Tuesday, November 22, 2011

Bring out your dead!

MORTICIAN: Bring out your dead!
Bring out your dead!
Bring out your dead!
Bring out your dead!
Bring out your dead!
CUSTOMER: Here's one -- nine pence.
DEAD PERSON: I'm not dead!
CUSTOMER: Nothing -- here's your nine pence.
DEAD PERSON: I'm not dead!
MORTICIAN: Here -- he says he's not dead!
CUSTOMER: Yes, he is.
MORTICIAN: He isn't.
CUSTOMER: Well, he will be soon, he's very ill.
DEAD PERSON: I'm getting better!
CUSTOMER: No, you're not -- you'll be stone dead in a moment.
From Monty Python's The Holy Grail
Further to my last bearish posts on Sunday and Monday, I was surprised to wake up and see the markets off tanking and made me feel like the character in the scene in The Holy Grail crying, "Bring out your dead!"
What's more, I found a number of disturbing parallels of today's technical conditions with 2008.
Consider this chart of the S+P 500. In 2008, the stock market undercut a major support level but the support violation turned out to be a fake-out as the bulls staged a last stand with a rally that lasted about two months. The waterfall then began after the rally fizzled out.
Today we are seeing circumstances that are eerily similar. The market violated support in early October, but the bears had their faces ripped off by a rally. The rally is now appearing to petering itself out. If history were to repeat itself, then the market will break its early October lows in early December and panic selloff will then begin.
Systemic risks rising
The global financial system is facing rising systemic risk again. I don't need to go through all of the gory details about how Italian and French yields are rising against Bunds. Financial Armageddon points out that sovereign CDS prices are blowing out:
It may have originated in the eurozone, but the current crisis looks to be following along the lines of the one that began in the U.S. subprime mortgage market four years ago. That is, a problem that authorities assured us was "contained" (the Bernank's famous last word) and resolvable has morphed into one that is uncontained and more dangerous by the day.

As the chart shows, an average of credit default swap (CDS) spreads for 71 countries around the world has now surpassed the peak seen in September and is hitting its highest level since April 2009. (Simply put, CDS are bets on the creditworthiness, or lack thereof, of a particular borrower).
The stress points are also showing up on this side of the Atlantic. In the wake of the failure of MF Global, Bruce Krasting wrote that the event could lead to a loss of confidence in broker-dealers because of the missing $600 million in segregated account funds. Indeed, a look at the relative performance of the Broker-Dealer Index against the market shows the XBD to be underperforming, just as it did in 2008 leading up to the Lehman Crisis. In fact, the rally that began in early October 2011 only showed up as a blip as the XBD remained in a relative downtrend dating back to January 2011.

Symptomatic of the current atmosphere of nervousness on this side of the Atlantic, it appears that now Jefferies is now under attack. Regardless of whether the concerns are correct or misplaced, medium sized firms can go under quickly because of a loss of confidence as Bruce Krasting pointed out that Drexel became insolvent within ten days of losing its funding sources.

Bond bullish = stock bearish
To reinforce my viewpoint about the bearish outlook, my friend and former colleague Mary Ann Bartels of BoA/Merrill Lynch wrote that her target for the 10-year Treasury Note is between 1.0% and 1.5%:

Should the 10-year yield fall to those levels from the current reading of 1.96%, such bond-bullish conditions would imply incredibly bearish conditions for the stock market.

In other words: Bring out your dead!

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.


Tiho said...

I would heavily bet against this view!

This call is going to be a huge money loser in 6 to 12 months, when we all look back at higher equity prices, higher commodity prices and higher Treasury yields.

Cam Hui, CFA said...


On a 6-12 month time horizon, I don't disagree with you. The stock market will see an important intermediate term bottom in the next 3-6 months.

In the meantime, it looks like that we are going lower.

Tiho said...

Well on that note, I'm not 100% sure if the selling will last another 3 to 6 months, but I hope that it does. Obviously everyone that is half smart would like to see lower prices.

Now, I'm not talking about equities here, as they remaining a secular bear market, but about commodities like Agriculture and Precious Metals. Great buying opportunities are setting up here, as they asset classes remain in a secular bull market.