Rosenberg Scours Commitment Of Traders Report, Finds Clues On Navigating The Market
THE LONG AND THE SHORT OF IT
Following the Fed’s first strong hints at QE2 in late August, we saw some wild movements in terms of market positioning across a variety of asset classes. These swings are highlighted in the weekly Commitment of Traders report, which we have discussed in the recent past. While fundamentals, valuation and technicals are all key in determining the direction of asset prices, how investors are positioned is no less important and right now, there is still an extreme level of speculative activity in some cases that is set to unwind as the risk-on trade fades away.
There was a tremendous amount of ebullience over the outlook, beginning in late August, and while some of the data have looked a little better, there is still a list of lingering concerns deserving of a higher, not a lower, risk premia, and in a word it comes down to discord, policy discord, to be precise. Discord within the Fed (Warsh torpedoes any plan for another round of quantitative easing). Discord within Congress (a deal over the Bush tax cuts is still wanting). Discord at the G20 (nothing concrete coming out of the meeting; 17 of the 20 members are not supportive of current U.S. economic policy — see Obama Tries to Repair Damage on page A9 of the WSJ).
Discord over trade issues (the planned U.S.-Korea trade pact was scuttled). Discord within the euro area (see Ireland Stirs Specter of EU Default and Euro-Zone Growth Data Underline a Widening Gap on page A7 of the WSJ).
Of course, there is also this issue of China feeling compelled to fight a food-led inflation surge by tightening monetary policy. This has implications for the commodity complex that may not be so favourable over the near-term. The strong likelihood that this was Bernanke’s last kick at the can means that whatever QE3 expectations being priced into the market (and that is the only way anyone can explain the blowoff following the QE2 announcement, which should not have come as a big surprise) is now in the process of being unwound. Moreover, the chances that a lame duck Congress reaches an agreement on taxes and jobless benefits is not 100%, which Mr. Market had believed at the recent S&P 500 peak.
So, it may pay for the time being to avoid the areas of the market where net speculative long positions exist and is in the process of unwinding. Long covering is a critical source of selling pressure.
- Equities: There are currently 5,780 net long contracts on the Chicago Mercantile Exchange (CME).
- Oil: There are a near-record 208,226 net long contracts on the NY Mercantile Exchange.
- Gold: There are a near-record 253,528 net long contracts on the Commodity Exchange (COMEX).
- Copper: There are a near-record 25,139 net long contracts on the COMEX as well.
- Silver: Not a record or a near-record but still a significant 42,556 net long contracts on the COMEX.
- Australian dollar: 49,743 net long contracts on the CME.
- Canadian dollar: Not as large as Aussie but still high net speculative long exposure, at 21,579 contracts.
- Euro: Huge net speculative long position of 35,879 contracts on the CME.
- The 10-year Treasury note: It now has a net long position of 15,781 contracts on the Chicago Board of Trade (CBOT).
- The 5-year T-note: It is most exposed with a net speculative long position of 167,729 contracts — of course, this is the part of the curve the Fed is targeting.
- The 2-year T-note: It commands a net speculative long position of 43,220 contracts even with a yield that recently was 30 basis points north of zero.
- The 30-year bond: It is the only maturity with a net speculative short position — of 1,917 contracts.
- Volatility: With the risk-on trade in full force for the past two months, the VIX futures has a net speculative short position of 13,345 contracts, which is at the high end of the historic range.
So, here’s how one would construct a strategy to take advantage of the prospect that we are now beginning to see as these speculative positions reverse course:
- It would involve a flattener in the bond market;
- Although we are still long-term bullish on the commodity space, looking at the position in the COT report, selling calls for protection in the commodity space could be a sound strategy. Expect silver to outperform gold still;
- Going long the U.S. dollar against the euro, but within the resource-based units, look for the loonie to outperform the Aussie;
- Look for the S&P 500 to now trade down to the low end of the 14-month long 1,000-1,200 range;
- Buy volatility, which is inexpensive and underexposed on the CBOE, which is bullish.
As for bonds, the Commitment of Traders data show the long bond to be under-bought, and as such, ripe for a rally, especially seeing how high the yield gap is between it and the rest of the Treasury curve. The 5-year Treasury is quite expensive at current levels and even the 10-year is still vulnerable near-term given its net speculative long position and the fact that it is just 3bps away from a technical level that could well set the stage up for a return to 3%-plus yields, which would be a wonderful buying opportunity. There is not a whole lot of fundamentals here behind these moves — the moves of the past week and likely ones in the next few weeks.
The asset classes are merely unwinding the excess risk-on trades and pricing out the chances that QE3 will ever see the light of day. Yes, this is what the market was starting to think since Bernanke left the door open for more in the press statement, but we are finding out ex-post that the Fed chairman has less support around the table than was generally perceived. When Governor Warsh basically comes out and says that he supported Bernanke only because he wanted to be seen as a team player suggests that any further experimentation with the Fed’s balance sheet will not be met with just one dissent from Tom Hoenig. While Martin Wolf did make some good points in the FT last week supporting the Fed, one has to wonder how the Fed’s balance sheet is going to be exposed to huge losses if bond yields ever do back up. I mean, this latest round of Fed bond buying occurred with the yield on the 5-year note at 1.1% and the 10-year yield at 2.4%.