Falling tail-risk = New secular bull?

As the Dow passed 14K and the view is turning towards the belief that the financial crisis is over, the logical conclusion is that we are seeing the birth of a new secular bull. Indeed, I examined the kurtosis of stock returns and found that it is falling.


Tails are getting thinner
For non-geeks, kurtosis is the measure of how fat the tails are in a return distribution. There are different kinds of fatness, as shown in the diagram below. Here is one explanation:

[W]ait till you hear two more terms: leptokurtic and platykurtic. These describe two different distributions, all part of what is known as kurtosis, the measure of the combined weight of the tails of a distribution in relation to the rest of it. When tails become heavier, the kurtosis value increases; when they are lighter, it decreases. A normal distribution has a kurtosis of 0, and is called mesokurtic (A below). If a distribution is peaked (tall and skinny), its kurtosis value is greater than 0 and it is said to be leptokurtic (No ointments needed.) (B below). If, on the other hand, the kurtosis is flat, its value is less than 0, or platykurtic (C below).

When kurtosis is 0, it is an indication that a distribution is normally distributed (like diagram A). The higher the kurtosis, the fatter the tails. To give a better real-life interpretation of this measure: A risk-manager at a hedge fund explained to me that once the kurtosis of an investment strategy gets above 2 or 3, he starts to get concerned about unusual fat-tailed events.

The chart below shows the trailing one (blue line) and four year (red line) kurtosis of daily SPX returns. We see periods where tails have gotten fatter (Lehman in 2008, Eurogeddon fears in 2011). Overall, four-year trailing kurtosis has been falling since the Lehman Crisis of 2008. In fact, one-year trailing kurtosis is at the lowest level since the Lehman Crisis. If it were to fall further, it is a signal that the market believes that this is a new era - and perhaps an indication that this is the start of a new secular bull market in equities.

Ray Dalio turns bullish
Certainly, there are some well-known advocates for a new secular bull. Ray Dalio of Bridgewater Associates recently hinted at a New Era (via Business Insider):

Dalio says 2013 is likely to be a transition year, where large amounts of cash will move to stock and all sorts of stuff – goods, services, and financial assets. People will spend more with the cash, they will invest in equities and gold – the cash will move.

This comment is consistent with his view that the US is undergoing a "beautiful deleveraging" (see my previous post A Dalio explanation of the Evans-Pritchard dilemma) where he explained his views in a Barron's interview:

Barron's: You've called the current phase of the U.S. deleveraging experience "beautiful." Explain that, please.

Dalio: Deleveragings occur in a mechanical way that is important to understand. There are three ways to deleverage. We hear a lot about austerity. In other words, pull in your belt, spend less, and reduce debt. But austerity causes less spending and, because when you spend less, somebody earns less, it causes the contraction to feed on itself. Austerity causes more problems. It is deflationary and it is negative for growth.

Restructuring the debt means creditors get paid less or get paid over a longer time frame or at a lower interest rate; somehow a contract is broken in a way that reduces debt. But debt restructurings also are deflationary and negative for growth. One man's debts are another man's assets, and when debts are written down to relieve the debtor of the burden, it has a negative effect on wealth. That causes credit to decline.

Printing money typically happens when interest rates are close to zero, because you can't lower interest rates any more. Central banks create money, essentially, and buy the assets that put money in the system for a quantitative easing or debt monetization. Unlike the first two options, this is an inflationary action and stimulative to the economy.

Barron's: How is any of this "beautiful?"

Dalio: A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn't dramatic. It doesn't produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That's a beautiful deleveraging.

We're in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.

We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That's why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that's a good thing.

In this week's of John Mauldin's Outside the Box column, Christian Menegatti and David Nowakowski of Roubini Global Economics (!) argue that the household delveraging process is well underway and they can see the light at the end of the tunnel:

Household balance sheet repair is virtually complete:

...though much of the debt has shifted to the government's balance sheet and the financial services sector is still undergoing a deleveraging process.

They remain constructive for the outlook for the American economy, though the healing process is not complete:

[D]eleveraging on the private side of the economy has been the flip side of the large government deficits. (In fact, the urge to save and the need to default—rather than stimulus—is the main cause of the sustained slump that is in turn the main cause of the reduced revenues and thus the fiscal deficits.) Figure 6 suggests that, compared with the post-World War II trend of rising household indebtedness, the recent debt reduction is already enough. But there is no financial or economic argument for this trend being the right long- term equilibrium. If wealth and income levels are back to mid-1990 levels, and economic uncertainty at 1970-90 levels, then household indebtedness might be more appropriate at 65% of GDP or even 50% of GDP. Even if the current pace of GDP growth combined with defaults and savings continues, it would take until 2016 or 2019 to reach those levels once more.

My problem with the New Era thesis
Here's my problem with the New Era thesis: Dalio runs a hedge fund that is global in scope. While I accept his view that we are seeing the light at the end of the tunnel for the United States, the US isn't the only country in the world and there are other major trading blocs on this earth. I understand Dalio's explanation (via Josh Brown) that there is too much liquidity sloshing around and, with tail risk off the table, cash should come back into equities. However, any rally from such a re-allocation for technical, rather than fundamental reasons, and it is not sustainable longer term, i.e. for investors with a five year horizon.


Macro risk not completely eliminated
Dalio has also said that, in connection with his "beautiful deleveraging" thesis, that Europe has its policies all wrong and certain to see further eurozone crisis down the road. What's more, China is still in the credit expansion phase of its growth and has yet to even begin its deleveraging process, which would be triggered by a realization that it has too much capacity (i.e., too many see-through buildings) supported by too much debt. Simply put, the global deleveraging process is not over!

Can we truly have a New Era bull market under those circumstances? Even if the US economy were to start growing at 2-3% real rate, what are the transmission linkages in the global financial system? If Europe were to lurch into another crisis over, say Cyprus, over the summer, can we be assured that a large European bank like Societe Generale won't go down over bad loans and do severe damage to the American financial system? While it is true that the ECB is winning the battle against the tail-risk of a sovereign debt crisis, they have yet to win the peace as there is little prospect of growth on the horizon. In this Project Syndicate article, Eric Labaye of the McKinsey Global Institute asks, in effect, where is the private investment in Europe? Corporate balance sheets are stuffed full of cash, but they don't seem confident enough to invest. If private capital isn't confident enough to invest in Europe, where will growth come from?

What's more, Bruce Krasting pointed out that the EURJPY exchange rate is skyrocketing. For a export sensitive economy like Germany, this has to hurt and will be a growth headwind for the engine of the eurozone.

What about China? What if China were to blow up in the next few years (see my recent post Is Chinese re-balancing bullish?), that a great big gaping hole won't appear in the balance sheet of a major bank like Citi, Deutsche, or HSBC? (Disclaimer: This is just speculation as I know nothing specific about any of the aforementioned banks.)

The other issue I have with the belief that we are witnessing the start of a new secular bull is valuation. Historically, stock market valuations tend to get highly depressed at the start of a new secular bull market. The chart below (via VectorGrader) depicts market cap to GDP, as a simple proxy for the aggregate Price to Sales ratio for the stock market. Note that when this ratio is falling, it coincides with a range-bound stock market.

If you were charitable, you could argue that stocks got to fair value before rising and market cap to GDP is at above average valuations compared to its own history. Maybe this is indeed a New Era, but secular bulls generally don't behave this way.

The best explanation I have is that the current bull is a cyclical upswing and not a secular one. This analysis suggests that we are still in a range-bound market. Stocks could go higher from these levels, but don't expect them to rocket to sustainable new highs in the next 12-36 months.



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.

Another front page sell signal?

Recently, Barry Ritholz highlighted a New York Times front page article entitled As Worries Ebb, Small Investors Propel Markets as a contrarian Front Page Cover sell-signal.

Now, with the Dow at 14K, Barron's has followed suit with a bullish headline:

Uh oh!


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.

Stocks cruisin' for a bruisin'

Notwithstanding the ugly GDP growth headline number, there are couple of ominous storm clouds forming on the market's horizon. Here are some possible catalysts that could create some volatility for equities in the days to come.


Is the consumer faltering?
Firstly, the Conference Board Consumer Confidence Index unexpectedly plunged from 66.7 in December to 58.6 in January, the second month of decline in the index. I had written about the Credit Suisse analysis (via FT Alphaville) showing that the elimination of the tax cut has virtually undone all of the gains that the typical American household had last year:

While the January reading is only a single data point, the fall in consumer confidence in light of the change in payroll tax is disconcerting, to say the least. The Conference Board press release echoed my concerns in a way that is eerily familiar after reading the Credit Suisse analysis [emphasis added]:

Says Lynn Franco, Director of Economic Indicators at The Conference Board: “Consumer Confidence posted another sharp decline in January, erasing all of the gains made through 2012. Consumers are more pessimistic about the economic outlook and, in particular, their financial situation. The increase in the payroll tax has undoubtedly dampened consumers’ spirits and it may take a while for confidence to rebound and consumers to recover from their initial paycheck shock.”

Additionally, a recent Gallup survey indicated that food and energy prices to financially hurt the consumer the most:

Americans are most likely to say the price of energy, the price of food, taxes, and healthcare costs are hurting their family's finances a lot or a little, out of a list of nine economic issues. Americans appear relatively unaffected by the availability of credit or immigration policies.

I am watching closely the rally in commodity prices. Should food and energy prices continue to rise and the payroll tax increase starts to really squeeze the American family's pocketbook, we could be in for a nasty surprise in consumer spending.

If the American consumer were to falter, then what happens to the economy?


Fiscal cliff anxiety, back from the dead
My second concern has to do with the possibility of the effects of sequestration. Remember all the anxiety over the fiscal cliff and how they disappeared with a last minute deal? Well, the sequestration threat hasn't gone away and the Washington Post reports that Deep spending cuts are likely, lawmakers say, with no deal on sequester in sight:

Less than a month after averting one fiscal crisis, Washington began bracing Tuesday for another, as lawmakers in both parties predicted that deep, across-the-board spending cuts would probably hit the Pentagon and other federal agencies on March 1.

An array of proposals are in the works to delay or replace the cuts. But party leaders say they see no clear path to compromise, particularly given a growing sentiment among Republicans to pocket the cuts and move on to larger battles over health and retirement spending.

The prospect of any deal appears dim and participants are resigned to across the board cuts:

Adding to the sense of inevitability is the belief that the cuts, known as the sequester, would improve the government’s bottom line without devastating the broader economy. Though the cuts would hamper economic growth, especially in the Washington region, the forecast is far less dire than with other recent fiscal deadlines, and financial markets are not pressing Washington to act.

Cuts to the military and the defense industry remain politically problematic. But Tuesday, even some of the Pentagon’s most fervent champions seemed resigned to the likelihood that the cuts would be permitted to kick in, at least temporarily.

A few months ago, the markets were highly anxious over the prospect of the sequester, which would make deep cuts to government budgets that were abhorrent to both sides. Now, Mr. Market seems to be relatively complacent about the prospect of impending government cutbacks, which would be highly contractionary. Put it another way: the sequester is just another form of forced austerity - and we know how well that worked out for Spain, don't we?

The stock market is highly complacent right now and doesn't seem to be bothered by the prospect of going over a fiscal cliff, but when will the anxiety that was evident in Q4 2012 reappear? With the markets overbought and sentiment at a crowded long reading (see my previous posts Is the whole world bullish? and More overbought warnings from BoAML), these concerns that I raised makes me think that the stock market is cruisin' for a bruisin'.


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.

More overbought warnings from BoAML

Just as BoAML strategist Michael Hartnett trumpeted his Great Rotation into equities investment theme which postulated that under-invested individuals and institutions would rotate from bonds into stocks, his colleague FX strategist Richard Cochinos made a tactical call against the risk-on trade (via Business Insider):

"Bottom line," Cochinos writes, "Several indicators are calling for a risk correction. USD selling has reached previous reversion levels and greater buy-backs are to come."

Cochinos first points to U.S. dollar selling by "real money" investors (i.e., pension funds, mutual funds, insurance companies, et al.), which has reached extreme levels recently – 1.8 standard deviations from the mean, to be exact.

Cochinos believes that the US Dollar is highly oversold and due for a reversal - and a USD rally would typically coincide with a risk-off environment.

In addition, he believes that equity flows are exhibiting overbought conditions:

Some of the analysis of Chief US technical analyst Mary Ann Bartels is also showing highly overbought conditions as well. The latest readings of her industry level overbought/oversold model is showing 16 overbought and 3 oversold industries for a ratio of over 5 to 1 - a highly extended condition [annotations in red are mine].

I don't want to put word in Mary Ann's mouth as she remains bullish and the title of her latest weekly commentary reads "Good earnings and liquidity power the markets higher". However, the industry level overbought/oversold model is one that I am very familiar with as I was once personally involved in producing that report on a weekly basis.

My own interpretation is that, despite the powerful positive momentum exhibited by stocks, these are conditions that usually precede corrections.




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 the whole world bullish?

A couple of weeks ago (see Big tests for stocks), I wrote that while sentiment models were showing crowded long readings, analysts were almost universally urging caution, which was actually bullish:

Maybe I am over thinking this: The sentiment picture seems just a little too neatly packaged to me and it would be just a little too easy to be overly bearish here. Positive flows into equity funds after a long winter of negative flows could be interpreted as positively as the return of bullish momentum. Indeed, Schaeffer's Research reported enormous buying of VIX calls last week as a bet on rising volatility (and falling markets), which is contrarian bullish. I heard several talking heads on CNBC late last week cited the same kinds of reasons to be bearish from a sentiment viewpoint.

While I understand that sentiment models, on an intermediate to longer term time horizon, can give a bearish picture, but is too much trader bearishness supportive of the markets here?

The financial crisis is over!
Fast forward to today, it seems that while the sentiment model readings remain largely unchanged (still overbullish), the tone of the commentary has turned universally bullish. As an example of this sentiment shift, Bloomberg reports that the latest consensus out of Davos is "the financial crisis is over":

The hive mind of Davos has concluded that the financial crisis is done, finished. The new worry: a bubble in the credit markets.

There is no official declaration, or even a formal survey. But the chatter at the World Economic Forum in Davos, Switzerland, is about the end of the financial crisis that began in 2008 and dragged on through last summer’s spike in Spanish and Italian government bond yields. “There’s a crystallization of thought that the financial crisis is over,” says Scott Minerd, managing partner and chief investment officer of Guggenheim Partners, a Santa Monica (Calif.) firm with about $160 billion under management.

BoA/Merrill Lynch is trumpeting its "Great Rotation" into equities investment theme:

The beginning stages of a great rotation in the markets create opportunities for cyclical and undervalued asset classes poised for recovery.

“This time last year, the risks to global growth were to the downside as the European debt crisis, China hard landing fears and the U.S. fiscal cliff clouded the economic outlook,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research. “For 2013, we expect the resolution of fiscal policy issues, another year of accommodative central bank actions and improving corporate profits to skew the macro and market risks to the upside.”

Soros less bearish on Europe
Remember how George Soros' endless warnings about Europe and how the European experiment was on the verge of failing? In June 2012, he sounded the alarm that Europe had three months to solve its problems. In this Der Speigel interview, he said that Germany had to take leadership and stop obsessing about austerity as the solution:

With the EU summit set to start on Thursday, pressure is on European leaders to find a way out of the euro crisis. Investor George Soros is pessimistic that a solution will be found and says time is extremely short. In an interview with SPIEGEL ONLINE, he warns that Germany could develop into a hated, imperial power.

Today, he has conceded that the euro is here to stay:

George Soros, one of the most outspoken critics of Germany's austerity policies to solve the European debt crisis, said that the euro is here to stay and will gain as other nations seek to devalue their currencies...

Germany will always do “the minimum” to preserve the currency, Soros said yesterday at the World Economic Forum in Davos, Switzerland. He forecast a “tense” two years for the euro region.

Dalio bullish
Other well known investors, such as Ray Dalio have turned more bullish (via Business Insider):

Dalio says 2013 is likely to be a transition year, where large amounts of cash will move to stock and all sorts of stuff – goods, services, and financial assets. People will spend more with the cash, they will invest in equities and gold – the cash will move.

As much as I would have great respect for investors like Soros and Dalio (and would loathe to be on the other side of a Soros or Dalio trade), the sudden outpouring of bullishness (or in Soros' case, an easing of bearishness) is a short-term red flag for traders.


A Front Page Cover sell signal
I wrote about my nervousness last week (see Too far, too fast) and I reiterate my concerns about the outbreak of excessive bullishness. Barry Ritholz also pointed out that a New York Times front page article entitled As Worries Ebb, Small Investors Propel Markets is a contrarian Front Page Cover sell-signal.


Looking for a bearish trigger
With sentiment at such crowded long readings, we just need a bearish trigger to spark a corrective selloff. As we are in the middle of Earnings Season, any negative surprise could spark a downdraft. My most likely candidate for a negative surprise is the Non-Farm Payroll release on Friday, where Gallup's tracking polls indicate that the employment situation deteriorated in January:

Approaching important relative resistance
Speaking technically, the relative performance chart of SPY (stocks) vs. TLT (US long Treasury bonds) below as a measure of the risk-on/risk-off trade shows the SPY/TLT ratio in a strong rally and approaching an important relative resistance level. The relative resistance level consists of both the previous highs seen in March/April 2012 and a Fibonacci retracement level, which suggests that the risk-on trade has a high probability of stalling soon.

At this point, my base case calls for stocks to correct 5-10%, at which the uptrend continues. However, that scenario is subject to change as circumstances change. We may be nearing an inflection point and will have to take this one day at a time.



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

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

Too far, too fast

Seemingly overnight, it seems that the whole world has turned bullish. According this report from Reuters, the Great Stampede Rotation into equities is just getting underway:

With the whiff of global economic recovery in the air as major central banks floor cash rates, buy bonds and neutralize systemic stability fears, mutual fund and retail investment flows are already on the move in 2013.

According to Lipper, net flows to U.S.-based equity funds in the first two weeks of 2013 was, at $11.3 billion, the biggest fortnightly inflow since April 2000. Including exchange traded equity funds (ETFs), the number tops $18 billion - well over twice the flow to equivalent bond funds.

What's more, fund-tracker EPFR said some $7 billion of inflows to emerging market equities alone in the first week of the year were the biggest on record and these have outstripped demand for emerging bond funds five weeks running.

The BoA Merrill Lynch fund manager survey shows fund manager bullishness at an extreme level:

Investors’ appetite for risk in their portfolios is now at its highest in nine years, while an increasing number judge equities as undervalued – particularly in Europe. Moreover, investors have reduced cash holdings to 3.8 percent from 4.2 percent in December. This marks the most positive reading of this measure of willingness to hold riskier investment assets since April 2011, though it has not reached levels that would represent a contrarian sell signal.

CNBC reports that bears are in the capitulation process:

A powerful rally in which virtually all fears have been bypassed has pushed stock marketdetractors to the brink, ready to wave the proverbial white flag as the only direction for the market seems to be up, up, up.

"They're almost ready to throw in the towel," Scott Bauer, of Trading Advantage, told CNBC. "I don't want to say 'capitulation,' (but) guys down here really are saying, 'All right, I can't fight it anymore, let's go.'"

Bespoke reports that roughly 80% of the components of the SPX are overbought:

The last time the market got to these level of overbought readings was in late October 2011 - and a short, sharp correction followed:

...though the longer term uptrend remained intact.  

I appreciate that there is powerful positive momentum underlying this rally and many of the macro headwinds have turned into tailwinds (i.e., Chinese hard landing becoming a soft landing; the ECB taking tail risk off the table; US fiscal cliff confrontation averted).   However, with the bears throwing in the towel, I am inclined to take some profits and take some chips off the table in the short term. We've come too far too fast. With bullish sentiment at such extremes, a corrective pullback is highly probable in the short term.


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.

Where is the leverage to gold?

Over at Zero Hedge there is a rant about how gold and gold stocks are better investments than the stock market and how there is a Wall Street conspiracy to suppress the gold price and keep the "dumb" investors in stocks.

With the Bank of Japan's latest move to fight deflation and seemingly to start another round of global competitive currency devaluation, it does certainly make some sense to hold some gold in a portfolio. However, I remain of the opinion that it makes no sense for gold bulls to hold gold stocks over bullion. Consider this chart below of the price of gold compared to the Amex Gold Bugs Index (HUI).

The top panel shows the price of gold in black and HUI in red. The bottom panel shows the HUI/gold ratio. A rising ratio indicates positive leverage to gold and a falling ratio shows falling leverage. The HUI/gold ratio rose and peaked out in late 2003. It then flattened out and started to decline in 2005 and continues to fall today.

I wrote about this topic in 2011 and 2009 and it continues to be true: Gold bulls shouldn't buy gold stocks! The reason why gold stocks have failed to keep pace with the price of bullion is gold mining companies can't replace lost production at the same cost as the older cheaper ore bodies get mined out. They are mining lower and lower grade ore and therefore their profits and cash flows are lower because of higher production costs (see my analysis Valuing gold stocks on cash flow, not assets).

Bottom line: If you are a gold bull, buy physical gold, GLD, CEF, or any other vehicle directly related to the price of gold. Just avoid gold stocks.



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 worried

I suppose that I should be happy and bullish. US equities staged a significant upside breakout last week, indicating positive price momentum.

Mid and small cap stocks have staged upside breakouts some time ago to all-time highs, which is a bullish confirmation of the trend.

As for the current Earnings Season, Bespoke reports that preliminary indications show that the beat rate is consistent with the historical average.

Buy the breakout?
My inner trader has turned more bullish given these developments, but my inner investor continues to be a cautious and worried bull for two reasons: Sentiment and the deterioration in consumer sentiment.

First of all, equity markets are overbought and sentiment measures are overly bullish, which is contrarian bearish (see my comment last week Big test for stocks). Measure of investor sentiment were in the crowded long zone last week and preliminary indications show that they got even more bullish, which is a warning sign that we could be due for a short-term pullback at the very least.

The more worrying sign is the deterioration in the University of Michigan sentiment index, as per Doug Short:

I detailed before the effects of the payroll tax cut expiry has had on the American consumer. Here is analysis from Credit Suisse (via FT Alphaville) showing that the elimination of the tax cut has virtually undone all of the gains that the typical American household had last year:

The US household sector remains fragile. Here is a report, with albeit somewhat dated data, (via Reuters) showing that while employment has recovered, the quality of jobs deteriorated:

The number of U.S. families struggling with poverty despite parents being employed continued to grow in 2011 as more people returned to work but mostly at lower-paying service jobs, an analysis released on Tuesday shows.

Others have jumped on this story, see this Marketwatch article Stocks face hurdle as payroll tax hits wallets,
Average U.S. household has about $20 less to spend each week..
When will stocks hit these potholes?

My inner trader tells me that these sorts of things don't seem to matter to the market until the market starts to pay attention, so I should relax and enjoy the bullish party. My inner investor is watching very closely for signs of weakness, particularly from the US consumer which could derail this rally.


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 Chinese re-balancing bullish?

With China's Q4 GDP up 7.9%, which was ahead of consensus expectations of 7.8%, I thought it would be a good time to look at China's likely growth path yet one more time. The Bonddad Blog had an excellent post entitled "Will China Save Us -- Again?" The blog post reviews the (pre-Q4 GDP) data showing a rebound in the growth of China's economy and closes with an indication that growth is re-balancing toward the consumer.

Is re-balancing good news?
There is no question that an over-reliance on infrastructure spending has resulted in unbalanced growth that is unsustainable. Michael Pettis recently highlighted an IMF study showing that Chinese investment accounted for close to 50% of GDP growth and concluded that this resulted in a subsidy of 4% of GDP per annum [emphasis added]:

Now close to 50 percent of GDP, this paper assesses the appropriateness of China’s current investment levels. It finds that China’s capital-to-output ratio is within the range of other emerging markets, but its economic growth rates stand out, partly due to a surge in investment over the last decade. Moreover, its investment is significantly higher than suggested by cross-country panel estimation. This deviation has been accumulating over the last decade, and at nearly 10 percent of GDP is now larger and more persistent than experienced by other Asian economies leading up to the Asian crisis. However, because its investment is predominantly financed by domestic savings, a crisis appears unlikely when assessed against dependency on external funding. But this does not mean that the cost is absent. Rather, it is distributed to other sectors of the economy through a hidden transfer of resources, estimated at an average of 4 percent of GDP per year.

Pettis went on to say that he believed that the IMF study actually underestimated the level of subsidy that the household sector has had to bear:

One of the implications of the study is that households and SMEs have been forced to subsidize growth at a cost to them of well over 4% of GDP annually. My own back-of-the-envelope calculations suggest that the cost to households is actually 5-8% of GDP – perhaps because I also include the implicit subsidy to recapitalize the banks in the form of the excess spread between the lending and deposit rates – but certainly I agree with the IMF study that this has been a massive transfer to subsidize growth.

Rebalancing = Growth slowdown
So a move to re-balance growth to the household sector good news and bullish for stocks and risky assets? Well, not in the short term. Here is Pettis' arithmetic:

But let us...give China five years to bring investment down to 40% of GDP from its current level of 50%. Chinese investment must grow at a much lower rate than GDP for this to happen. How much lower? The arithmetic is simple. It depends on what we assume GDP growth will be over the next five years, but investment has to grow by roughly 4.5 percentage points or more below the GDP growth rate for this condition to be met.

If Chinese GDP grows at 7%, in other words, Chinese investment must grow at 2.3%. If China grows at 5%, investment must grow at 0.4%. And if China grows at 3%, which is much closer to my ten-year view, investment growth must actually contract by 1.5%. Only in this way will investment drop by ten percentage points as a share of GDP in the next five years.

The conclusion should be obvious, but to many analysts, especially on the sell side, it probably needs nonetheless to be spelled out. Any meaningful rebalancing in China’s extraordinary rate of overinvestment is only consistent with a very sharp reduction in the growth rate of investment, and perhaps even a contraction in investment growth.

So it's pay the piper now with a growth slowdown, or pay the piper later with a crash. The key for investors is timing and the pace of policy change [emphasis added]:

In fact I think over the next few years China will indeed undergo a sharp contraction in investment growth, but my point here is simply to suggest that even under the most optimistic of scenarios it will be very hard to keep investment growth high. Either Beijing moves quickly to bring investment growth down sharply, or overinvestment will contribute to further financial fragility leading, ultimately, to the point where credit cannot expand quickly enough and investment will collapse anyway.

China is an accident waiting to happen. The only level of uncertainty is the timing. That's why I am watching the canaries in the Chinese coalmine.



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.

Big tests for stocks

It would be so easy to get bearish on stocks here. Last week, there was lots of buzz in the blogosphere about how investor sentiment had gotten overly bullish, which is contrarian bearish. The AAII sentiment readings have certainly moved into a crowded long region (via Pragmatic Capital):

The blogger Right Side of the Chart also voiced a similar warning, with further analysis showing how stocks have performed in the wake of past crowded long readings:

In addition, EPFR reported that investors had turned positive on equity funds after a long hiatus as the last time that such flows into equity funds was seen was September 2007. Mark Diver of Nomura (via FT Alphaville) indicated that such flows represented a contrarian sell signal:

Even David Rosenberg quipped in last Friday's Breakfast with Dave that:

As for the USA, almost everyone I talk to is now bullish. There are many folks out there that think that even I have turned bullish...

A mixed sentiment picture?
Maybe I am over thinking this: The sentiment picture seems just a little too neatly packaged to me and it would be just a little too easy to be overly bearish here. Positive flows into equity funds after a long winter of negative flows could be interpreted as positively as the return of bullish momentum. Indeed, Schaeffer's Research reported enormous buying of VIX calls last week as a bet on rising volatility (and falling markets), which is contrarian bullish. I heard several talking heads on CNBC late last week cited the same kinds of reasons to be bearish from a sentiment viewpoint.

While I understand that sentiment models, on an intermediate to longer term time horizon, can give a bearish picture, but is too much trader bearishness supportive of the markets here?


Some big tests coming up
Notwithstanding the sentiment model readings, here are the key tests that I am watching for the stock market.

First, how stocks react to news is always an important indication of market direction. How will the market react to the news that the White House has ruled out the trillion dollar coin as a solution to the debt ceiling impasse? As I write these words, overnight ES futures are slightly positive indicating a lack of anxiety over the elimination of one solution to the debt ceiling debate.

The Treasury is expected to run out of money somewhere between February 15 and March 1. Here is a chart from January 10 (via Business Insider) of how the Dow reacted the last time we had a debt ceiling debate. Complacency reigned, until about a week before the impasse. At that point, the market began to crater. The reaction this week to the end of the trillion dollar coin option will be an important indication of market psychology.

What about earnings?
As well, don't forget that Earnings Seasons is just starting. David Rosenberg reported last Friday that:

And let's not forget the earnings landscape. So far, we have had 26 S+P 500 companies report and they seem to be meeting their beaten-down targets (indeed, 17 have surpassed their estimates, only six have missed). But of the 11 that have provided guidance, nine have have taken it down and just two have taken it up, for a ratio (albeit on a limited sample size) of 4.5x versus a historical average of 2.0.

While it's still early, an earnings beat rate of 65% (17 of 26) is only slightly ahead of the historical average. On the other hand, the high level of negative guidance is something to be concerned about.

Here is why the forward guidance matters so much. FT Alphaville reported that a New York Fed paper showed that the effects of payroll tax expiry is devastating to consumer spending:

This paper presents new survey evidence on workers’ response to the 2011 payroll tax cuts. While workers intended to spend 10 to 18 percent of their tax-cut income, they reported actually spending 28 to 43 percent of the funds. This is higher than estimates from studies of recent tax cuts, and arguably a consequence of the design of the 2011 tax cuts. The shift to greater consumption than intended is largely unexplained by present-bias or unanticipated shocks, and is likely a consequence of mental accounting.

What's more, analysis from Credit Suisse showed that the payroll tax expiry has taken away all of the net earnings gains of 2012:

That's why it will be critical to watch the body language from forward guidance, especially from companies that are sensitive to consumer spending.

Right now, we are seeing leadership from small and mid-caps in the US, which technicians have pointed to as a sign for being bullish. However, if the American consumer were to falter, then this leadership will start to fading like the morning mist.

My inner investor is very nervous about this stock market. My inner trader is a little bit more sanguine and believes that there could be a bit more upside that he may be able to catch. However, he is tightening up his stops to limit his losses and keeping an eye on the exit.




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 canaries in the Chinese coalmine

Notwithstanding the upside surprise in the Chinese December trade data, Kate Mackenzie at FT Alphaville recently highlighted some SocGen analysis showing the dire effects of a hard landing in China (sub 6% growth). Here is the bottom line:

World GDP: -1.5 per cent (0.3 per cent a direct effect of China’s slowdown and the remainder through transmission mechanisms outlined below)

Trade partners:

• Taiwan: -4.5 per cent
• South Korea -2.5 per cent
• Malaysia: -2.5 per cent
• Australia: -1.2 per cent
• Japan: – 0.6 per cent
• Eurozone: -0.3 per cent
• US: -0.2 per cent

The analysis postulated a 50% drop in base metals, Brent crude to bottom at about $75 and an abrupt drop for gold but a recovery thereafter.


Trouble in shadow banking land
In a separate post, Mackenzie wrote about on China's shadow banking system, which is fast becoming China's version of subprime mortgage market [emphasis added]:

China’s shadow finance sector is big — UBS estimated last year it is equivalent to at least a quarter of the country’s annual GDP, and maybe as much as half. And it is growing fast; in the second half of 2012 it reached half of ‘total social financing’, the country’s measure of total credit.

When this all blows up, it won't be pretty. There are indications that the Chinese authorities plan to rein in the shadow banking system in 2013. Here is the problem. Loan growth has been anemic in the formal banking sector:

With slow loan growth in the formal banking system and tightening controls in the shadow banking system, where is credit growth going to come from? What will happen to the Chinese economy when credit dries up?


Watching the canaries in the coalmine
This analysis presents a dire outcome for the Chinese economy this year. Cue the SocGen hard landing analysis. Here is how they postulate a hard landing scenario would unfold (via Business Insider) [my emphasis]:

Whatever the catalyst, the excess capacity in the manufacturing sector – estimated at 40% in 2011 by the IMF – would be exacerbated by a sharp growth slowdown. This would cut corporate margins sharply, making profits plunge, and triggering a downward spiral in domestic demand. Bankruptcies and unemployment would occur on a large scale, endangering financial and social stability.

One factor that could accelerate the downward spiral is the high leverage of China’s corporate sector, which exceeded 120% of GDP at end-2011 and has kept rising throughout 2012. As the crisis progressed, non-performing loans would undoubtedly rise beyond the capacity of local governments to contain them, as their fiscal resources dwindled.

Even in China’s (semi-) controlled system, banks could choose to freeze lending as a knee-jerk reaction, while the authorities rushed to draft a decisive response. The rapid development of the non-bank credit market in the last few years, especially shadow banking activities, has created a new vector through which a systemic liquidity crunch could take place. Capital outflow would likely ensue, stretching domestic liquidity conditions further.

Traders should be aware of these risks, but not panic. The current risk of an immediate meltdown is low and there is a timing tool available. I am watching my four canaries in the Chinese coalmine, namely the share price of the Chinese banks listed in HK:

• Agricultural Bank of China Limited (1288.HK)
• Bank of China (3988.HK)
• Industrial and Commercial Bank of China Limited (1398.HK)
• China Merchants Bank Co., Ltd. (3968.HK)

Should restrictions in the shadow banking system cause a credit crunch and collapse in the financial system in China, then we should see a corresponding response in the prices of these banks. Currently, the shares of these four canaries are near or at 52-week highs, indicating little signs of stress in the banking system.

Traders should therefore relax but be vigilant.

Hard or crash landing?
I have always been of the view that the world will see a cyclical downturn one day. The timing of that downturn is uncertain. I have no idea of whether it will happen this year, next year or in the next 5 years. When that cyclical downturn is upon us, however, China's export sensitive economy may not be resilient enough to withstand the slowdown. The result will not be just a hard landing (subpar growth of less than 6%), but possible a crash landing (negative GDP growth) that is not in anybody's spreadsheet.

That crash landing scenario would be disastrous for the economies of China's major trade partners and commodity prices and the ensuing tail risk will be in the same order of magnitude as the Lehman or Russia Crisis.

That's why it pays to watch the four Chinese canaries in the coalmine.


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.

No free lunch for central bankers

I got a fair amount of feedback from my post From anti-inflation to pro-inflation, where I described the journey that central bankers have taken from 1980 and the height of the Paul Volcker's tight monetary policy era. In the post-Lehman Crisis period, central bankers have changed their focus from fighting inflation to encouraging a little inflation, from monitoring money growth to loose monetary policy, quantitative easing, nominal GDP targeting and, finally, the loss of central bank independence coordination of monetary policy with fiscal authorities.

With the news that the new government is about to launch 12T Yen (USD 136 billion) fiscal stimulus program and the BoJ appearing to acquieces and support the stimulus with more bond buying, Japan is the country that has gone furthest down this road.


The market effects of the Bernanke and Draghi Put
I want to address in this post the likely effects of this shift in central bank thinking on market prices. In the wake of the near-death experience of the Lehman Crisis of 2008, central bankers have taken steps to put a floor on the price of financial assets. Market analysts have called this the Bernanke Put, as applied to the Federal Reserve, and the Draghi Put, as applied to the European Central Bank. These central bank Puts function like an insurance policy with a deductible. Investors assume some degree of risk, the deductible, but if the macro-economic situation deteriorates to the extent that a market crash is likely, major global central banks have they will step in to rescue the markets.

These insurance policies come with costs. To explain, standard financial theory posits that asset returns follow a bell-shaped distribution. The graph below shows an idealized Gaussian distribution with the returns plotted on the x-axis and frequency, or probability, of those returns on the y-axis. (Yes I know it's not normally distributed but has fatter tails, but it is still a bell-shaped curve.) But what happens to the return distribution when central bankers try to eliminate or reduce the left tail of the return distribution?

Trading Eurogeddon for lower growth
In Europe, where the ECB’s actions have been combined with a fiscal policy of “all austerity, all the time” and a social consensus that is tilted towards a relatively robust safety net, the ECB has traded off the certainty of a no Eurogeddon scenario against lower growth, as depicted by the idealized graph on the below. Note how the expected return distribution is no longer symmetrical as the left tail has been cut off. The “mode”, or the value that is likely to appear the most, is also skewed to the left.

The risk of a eurozone sovereign or banking crisis is off the table, but Europe is in recession. While the actions of the ECB has bought time for EU member states to move toward structural reform, the price paid is lower growth in the short-term.

Trading tail-risk for greater volatility
In addition, I believe that the actions of global central bankers have made the markets more volatile in the short-term. The FX team at Bank of America/Merrill Lynch (BoAML) (via FT Alphaville) observed that volatility in the euro-US Dollar exchange rate has risen dramatically in the past few years, as shown by the graph below.

The BoAML FX team observed that markets movements are now far more sensitive to policy decisions and headline news [emphasis added]:

It is perhaps somewhat counter-intuitive, as low volatility has traditionally been associated with low uncertainty, but we are still seeing high levels of uncertainty in FX. This is understandable given the large number of risks across multiple regions (for example, Eurozone financial crisis, weak US growth, US fiscal cliff and China slowdown). Further, these types of risks leave investors tracking policy makers and trading news headlines for policy trajectory information. This is resulting in sudden and rapid moves in FX followed by periods of range-trading.

By eliminating tail risk and raising certainty, central bankers have ironically raised short-term volatility instead.

In conclusion, central bankers can't completely eliminate volatility and their policies come with costs. In the case of Europe, the ECB has traded Eurogeddon for a recession. In general, market volatility has risen and become far more sensitive to headline news.

It just goes to show that there is no free lunch in central banking.



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.

Headwinds for the bull case

I called for a Santa Claus rally in late November (see Waiting for a Santa Claus rally) and equity markets cooperated and prices have moved up strongly since then. Now that Santa Claus has come and gone and we have seen the "fiscal cliff" relief rally, what's next?

Technically, there are a lot of reasons for stocks to at least pause at these levels. The SPX is now testing an important resistance level.

More comforting for the bulls is the broader NYSE Composite has managed to stage an upside breakout through resistance, indicating that the underlying strength is broad and deep.

However, I don't expect that the SPX will break through to new highs in the short run for several reasons. Simply put, this bull is getting tired and this latest up move is facing too many headwinds. First of all, the SPY to TLT ratio as a measure of the risk-on/risk-off trade is also testing a relative resistance level and showing a near overbought reading where stocks have retreated in the past.

In addition, the VIX Index has retreated to a major support zone where it has bounced off in the past. The CBOE noted that the VIX saw its largest percentage move since inception (h/t Global Macro Monitor), which is another sign of an oversold condition for the VIX and overbought condition for equities. In order for the stock market to advance, volatility would have to fall through a major support level.

Last but not least, the bulls have to contend with the seasonal patterns seen in past Presidential cycles. As the chart below from the Chart of the Day shows, the opening week of the first year of a presidential term starts with a rally, which we have seen right on schedule, and the market starts a broad decline into February. So far, the stock market's behavior in 2013 is consistent with this historical pattern.

Watch this Earnings Season!
In addition, Earnings Season will be a source of volatility for stocks. Barry Ritholz warned about an "earnings cliff" and Q4 earnings will be an important test of his thesis. I explained before (see What happens after the Santa Claus rally?) that the "earnings cliff" is the result of a deteriorating profit outlook by large cap multi-national companies. In that context, the outperformance of the NYSE Composite, which is more reflective of small and mid cap stocks, is consistent with that thesis.

Jeff Miller over at A Dash of Insight has an excellent post where he discussed earnings expectations and concluded that this Earnings Season could be pivotal to stocks:

For the upcoming earnings season I remain open-minded and I will be very attentive. Last quarter was a minefield for corporations. If the complete story -- earnings, revenue, outlook -- was not perfect, the stock price moved lower. I avoided earnings dates in our most aggressive trading programs, and I was nearly always right.

So what now? We all know that the economy remained sluggish in Q4, so earnings will not be great. Much of the uncertainty has been lifted. We know the election result and also tax policy for the near future. Will companies provide a little more guidance? What will it be?

I have more respect for the analyst updates than I do for the pontificating pundits with opinions but absolutely no record. I understand that analysts are too bullish in their multi-year forecasts -- basically following trends with no allowance for bad news. I also understand that by the time earnings are actually reported, the bar has been lowered so that more than 60% of companies beat expectations.

Most experts share these views, but I seem to be alone in drawing the logical conclusion:

If estimates are too bullish in the long run and too bearish at the time of the report, there must have been a "crossover date" when the forecasts were pretty good. My research shows that this occurs at about one year in advance.

To summarize: This earnings season will be important for estimate revisions as well as the current "beat rate."

In short, the bull case is facing too many technical and fundamental headwinds to see the market advance too much further in the short-term. I believe that we are likely to see a pullback at these levels. The bulls will have to watch how the market behaves in response to news, such as the upcoming Earnings Season and the political posturing that is likely to occur over the Debt Ceiling, in order to discern the likely direction of the next major move.


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.