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. 

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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.

Tech revival? Watch AAPL


Author Cam Hui

Posted: 06 May 2013

There was some excitement this week about the relative breakout of the Technology sector against the market:

Given the dominant weight of Apple in the Technology sector, consider the relative performance of an equal weighted Tech index. the equal-weighted NASDAQ 100 (QQEW) against the SPX. While the XLK has rallied out of a relative downtrend against SPX, QQEW remains range-bound against the market. In other words, the average Tech stpcl has performed in line with the market in general.

The rally out of the downtrend is far more evident in AAPL:

So if you start to get excited about the potential rally in Technology stocks, pick the appropriate benchmark and know what you are betting on.

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.

Technical analysis as behavioral finance

Posted: 03 May 2013 12:18 AM PDT

A couple of items came across my desk that, in combination, made me think about how we think about finance today. The first was Mark Buchanan’s review of Gary Gorton’s book Misunderstanding Financial Crises where the author took down the blindness of economists and, by extension, the theory of rational expectations [emphasis added]:

I think it’s the most convincing book I’ve read so far that links the mechanisms of the recent crisis to crises in the past. In effect, he argues that the crisis was the direct result of the uncontrolled creation of money by the shadow banking sector, and ultimately took place as a classic bank run, no different from runs in the past, except that this run took place mostly out of public view because it didn’t involve ordinary bank deposits. The new kind of money in this bank run was stuff such as repo agreements and commercial paper which played the role of money for financial institutions. In 2007-2008, when lenders lost confidence (for good reason) in the mortgage-backed collateral backing this money, they demanded that money back, and the financial system seized up.

The explanation is convincing and wholly natural. The argument is most convincing because Gorton does a masterful job of placing this bank run in the context of the long history of past runs. And also because Gorton, as an economist, places blame squarely on the economics profession (himself included) for being asleep at the wheel:

Think of economists and bank regulators looking out at the financial landscape prior to the financial crisis. What did they see? They did not see the possibility of a systemic crisis. Nor did they see how capital markets and the banking system had evolved in the last thirty years. They did not know of the existence of new financial instruments or the size of certain money markets. They did not know what “money” had become. They looked from a certain point of view, from a certain paradigm, and missed everything that was important… The blindness is astounding. That economists did not think such a crisis could happen in the United States was an intellectual failure.

It seems to me that there is a certain amount of denial among economists. I have noticed, in talking about the ideas in this book with my economist colleagues, that there is a fairly clear generational divide on this. To younger economists and graduate students, it is obvious that there was an intellectual failure. Some older economists are inclined to hem and haw, resorting to farfetched rebuttals. It is clear that this is a sensitive issue, as like banks no one wants to have to write down the value of their capital.

…One other thing of interest. Gorton in a late chapter, when discussing the spectacular failure of the rational expectations paradigm, quotes University of Chicago economist James Heckman, winner of the economics’ Nobel Prize (yes, that’s not its actual name) in 2000, from an interview he did with John Cassidy in 2010.

Why didn’t economists saw the financial crisis coming? What happened to rational expectations?

In a recent interview, Nobel laureate Daniel Kahneman explained his problem with the rational agent and rational expectations hypothesis this way:

Think of the kind of market that Adam Smith described. You can get a lot of insight into how just the right amount of bread gets to London in the morning by assuming that the baker and the other participants in the market pursue their own interests in a sensible manner. The rational-agent model takes this idea to its logical extreme. If you want to predict the behavior of a market, you are best off assuming individual agents who act in a way that is predictable and fairly simple—for example by assuming that the participants are similarly motivated and exploit all their opportunities. I am not an economist, but I find it hard to imagine that they will ever give up the use of schematic individual agents, even if they endow these agents with a little more realistic psychology. And I see no reason why they should.

The rational agent model has more questionable consequences in the domain of policy because the assumption that individuals are rational in the pursuit of their interests has an ideological coloring and policy implications that many would view as unfortunate. If individuals are rational, there is no need to protect them against their own choices. At the extreme, no need for Social Security or for laws that compel motorcycle riders to wear helmets. It is not an accident that the department of economics at the University of Chicago, one of the most illustrious in the world, is known both for its adherence to a strict version of the rational actor model and for very conservative politics.

Rational expectations: Is this an anomaly?
The other item of note was a post at George Washington’s blog (via Zero Hedge) showing how much more likely an American is to die from heart disease, car accidents and other common causes of death than from terrorism:

– You are 17,600 times more likely to die from heart disease than from a terrorist attack
– You are 12,571 times more likely to die from cancer than from a terrorist attack
— You are 11,000 times more likely to die in an airplane accident than from a terrorist plot involving an airplane
— You are 1048 times more likely to die from a car accident than from a terrorist attack

Now ask yourself, how much has the United States government spent on combating terrorism compared to heart disease, cancer and automobile accidents? If this had been academic finance literature, then these mis-pricing or mis-allocation of resources would be termed an anomaly, much like low P/E or small capitalization were deemed to be market anomalies in the 1970’s.

Here’s another thought from the Chicago school: If the world needed to be rid of terrorism, or __________ [insert the dictator of your choice], wouldn’t the market have done it?

In praise of behavioral finance
Behavioral finance is the school of thought that tries to understand human behavior in the context of what “should” be rational expectations. I have long believed that technical analysis is a branch of behavioral finance.

I recently wrote an essay about the evolution of thinking about technical analysis and why it works. You can read it here.

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.

Watching silver for the bottom in gold


Author Cam Hui

Posted: 26 Apr 2013

In a recent post (see What to do about gold?) I suggested that a tradable bottom for gold may be near, but to wait for some signs of price stabilization:

Personally, I would be inclined to step aside for now and watch how this trade develops. Gold could have great upside potential once it bottoms, but prudence calls for waiting for some signs of stabilization before getting long. I would rather miss the first 10-20% move than lose another 50% should I get long prematurely.

It appears that we are seeing signs of a panic bottom and some signs of stability. The chart of GLD is showing the classic signs of a capitulation bottom:

The same goes for GDX:

As much as my inner trader is itching to jump onto the long side with both feet, a falling silver/gold ratio is flashing a caution signal. The chart below shows the silver/gold ratio as the solid line and the gold price as the candlestick chart. If silver is the high-beta version of gold, i.e. the poor man’s gold, why is the silver/gold ratio continuing to fall here?

In the last couple of instances where gold had bottomed, the silver/gold ratio bottomed at about the same time. Here is the 2008 bottom:

Here is 2004:

The most charitable explanation that 2013 corresponds to the 2001 gold bottom, where the silver/gold ratio continued to fall. As the gold price stabilized, rallied and then fell back to test the bottom, the silver/gold ratio stabilized, though it was several months late in confirming the start of the secular gold bull.

The markets in 2011 and 2013 may not be directly comparable. 2001 was the end of a multi-decade secular gold bear market. Today, the price of gold peaked out in late 2012 and fell back below important technical levels after a long bull market.

Bottom line: We are likely seeing a short-term bottom for gold here. On the other hand, don’t be so sure about the intermediate term trend. There may be more downside to come. We’ll just have to watch and wait to see how some of these technical patterns resolve themselves.

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.  

A Value rally, or defensive sector rally?


Author Cam Hui

Posted: 9 Apr 2013

Despite Friday’s disappointing Non-Farm Payroll release, I remain relatively constructive on the stock market’s outlook for several reasons. First, the market sold off on the open, but rallied into the close – a positive sign.

Second, higher beta parts of the market have been outperforming in spite of the negative news. Consider this chart of the relative performance of small caps against the large caps indicating that the risk-on trade may not be done yet.

The risk-on rebound isn’t just confined to the United States. Here is the performance of Greece compared to Europe, which is a key measure of risk aversion:

Here is the relative performance of Italy:

You get the idea.

What about the defensive stock leadership?
The one cautionary sign that I had mentioned last week was the leadership of defensive sectors (see Something’s not right about this rally). I was not the only one to notice this effect. David Rosenberg mentioned it last Thursday and the WSJ featured a comment from UBS on the curious leadership behavior:

As the chart from UBS strategist Jonathan Golub shows, the classic defensive sectors, such as health care and consumer staples, led the way during the first three months of the year, while some of the more cyclical sectors, such as energy and tech, lagged near the bottom of the pack.

Defensive leadership or Value leadership?
There may be a more benign explanation for the leadership of defensive sectors. Value stocks have been outperforming Growth stocks since last June. The chart below of the relative performance of the Russell 1000 Value Index against the Russell 1000 Growth Index tells the story.

It just so happens that the Russell 1000 Value Index is overweight the kinds of sectors that have been outperforming, such as Financials and Utilities and the Russell 1000 Growth Index is overweight the sectors that have been lagging, such as the cyclically sensitive Industrials and Technology.

What’s more, leadership in Value isn’t just a sector effect. A contact of mine at MSCI Barra indicated to me that their factor analysis shows the performance of Value factors like Book to Price and Dividend yield to be outperforming as well. That outperformance was net of industry effects.

Bottom line: The upcoming Earnings Season will give us the best answer to the question of whether the real leadership is defensive stocks, which suggests caution, or Value stocks, which could be neutral to bullish.

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.

Something’s not right about this rally


Author Cam Hui

Posted: 2 Apr 2013

OK, so the SPX made a new high. Many of my momentum models are bullish, but my relative strength work (see my previous post on combining momentum with trend following techniques) is making me scratch my head.

To explain, my work based on a paper by a team of researchers at Cass Business School entitled The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation suggests that when the market is experiencing an uptrend, you should go for broke and buy the “hot” sectors of the day. On the other hand, when the market is falling, buying the “hot” sectors is a recipe for disaster.

A risk friendly market trend
First of all, my trend following and momentum models is pointing to a risk-on market. Consider the relative returns of SPY (stocks) against IEF (7-10 year Treasuries) below. Unquestionably, we are seeing an uptrend in the risk trade:

The risk-on trade isn’t just restricted to stocks vs. bonds. The same effect could be seen in the credit market, where junk bonds are outperforming:

Defensive leadership
Here is what’s bothering me. We are obviously seeing an uptrend in the stock market, as evidenced by the new highs. However, sector leadership is gradually shifting away cyclical sectors to defensive sectors and industries. Take a look at what the leadership is today.

The chart below shows the relative returns of Financials (XLF) against the market (SPY). Financials are in a well-defined relative uptrend against the market.

Here are the Transportation stocks, which is a small cyclically oriented industry. These stocks are also in a well-defined relative uptrend.

OK. So far so good. Now here comes the surprises. Look at the relative strength in Healthcare:

…and the turnaround in the relative strength of Utilities:

Commodity cyclicals lagging
I have written that cyclical sectors are displaying a pattern of relative sideways consolidation after an uptrend (see An uncomfortable bull). I won’t repeat myself, but you can click on the link and see the charts there.

What’s bothering me is that commodity related sectors are lagging badly. Consider the equal-weighted Continuous Commodity Index, which is in a minor downtrend. Though it doesn’t seem disastrous and commodity prices have firmed somewhat in the past three weeks, the price action of the commodity complex is not exactly signaling a robust global recovery.

On the other hand, the price action of industrial metals look downright ugly.

Here are some price relative charts of commodity sensitive stock markets against ACWI, or the MSCI All-Country World Index. Australia looks ok, but it’s the exception.

Canada, on the other hand, is in a relative downtrend and has been underperforming since last November.

Here is Brazil. Enough said here:

Here is the relative chart of South Africa (in black), though its relative performance may be linked to the relative performance of gold stocks (in orange):

The relative performance of the cyclically sensitive South Korean market is not exactly inspiring either. South Korea remains in a relative downtrend, though it has staged a relative rally in the last week or so.

What’s going on?
Frankly, I am puzzled by the nature of the sector leadership when the market is making new highs. My momentum and trend following models are telling to stay long. My relative strength models are telling me to rotate into defensive sectors like Utilities and Healthcare. When I net this all out, I wind up in a fairly neutral position.

Something’s not right about this rally. Mohamed El-Arian of Pimco pretty much said the same thing when he indicated that the Markets are sending unusual signals [emphasis added]:

The rally reflects slowly-improving economic conditions, relatively robust corporate profitability and anticipation of stronger domestic and foreign inflows into the equity market. Yet this is far from the whole story.

Investors need only look at where some other benchmarks ended the quarter to get a feel for the unprecedented and artificial nature of today’s capital markets.

Few would have predicted that the impressive equity performance would be accompanied by a 10-year U.S. Treasury rate as low as 1.85 percent, a 10-year German government bond (bund) rate as low as 1.29 percent and gold as high as $1,596 an ounce. Think of this as the markets’ way to signal to investors some key issues for the quarters ahead.

More on this topic in subsequent posts.

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.

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