There’s Nothing Good Here
The Investment Team at Broyhill huddles up at 6.30AM every Monday Morning, to review market action, various measures of sentiment, and portfolio positioning, to name a few. For the two hours leading up to our Morning Macro Call, we scan dozens of charts, pour over piles of data and review all of the models critical to our investment strategy. Notes from our meetings are distributed internally and reviewed in aggregate at our Monthly Macro Meeting.
We’ve noted a significant shift in the investment landscape over the course of the past few weeks, so we thought we’d share this morning’s Views from the Blue Ridge:
There’s Nothing Good Here
As we entered 2010, our work suggested the continuation of the reflation trade during the first half of the year alongside of rising coincident indicators and increasing inflationary pressures. While risk assets are clearly overpriced, we’ve moved slowly to reduce exposure until now, as we did not anticipate a sharp correction until leading economic indicators clearly rolled over.
That was our read of the tea leaves heading into the new year. Our investment posture, however, does not rely upon market forecasts or predictions. Instead, we take our evidence as it comes and make adjustments accordingly, rather than stubbornly holding on to an outdated hypothesis. As John Maynard Keynes stated, “When the fact changes, I change my mind. What do you do, sir?”
Suffice it to say, that the facts have changed. We’ve provided a brief summary of John Hussman’s recent Market Comments below, which we feel best illustrate this shift in investment climate:
Despite the recent decline, the Market Climate remains characterized by overvalued, (intermediate-term) overbought, overbullish and rising-yield conditions. Having broken an uptrend that has been largely intact since March, as well as a sideways range of support established over the past few months, the natural tendency of the market after such a break is to recover back to the point of prior support, so we should not be surprised if the S&P 500 enjoys a sharp recovery rally modestly above the 1100 level, even if the recent correction has further to go. If we observe a “recovery rally” of poor quality from the current short-term oversold conditions, we would be inclined to move to aggressively toward our “Safe Portfolio.” Importantly, recent market action has historically been associated with a moderate continuation of upward stock market progress and a tendency to make successive but very marginal new highs, typically followed by abrupt and often severe market losses within a time window of about 10-12 weeks.
The uptrend since the March low can be seen on the weekly chart below. Of equal importance is that the market’s Price Momentum is very overbought and rolling over through its 10 EMA.
The market’s “sideways range of support” is also shown on the daily chart below. You can clearly see the break below 1100, which should now become resistance.
Internal weakness is also confirmed by the following charts with comments in blue from the January 29, 2010 Weekly Chart Blog at The Chart Store:
A. Percent of stocks above their 200 DMA rolling over;
B. MACD has stalled and clearly rolled over;
C. Unfortunately, we are a long way from support;
Portfolio risk is elevated as the “market call” drives all asset prices. Coincidentally, deterioration can be seen across asset classes year-to-date:
A. Credit spreads ticked up from extremely low levels given the macroeconomic risks dominating the investment landscape today;
B. Dollar strength may be interpreted as a resurgence of deflationary pressures. Similar “Red-Flag Reversal” (MACD crossover) was last seen in early 2008;
C. Dollar strength predominantly expressed through a weakening Euro; More on this and other sovereign risks in the Broyhill Letter;
The Tape moved from bullish to neutral – has cracks, but isn’t broken yet. Given the massive underlying risks from a macro perspective, it is prudent to leave the last ten percent for the next guy.
Short-term timing model is also neutral now. Watch closely for a “sell” signal, as this would mark the first from the March lows. Percent of stocks above their 10-Week MA and 40-Week MA shows weakness across our Global Composite. Percent of new highs versus new lows is approaching it’s first ‘lower-low’ in almost a year. This is a major reversal of a rising trend in new highs since the October 2008 “panic lows.”
Money supply growth is declining, perhaps as deflationary forces are taking hold again. Last year’s surge in the monetary base drove the broad based reflation in risk assets. Investors should ask themselves, what will support stocks going forward?
Growing red flags in the commodity space.
Commodity Model moved to neutral for the first time since the rally started. Internal model has clearly rolled with external model starting to turn down as well. Equity weakness in the materials sector is also pointing toward risks to commodity prices. We are still long commodities b/c inflation is still rising and historically, commodities have done best at this point in the cycle. But when CPI rolls, run for the exits!! We are rigorously revisiting all of our exposures here and reviewing our thesis given underling weakness in the face of what should be cyclical strength. Is the market already looking forward to a declining CPI in the H2-10 and the return of deflation?
Equity sentiment has gone from euphoric to optimistic levels, while the supply/demand story is ending.
At the same time, pessimism in treasury markets remains rampant, with over 80% of those surveyed looking for yields greater than 4% in 2010. We were looking for 4.25% before buying the long bond, but we may not get there, if sovereign risks overshadow improving coincident indicators.
The Dow has continued to fail at the downtrend which started back in 2007 . . .
At the same time the S&P is reversing course . . .
Watch the Yen/Euro Cross for an indication of investor’s willingness to assume risk. This picture is not pretty today. “There’s nothing good here,” except for the potential for a short-term bounce from oversold levels.