The Pavlovian sequester response?


Author Cam Hui

Posted: 02 Mar 2013

Has the equity market been conditioned, like Pavlov’s dogs, to expect a last minute sequestration deal? Why has there been no negative market reaction when it was reported (via NBC) that Obama would meet Congressional leaders on Friday, after the sequester deadline [emphasis added]?

After weeks of argument over the sequester, bipartisan congressional leaders will meet with the president at the White House on Friday — the same day that automatic federal spending cuts are scheduled to go into effect.

President Barack Obama will meet with House Speaker John Boehner, House Minority Leader Nancy Pelosi, Senate Majority Leader Harry Reid and Senate Minority Leader Mitch McConnell to discuss the across-the-board budget reductions to federal agencies, aides told NBC News.

Republicans were quick to question why the White House would schedule the meeting only on the final day of the belabored back-and-forth over the cuts.

“If the President is serious about stopping the sequester, why did he schedule a meeting on Tuesday for Friday when the sequester hits at midnight on Thursday?” a Republican aide told NBC. “Either someone needs to buy the White House a calendar, or this is just a – belated – farce. They ought to at least pretend to try.”

I don’t need to go on and on about the deflationary effects of immediate and overnight cuts in government spending. Here is Fed chairman Ben Bernanke on the likely effects of sequestration (via The Bondad Blog):

However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.

The market’s reaction
I have been watching Defense and Aerospace stocks, as represented by ITA and PPA, as a barometer of market sentiment about the effects of sequestration. As you can see by the relative performance of ITA against the market, ITA has been in a minor relative uptrend for most of February and has beaten the market in the last couple of days.

The relative performance of PPA also shows a similar pattern of relative outperformance for February and this week.

So let me get this straight. President Obama is meeting with senior Congressional leaders to discuss sequestration on Friday, after the deadline has passed. Meanwhile, the Dow rallies and defense stocks, which are highly sensitive to government spending, are outperforming the market.

Is the market just conditioned to getting a last minute deal, just like what we saw during the 2011 debt ceiling impasse, or endless eurozone summits over Greece in the same year?

What happens to equity prices if the cavalry doesn’t arrive?

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 QE glass half-full or empty?


Author Cam Hui

Posted: 12 June 2012

How the market reacts to news can be an important clue of future direction. In my last post, I wrote that you shouldn’t expect too much from the ECB or Fed this week. The European Central Bank certainly disappointed the bulls with their inaction, not only on interest rates, but on the prospects for “extraordinary measures”.

Now it’s Ben Bernanke’s turn.

We already have a clue on what Bernanke will say from Jon Hilsenrath’s WSJ article entitled Fed Considers More Action Amid New Recovery Doubts. Here is what I am watching for. Will the markets key on the comment that action is not likely in the June FOMC meeting?

The Fed’s next meeting, June 19 and 20, could be too soon for conclusive decisions. Fed policy makers have many unanswered questions and have had trouble forming a consensus in the past. Top Fed officials have said that they would support new measures if they became convinced the U.S. wasn’t making progress on bringing down unemployment. Recent disappointing employment reports have raised this possibility, but the data might be a temporary blip. Moreover, the Fed’s options for more easing are sure to stir internal resistance at the central bank if they are considered.

Or will the market key on the fact that the Fed is considering further quantitative easing [emphasis added]?

Their options include doing nothing and continuing to assess the economic outlook—or more strongly signaling a willingness to act later if the outlook more clearly worsens. Fed policy makers could take a small precautionary measure, like extending for a short period its “Operation Twist” program—in which the Fed is selling short-term securities and using the proceeds to buy long-term securities. Or, policy makers could take bolder action such as launching another large round of bond purchases if they become convinced of a significant slowdown.

What Hilsenrath wrote is not that different from what New York Fed President Dudley said in late May in the WSJ, that the Fed will act should it see signs of economic weakness:

Expectations for U.S. economic growth, while “pretty disappointing” at around 2.4%, is sufficient to keep the central bank from easing monetary policy, Federal Reserve Bank of New York President William Dudley said.

“My view is that, if we continue to see improvement in the economy, in terms of using up the slack in available resources, then I think it’s hard to argue that we absolutely must do something more in terms of the monetary policy front,” Dudley said in an interview with CNBC, aired Thursday.

Now that we know what Chairman Bernanke is likely to say, watch the market reaction. Is the QE glass half-full or half-empty?

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.

Time for the Draghi and Bernanke Puts?


Author Cam Hui

Posted: 05 June 2012

This week is an important week for investors who are watching for central bank action in the wake of market angst over Europe and the American economy. On Wednesday, the ECB will announce its interest rate decision and Mario Draghi will hold the customary press conference afterwards. On Thursday, Ben Bernanke will be testifying before Congress.

What will they say?

Don’t expect too much
While I do expect that the ECB and Federal Reserve will intervene eventually, I do think that the markets may be getting ahead of themselves in anticipating another round of LTRO from the ECB or QE from the Fed. After all, Mario Draghi said last week that the ECB was reaching the limits of what it could do and it’s now up to the politicians:

Draghi told a European Parliament committee in Brussels that without more aggressive action by policy makers the euro “is being shown now to be unsustainable unless further steps are being undertaken.”

He said it wasn’t his job to make up for the failures of policy makers. “It’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front,” he said.

The ECB is likely to reduce interest rates in the face of economic weakness in the eurozone, but don’t expect too much more. If Draghi were to reverse course from last week and announce some extraordinary measure like another round of LTRO, it would not only erode the ECB’s credibility, but could paradoxically have a negative effect on the markets as it asks, “What looming disaster does the ECB know about that we aren’t aware of?”

QE3 in June?
Across the Atlantic, there is a lot of expectation built up that we are due for another round of QE at the June FOMC meeting in the wake of last week’s ugly NFP report. Veteran Fed watcher Tim Duy disagrees  [emphasis added]:

Bottom Line: At this point, the direction of US data, the pathetic state of Europe, and the evolving slowdown across the rest of the world all point toward additional action by the Federal Reserve. Assuming this continues, it is an issue of timing and tools. My baseline is steady policy at the June meeting (depending, of course, on the usual financial turmoil disclaimer), with a possibility of an extension of Operation Twist. The latter option is something of a tough sell for me; it is cheap, but will prove to be ineffective. If the Fed needs to move, they need to reverse course back into quantitative easing. They need time to build internal support for such a move, which argues for action later in the summer or early fall, much as we have seen in the past two years. I just don’t think they have enough to shift policy at this juncture.

Don’t forget that Bernanke and the Bernanke Fed is made up largely of conservative academics, who tend to wait for definitive evidence of a slowdown before acting. As I wrote before about the difference between the Bernanke and Greenspan Fed (see Yes to QE3, but not yet), both the Greenspan Put and Bernanke Put exist, the difference is in reaction time:

[P]ut yourself in Bernanke’s head. His academic reputation was built on the study of central bank action during the Great Depression. This is probably a little voice in his head telling over and over again, “Don’t let another Great Depression happen on your watch.” As a result, we have the Bernanke Put.

Greenspan had a long career on the Street as a forecasting economist and tended to be more proactive:

Greenspan’s approach as Fed Chairman was to stimulate whenever he saw signs of weakness – and he was far more market savvy than Bernanke. Therefore the Greenspan Fed tended to be more proactive and tended to get ahead of events. The Great Moderation was the result of the Greenspan Put – and those policies worked well, until they went overboard with the stimulus (and we are still paying the price for those policies).

My guess is that investors looking for hints of another round of QE from the Fed on Thursday are likely to be disappointed.

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.

2012 = 1998?

Posted: 04 Jun 2012 12:16 AM PDT

Weekends are a good time to think and reflect. After last week’s carnage in the stock market, some thinking and reflection was more than overdue. The question I had was, “What is the market headed?”

When I consider the different dimensions by which investors evaluate equities, they present a mixed picture that is, while bearish, does not point to disaster:

  • Sentiment: bullish
  • Valuation: neutral to slightly bearish
  • Momentum: bearish
  • Macro: bearish, but subject to policy-induced whipsaw

Sentiment models are screaming “buy”!
Let’s go through each of these one at a time. Martin T. over at Macronomics noted that Wall Street strategists are off the charts bearish, which is contrarian bullish.

As well, US 10yr yields are trading 3 standard deviations from the 30+ year downtrend, which indicates a crowded long in the Treasury safe haven trade.

Scott Grannis has noted the same level of exuberance when he asked “What record-low Treasury yields tell us“. His take:

If I had to sum up what all this means, I would say that the evidence of market prices points to a very high level of fear, uncertainty and doubt among global investors. Today’s record-low 10-yr Treasury yield is just the latest sign that investors are consumed by fears. When emotions reach such heights, as they did in the early 1980s and in late 2008/early 2009, investors willing to bear risk stand a good chance of being rewarded, provided the future turns out to be less awful than the market expects.

Valuation: Neh!
Typically, when sentiment is this bearish, Value investors are all crawling out of the woodwork and shouting, “I can’t believe that there are so many bargains!”

While I have heard that comment directed at a number of European companies, i.e. these are real world-class companies trading at bargain prices (see one example at the FT article While all around ar panicking…buy), the same couldn’t really be said of most markets. The Value investors just aren’t there.

Consider, for example, this Barron’s interview with Jeremy Grantham, who is known to have a value bias, on February 25, 2012 when the SPX was about 1360, which is about 6% above Friday’s close of 1278.

We do a seven-year forecast every month. On a seven-year forecast, global equities outside the U.S. are boring. They’ve been so nervous the last year that they mostly reflect the right degree of fear about European problems. Emerging markets and developed markets outside the U.S. are within nickels and dimes of fair value. This is very unusual. We are in the asset-allocation business, and we like to see horrific roller coasters: It gives us something to get our teeth into. What could be more boring than global equity markets at fair value?
About a quarter of the U.S. equity market—the high-quality, boring, great companies—is about fair price, too. The other three quarters are overpriced, and based on our numbers have a slight negative imputed return.

While Grantham doesn’t represent the final word in stock market valuation, he is a good bellwether for what Value investors think. As of the end of February, he believed that non-US equities were roughly at fair valuation. US equities are overpriced, with only a quarter, i.e. high quality stocks, at fair value.

His comments were not a stunning endorsement for the stock market.

A Dow Theory sell signal
The Dow Theory is one of the original trend following models, which is based on price momentum and looks for confirmations from different sectors of the market: industrials, transportation and utilities. Long-term market analyst and Dow Theorist Richard Russell recently flashed a major sell signal for stocks [emphasis added]:

IMPORTANT — Dow Theory — The D-J industrial Average recorded a high of 13,279.32 on May 1, 2012.  This Dow high was not confirmed by the Transports.  The two averages then turned down and broke below their April lows.  This action confirmed that a primary bear market is in progress — it was a textbook bear signal.

Could you be a little more clear, Richard?

Macro picture gets worse
Last week, the news flow from Europe continued to deteriorate. The latest Greek tracking polls have SYRIZA on top again:

Not only that, the markets are now getting concerned about Spain – a country that’s too big to fail. In the meantime, ECB head Mario Draghi stood aside last week and said that the ECB can’t do much more. It’s all up to the politicians:

Draghi told a European Parliament committee in Brussels that without more aggressive action by policy makers the euro “is being shown now to be unsustainable unless further steps are being undertaken.”

He said it wasn’t his job to make up for the failures of policy makers. “It’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front,” he said.

Last week, I wrote that investors should focus on China, not Europe. The news out of China is headed south. The latest PMIs are signaling a global slowdown, not just in China but in Europe as well. I raised the issue of when investors might focus on the question of capital flight out of China, when Tim Duy picked up on the same story. Should the market start to price in the tail-risk of capital flight, look out below!

Then we have the ugly US Non-Farm Payroll Friday. The only good news is that more data points of economic weakness will give the Fed political cover to act and unveil another round of QE. Despite what the central bankers say, don’t forget that when things get bad enough, there will a policy response. As an example of the anticipated response, Mark Dow at Behavioral Macro believes that the IMF is putting on the face paint for a rescue of Spain. While the response may not fully solve the problem, it will kick the can down the road and spark a stock market rally.

A repeat of 1998 in 2012?
Putting it all together, what does it all mean? The market is supported by washed out investor sentiment, but not by valuation. The macro backdrop and momentum looks ugly. Is this the start of another cyclical bear?

Probably not. Valuations don’t look excessively stretched, but they aren’t screaming “buy” either. Major bear markets generally don’t start with these kinds of valuation metrics.

My best wild-eyed-guess is that we will see a major air pocket like 1997 (Asian Crisis) or 1998 (Russia/LTCM Crisis) in which some macro event sparks a major selloff, but turns around based on policy response. There are plenty of macro triggers out there. Greece, Spain, China, etc.

Market analogues have limited uses, but look at the chart of the stock market in 1998. The market had an initial dislocation (Greece), stabilized and rallied (as we did a couple weeks ago) and started selling off again. At the nadir of the Russia Crisis that threatened to sink Long-Term Capital Management, the Fed came in and knocked some heads together to save the system.

Now look at the chart of the market this year and last year. See any parallels?

Don’t misunderstand me. This is not a forecast that stocks are going to plunge this week. Analogues are analogies and they are imperfect. Markets are extremely oversold on a short-term basis and I don’t think that we’ve actually seen the macro trigger for a waterfall decline yet, though there are lots of potential triggers.

Not enough pain
Nevertheless, were this scenario were to play out, it suggests that we haven’t quite seen enough pain and we need one more capitulation down leg to equities. For now, my Asset Inflation-Deflation Trend Model remains at a deflation reading, indicating that the model portfolio should be primarily positioned in the US Treasury market. I will be primarily using that model and some short-term timing tools to try to spot the turn. Here is what I am watching. The chart below of the Euro STOXX 50 is falling, but not quite at the lows delineated by the 2009 and 2011 lows. Wait until the index approaches that zone and watch for signs of a “margin clerk” liquidation forced selling in the panic.

Here in Canada, I am also watching the ratio of the junior TSX Venture Index to the more senior and established TSX Composite. While there is a lot of pain, utter and blind panic hasn’t quite set in yet.

When the blood starts to run in the streets, official intervention will be all but inevitable. At that time, that will be the opportunity to buy the pain in Spain.

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.

Bernanke is Clear on Triggers for QE3, and We Aren’t Close to Them


Author Larry Berman

Posted: 31 Mar 2012 reposted from etfcm

The next top that is likely to develop over the coming months will likely serve to suck in any remaining sideline cash while the smart money continues to distribute shares to the late to the party lemmings.

Of course, we are only correct here if the real economy is not improving and we are only getting the benefit from Bernanke stimulus. If the economy is really improving, which we doubt, then earnings are just fine and valuations remain relatively cheap. Is that the case or not? We think not, but we’ve been wrong before.

We are at a key point of inflection, so we have reduced client exposure to half the maximum for our US large cap and small cap portfolios. At this point, we see the glass as half full, so we are half in. If the glass breaks, leaks, or fractures, we’ll turn exposure to zero. Otherwise, we are waiting for higher levels to feed the quacking ducks on TV as to how wonderful the recovery is.

The Senate had the opportunity to pass important legislation to take unneeded subsidies from big oil (XOM made $50B+ EBIT) and channel them into renewable and other productive technologies—they failed!!!


Impacts on the Energy Sector


Author Larry Berman

Posted: 28 Mar 2012 re-posted from etfcm

The rising costs in the energy patch and increasing stress on nat gas prices seems to be having a significant impact on the energy sector despite the fact that WTI is trading at $100+.

We saw a presentation today that suggested the realized revenue on a barrel of Oil Sands gunk is less than $70 and costs are running in the $60 range, so not too surprising that the sector is trading under a bit of stress right now. Now that WTI cannot hold the war premium it has built up, that would suggest the XEG could easily trade back to $15 all things being equal (ceteris paribus)—which of course they are not.

Gold could hug its 200-day average like it did for a few weeks last month when it was trying to rally back, which suggest the gold stocks could struggle a bit too. We know seasonals for gold stocks are not strong until summer months.

 

Dips in Gold Stocks are Potential Buy Opportunities


Author Larry Berman

Posted: 16 Mar 2012 reposted from etfcm

The TSX has been in a sideways chop for the past week, but under the hood, the financials led by insurance companies (they tend to do better when interest rates are expected to rise), have been very strong while the commodities and energy stocks have been very weak.

Of the large cap gold stocks, several have made new 52 week lows, which remind us that we are probably close to a buy point given the highly volatile chart patterns. The charts have been manic over the past year and despite gold bullions advance, gold stocks are getting no respect. Every dip to these prices has been a buying opportunity for gold stocks and this time should be no different.

Recall, the past two times the market was sure the Fed would need to raise rates because all was well, the equity markets tanked and gold took off. The harder part now is in the energy sector, where there is smoke there is fire. Governments once again are discussing releasing oil from the SPR. WTI plunged $2 in about 4 minutes after the announcement hit Reuters owing to the geopolitical risk premium driving the sector.

 

 

The Only Strong Commodity Sectors at Present are in Energy


Author Larry Berman

Posted: 12 Mar 2012 reposted from etfcm

There appears to be a base pattern developing in the broad DJP commodity indices, but the steeper contango seen in many commodities is taking a toll on the buy and hold commodity investor. The only sectors that look strong at this point are in the energy sector (except natural gas), which has become so cheap by historical standards it is actually compelling.

Natural gas equities as measured by FCG is still not as cheap as one would expect given the price of the underlying. ECA, the pure natural gas play is developing a major base pattern and looks compelling to accumulate on weakness. We do however expect significant disappointment during the next earnings period on the gassy energy stocks.

Copper looks to be struggling and industry leader FCX is clearly showing very poor behaviour after it failed breakout over its 200-day average. Agricultural stocks within MOO, also look to be undergoing more corrective price action that probably has 5-10% downside before it is attractive.

Bernanke is Clear on Triggers for QE3, and We Aren’t Close to Them


Author Larry Berman

Posted: 1 Mar 2012 reposted from etfcm

Yesterday was the first notable higher volume distribution day since December. All the news wires and headlines this morning are blaming Bernanke’s lack of talk about QE3. He has been pretty clear what the triggers are for QE3 and we are not close to any of them. In fact, the thought that they would launch another QE with operation twist still playing out is staggering. There are many very smart people on Wall Street—we find it hard to believe they are that naïve. Nevertheless, these things move markets and are part of trying to navigate the markets.

Outside of some surprise at the reaction, specifically in the 50 handle drop in gold in about a nanosecond as Ron Paul was giving Big Ben a thorough lashing (if this was 1012 and not 2012, it might have been a public bloodletting). Ron Paul has just joined Newt in the unelectable category of candidates who are out of touch with reality. Without the Fed, we would be in the 1930s. Right now we are only in 1999 in Japan. 1352 remains important near-term support; the trading trend is higher until that breaks.

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