Watch these lines in the sand!


Author Cam Hui

Posted: 21 June 2013

The fact that the Fed telegraphed its decision to begin tapering QE later this year, assuming that the current trajectory of economic data holds, was not an enormous surprise to me. However, the combination of the Fed decision, bad China data overnight and a liquidity squeeze in China have served to exacerbate the global market selloffs as I write these words.

Is this just a minor correction or the start of something worse? These are some technical lines in the sand that I am watching. First of all, the decline in the SPX has been contained at its 50-day moving average in the recent past. Can support at the 50 dma, which is at about 1618 hold?

As well, bond yields have been spiking in the wake of the FOMC decision. Past surges in 10-year Treasury yields have been contained at about the 2.4% level. Can 2.4% hold?

Bearish trigger in Europe
I have also been relatively constructive on European equities and believe it to be a value play. Despite the negative tone on the markets, eurozone PMIs have surprised on the upside (via Business Insider):

I wrote that past declines in European equities have been contained at its 200 day moving average (see The bear case for equities). Can the 200 dma hold?

Bearish trigger in emerging markets
In China, the combination of poor June flash PMI and a liquidity crunch have served to throw the markets into a tizzy. Zero Hedge reports that overnight repo rates spiked to 25%, which is evocative of the market seizures seen during the Lehman Crisis.

At this point, we don’t know if this credit crunch is deliberate or if the Chinese authorities have lost control of the interbank market (see FT Alphaville discussion). Michael McDonough sounded the alarm about the possible negative effects of this credit crunch on Chinese growth:

Should the Chinese credit crunch get out of control and start to spill over into the global markets, we should see the first signs of it in emerging market bonds. I wrote to watch the relative performance ratio of the emerging market bond ETF (EMB) against US high yield (HYG), which is testing a key relative technical support level (see An EM yellow flag):

I had written in the past to watch the price of the Chinese banks listed in HK as warning signs (see The canaries in the Chinese coalmine). That indicator may have lost some of its power as Reuters reported on Monday that the Chinese authorities have stepped in to increase their stake the state banks in order to “boost confidence”:

China’s government has stepped up efforts to lift confidence in the country’s flagging stock markets by buying more shares in the four biggest commercial banks, stock exchange statements showed on Monday.

Central Huijin Investment Co, which holds Beijing’s investments in state-owned financial firms, spent about 363 million yuan ($59.2 million) buying bank shares on June 13, Reuters calculations based on stock exchange filings showed.

This is the third time Huijin has been known to be buying shares in the secondary market since June 13, when China’s stock market skidded to six-month lows after data showed the world’s second-biggest economy was cooling faster than expected.

Watch the tripwires!
In summary, I wrote on Monday that my Trend Model had moved to “neutral” from “risk-on” (see Is the correction over?). For now, I am in watch and wait mode and monitoring these bearish tripwires before I go into full-flown “risk-off” mode:

  • Can the 50 dma hold for the SPX?
  • Can the 10-year Treasury yield breach the 2.4% level?
  • Can decline in the STOXX 600 be arrested at the 200 dma?
  • Will emerging market bonds melt down?

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. 

Advertisements

The bear case for equities


Author Cam Hui

Posted: 11 June 2013

I have been fairly bullish in these pages and I remain cautiously bullish today. However, successful investors and traders look at the other side of the coin to see what could go wrong with their thesis. Today, I write about the bear case, or what’s keeping me up at night.

The signal from emerging market bonds
James Carville, former advisor to Bill Clinton, famously said that he wanted to be reincarnated as the bond market so that he could intimidate everyone. The message from the bond market is potentially worrying. In particular, emerging market bonds are selling off big time. The chart below of the emerging market bond ETF (EMB) against the 7-10 year Treasury ETF tells the story. The EMB/IEF ratio broke an important relative support level, with little signs of any further support below the break.

Technical breaks like these are sometime precursors of a catastrophic event, much like how the crisis in Thailand led to the Asian Crisis. For now, the concerns are somewhat “contained”. Yes, junk bond yileds have spiked…

On the other hand, the relative performance of high yield, or junk, bonds against 7-10 year Treasuries remain in a relative uptrend, which indicates that the trouble remains isolated in emerging markets.

Here is the relative performance of emerging market bonds against junk bonds. They have been in a multi-year trading range. Should this ratio break to the downside, it would be an indication that something is seriously wrong in EM that smart investors would be well advised to sit up and take notice of.

For now, this is just something to watch.

Are European stocks keeling over?
The second area of concern is Europe. Despite my bullish call on Europe (see Europe healing?) European stocks have been performing poorly in this correction. As the chart below of the STOXX 600 shows, the index has fallen below its 50 day moving average, though the 200 day moving average has been a source of support in the past.

The 200 dma is my line in the sand.

Faltering sales and earnings momentum
In the US, high frequency macro indicators are showing a pattern of more misses than beats, as measured by the Citigroup Economic Surprise Index.

Ultimately, a declining macro outlook will feed into Street sales and earnings expectations for the stock market. Ed Yardeni documented the close correlation between the Purchasing Managers Index against revenue estimates.

Viewed in this context, the PMI “miss” last week is especially worrying. Indeed, Yardeni showed that the Street’s forward 52-week revenue estimates are now ticking down. Unless margins were to expand, which is unlikely, earning estimates will follow a downward path and provide a headwind for equity prices.

As Zero Hedge aptly puts it, this is what you would believe if you were buying stocks right now:

My take is that the downturn in high frequency economic releases a concern, but it is something to watch and it’s not quite time to hit the panic button yet. I agree with New deal democrat in his weekly review [emphasis added]:

After several weeks of more positive signs, last week we returned to the pattern of gradual deterioration that began in February. This week most indicators remain positive and there were fewer negatives…

Last week I said that for me to be sold that the data is actually rolling over, I would want to see a sustained increase in jobless claims and a sustained deterioration in consumer spending. That wasn’t happening as of last week, and it certainly didn’t happen this week either. The economy still seems to be moving forward – but in first gear.

In summary, most of these concerns are on the “something to watch” list to see if any of these risks turn out to be more serious. My base case, for now, is that the market is undergoing a typical rolling correction, with leadership shifting from interest sensitive issues to deep cyclicals (see my recent postCommodities poised for revival). Until the late cycle commodity stocks roll over, there is probably more upside to stocks from these levels, but I am still looking over my shoulder and defining my risk parameters carefully.

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. 

Would you short this?


Author Cam Hui

Posted: 10 June 2013

Look at this four-year weekly chart. Would you buy, sell, or hold this?

I will write about what it is on Monday and discuss it further.

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.

Commodities poised for revival


Author Cam Hui

Posted: 07 Jun 2013

Yesterday’s stock market selloff was an event that we haven’t seen in some time, as major averages fell over 1% across the board – and globally. Nevertheless, I saw a glimmer of hope for the bulls, as commodities were performing well despite the carnage. If a deep cyclical sector like that is displaying rising relative strength, it suggests that the end of this correction may not be too far off.

Commodities unloved and washed out
Simply put, the commodities complex is unloved, washed out and showing signs of investor capitulation. The chart below from BoAML shows the aggregate large speculator (read: hedge fund) net position from the Commitment of Traders report in the CRB Index. Large speculators have liquidated their net long positions from a near crowded long level to net short. Moreover, readings are consistent where declines have halted in the past.

Here in Canada, the junior resource companies are beyond washed out. The chart below of the relative performance of the junior TSX Venture Index against the more senior TSX Composite is at all-time lows – and below the level of the capitulation lows seen following the Lehman Crisis.

Here in Vancouver, which is the heart of junior mining country, I personally know of scores of well-qualified people who are in the industry who are struggling with the difficult environment.

Green shoots
In the midst of this bleak landscape, I am seeing nascent signs of recovery for the sector. What is encouraging was the positive performance shown during yesterday’s ugly selloff. One of the top recent performers has been industrial metals, which has:

  1. Rallied through a downtrend;
  2. Staged an upside breakout through a wedge; and
  3. Staged an upside breakout through a resistance level yesterday – which was impressive given the headwinds provided by the risk trade.

At the same time, gold seems to have made a temporary bottom and it’s starting to grind upwards as the precious metal is displaying nascent upside strength.

I am watching carefully the Brent price, which is a better proxy for world oil prices, for signs of an upside breakout through a downtrend. We almost achieved the breakout yesterday, but not quite.

The relative performance of energy stocks against the market is starting to show positive relative strength, which is another early warning of shifting leadership.

Macro and market implications
While I understand that commodities and commodity related stocks are unloved, washed out and poised to rally. These combination of sold-out sentiment and early signs of rising relative strength are pointing to a recovery in these sectors.

From a macro perspective, the recovery of deep cyclical sectors like these are consistent with a relatively upbeat outlook for growth economic growth. In that case, the environment for equities is encouraging and any correction should be relatively shallow – barring any macro surprises,

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.

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.

Europe healing?


Author Cam Hui

Posted: 28 May 2013

Sometimes things are so bad it can’t get any worse. That seems to be case in the eurozone, which is mired in deep recession and possibly a multi-year depression.

Yet I am seeing signs of improvement. Mario Draghi’s ECB has moved to take tail risk off the table. What’s more, the periphery is starting to turn around. Walter Kurtz of Sober Look noted last week that peripheral Europe is starting to improve:

Today we got the latest PMI numbers from the Eurozone (see figure 2). France is clearly struggling and Germany’s growth has been slower than many had hoped – due primarily to global economic weakness. But take a look at the rest of the Eurozone. While still in contraction mode, it shows an improving trend.

Spain printed a trade surplus last month (surprising some commentators), which may be a signal to rethink how valid some of these forecasts really are. Nobody is suggesting we will see Spain or Portugal all of a sudden begin to grow at 5%. But given the extremely pessimistic sentiment of many economists (a contrarian indicator), it is highly possible we are at or near the bottom of the cycle. People should not be surprised if we start seeing some positive growth indicators – especially in the periphery nations – in the next few quarters.

Indeed, bond yields in the periphery have been showing a trend of steady improvement and “normalization”. As an example, look at Italy:

Here is Spain:

Here is the real clincher. Greek 10-year yields have fallen from over 30% to under 10% today:

As a sign of how the bond markets have normalized and how risk appetite has returned to Europe, consider this account of what happened with Slovenia early this month. Slovenia was doing a bond financing, then Moody’s downgraded them two notches to junk:

After several days of roadshowing, the troubled Slovenia decided to open books for 5 and 10y bonds on Tuesday (30 April). Given that in the previous weeks peripheral bond markets rallied like mad, it wasn’t too heroic to assume that the book-building would be quite quick. Indeed, in the early afternoon books exceeded USD10bn (I guess Slovenia wanted to sell something around 2-3bn) and then reached a quarter of what Apple managed to get in its book building. If I were to take a cheap shot I would say that Slovenia’s GDP is almost 10 times smaller than Apple’s market capitalisation* but I won’t.

And then the lightning struck. Moody’s informed the government of an impending downgrade, which has led to a subsequent suspension of the whole issuance process. I honesty can’t recall the last time a rating agency would do such a thing after the roadshow and during book-building but that’s beside the point. That evening, Moody’s (which already was the most bearish agency on Slovenia) downgraded the country by two notches to junk AND maintained the negative outlook. This created a whopping four-notch difference between them and both Fitch and S&P (A-). The justification of the decision was appalling. Particularly the point about “uncertain funding prospects”. I actually do understand why Moody’s did what it did – they must have assumed that the Dijsselbloem Rule (a.k.a. The Template) means that Slovenia will fall down at the first stumbling point. But they weren’t brave enough to put that in writing and instead chose a set of phony arguments.

Did the bond financing get pulled or re-priced? Did bond investors run for the hills and scream that Slovenia is the next Cyprus? Not a chance. In fact, the issue sold out and traded above par despite the downgrade:

Then the big day came – books reopened, bids were even stronger than during the first attempt and Slovenia sold 3.5bn worth of 5 and 10y bonds. On Friday, the new Sloven23s traded up by more than 4 points, which means yield fell by more than 50bp from the 6% the government paid. A fairy tale ending.

Key risk: France
From a longer term perspective, the elephant in the room continues to be France (see my previous post Short France?). French economic performance continues to negatively diverge with Germany. This isn’t Greece or Ireland, whose troubles could be papered over. France is the at the heart of Europe and the Franco-German relationship is the political raison d’etre for the European Union. France cannot be saved. It can only save itself. 

Despite these dark clouds, the markets are relatively calm over France. The CAC 30 is actually outperforming the Euro STOXX 50:

From a global perspective, European stocks are also showing a turnaround against the All-Country World Index (ACWI):

I am watching this carefully. European stocks could turn out to be the new emerging leadership and the source of outperformance.

Full disclosure: Long FEZ

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.  

Commodity weakness is likely localized


Author Cam Hui

Posted: 25 Apr 2013

The old Cam would have been freaking out. The first version of my Inflation-Deflation Trend Allocation Model depended solely on commodity prices as the canaries in the coalmine of global growth and inflationary expectations. The chart below of the equal-weighte Continuous Commodity Index is in a well-defined downtrend. The weakness isn’t just restricted to gold, but other commodities like oil and copper are all falling.

However, we found with further research that adding global stock prices to commodity prices as indicators gave us a better signal, in addition to giving us a more stable signal.

Equities not confirming weakness
The three axis of global growth are the US, Europe and China. I am finding that signals from all three regions are not really confirming the signals of weakness given by falling commodity prices. Consider, for example, Caterpillar’s earnings report yesterday. The company, which is a cyclically sensitive bellwether, reported punk sales, earnings before the opening bell and revised their outlook downwards [emphasis added]:

We have revised our outlook for 2013 to reflect sales and revenues in a range of $57 to $61 billion, with profit per share of about $7.00 at the middle of the sales and revenues outlook range. The previous outlook for 2013 sales and revenues was a range of $60 to $68 billion and profit per share of $7.00 to $9.00.

“What’s happening in our business and in the economy overall is a mixed picture. Conditions in the world economy seem relatively stable, and we continue to expect slow growth in 2013,” said Oberhelman.

“As we began 2013, we were concerned about economic growth in the United States and China and are pleased with the relative stability we have seen so far this year. In the United States, we are encouraged by progress so far and are becoming more optimistic on the housing sector in particular. In China, first quarter economic growth was slightly less than many expected, but in our view, remains consistent with slow growth in the world economy. In fact, our sales in China were higher in the first quarter of 2013 than they were in the first quarter of 2012, and machine inventories in China have declined substantially from a year ago,” said Oberhelman.

“We have three large segments: Construction Industries; Power Systems; and Resource Industries, which is mostly mining.While expectations for Construction Industriesand Power Systems are similar to our previous outlook, our expectations for mining have decreased significantly. Our revised 2013 outlook reflects a sales decline of about 50 percent from 2012 for traditional Cat machines used in mining and a decline of about 15 percent for sales of machines from our Bucyrus acquisition,” said Oberhelman.

In other words, CAT remains upbeat on US housing. China is weak-ish and mining is in the tank. It seems that much of this negative outlook has been discounted by the market. While the stock fell initially, it rallied to finish positively on the day on heavy volume.

For now, the US economy look OK. I agree with New Deal Democrat when he characterized the high frequency economic releases as “lukewarm”. We are not seeing gangbusters growth, but there is no indication that the economy is keeling over into recession either. The preliminary scorecard from the current Earnings Season is telling a similar story. The earnings beat rate is roughly in line with the historical average, although the sales beat rate has been somewhat disappointing.

Risk appetite rising in Europe
Across the Atlantic, Europe is mired in recession. However, there is little sign that tail-risk is rising. I have been watching the relative performance of the peripheral markets in the last few days as stocks have weakened. To my surprise, European peripheral markets have been outperforming core Europe, indicating that risk appetite is rising. Here is the relative performance of Greece against the Euro STOXX 50:

Here is Italy:

…and Spain:

Well, you get the idea.

Weakness in China?
What about China? Chinese growth has been a little bit below expectations, such as the March Flash PMI released overnight. Shouldn’t weakness in Chinese infrastructure growth would be negative for commodity prices? Isn’t that what the commodity price decline is signaling?

Well, sort of. Maybe. We have seen a great deal of financialization of commodities as an asset class. An alternate explanation of commodity weakness is the unwind of the long positions of financial players . Indeed, analysis from Mary Ann Bartels of BoAML shows that large speculators have moved from a net long to a net short position in the components of the CRB Index:

One key gauge I watch of Chinese demand is the Australian/Canadian Dollar cross rate. Both countries are similar in size and both are commodity producers. Australia is more sensitive to Chines growth while Canada is more sensitive to American growth. As the chart below shows, the AUDCAD cross remains in an uptrend in favor of the Aussie Dollar, though it is testing a support region.

In conclusion, the preliminary verdict from the market is that commodity weakness is localized – for now. Barring further weakness in commodity prices and the other indicators that I mentioned, the implication is that US stock market action will be choppy because of the uncertainty caused by commodity weakness and Earnings Season, but any downside will be limited. As the point and figure chart of the SPX below shows, the S+P 500 remains in an uptrend and I am inclined to give the bull case the benefit of the doubt for now.

So relax and chill out.

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.

Short France?


Author Cam Hui

Posted: 16 Apr 2013

I have found that the best trades are ones based on a well-defined fundamental reason combined with a market catalyst. Investors who put on a trade based purely on fundamentals run the risk of being early – and Value investors are a classic example of this tendency. Fundamentals have a way of not mattering to the market until it matters. A much better way to position your portfolio is to wait for the market catalyst by watching the technical conditions of the trade.

A bearish call on France
Consider this article from Charles Gave of Gavekal (via ZeroHedge): France Is On The Brink of A Secondary Depression:

France is engulfed by a political, economic and moral paralysis. The president has record low popularity, unemployment is making new highs and the tax czar of a supposedly left wing government just quit after repeatedly lying about a pile of cash he had stashed in a Swiss bank account. From such a sorry state of affairs, you might think that things could only get only get better. Unfortunately, economic cycles do not work this way and it is my contention that France is about to enter what was known during the gold standard era as a “secondary depression.” The rigid design of the euro system means the whole eurozone is prone to the kind of brutal cyclical adjustments seen in that hard money era of the 19th and early 20th centuries. But having reached the logical limits of its decades long experiment in state-run welfare-capitalism France is far more exposed than even its struggling neighbors.

The article is well worth reading in its entirety, because it lays out the bearish divergence for France against the rest of Europe. There is a French elephant in the eurozone room that no one dares to speak about. While Brussels can manage crisis after crisis in peripheral countries, a blowup in France is too big to contain as the French-German relationship lies at the political heart of the European Union.

Hale Stewart at the Bonddad Blog jumped on the same theme last week when he wrote:

The French ETF is looking more and more like a great short opportunity. As I first noted a little over a week ago, the French economy is in terrible shape: GDP has barely grown for the last 7 quarters, unemployment is rising, industrial production is dropping and the budget and current account deficits are increasing.

Too early to short France
What has been described so far is best characterized as a “trade setup”. This is a trade with a strong fundamental backdrop. My inner investor tells me to be wary of France and its effects on Europe, but my inner trader tells me, “Not yet.”

These fundamentals have a way of not mattering to the market until it matters. Right now, the market is shrugging off the warning signs. Consider this chart of the relative performance of French equities to eurozone equities below. Relative support seems to have held despite the potential negative news and the CAC is actually rally on a relative basis in the short term.

This may be a case of when it rains, it pours, but you have to wait for the rain. The “rain” to which I refer to is the emergence of a risk-off trade. Right now, there is no sign of that happening. Look at the relative strength of Greek stock to eurozone stocks – it’s signaling a risk-on market.

The same could be said of Italy. Look at the relative performance of the MIB against the Euro STOXX 50:

In short, this is a trade setup to be watched. Watch how the fundamentals develop, because you have the time. Should the technicals deteriorate, then you have a great trade with tremendous upside potential – but not today.

Later this week, I will write about another potential trade setup in a hot topic – gold.

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.  

You just don’t understand Europe…


Author Cam Hui

Posted: 29 Mar 2013

In the wake of the disappointing market reaction to the Cyprus deal, I just want to repeat the comment I hear from some of my European contacts: “You just don’t understand Europe.”

Don’t be fooled by the theatre
Europeans elites do their deals behind closed doors and what we see in the headlines is mostly theatre. By contrast, Americans focus much more on process and headlines – and that’s where they go off the tracks when analyzing the eurozone crisis. That’s why we get alarmist comments, like John Mauldin’s Thoughts from the Frontline: You can’t be serious in which he worried about the precedences set by the Cyprus deal and the effects on European banks:

Basel III standards require European banks to increase their deposit ratios. This European response to Cyprus is going to make that harder for banks in smaller European countries to accomplish. Very tiny Luxembourg has banking assets 13 times the country’s GDP. Yes, I know that Luxembourg’s banks are the very epitome of solid banking and that the majority of those assets are loans to central banks and other credit institutions, but there is no way on God’s green earth that Luxembourg as a country could even begin to think about backing its banks. Of course, everyone knew that before this crisis, but if you are the treasurer of a large corporation, how soundly do you sleep at night after Cyprus? And God forbid you have an account in one of the peripheral countries. In the case of Ireland, the lesson was that the money would be found to back the banks, even if taxpayers suffered. But now? New rules for new times. And then you open The Financial Tim es this weekend and read (emphasis mine):

The chairman of the group of eurozone finance ministers warned that the bailout marked a watershed in how the eurozone dealt with failing banks, with European leaders now committed to “pushing back the risks” of paying for bank bailouts from taxpayers to private investors.

Jeroen Dijsselbloem, president of the eurogroup, was speaking after Cyprus reached its 11th-hour bailout deal with international lenders that avoids a controversial levy on bank accounts but will force large losses on big deposits in the island’s top two lenders.

By contrast, I was recently relatively sanguine about Cyprus (see Don’t get too excited about Cyprus and More of the usual Eurocrisis drama). I wrote that a Cypriot solution is specific to Cyprus:

I believe that bailouts of other eurozone countries, should they be necessary, will conform to a different template of conditionality other than the imposition of a tax on bank deposits. For example, the ECB has made it clear that it will backstop Spain, but on condition that the government undertake structural reforms and austerity. In the case of Spain, Rajoy has yet to swallow the bitter pill that comes with an OMT bailout.

Don’t forget Draghi’s Grand Plan
To explain, the real agenda of the European elites consists of three components:

  1. Push for structural reform long term;
  2. Austerity in the short-term; and
  3. The ECB stands by to hold everything together if the above two steps are taken.

Mario Draghi revealed this Grand Plan in February 2012 (see Mario Draghi reveals the Grand Plan) in a WSJ interview. Here are the key quotes from that interview [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.

He went on to say that the European social model was dead:

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.

Unlike Dijsselbloem, who is a rookie, Draghi is an experienced central banker who chooses his words carefully and he reveal his agenda in February 2012. Investors looking at Europe should remember that.

If you understand the Draghi Grand Plan, then you will understand how the eurocrats are likely to react when the next sovereign crisis occurs. First, the ECB will “do whatever it takes” to save the eurozone, but help from Frankfurt (the ECB) and Brussels (EU) comes with strings. In all likelihood, the eurocrats will believe that the country seeking help needs austerity and structural reform. In such a case, be the price to be paid will be paid is austerity and structural reform and the solution will not to stiff bank depositors (think Spain as an example as Rajoy’s reluctance to embrace Draghi’s “conditionality”).

The kind of “conditionality” demanded by the ECB and is therefore highly situation specific. Cyprus was truly a unique case. Don’t expect the same template to be used for Spain or Portugal. That’s where outsiders make the mistake.

Investment implicationsLast week, I wrote that I was watching the relative returns of Greek stocks to eurozone stocks as a barometer of the level of stress in Europe, largely because of the Greek-Cypriot link and because Greece is the high beta play in Europe. When I looked last night, GREK had tanked relative to FEZ and had violated an important level of relative support.

The Athens Index had also dived relative to eurozone stocks. Though the degree of relative performance was not as bad, it is nevertheless a cautionary signal for the risk trade in Europe.

The French elephant in the room
The negative market reaction over Cyprus suggests to me that we are going to go through a “the glass is half empty” cycle in Europe and traders should be prepared accordingly. The key indicators to watch is the performance of France. France is the elephant in the room. The French economy is suffering a negative divergence with Germany. Consider this graph of French and German PMI (via Business Insider).

The eurocrats can deal with Italy, Spain and Ireland, but France is at the core of the EU and impossible to save. The Economist described France as the time bomb at the heart of Europe:

European governments that have undertaken big reforms have done so because there was a deep sense of crisis, because voters believed there was no alternative and because political leaders had the conviction that change was unavoidable. None of this describes Mr Hollande or France. During the election campaign, Mr Hollande barely mentioned the need for business-friendly reform, focusing instead on ending austerity. His Socialist Party remains unmodernised and hostile to capitalism: since he began to warn about France’s competitiveness, his approval rating has plunged. Worse, France is aiming at a moving target. All euro-zone countries are making structural reforms, and mostly faster and more extensively than France is doing (see article). The IMF recently warned that France risks being left behind by Italy and Spain.

At stake is not just the future of France, but that of the euro. Mr Hollande has correctly badgered Angela Merkel for pushing austerity too hard. But he has hidden behind his napkin when it comes to the political integration needed to solve the euro crisis. There has to be greater European-level control over national economic policies. France has reluctantly ratified the recent fiscal compact, which gives Brussels extra budgetary powers. But neither the elite nor the voters are yet prepared to transfer more sovereignty, just as they are unprepared for deep structural reforms. While most countries discuss how much sovereignty they will have to give up, France is resolutely avoiding any debate on the future of Europe. Mr Hollande was badly burned in 2005 when voters rejected the EU constitutional treaty after his party split down the middle. A repeat of that would pitch the single currency into chaos.

The lines in the sand
I am watching closely this ratio of the CAC 40 to Euro STOXX 60 to see which way it breaks out of the relative consolidation range.

If it rallies through upside relative resistance, then any crisis is just more theatre and can be regarded as a buying. On the other hand, if it breaks to the downside, there’s going to be 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.

An uncomfortable bull


Author Cam Hui

Posted: 25 Mar 2013

I suppose that I should be happy. I correctly turned bullish on a tactical basis (see Give in to the Dark Side). I correctly called the Cyprus mini-crisis (see Don’t get too excited about Cyprus and More of the usual Eurocrisis drama). As I write these words, the news of the Cyprus deal is sparking a modest risk-on rally.

Over here on this side of the Atlantic, the American economy continues to chug along, despite the sequester and payroll tax hike. I agree with Tim Duy when he writes that the recovery is real.

Sector performance signal caution
When I reviewed my charts on the weekend, I came away vaguely dissatisfied. The relative performance of industries and sectors reveal a market whose leadership that is increasingly turning away from cyclical groups and toward defensive sectors and a “negative beta” group.

If we are seeing such a bullish outlook (Europe, US economy), why are cyclically sensitive sectors not doing better. Consider the relative performance of Consumer Discretionary stocks against the market. This sector is currently seeing a sideways consolidation after stalling out of a relative uptrend that began last August.

Industrials are also displaying a similar pattern as Consumer Discretionary stocks: Stalling out of a relative uptrend followed by sideways consolidation:

The same could be said of homebuilding stocks:

The only cyclically sensitive group that I could find that is still in a relative uptrend against the market are the transportation stocks, which is a relatively narrow group:

Defensive sectors taking the lead
On the other hand, defensive sectors are starting to take the leadership position. Why are they outperforming when the stock market is advancing?

Consider, as an example, the relative performance of Consumer Staples, which is staging a relative strength rally:

Health Care, another sector thought to be defensive in nature, is already in a shallow, but well-defined relative uptrend after staging an upside breakout through relative resistance:

Utilities are forming a relative saucer bottom against the market:

Golds: The negative beta play
What’s more, gold stocks are showing signs of revival. The Amex Gold Bugs Index has rallied through a relative downtrend line against the market, though the longer term relative downtrend (dotted line) remains intact:

HUI has already staged a relative turnaround against bullion as it has strengthened through the relative downtrend against gold.

Gold and gold stocks have somewhat defensive characteristics as they have had a zero or negative correlation against the SPX in recent weeks. Their revival could be a warning sign for stock bulls.

Be very, very careful out there
As I wrote in my recent post Give in to the Dark Side, my inner investor was already skeptical about this most recent rally:

My inner investor continues to be concerned about this market advance. He believes that the prudent course of action would be to move his portfolio asset allocation to its policy weight, i.e. if the policy weight is 60% stocks and 40% bonds, then the portfolio should be at 60/40.

At the time, my inner trader wanted to throw caution to the winds and get long the market. Now, my inner investor is telling him, “I told you so.” Under these circumstances, my inner trader is getting very, very nervous and he is tightening up his trailing stops. The behavior of these sectors is flashing warning signals that if even if this market were to rally further, the advance could be very choppy.

Until we see some evidence of upside relative breakouts of consolidation ranges in cyclical sectors and industries, these market internals should make anyone who is bullish an uncomfortable bull.

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. 

%d bloggers like this: