Monday Musings

A few weeks ago, we noted the potential for an oversold bounce despite what appeared to be a clear shift in the investment landscape.  Now that most major equity indices have rallied for two consecutive weeks (with the S&P 500 stalling at a 50 DMA which looks to be rolling over), it is critical to assess the underlying strength of this move.  Suffice it to say, that the evidence is mixed at best.  Many of our immediate term commodity and commodity currency models have moved back into “buy” territory, but we view Dollar Strength as a BIG RED DEFLATIONARY FLAG.  The Greenback’s long term trend moved back to positive recently and the USD remains strong across all three durations – short term, intermediate term, and long term.  Importantly, Financials stand out as the most overbought S&P sector on a one-year basis, in the face of strong secular headwinds and declining relative strength.  Ditto for the Consumer Discretionary sector, although the stocks have yet to figure it out.

When the market’s prior leaders fail to rebound convincingly, the market often struggles.  And at this point, the reflation trade has failed to return to prominence with the biggest disappointment, visibly the dull bounce in emerging markets.  This may be the beginning of a transition in the investment landscape – and odds favor the outperformance of Quality at this point in the cycle.  Interestingly, Energy, Consumer Staples, Healthcare & Telecom remain at the bottom of our one-year mean-reversion scoreboard.

And speaking of the cycle, the charts below from Albert Edwards at Soc Gen, continue to be the primary reason for our defensive posture, despite tentative signs of a market rebound from extremely short term oversold levels.  As Big Al describes:

“Early last year the safe re-entry back into risk assets was signaled by a clear upturn in leading indicators. So too now should investors be concerned that the leading indicators are topping out. The recovery in the leading indicator for China seemed to precede that of the composite for the OECD and similarly China has now topped out ahead of the OECD composite (see chart below). Indeed, other emerging economies such as India (below) and Brazil are also seeing clear warning flags of cyclical caution.”

Once again, we think Dr. John Hussman accurately portrays the Market Climate today:

“As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action. Internals have improved moderately during the rebound of the past two weeks, though price-volume behavior remains poor. Interest rates have become notably hostile, and presently would weigh on the prospective return/risk ratio of stocks even if internals were to improve here. That suggests that the rebound we’re seeing from the correction low of a couple of weeks ago may turn out to be a whipsaw. For now, the Strategic Growth Fund remains fully hedged, and the combination of rich valuations, yield pressures and potential credit strains are the primary concerns.”

We’ll wrap up our thoughts this morning with a few brief articles worth reading.  The first from George Soros, followed by Ambrose Evans-Pritchard, and a few former Treasury Secretaries who “get it.”

The euro will face bigger tests than Greece

“The euro was a unique and unusual construction whose viability is now being tested. The construction is patently flawed. A fully fledged currency requires both a central bank and a Treasury. The Treasury need not be used to tax citizens on an everyday basis but it needs to be available in times of crisis. When the financial system is in danger of collapsing, the central bank can provide liquidity, but only a Treasury can deal with problems of solvency. This is a well-known fact that should have been clear to everyone involved in the creation of the euro.”

Britain and the PIGS

“As of today, the British government must pay a higher interest rate to borrow money for ten years than either the Italian or the Spanish governments, despite the extraordinary ructions going on within the eurozone.  While Britain went in to this crisis with a much lower public debt than Greece or Italy (though higher total debt than either), it now has the highest budget deficit in the OECD rich club — and perhaps the world — at 13pc of GDP. I have a very nasty feeling that markets are about to pounce on Britain. All they are waiting for is a trigger, perhaps a poll prediction of a hung-Parliament or further hints that Tories dare not confront the beneficiaries of state spending.”

Ex-Treasury Secretaries Back Volcker Rule

“The principle can be simply stated, the five said in a letter to The Wall Street Journal. Banks benefiting from public support by means of access to the Federal Reserve and FDIC insurance should not engage in essentially speculative activity unrelated to essential bank services.”