.

The result of that research was a set of “ensemble” models that I’ve discussed at greater length in other commentaries. With those models in hand, we find that the main points where the ensembles would have led us to do things differently than we did in practice were in late-2008, when the approach would have been even more defensive than we were in practice (based on the failure of the market to generate enough confirmation of the periodic “reversals” we saw at the time), and more constructive during much of 2009 and early 2010 (largely based on a retreat in credit spreads, and various subsets of indicators that validated improved conditions). Even so, with a few moderate exceptions, the ensembles have instructed us to remain largely hedged since April 2010. Of course, part of our discipline is the constant attempt to improve that discipline, so we’ve certainly learned a few subtle things that we could have done differently during 2010 and 2011, but the core differences are in that 2009 and early-2010 period.

The key point is this. The performance of our hedging approach in Strategic Growth from inception through the end of 2008, and from late-2010 to the present, can be taken – gains, losses, sunshine, warts, and all – as an accurate reflection of our existing investment strategy at the time. In contrast, it should be clear – especially to shareholders who regularly read these weekly comments – that our performance during 2009 through early 2010, when we very openly worked to modify our hedging methods, is not an accurate reflection of what we can expected to do in future cycles, even under identical circumstances.

Needless to say, all of our actions and performance are relevant to shareholders, including that 2009-2010 period. It’s just that part of that performance reflects an open, deliberate and singular change in our methodology, and should not be extrapolated to future cycles.

Accordingly, if you are a short-horizon investor and are uncomfortable with our tendency to miss rallies that occur in periods that we identify as overvalued and vulnerable to recession risk, you should not own the Strategic Growth Fund, because that sort of performance, under those circumstances, is not unusual for our strategy. Likewise, if you don’t intend to hold the Strategic Growth Fund over the course of a complete bull-bear market cycle, you should not invest in the Fund, because we have no firm expectation that the Fund will outperform the market over smaller segments of the market cycle.

In contrast, if you are a long-term investor in the Fund, but having seen us suspend risk-taking in 2009 and early-2010, are now concerned that it is our strategy to remain fully hedged regardless of market conditions, I believe that this concern is unnecessary. Our stock selections have outperformed the major indices by a significant margin since inception, and I believe that our hedging approach is well-suited to reduce our risks while contributing to our returns over the complete market cycle, if not always over shorter segments of that cycle.

As always, my goal is not to have more shareholders (or fewer), but to ensure that our shareholders fully understand our approach, and that they understand risks that are relevant, as well as those that are not. I have little doubt that some of these comments will be taken out of context and used to toast me in the blogosphere, but that’s life. My main concern is that our shareholders understand our approach. Very simply, I’m confident that we’ve addressed the challenges that we faced during the recent credit crisis, and that our hedging models are well-suited to navigate the market cycles ahead. For investors in Strategic Growth Fund, probably the best evidence of that confidence is that the Fund represents the largest holding among my own investments, with nearly all of the rest invested in Strategic Total Return and Strategic International.

Market Climate

As of last week, the Market Climate for stocks remained characterized by rich valuations (associated with a 10-year total return projection of 4.4% annually for the S&P 500), an exhaustion syndrome that has typically been followed by market declines averaging about 25% within the following 6 months (see Warning: Goat Rodeo ), and on the heels of last week’s upward move in shorter-dated Treasury yields, the reappearance of the familiar overvalued, overbought, overbullish, rising-yields syndrome. We know from a great deal of market history that this “Aunt Minnie” is associated with what we call “unpleasant skew” – a few weeks of further marginal new highs, where each initial selloff is met with a fresh advance to very slightly better levels that give the impression of endless resilience, often followed abruptly by an “air pocket” that can wipe out weeks or months of prior upside progress in a handful of sessions. This pattern should be familiar to those who read these comments regularly.

Given the convergence of a number of nasty Aunt Minnies here, it’s difficult to keep from crossing the line between our usual “on average” language to outright “warning” language – simply because the typical outcomes are ultimately so disproportionately bad. Still, it’s important to remember that even these syndromes don’t necessarily resolve into immediate risks, and those slight new highs are often so highly celebrated that it’s tempting to join the party if the process drags out for any length of time. Even here, it’s not entirely certain that market conditions won’t shift in a way that allows for some modest amount of market exposure, but at present, we would characterize conditions as very unfavorable for long-term investors, and speculative even for speculators. Both Strategic Growth and Strategic International are well hedged, though we’re not raising our put option strikes here, in order to limit any significant erosion in option premium in case that “unpleasant skew” drags on for a several weeks.

In Strategic Total Return, we clipped back our holdings in precious metals shares on strength early last week, to about 7% of assets. The Fund continues to have a duration of about 4.5 years in Treasury securities, so our overall stance remains generally conservative but not outright defensive. A continued increase in Treasury yields would likely provoke a further reduction in our precious metals holdings, as gold stocks in particular do not typically behave well when long-term rates are advancing. That said, my impression is that the enthusiasm about the economy is most likely misplaced, so we may modestly increase the duration of the Fund if yields rise further. Given the overwhelming influence of seasonal adjustment on the January employment figure, which transformed an actual loss of 2.7 million jobs into a reported gain of 243,000, the enthusiasm over that number is almost certainly excessive.

Copyright © Hussman Funds

Tags: Economic Events, Economic Recession, Economic Risks, Employment Report, Financial Markets, Foresight, Hindsight, Hussman, Hussman Funds, Important News, Investment Approach, John Hussman, Market Behavior, Market Crash, Non Farm Payrolls, Randomness, Recessions, Risk Management, Stress Testing, Sugar Coat, Warts, Wide Gap
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More Than Meets The Eye (Hussman)

Tuesday, August 2nd, 2011

More Than Meets the Eye

by John P. Hussman, Ph.D., Hussman Funds

On the surface, the agreement on the U.S. debt ceiling can be expected to produce a significant relief rally in the financial markets, particularly if one views uncertainty on that front to be the reason for last week’s market weakness. That prospect, coupled with the predictable support that investors gave the S&P 500 precisely at its 200-day moving average, prompted us to cover just over 10% of our short calls, but retaining full hedge on the remainder of our holdings, and keeping a strong line of protection about 2% below Friday’s closing levels using index put options (near that 200-day). That’s still a fairly tight hedge, because unfortunately, the ensemble of observable data continues to indicate negative expected returns. So while we’ve modified our position slightly to allow for reduced uncertainty on the deficit front, and the likelihood of “knee jerk” technical support at the widely-followed 200-day average, the expected return/risk profile in stocks remains negative in our estimation. Of course, our precise hedge will change from day-to-day as market conditions change.

Part of the problem here is that market internals have deteriorated badly, particularly last week, where breadth was nearly 10-to-1 in favor of declining issues, and downside leadership exerted itself with more stocks hitting new 52-week lows than new highs. Meanwhile, though new claims for unemployment dipped just below 400,000 last week, we would be more encouraged if the margin was greater, and sustained over a period of many weeks. At present, the 4-week average is running at about 414,000, a level which has historically been associated with growth of only about 30,000-50,000 in monthly non-farm payrolls on average (see the July 11 comment), though there’s certainly month-to-month noise around those averages.

The overall impression from the data suggests the possibility that there is more information in the recent breakdown in market internals than can be explained by debt ceiling concerns alone. On that note, there are emerging economic signals whose leading tendencies are strong enough to make a review worthwhile.

We’ll begin with our own recession warning composite, which accurately signaled oncoming recessions in 2000 and 2007 (see the November 12, 2007 comment Expecting A Recession ). That particular conformation of indicators never deteriorated sufficiently in 2010 to provoke a recession warning, though the deterioration in the ECRI leading index and other measures clearly indicated serious concern. In any event, QE2 effectively forestalled incipient economic weakness in 2010. Given that second quarter GDP came in at just 1.3% annually, and first quarter GDP growth was revised down to just 0.4% (from a prior estimate of 1.9%), it is wholly unclear that the Fed’s extraordinary actions have been worth the market distortions, predictable commodity hoarding, injury and social unrest among the world’s poor (resulting from food and energy price increases) and significant “unwinding” risks that this policy has produced.

The components of our recession warning composite might be called “weak learners” in that none of them, individually, has a particularly notable record in anticipating recessions. The full syndrome of conditions, however, captures a critical “signature” of recessions. That signature of “early warning” conditions is based on financial market indicators including credit spreads, equity prices and yield curve behavior, coupled with slowing in measures of employment and business activity. Every historical instance of this full syndrome has been associated with an ongoing or immediately impending recession.

The components (which I’ve reordered for simplicity) are:

1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields.

2: Falling stock prices: S&P 500 below its level of 6 months earlier. This is not terribly unusual by itself, which is why people say that market declines have called 11 of the past 6 recessions, but falling stock prices are very important as part of the broader syndrome.

3: Weak ISM Purchasing Managers Index: PMI below 50, or,

3: (alternate): Moderating ISM and employment growth: PMI below 54, coupled with slowing employment growth: either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron’s piece many years ago), or an unemployment rate up 0.4% or more from its 12-month low.

4: Moderate or flat yield curve: 10-year Treasury yield no more than 2.5% above 3-month Treasury yields if condition 3 is in effect, or any difference of less than 3.1% if 3(alternate) is in effect (again, this criterion doesn’t create a strong risk of recession in and of itself).

At present, both measures of credit spreads in condition 1 are widening, the S&P 500 is within about one percent of its level 6 months ago, the Purchasing Managers Index is at 55.3%, total nonfarm payrolls have grown by only 0.8% over the past year, the unemployment rate is up 0.4% from its March 2011 low, and the Treasury yield spread is just 2.7%. From the standpoint of this composite, we would require only modest deterioration in stock prices and the ISM index to produce serious recession concerns.

This impression is supported by a number of other observations. First, the year-over-year growth in U.S. real GDP is now just 1.6%. As David Rosenberg notes (via John Mauldin), this level of growth has historically been slow enough to anticipate an oncoming recession.

Wells Fargo’s senior economist Mark Vitner reiterated the point last week, noting that since 1950, year-over-year growth in real GDP has dipped below 2% on 12 occasions. In 10 of those instances, the economy was already in recession or quickly entered one. The exceptions were 1956 and 2003.

For our part, we’ve always believed that the strongest evidence is obtained by combining multiple data points into a single “gestalt.” So I have difficulty concluding that the U.S. is on the verge of recession simply because the year-over-year growth rate has stalled. At the same time, we are closely monitoring a much broader set of data, because the deterioration has been very rapid. I should be clear – the evidence is not yet convincing that a recession is imminent, but it is also important to recognize that the developing risks are greater than most investors seem to assume at present.

I should also note that while our recession warning composite uses the ISM Purchasing Managers Index as a component, we believe it is important to monitor a much broader set of survey-based data, including the ISM (National, Chicago, Cincinnati, Milwaukee) and Federal Reserve (Empire Manufacturing, Philadelphia, Richmond, Dallas) indices. As you can see from the chart below, the combined evidence from these measures collapsed sharply during the summer of 2010, and enjoyed a brief bounce as the Fed embarked on its second round of quantitative easing. The deterioration in recent months is of significant concern, though again, we would need to see further weakness in a number of measures before attaching a significant probability to an oncoming recession.

Notably, the full effect of QE2 on economic activity was to provide transitory bump to short-term growth. Of course, that’s not a surprise, as we knew (and the Fed should have known) that there is virtually no “wealth effect” from stock market values to real GDP (specifically, the historical impact has been an increase of just 0.03-0.05% in GDP for every 1% increase in stock market capitalization). Yet, in order to achieve this pitiful amount of can-kicking, the Fed has now leveraged its balance sheet to 55-to-1, driving the monetary base to 18 cents for every dollar of nominal GDP. Notably, we’ve never observed Treasury bill yields at even 2% when the base has been anything greater than 10 cents per dollar of nominal GDP. Given the non-linear relationship between short-term interest rates and the amount of base money per dollar of GDP, a non-inflationary increase in interest rates to just 0.50% would presently require approximately $1 trillion in Treasury bond sales by the Fed, more than reversing its entire volume of purchases under QE2 (see Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet ).

Tags: 52 Week Lows, Breadth, Debt Ceiling, Downside, Estimation, Financial Markets, Hussman Funds, Likelihood, Market Weakness, Moving Average, New 52 Week Lows, New Highs, Non Farm Payrolls, Observable Data, Rally, Remainder, Risk Profile, S Market, Uncertainty, Unemployment
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A Wile E. Coyote Market (Hussman)

Monday, July 11th, 2011

A Wile E. Coyote Market

by John P. Hussman, Ph.D., Hussman Funds

Friday’s employment report, showing an increase of 18,000 in non-farm payrolls and a jump in the unemployment rate to 9.2% was widely viewed as a “shocker.” Frankly, I don’t understand the surprise. Between February and April, weekly new claims for unemployment (4 week average) dipped below 400,000, which was associated with a few months of nice growth in non-farm payroll employment. Since then, weekly unemployment claims have moved higher, and have been running at an average near 425,000 new claims weekly. Historically, that’s a level that’s fairly well correlated to roughly zero growth in non-farm payrolls. The data is certainly very choppy from month-to-month, which is enough to produce surprises around that average, but the errors also tend to mean-revert, meaning that unexpected job growth figures one month tend to be corrected in the opposite direction (where the “expectation” is taken on the basis of the weekly claims figures).

So the payroll figures were bad, but from our standpoint, they were predictably bad. The notion that this is some sort of a misprint or seasonal adjustment problem is just not supported by the data. That said, the expected monthly non-farm payroll numbers are very sensitive to the weekly unemployment claims figures. If we can get the weekly unemployment claims figures down toward 375,000 on a 4-week average, it will be reasonable to expect monthly payroll job growth on the order of 200,000. That level is our “mean-reversion benchmark” assuming that we gradually close the gap between actual and potential GDP over a 4-year period. Clearly, recent economic performance is well below “benchmark” levels.

Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) was also well ahead of this apparent “surprise,” noting last month that “You’re not going to see the quarter of a million jobs on average anytime soon.” Unlike the emergent weakness we saw in 2010, the recent weakening in leading measures of economic growth have been more in line with what he calls the “Three P’s.” Achuthan argues that the oncoming global economic slowdown is likely to be pronounced, persistent, and pervasive – “not a one or two month affair” – though the data is not sufficiently discouraging to warn of an outright recession at this point (and we would agree). ECRI suggests that “the broad economy is going to slow alongside the industrial sector… it’s all going to be synchronized.”

To some extent, the disappointment on the payroll figure was the result of high expectations last week that followed an uptick in the ISM Purchasing Managers Index, which got an enthusiastic response from investors. What was odd about that enthusiasm, from our standpoint, was that the individual components of the ISM report suggested little of the good news that investors took from it. By far, the strongest components of the report were growth in inventories among the respondents, and growth in their customers’ inventories. Order backlogs actually fell significantly, and new orders were stagnant. So the picture from the ISM was one of inventory buildup and sluggish new orders, coupled with rear-view growth that has brought down previous order backlogs.

The overall effect of the incoming economic data is to suggest that while upcoming earnings reports may be reasonably good from a rear-view perspective of the second quarter, earnings guidance for the second-half of 2011 could tend to be either weak or non-existent.

Unlike 2010, there appears to be little latitude for a robust fiscal or monetary response to the weakening in leading economic measures. Not that we would view any of those responses – aside from facilitating debt restructuring – as promising in any event. Before contemplating a round of QE3, the hawks on the Fed are likely to ask what benefit QE2 provided to the real economy, aside from Fed sponsored speculation, market distortions, and commodity price inflation.

Moreover, as of Wednesday July 7, the Fed’s consolidated balance sheet shows $2.87 trillion in assets, versus $51.7 billion in capital, for a leverage ratio that is now up to 55.6-to-1. This isn’t getting any better, and is far beyond where Bear Stearns, Lehman, Fannie Mae or Freddie Mac were at just prior to their respective insolvencies. Of course, nobody is going to shut down the Fed just because it is approaching technical insolvency, but we ought to recognize that anytime interest rates rise, the interest being paid on Treasury debt is quietly being used to cover the Fed’s capital losses.

Tags: Apparent Surprise, Benchmark Levels, Coyote, Economic Cycle Research Institute, Economic Performance, Ecri, Employment Report, Expectation, Gap, Hussman Funds, Lakshman, Non Farm Payrolls, Payroll Employment, Seasonal Adjustment, Shocker, Standpoint, Unemployment Claims, Unemployment Rate, Wile Coyote, Wile E Coyote
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Hussman: Extraordinarily Large Band-Aids

Monday, June 7th, 2010

This article is a guest contribution by John P. Hussman, Ph.D., Hussman Funds

Market internals deteriorated further last week, while valuations eased off of their recent extremes, but remain clearly elevated on our metrics. The continued combination of unfavorable valuations and unfavorable market action holds us to a fully hedged investment stance. The majority of the day-to-day fluctuation in the Strategic Growth Fund here is driven by the difference in performance between the stocks held by the Fund and the indices (S&P 500, Russell 2000, Nasdaq 100) we use to hedge. We have no inclination to buy dips here, because we have no support from either valuations nor market action.

What was most surprising about Friday’s “disappointing” jobs report was that it was a surprise. As I observed a few months ago in Notes on a Difficult Employment Outlook “Presently, the 4-week moving average of initial claims for unemployment is running at 468,500. This level is normally consistent with monthly payroll job losses on the order of 80,000. Against that, however, we are likely to get significant short-term job growth from census hiring, which can be expected to exert a positive impact on non-farm payrolls through mid-year. I continue to view the 4-week average of initial claims as one of the more informative series to monitor regarding the employment situation.”

A 4-week average of about 400,000 – 425,000 jobless claims is roughly where we would expect to observe flat jobs growth (excluding temporary factors like census hiring). With the recent figures running closer to 450,000, the fact that we got a positive private sector number at all was something of a gift. As the stock market sold lower on the news, it was fascinating to hear several analysts saying palliatives to the effect of, “Well, some amount of month-to-month variation should be expected. Nobody expected the economy to have a ‘V’ shaped recovery.”

Excuse me, but that’s precisely what the market has priced in. And that’s the problem.

Tags: Dips, Employment Outlook, Employment Situation, Extremes, Fluctuation, Hussman Funds, Inclination, Informative Series, Initial Claims, Jobless Claims, Metrics, Moving Average, Nasdaq 100, Non Farm Payrolls, Private Sector, Russell 2000, Sector Number, Stock Market, Term Job, Valuations
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Risk On… Risk Off… Risk On…

Tuesday, April 6th, 2010

This commentary a guest contribution by David Andrews, CFA, Director, Investment Management & Research, RichardsonGMP Partners

Much like the weather at this time of year, investor appetite for risk also tends to come and go and can change rather quickly. Much like Mother Nature in springtime, the only thing consistent right now seems to be, well …inconsistency. Economic data continues to be, at best, mixed. Last week was no exception as the markets were disappointed by an ADP employment report for March which showed that rather than creating employment in March, the U.S. economy actually lost 23,000 private sector jobs. With 90% of the world’s markets closed in observation of Good Friday, the March non-farm payrolls report was strong with the creation of 162,000 jobs in the U.S. This followed the loss of 14,000 American jobs last month. Employment reports followed weaker housing data from the previous week and gave investors pause about the state of recovery in the world’s largest economy. Without improvements in both employment and housing it will be difficult for the U.S. recovery to gain momentum. On the positive side, manufacturing data and consumer confidence surveys came in better than expected for March. In Canada, GDP for January was better than expected (+0.6% actual vs. +0.5% expected) adding yet more fuel to the likelihood of a hike to short term rates by the Bank of Canada sooner rather than later. Not waiting for it to be official, Banks increased rates on many of their loan products. Five year fixed rate mortgages increased by about 60 basis points last week.

Prevailing concerns about Eurozone debt problems seemed to ease last week following the announcement that the European Union and the International Monetary Fund had devised a plan to back stop Greece’s ailing financial position. The rescue package is a combination of EU and IMP bilateral loans to be triggered only if Greece cannot raise funds independently in the capital markets. Last week, Greece was successful in raising 5 billion Euros of 7 year notes. Europe’s leaders had hoped the announced deal would effectively lower the cost of borrowing for Greece until they can get their deficit down to 8.7% of GDP from the current 12.7%. Yields on 10 year Greek bonds have ticked up an additional 25 basis points since the rescue was announced, so it would seem the market is trying to test the mechanism of support. For perspective, it now costs the Greek government twice as much to borrow as it does the Germans based on 10-year yields.

Energy stocks strengthened last week as crude oil investors bid up the price against a softening U.S. dollar and evidence that economic indicators were indeed pointing to improvement. Crude oil broke out of its recent $70-$85 range on better global economic data and expected demand. We see oil continuing to appreciate as the economic recovery continues to improve into the spring. The conference board recently reported a big positive move in consumer confidence in March and we also saw the U.S. dollar weaken last week which is also supportive of the oil price (priced in U.S. dollars). Crude had a bullish break above US$83.95 with an intermediate technical target of US$105. Copper and Gold also had significant technical breakouts last week, indicating that the “Risk On” trade was back in vogue. Copper is often referred to as “Dr. Copper” for its predictive ability to forecast the economic future. So goes copper, so goes the economy is a common axiom and while not infallible, traders and investors should take note.

Looking ahead to this week, the economic calendar is a bit lighter than usual but we do get ISM non-manufacturing for March and February’s pending homes sales out on Monday. On Thursday, weekly jobless claims are released and Canada’s March employment data is out Friday. For the record, the Dow Jones Industrial average in New York closed last week at 10850.36 or up 0.29% (local currency) for the holiday shortened week. The S&P/TSX closed above the 12000 mark at 12151.10 or up 1.0%.The value of the Canadian dollar increased 1.24% against the U.S. dollar last week.

Source: weekly-5-april-2010-final, Richardson GMP Limited.

Tags: Amp Research, Bank Of Canada, Basis Points, Bilateral Loans, Canada Gdp, Canadian Market, Consumer Confidence, Debt Problems, Economic Data, Employment Report, Employment Reports, Financial Position, Fixed Rate Mortgages, Good Friday, Inconsistency, International Monetary Fund, Investment Management, Loan Products, Non Farm Payrolls, Springtime, Year Fixed Rate Mortgages
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