Thursday, December 31, 2015

My hits and misses of 2015


As 2015 draws to a close, this would be a good time to review how I did during the year. As regular readers know, I have two personas, my inner investor and my inner trader. My inner investor had a decent year, while my inner trader had a year that he would rather forget.





The full post is at our new site here.




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As well, I would like to remind readers that we will cease to accept new subscribers as of January 15, 2016 as a way to better control the growth of our new community. Hurry, the deadline is coming up faster than you think.

Tuesday, December 29, 2015

The reason why the bulls should be cautious about a January hangover

In my last post, I wrote about the possible appearance of a rare Zweig Breadth Thrust buy signal this week (see The 2016 macro surprise that no one talks about). Tuesday was the last day in the 10 day window for the ZBT buy signal to be triggered. Alas, it doesn't seem to have happened.




So where does that leave us? The near term outlook for the bulls is still constructive, as the market has rallied through a key downtrend line (shown above). Moreover, we are still in a period of seasonal strength.

However, bullishly oriented traders should be wary about overstaying their welcome. The Santa Claus rally was nice but the party is starting to get out of hand. The neighbors have called the cops and they are due to arrive very soon.

The full post is at our new site here.



Site Notice
If you signed up for the notification of our Early Bird Special Offer but did not receive it, I have had some reports that they got classified as spam so please check your spam folder. Otherwise you can email me at cam at humblestudentofthemarkets dot com and I will send you the link.

As well, I would like to remind readers that we will cease to accept new subscribers as of January 15, 2016 as a way to better control the growth of our new community. Hurry, the deadline is coming up faster than you think.

Sunday, December 27, 2015

The 2016 macro surprise that no one talks about


Trend Model signal summary

Trend Model signal: Neutral
Trading model: Bullish

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below.


Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent.


The boy who cried wolf
We all remember the story of the boy who cried wolf. The villagers got one false alarm after another, which made them increasingly annoyed. When the wolf finally came, his warnings were ignored and he suffered the consequence.

I want to tell a more modern story of the boy who cried wolf. In this case, the wolf is inflation. In the wake of the Great Financial Crisis (GFC), there was a cacophony of voices (myself included) who warned that all the QE and money printing would eventually result in runaway inflation and USD devaluation. Even Warren Buffett was caught up in that frenzy when he penned his "unchecked greenback emission" NY Times Op-Ed in 2009:
Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.
Despite these dire forecasts of doom,  the USD has rallied in the wake of the GFC and gold prices are roughly flat from that period. That thesis of secular runaway inflation turned out to be wrong.



Today, a different kind of inflationary wolf pack stalks the landscape. Instead of the specter of secular runaway inflation, the cyclical inflationary wolves are gathering. When they descend on the flock in 2016, it will be the macro surprise that almost no one is talking about.


The full post is at our new site here.




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As well, I would like to remind readers that we will cease to accept new subscribers as of January 15, 2016 as a way to better control the growth of our new community. Hurry, the deadline is coming up faster than you think.


Tuesday, December 22, 2015

Is Warren Buffett losing his touch?

How would you evaluate a manager with this kind of 10-year investment performance? Terrific? Or Meh!


It depends on when you got in. Sure, the 10 year numbers look terrific, but he is roughly flat with the benchmark over five years and he had a difficult 2015.

What if I told you this track record was none other than the legendary Warren Buffett? The chart represents the relative performance of Berkshire Hathaway B (BRKb) against the market.

The full post is at our new website here.



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Sunday, December 20, 2015

Do you believe in Santa Claus?


Trend Model signal summary

Trend Model signal: Neutral
Trading model: Bullish

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below.
Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent.



Hitting the Exacta

Regular readers know that I have been bullish on stocks for a couple of months now. While I had expected a seasonal Santa Claus rally, Santa hasn't been around and stock prices have been weakening. In one way, Old St. Nick may have left a present for the bulls under the tree as the recent sell-off has left the market oversold. As a result, two of my Trifecta Bottom Model indicators have flashed a buy signal. I call this hitting the Exacta.

My Trifecta Bottom Model (which was described in a past post Sell Rosh Hashanah?) consists of the following three conditions, which must occur closely (within a week) of each other:
  1. VIX term structure (VIX/VXV ratio) inversion
  2. NYSE TRIN more than 2
  3. My favorite intermediate term overbought-oversold model, which is the ratio of % of SPX stocks over their 50 day moving average (dma) / % of SPX stocks over their 150 dma less than 0.5
Each of these conditions, by themselves, are indicators of high levels of market fear. When used in conjunction with each other, they have been uncanny at calling short-term market bottoms. The chart below shows past instances of the market has hit the Trifecta (vertical red lines, triggered all three conditions) or the Exacta (blue vertical lines, two of three) in the last three years. The only failure of this model was the sell-off in August 2015, where an oversold market became more oversold. In all other instances, the market have rallied off these buy signals.

Trifecta Bottom Model

Last week, the market hit the Exacta again as the VIX term structure inverted and TRIN spike to over 2 within a week of each other. The question is whether this is August 2015 all over again, or a run-of-the mill instance of a short-term bottom.

The complete post is at our new site here.


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Thursday, December 17, 2015

Why the next recession will be very ugly

In a recent post, I was relatively upbeat about the near term market outlook but warned that the next recession could be very ugly (see A major bear market in 2016?). To explain, I have found three possible time bombs that are set to go off at the next recession:
  • The Fed's balance sheet;
  • A possible financial crisis in China because of her inability to re-balance its economy fast enough; and
  • Possible blowups lurking in the global financial system.
The full post is at our new website here.






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Tuesday, December 15, 2015

Climate science as a case study in quant modeling

As we ponder the upcoming FOMC decision and statement, I have little or nothing to add that I haven't said before. However, I would like to offer the following case study as a lesson in the kinds of decisions that policy makers, whether at the Fed or elsewhere, make when facing important decisions.

The full post is at our new site here.

Monday, December 14, 2015

A major bear market in 2016?

As stock prices have recently weakened, I have received some comments regarding the start of a bear market in 2016. To put it into context, bear markets start for one of three major fundamental reasons:
  1. War or revolution leading to a permanent loss of capital (think Confederate war bonds, or German panzers smashing through French lines on their way to Paris in 1940);
  2. An overly aggressive central bank tightening and tipping the economy into recession (you have got to be kidding me); or
  3. An economic recession.
Since the first two points are highly unlikely to cause a bear market in the near future, I will focus on the likelihood of a recession. My framework of analysis is examine the economies of the three major trade blocs in the world, namely the US, Europe and Greater China.

The full post is at our new website here.

Sunday, December 13, 2015

The only market indicator that matters in 2016

Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bullish

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below.


Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent.


The Dollar and euro's most excellent adventure
I had expected that the markets might become little sloppy as we approached the FOMC meeting (see Waiting for the whites of their (oversold) eyes), but I didn't expect the kind of risk-off tone seen last week. Despite the market weakness, I could tell you that:
  • Fundamentals, such as forward EPS revisions, remain constructive
  • The US economy remains strong with no sign of a recession on the horizon
  • The market is oversold
  • Sentiment is showing a crowded short reading, while insiders are buying
  • Seasonality is bullish for stocks
None of that matters very much, as the signals from the Federal Reserve next week will set the market tone, not just for the rest of the year, but for most of 2016. If I had to focus on one key market indicator coming out of FOMC meeting, it would be the reaction of the US Dollar to the Fed decision.


The full post is at the new website here.

Thursday, December 10, 2015

What's wrong with South Africa?

The study of emerging markets is a useful exercise in examining our assumptions about economies and markets because they sometimes operate by different rules than developed economies. As an example, Bloomberg reported today that the markets are freaking out over the firing of the finance minister:
South African markets were thrown into turmoil after President Jacob Zuma fired the finance minister, strengthening his grip on power amid differences over government spending.

The rand weakened for a sixth day in the longest streak of losses since November 2013 and bond prices dropped the most on record, pushing yields to their highest levels since July 2008. The country’s bank stocks tumbled the most in more than 14 years following the dismissal late on Wednesday of Finance Minister Nhlanhla Nene. The cost of insuring South African debt against default rose to the highest in more than 6 1/2 years.
As the chart below shows, South African assets are indeed tanking. The top panel shows the South African ETF (EZA), which is priced in USD. The bottom panel shows the relative performance of the South African Rand relative to the Aussie Dollar, which is another commodity currency.


What's wrong with South Africa?


The complete post at our new site here.

Tuesday, December 8, 2015

Waiting for the whites of their (oversold) eyes

I received a couple of comments to my last weekend post that it was somewhat lacking in a short-term trading outlook (see 2016: Time to get bearish and go "Zero Hedge"?). As my previous view that the US equity market would grind up until year-end hasn't worked out, it would be appropriate to update the short-term stock market conditions.



Full post at the new website here.

Sunday, December 6, 2015

2016: Time to get bearish and go "Zero Hedge"?

Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bullish

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below.


Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent.


My worries for 2016
As the above chart shows, I have been pretty bullish on equities since the market bottomed in September. However, as I peer into 2016, ominous signs are starting to appear. For my inner investor, the key question is whether to go full "Zero Hedge" and turn bearish on the outlook for 2016. Here is my list of worries:

The full post is at the new site here.





Blog notice
We continue to experience glitches with our payment system at our new site and we are unable to process new subscribers at this time. The site was down on Thursday and part of Friday as our new SSL certificate was installed and we apologize for any inconvenience. In the meantime, all content is free. We will make an announcement when these problems are resolved and the site is open for business.

Readers can still register for the Early Bird discount offer of 14 months for the price of 12 at USD 199.99. You can get on the list for that offer at this link here. (If you have already emailed me in the past or responded through my previous survey, you are already on the list there is no need to do so again.)



Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Wednesday, December 2, 2015

A surprise from rotational analysis

One of my tools in my market analysis toolbox is leadership analysis. In particular, I found that in bull phases, it pays to buy the market leaders (see Momentum + Bull market = Chocolate + Peanut butter). I was playing around with Relative Rotation Graphs, or RRG, the other day and what I found was a surprise.



The full post is at our new site here.



Blog notice
We are experiencing some glitches with our payment system at our new site and we are unable to process new subscribers at this time. In the meantime, all content is free. We will make an announcement when these problems are resolved and the site is open for business.

Readers can still register for the Early Bird discount offer of 14 months for the price of 12 at USD 199.99. You can get on the list for that offer at this link here. (If you have already emailed me in the past or responded through my previous survey, you are already on the list there is no need to do so again.)



Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Tuesday, December 1, 2015

Welcome to our new home

Welcome to the new home of Humble Student of the Markets. We are experiencing some glitches with our payment system and we are unable to process new subscribers right now. We will have that fixed ASAP. In the meantime, all content is free and here are my pledges for the new site:

More at our new site here.

Monday, November 30, 2015

Demographics and gold: Something doesn't add up

This is another in a series of occasional posts on quantitative analysis. I am indebted to Josh Brown for pointing me to an article by Larry Swedroe, which discusses a study on demographics and real interest rates. While I found that I can derive significant insights from single variable studies like these, the world is more complex and univariate analysis illustrates the pitfalls of relying on single variable models.

More at our new website here.




Blog Notice
The Humble Student of the Markets blog will become a subscription driven site on December 1 (see Why this isn't investment advice (and a site update)). The new site is live now at humblestudentofthemarkets.com, Please come by and take a look and please change your bookmarks accordingly.

We are scheduled to open to subscribers on December 1, but we are having some glitches with our payment system that we are trying to solve. We will have that up ASAP. In the meantime, all content is open to the public for the time being.

The new site will not be accepting subscribers until December 1. We have an Early Bird discount offer of 14 months for the price of 12 at USD 199.99. You can get on the list for that offer if you contact me at this link here. (If you have already emailed me in the past or responded through my previous survey, you are already on the list there is no need to do so again.)

Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Saturday, November 28, 2015

Waiting for Santa Claus

Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bullish

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below.


Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent.


Good news and bad news
The market action last week saw some good news and some bad news. The bad news came in the form of weakness in the Greater China equity markets, but that was offset by the goods news of upside breakouts in Europe and a positive relative strength showing by US small caps. When I net it all out, I remain constructive that equity bulls will see another visit from Santa Claus this year.


The complete post is at our new website here.



Blog Notice
The Humble Student of the Markets blog will become a subscription driven site on December 1 (see Why this isn't investment advice (and a site update)). The new site is live now at humblestudentofthemarkets.com, Please come by and take a look and please change your bookmarks accordingly.

The new site will not be accepting subscribers until December 1. We have an Early Bird discount offer of 14 months for the price of 12 at USD 199.99. You can get on the list for that offer if you contact me at this link here, but hurry as the cutoff for the signup for that offer expires at midnight November 30, 2015. (If you have already emailed me in the past or responded through my previous survey, you are already on the list there is no need to do so again.)

Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Wednesday, November 25, 2015

Investment insights when giving thanks

In Canada, we had our Thanksgiving a month ago (because the growing season is shorter and it makes no sense to have Thanksgiving in November when it's freezing in much of the country). Nevertheless, in the spirit of American Thanksgiving, I reflected on what to give thanks about.

In light of the events in Paris and Brussels, one silver lining in the world has been the dramatic slide in war deaths in the last half century. We haven't totally eliminated wars, but in comparison to the horrific carnage of the two World Wars, the modern era`s casualty rate is one thing to be thankful about.


Continued at the new blog here.


Blog Notice
As regular readers are aware, this Humble Student of the Markets blog will become a subscription driven site on December 1 (see Why this isn't investment advice (and a site update)). The new site is live now at humblestudentofthemarkets.com, Come by and take a look and please change your bookmarks accordingly.

The new site will not be accepting subscribers until December 1. I have an Early Bird discount offer to readers and you can get on the list for that offer if you contact me at this link here. (If you have already emailed me in the past or responded through my previous survey, there is no need to do so.)

If you have signed up for the Early Bird discount offer, we will be sending out an email with the full details this weekend.

Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Tuesday, November 24, 2015

Two announcements

If anyone is interested, I will be in Seattle on December 3, 2015 for the Puget Sound MTA meeting. The feature speaker is my friend and former Merrill Lynch colleague Fred Meissner of The Fred Report.
Location:
First Floor Conference Room
101 Elliott Avenue West
Seattle, WA 98119

Date and time: December 3, 2015 at 7pm

Cost: Free for Members and Non-Members.
Please come by if you are in the area.


Blog Notice
As regular readers are aware, this Humble Student of the Markets blog will become a subscription driven site on December 1 (see Why this isn't investment advice (and a site update)). The new site is live now at humblestudentofthemarkets.com, Come by and take a look and please change your bookmarks accordingly.

The new site will not be accepting subscribers until December 1. I have an Early Bird discount offer to readers and you can get on the list for that offer if you email me at cam at humblestudentofthemarkets dot com. (If you have already emailed me in the past or responded through my previous survey, there is no need to do so.)

If you have signed up for the Early Bird discount offer, we will be sending out an email with the full details this weekend.

Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Monday, November 23, 2015

Could the job market derail the equity bull?

Recently, I have seen more and more concerns raised about the state of the employment market. Specifically, this chart of weekly initial unemployment claims (inverted scale) has had a tight inverse correlation with stock prices. As weekly initial claims are already at 20 year lows  claims will inevitably turn up at some point in the future. Will that rollover derail the stock bull?


Doug Short put this data set into much better context with this chart of initial claims normalized by the size of the civilian labor force, which is another indication of how tight the labor market has become.


Tom McClellan raised concerns too, though he was looking at the data through the lens of weekly claims compared to lumber prices as an economic barometer.



Regardless, the conclusion is the same. Weekly initial claims are poised to start rising in the very near future.


Don't go Zero Hedge on me!
I think everyone should relax and take a deep breath. Sure, the 20 year chart of weekly initial claims data has been highly correlated with stock prices, but this correlation hasn't been as strong in other past periods. I went back to 1965, which was the start of the initial claims data history and analyzed the 1965-1986 period. Stock prices had a rough inverse correlation for much of this study period. Then something funny happened in the mid-1980s as the recovery took hold - stock prices and claims went their separate ways as the inverse correlation broke down. Put it another way, the economy was improving and the labor market tightened, but the stock market shrugged off the labor market effects because of an improving growth outlook.


Fast forward to the 1986-2003 era, we can see this historic relationship breaking down even more. Initial claims started to rise (recall the inverse scale) in the late 1980s, but stock prices did not break down until about a year afterwards. Claims were mostly flat in the 1990s, but stock prices went on a tear. Moreover, there was another episode about 1995 when claims rose but stock prices went up - until the inverse correlation re-asserted itself after the NASDAQ crash.


Here is the chart of the entire history, does anyone really want to rely on this relationship to make an investment conclusion? So relax and don't panic and go all Zero Hedge on me.


Recency bias, anyone?


A late cycle market
Here is what I think is going on. I concur with the more nuanced interpretation of current labor market conditions from New Deal democrat when he wrote that he was underwhelmed by the JOLTS report because hires were not rising along with job openings.


His key conclusion is the economy is past mid-cycle (translation: late cycle):
While job openings have skyrocketed, both actual hires and quits stalled, and this month both turned negative YoY for the first time since the 1-month 2012 pause.

This is an important indication that we are past mid-cycle.
He continued:
I have also recently started paying more attention to the Fed's Labor Market Conditions Index (blue in the graph below), which appears to be a good leading indicator for YoY payroll growth (red):

While there were some huzzahs! that there were upward revisions to the last 6 months in this index, the above graph shows that, in context, it is not pointing to strong payrolls growth in the months ahead. Rather, I expect each such report to be lower than the conquerable report one year ago. This simply reinforeces the argument that we are past mid-cycle (as the YoY% growth in jobs generally peak near mid-cycle).

In other words, expect NFP to start weakening and weekly initial claims to start rising. This is all normal behavior for a late cycle economy.

Investors should not panic. In a late cycle market, inflationary pressures start to rise, such as wages which lead to cost-push inflation. Investors should therefore be positioned accordingly in late cycle sectors such as the capital goods and hard asset/resource sectors of the market (see my post Profiting from a late cycle market).

The bull is still alive - at least for a few more months.



Blog Notice
As regular readers are aware, this Humble Student of the Markets blog will become a subscription driven site on December 1 (see Why this isn't investment advice (and a site update)). I have an Early Bird discount offer to readers and you can get on the list for that offer if you email me at cam at humblestudentofthemarkets dot com. (If you have already emailed me in the past or responded through my previous survey, there is no need to do so.)

Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Please watch this space for more updates as they are available.

Sunday, November 22, 2015

How the market can rise (and commodities rally)

Trend Model signal summary
Trend Model signal: Neutral
Trading model: Bullish

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below.


Update schedule: I generally update Trend Model readings on my blog on weekends and tweet any changes during the week at @humblestudent.


The market can grind-up
For the last few weeks, my themes for the US equity market is a bullish outlook, combined a setup for a rally of commodity and capital goods sectors. With respect to the first theme of the bullish equity outlook, I use the framework of the Zweig Breadth Thrust off the panic sell-off bottom of August and September (see Bingo! We have a buy signal!). Michael Batnick recently tweeted this chart from Credit Suisse (annotations in red are mine):

In the context of a strong momentum thrust from a market bottom, this chart is a good road map of what may happen next. We have gone through a brief period of consolidation and pullback. In general, the market tends to grind up from here.

Further, we are approaching a period of bullish seasonality. Stocks tend to have a positive bias Thanksgiving Week and analysis from Ryan Detrick showed that the rest of the year tends to be bullish as well (via Marketwatch):



Sentimental support
Sentiment models are also supportive of higher prices. The NAAIM survey of RIAs show that sentiment has recovered from bearish extremes and they are trending bullish. Risk appetite pulled back slightly last week, but they have further room to run and portfolios are not fully invested.


The BoAML Fund Manager Survey (FMS) shows that global managers remain underweight US equities, which indicates a potential for a bullish stampede as we enter a period of positive seasonality aided by the momentum tailwind of a Zweig Breadth Thrust.


I am also encouraged by the latest readings from Barron`s of insider activity. We have seen two weeks of heavy insider buying as the stock market has pulled back and consolidated its gains.
The combination of bullish momentum, positive seasonality and improving, but not overbought, sentiment readings point to a grind up into year-end.


A late-cycle market
I have also been advocating a rotation into late cycle commodity sensitive sectors (see Profiting from a late cycle market and Global reflation = Buy risk (and cyclicals)). That trade setup continue to develop. Technicians know that the an oversold and wash-out market combined with signs of reversal is a powerful buy signal. We are starting to see signs of that today in the late-cycle sectors.

The BoAML FMS is instructive on sentiment. The top three most crowded trades of long USD, short commodities and short EM equities are all correlated and amount to the same macro theme.


Fund managers' biggest over and underweight positions relative to their history reflect the unloved nature of these sectors.


However, we are starting to see signs of reversal as global growth expectations turn up:


The elephant in the room has been China, but managers believe that the China growth outlook is stabilizing and recovering.


I pointed out last week that Tom McClellan had identified a 10-month cycle in copper prices, which should be bottoming about now. McClellan also warned that he did not expect a durable bottom until we saw price capitulation, as measured by the 10-day rate of change. We may have seen that last week. In the past, copper prices have tended to rally whenever the 10-day ROC hit -10% (marked by the vertical blue lines).



Sober Look also highlighted analysis from JPM indicating that cyclical stocks are beating defensive stocks as a sign of reflation.


Don`t worry about rates and Dollar
The issue of Fed policy has come up numerous times in discussions with investors about my bullish outlook on equities and commodities. I have been repeatedly asked the question, "The Fed is likely to raise interest rates in December, wouldn't that be bearish for stocks, bullish for the USD and therefore bearish for commodities?"

Not necessarily. There are two parts to that question. Historically, the Fed has begun a rate hike cycle when it sees inflationary pressures start to tick up. Everything else being equal, higher interest rates would be negative for equity valuations because E/P, which is the inverse of the P/E ratio, would fall and therefore depress P/E multiples. But everything else isn't equal. Typically, the negative effects of a slight P/E contraction are offset by better earnings growth, or bigger E in the P/E ratio. Indeed, the latest figures from John Butters of Factset shows that forward EPS estimates are rising again, which is equity bullish (annotations in red are mine).


As well, the market discussion has moved on from the timing of the first rate hike to the pace of the rate hikes. Ned Davis Research showed that the stock market has historically reacted much better to a slow pace of rate increases than a fast pace. In the current circumstances, the Federal Reserve has made it very clear that the pace of tightening will be slow, measured and data dependent.


What about the US Dollar? Isn't a rate hike USD bullish and therefore commodity bearish because of their inverse correlation? Not necessarily. The upcoming rate increase must be the most telegraphed initial rate hike in Federal Reserve history. The market will undoubtedly shift its focus to the evolution of the dot plots to see how quickly the Fed is likely to raise rates. Assuming that the FOMC does raise rates in December, the USD may very well see a reflex rally evaporate should Yellen makes it clear, as she is likely to, that the trajectory of future rate hikes will be slow and shallow.

Indeed, Urban Carmel showed that the USD has often fallen after the first rate hike:

USD Index after first rate hike

...and commodity prices, as measured by the CRB Index, has tended to rise:

CRB Index after first rate hike

From a technical perspective, the USD Index is approaching a key long-term Fibonacci retracement level, which may be a signal for a pause and pullback:



The week ahead
Looking to the week ahead, I am unabashedly bullish. The SPX rallied last week and regained its 200 dma. Momentum is positive but not overbought on RSI5. My preferred breadth metrics remain neutral to positive (see my recent post Don't worry about bad breadth for a discussion on my interpretation of breadth).


We are also entering into a period of positive seasonality as Thanksgiving Week has generally been stock market friendly (via Urban Carmel):


Ryan Detrick showed that we have seen a 12 year streak of positive returns for the final 30 days of the year. 2015 is not likely to be the unlucky 13th year given the strong momentum backdrop this year.


IndexIndicators measures of breadth are not overbought either on a short-term (1-3 day) basis:


...or on a longer term (1-2 week) basis, but price momentum remains positive.



Bottom line: Stock prices are likely to move higher. Both my inner investor and inner trader are bullishly positioned, with exposure to the market and in the commodity sensitive sectors of the market.


Disclosure: Long SPXL, ERX, NUGT



Blog Notice
As regular readers are aware, this Humble Student of the Markets blog will become a subscription driven site on December 1 (see Why this isn't investment advice (and a site update)). I have an Early Bird discount offer to readers and you can get on the list for that offer if you email me at cam at humblestudentofthemarkets dot com. (If you have already emailed me in the past or responded through my previous survey, there is no need to do so.)

Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).

Please watch this space for more updates as they are available.

Thursday, November 19, 2015

Why this isn't investment advice (and a site update)

As this site will become a subscription site in the near future (more details below), I was in the process of developing a standard legal disclaimer of why the content is not investment advice. Instead of just hiding behind standard legalese, I thought that I would write about the real issues that go beyond the regular regulatory framework.

Ben Carlson had a terrific post about the experience that David Rosenberg had when he transitioned from the Chief US Economist at Merrill Lynch to being a strategist at Gluskin Sheff:
When you’re the Chief Economist at Merrill Lynch you think you’re the starting pitcher for the New York Yankees. You have it all figured out. I realized when I got to Gluskin Sheff how much I didn’t know.
Then came the shock:
The whole life of a portfolio manager, their brain, is one giant distribution curve of outcomes. I’ve learned more in the past six years at Gluskin Sheff on the buy side, as a strategist and economist, than the previous twenty-two combined [in various sell side roles]. Because I figured out how to produce a forecast that’s meaningful for somebody who manages money for a living.

Different kinds of advice
What a seasoned professional like David Rosenberg didn't realize was that the process of managing a portfolio involves several levels of decisions:
  1. What do you buy and sell?
  2. How much do you buy and sell?
  3. Timing the trade
The vast majority of the discussion on the internet and in investment research revolves around (1) of whether something represents a good investment or trading opportunity. That was the universe where Rosenberg spent most of his life before Gluskin Sheff.

Less discussed are the questions of investment suitability and portfolio risk. In general, most investors encounter three kinds of advice, depending on how much the advisor knows about the client:
  • Unlicensed, but sometimes well-informed, advice: An example might be an wine expert stating, "XYZ Pinot Grigio has a nice fruity taste" without knowing whether you like wines, like fruity wines, much like whether a talking head on TV giving an opinion knows anything about an investment is suitable for you, because he knows nothing about you.
  • Suitable advice: Stock brokers are held to a suitability standard, which means that he knows enough about you to say that an investment is deemed to "suitable" for you. Under the suitability standard, the client has final say on how much to buy and sell. It also means that, in theory, that if a $1 lottery ticket is suitable for a millionaire, then the broker is free to try to sell the millionaire a million $1 lottery tickets under this standard. 
  • Fiduciary advice: A fiduciary is in a position of "trust", which is a term that has legal implications. In general, you give a fiduciary, or portfolio manager, discretion on all three of the aforementioned steps. A portfolio manager therefore has to know a lot more about you in order to decide on how much to buy and sell and to build a portfolio with the appropriate expected risk and return characteristics.
In my case, I know nothing about my readers and I am not licensed in any jurisdiction. Hence the disclaimer "this is not investment advice" is appropriate.


A website update
I wrote before that I am in the process of turning Humble Student of the Markets into a subscription based website (see Humble Student lives!). I can now update my readers on the development progress of the new site. We are in the process of putting the final touches on the new website. While all the operational details will be accurate, I apologize in advance if there is any slippage in dates mentioned.

The new site will be located at humblestudentofthemarkets.com. We are scheduled to go live in about a week and the readers will be able to subscribe on December 1st. All of the posts on the current (old) site will remain as an archive. There will also be a transition period of several months where the old site will summarize and link to fresh content on the new site.

I have tried to keep the pricing on the low end of the range for similar sites, where prices start at about USD 200 per year and go up from there. Subscription rates will be:
  • Free: For any content older than two weeks. If you are not ready to subscribe, you can still sign up for email notifications of free posts as they become available.
  • Annual:  USD 199.99 per year. Anyone interested can still email me at cam at humblestudentofthemarkets dot com for a discounted early bird offer (If you have already responded before, there is no need to do so again).
  • Monthly: USD 19.99 per month, for anyone who is unsure about committing to an annual subscription.
  • Day pass for 24 hour access: USD 4.99 for anyone read the summary and wants to see more.
Media, press professionals and blog aggregators with email domains confirming their affiliations are invited to apply for free subscription access (cam at humblestudentofthemarkets dot com).


Building a community
When I first began writing Humble Student of the Markets, it was just an avenue for me to get my thoughts out. However, with the previous discussion about the appropriateness of investment opinion and advice above, I have concluded that the greatest value that I can offer isn't just me talking out loud to my readers, but to engage them in a conversation and to build a community.

I hope that the new Humble Student of the Markets moves beyond a simple subscription site to a moderated community of investors sharing ideas. I have therefore decided to open the site to subscribers as of December 1, 2015 and stop accepting new members on January 15, 2016 to better control the growth of this community (day passes will still be available). I will take a couple of months to assess how the new members are interacting before opening up the site to new members again.

Here is a sample of the front page of the new website:



I hope that you can join us.

Monday, November 16, 2015

Don't worry about bad breadth

Recently, I have been seeing more and more bearish warnings from chartists about deteriorating breadth (example here). Even though I am bullish, I always pay attention to people who have the opposite viewpoint to make sure I didn't miss anything in my analysis.

Much of the concern stems from the deteriorating breadth shown by the NYSE Advance-Decline Line, which has been showing a series of lower highs and lower lows.


The NYSE A-D Line is based on the components of the NYSE Composite, which is a broad based index with many more stocks than the SPX. On a hunch, I decided to look at the SPX A-D Line, as an apples-to-apples comparison for the SPX. Lo and behold, the SPX A-D Line actually made a new high in the latest advance from the August low, which confirms the strength of the rally. As well, the % bullish metric (bottom panel) is not showing any negative divergence either.



How the NYSE Composite differs from the SP 500
What's going on? One of the criticisms of the NYSE Composite is that it has a number of closed-end funds, whose price action may not be relevant when calculating an A-D Line. As well, the NYSE Composite has more small cap stocks, which does measure whether the "generals" or the "troops" of the market are leading the latest advance - that's what we are really trying to measure with breadth.

The chart below shows the NYSE Composite to Equal-weighted SPX ratio as a way of measuring the small and large cap effect. As the chart shows, this ratio has been falling since the 2009 low. Can this (and therefore the NYSE Composite) be  a trustworthy indicator of market breadth?



Small vs. large caps
Another way of thinking about underlying strength of the "troops" and "generals" is to look at the relative performance of small and large cap stocks. The chart below shows the Russell 2000 to SPX ratio. In theory, improving market breadth, as measured the small vs. large cap ratio, "should" be a signal of underlying strength.


The history of this indicator has had a mixed result in the last 20 years. Large caps dramatically outperformed small caps during the Tech Bubble of the late 1990s and underperformed in the bear market afterwards - which were false signals. On the other hand, this ratio did flash advance warning of breadth deterioration leading into the 2007 top. Today, it topped out in late 2013 and it has been showing a series of lower highs and lower lows.


Mixed breadth signals
In summary, evidence of deteriorating breadth comes mainly from broad based indices like the NYSE Composite, which is really a measure of small vs. large cap performance. This has shown itself to be a unreliable indicator of market tops. An apples-to-apples measure of SPX breadth using SPX only components made a new high during the most recent advance, which confirms the strength of the rally from the August bottom.

As a tactical bonus for the next two weeks, consider this analysis from Rob Hanna about what happens to the market when it experiences two unfilled gaps down and the SPX is below its 200 dma:


Based on this analysis, the US equity market should have a bullish tailwind this week. Moreover, next week is Thanksgiving week, which is also seasonally bullish.

The path of least resistance for stock prices is therefore up.