Thursday, July 31, 2014

Going Down Stairs with 10-Year Yields

Despite the strong GDP print yesterday that reinvigorated the raise-rates camp and sparked an almost 4 percent rally in 10-year yields, we continue to feel these participants are once again placing the cart before the horse, when it comes to what Chairwoman Yellen has repeatedly articulated will be a "considerable time" after the QE programs are wound down this October - and when they consider their next policy response. 

From our perspective, where the rubber meets the road with the specifics of actually raising rates is much further off in the future and only after the markets normalize to this rather significant shift in support - from both a structural and psychological point-of-view. (For more of our thoughts on the effects of this normalization and why we don't find parallels with recent history, see Here)

With respect to 10-year yields, the frictions from the end of QE should continue to support the Treasury market and we expect the next step lower in yields to be taken as the markets stroll into August. 

Tuesday, July 29, 2014

The Miners Lead a Rising Tide

The asset relationships we have focused on over the past several weeks, is showing patterned replication in its leading proxy (precious metals miners) - just as the other lagging sectors look to begin making their respective pivots. 

While those panning silver and gold have viewed the early July highs as a bearish echo of the Q1 interim top, we have approached the recent consolidation trend as commensurate with the move out of the cyclical low last December.

With respect to the kinetic asset sequence of the broader macro story, precious metals have led the moves in long-term Treasuries - which eventually have led a rising tide in a larger basket of commodities. 

For further reading on this concept - see some of our more recent notes:

The Second Stage
The Sweet Spot
Follow The Yellow Brick Road

Friday, July 25, 2014

the Second Stage

At the end of last year, we held the opinion that the arrival of the much feared taper was a positive development for corners of the market most influenced by inflation expectations - or lack thereof. Commodities, commodity currencies, TIPS, emerging markets, Chinese equities - they had all followed the strong disinflationary trend that was established in Q2 2011 and buttressed by additional Fed interventions. With the Fed signaling to the market last year that they would be gradually removing these extraordinary measures, we felt inflation expectations would normalize as well in its wake. While many had looked for another maelstrom to develop in emerging markets and sectors such as precious metals and commodities, we read the tea leaves to indicate an opposite dynamic and one that could reverse their respective downtrends.

Throughout the year we have followed three risk ratio proxies that have illustrated the staggered start that has unfurled in these reflationary trends since the initial taper was declared last December. Precious metals were the first to put in what we perceived to be a cyclical low at the end of last year, followed by the broader commodity sector - with emerging market (EEM) and Chinese equities (FXI) following their leads in Q1. With the final taper on deck this October, we expect the second staggered stage for these reflationary trends to be well on their way higher. 

  • Despite the shake-out yesterday in long-term Treasuries and precious metals, support is in place for the second stage to develop. From a long-term pattern perspective, the recent retest of this years low is derivative of the broader structure - with respect to inflation, commodities and long-term Treasuries (see chart >) relative to equities. 
  • Similar to the structure of the precious metals sector - which tested the lows (relative to equities) coming into June, the broader commodity space has followed in its month-old footprints and is poised to begin the next leg higher. 
  • Throughout the year we have favored emerging market (EEM) and chinese equities (FXI) and have followed their lagged pivots higher with these other reflationary trends. Considering the leading structure present in precious metals and commodities, an interim high may have been made this week.
  • Going forward, the next leg in the US dollar and long-term yields appears to be the hinge points for both precious metals and the broader commodity sector. Despite its recent retracement move higher which exceeded our own expectations, the big picture macro view - which includes the set-ups in long-term Treasuries, commodities and the burgeoning reflationary trends in emerging markets and China - should maintain pressures on the dollar from a long-term perspective.

Thursday, July 24, 2014

There's Gold in Them Hills

If you're ridin' ahead of the herd, take a look back every now and then to make sure it's still there with ya. - Cowboy saying

The Treasury market continues to ignore the sharp shouts of rising rates, even as some of its loudest cowboys attempt to call the herd back to the foothills of higher elevations. In as much as the market was susceptible to the cattle prod of the Fed or the pundit last year, the current run appears to have taken a different mountain pass and spread away from their disoriented handlers. How low long-term yields eventually go on this drive is up for debate, but we do believe they are still headed materially lower - which should maintain the gallop in precious metals and hard commodities as inflation firms and real yields wilt.  
From our perspective, the next cut lower for 10-year yields appears to be on the nearing horizon as we skip and slide into the dog days of August. Throughout this year we have incorporated the historic performance study of the 1994-1995 Fed rate tightening cycle, which has provided the return trajectory from the relative historic extreme that most participants had ignored going into this year.

The long and short of things: we continue to favor long-term Treasuries and precious metals as we expect the leathered year-old saddle range to be broken in yields this summer - releasing another bull charge in gold. 

Tuesday, July 22, 2014

Thoughts on Apple

Since we began contrasting Apple with the historic oil comparative in December of 2012, we have utilized it as a mean reversion template of comparable market trends. Both were the deepest, most dominant and crowded trades of their day and have expressed very similar reflexes as they boomed from the mean, busted below - and now seen with Apple today - bounced its way back above long-term trend performance. 

Coming into Apple's Q1 earnings report this April, we felt momentum was still presenting an upside bias for the stock - as we had looked for another stair higher to be climbed in the range. 

With Apple very close to breaking out to new all-time highs as it rolls into another earnings report this afternoon, underlying conditions have expended considerable momentum and present the real risk of reversing the positive Q2 performance trend.  
As shown above, Apple extended its run from its last earnings report - even exceeding our upside target range and presenting the first audible in nearly eighteen months from when we initially started commenting on the comparative momentum profile. With that said, the audible was translated with a positive outcome for the stock, which has maintained our interest for comparative bearings - as we have held a favorable long-term opinion of the stock since April of last year, despite our expectations of another retracement move lower.

Considering the current disposition, both above its long-term mean and exhibiting what we read as expended and divergent momentum - we expect the latest advance to reverse lower through this years range.  
Although the above longer-term study is off-set by the previous configuration (first chart) and Apple's even loftier trajectory, the congruences expressed between the two performance profiles are evident when Apple is pivoted on the comparative regression axis. 
For further reading on this concept - see some of our previous notes on Apple:

Apple Cider
Reboot Complete
Apple Reboots 
Apple Picking
Fruit Salad
Apple Turnover
The Universal Law of Gravitation

Friday, July 18, 2014

Gravitational Yields

10-year yields continue to drip lower, reacting to the recent and heart-wrenching geopolitical tragedies that appear to flame a growing instability behind a benevolent market environment. And while the latest turn of events has provided further motivation for participants reflexive appetites towards certain safe-haven corners of the market, we are reminded that these respective asset trends have been in place throughout 2014. Long-term Treasuries and precious metals continue to outperform equities, while the broader commodity sector has recently retraced back to commensurate returns with the SPX this year. 

As we highlighted in last weeks notes (see Here & Here), long-term Treasuries and commodities were following in the month old footprints of the precious metals sector. Filling out the proportion of the pattern, both asset classes have pivoted higher over the past week after testing the lows (relative to the SPX) from earlier in the year. Long-term Treasuries have been leading the move higher over the past two weeks and we anticipate that the broader commodity space will be pulled up in its wake going forward. Following the lagged blueprint of the study, emerging market equities look susceptible over the coming weeks to retracement declines relative to the SPX. 

The precious metals sector retraced sharply lower over the past week, turning down for the first time since the explosive rally out of the June 2nd lows. Relieving strongly overbought conditions while the currency markets complete their retracement obligations, we remain firmly bullish towards the sector's prospects in the balance of the year. Our comparative studies of the US dollar, the euro and 10-year yields all point towards favorable backdrop conditions, as real yields walk lower - encouraging the developing trends in long-term Treasuries and commodities. The TIP study that we have highlighted throughout the year continues to make its way towards another leap higher in the range that we anticipate will be made in the second half of summer.    

As 10-year yields work towards another breakdown below the late May lows, we expect the yen will finally break higher out of the flagging range it has traded in throughout this year. All things considered, this is buttressed by our comparative expectations that the Nikkei will take another retracement move lower - before finally making a break above long-term resistance this fall. 

Wednesday, July 16, 2014

Tinder Conditions & Phoenix Rising

A brush fire broke out last week on the Iberian peninsula - roiling world markets and reminding investors that the embers of the European financial crisis are still smoldering beneath the ashes of the previous blaze. Last Thursday, shares of Banco Espirito Santo - Portugal's second largest bank, were suspended from trading after falling some 17 percent in the session. The spark was thrown off the day before, when Espirito Santo International - the privately held parent company and controlled by Portugal's most powerful family, delayed repayment on short-term debt owed to customers of its Swiss bank subsidiary. 

The recent events were set in motion last year, when the ECB mandated that a broad scope asset quality review (AQR) of all European banks would be completed in 2014. This past May, pressures started to build when Banco Espirito Santo disclosed that an audit ordered by the Bank of Portugal, had found Espirito Santo International - in "serious financial condition" with accounting irregularities. Further risks extend from how interconnected business economies are through the significant reach of Espirito Santo International, and one could argue presents a microcosm of the broader hazards still unseen throughout Europe. From the Times: 
The ripple effect, though, is already being felt in the country’s corporate world — including at Portugal Telecom. That company is in the process of merging with Oi, operator of one of Brazil’s biggest wireless networks.Continue reading the main storyContinue reading the main story
Continue reading the main story
Portugal Telecom was due this week to get back a €900 million loan of three-month commercial paper issued by a company called Rioforte. But Rioforte is owned by Espírito Santo International, the holding company whose missed debt payment triggered last week’s market sell-off.
In a further sign of how interconnected the businesses are: Banco Espírito Santo owns a 10 percent stake in Portugal Telecom, while Portugal Telecom holds 2 percent of the bank. - Back From the Brink, Portugal Still Has a Long Way to Go - NY Times 7/15/14
In May 2011, when Portugal received a 78 billion bailout from the IMF and EU, Banco Espirito Santo was the only large bank not tapping the lifeline and requesting bailout money. In hindsight, it appears likely because of the significant risks and skeletons that would have been disclosed in opening its books to oversight by the IMF. 

In many ways, it's emblematic of the nearly mission impossible challenges the ECB face in both restoring confidence in a historically opaque and entangled banking system, while opening the lending channels that reflexively constricted throughout the long downturn in Europe. All the while, juggling the different needs and concerns of 18 separate economies and political systems - some of them less than upstanding through the years. If you think the Bank of Japan has had a rough ride (and they most certainly have) down hill over the past 25 years, the ECBs descent over the past six and into the indefinite future could very well eclipse many of their worst expectations. On one hand, we find it highly unlikely that the conditions personified in Banco Espirito Santo is an isolated example throughout Europe - and on the other we are skeptical of the political capital that inevitably will be required and that was already in short supply as the initial bailouts were negotiated and implemented.  

What the ECB has finally requested with the AQR is a better late than never initiative, but it remains to be seen whether they can successfully mitigate the same perennial conditions that haunted Japan over the past three decades with zombie banks not weak enough to go under and neither strong enough to lend. Moreover, near term risks remain as greater sunlight is provided by the AQR and when the ECB finally takes over oversight of banks this coming November - that have enjoyed historically convenient political understandings and largely benevolent market conditions over the past two years. 


Right on cue with our equity cycle comparative with Japan - circa 1996, the events in Portugal last week helped extend the recent pivot lower in Spain's equity markets, from what we expect was a cyclical high for the index in June. While the initiatives taken by the ECB over the past year pave the way towards additional stimulus in Europe, we do not believe it will be enough to overcome market conditions already stretched - both on an absolute basis and from a comparative perspective with deflation's most recent prisoner. 

Speaking of deflation's most recent prisoner, we continue to be encouraged by Japan's leading indicator in overcoming the long standing conditions that have rejected the Nikkei on three previous occasions (1996, 2000 & 2007). 
The 1987 roadmap that we have followed throughout the year in the Nikkei appears to be replicating the less mentioned, but more important - long-term outcome the momentum comparative implied. That market inertias would be quickly restored to the upside, once the retracement decline was completed. 

As we mentioned in previous notes, this same pattern was replicated in the SPX as it navigated and was rejected by the Meridian in 1987, 1994 and in 2011. On each occasion, the low offered investors an excellent buying opportunity.

Similar to the patterned reversal in the SPX in the fall of 2011, investors may get one more chance to buy Japanese equities on sale before overcoming long-term resistance. Either way, on an intermediate-term horizon - the phoenix appears to be rising. 

Friday, July 11, 2014

the Sweet spot

With light sweet crude falling another 2% on the day, the commodity looks quite attractive for those looking to either diversify a portfolio, or capture the next leg higher - which we believe has already been foreshadowed by the recent moves in precious metals.

Earlier in the week (see Here), we had mentioned that the broader commodity space was following in the month old footprints of the precious metals sector, as the CRB (relative to equities) was testing the cycle lows from earlier in the year. 
We expect that similar to the upside pivots in early June in silver and gold, oil will also find its footings and surprise to the upside.
To a large degree, the commodity sector is jockeyed through major pivots by trends in the US dollar.  
Since turning bearish on the US dollar index last June, we have followed a historic momentum comparative of the index - that continues to point towards lower lows in the dollar. All things considered, the CRB should break higher towards its previous cycle peak - as the US dollar index plumbs the bottom of its long-term range.