Should you have sold in May?


Author Cam Hui

Posted: 04 Jun 2013

All it took was someone to whisper “Fed tapering” and volatility has returned with a vengeance to the markets. I explored this topic in late April (see Sell in May?) and outlined various criteria for getting bearish. For now, most of them haven’t been met, which means that I am still inclined to give the bull case the benefit of the doubt.

Surveying the Big Three global economies (US, Europe and China), I see signs of healing – which suggest that markets are likely to continue to grind higher, albeit in a volatile fashion. Let’s take the regions one by one.

US: Muddling through
As I mentioned, I outlined a number of bearish tripwires in my previous post Sell in May?

  • Earnings getting revised downwards, or more misses in earnings reports;
  • More misses in the high frequency economic releases;
  • Major averages to decline below their 50 dma; and
  • Failure of cyclical sectors to regain their leadership and defensive sectors to outperform.

With the exception of high frequency economic release data, none of the aforementioned tripwires have been triggered. The chart below shows the decline in the Citigroup Economic Surprise Index, but my own personal impression of high frequency economic data is that the results have been mixed. Even then, bad news may be good news as a weakening economy may provide the impetus for the Federal Reserve to delay any tapering of QE-infinity.

We will have a major test of market psychology this Friday. Supposing that the Non-Farm Payroll misses expectations, will the markets react positively because it is another data point supportive of further QE, or negatively because employment isn’t growing as expected?

In the meantime, the major market averages remain in a well-defined uptrend. So why are traders so skittish?

In fact, market participants have been so skittish that it only took a minor decline in the major averages for the percentage of bulls from the AAII survey to tank from a crowded long reading (chart via Bespoke). This kind of nervousness do not typically mark major market tops.

In late April, I also wrote that the bearish case also depended on the continued leadership of the defensive sectors and for cyclical sectors to continue to underperform. Well, those trends reversed themselves dramatically in the month of May. The relative performance chart below of Utilities (XLU) and REITs (VNQ) against the market shows that defensive and yield related sectors took a huge hit in the month:

Meanwhile, cyclical sectors as measured by the Morgan Stanley Cyclical Index have started to turn up against the market. What’s more telling is the fact that cyclical sectors performed well in Friday’s market selloff.

Europe: The next step in the Grand Plan
Across the Atlantic, I am seeing signs of healing in Europe (see Europe healing?) What’s more important is the fact that eurozone leaders are taking steps beyond pure austerity measures to address their structural problems.

Recall during the eurozone crises, many analysts said that there were only two solutions to eurozone problems, which was a competitiveness gap between the North and South. Either Greece (or insert the peripheral country of your choice here) leaves the euro and devalues to regain competitiveness, or the North (read: Germany) makes an explicit political decision to subsidize the South. It appears that the latter is happening (from The Guardian) and the focus issue is youth unemployment:

The French, German and Italian governments joined forces to launch initiatives to “rescue an entire generation” who fear they will never find jobs. More than 7.5 million young Europeans aged between 15 and 24 are not in employment, education or training, according to EU data. The rate of youth unemployment is more than double that for adults, and more than half of young people in Greece (59%) and Spain (55%) are unemployed.

Der Spiegel echoed the German “party line” about youth unemployment:

But a new way of thinking has recently taken hold in the German capital. In light of record new unemployment figures among young people, even the intransigent Germans now realize that action is needed. “If we don’t act now, we risk losing an entire generation in Southern Europe,” say people close to Schäuble.

The new solution is now direct country-to-country assistance instead of assistance through the usual EU institutions [emphasis added]:

To come to grips with the problem, Merkel and Schäuble are willing to abandon ironclad tenets of their current bailout philosophy. In the future, they intend to provide direct assistance to select crisis-ridden countries instead of waiting for other countries to join in or for the European Commission to take the lead. To do so, they are even willing to send more money from Germany to the troubled regions and incorporate new guarantees into the federal budget. “We want to show that we’re not just the world’s best savers,” says a Schäuble confidant.

The initial focus of the direct assistance is Spain:

Last Tuesday, Schäuble sent a letter to Economics Minister Philipp Rösler in which he proposed that the coalition partners act together. “I believe that we should also offer bilateral German aid,” he wrote, noting that he hoped that this approach would result in “significant faster-acting support with visible and psychologically effective results within a foreseeable time period.”

Schäuble needs Rösler’s cooperation because the finance and economics ministries are jointly responsible for the government-owned KfW development bank. The Frankfurt-based institution is to play a key role in the German growth concept that experts from both ministries have started drafting for Spain. Spanish companies suffer from the fact that the country’s banks are currently lending at only relatively high interest rates. But since it is owned by the German government, the KfW can borrow money at rates almost as low as the government itself. Under the Berlin plan, the KfW would pass on part of this benefit to the ailing Spanish economy.

This is how the plan is supposed to work: First, the KfW would issue a so-called global loan to its Spanish sister bank, the ICO. These funds would then enable the Spanish development bank to offer lower-interest loans to domestic companies. As a result, Spanish companies would be able to benefit from low interest rates available in Germany.

The concerns over youth unemployment isn’t new. ECB head Mario Draghi spoke about the structural problems relating to youth unemployment in early 2012 (see Mario Draghi reveals the Grand Plan). In a WSJ interview, Draghi discussed what he believed it took to solve the youth unemployment problem [emphasis added]:

WSJ: Which do you think are the most important structural reforms?

Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.

The first step in the Grand Plan was to gradually go after all the entrenched interests of people with lifetime employment and their gold-plated pension plans, etc. In other words, get rid of the European social model:

WSJ: Do you think Europe will become less of the social model that has defined it?

Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.

WSJ: Job for life…

Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.

Now that they are taking steps to clean out the deadwood, the next thing to do is to plant, i.e. directly address the youth unemployment problem. These are all positive structural steps and, if properly implemented, result in a new sustainable growth model for Europe.

In the meantime, the Euro STOXX 50 staged an upside breakout in early May and, despite the recent pullback, the breakout is holding:

Stabilization in China
The bear case for China is this: The leadership recognizes that the model of relying on infrastructure spending and exports to fuel growth is unsustainable. It is trying to wean the economy off that growth path and shift it to one fueled by the Chinese consumer. Moreover, it has made it clear that given a choice between growth and financial stability, the government will choose the latter. This was a signal that we shouldn’t expect a knee-jerk response of more stimulus programs should economic growth start to slow down.

Indeed, growth has slowed as a result. The non-consensus call I recently wrote about is that China seems to showing signs of stabilization (see Even China join the bulls’ party). Since that post, further signs of stabilization is also coming from direct and indirect indicators of Chinese growth.   First and foremost, China’s PMI came out late Friday and it beat expectations (from Bloomberg):

China’s manufacturing unexpectedly accelerated in May, indicating that a slowdown in economic growth in the first quarter may be stabilizing.

The Purchasing Managers’ Index rose to 50.8 from 50.6 in April, the National Bureau of Statistics and China Federation of Logistics and Purchasing said in Beijing yesterday. That was higher than all estimates in a Bloomberg News survey of 30 analysts and compares with the median projection of 50, which marks the dividing line between expansion and contraction.

Moreover, the KOSPI in nearby South Korea, which exports much capital equipment into China, is behaving well. This is somewhat surprising as South Korea competes directly with Japan and the deflating Japanese Yen is undoubtedly putting considerable pressure on the competitiveness of Korean exports:

Other indirect indicators of Chinese demand such as commodity prices are stabilizaing. Dr. Copper rallied out of a downtrend and appears to be undergoing a period of sideways consolidation.

A similar pattern can be seen in the industrial metal complex:

Oil prices, as measured by Brent (the real global price), is also trying to stabilize:

Key risks
In summary, the overall picture seems to be one of stabilization and recovery around the world. In such an environment, stock prices can continue to move higher in a choppy fashion. There are, however, a number of key risks to my outlook:

  • US macro surprise: If we get an ugly NFP this Friday and further signs that US macro picture is slowing, it will negatively affect the earnings outlook and deflate stock prices.
  • Japan: John Mauldin has a succinct summary of the issues facing Japan that I won’t repeat but you should read (see Central Bankers gone wild). The issue of a blowup seems to be one of timing and a catastrophic outcome could be close at hand. With bond yields spiking, how will the economy adjust to rising rates? Already, Toyota has pulled a bond issue because of rising rates. Zero Hedge pointed out how JPM has postulated that “a 100bp interest rate shock in the JGB yield curve, would cause a loss of ¥10tr for Japan’s banks”:

The rise in JGB volatility is raising concerns about a volatility-induced selloff similar to the so called “VaR shock” of the summer of 2003. At the time, the 10y JGB yield tripled from 0.5% in June 2003 to 1.6% in September 2003. The 60-day standard deviation of the daily changes in the 10y JGB yield jumped from 2bp per day to more than 7bp per day over the same period.
As documented widely in the literature, the sharp rise in market volatility in the summer of 2003 induced Japanese banks to sell government bonds as the Value-at-Risk exceeded their limits. This volatility induced selloff became self-reinforcing until yields rose to a level that induced buying by VaR insensitive investors.

  • An emerging market blowup and subsequent financial contagion: The hints of Fed tapering have negatively affected the emerging market bond market and they are starting to roll over against Treasuries. I am monitoring this chart of emerging market bonds against 7-10 Treasuries carefully for signs of market stress and contagion.

The Short Side of Long has indicated that, in general, sentiment towards equities remain at frothy levels which suggests that a short-term pullback may be in order, However,  I am still inclined to stay long equities on an intermediate term basis and give the bulls the benefit of the doubt, but at the same time watching over my shoulder for signs of trouble.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Secular bull or bear?


Author Cam Hui

Posted: 07 May 2013

As US equities have rallied in the last couple of weeks, there has been much discussion about the rotation in sector leadership from defensively oriented sectors to the deep cyclical sectors. Does the rotation mean that this market is truly ready to take off to further new highs? What does it all mean?

I have spent a fair amount of time pondering that question (see my recent post Sell in May?). My conclusion is where you come down on the question of whether this is the start of a new secular bull market where stocks move to new highs or whether we are just seeing the top of a range-bound secular bear.

To explain, consider this long-term chart of the Dow, where the market has seen alternating secular bulls, where stocks rally to multi-decade highs, and secular bears, where the market remains range-bound for years.

Still a secular bear market
My main belief is that we remain in a secular bear for two main reasons: demographics and valuation. I have written about the demographics issue before (see Demographics and stock returns and A stock market bottom at the end of this decade). For stocks to go up, there has to be more buyers than sellers at a given price. The propensity of Baby Boomers, as they move into retirement, is to take money out of stocks. In order for equities to rise, those negative fund flows have to be met by the retirement savings of their children, the Echo Boomers. Two research groups looked into this topic (see papers here and here). Their conclusion – the inflection point at which the fund flows of Echo Boomers moving into stocks start to overwhelm the Baby Boomers taking money out is somewhere between 2017 and 2021.

In addition, long-term valuations don’t appear compelling. I have long considered the market cap to GDP ratio as a proxy for an aggregate Price to Sales ratio for the stock market. The chart below from Bianco Research via Barry Ritholz, shows this metric, whose history goes all they way back to 1925, to be well above its long-term average. In addition, note that instances of falling market cap to GDP ratios correspond with secular range-bound bear markets.

Another reason for the long-term secular bear case comes from John Hussman, an investor for whom I have much respect. His latest 10-year return projections for the SPX is about 3.5% (see My answer to John Hussman). Even with bonds yields at microscope levels, a 3.5% return expectation for US equities is nothing to get overly excited about.

The bull case (and it’s always important for investors to consider opinions contrary to his own) is represented by Ray Dalio’s “beautiful deleveraging” concept (see my post Falling tail risk = new secular bull?). Dalio believes that the United States has undergone a “beautiful deleveraging” process in the wake of the financial crisis of 2008. A “beautiful deleveraging” involves just the right amount of austerity, debt restructuring and money printing. He went on to observe that, by contrast, Europe has gotten it all wrong and that region is likely to be mired in a Lost Decade.

If Dalio is correct, then the rotation that we are observing from defensive to cyclical sectors is another sign of a new upleg in equity prices and therefore the start of a new secular bull.

The intermediate term outlook
While my analysis of the secular bull vs. bear is based on a long-term multi-year investment time frame, what about the intermediate term time frame for the next several weeks to months?

Here’s what’s bothering me about the emergence of the cyclical leadership. First of all, commodities look positively sick. Here is a chart of the industrial metals. Does this look like the basis for a cyclical rebound?

In addition, the Citigroup Surprise Index has been turning down, both in the US and globally. Despite Friday’s NFP upside surprise, the internals of the employment report appeared to be negative and it was before long that there were a cacophony of voices pointing out the weaknesses in the report (for examples, see herehere and here).

I agree with the blogger MicroFundy when he pointed out the divergences between the macro picture and US stocks:

I think we are getting real close to a major inflection point. It seems like every macro-economic data point I come across is saying one thing – the same thing. There is an extremely high correlation between all the varying data points and indicators. Data like the 10yr treasury yields, PMI manufacturing, durable goods orders, copper prices, international (ex Japan) stock markets, inflation expectation, margin levels etc – are all saying that the (global &) US economy is slowing, and that the risks of deflation/contraction/recession are growing.

The only thing diverging from this pattern in all of the charts below is the US equity markets.

His conclusion is “something’s gotta give”:

There are two extreme scenarios that can “correct” the above divergence, although I believe it will be a combination of the two.

1 – We could see a correction of 15-20% that would put the US equity markets back in line with most of the charts above. It would then be priced closer to fair value based on most of the recent economic data.

2 – The economic data can pop back up. Whether it was because of the payroll tax increase, sequestration, or some other seasonal event(s)… maybe this is/was just a blip on the radar these last few months, and the economic data will “catch up” to the US equity markets.

If these scenarios were mutually exclusive, I would bet the farm on #1. A realistic base case assumption though, is a combination of the two. I am anticipating a good 10% correction combined with a small pickup in some of the macro data.

Either way, something’s gotta give. The level of divergence here is bordering historical, and the relative and absolute over-valuation of some of these high-yield names are frightening.

With Europe mired in recession, commodity markets signaling that Chinese growth is stalling, the US is once again holding up the world. If the American economy is holding up the world, then why is US equity performance faltering against global equities? The chart below shows the relative performance of SPY against ACWI (All-Country World Index). If we are indeed seeing a launch of a new secular bull, shouldn’t the US, which has been the beneficiary of the “beautiful deleveraging”, be leading?

A bearish bias
While I have outlined my bias for the bear case, investing is about probabilities and I honestly don’t know how this market is going to resolve itself. While the bear case is compelling, Street earnings and revenue estimates continue to get revised upwards (as per Ed Yardeni).

Until we see some sort of negative macro surprise that cause estimates to get revised downwards, the stock market is likely to grind higher. As I wrote last week, there is no catalyst yet for a bearish impulse for stocks yet.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

A reply to the Ritholz secular bear question


Author Cam Hui

Posted: 19 Feb 2013

I haven’t had the time, but I had been meaning to write a reply to Barry Ritholz’s posts last week where he indicated that he believed that the secular bear market that began in 2000 was in the process of ending (see Explaining My Position on Secular Bear Markets). His caveat was:

I DO NOT KNOW IF ITS OVER. It could be, but I suspect it is not. I do think that it is in the process of coming to an end, and that’s why I used the baseball metaphor of in the 7th inning.

Note: “Coming to an end” does not mean over. I erroneously assumed most people would understand what “in the 7th inning” meant — to those folks overseas, an American game of baseball has 9 innings. The 7th inning means its late in the game, but there are still a few innings left to be played.

I would tend to agree with his assertion that we are much closer to the end than the beginning of this secular bear, but I don’t think that it’s over for a couple of reasons:

  1. Valuations: Stock market valuations have not declined sufficiently to levels where secular bulls have historically begun; and
  2. Demographic effects on fund flows: The Baby Boomers are just starting to retire and take money out of stocks. Who are they going to sell to?

A long term look at stock market valuation
My favorite long-term valuation metric is Market Cap to GDP (via VectorGrader) as a rough proxy for the aggregate Price to Sales for the stock market. Market Cap to GDP, shown on the top panel, remains elevated relative to its own history. Secular bulls have historically begun when this measure has been depressed. In addition, note how falling Market Cap to GDP ratios have corresponded to secular bear markets, which have shown up as sideways markets.

The above chart of Market Cap to GDP only goes back to 1950, in which we have only had one episode of a secular bear, or sideways market. Barry Ritholz also showed, in a separate post from his secular bear post, a much longer history of this ratio that goes back to 1925 from Bianco Research. Market Cap to GDP remains highly elevated relative to its own history. That’s one reason why I don’t believe that a secular bull can start from current levels.

Indeed, Warren Buffett uses a similar ratio of Market Cap to GNP as a valuation measure for stocks. Cullen Roche at Pragmatic Capitalism pointed out that this metric has risen to levels that could only be called  overvalued:

For the first time since the recovery began, Warren Buffett’s favorite valuation metric has breached the 100% level. That, of course, is the Wilshire 5,000 total market cap index relative to GNP. See the chart below for historical reference.

I only point this out because it’s a rather unusual occurrence and the recent move has been fairly sizable. It happened during the stock market bubble of the late 90′s, but then occurred again just briefly during the 2006-2007 period when the valuation broke the 100% range in Q3 2006 and stayed above that range for about a year. We all know what followed the 2007 peak in stock prices.

Demographic headwinds for stocks
Another reason for the continuation of a secular bear, or sideways stock market, is the outlook for fund flows. Simply put, stock prices rise when there are more buyers than sellers. So what happens when Baby Boomers in retirement or nearing retirement withdraw money from stocks? Can their children and grandchildren support stock prices at these price and valuation levels?

I wrote about this topic in 2011 (see A stock market bottom at the end of this decade) and cited two demographic studies by the San Francisco Fed and by Geanakoplos et al.  The conclusions of these studies were that the projected inflection point where the fund flows of the Echo Boomers into stocks start to overwhelm the fund flows of their parents the Baby Boomers is somewhere between 2017 and 2021.

Until then, we will have to live with the ups and downs of a sideways and range bound stock market. Investors should therefore expect that the risk-on/risk-off environment should continue until the end of this decade.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Too much bullishness?


Author Cam Hui

Posted: 04 July 2012

This morning, Mark Hulbertreported that he was seeing too much bullishness among market timers:

Consider the average recommended equity exposure among a subset of the shortest-term stock market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Stock Newsletter Sentiment Index, or HSNSI). It currently stands at 47.0%.

To put the 47.0% recommended exposure into context, Hulbert wrote:

Particularly disturbing is that the HSNSI is now higher than where it stood on May 1, when the bull market that began in March 2009 hit what so far is its highest closing level. It’s five percentage points higher, in fact, even though the Dow is more than 400 points lower today than then.

When I read commentary like that, I like to look for confirmations from other data sources – but I didn’t find it. I don’t know what Hulbert’s sample composition is, but the July 2 Ticker Sense blogger sentiment poll, to which I am a participant (and I voted “neutral”), shows a high degree of disagreement between the bulls and bears:

There are a few explanations for this discrepancy. The sample surveys of the two polls are different, which can lead to differing conclusions. Another explanation could be a difference in methodology. Hulbert measures the average recommended exposure, while the Ticker Sense poll just asks about direction, i.e. if you are bullish or bearish. The bullish timers polled by Hulbert could be extremely bullish, while the bearish timers were only cautiously bearish. Such a result would skew HSNSI and pull the average up far more than “normally” warranted.

Any way I look at it, this doesn’t look like a case of excessive bullishness to me.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Are market expectations too low?

Posted: 03 Jul 2012 12:01 AM PDT

The market expectations going into the European summit last week was extremely low. When the leaders of Europe announced the usual plan to have a plan, the markets surged. Despite the weekend’s chorus of how the devil is in the details of the plan and why the plan won’t work, European stock markets continued to rise on Monday.

This begs the question: Are market expectations too low? As I wrote last week, read the market reaction, not the Summit statement.

The Chinese hard-landing story
Consider the case of how the market is reacting out the story on China and the possibility of a hard landing. On the weekend, Barron’s published a cover story called Falling Star, summarized by the subtitle “The Chinese economy is slowing and is likely to slow a lot more. Get ready for a hard landing.”

China, the article says, is an accident waiting to happen. The points made aren’t anything new for those of us who have been watching China for a while:

After three decades of annual growth averaging 10%, China’s bullet-train economy is slowing markedly. Economic problems in Europe and the U.S. are stunting export growth, long the primary driver of China’s economic miracle. Growth in industrial production has likewise been decelerating for months. This year growth in gross domestic product could slip to 8%—and it may get a lot worse from there. Though recently announced interest-rate cuts and a ramp-up in the government’s already massive infrastructure spending could postpone the day of reckoning, to us it looks like the Great China Growth Story may be falling apart.

For those without a Barron’s subscription, Josh Brown has a good summary of the article here.

Overnight, both China’s official PMI fell to 50.2 from 50.4 and the HSBC manufacturing PMI fell to 48.2, indicating weakness.

What did the market do in the face of all these negative stories? The Shanghai Composite ended up flat on the day Monday and rose on Tuesday. In my last post (see Can China hold things together?), I pointed out a number of extreme risks that are not outlined in the Barron’s article, but current market conditions indicate few signs of financial stress.

Is the US slowing?
As the sun rose on Monday across the globe, individual country PMIs were reported and the reports were generally punk. Contraction, rather than expansion, was the word of the day. As the US market opened, the Markit US PMI came in weaker than expected and ISM missed with a 49.7 reading, compared to market expectations of 52.0. Ed Yardeni has a good post summarizing the broad nature of the slowdown. He cites initial unemployment claims, durable goods orders, regional business surveys, consumer sentiment and consumer spending as sources of economic weakness.

Treasuries rallied hard on the news of economic weakness, but stocks ended the day flat.

On the other hand, housing is showing signs of a rebound. The New York Times reported last week:

Announcements of a housing recovery have become a wrongheaded rite of summer, but after several years of false hopes, evidence is accumulating that the optimists may finally be right.

The housing market is starting to recover. Prices are rising. Sales are increasing. Home builders are clearing lots and raising frames.

Calculated Risk also pointed out that the number of cities with increasing prices were on the rise.

What’s going on? Is the American economy tanking or recovering? If housing is indeed recovering, or even stabilizing, it would provide the underpinnings of a bullish impulse for stocks. The New Deal Democrat has an insightful post where he believes that housing is shaping up to be the stealth (bull) story of the year.

A NFP preview
Friday’s NFP release will be one of the first acid tests of the bull/bear debate on the US economy. The consensus expectations for this month is 80K, which seems very low to me. Gallup does a daily survey of the employment situation, which suggests that while the raw unemployment rate will be unchanged from last month, the seasonally-adjusted unemployment rate will fall.

If I were a betting man, I would take the “over” bet on NFP this Friday. If I am right, it would mean another relief rally because market expectations have been racheted down too low.

Don’t get me wrong. My inner investor continues to be very nervous about the macro backdrop. The global economy is weakening. Europe just kicked the can down the road by a few weeks and Greece will undoubtedly fall apart again before the end of 2012. I am also concerned about the tail-risk of a black swan event coming out of China.

My inner trader is telling me that we are poised for a relief rally on any form of good news, largely because expectations are too low. Enjoy the party but stay close to the exits.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Not enough panic?


Author Cam Hui

Posted: 25 May 2012

As stocks have descended in the last few weeks, investor sentiment measures have moved into zones indicating excessive fear. As an example, the Citigroup Panic/Euphoria model is in the “panic” territory, which is contrarian bullish.

Numerous other indicators, such as the Ticker Sense Blogger Survey, to which I contribute and voted “bearish” last week, also confirms the observation that there are too many bears.

Watch what they do, not what they say
What’s bothering me is that while all these sentiment surveys point to excessive bearishness, market based indicators such as the VIX Index is not showing very much fear at all.

Remember, what what they do, not what they say. While I have written before that this market is deeply oversold and due for a relief rally, these readings are suggestive that there is more downside before we see an intermediate term bottom.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Have a plan for 2012


Author Cam Hui

Posted: 03 Jan 2012 12:27 AM PST

Sometimes the investment process is more important than the investment decision. In the past few days, I have outlined:

I urge all investors to have a game plan for the year ahead and beyond. Despite all of our best efforts, our forecasts can and will fail and how you react to the change in direction is more important than the decision you take today.

Strategies for different parts of the cycle
Barry Ritholz recently showed a series of charts of the economic cycle and how investors should react to them, two of which I show below. However you approach the market, whether it’s asset and sector rotation, or stock picking, recognizing your investment environment is key to alpha generation. This chart shows the analytical framework for the asset and sector rotators:

 

And this one is a framework for the stock pickers:

Be tactically aware of the investment environment
My approach is to become more tactical in my asset allocation using my Asset Inflation-Deflation Trend Model. An article in Registered Rep shows how many investment advisors are turning to tactical asset allocation as an investment solution to dampen portfolio volatility:

Following the twin market implosions of the past decade—first tech, then real estate—many retail financial advisors are looking for more tactical, meaning active, asset allocation solutions for client portfolios to dampen volatility, improve total returns and avoid market catastrophes. At least some of them fear that if they don’t dramatically change the way they allocate client portfolios, moving away from traditional buy-and-hold investing strategies, they could lose clients. So say a handful of advisors and an investing expert.

Not becoming more tactial could pose a business risk:

Things could get especially bad if another bear market hits, says Ron Carson, founder and CEO of Carson Wealth Management Group. “[Investors] are hanging on by a thread right now, and I don’t think they’re going to forgive.” A Natixis Investor Insights Study found that 63 percent of investors are now paying more attention to risk than ever before. If the market nose-dives, advisors are going to want to have a different story to tell. They can’t just tell clients to hang on and wait it out like many of them did in 2008.

The movement to tactical asset allocation has turned from a trickle to a flood:

According to a survey by Cerulli Associates, the number of FAs using either a pure tactical allocation or strategic allocation with a tactical overlay is now at 61 percent, up 8.3 percent from 2010. A Jefferson National survey from September 2011 found that 75.5 percent of advisors believe that active portfolio managers can outperform an index over the long term. In Jefferson National’s 2010 survey, 66 percent of advisors said clients were more confident with a tactical asset management strategy, while only 34 percent said clients were more confident with a traditional buy-and-hold strategy.

Are you betting the farm?
Stocks didn’t go anywhere in 2011. In fact, they haven’t gone anywhere since the NASDAQ peak in 2000. In the current low-return environment, advisors find that clients are less forgiving of draw-downs in their portfolio.

In days past, the practice of overweight a portfolio with a manager to make a big style or macro bet that “looks through the economic cycle”, e.g. a value manager, was perfectly acceptable. The downside to managers that make such style bets is they tend to badly underperform during certain periods when their style is out of favor – and investors are far less tolerant of such draw-downs in the current volatile and low return environment.

As an example, there were numerous managers who were wary of internet stocks during the Tech Bubble runup. I had watched many good managers and strategists go down in flames because they were one or two years early because their investors couldn’t stand the underperformance. Today, investors are highly intolerant of negative volatility, largely because of the low return environment that we have been stuck in for the last decade.

Have an investment plan
The message is clear. Take control of your portfolio. Be aware of the investment environment. Your investment philosophy and objectives are up to you. However, you should make sure that you have engineered your portfolio’s risk profile sufficiently so you survive to get to your objective.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The road ahead: bull & bear case


Author Cam Hui

Posted: 31 Dec 2011 10:11 AM PST

As 2011 draws to a close and we 2012 dawns, it’s time to consider the bull and bear cases for the stock market and risky assets. I had already outlined my bull case for the market on December 19 (see The bull case for stocks). The bull case consists of:

  • The coordinated central bank liquidity injection of November 30 has taken a Lehman-like event off the table.
  • In the US, the Fed does QE3 in the 1H, which would send asset prices flying.
  • In Europe, the ECB is already engaged in a form of QE though the back door using LTRO, which should heal banking balance sheets over time.

Go and read my previous post, there is little more to be said.

The bear case for stocks
From a macro viewpoint, the three regions to watch are Europe, the US and China and the emerging markets. The market was focused on the possibility of a European banking crisis during much of 2011. No, the bear case for stocks in 2012 does not rest with Europe. I believe that market’s focus will shift from Europe to the other regions of the world in 2012.

Europe: From heart attack to cancer
The ECB’s LTRO program, which offered banks unlimited liquidity for up to three years, has virtually eliminated the possibility of a banking failure. In addition, coordinated central bank intervention that offered unlimited USD liquidity also showed that central bankers around the world are well aware of the risks of a Lehman/Creditanstalt credit event and have taken steps to address the problem. Nevertheless, problems remain and all Draghi & Company has done is bought time for the politicians to address the long term issues.

What is the market saying about Europe? Scott Grannis wrote in his PIIGS Update that conditions in the bond market are normalizing, though far from ideal. The ECB’s balance sheet expansion does not appear to be leading the eurozone down the hyperinflation path, but problems remain. In other words, Europe has gone from avoiding the imminent heart attack to a lingering but treatable cancer. We will have to watch and see how the politicians address the longer term problems of the competitiveness disparity between North and South, as well as the debt situation of the PIIGS. No doubt, we will continue to have crises and summits, but the risk of a catastrophe is lower than it was in 2011.

A US recession in 2012?
One thing that investors shouldn’t forget that stock prices depend on fundamentals, i.e. earnings, growth outlook, interest rates, etc. An American recession would affect the outlook for earnings and therefore depress stock prices as a result. The question for the bears is, “Will the US experience a recession in 2012?”

Certainly, a recession would not be out of the question here. This post from Pragmatic Capital shows that the US was in recession 18.3% of the time in the 2000-2011 period and a whopping 30% of the time if you consider the 1855-2011 time span. The likes of ECRI and John Hussman have been trumpeting their recession forecasts for the American economy. On the other hand, recent economic releases have largely been coming in ahead of expectations, which point to an economy with subpar growth, but no signs of a slowdown.

Should the US experience a recession, the S+P 500 could easily fall to the 900-1000 level, though it is unlikely to revisit the post-Lehman panic low of 666.

Watch out for China
I believe that the bear case for stocks rests largely with China and the emerging markets. I wrote on December 13 to watch for the China is slowing stories to emerge (see A “China is slowing” scare?). Whether China slows to a hard landing, i.e. sub-5% growth, or not is less relevant to the markets as the scenario of the markets starting to discount the possibility of a Chinese hard landing.

Since I wrote that post, the scare stories are starting to appear. Consider:

I could go on, but you get the idea. More worrying is the fact that other analysts are starting to pile on, not just the China is slowing story, but the prospect of slowing growth in the emerging markets. As an example, Stephen Roach recently penned an article entitled Why India is riskier than China.

I wrote here that the stock indices in India and China are not behaving well. I believe that the biggest risk for the stock markets is a rising level of risk aversion as investors price in the increasing likelihood of a slowing growth from the emerging market economies.

Listen to the markets
In the end, I stand with the bears on the recession, or economic slowdown, call. Commodity prices remain in a downtrend, which is a signal of slowing global demand for raw materials.

The CRB Index is liquidity weighted, which means that it is more energy heavy. As you can see below, oil prices have been behaving relatively well lately.

We can get a even better picture of global commodity demand from the Continuous Commodity Index, which is the CRB Index on an equal weighted basis. The picture of the CCI looks even worse than the CRB as it has undercut its October lows and remains in a well-defined downtrend.

As well, you can tell a lot about short-term direction by the way the market responds to news. In the past couple of weeks, we saw a couple of important signs that much of the good news is priced into stocks. The first occasion occurred when the market sold off in the aftermath of a better than expected LTRO at €489 billion. Te second was when it sold off again when Italy sold six-month bills at yields that were roughly half of what they were in November.

When the markets go down on good news, the bulls should be wary. In addition, signs of a global slowdown are on the horizon.

That’s why I stand with the bears.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

 

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