Secular bull or bear?


Author Cam Hui

Posted: 07 May 2013

As US equities have rallied in the last couple of weeks, there has been much discussion about the rotation in sector leadership from defensively oriented sectors to the deep cyclical sectors. Does the rotation mean that this market is truly ready to take off to further new highs? What does it all mean?

I have spent a fair amount of time pondering that question (see my recent post Sell in May?). My conclusion is where you come down on the question of whether this is the start of a new secular bull market where stocks move to new highs or whether we are just seeing the top of a range-bound secular bear.

To explain, consider this long-term chart of the Dow, where the market has seen alternating secular bulls, where stocks rally to multi-decade highs, and secular bears, where the market remains range-bound for years.

Still a secular bear market
My main belief is that we remain in a secular bear for two main reasons: demographics and valuation. I have written about the demographics issue before (see Demographics and stock returns and A stock market bottom at the end of this decade). For stocks to go up, there has to be more buyers than sellers at a given price. The propensity of Baby Boomers, as they move into retirement, is to take money out of stocks. In order for equities to rise, those negative fund flows have to be met by the retirement savings of their children, the Echo Boomers. Two research groups looked into this topic (see papers here and here). Their conclusion – the inflection point at which the fund flows of Echo Boomers moving into stocks start to overwhelm the Baby Boomers taking money out is somewhere between 2017 and 2021.

In addition, long-term valuations don’t appear compelling. I have long considered the market cap to GDP ratio as a proxy for an aggregate Price to Sales ratio for the stock market. The chart below from Bianco Research via Barry Ritholz, shows this metric, whose history goes all they way back to 1925, to be well above its long-term average. In addition, note that instances of falling market cap to GDP ratios correspond with secular range-bound bear markets.

Another reason for the long-term secular bear case comes from John Hussman, an investor for whom I have much respect. His latest 10-year return projections for the SPX is about 3.5% (see My answer to John Hussman). Even with bonds yields at microscope levels, a 3.5% return expectation for US equities is nothing to get overly excited about.

The bull case (and it’s always important for investors to consider opinions contrary to his own) is represented by Ray Dalio’s “beautiful deleveraging” concept (see my post Falling tail risk = new secular bull?). Dalio believes that the United States has undergone a “beautiful deleveraging” process in the wake of the financial crisis of 2008. A “beautiful deleveraging” involves just the right amount of austerity, debt restructuring and money printing. He went on to observe that, by contrast, Europe has gotten it all wrong and that region is likely to be mired in a Lost Decade.

If Dalio is correct, then the rotation that we are observing from defensive to cyclical sectors is another sign of a new upleg in equity prices and therefore the start of a new secular bull.

The intermediate term outlook
While my analysis of the secular bull vs. bear is based on a long-term multi-year investment time frame, what about the intermediate term time frame for the next several weeks to months?

Here’s what’s bothering me about the emergence of the cyclical leadership. First of all, commodities look positively sick. Here is a chart of the industrial metals. Does this look like the basis for a cyclical rebound?

In addition, the Citigroup Surprise Index has been turning down, both in the US and globally. Despite Friday’s NFP upside surprise, the internals of the employment report appeared to be negative and it was before long that there were a cacophony of voices pointing out the weaknesses in the report (for examples, see herehere and here).

I agree with the blogger MicroFundy when he pointed out the divergences between the macro picture and US stocks:

I think we are getting real close to a major inflection point. It seems like every macro-economic data point I come across is saying one thing – the same thing. There is an extremely high correlation between all the varying data points and indicators. Data like the 10yr treasury yields, PMI manufacturing, durable goods orders, copper prices, international (ex Japan) stock markets, inflation expectation, margin levels etc – are all saying that the (global &) US economy is slowing, and that the risks of deflation/contraction/recession are growing.

The only thing diverging from this pattern in all of the charts below is the US equity markets.

His conclusion is “something’s gotta give”:

There are two extreme scenarios that can “correct” the above divergence, although I believe it will be a combination of the two.

1 – We could see a correction of 15-20% that would put the US equity markets back in line with most of the charts above. It would then be priced closer to fair value based on most of the recent economic data.

2 – The economic data can pop back up. Whether it was because of the payroll tax increase, sequestration, or some other seasonal event(s)… maybe this is/was just a blip on the radar these last few months, and the economic data will “catch up” to the US equity markets.

If these scenarios were mutually exclusive, I would bet the farm on #1. A realistic base case assumption though, is a combination of the two. I am anticipating a good 10% correction combined with a small pickup in some of the macro data.

Either way, something’s gotta give. The level of divergence here is bordering historical, and the relative and absolute over-valuation of some of these high-yield names are frightening.

With Europe mired in recession, commodity markets signaling that Chinese growth is stalling, the US is once again holding up the world. If the American economy is holding up the world, then why is US equity performance faltering against global equities? The chart below shows the relative performance of SPY against ACWI (All-Country World Index). If we are indeed seeing a launch of a new secular bull, shouldn’t the US, which has been the beneficiary of the “beautiful deleveraging”, be leading?

A bearish bias
While I have outlined my bias for the bear case, investing is about probabilities and I honestly don’t know how this market is going to resolve itself. While the bear case is compelling, Street earnings and revenue estimates continue to get revised upwards (as per Ed Yardeni).

Until we see some sort of negative macro surprise that cause estimates to get revised downwards, the stock market is likely to grind higher. As I wrote last week, there is no catalyst yet for a bearish impulse for stocks yet.

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.

Stay long USD assets


Author Cam Hui

Posted: 03 May 2012

Sometimes it’s useful to sit back and examine the technical leadership of the market to see where the strength is coming from and to understand the message of the market. Instead of the usual analysis of technical leadership from a sectors or market cap perspective, I thought that I would do something slightly different and look at the global picture of international stock leadership.

The bottom line? The current macro outlook is highly uncertain, suggesting that the near-term path for equities will be choppy and volatile. The charts are showing continued leadership by US equities and the US Dollar. All other global regions are underperforming. Under these circumstances, I would stay with the strength and concentrate the bulk of any equity exposure in the US and overweight USD assets in a global portfolio.

Where is the leadership?
The chart below shows the relative performance of US equities, as represented by SPY, against ACWI, or the ETF for the Morgan Stanley All-Country World Index. Since all prices are quoted in US Dollars, the currency effects have all been filtered out of the analysis. As you can see, US equities have been in a relative uptrend against ACWI for about a year:

What about Europe? The market is telling us that it is indeed concerned about the eurozone, as its equities have been underperforming for over a year.

The other large developed country in EAFE is Japan. The performance of Japanese stocks is nothing to write home about. They are either flat to weak against ACWI, depending on you interpret this chart.

Emerging market equities have not been a pretty picture. The relative performance of these stocks show that they appear to be rolling over on a relative basis.

Until the BRIC countries, and China in particular, begin to show some sustained strength, I would underweight these stocks in a global portfolio. There is a glimmer of hope, as Bloomberg reported that Analysts who called 2010 bottom in China stocks now say buy.

Finally, a look at the US Dollar Index shows that it remains in an uptrend that began last summer. Currently, it appears to be testing the bottom trendline of the uptrend, but I would give the USD bulls the benefit of the doubt for now.

What about the fiscal cliff?
Recently, Fed Chair Ben Bernanke warned Congress about taking sufficient action so that the US doesn’t go over the fiscal cliff. Bloomberg reported that he said:

If no action were to be taken by the fiscal authorities, the size of the fiscal cliff is such that there’s no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy.

Other analysts, like Nouriel Roubini, David Rosenberg and Citi’s Steven Wieting have warned about the impending fiscal cliff that the US faces. No doubt the risks are gargantuan and my inner investor is highly concerned about an overly high concentration in USD assets under these circumstances.

My inner trader tells me that, for the markets, these things don’t matter until they matter. Stay with the relative performance trend and then pull back when you see the trend break.

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

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

Equity markets are betting on the consumer


Author Cam Hui

Posted: 26 Mar 2012

Last week, I wrote that the character of the stock market had changed. The market had gone from a central bank liquidity driven rally, which favors hard assets and asset inflation plays, to a focus on the American consumer as a source of growth (see This bull depends on the US consumer).

To review, leadership had gone to Consumer Discretionary stocks, which was in a relative uptrend against the broad market:

…and Financials, which had broken its relative downtrend line and has now staged a relative breakout through resistance:

Europe mirrors the US
I reviewed the chart patterns of the European sectors on the weekend and (to my surprise) found a similar pattern. European Financials had broken out of a relative downtrend, but they weren’t as strong as American Financials as they have not yet staged a relative breakout, but appear to be undergoing a sideways relative consolidation:

European consumer stocks are broken down as Consumer Goods and Consumer Services, which is not quite the same categorization that we find in the United States. Nevertheless, I was surprised to see that the European Consumer Goods sector has been in a long relative uptrend against the market and had staged a relative breakout and pullback after spending several months undergoing a sideways consolidation period:

The European Consumer Services sector was not as strong, but had nevertheless provided leadership in the latest rally.

Market bullish on US and Europe consumer, but worried about China
When I look around the world and listen to the market, the stock markets are telling me that first stage booster of central bank liquidity has dropped and and it’s up to the second stage rocket, namely the American and European consumer, is on course to lift us past escape velocity. There is one drag to our rocket, however, and that’s the prospect of a slowdown in China, as the weakness in commodity prices and commodity sensitive currencies are signaling those concerns.

Expect a rally, but define your risk tolerance
A bullish bet is therefore a bet on the health of the American and European consumer – and that is indeed a fragile foundation for a rally. Nevertheless, unless I am convinced otherwise the stock market remains in an uptrend. The chart below shows the weekly NYSE Summation Index, which is a breadth indicator, which I have overlaid a slow stochastic, an overbought/oversold indicator. If past history is any guide, stocks are tactically oversold and likely to rally in the next couple of weeks.

If you believe that we are in an uptrend, then the current period is likely to resemble the circled December 2010 correction and consolidation period in the middle of the QE2 rally. If you believe that the market is likely to correct further, another analog (circled) might correspond to the weakness seen in June 2010.

In both cases, the oversold readings of the stochastic point to a tactical rally in stocks for the next couple of weeks. In all cases, it would be wise to stay long, but carefully define your risk tolerance with the appropriate stop loss orders. In the meantime, watch the news flow and in particular closely watch how the market reacts to news coming out of China.

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.

A terrible 2011 for hedge funds


Author Cam Hui

Posted: 27 Dec 2011 12:21 AM PST

I started this blog four years ago and my first post was about how hedge fund returns have been correlated with stock returns. That correlation hasn’t changed.

That’s because hedge funds and stocks are all part of the risk trade. Hedge funds take risks and so do stock investors. In the current environment where the market oscillates between “risk-on” and “risk-off”, it’s not unexpected that hedge funds returns be correlated with stock returns. The chart below shows the returns of the HFRX Global Hedge Fund Index, which is a representative index of all investable hedge funds, compared to the S+P 500.

Even though hedge fund returns were correlated to the S+P 500, the above chart shows that they tended to be less volatile than the S+P 500. What that means is that when stock returns are down, hedge fund returns should be counted on to be down less and beat stock returns. In 2011, the chart below shows that they didn’t and lagged the S+P 500 instead.

A funny thing happened in 2011. First of all, hedge funds had a terrible year as they substantially underperformed the S+P 500. On a year-to-date basis to December 16, 2011, the HFRX Global Hedge Fund Index was down -9.0% after fees compared to -1.3% for the S+P 500.

The negative performance occurred across the board. The chart below shows the YTD returns of the various HFRX sub-indices. The Global Index was down 9.0%, but every single category of hedge fund returns underperformed the S&P 500.

The poor performance of hedge funds in all categories is illustrative of the headwinds faced by active managers in 2011. Nothing worked!

Two categories that performed particularly poorly were directional strategies, namely Market Directional and Equity Hedge, which allowed a manager to go long or short. Fundamental Value was the laggard at -23.6% for the year.

The carnage in hedge fund performance can be seen anecdotally from the headlines. John Paulson‘s Advantage Plus flagship fund’s performance through December 16 is down -9% in December and -52% on a YTD basis. Legends like George Soros exited the business of managing money to focus on his own funds. I could go on, but you get the idea.

I am working on a much longer post analyzing why hedge funds performed so poorly in 2011. More on than later.

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

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

4.48 vs 6.06


The widely anticipated move by the European policy makers was well received by the global equity markets.  Although the 50% voluntary haircut in Greek debt and levering the EFSF four to five times for around a trillion euro fund to backstop the potential contagion was cheered by the equity markets, once again the droll credit/bond analysts have not bought it.  The European and US markets rallied hard on the news with the Dow Jones rallying 4.48% in the last few days. However the bond markets were unmoved and in fact yields rose a little for Italy – one of the profligate issuers of debt in Europe. One could argue that most of the debt is borrowed internally unlike say Greece and the country does have a robust manufacturing industrial base unlike Greece. But that being said, on Friday, they paid the most for their 10 year debt since joining the Euro in 1999 reflecting a yield of 6.06%. This is up from 5.84% only last week. The PIIGS threshold yield was approximately 7% where that pushed them into problem territory. The problem with Italy is that it is the #3 issuer of debt ceded only the US and Japan.  So there is a global push and pull right now between the equity and credit bulls and bears. The question is if this is such a good plan then why are yields rising – they should be falling.

Bottom line: given that the bond market dwarfs the equity market, I remain unmoved and I am selling into this rally.

Italy is too big to fail, too big to bail…

%d bloggers like this: