Global Tactical Asset Allocation Q2 Update On Commodities
The latest commodities commentary from Damien Cleusix of Global Tactical Asset Allocation:
Investors surveys are indicating a high level of optimism. Long gone are the days when they reached high levels of bearishness (at the end of August). Hedge Funds have increased their leverage (gross positions) and have their highest net long position since 2007.
Option indicators have deteriorated markedly. The CBOE equity put call ratios remains low with a rising 10 and 21 days moving average (same is true for the inverse of the ISEE equity only CP ratio). The OEX PC ratio has been extremely high recently with a multitude of bearish "above 2" readings. At the retail levels, we are seeing almost 60% of the activity concentrated in bullish strategies. The buy to open put call ratio is very low, and very few puts are bought to open while many are sold to open. There are no fears of waterfall declines. Skews have risen before implied volatility did which has historically been a negative.
Analysts earnings estimate ratios have been rising rapidly while corporate guidances have been declining. Analysts earnings outlook is more upbeat than the sales one. They expect margins to increase from current record levels.
Insiders activity remains bearish for most markets. We had net buying in the US during the last week of August but the selling has been of historic proportion in the US during the past 4 months. The UK buy to sell ratio is slowly reaching its 2007 lows while we are seeing more companies buying stocks than selling in Europe. In Asia, there were heavy selling in January but there were only few buy or sell transactions in February.
Our preferred “market timers” continue to have opposite opinion on the markets future path. J. Hussman is completely hedged while S. Leuthold has kept the exposure he rapidly built last autumn. The best value managers have continued to reduce their exposure to the market indicating that the markets will have to fall more before we see fundamentalists buying from the technical traders.
Speculators have a relatively high net long Nasdaq 100 future position. Strategists have maintained their equity allocation recommendation at its cyclical high. We are seeing a rush into bullish and leveraged bullish funds at Rydex and a collapse in assets of bearish funds where stop losses are being hit by the relentless advance.
The VIX time-spread has corrected slightly but remains far from the levels where the markets start to rebound after a meaningful correction.
Breadth volatility continues to be very high. It is currently hard to give as much weight as we usually do to this area. The positives are that the various advance decline lines have not diverged negatively and we had numerous intermediate-term thrusts late last year. The negatives are that our Nasdaq new highs-lows model produced a sell signal, the markets experienced a high number of buying climaxed 2 weeks ago and the number of 52 weeks new highs have failed to confirm various indices new cyclical highs. The latter was one of the elements which was supportive after the April top. Markets tend to at least retest the highs when the correction starts at the same time that the number of new highs makes a cyclical high. Selling pressure has increased in the past 10 months. Note that this is not the opinion of Lowry's Research, THE reference with regard to breadth analysis which is saying that selling pressure is not yet a big problem. Our short-term top warning models have been on high alert since the third week of February with worrying divergences between the % of stocks above short-term moving average and their respective indices . Dispersion has increased but has yet to reach bearish levels.
On the liquidity side, net inflows in US domestic and developed markets equity funds have picked up markedly while there was no net inflows into emerging markets equity funds in the past 13 weeks. The cash ratio has declined everywhere and does not leave much dry powder to managers. Net redemption will have to be met by selling current holdings. The number of buybacks has declined slightly in the US and plateaued in Japan. In the US we have seen a big increase in IPOs and secondary offerings. Corporate America is now a net seller. And remember, they are many issues still in the pipeline with ridiculous valuation being applied to some new US start-ups already soon to be IPOed with no barrier to entry companies.
Margin debt has increased sharply in the US. It is not far from the 2007 highs when one look at its size relative to overall market capitalization.
Pension funds’ funding status has improved since November, courtesy of rising assets and declining liabilities (discount rate rising). But this remains one of the big, big problems the markets and retirees will have to face in the coming years.
M2 has gained some short-term momentum . Permanent Open Market Operation are now an almost daily exercise.
Seasonals are supportive. Our mechanical seasonal model is on buy since early October. The 40 cycles low is due around the middle of March . With regard to the Presidential Cycle, the 18 months following the mid-term election have been the strongest historically but remember that the typical fiscal and monetary cycle has been distorted and pushed forward in the past 2 years. Average outcome very unlikely. The market has a tendency to perform well between the middle of March and the middle of May.
Intermarket relationships are mostly negative. The fact that the correlation at the stock, style, index and asset levels has been very high recently makes intermarket analysis a much less powerful tool. The defensive sectors have performed poorly in the past 4 months but have been rebounding strongly during the past 10 days. The Nasdaq, semiconductor and bank sectors have underperformed in the last few weeks. Emerging market are underperforming (always worrying to see the leader in this situation when prices move higher). High yield bonds are not diverging negatively but corporate CDS have. The increase in oil price (and other commodities), if sustained (they have already reach levels where they are strong headwinds but can not yet break the macro cycle by themselves), will have very nasty consequences. Commodities spot returns are starting to print short-term negative divergences, with copper correcting sharply. Treasury bonds yields have started to decline.
Markets have started, later than expected, to correct some of the short-term excesses they have accumulated in the past few months. While in normal time we would have expected the correction to be in the 7-12% range for the S&P 500 (1180-1240)(use beta to adjust for other markets) the events in Japan are making any forecast even more useless than in normal time. The earthquake and tsunami in themselves are not posing any meaningful short to medium-term risks, the Fukushima nuclear plant accident will if it escalates.
Our cyclical models are still positive so we have to assume that we will see new highs later this year. Note that the failure on the number of new highs to confirms the current highs, the high yield bond markets divergence and some other elements make this assumption less strong that it was last summer. One should be mentally ready to sell the long position which will be acquired when certain "oversold" thresholds are reached with a loss if a rebound fails to materialize and the cyclical models move to a sell signal.
We are puts sellers on a test of the 1240-1250 area (S&P 500). We would sell 6-10% OTM puts on various indices with a May-June expiry. We are keeping the short calls position which has now moved deep OTM (10-16%). We will take an outright long position on various indices on a S&P 500 move to the 1180-1200 area if signs of panic appear and breadth become very oversold (less than 10% stocks above 10 days moving average and 50 days moving average on broad indices, no too important breakdown in new highs lows statistics,...). We would become even more aggressive if we see divergences forming between prices and our broad range of breadth indicators.
We would continue to underweight emerging markets but less than before in the short-term, Europe and small caps(US, European and emerging markets small caps could/will underperform large caps by 3-5% yearly in the next 5-7 years) . We would overweight Japan (once we are sure that Fukushima nuclear plant is under control) (but hedge the currency risk) and the US. Buy high quality stocks (and hedge the market risk when we recommend it). Value and growth are likely to behave badly in a downturn so value managers won't offer the decorrelated returns they offered during the 2000-2003 decline. Buy value when value dispersion is high not low as it is now
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