How easy is this Fed?

As we wait for the announcement from the FOMC, the markets has been seeing a number of mixed signals from the Fed lately. Josh Brown thinks that the Fed has no idea what happens next - and that's ok. I think that the Ben Bernanke has been incredibly activist and accommodative because of his academic study of the Great Depression and this Bernanke Fed isn't about to stop.

There are others who subscribe to my view of an easy Bernanke Fed. In a Barron's article (subscription required), former Fed insider Vincent Reinhart, of Morgan Stanley (and husband of Carmen Reinhart), believes that Bernanke may not have the political capital to undergo another QE cycle in 2H2012, so any accommodation needs to be brought forward:

But a long-time observer of Fed policy—from the inside and the outside—thinks another round of quantitative easing, or other measures, is likely later this year. Vincent Reinhart, Morgan Stanley's chief U.S. economist, formerly was director of the Fed's Division of Monetary Affairs and served as the FOMC's secretary and economist, so he has seen things from both sides.


In his latest report, Reinhart writes there is a 75% probability the Fed will take some "unconventional action by June" because of the "political calendar." The central bank is supposed to be above the political fray, but this former Fed insider thinks Ben Bernanke & Co. will want to keep a lower profile in the second half of the election campaign season.

Secondly, the economics also will justify a move, he continues. (I may be naïve but I still find it jarring to list economics after politics in determining Fed decisions, but I'm not an ex-insider.) Economic slack (read "unemployment") persists and inflation remains below the Fed's medium-term projections, Reinhart notes.

Moreover, he notes the Fed sees risks the economy could slow. "Here, too, at Morgan Stanley, we share the view that the fillip to economic growth associated with a restock of inventories is fading and that real [gross domestic product] growth will slow notably in current quarter. Anxiety-inducing headlines that the economy is losing steam will be conducive to Fed action."

If Vincent Reinhart is correct, then Bernanke may not have the political capital to undertake another round of QE. That's why we had the "leak" about the Fed considering "sterilized bond buying" as a way of appeasing the hawks inside and outside the Fed.

I have no idea how much Vincent's thinking is influenced by Carmen's and vice versa, but this thread of continued central bank accommodation is consistent with Carmen Reinhart's theme of "financial repression", which she believes is here to stay [emphasis added]:

As they have before in the aftermath of financial crises or wars, governments and central banks are increasingly resorting to a form of “taxation” that helps liquidate the huge overhang of public and private debt and eases the burden of servicing that debt.

Such policies, known as financial repression, usually involve a strong connection between the government, the central bank and the financial sector. In the U.S., as in Europe, at present, this means consistent negative real interest rates (yielding less than the rate of inflation) that are equivalent to a tax on bondholders and, more generally, savers.

In the past, other measures also included directed lending to the government by captive domestic entities (such as pension funds or banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter coordination between governments and banks, either explicitly through public ownership of some institutions or through heavy “moral suasion” by officials.

If I am right about this theme about the Fed getting to give the patient another shot of adrenaline, then it would be regarded as short-term bullish for risky assets (though it may not do much longer term).

That`s why my inner trader is carefully scrutinizing the FOMC statement to watch for any change in language.



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

March 2012 = December 2010?

I wrote back on February 22, 2012 to expect a period of consolidation and correction, but the intermediate trend remained up. Last week, we saw the stock markets decline for 1% or more on Tuesday. Since then, equities have been flat. There is no doubt that correction is here.


Which analog? March 2011 or Dec 2010?
At the same time, a number of bears have suggested the current market is similar to the conditions of March/April 2011 when the market began to top out and ultimately fell, citing conditions such as insider selling.

I beg to differ. While insider activity is a concern, the flood of central bank liquidity continues. This Bernanke Fed has shown itself to be highly activist. Chairman Bernanke has indicated that he is willing to tolerate a higher inflation rate under the current weak conditions. The leak about sterilized QE shows the lengths Bernanke is willing to go in order to appease the hawks and get what he wants, i.e. further stimulus, at the same time.

Moreover, I have written before that funds flow remains positive for equities and the risk-on trade. Institutions are underweight and re-allocating funds into equities. Once the allocation begins, it's hard to stop. Individuals were underweight and are now roughly market weight as their fund flows are just getting started. Todd Salamone of Schaeffer's Research put it this way:

[A] survey by the National Association of Active Investment Managers (NAAIM) revealed that the average manager was only 57% net long last week, down significantly from the 74% the prior week. For perspective, optimistic extremes during the past five years have been at 85% or higher net long, which we last saw in early 2011.

In short, I believe the best analog for this market is the brief correction we saw in December 2010, which was in the middle of the QE2 rally in equities.

The periods look the same. I have circled the December 2010 period in blue and the March/April 2011 in green. The stock market had seen a golden cross shortly before the December 2010 correction, just as we did now. The rally was just getting started as a result of the tsunami of central bank liquidity, just as we are now.

The market declined to test the 50-day moving average and rallied. By contrast, the market corrected harder in March 2011 and fell through the 50-day moving average. (At the very least, these episodes show the value of the 50-day MA trailing stop as a risk control device.)

We can see a similar pattern by looking northward to the more resource-heavy and cyclically oriented TSX Composite in Canada. The market was in an uptrend and corrected in December 2010 and the uptrend was ultimately broken in March 2011. Today, the market remains in an uptrend that began in October 2011 and corrected but the current uptrend remains intact. During the QE2 rally, the market experienced a golden cross in September 2010. Today, the market is about to see a golden cross, indicating that the rally is just getting started.

Similarly, the relative performance of the Morgan Stanley Cyclicals Index against the market tells the same story. Cyclicals remain in a relative uptrend today. During the QE2 rally, the December 2010 correction was just a hiccup in the relative uptrend, which ended in March 2011 when the uptrend was violated.

In short, the internals are pointing to a brief correction just as we saw in December 2010. Monetary conditions are similar. Uptrends are intact, as measured by trend lines and 50-200 day trend following models.


Is this correction over?
My inner investor is convinced that he should stay long and ride out this short-term volatility. On the other hand, my inner trader wants to know if the current correction is over.

Not quite. The chart below shows the weekly Summation Index for NYSE stocks, a breadth indicator, to which I overlaid an overbought/oversold stochastic model. Here are a few observations. First, the fact that the Summation Index got to overbought levels suggested that the market was poised for a consolidation and corrective period. Now that we have entered that correction, which has been albeit mild, we need to see the stochastic move to oversold levels before calling the all-clear, just as we saw during the December 2010 episode.

In conclusion, my inner investor is staying long. My inner trader is expecting another week or two of correction and consolidation before the uptrend in stocks and other risky assets continues.



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.

All of Europe's a stage...

Bloomberg had a good summary of Mario Draghi's comments from the ECB press conference on March 8, 2012 in an article entitled Draghi Lays Groundwork for ECB Stimulus Exit as Inflation Takes Spotlight [emphasis added]:

Declaring that the environment “has improved enormously” and there are “many signs of returning confidence in the euro,” Draghi yesterday turned the spotlight on “upside risks” to inflation, which is now forecast to remain above the ECB’s 2 percent limit this year. That suggests policy makers don’t plan to cut rates further or add to their 1 trillion euros ($1.32 trillion) of long-term loans to banks, economists said.... 

The Frankfurt-based ECB must “go back to normal, classical central bank policy,” he said.

Draghi's message to the politicians was, "We've done our part, it's time for you to do yours" as he hinted that not only would there be no further LTROs, but the next ECB step would be some form of tightening.

How much of that is to be believed?


The Theatre in Europe
I wrote about how Draghi revealed the Grand Plan in a WSJ interview, which consisted of:

• "Good" government austerity, in the form of lower taxes and less spending; and
• Structural reform, in the form of the elimination of the European social model.

For the that Grand Plan to work, you need a compliant central bank to print money so that the system doesn't seize up. So how much of what Draghi said is bluster and how much is real?

I interpret what Draghi said as being totally consistent with the message of: We will print more money if necessary, but on the condition that the politicians move forward with the Grand Plan's reforms. Otherwise, be prepared for tightening.

It seems to me that even the Germans are on board with the Grand Plan. Despite the German cultural aversion to money printing, notice that there wasn't a single complaint from either the Bundesbank or any of the German hardliners about LTRO, which has been documented to enormously expand the ECB balance sheet? Instead, we got a letter from Weidmann of the Bundesbank complaining about a technical point with LTRO, i.e. the quality of collateral.

Is this complaint about collateral quality just theatre? If so, then is Draghi's comment about going "back to normal, classical central bank policy" also part of that theatre?

I interpret all these statements as part of the "show" that's been going on in Europe as the elites proceed with the Grand Plan. The German complaint is part of the chorus of doubt that accompanies the main show and so is the ECB response, but they are not likely to be significant. No doubt, the ECB has the power to derail everything should any government step out of line, but my guess is that everyone pretty much knows the score. If needed, don't be surprised if the ECB stepped up with further LTRO or LTRO-like programs. Recall that I wrote that analysis reveals that the European banking systems may need up to four LTROs in order to fund their liquidity needs to 2013.

I recognize that the ECB doesn't want the banks to get addicted to LTRO, but do you expect the Draghi to allow European banks to fail as long as the Grand Plan is proceeding smoothly?

Expect more drama, but also expect a happy ending as long as all the players know their lines.



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

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

The NFP coin toss

My inner investor tells me that what matters in the medium term is the American consumer behavior and much of that depends on the employment picture and how good they are feeling about themselves and the economy.

My inner trader tells me that, given the corrective market action we saw on Tuesday, Friday's NFP release is going to be a huge bellwether in determining short-term market direction.


Duelling models
Ahead of the NFP release, we have seen hugely disparate in either direction. TrimTabs is forecasting a subpar 149K new jobs, "based on an analysis of daily income tax deposits to the U.S. Treasury from all salaried U.S. employees". Gallup, which does a telephone poll of 18K respondents by telephone, put out a press release indicating that they expect the March unemployment rate to tick up significantly.

On the other hand, other forecasters like Deutsche Bank is looking for a big upside surprise to the NFP number. Ed Yardeni says the same thing by pointing to the the buoyant ISM surveys and the aggregated results of Regional Fed surveys of manufacturing activity.

On the negative side, the NFIB, which represents small business, said that they were not seeing a particularly upbeat employment outlook from their membership.

...but the ADP report said that a lot of job growth they saw came from smaller businesses.


Analyzing the data
What do you do? Who do you believe?

Here is how I have analyzed the data. First, the Gallup data is not seasonally adjusted. A comparison of this February vs. February last year shows an improvement. As a quick and dirty on a seasonal adjustment, if you compare the sequential change last Jan to Feb was 0.4% and so was this year. So maybe even if Gallup is right, NFP doesn't come in that badly?


On the other hand, the Gallup poll sample is 18K respondents. The sample size of the Regional Fed survey that Yardeni depends on is probably lower, though they are businesses and not individuals.
 
The Gallup survey is a rolling survey, which tends to be a bit more accurate. However, Gallup forecasts the unemployment rate, which is a function of employment and labor force size (and labor participation rate). However, the market focuses on employment, not unemployment. So given all the seasonal adjustments (a wildcard), even if Gallup is right the number may not come out that badly.
 
Even though I am leaning slightly bullishly on the NFP release. Trying to guess the NFP headline number and the subsequent market reaction is like betting on the flip of a coin. At best, the NFP figure is extremely noisy. Even if you had an edge, which would be slight given the enormous error term, it would be like being the house at a casino where a high roller ambled up to a roulette table and put several billions dollars on red. Despite having a slight edge, you would be feeling extremely nervous.




Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
 
None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The energy bull still lives

Ambrose Evans-Pritchard recently wrote an article entitled Plateau Oil meets 125m Chinese cars, in which he discusses why oil prices haven't fallen despite the anemic nature of global economic growth [emphasis added]:

What is deeply troubling is that Brent crude should have reached fresh records in sterling (£79) and euros (€94) - with a knock-on effect on US petrol prices, mostly tracking Brent - even though the International Monetary Fund has sharply downgraded its world growth forecast to 3.25pc this year from 4pc in September, and even though International Energy Agency (IEA) has cut its oil use forecast for this year by 750,000 barrels per day (bpd).

Oil is not supposed to ratchet defiantly upwards in a downturn, which is what we have with the Euro zone facing a year of contraction in 2012, and much of the Latin bloc sliding into full depression. Japan‘s economy shrank in the fourth quarter.

The reason is Peak Oil, or Plateau Oil, where crude supply is not expanding to meet rising global demand because of rising emerging market affluence.

Asia’s emerging powers of Asia - the key force driving the commodity boom of the last decade - are in various stages of “soft-landings” after hitting the monetary brakes last year to check property bubbles and curb inflation. China’s manufacturing has been bouncing along near contraction levels through the winter. So what happens when it recovers?

The unpleasant fact we must all face is that the relentless supply crunch - call it `Peak Oil’ if you want, or `Plateau Oil’ - was briefly disguised during the Great Recession and is already back with a vengeance before the West has fully recovered.

The commodity markets are now selling off over China's new GDP growth of 7.5% as it shifts from export driven growth to internal consumption growth. I would argue that the move is commodity bullish (instead of bearish as interpreted by the market knee-jerk reaction) because resource intensity grows because of the shift to consumption, as shown by this analysis from the Council on Foreign Relations.

Indeed, the emerging market demand story has become so prominent that Big Picture Agriculture points out that Asian oil demand has already risen to exceed North American demand.

Not too late to buy energy stocks
It's such these kinds of positive fundamentals that makes me a long-term commodity and energy bull - and it's not too late to buy energy stocks. The chart below shows the price chart of Select SPDR Energy ETF, or XLE, going back to 2000.
 

 
I have also constructed a crude trading signal for energy stocks. Below the main XLE price chart, I show the relative performance of the more volatile Oil Services ETF (OIH) against the more stable XLE, which is more heavily weighted with integrated oils. Note that troughs in the OIH/XLE ratio have been good times to buy. Investors would have seen higher prices within a year after each of those buy signals. Moreover, if you had waited for the OIH/XLE ratio to rise by 0.25 to 0.30 after each of those buy signals and sold your position, you would have profited handsomely.
 
We just saw a buy signal for energy stocks last year. Based on the OIH/XLE ratio, it's not too late to buy and ride the energy stock 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.

Why I am still bullish (II)

I got a fair amount of feedback and pushback on my last post (see Why I am still bullish). Most have pointed to contrarian sentiment indicators, such as the Rydex Bull/Bear ratio, showing that traders are excessively bullish on stocks.

The Do's and Don'ts of sentiment models
Let's go back to first principles on sentiment models. The basic assumption behind sentiment models is that if a certain group is in a crowded long position, then there is little or no buying power to push the market up further. I said in my last post that both individuals and institutions are in no way overweight equities relative to historical experience. Institutional fund flows into stocks have barely begun, which provides sustainable buying power. Individual investors have been selling out of equity mutual funds and funds flows barely turned positive. Are those signs for you to run for the hills?

Such conditions set up the possibility that we can experience a series of readings that show too many bulls in sentiment models, which are shown in red in the chart above, during a rally where the market advances steadily such as the QE2 stock market rally that began in late 2010. At the same time, technicians could see a series of "good overbought conditions" as the market grinds higher.

For traders, sentiment models can be notoriously fickle. Since the Dow first kissed the 13K level and pulled back, some measures of sentiment have seen bullishness drop significantly. In fact, the latest Bespoke survey, which is admittedly unscientific, shows more bears than bulls and we have seen similar levels of waning bullishness amongst the respondents of other surveys.

A case of bad breadth? Or just a "good" Apple?
Another knock against the bullish outlook are the negative divergences seen in the markets. The Dow Jones Transportation Average has lagged. But as Mark Hulbert pointed out, there has been disagreement among Dow Theorists about the significance of that divergence.

Other technical analysts have pointed to the poor relative performance of small cap stocks. It is said that when large caps lead the market, it is a sign of faltering leadership, i.e. the generals are leading but the troops aren't following.

Are small caps truly faltering, or is is just the case of a large cap rocketship - in this case Apple?

The chart below shows the relative performance of the small cap IWM against the large cap SPY. The relative performance of small caps against large caps broke down in late February by violating a relative uptrend that began in October (shown in green) and at the same time broke down against a relative support level (shown in blue). Now consider the relative performance of IWM against EWI, which represents an equal-weighted S+P 500 and largely neutralizes the effects of Apple's rally, shown on the bottom panel. Note that small caps remain in a relative uptrend against large caps. How much of the relative breakdown is due to the capitalization effect of Apple?

You can see the same effect more dramatically when we compare the relative performance of the NASDAQ Composite against the NASDAQ 100. Similarly, the small cap NASDAQ Composite broke down in late February against the mega-cap NASDAQ 100. However, the bottom panel shows that the NASDAQ Composite remains in a relative uptrend against the equal-weighted NASDAQ 100.

A correction is possible but not inevitable
So where does that leave us? If you are an investor, the intermediate term trend is still up (note that Warren Buffett recently expressed his bullishness). I would be inclined to stay long and ride out any short-term choppiness.

If you are a trader, you have to be prepared for a correction, which may or may not occur. In some ways a correction is overdue because stocks have been rising steadily this year without a single day where the market has fallen 1%. On the other hand, you also have to be prepared for the possibility that there is no correction and the market grinds upwards while undergoing a series of "good overbought conditions" until individual and institutions have fully loaded up on equities.

Even if a correction were to appear, it would likely be mild. The first support level for the S+P 500 would be the 50-day moving average, which is 3-4% below current levels. In this video, Jeffrey Hirsch, of the Stock Traders Almanac, believes that the market is likely to see a mild correction in the second half of March but would view that as a opportunity to deploy more cash. He then expects the markets to continue to rally until year-end.



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.

Why I am still bullish

As the stock market consolidates and the Dow flirts with the 13K level, there have been some calls for an intermediate term top. I remain bullish over the next few months for the following reasons:

• The risk trade bull run remains intact
• Positive funds flow are buoying the markets;
• Panic levels are still elevated;
• "Expert opinion, defined as the better market timers, are bullish;
• The Bernanke Put and Draghi Put still lives; and
• The China property bubble lives on for another day.

The risk-on trade is still "on"

If you were to view the stock market through the lens of the risk-on/risk-off trade, then the risk-on bull move remains intact. Consider this chart of the relative performance of SPY against IEF, which shows a short-term relative uptrend in the context of an intermediate term uptrend.

Positive funds flows
Josh Brown pointed to a Reuters article indicating that institutional equity funds flows are positive. He went to say that they are likely to continue:

In my experience, these types of raising and lowering equity exposure cycles take place at a glacial pace and they rarely turn or stop on a dime.

Scott Grannis wrote that individual investor equity funds flows are just starting to turn positive and there is a lot of room for them to go further into stocks:

...and out of bonds, whose flows are still positive:

Grannis' conclusion was:

Adding it all up, I would say that we are a long way from seeing over-priced equities. Let's wait to see many months or even a few years of inflows to equity funds before concluding that the guy on the street is too bullish.

Panic levels are still elevated
Also consider the readings of the Crash Confidence Index from the Yale School of Management. A low level indicates a high level of fear and a high level indicates a high level of complacency. While the ECB's LTRO program has largely taken the risks of a banking meltdown off the table, investors confidence remain low and fear levels are still elevated. I interpret these conditions as being contrarian bullish.

"Expert" opinion is bullish
Mark Hulbert reports that the best market timers are leaning bullish, while the worst market timers are leaning bearish.
 
As an example, I don't know where the Aden sisters are in Hulbert's ratings, but I have tremendous respect for them and they are bullish. I have followed them, off and on, since the late 1970's during the gold mania that took bullion up to its peak of $850 in 1980, which they correctly called. Unlike other gold bugs, they turned bearish on gold and turned bullish on equities in the intervening period. They correctly called the rebirth of the commodity bull about ten years ago.
 
 
The Bernanke and Draghi Puts still lives
Ben Bernanke, in his testimony to Congress last week, said in so many words that QE3 isn't a done deal and they are watching the data carefully.

In light of the somewhat different signals received recently from the labor market than from indicators of final demand and production, however, it will be especially important to evaluate incoming information to assess the underlying pace of economic recovery.

The markets sold off but the flip side of this coin is that they are ready to act should the economy weaken.

The dual objectives of price stability and maximum employment are generally complementary. Indeed, at present, with the unemployment rate elevated and the inflation outlook subdued, the Committee judges that sustaining a highly accommodative stance for monetary policy is consistent with promoting both objectives.

So does that mean that good economic news is good news for the markets but bad news isn't necessarily bad news?

As for the ECB, interbank lending in Europe is still seized up. This analysis shows that the European banking system needs another four LTROs to get through to 2013. Don't be surprised if the ECB announces further rounds of LTRO.

In short, the Bernanke and Draghi Puts will "put" a floor on the stock market for now.


 
The Chinese property bubble lives on another day
Walter Kurtz, writing at Pragmatic Capitalism, noted that the property market in Beijing and Shanghai are recovering. Such a development should forestall any immediate concerns about a crash in the Chinese property bubble as official actions have kicked the can down the road and delayed the day of reckoning yet once more.
 
The Shanghai Composite has responded with a rally as a result of these measures. As the chart below shows, the index has rallied through a downtrend line and it has not even approached the first Fibonacci retracement level, which would serve as a resistance level.
 

 
 
 
Bearish tripwires
To be sure, not every market forecast is correct. Here is some of what I am watching for to see whether the bears are wrestling control of this market away from the bulls. These are some important questions that need to be answered in order to determine the next major move in equities.

First and foremost, the big question is can the Dow can overcome the 13K mark?

Looking at foreign markets, can the Hang Seng overcome resistance after rallying to fill the gap depicted in the graph below?

What about Europe? The Euro STOXX 50 appears to be undergoing a sideways consolidation. Can it rally to overcome resistance?

The cyclically sensitive Australian Dollar is temporary stuck in a trading range. Will it break out to the upside, which is bullish, or to the downside, which is bearish?

Another important cyclical indicator is the relative performance of the Morgan Stanley Cyclical Index against the market. Cyclicals started 2012 on a tear, but they have begun to consolidate sideways on a relative basis. Can the relative support level hold?

Lastly, technicians have been sounding words of caution because the Dow Transports have been lagging and have not confirmed the advance of the Industrials Average. Mark Hulbert writes that there is some disagreement about prominent Dow Theorists about the significance of this divergence:

Frustratingly, not all Dow Theorists agree on an answer. In fact, two of the three monitored by the Hulbert Financial Digest — Jack Schannep of TheDowtheory.com and Richard Moroney of Dow Theory Forecasts — think the appropriate point of comparison is not last summer but late October. And because, near the end of December, the Dow averages rose above their late-October highs, both Schannep and Moroney believe that the Dow Theory is solidly in the bullish camp — notwithstanding where the Dow transports might be relative to their July high.

In contrast, Richard Russell, editor of Dow Theory Letters, says he’s worried about the Dow transports’ weakness and, in part for that reason, is largely out of the stock market.

The chart below shows the relative performance of the Dow Jones Transports against the Dow Industrials. If relative performance were to fall below the 38% Fibonacci retracement support level, it would mean that the bears have taken control of the market.

In conclusion, I believe that equities are consolidating their gains but remain in an intermediate bull phase. During this consolidation period, doubts will appear about the legitimacy of the bull leg, as they are now. My view is that the next major move is up, but I am watching and open to the possibility that I am wrong and a correction can run deeper than I expect.


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

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

The optimistic view of Europe

Forget about the alligators. Let's talk about draining the swamp. There is a way out of this quagmire for Europe. Ken Rogoff, in an interview with Der Spiegel, believes that political integration (or a "United States of Europe") is closer than anyone expects:

SPIEGEL: Do you honestly believe that the countries in the euro zone can bring themselves to hand over that much more power to Brussels?


Rogoff: The terrible thing is that few countries in Europe seem genuinely prepared for that. Those politicians who know what is needed keep quiet, fearing opposition from the voters. But the pressure of this crisis will create a momentum whose scope and impact we cannot yet imagine. At the end of the day, the United States of Europe may well come about a lot quicker than many would have thought.

SPIEGEL: With all respect to your optimism, the Europeans are unlikely to play along with that. The popular opinion in most member states is that Europe has far too much power, not too little.

Rogoff: Europe is in an interim stage, quite similar to that in late 18th century America. The ratification of the United States constitution in 1788 was preceded by 12 years of a loose confederation, which sometimes worked but usually didn't. Europe is in a similar situation today. States are like people, it is difficult to sustain a stable half-marriage; either you go for it or you forget it.

Much of the latest eurozone crisis stems from the fact that there was economic integration without political integration. Rogoff believes that the European elite within the Community will take this latest crisis to push for greater integration.

This is all part of the Grand Plan that I wrote about before. Mario Draghi, in an interview with the WSJ, said that the steps include:

1. Austerity, defined as lower government expenditures and lower taxes; followed by
2. Structural reform, defined as the elimination of the European social model.

In the meantime, the ECB stand ready to provide the necessary tonic (such as LTRO) to smooth the transition as long as the eurozone was moving in the right direction. Greater European integration, as per Rogoff, would be one of those steps.

The optimist in me says that if the Europeans manage to pull this off, it will result in a new Renaissance for the EU and the global economy. The World Bank warned this week that China may be at risk of a middle-income trap as the supply cheap labor, which was the primary source of competitive advantage, diminishes. Were Chinese growth were to slow and the slack were to be taken up by a surge in Europe in the next decade, it would be a source of welcome global rebalancing.


Key risks
The caveat, of course, is that everything has to go right. For example, Bruce Krasting pointed out that some hospitals in the PIGS countries have not paid their drug bills for up to three years and the outstanding bills amount to €12-15 billion. Stories like these suggest that there are liabilities out there beyond sovereign debt as represented by the bond market that the market isn't very aware of. How much and can the Powers That Be skirt these potholes as they come up? I don't know.

The greatest political challenge to the Grand Plan of austerity, structural reform and political integration is the discontent on the Street. Consider this chart of European youth unemployment. Note how it is going up everywhere except for Germany.

We have a map showing how to get out of the swamp. Can the European elites steer the EU out? I am not sure, but not all is lost. Just remember how Thatcher's reforms revitalized Britain. Is the current situation on the Continent very much different from the UK in the early 1980's?

I remain cautiously optimistic longer term. Consider the judgment of the markets. If Europe is in such trouble, then why has the EURUSD exchange rate been rallying?

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.

Why an Israeli strike on Iran is unlikely

Bruce Krasting wrote a post today about the likelihood of an Israeli strike on Iran. I would like to add my two cents worth on the issue and describe I think it is unlikely. Here is what he wrote:

Will Israel allow Iran to develop a nuke?
Not a chance in hell.

What is the “over - under on timing”?
Certainly less than two years.


Does Israel have the capacity to take out concrete hardened facilities in Iran?
Yes, but this is by no means an easy task.

The latest question is where I differ from Krasting. An Israeli strike on Iran isn`t the same as past strikes on a single reactor in Iraq, which involved a single target.

Consider the logistics of an air strike on Iran. Most of the analysis that I have seen indicate that a strike on Iran would involve simultaneous strikes on between 40 and 80 targets. Here is one example out of many that I`ve found [emphasis added]:

There are 25 to 30 installations in Iran which are exclusively or predominately dedicated to the nuclear program. Six of them are targets of the first rank: the uranium enrichment facility at Natanz, the conversion works in Isfahan, the heavy water reactor in Arak, the weapons and munitions production facility in Parchin, the uranium enrichment facility in Fordow, and the Bushehr light water reactor.

Iranians have air defenses. It isn't just a simple case of taking out these sites, some of which are hardened and buried under tons of rock. You have to hit radar sites, communications sites, SAM sites, air bases, etc. Once you add it all up, 80 or site separate air strikes is a realistic number.

Krasting also put up a map of the region and wrote that a route over Syria and Iraq is the most likely possibility, a conclusion with which I agree.

Supposing that the Israeli cabinet authorized airstrikes on Iran. Consider the questions:

1. If the IAF had to fly escorts, jamming aircraft and likely refueling tankers (so that the strike force would have sufficient range to return to base), does it have sufficient air assets to conduct 40-80 simultaneous strikes? Answer: No.
2. If some of these sites are so hardened, could they be taken out without the use of tactical nukes? Answer: Maybe, but if they were to nuke Iran, they would have to consider the repercussions.
3. Who has that kind of capability to conduct such an operation? Answer: The Americans.
4. Given the size of the air armada that would have to transit Syria and Iraq, would Israel inform the Americans of such a strike? Answer: Maybe, but there are risks.

Whatever you think about Iran and her nuclear ambitions, any operation that contemplates the bombing of Iran is fraught with risk. The Israelis likely don't have that capability. Even if they did, they would have to do it with the approval of the Americans, who have that kind of capability of cruise missiles and air assets.

Consider the blowback if the Israeli cabinet decided not to inform their American allies of a strike on Iran. First, such a massive air armada would have to transit Iraqi airspace. While the Iraqi wishes may be ignored, the US still has military assets in the region. How would American commanders react to a surprise air armada transiting Iraqi airspace? Does the Israeli cabinet want to take a chance of having engaging American fighters (if they chose to intercept) or allowing IAF planes to be shot down by the Americans?

That's why I believe that any decision to bomb Iran must be done with the approval of the United States, which is unlikely. Obama, or any other president, will know that the Iranians will interpret a bombing campaign as being done with the approval of America, which will leave American troops in Iraq and elsewhere in the region vulnerable to guerrilla attacks as well as expose the American homeland to higher risks of terrorism. Notwithstanding the political and costs to American standing in the Middle East and Muslim world., I wrote before the United States cannot afford another war and I stand by that analysis.

In short, any strike on Iran by Israel must be done with American cooperation - and the US is unlikely to give the green light to such an action given the political risks and fiscal costs involved.



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.

We are all QEers now

Richard Nixon famously said in 1971 that we are all Keynesians now. Within a decade, the unintended effects of Keynesian stimulus were plain to see for everyone as inflation raced upwards and out of control.

Today, as the world holds its breath for the results of the ECB's LTRO2 auction later in the week, we are all Quantitative Easers. The Bank of Japan, Federal Reserve, the European Central Bank and Bank of England have all embraced quantitative easing, or money printing. Recently, both the BoE and BoJ have announced further rounds of quantitative easing.

In the short run, there are clear benefits to the US federal government of the Fed's ZIRP and quantitative easing. In 2011, the US paid $454 billion in interest payments under ZIRP and, despite skyrocketing debt, interest expect was less than it was in parts of the 1990's.

Moreover, L Randall Wray points out that the Federal Reserve holds assets equal to one-fifth of GDP. What's more, an astounding 50% of its assets have maturities of 10 years or more.

Governments of the developed world are trapped by their central bankers dual policies of ZIRP and QE. If central bankers were to raise rates, interest costs would spiral out of control and overwhelm budgets. Just read Reinhart and Rogoff to see what happens next.

This has resulted in a binary investment environment of risk on, when central bankers are engaged in QE, and risk off, when they are not. The endgame will either inflation or debt default - and I don't know what the result will be.

For investors, this means becoming more tactical in understanding the risk on/risk off backdrop and participating in the trend of the day. Right now, central bankers are engaged in another round of QE around the world. Despite what you may think of the ultimate costs of such policies, the right thing for an investor to do is to party and worry about the consequences later.



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.

Mario Draghi reveals the Grand Plan

Policy in Europe has generally been done in the back rooms, with the theatre, e.g. PIIGS debt re-negotiations, done in the front rooms. Last year, the markets were panicked because they perceived the backroom elites had lost control of the situation and events were spiraling out of control.

Today, it appears that the elites have calmed things down and there had always been a Grand Plan. We got hints of this when Angela Merkel said that there was no silver bullet to the eurozone crisis, but resolution was a "long process".

Now ECB head Mario Draghi, in a WSJ interview, reveals the Grand Plan. Not only does he speak on monetary policy, I found it more important that he touched on fiscal policy and micro-economics, which is an indication that he was speaking about the European Grand Plan.

The Grand Plan involves austerity, but it's not all austerity all the time. Draghi distinguishes between "good austerity" and "bad austerity".

WSJ: Austerity means different things, what’s good and what’s bad austerity?

Draghi: In the European context tax rates are high and government expenditure is focused on current expenditure. A “good” consolidation is one where taxes are lower and the lower government expenditure is on infrastructures and other investments.

WSJ: Bad austerity?

Draghi: The bad consolidation is actually the easier one to get, because one could produce good numbers by raising taxes and cutting capital expenditure, which is much easier to do than cutting current expenditure. That’s the easy way in a sense, but it’s not a good way. It depresses potential growth.

Lower taxes and less government expenditures? That sounds positively...Anglo-Saxon (excuse my French).

Draghi went on to say that the next step, after austerity, is structural reform "because the short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place". Draghi went on to say [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.

In other words, union busting and going after all of the entrenched interests of the old with their lifetime jobs and gold-plated pensions at the expense of the young jobless. It sounds positively Thatcherite. Draghi went on to say that the old days of the European social model are gone [emphasis added]:

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.

Mario Draghi is an important central banker and chooses his words carefully. I can't believe that he would go rogue and speak so frankly about fiscal and other government policy outside the ECB's mandate without the consent, or at least informing, the likes of Merkel and Sarkozy. So you have to believe that he is speaking on behalf of either the Elites or at least Merkozy in detailing this Grand Plan.
 
 
Can the Grand Plan work?
Today, I see commentary about how austerity is biting and the people of Greece (followed by Portugal) cannot possibly survive with a policy of all-austerity-all-the-time. They are missing the point. Draghi said that structural reforms must follow because "short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place."
 
This sounds like a long and hard road. Can it succeed?
 
The plan sounds like it was written out of the Maggie Thatcher playbook. It is also somewhat Teutonic in that it is well aware of the link between competitiveness and productivity, as well as the remarkable German technique of achieving a consensus between business, labour and government.
 
I am cautiously optimistic that the Grand Plan could work, which would lead to a period of European Renaissance. For it to work, however, many things have to go right. First of all, you need all of the actors to fall into line and no one to quit because "enough is enough". So watch the upcoming Greek elections and watch the upcoming French elections for how much support Marine Le Pen gets as important barometers of discontent on the Street. I remain optimistic because we are not at that breaking point because, despite the mass content with the bailout plan, the latest opinion polls of Greeks show that 77% want to stay in the eurozone "at all costs".
 
As well, you need to have an accommodative Dr. Draghi (and Dr. Bernanke) standing by to inject the patient with additional quantitative easing morphine if necessary while he is still in recovery. That appears to have been accomplished. Note how Draghi did not rule out another round of LTRO despite other quarters of the ECB voiced concerns about the banking system becoming overly dependent on ECB support:

WSJ: Would you be open to doing more, or longer, LTROs if needed?
Draghi: You know how we answer these questions. We never pre-commit.

Also notice how the ECB's LTRO program amounts to de facto quantitative easing and money printing, but there hasn't been a single word of protest from the German hardliners? That's an indication that there is a Grand Plan which the elites are executing.
 
The jury is out on the Grand Plan but if this all works, Merkel could be lionized as the new Thatcher and Draghi as the new Maestro.
 
 
 
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.

War with Iran:Would you go bankrupt for your country?

There has been a fair amount of chatter about a geopolitical risk premium on the price of oil stemming from a conflict with Iran. While I generally don't agree with candidate Ron Paul on most matters, I do agree with him when he said in a debate last week that America can't afford another war.

The Institute for Economics and Peace (h/t Josh Brown) came out with a paper called Economic Consequences of War on the U.S. Economy, which Josh summarizes as:

• Public debt and levels of taxation increased during most conflicts;
• Consumption as a percent of GDP decreased during most conflicts;
• Investment as a percent of GDP decreased during most conflicts;
• Inflation increased during or as a direct consequence of these conflicts.

Fiscal conservatives should be appalled by the march to war, especially when you consider the immense deficits that are facing the government today. I once rhetorically asked if the Pentagon has a downward sloping demand curve and today I very much doubt it. Consider this account of how gasoline costs $400 per gallon in Afghanistan - that's before the Pakistanis cut off supply routes that raised prices roughly sixfold. Are American interests in Afghanistan that important to warrant those kinds of costs? (I read somewhere once that the United States spent $1 million for every Vietnamese man, woman and child during the Vietnam War. Could it have achieved its objectives for a lower cost?)

Instead of fighting wars intelligently, the military industrial complex focuses on the development of gadgets like the iRobot’s Warrior, which is “strong enough to tow a car and dexterous enough to open its trunk using the handle.” Is this the sort of device the military really needs in a counterinsurgency?

Imagine if your local police force deployed such machines instead of real people and you interacted with them through an automated call center. How would that affect your interaction with the police? Would you trust them more? Or less?

Instead of fighting wars intelligently, the military industrial complex is now intent on building the Death Star - and damn the cost!

Star manager Jeff Grundlach compared the US to the Roman Empire. American share of global military spending is 43%, but meanwhile its debt is spiraling out of control.

During times of vital interest to a nation, its leaders have asked its young men to be prepared to die for their country. On the other hand, how many Americans are prepared to lose their jobs and homes and go bankrupt for their country?

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.

Is ECRI changing its recession call?

Here's an announcement on the ECRI website.

Will Achuthan back off on the recession call? If he did then surely clients would have heard it first but I haven't heard any leaks from the blogosphere. On the hand hand, it does say "updated outlook".

Stay tuned.



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.

Watch how the ECB acts, not it says

As we await the ECB's LTRO2 auction next week, there was a story on CNBC entitled ECB preparing to close liquidity floodgates:

The European Central Bank wants its second offer of cheap ultra-long funds next week to be its last, putting the onus back on governments to secure the euro zone's longer-term future.

There is no doubt that the ECB would rather not seen banks staying on LTRO life support, but what it wishes for and what it will do are two completely different matters. The story sounds like a plant, intended to warn the markets not to expect another round of LTRO.

The expectations that LTRO will stop on February 29 don't seem credible. Consider this Bloomberg story on February 10 of how Mario Draghi was practically begging banks to participate in the three-year LTRO program:

European Central Bank President Mario Draghi lashed out at bankers who said tapping the ECB’s three-year-loan program carries a stigma, after executives including Deutsche Bank AG (DBK)’s Josef Ackermann said they shunned the loans.

“There is no stigma whatsoever on these facilities,” Draghi said at a press conference in Frankfurt yesterday. “Some have made some sort of statements that I would call statements of virility, namely it would be undignified for a bank, a serious bank, to access these facilities. Now let me say that the very same banks that made these statements access facilities of different kinds -- but still government facilities.”

Which do you think represent the real views of the ECB?



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.

Preliminary verdict: Consolidation and correction

In my last post, I wrote that I was watching the European bourses and the Hang Seng Index for signs of whether we are likely to see a continuation of the bull move or a consolidation period.

The preliminary verdict is consolidation and correction. You can tell the short-term tone of the market by how it reacts to news. On the weekend, China unexpected cut reserve requirements by 50 bp. The Shanghai Composite rallied on the news, but the Hong Kong market was unable to hold its gains and finished the last few days beneath a key technical resistance level.

In Europe, we saw the Greek bailout deal finalized late in the night. Markets staged a mild rally on the news and then sold off. The Dow rallied to kiss the 13K level and wound up roughly flat on the day. Does this sound like a market where the bulls are in control or does it sound like they're exhausted?

In the wake of the easing of financial tensions in the eurozone, can anyone explain to me why the EURCHF exchange rate hasn't rallied and appears to be slowly declining to the 1.20 level where the SNB said it would defend?

The Swiss Franc has long been regarded as a safe haven and the EURCHF rate is a measure of risk appetite so the above chart appears to be anomalous. What does the FX market know that the equity markets don't know?

I generally agree with Barry Ritholz's scenario for the market, though I believe that the Fed is likely to be proactive on QE3:

If the past is prologue (and that cannot be relied upon), we could see a scenario something like this (Note: Wild ass guessing to follow). Markets kiss 13,000, pullback and consolidate. But they are not overbought sufficiently for anything more serious than a modest retracement, and so they continue higher for several months, until the % of stocks over 200 day MA is near 90% (they are at 75% today). That takes us somewhere between March and June. The next sell off begins, lopping 25% or so off of the SPX. The Federal Reserve waits until after the November election to introduce QE3, and the cycle starts anew.

My base case scenario calls for a short (1-3 week) consolidation phase and a grind upward. After that, we'll have to watch how events unfold.


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.

Breakout or consolidation?

On Friday, the Dow Jones Industrials Average staged an upside breakout to a new recovery high. The move was confirmed by the large cap OEX, but not by many other averages.

The S+P 500, for example, is still struggling with resistance. The intermediate term trend, however, appears bullish as it is in a well-defined uptrend and there are signs of global healing from stock indices around the world. In my mind, there is no question that the bulls are in control of this market in the intermediate term. The more relevant question is whether they have exhausted themselves in the short-term. Can the S+P 500 clear resistance or are we due for a period of consolidation?

More disturbing for the bulls is the narrowing leadership of this rally as it has been led by the large cap stocks. Small caps have not been as strong, which is a bearish negative divergence. As shown below, the small cap Russell 2000 is barely approaching its resistance zone, though it is in a similar well-defined uptrend.

Cylicals say consolidation
To discern the future direction of equities, I turn to the answer from three place. I analyzed the chart patterns of the cyclicals, as well as the other two sources of macro risk, Europe and China. Consider the Morgan Stanley Cyclicals Index. These stocks staged an upside breakout in mid-January, but have started to consolidate as they moved sideways through the uptrend line.

Other cyclically sensitive indices and currencies, such as the Australian Dollar, the Australian All-Ords, the Canadian Dollar and the TSX Index all show a pattern of breakout and consolidation.

Commodity prices, on other hand, have lagged this rally. They broke out of a downtrend in mid-January and they appear to be consolidating. I am watching to see if the sideways pattern continues or if they can stage an upside breakout through resistance.

Are fundamentals improving?
Josh Brown puts the bull and bear debate into perspective this way:

I'm convinced that the single most important decision facing asset allocators right now is whether or not to join The Big Shift or to ignore it and ride it out. Guys like me need to decide if we're going to dance with the sinners in the high-beta, risk-on sectors that have been leading this market or stick with the saints - the defensive, income-heavy non-cyclicals that saved our lives when things got dicey last year.

He went on to say that equity prices may have gotten ahead of fundamental [emphasis added]:

The trouble with this is that while we may yet be able to avoid another recession scare this year, the data simply does not confirm (just yet) what the homebuilders, banks, casinos, REITs and materials stocks would have us believe. Instead, I think we're witnessing a major rotation, one of the biggest I've ever seen, and that it cannot get much further until the data on housing and jobs improves markedly and materially.

Have the fundamentals improved? Well, sort of. On the earnings side, things are improving as reporting season progresses. Thomson-Reuters reports that the "beat rate" for companies have been steadily getting better.

Corporate guidance, while negative, has been improving as well [emphasis added]:

Looking ahead to the next earnings season, in which companies will give investors a glimpse of how they are faring in the early months of 2012, the number of companies offering downbeat guidance continues to exceed those steering analysts’ forecasts higher. So far, 52 companies in the S+P 500 have issued negative earning guidance compared to 20 that have issued positive earnings guidance for the first quarter of 2012; the resulting ratio of negative to positive preannouncements is 2.6. While that’s still not telling investors that corporate executives are bullish, it’s a significantly more positive reading than the N/P ration of 3.6 observed as recently as last week.

Watch overseas markets
The other important "tell" of market direction are Europe and China, which are the two big sources of macro risk. I am watching closely the action of the Euro STOXX 50, which has staged an upside breakout, but it isn't clear whether the breakout will hold. (With the ECB about to unleash LTRO2 that is expected unleash over €600b of liquidity to the eurozone banking system, does anyone want to bet against a breakout?)

Moving east, I pointed out last week that the Shanghai Composite had rallied through a downtrend line. That development had alleviated my concerns of China as a source of tail risk and signaled that a hard landing is less likely. Indeed, China has cut bank reserves another 50 basis points as it followed suit on a trend of global monetary easing by the BoJ and BoE.

Next door in Hong Kong, the Hang Seng Index has rallied to fill a downside gap and is encountering overhead resistance. I am watching carefully to see if the bulls can stage a rally to overcome resistance.

Where to next?
Is this a period of breakout or consolidation? My inner investor tells me to stay with the bull trend in equities as they are in a well-defined uptrend. Moreover, a glance at the 30-year Treasury yield shows that it is forming a saucer bottom pattern, indicating that the risk-off trade is on its last legs.

My inner trader, on the other hand, is more agnostic on the question of breakout or consolidation. On one hand, he is aware that the combination of under-invested equity investors and bullish sentiment can  lead to  a series of "good overbought" conditions that result in higher prices. On the other hand, the markets are overbought and they are ripe for a pullback and he is watching market conditions carefully next week for signs which way the markets break.



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.