Steen's Chronicle: No more Silver Bullets?

24 May 2011

Steen's Chronicle: No more Silver Bullets?

Steen Jakobsen, Chief Economist

Madrid or Cairo?
I could give you a song and a dance rooting on how there is risk of both upside and downside from here, but let me instead cut straight to the chase:
 
I am turning net negative on the markets from here – my old call was for 1380/1400 in the S&P cash index and with the recent high of 1371, I now deem this to have been effectively reached. This negative outlook risks coming at a local low in the market, but there are several factors that make me make this call despite this risk:
 
Gold and S&P have started to move in opposite directions -This is a key indicator – In order for this to be a “proper correction” we need them to move in opposite directions as gold should find buyers nervous about stocks, politics and the general outlook. The correction so far this year has been general risk-on / risk-off on liquidity, etc. Things are looking different this time around.

China leads and has led since the crisis in 2008 – Every single turn: down and up has happened in China first.  On that note, the Shanghai composite index took out long-term support over the last three sessions.

Spain – scoring its own goal – Despite the consensus that the risk to Spain comes from the “reprofiling” of Greece debt, it’s more likely to be self-induced – I.e: the economic- and poltical environment deteriorates faster than the political will to resolve it. The local elections are a sign of increasing pressures.

Social tension - I have travelled extensively in Asia, the Middle East and Europe over the last two months and the social tension everywhere is rising. The social cohesion or lack of it is not something the market deals with as it is seen as too “unacademic”. But trust me in the talks, speeches and customer talks I have had it’s a real concern and nothing says it better than the recent surge of youth determination to show their disapproval of their government and their plight in Spain.

Technical patterns. I use a “back-bone” model which essentially is a momentum model – it’s simple but it keeps you honest (and long when needed!). This model is throwing out huge warning signals as it has entered a short on EMG-Markets and is now looking close to shorting the SPX Index.

SPX – support lines broken

SPX moving avg. model close to going short

 Emerging Markets (EEM ETF) already short

Valuation - My colleagues Mads Koefoed and Peter Garnry have developed an extremely interesting model which combines valuation with momentum of earnings in a consistent bottom-up way. The model indicates we are seeing “stretched” valuations. This model will soon be available for a general audience.

Chart 4: Saxo Bank valuation model (CAPE + Piotroski based) – showing expensive valuation

Finally, despite fundamentals being of no relevance, my negative view on Asian growth especially and world growth generally are being slowly vindicated – with the first derivative being one of increased fiscal deficits due to lower growth and tax revenue. Yes, the world may be prepared to deal with fiscal spending cuts, but the negative economic gravity seems to be outperforming the political will to deal with the problem. Another fundamental fact lost on most analysts is that in order for austerity(spending cuts) to work, they must ALWAYS be accompanied by loose monetary policy – the one thing we are not getting, no matter what happens from here.

Citigroup Index and Saxo weighted model

A local low in the stock market is clearly a risky proposition – the first obvious risk being that the G-8 at the end of this week creates some sort of consensus on how to solve the issues, but it is a risk I am willing to take as the ECB and Finance Ministers battle it out about Greece, Portugal and soon Spain. The other risk being some major Marshall plan secretively being worked out behind the scenes – again I am willing to risk 5-7% upside to be conservative.
 
In my notes above I have only indirectly included the clear and present risk of the situation in Europe getting worse – the reason being that it’s clearly priced in to some degree. What I do not see priced in are most of the other factors I have described. Market trends change more often than not on political events. I see this week-end’s Spanish election as a key catalyst. When watching people camping out in Madrid’s squares, it’s hard not to remind yourself that this is how things started in Egypt and the rest of MENA. A youth unemployment rate of 45% and a general unemployment rate of more than 21% is clearly not socially sustainable.
 
It may be this social dimension which is the real trigger for change and reason for a correction, and if so the market will prove unprepared as I am yet to see any trading model or statistical projection that includes social cohesion in its regressions. It could be the case of it's not what you do see, but what you don’t see that is most important.
 
The new target for the S&P cash index will be 1225/35. If we take out 1350 again on the upside, on the other hand, I will clearly need to revisit my overall call, but for now caution is recommended.

 

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Steen's Chronicle: Wrestling with a lack of liquidity

18 May 2011

Steen Jakobsen, Chief Economist

The market has many victims these days and I see this continuing as it wrestles with less liquidity, troubled by concerns about China's growth stalling, the end of QE2 in the U.S. and the Eurozone's peripheral debt woes being now played out in the Greek tragedy. In this chronicle I touch on all of these issues, which combined point to tough times ahead.

The Chinese slow-down factor
The key conclusion from my Asian visit last week was that Asia has reached peak growth. This entails refocusing on social dimensions and a wish to engineer a soft-landing. I’m confident that China will avoid a hard landing but more skeptical than consensus on how China will fair in terms of growth in the second half of 2011 and in 2012. Inflation will continue higher, precisely because China is currently witnessing peak growth and hence production capacity levels are at extremes where the pool of cheap labour has almost been exhausted and electricity and energy resources overall are at a maximum price level. Added to this is the major drive in the five-year plan to create “inclusiveness” and there is a growing risk that the 50% of net new growth added to world growth by China will stall or maybe even contract (as measured by its velocity).
The best hedge for a slow-down in growth China remains Australia. Australia is showing clear signs of bubbles in housing with some estimates saying house prices are 25 per cent above long term sustainable prices (Source: ABC.NET.AU). Australia remains a powerful force in producing resources, i.e., mining, and a main exporter to China. We are negative on AUD assets overall.

Source: Bloomberg: Interest differentials of the two main currencies against AUD
(JPY and USD).
We, at Saxo Bank, will cover the China slow-down factor and its impact as one of our major themes for the second half of 2011. We think the headline is about liquidity withdrawl.
Less risk capital
The exit from QE2 in the U.S. will mean net less risk capital for banks as the Federal  Reserve's balance sheet will remain unchanged to slightly lower. Add to this is the role of the European Central Bank, which is determined to force politicians in Europe to make structural changes via the continuation of interest rate hikes (by 25 basis points at least) for another two quarters. Finally, and again, China and Asia whom are busy curtailing inflation through a combination of higher currency and interest rates. The peak in liquidity may be near.
Neutral to defensive calls on equities
We still need to see our back-bone of generic models turn around, but both for Emerging Markets and the G-10 countries it looks like this week could force us to have an outright negative view on equities and valuations. If this is confirmed you will hear more from me, but for now we advocate alertness on risky assets. I have called for 1280/1330 as the medium-term objective for the S&P cash – the high has been 1271, so though we are not truly there (but still too close for comfort), this leads us to neutral to defensive calls on equities for the next month or two.
The role of the EU and the IMF in the Greek tragedy
Finally, a short comment on the European Union and the International Monetary Fund.  The political theory we use is one which states:  'politicians will do nothing as long as the cost to political opportunity remains zero for their re-election, and only when the opportunity changes will there be a political will to change'. This is the reason why I argue Greece will see “reprofiling” or soft-restructuring happen before the consensus view of 2013 (and most likely in Q4 2011 or Q1 2012). Chancellor Merkel in no way wants to be out and about on her election campaign while trying to safeguard Greece.
The key thing to watch for in the EU remains Spain. Not for the contagion risk of Greece (no matter whether a soft or hard default occurs, which is priced in), but more because of the underestimated risk of a deteriorating fundamental picture in Spain. Housing and unemployment in Spain are still in deep trouble, so it is quite likely that contagion could come from no progress in underlying fundamentals there and that Greece purely becomes the catalyst.

Who’s going to pick up the tab?

http://www.tradingfloor.com/posts/steen-jakobsen/steens-chronicle-whos-going-to-pick-up-the-tab-3512

29 April 2011

Steen's Chronicle: Who's going to pick up the tab?

Steen Jakobsen, Chief Economist
America is a country that doesn't know where it's going but is determined to set the speed record getting there - Laurence J. Peter
Last night I had the pleasure of speaking at a Saxo EBANK seminar in Copenhagen with the world famous blogger Mike "Mish" Shedlock -he of the Mish's Global Economic Trend Analysis blog.

First, I must note that it was a novel experience for me in my twelve years of speaking engagements to be out-gunned on the negative side on my investment outlook. In the past, so many have asked me after my presentations: 'Steen, you are always selling everything – what are we supposed to BUY?  Clearly, I need to bring Mish along on more of these speaking gigs and play off his gloom to make my views appear a bit more cheery.

Mish raised several critical themes and issues in the current financial environment, but the most interesting was the often forgotten focus on leverage in the US – which we all know is high, but  do we really understand exactly how high?
 
Financial leverage in the United States
Fed Balance Assets – white line, MZM – broad money – Yellow, Public Debt – Green and finally Credit Market Debt  - Red line


Source: Bloomberg

The US Fed has more than tripled its balance sheet since 2008, and US public debt has followed suit. Meanwhile, the broader money measure, as a benchmark for baseline money in the economy, has remained stable. The point here is not rehash the well publicized fact that the Fed has printed money, but more to point out that when you have this kind of leverage, even small policy errors can have major implications.

I will never forget how in the pre-Financial crisis day, I listened in on a Lehman CFO analyst call in which she boasted that they had brought down their balance sheet leverage from 40 times to less than 30! In retrospect, it's so easy to point out that this means it only takes a 3.34% move in the wrong direction in underlying assets to wipe you out rather than a 2.5% move – not a huge difference.

My piece yesterday on the possibility of an upcoming US dollar crisis drew some attention, but I must say the more I think about the main issue: How the Fed and to some extent the ECB continue to write off any material changes in the economic reality as "noise" or "transitory effects", the more I believe that all economists, a.k.a. dismalists need to own up to the fact that all models in economics are flawed – They are all fair-weather models that work when we have a tailwind and clear visibility, but as soon as things start going down the drain, the model continues to see clear skies ahead instead of a thunderstorm of uncertainty.

Here's what you get when you compound the erroneous assumption that these economic models work with the scary cherry of financial leverage on top: Main Street suffering, Wall Street celebrating, a lack of real traction in the economy, whether investment or job creation, spiking inflation expectations, US dollar weakness, and a flight to tangible assets and other seemingly tangible assets like stock. This paradigm can gain and has gained incredible inertia over a certain period of time – but we are now entering the part of the party where someone needs to go to the bar and cough up some cash to pay for the drinks. I fail to see anyone at the party willing or even able to do so. The two or three giants: Asia (China+ India), the Middle East, and to some extent Germany have domestic issues that are too pressing for them to continue to bail-out everyone. And while on the one hand the political establishment does know it needs to strike a deal, on the other hand, a wait-and-see mentality seems to have no downside risk in the meantime and hence we will continue to see plenty of non-solutions and decision-making delays on offer. Meanwhile, silver, gold, and stocks continue their upward spiral and the US dollar keeps dropping.

The current market environment seems relaxed about it probably being too easy and therefore very dangerous. Please realise that high leverage always means high risk and if nothing else that is probably the best advice I can give anyone, not that anyone asked for it. This was also the bottom line of Mish's presentation yesterday. Yes, it is appealing to join the crowd, but sometimes it is also better risk-reward to say like Groucho Marx: " I don't care to belong to any club that will have me as a member".

Fed distances itself from high oil price

Excellent balanced comment from FT editor – and the conclusion is simply: Scary!

Anyone who does not believe in debasing?

Nice week-end

http://view.ed4.net/v/8P1R88/S3E9NO/EXCYA0X/0GTGP/

Note from the editor

Fed distances itself from high oil price

By Javier Blas The US Federal Reserve has a message for the commodities markets: it was not us and we plan to ignore you. Let me explain. Over the past few days, the US central bank has published a number of research pieces about monetary policy and commodities prices in which it argues that its loose monetary policy is not behind – as some critics claim – the spike in commodities prices. The research also concludes that the Fed should ignore the impact of high commodities prices on inflation – again, something that critics dispute vehemently – and focus instead on core inflation. The research by the Federal Reserve Bank of San Francisco and the Federal Reserve Bank of Chicago shows, in any case, the growing importance that commodities play in monetary policy nowadays. As the Chicago Fed puts it: "The recent run-ups in oil and other commodity prices and their implications for inflation and monetary policy have grabbed the attention of many commentators in the media." Yes indeed, they have: over the past few weeks, oil has hit $125 a barrel, copper a record of more than $10,000 a tonne and corn an all-time high of almost $8 a bushel. Difficult to ignore this stuff, even if the Fed would prefer that the media – and the market – looked elsewhere. The San Francisco Fed, which published the paper on the impact of US monetary policy and commodities prices, says that its analysis does not provide evidence that large-scale asset purchases, better known as quantitative easing, fuelled the rise in commodity prices. "It shows that, despite the fall in long-term interest rates and the depreciation of the dollar, commodity prices fell on average on days of large-scale asset purchases announcements," the research paper concludes. "Some critics argue that Federal Reserve purchases of long-term assets are fuelling this rise by maintaining an excessively expansionary monetary stance. However, daily data indicate that Federal Reserve announcements of large-scale asset purchases tended to lower commodity prices even as long-term interest rates and the value of the dollar declined," the San Francisco Fed's research paper adds. The analysis, however, ignores the impact pre- and post-announcements of large-scale assets purchases. The Fed communicated well its intentions to the market, so it is hardly surprising that investors bought the rumour and sold the news. Hence, the findings of the Fed. Once the San Francisco Fed has felt reassured that the US central bank has nothing to do with high commodities prices, the Chicago Fed has looked at how it should react to them. The Chicago Fed has concluded in a research paper – signed by its own president Charles Evans – that it could ignore them. The study says that "sharp increases and decreases in commodity prices have had little, if any, impact on core inflation", the preferred measure of inflation of the Fed. The bank argues that the share of commodities in the US economy is decreasing and adds that, in the case of oil, the price increases do not need to force the central bank to tighten its monetary policy as oil price "increases tend to slow the economy even without any policy rate increases". The bank further argues that it would need to act only if high commodities prices spill over to core inflation. But it concludes that is an unlikely case: "Assuming there is a generally high degree of central bank credibility, there is no reason for such expectations to develop – in fact, in the post-Volcker period, there have been no signs that they typically do." The Fed has a point here, particularly on the fact that high commodities prices are self-correcting to the economy slowing economic growth. The main problem is that some other central banks – particularly in emerging countries – are taking home the message of the Fed. For them, however, high commodities prices are a problem: the share of raw materials consumption per unit of gross domestic product is higher and the credibility of other central banks is usually less than the Fed.

Steinhardt talks the trust - amazingly honest interview - must see..

http://video.cnbc.com/gallery/?video=3000014541

 

 

 

Classic dilemma - calling the bluff?

We are now stretched in major asset classes, particularly in US dollar and equities.  From the mean-reverting perspective we are certainly entering buy levels, but this could be one of those black swans - the situation in Japan is clearly not contained: tepco-director-weeps-after-disclosing-truth-about-fukushima-disaster & also this week-end we could see military action in Libya. I have scaled down the exposure but keep options on dowside in stocks and long metals. Took the USDJPY off, but looking to resell US as we are most likely seeing a start of serious weaker US Dollar.

This stakes in this poker game are high, Governments are all in, Central bank likewise - now the market is looking across the table considering whether to call the bluff, knowing odds are 70/30 their way - still there is 30 pct chance of them having the four aces!

This is one of the more reliable mean-reversion indicators:

Oversold McClellan Oscillator

http://www.mcoscillator.com/market_breadth_data/

 March 18, 2011
Our chart this week is the same one that we feature every day on our Market Breadth Data page, in the free portion of our web site.  This is the original McClellan Oscillator, originated in 1969, and calculated based on the difference between the numbers of advancing and declining issues on the NYSE.  You can learn more about its calculation and interpretation here.
Investors' worries over the earthquake, tsunami, and nuclear crisis in Japan led to a 6.8% total selloff in the NYSE Composite Index, and produced a deeply oversold reading of -269.6 in the McClellan Oscillator.  Readings below -200 are pretty rare, and in the past year we have only seen it dip down that low or lower on four previous occasions.
What happens in the days and weeks after we see one of these extreme excursions depends on what else is going on.  The McClellan Oscillator is a great tool, but it should never be used all by itself, and without an understanding of what else is going on.  By itself, a McClellan Oscillator low below -200 says that the market is oversold and due for at least a bounce.  But it depends on other factors to determine whether that bounce turns into a resumption of an uptrend, or instead just serves to temporarily relieve the oversold condition.
During the May 2010 Flash Crash, we saw the McClellan Oscillator get down as low as -388.  It bounced almost all the way up to the zero line, before falling back down again to an even lower low of -426, which is the all-time low on a raw basis (not adjusting for the larger number of issues).  It took a lot more pattern development in the weeks that followed to get the market started on the upward path again.  And it did not hurt that the Fed started its second round of quantitative easing (QE2) on Aug. 17, 2010.
The first round of QE had ended on Mar. 24, 2010, a month ahead of the April 23 price top.  So the Fed's liquidity was not there during the May 2010 Flash Crash to help smooth out the liquidity problems that month.  By contrast, the post-election selloff in November produced a McClellan Oscillator reading of -266 at a time when permanent open market operations (POMOs) were still underway.  That turned out to be just a quick dip, and the market got back to trending higher.
Now, we have another McClellan Oscillator reading below -200, at a time when POMOs are still underway.  And we are also still in a period of favorable seasonality right now.  Both the POMOs and the positive seasonality are scheduled to end in June, and so from that point onward we can adopt a different interpretation of the meaning of an extreme McClellan Oscillator reading.
Tom McClellan

USD at critical level.........

http://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=1&mn=0&dy=0&id=p25646417572&a=223442909