As The Dollar Takes Off, The Dow Falters - Risk Appetite is Threatening Collapse

Friday, January 22nd, 2010

This article is a guest contribution by John Kicklighter, Currency Strategist for DailyFX.com.

Any doubts that the market has forged higher without the support of stable fundamentals should be completely dispelled after this week’s sharp reversal. Even if this recent slump in investor sentiment doesn’t ignite into a true reversal of capital flows; the simple fact that the markets retraced so aggressively and in tandem stands as testament to the fear that lies just beneath the surface.

•    The Dollar Takes Off and Dow Falters – Risk Appetite is on the Verge of Collapse
•    When Sentiment Falls Apart Correlations will Tighten and Momentum Increase
•    How Over Extended are the Market and What are Fair Fundamental Values?

Any doubts that the market has forged higher without the support of stable fundamentals should be completely dispelled after this week’s sharp reversal. Even if this recent slump in investor sentiment doesn’t ignite into a true reversal of capital flows; the simple fact that the markets retraced so aggressively and in tandem stands as testament to the fear that lies just beneath the surface. What’s more, there are plenty of fundamental reasons to be concerned about the state of the markets or more precisely the conviction of those participants that drove the supposed high-yield / high-return asset classes to their over inflated levels. Among the long line of fundamental concerns that have slowly eroded the foundation of the most aggressive influx of speculative capital in history, we have non-existent yields, government efforts to restrain capital interests and the withdrawal of vital stimulus among many other factors.

In gauging the threat of a significant retracement going forward, we need only pick our poison. Every major asset class has its own benchmark that is ready to suffer the ravages of risk aversion. In the Forex market, many prominent carry-based currency pairs have already marked critical breaks and reversals. The dollar has taken meaningful steps towards true recovery. Now, we await the clear break of the Carry Trade Index. The same conditions exist in more speculator-responsive markets. The Dow Jones Industrial Average broke out of a 300-point range for the first time in two months. In commodities, gold has overwhelmed a trend that has defined the metal’s bullish drive for more than five months now. These markets are at the very edge and require only the slightest gust of fundamental wind to transform a retracement into a true change of trend.

What could motivate investors to throw in the towel and either book profit or unwind failing positions? The most basic force at work will be fear itself. Should the more prominent benchmarks pitch into a clear downtrend, market participants will require little motivation to exit the market. Remember, it wasn’t long ago that the these markets suffered their worst crisis in modern history. While the collective memory of the markets is short; there is little doubt that traders will heed the warning signs and attempt to preserve any returns they have made over the past year. So, in these terms; all we need is a catalyst. There are plenty of sparks to push sentiment over the edge. The most recent threat to speculation comes in the form of government regulations and restrictions. These past two weeks, China has taken meaningful steps to limit leverage and aggressive speculation to prevent a potential bursting of an asset bubble.

There is no argument to be made against the overextended market. Raising the reserve ratios, tightening loan requirements and other steps are no doubt reasonable; but their effectiveness in this stage of the game is too little, too late. And, China (the objective of a sizable percentage of the market’s most speculative funds) isn’t the only country bearing down on the volatile capital markets. US President Obama recently announced proposals that would limit the size and risk profile of the nation’s largest banks. This is a reasonable and direct step for a country that has been rocked by the failure of ‘too-big-to-fail’ firms; but there is little doubt that the side effects of such policy would be to reduce leverage and liquidity. Furthermore, these steps are being taken at the exact same time that the world’s policy makers are withdrawing the stimulus that has been so essential to market’s recovery to this point. As it was, there were concerns that speculators would be able to stand on their own when stimulus and guarantees were removed. Now they are looking at restrictions.

Written by: John Kicklighter, Currency Strategist for DailyFX.com.
Questions? Comments? You can send them to John at jkicklighter@dailyfx.com.

Source: DailyFX - The Dollar Takes Off and Dow Falters – Risk Appetite is on the Verge of Collapse http://www.dailyfx.com/forex/fundamental/article/carry_trade_basket/2010-01-22-0657-The_Dollar_Takes_Off_and.html

Tags: asset class, Asset Classes, Capital Interests, China, Collapse, Commodities, Correlations, Currency Pairs, Currency Strategist, Emerging Markets, Falters, Forex Market, Fundamental Concerns, Fundamental Reasons, Fundamental Values, Gold, Government Efforts, Influx, Investor Sentiment, Retracement, Risk Appetite, Risk Aversion, Simple Fact, Speculative Capital, Vital Stimulus
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David Rosenberg: Mr. Market has a full tummy

Friday, September 4th, 2009

The stock market assessment below comes from highly regarded David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates.

We may well be in an entirely new phase right now. For months, the equity market had this uncanny ability to rally on any good news, as the psychology took hold that less-negative data was a positive (like having your golf score go up but at a slower rate). Any adverse data that caused a retracement from March to August was treated as a buying opportunity.

But having gone from pricing in -2.5% real GDP growth at the lows to +4.0% now, it looks like Mr. Market is becoming a little more discerning in terms of interpreting the economic data. Even before yesterday’s [Tuesday] selloff, the equity market was no longer rallying on “good news”, and there were many such data points that rallied the economics community to the sidelines, pom-poms and all, in order to cheerlead the incoming information - durable goods orders, all the housing data, consumer confidence, and even Bernanke’s re-appointment. Three months ago, the stock market would have been rallying like mad based on all these goodies - but it hasn’t this time around.

Yesterday was an exclamation mark on just how much is priced in because ISM surged to 52.9 and pending home sales soared 3.2% MoM (best level since June, 2007, no less) - though construction spending in June did dip 0.2% as declines in nonresidential and public construction overwhelmed the recovery in the residential sector. And there was also the news that global chip sales rose in July for the fifth time in as many months - by a ripping 5.3% (though still down 18.2% YoY). Not only was the stock market down 2.2% yesterday, but it was on higher volume to boot (+19% on the NYSE) - distribution days are never very good signposts.

As everyone knows, we have been very busy working hard to identify what the markets are discounting in terms of future economic growth and came to the conclusion months ago that the equity rally in particular was leapfrogging the outlook. It’s one thing to price out the recession, which is what a 20% rally suggests, but once you surge over 50% from any low the market is usually in year two of the recovery phase. Even if the economy does better than we think it is capable of, the reality is that the stock market has discounted a whole lot of growth - from our lens, two year’s worth. We can debate the macro outlook, to be sure, but the market does look now as though it is going to sit and wait for the fundamentals that have been priced in to come to fruition.

From a purely technical standpoint, which is beyond our purview but must be addressed since so much of the bear market rally was technically-based, a 50% retracement would imply a corrective phase to 840-850 on the S&P 500, which would imply that the market is back to pricing in a 2.0% growth trajectory for the coming year (precisely where the corporate bond market is in terms of its embedded outlook for growth). If in fact we are in a corrective phase, this would mean at least 15% downside potential in equity prices, and a shift towards defense, stability and income at a reasonable price would seem prudent after a rally that was led mostly by junk and cyclical securities.

Presently, it is still unclear whether or not we are going to necessarily undergo this correction - so many times in this bear market rally buyers have come in after the type of giveback we have endured, which has been just 3.2% thus far from the 1,030.89 interim peak on August 27. A break below the most recent low of 979.73 back on August 17 would probably be very meaningful in this sense, and again, what is different this time is that we just came off a week with some new information - Mr. Market is no longer rallying on good news. And, this is exactly what the tell-tale sign was back in 2002, when after a huge rally, the S&P 500 failed to rise on the day that the ISM broke above 52.0 as it did yesterday (when the March 2002 data were released on April 1 of that year) - that was an early sign to take profits because the market slid more than 30% over the next six months.

Similarly for the bond market, it would be critical for the yield on the 10-year note, now at 3.37%, to “take out” the interim July 10 low of 3.32% - if that happens, a break towards 3.00% is very probable.

Tags: Chief Economist, Consumer Confidence, David Rosenberg, Durable Goods Orders, Economics Community, Exclamation Mark, Fifth Time, GDP Growth, Global Chip Sales, Gluskin Sheff, Golf Score, Market Assessment, Poms, Public Construction, Real Gdp, Residential Sector, Retracement, Selloff, Signposts, Uncanny Ability
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David Rosenberg: Equities on a roll, but still overvalued

Monday, August 31st, 2009

David Rosenberg, formerly the Chief North American Economist at Merrill Lynch in New York, returned to his native Canada to settle at Toronto-based Gluskin Sheff, following the Bank of America acquisition. He is highly respected and one of the most candid and lucid macro-economists and his grasp of the market related economics is refreshing. Rosenberg says there is no point in making economic forecasts that are not backed up by actionable investment calls. His Breakfast, Lunch, Coffee and Tea With Dave newsletters are worth reading.

Last week, Rosenberg shared his thoughts on the question, “Is the financial crisis over?” (08/25)

Not if you’re not too big to fail. We are now up to 77 failed U.S. banks so far in 2009. This already matches, in just eight months, the number of lenders who failed in the previous 16 years combined.

About bear markets and valuation:

One should always keep an open mind. Practically all bear markets have a 50% retracement and this cycle has been no different. However, what we have witnessed is unprecedented because at no time in the past has the stock market rallied more than 50% ahead of the supposed end of a recession. Normally, the
move off the lows to the official end of the economic downturn is 20%. And, the trailing P/E multiple on operating earnings is now north of 25, a record eight point expansion in a short time frame (the P/E on reported earnings is nearly 130x!).

Go back to the March lows, and the market was down around 60% from the peak,but then again, earnings plunged the same amount. At the lows, valuation levels
suggested that equities were pricing in $50 of operating earnings and -2.5% real GDP growth for 2009. And guess what? That’s exactly what we are likely to get.

What’s priced in five months and 50% later? Call it $70 on operating EPS for the coming year and +4.0% real economic growth. In other words - the stock market is fully priced and then some. But for the time being, the technicals and sentiment - the high level of enthusiasm - and the risk of a “buying panic” by lagging portfolio managers are very likely going to make folks, like Walter Murphy, look prescient.

About last week’s so called good news (08/26):

1. Bernanke reappointed

We really fail to see how it could possibly be that the same central bank official, who, over a span of a decade, presided over two massive bubbles and their busts, can be viewed as being a positive force for the markets. Perhaps there is some solace in knowing that the same person who created this awesome and complex $2 trillion Fed balance sheet will be around to dismantle the largesse since he’s probably the only one that knows how.

2. The first monthly increase in the Case-Shiller home price index

As for the second point, there is a difference between a trendline and the noise around that trendline. Home prices are down a massive 31% from their peak and have been in a vertical-down pattern for nearly three years. Perhaps a respite is in order, but with the true underlying unsold inventory near 12 months’ supply, which is double what would typify a balanced housing market, it would seem like wishful thinking that we have suddenly achieved a fundamental low in residential real estate values (especially at the high end).

3. The seven-point jump in consumer confidence in August

With regard to point number three, we welcome any rise in consumer confidence but an honest appraisal of the data would show that 54.1 is still a very depressed level. In fact, the average index level during recessions is 73.0 - August’s reading was nearly 20 points below that. So, if the recession is indeed over and done, somebody forgot to tell this 70% chunk of GDP otherwise known as the consumer.
Now, what about Mr. Market, who is still in a most joyful mood. Well, the normal level of consumer confidence in the month in which the S&P 500 is up 55% from an oversold bear market low is 100. So, the stock market is behaving as if consumer confidence is twice the level it really is.

What is the enemy of this bear market rally?

The real enemy for the equity market is Mr. Bond - that pesky Treasury market that just won’t sell off and validate the great reflation trade. Indeed, if we were seeing a real asset allocation move on the part of investors, as opposed to massive and ongoing short covering, then the 10-year Treasury note yield would be trading close to 5.0% - especially with these freshly minted Obama debt forecasts. But instead, the 10-year note is now getting perilously close to the July 10 low of 3.32%. Keep in mind that July 10 was the day when Meredith Whitney gave the green light to Goldman, and Roubini declared the recession to be ending, and what a spark that provided to this last leg of the bear market rally. Now what if Doug Kass’ declaration yesterday that the major averages have hit their highs for the year proves as prescient in the other direction? Come on, not only is the market trading at a nutty 130x multiple, but September-October is right around the corner (as is H1N1).

Equities are on a roll… but still overvalued (08/28):

We continue to hear how undervalued the stock market got to this cycle, but it was really the corporate market that was priced for Armageddon. The equity market, at the lows, was discounting -2.5% real GDP, but if it was pricing in the same outlook as corporates, Baa spreads pierced the 600 basis point threshold, then the S&P 500 would have bottomed near 315, not 666. (Hey, that still would have been a triple-bagger from the 1982 lows!)

Be that as it may, what we have on our hands is a liquidity-induced and technically-strong equity market, and as Bob Farrell has been known to say, these types of rallies quite often “go further than you think” but they do not generally correct by “going sideways”. Even if the recession is over, the market usually is up 20% from the time of the bottom to the end of the downturn. By the time we are up over 50% on the S&P 500, what is “normal” is that we are heading into the second year of recovery (recession being over isn’t even a debate), the economy has shown an ability to expand without the need for government assistance and GDP would have risen nearly 5.0% by now and helped create about 1 million jobs. In other words, after the market has jumped over 50% from the low, we have moved beyond hope and into reality.

You can sign up to receive David Rosenberg’s letters by email here.

Tags: Acquisition, American Economist, Bank America, Bank Of America, Bear Markets, Breakfast Lunch, Canada, Candid, Coffee And Tea, Core Beliefs, David Rosenberg, Economic Downturn, Economic Forecasts, Economics, Economists, Eight Months, Five Months, GDP Growth, Gluskin Sheff, Gold, Grasp, Lows, Merrill Lynch, Native Canada, Real Gdp, Recession, Retracement, Stock Market, Technicals, Valuation Levels
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Sell in May and go away: fact or fallacy?

Wednesday, April 29th, 2009

Where is the stock market heading? Has the rally that started in early March been exhausted? These are the key questions on all investors’ minds as financial markets remain caught between the frantic actions of central banks to get the cogs of the credit system and economy turning again on the one hand, and a still shaky economic and corporate outlook on the other.

It is therefore no wonder that even so-called “pop analysis”, including some legendary axioms, is resorted to in a quest for direction. And besides “buy low and sell high” few other axioms are more widely propagated than “sell in May and go away”. A Google search revealed an astounding 127,000 items featuring this phrase.

As equities have seen a particularly strong six-week rally, followed by what looks like the start of a consolidation/retracement of some of the recent gains, investors are justifiably questioning the market’s next move. And they nervously wonder whether this May will not only herald longer days in the Northern Hemisphere, but also live up to its reputation as the advent of a corrective phase in the markets.

The important issue, however, is whether this axiom actually has any scientific basis at all. Analyzing historical returns, the figures vary from market to market, but long-term statistics seem to show that the best time to be invested in equities is the six months from early November through to the end of April of the next year (”good” periods), while the “bad” periods normally occur over the six months from May to October.

A study of the MSCI World Index, a commonly used benchmark for global equity markets, reveals that since 1969 “good” periods returned +6.5% per annum while investors were actually in the red by -1.0% per annum during the “bad” periods.

“Sell in May and go away” also holds true for the US stock markets. An updated study by Plexus Asset Management of the S&P 500 Index shows that the returns of the “good” six-month periods from January 1950 to March 2009 were 7.9% per annum whereas those of the “bad” periods were 2.5% per annum.

A study of the pattern in monthly returns reveals that the “bad” periods of the S&P 500 Index are quite distinct, with five of the six months from May to October having lower average monthly returns than the six months of the good periods. Interestingly, May - the first month of the bad patch - is the only exception.

But what exactly does this mean for the investor who contemplates timing the market by selling in May and reinvesting in November? Further analysis shows that had one kept the investment in the S&P 500 Index only during the “good” six-month periods, and reinvested the proceeds in the money market during the “bad” six-month periods, the total return would have been 10.5% per annum.

These calculations do not take tax into account. And, of course, every time one switches out of and back into the stock market there are costs involved, which would also reduce the returns for the market timer.

How did the good and bad periods stack up during the past two years? The results are as follows.

• May 2007 - October 2007: +4.52%
• November 2007 - April 2008: -9.62%
• May 2008 - October 2008: -30.1%
• November 2008 - April 2009: -5.1%

Some you win, some you don’t! It seems that the axiom “sell in May and go away” in itself is a rather doubtful basis for timing equity investments. However, it may serve a useful purpose as input, together with other factors, to otherwise rational decision making.

Tags: Annum, Axiom, Axioms, Central Banks, Cogs, Corporate Outlook, Corrective Phase, Early November, Fallacy, Financial Markets, Global Equity Markets, Google, Google Search, Historical Returns, Msci World Index, Northern Hemisphere, Retracement, Stock Market, Term Statistics, Us Stock Markets
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Treasury Bills - Is This The Low?

Tuesday, January 13th, 2009

This post is a guest contribution by Bennet Sedacca*, President of Atlantic Advisors Asset Management

In the chart below, please note the very simple channel in long bond futures going back to the beginning of the bull market. Prices seem to top every 5 years and, right on schedule, they’ve topped again.

Click here or on the chart below for a larger image.

The usual correction is in the 18-25% range if it revisits the lower end of the channel. From the top, at roughly 142, a 25% move would be to 106 or so, which is still a whopping 4.4%. I think is far too low considering a) what actually now sits in the Treasury and b) the sheer amount of global supply that is forthcoming. Even in a slow economy, I think foreigners will need to be sellers. I am finishing up my Mortgage Backed Securities program today and heading to more cash.

One more thing. The secular bull market in stocks, in my opinion, ran from 1974 to 2000. Twenty-six years. The bull market in bonds looks like it ran from 1982-2008, also twenty-six years and exactly the length of time I have been at this. With the “blow-off” move we just had, my guess is that the top is in, perhaps for a very long time … like a decade.

Using a Fibonacci analysis leads us to targets that are … well, nauseating and could be a 50% retracement of the whole move. So buyers of long bonds beware. And if you want to refinance, and can actually find a good program, I wouldn’t hesitate. That goes for individuals and corporations alike. Why the Treasury is BUYING bonds at these levels instead of selling long Treasuries is beyond me.

Click here or on the chart below for a larger image.

* President of Atlantic Advisors Asset Management, Bennet Sedacca brings with him more than 26 years of securities industry experience. From 1981 to 1997 he worked for several major investment banks, specializing in high-grade fixed-income securities marketing, trading and portfolio management. In 1997 he formed Sedacca Capital Management focusing on portfolio management for high-net worth individuals and small to mid-sized institutions.

Tags: Asset Management, Bond Futures, Buying Bonds, Fibonacci Analysis, Fixed Income, Foreigners, Global Supply, Income Securities, Industry Experience, Investment Banks, Length Of Time, Mortgage Backed Securities, Portfolio Management, Retracement, Secular Bull Market, Securities Industry, Slow Economy, Treasuries, Treasury Bills, Treasury Bonds
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