Monday, 7 October 2013

Shutdown shenanigans!

As we roll into the 7th day of the US government “shutdown”, nobody seems particularly perturbed. Here are some potential reasons why:

1) With all due respect to those individuals that are currently going unpaid as a result of the shutdown, the “shutdown” is really more of a media show than an economic event. Sure American shrimps maybe going uninspected as a result of the shutdown but the fact is ~80% of government cannot be shut down.

2) The S&P 500 is up +19% year to date. This has caused a change in sentiment that only a +19% rally in equities can cause. The glass is now half full and people want to buy any shutdown-related dip.

3) The “real issue” is seen as the brewing debt ceiling debate and the prospect of a US government default. This is also the reason S&P futures are down 1% currently...and maybe we NEED right now is a good old-fashion shakedown in the equity market to scare the politicians into some sort of agreement.

Sadly as of this morning, brinksmanship regarding the debt ceiling debate shows no sign of abating and with only 10 days left to secure an agreement, people are understandably starting to get nervous. The FT ran this story over the weekend. Lines like “Mr Boehner, Speaker of the House of Representatives, said the Republican majority would not pass bills to fund the government or increase the debt ceiling unless the Obama administration was willing to make concessions on healthcare and other issues” does not inspire confidence in a speedy resolution.

I don’t pretend to be an expert on US politics but from what I have read it seems as though:

1) There are quite possibly enough moderate Republicans in the House whose votes, which if combined with Democrat votes, could see a “clean” continuing resolution bill pass.

2) The reason Boehner has not brought such a bill to be voted on in the House is due to the so-called “Hastert Rule”. The unwritten rule states that a Speaker should not put up for vote any bill that does not have the support of a majority of his rank-and-file members.

If the above is true, I think Mr Boehner’s reputation and legacy could be seriously compromised if an agreement on the debt ceiling is not reached. The political fallout of a debt-ceiling breach will be truly horrendous for everyone involved in US politics however it seems to me as though Boehner and the Republicans will have the greater share of fingers pointed at them.

Certainly volatility remains much lower now than during the previous debt ceiling fiasco in 2011. This possibly reflects the fact that everyone believes the asshats politicians will get their act together just in time. Some argue the market is overly sanguine and put protection should be purchased given the low volatility and high event risk. Personally I think the backdrop is different now to then. Sentiment has changed (see point 2 above). Not only that, in 2011 the world was also contending with an earthquake, tsunami and potential nuclear disaster in Japan at around the same time.

There is a famous quote attributed to Winston Churchill, that Americans can always be counted on to do the right thing…after they have exhausted all other possibilities. Let’s hope this holds true, otherwise 17th October may end up getting renamed Zerohedge Day*! 

Further reading on this topic:

America Flirts With Self Destruction (Martin Wolf)

Obama Doesn't Rule Out Using 14th Amendment To Raise The Debt Limit (Yahoo News)

John Boehner’s room for manoeuvre limited by unofficial principle (FT)

*For the uninitiated, Zerohedge is a prominent financial blog that has consistently made apocalyptic predictions regarding the global financial system since the financial crisis.

Thursday, 3 October 2013

Playlist for the Budget Negotiations!

What would be a cool/funny/appropriate soundtrack to the US budget negotiations?

Here are a few tracks I came up with:

21st Century Breakdown - Green Day

(Can't Get No) Satisfaction - The Rolling Stones

What's My Age Again? - Blink 182

Everybody Wants Some - Van Halen

I Still Haven't Found What I'm Looking For - U2

Talk To Me, Talk To Me - James Brown
Dammit - Blink 182

No Way Back - Foo Fighters

Give It Away - Red Hot Chilli Peppers

American Idiot - Green Day

Come Together - The Beatles

Long Road To Ruin - Foo Fighters

Burning Down The House - Talking Heads

I'm sure there are 1000's of others!!

Monday, 23 September 2013

More good news on shipping, more thoughts on the "no taper" decision, a short-term warning sign

It seems it’s not just seaborne freight that is sending positive signals. The Association of American Railroads (AAR) ... reported increased total U.S. rail traffic for the month of August 2013, with intermodal setting a new record and carload volume increasing overall compared with August 2012.

Not surprisingly, railroad stocks have also been performing pretty well of late…

…while bellwether global transportation companies UPS and FedEx are also trading at record highs. These observations also augur well for continued recovery in the global economy.

Regarding the Fed and its influence on markets: I stumbled upon a great article at Motley Fool which had a fascinating chart that I have inserted below. The chart shows cumulative returns on the S&P500 from 1994 to 2011 with and without the 24 hour period following FOMC announcements. This chart shows two things:

1)      Most of the market’s gain from 1994 to 2011 came within 24 hours of Fed policy meetings (I found the impact staggering!); and

2)      The Fed has been influencing markets since long before Jon Hilsenrath became a household name (i.e. the Fed’s market influence is NOT some new, post-crisis paradigm)!

There has been much hand-wringing over what would happen to the equity market once the Fed starts tightening (or even reduces the amount of easing on offer via tapering). Remember, the Fed has a mandate to control inflation and support employment. Bernanke made it clear last week that the Fed will continue to provide accommodation until the economy gets stronger. And a stronger economy might be good for equities…the last time the fed tightened monetary policy, from 2004-2006, US equities rose approx. 40%. And if the economy doesn’t improve in line with Fed expectations, the Fed will keep stimulating…which might also be good for equities.

This does not mean things go up in a straight line. Witness Friday’s swoon, attributed to comments from Fed President Bullard regarding the possibility of tapering in October. However, the very notion that the Fed will at some point throw its hands in the air, yank stimulus and let the economy tank is not only unlikely, it is clearly against its mandate. Again, today is not the time to allocate (or not!) investment capital based on worries over the Fed’s exit strategy.

If I sound positive it’s because I am, structurally. Short term I am a little more cautious. In a previous note I mentioned how two of the sectors that lead the market higher – homebuilders and financials – looked as though they had broken down. While both sectors have recovered somewhat since then, neither has confirmed the new all-time highs seen in the S&P500 (see chart below). Non-confirmations like this often serve as a prelude to a broader pullback (a.k.a. “volatility” in investment banking parlance). Such a pullback is likely to be more technical in nature, although some scary narrative (debt ceiling fiasco round 3 anyone?) will almost certainly be applied to it. I would be inclined to treat any such event as a buying opportunity.

S&P500 (white line, making new highs), Financials ETF (orange line, not making new highs), Homebuilders ETF (red line, not making new highs):

Now is not the time to worry about the Fed's exit strategy

The Fed’s decision not to taper asset purchases on Wednesday has clearly left the market with a more bullish disposition than it had going into the announcement. I think it’s important to remember that 1) the impact of QE is more psychological than anything else; and 2) $10bio per month is pocket change in the scheme of things. So I expect the exuberance of the decision to not taper to be ephemeral.  Likewise when the Fed does eventually begin to taper (late this year or early in 2014) the angst will likely prove temporary as well.

Still, DM equities caught a bid and EM equities ripped higher! The USD suffered its worst slump in 3 months (consider than FX markets turnover nearly $5 trillion per DAY, in the context of an expected reduction in asset purchases of $10 billion a month if you still doubt the effects were are talking about here are predominantly psychological!) This lent considerable support to gold, the commodity complex and EM and commodity currencies.

10yr UST yields dropped expectedly and are now challenging near term support. I expect bonds will rally/yields will fall further from here…2.50% on the 10yr looks like a reasonable near term target.

The Fed has received a barrage of criticism in the press over poor communications and lost credibility (here, here, here, here) which highlights more than anything how much people hate to be wrong. I remain surprised by just how convinced the market was that we would see a September taper, given anything the Fed had told us.

Bernanke specifically mentioned “Upcoming fiscal debates may involve additional risks to financial markets and to the broader economy”. So even though markets are more psychologically predisposed to take risk as a result of the no taper decision, markets will not move up in a straight line if “Debt Ceiling Fiasco Mk III” looks like a high probability.

Changing the subject, I want to share with you below some charts that lead me to conclude that economic surprises over the next year or so could well be on the upside rather than the downside.

The chart below is of the Baltic Dry Index, one of the more common benchmarks of shipping activity. The index measures a combination of different shipping prices and gives a benchmark of the cost of freighting dry goods (e.g. coal, grain, iron ore) by sea. It’s a popular benchmark because the theory goes, when economic activity picks up, more goods get shipped and shipping rates rise.

Right now this index is having its best run in two years. It is coming off very depressed levels so I would hardly get too excited about the absolute level of the index. However it is moving decisively in the right direction - which serves as evidence that that things globally might be getting better.

Coincident with the rise in the Baltic Dry Index we can see that volumes at some of the busiest ports in the world (Shanghai, Singapore, Hamburg, Los Angeles) are trending up nicely:

Shanghai container volumes:

Singapore container volumes:

Port of Hamburg container volumes:

Los Angeles container volumes: 

Further confirmation of the current state of shipping can be seen in the stock price of the Guggenheim Shipping ETF, which is clearing 2-year highs:

There chorus of negative commentary fretting over the Fed’s exit strategy is significant. And look, one day the Fed will raise rates. One day the bull market in equities will be over. 

However what the charts above tell me is that a recovering world economy is the right trade to focus on right now. Now is not the time to be allocating investment capital based on worries over the Fed’s exit strategy. Let’s maybe start to worry about that in another year or so.

Thursday, 15 August 2013

Risks and opportunities I'm watching right now


Having broken down, USDJPY has rallied back to “kiss” the old uptrend line which is now acting as resistance. A strong Yen will make it hard for Nikkei – and in my view all risky assets – to rally. As I have noted before, USDJPY warrants close attention and is one of the key charts I am watching right now.
Is really struggling at the top of the trend channel and also struggling with round number resistance at 1700:

Loss of momentum is easy to see on a 6 month chart of the S&P (see divergence on MACD and MACD histogram in chart below). A break of 1670 (i.e. the 16th July low) would mark the first lower low and the possible start of a new downtrend - a negative development for equities.  I am not calling the end of the bull market at this juncture; rather am observing that the evidence in favour of a pullback is mounting.

Notice how the financials (one of the leading sectors of the US market) have already made a lower high followed by a lower low. In doing so they have diverged with the S&P500. Be alert to a similar pattern developing in the broader market:

The Homebuilders – a sector which lead the market on the way up – look as though they may have broken down (chart below is ITB – iShares US Home Construction ETF)

The chart below shows new 52 week highs on NYSE. Clearly less stocks are participating in the rally as “the market” presses higher (not an encouraging sign for further gains):

10yr US Treasury Yields:

Conventional wisdom holds that "when" the Fed begins the taper next month, UST yields will break higher. This also warrants close attention. I see a risk that even "if" the Fed does begin to taper next month, we could still see 10yr UST yields pull back to ~2.15% before resuming their uptrend. A pullback in equities/risk in general would put downward pressure on UST yields. Always be wary of conventional wisdom.
It’s not all doom and gloom!

Remember the AAPL chart from my last update? Sometimes these things play out exactly as expected. Target remains $540.
 Chinese equities (which dance to the beat of their own drum) have bottomed:
PE of the Shanghai Composite is well below the long term average PE (red line) and the 5yr average (green line):

I know I said in my last post that valuations don't have an impact on the tape unless they reach extreme levels. Well, Chinese equities look extremely cheap.

When you look at many of the large-cap defensive stocks in the US (e.g. Altria, AT&T, Coca-Cola, McDonalds, the utilities sector etc etc), they appear to have been trending down ever since the Shanghai Composite bottomed. Coincidence? Perhaps. However I think we are at the early stages of a shift in asset allocation away from relatively expensive US defensive stocks into relatively cheap Chinese (and other EM) stocks.

In summary: US equities are due for a pause that refreshes. Remain patient but alert to opportunities in weakness. Valuations on Chinese equities look compelling and the price action is now looking more encouraging. If you are overweight US equities (particularly defensives) consider reallocating to China (and EM).