Market update 21 February 2012

From my last update 04 January 2012:

The long term charts remain bearish with the intermediate charts neutral and the short term charts leaning bullish. It is still too early to make a longer term directional call one way or the other but my study of my charts (300+) has me leaning slightly bullish intermediate term. However, I think the 1st 2 weeks of Jan 2012 will be a good indicator has to how we go the rest of the year.

Ideally I would like to see a pullback in the 1st week followed by a strong 2nd/3rd week. That would be a nice set up for a long play in the provident fund. Conversely, a strong 1st week will have me worried the dumb money is chasing stocks only to be brought down into the end of the month.

Technically we are still in a bear market but glimmers of hope on the daily price charts and ratio charts have me watching closely. Given the recent short term strength, I am comfortable holding my 50% cash/50% equity positions for the next few weeks to see how the beginning of the month pans out.

Since my last update the markets have been very bullish. It appears most fund managers were on the sidelines going into 2012 and are trying to make up for lost time with large exposure to increasing numbers of risk assets such as Google, Apple, etc. The pullback I was hoping would occur in mid-Jan did not occur. This is a worrying development as it has invited a low volume short squeeze rally which I believe is giving investors a false sense of hope that the worst is behind us.

I was going to prepare a long dissertation on why I felt the current rally was somewhat suspect when I read the following article from Doug Noland ( the Senior Portfolio Manager of the Federated Prudent Bear Fund and Federated Prudent Global Income Fund) which nicely reflects my current thoughts:

A New Bull Market?

By: Doug Noland | Sat, Feb 18, 2012

This week I was compelled to respond to a vicious rumor that I'd turned bullish. I cannot refute that the market backdrop is today constructive for global risk asset inflation. Risk aversion has dissipated, and risk embracement and rank speculation have returned with a vengeance. Bulls and speculators alike have been emboldened, yet again. Bears have been pummeled into submission. Those that buy global risk assets on the premise that policymakers will backstop markets assuredly exclaim, "I told you so!" My analytical framework has always included the possibility for a climax "blow-off top" scenario that would doom the historic "global government finance Bubble." I guess I'm as bullish as Ludwig von Mises must have been when he coined the phrase "crack-up boom."

Market ebullience has evoked chatter of the emergence of a new bull market. From my perspective, there is little new here. The current environment remains consistent with market trading dynamics that saw major stock indices more than double in price from March 2009 lows. It was an historic rally incited by the unprecedented global fiscal and monetary response to the '08 crisis. More recently, it has been a powerful rally incited by an abrupt policy-induced market about face - one chiefly fueled by the reversal of hedges and short positions. It's evolved into one heck of a short squeeze.

I've lived through a number of abrupt policy-induced rallies going back to 1991. These "bull market" advances tended to last a couple years or so, building momentum until speculative excess finally sowed the seeds of their own demise. Bond market - and certainly MBS/mortgage derivatives - excesses in 1992/'93 ensured the 1994 fixed income rout. The 1995 Mexican bailout ushered in catastrophic speculative excesses in the emerging markets, especially among the "Asian Tigers," as well as in Russia, Argentina and elsewhere. The 1998 LTCM bailout incited "blow-off" technology Bubble excess. The post-tech Bubble policy bailout stoked much greater systemic excess; the global policy response to '08 even more so. Greek bailout I...

Now it's the December introduction of the ECB's Long-Term Refinancing Operations (LTRO) coupled with concerted global central bank liquidity operations and assurances. Finally, analysts trumpet, the type of policy resolve necessary for European debt crisis resolution. It's justifiable that market players today contemplate the possibility that policymakers have created a backdrop conducive for yet another couple year period of market exuberance.

There may be little new in the market backdrop, yet we must recognize that the policy backdrop has changed profoundly though, perhaps, subtly. The nature of policy responses has evolved and escalated; measures have become overwhelming, preemptive and essentially unbounded. The early '90s policy measures (largely rate cuts) were in response to large-scale bank and savings & loan failures. Other policy responses followed huge debt defaults, banking and Credit system failures, and widespread financial turmoil. The "Lehman moment" quickly elicited the policy bazooka. These days, global central bankers are determined to resort to the big guns before there is so much as a failure of a significant financial institution. If market expectations are met later this month with the second round of the ECB's LTRO facility, the ECB will have provided well over a Trillion euro of additional liquidity prior to the failure of a single major European bank. It has become systemic "too big to fail" - and the markets are keenly aware of policy ramifications.

And I'll tell you where the analysis has turned most tricky. In the past, these policy-induced market reversals emerged from a period of acute market illiquidity and associated systemic stress. A major loosening of financial conditions would unfold following a problematic period of risk aversion, tightened Credit and associated economic weakness. Corporate profits would be faltering and confidence in U.S. equities and risk assets would be strained. The U.S. Credit system would be fragile. This time is different.

It is worth noting that the worsening of European debt strains in 2011 actually engendered an important loosening of Credit conditions here in the U.S. Treasury and agency debt markets, the commanding source of system Credit expansion, experienced a near buyers' panic. Markets always fear the unknown. Suddenly, collapsing Treasury yields and Fed QE3 talk ensured that any fledgling momentum for Washington fiscal restraint was nipped in the bud. As such, the bulls were assured of ongoing massive fiscal support for spending, corporate profits and GDP expansion, without worry that economic momentum might have the Fed looking to shrink its balance sheet and tiptoe away from near-zero rates.

We are now into the fourth year of previously unimaginable stimulus. Considering zero rates, massive Federal Reserve monetization and unconscionable deficit spending, economic performance has been abysmal. There has been ample confirmation - economically and financially - to the secular bear thesis. And this fragility has virtually guaranteed ongoing fiscal and monetary largess. At the same time, the backdrop should engender sufficient economic momentum to support bullish sentiment. Today's ultra-loose financial conditions - especially in government and mortgage finance - should equate to decent GDP growth, seemingly solid corporate profits and, even, more than a faint pulse in housing. And this could suffice as support for the bull thesis. Of course, the stronger the markets the more positive the news flow and analysis - which can support a self-reinforcing boost in overall confidence.

But don't count me bullish. I see no holes in the analysis that this remains an ongoing slow train wreck - the unfolding worst-case-scenario. The European financial and economic crisis will not be resolved anytime soon (think post-Bubble Japan). Greece is an unmitigated disaster and, throughout Europe, economic structure now (in a post Credit boom backdrop) matters. I don't see how such dissimilar economic structures (and social and political systems), say between Italy and Germany, are consistent with a common currency. LTRO only buys time. China is, as well, an accident in the making.

Here at home, Treasury debt issuance is unsustainable. An incredible amount of finance is being mispriced, over-issued and misallocated. It may equate to GDP growth, but it won't amount to sustainable robust and balanced economic performance. Indeed, we should by now be familiar with the dynamic where the more prolonged the Bubble the greater the distortions and maladjustment to our already maligned economic structure. And surely the last thing our system needs at this point is another bout of destabilizing speculative excess in our stock and risk markets. It's a dangerous phase.

Yet these types of policy-induced market runs become the devil's playground for precarious Bubble excess. With the bears out of the way, stock prices become easily detached from underlying fundamentals. Markets become dislocated - and speculation runs roughshod. Markets will tend to climb walls of worry - and derivatives will tend to leverage market buying power. And a marketplace dominated by trend-following and performance chasing trading dynamics forces everyone in. It convinces most to disregard risk. Hedging is abandoned, and everyone gets comfortably positioned on the same side of the boat.

I look at the global backdrop and see all the makings for a major, major market top. It's just impossible to know how far away - both in time and price - we are from such an outcome. I don't envisage a new bull market - but instead see the same type of manic marketplace that brought us the 2010 "flash crash" and the 2011 10-day market shellacking.

The bottom line is the unprecedented amount of monetary stimulus that has been injected into the system by central banks worldwide has led us to this current "recovery". In no way does this action eliminate any of the debt problems we are experiencing; it merely papers over the problem for an undetermined (and unforcastable) period of time.

Can an individual participate in this type of market? Absolutely..........but with the caveat that you need to act more as a speculator rather than as an investor.

A speculator understands he is playing in a dangerous market. He is aware of the potential downside risk of being exposed to risk assets and he accepts the consequences of the market potentially dropping out beneath him at any moment without warning.

On the other hand, an investor believes he can purchase equities in good solid companies, hold them for a long period of time (at least 1 complete business cycle) and gain a combination of capital gains and dividend yields on those investments.

The key question is whether we are in a stable, solid, predictable and reliable "standard" investment cycle (which would favor the buy and hold investor strategy) or are we in an unstable, "non-standard", unpredictable and unreliable investment cycle (which would favor the speculator strategy). My vote goes to the later.

For those who are pilots I would use the analogy that playing in this markets is like you are a fighter pilot flying a jet with cracks in the main spar, faulty Kapton wiring and a time expired engine. The plane will still fly but we would be damn sure to have done a thorough preflight on the ejection seat before takeoff and make doubly sure the pin was removed and the ejection handles were easily available in flight (along with a mindset to not think twice about ejecting should any of the problem areas suddenly become an imminent and immediate issue). Having that sort of mindset allows you to play in these markets. Those that don't should not be participating.

As I mentioned in my last update, the U.S. has been the leader in the current market advance with Europe underperforming. One of the disadvantages of the Emirates Provident Fund is the variety of investment vehicles we are offered is extremely limited. As such, should we desire exposure to equities we are forced (by the company) to accept broad exposure to worldwide investments (as opposed to using an individual brokerage account whereby you can target exposure to specific geographic areas and specific investment vehicles). As such, we are forced to do the best with can with what we have been offered.

Given the above and the recent underperformance by Europe I will no longer use the S&P 500 index as my proxy for these updates to the A + B accounts. It is still a very valid proxy for those who invest outside the provident fund in their own brokerage "C" account so I will save that comparison for my next blog post (where I have been doing considerable research on a high alpha investment strategy I have implemented in my own accounts). For these updates I will be using the iShares MSCI ACWI Index fund (an ETF which closely tracks the performance of the MSCI All-Country World Index). This ETF should more closely represent the rates of return for those equity vehicles currently being offered in our Provident Fund accounts.

CLICK ON ALL CHARTS TO ENLARGE:


ACWI Monthly Chart:

At the end of January the monthly ACWI chart was still bearish as price closed the month of January below the 10 month simple moving average along with non-confirmation from the supporting technical indicators.

As of Friday's close the monthly chart of ACWI is inter-month bullish (month to date the ACWI is up by 4.09%). By my rules of usage, the final determination of status is not valid until the end of the month (end of Feb). Should price close the month of Feb above the 10 month SMA (currently @ 44.34) the monthly chart would be bullish.

Current Status: The long term mid-month chart is BULLISH


ACWI Weekly Chart:

The weekly chart turned bullish the 2nd week of January as shown on the chart. In the past 3 weeks price has broken and remained above a double line level of resistance which has now turned into support. Any short term pullback should hold 45.24 in order to remain bullish.

It appears the market now wants to target the previous highs @ 48.15, 48.64, and 49.83 (which would also coincide with the apex of the upper trend line drawn on the chart; setting up the possibility of a bearish rising wedge). Any breakout above those levels and there will be little doubt we have entered a new bull market. Only time and price will tell whether that is the case.

Current Status: The intermediate term weekly chart is BULLISH.


ACWI Daily Chart:

The daily chart turned bullish December 22, 2011. In my comments in early January, I indicated this but pointed out a bothering indicator was the non-confirmation from the On Balance Volume (OBV) and the downward slope on the Accumulation/Distribution indicator. These indictors returned to bullish on Jan 13, 2012 and confirmed the current uptrend was "for real".

An interesting aspect of this chart is the inability of price pullbacks to trigger a cross of the RSI(2) 5 level. The last time it was able to do so was the large pullback in late November, 2011. This indicates all significant pullbacks are being bought (bullish price action). Should the RSI(@) continue to show strong buying power above the 5 level this short term trend will remain intact.

Current Status: The short term daily chart is BULLISH.


ACWI PnF Chart:

The Point and Figure chart (which I use extensively due to the noise it filters out) turned bullish on a price print of 42.00. It currently projects (based upon the "shape" of the chart) a Bullish price objective of 62.00.

Current Status: The Point and Figure chart is BULLISH.


BOTTOM LINE:

The short term and intermediate term charts are bullish.  The long term chart is bullish but needs a monthly close to confirm.

The markets are currently overbought on a short term basis.  I am expecting a pullback imminently (based on my cycle analysis in the next 8-10 days).  Should price remain bullish on that pullback in all 3 time frames (daily/weekly/monthly) I will increase my equity exposure to 75%.  Alternately should the anticipated pullback be more severe in nature than the previous ones (as indicated by an RSI(2) close below 5) then I would be forced to assume the short term trend has turned down and will wait for the shakeout to occur before committing further capital.

In either case, my baseline strategy has turned moderately bullish (with 1 hand on the ejection seat handle!).  I will view any positions as speculative given the current environment and be prepared to adjust as necessary.


Emirates Provident Fund:

As of Friday, 17 February 2012 I remain in a strategic 50% equities/50% USD cash weighting as follows:**

-BlackRock US Dollar Cash Portfolio Fund: 50%

-Russell Global 90 Fund: 15%

-Fidelity International Fund: 10%

-BlackRock Equity Portfolio Fund: 25%

**Actual positions will change daily based upon price action and market volatility.


A subscriber sent me a note recently pointing to a change to the BlackRock accounts.  Apparently they are going to be reorganizing our holdings into new accounts (which is acceptable) but with the caveat that switches within those funds will not be available from 01 March-27 March inclusive (which is unacceptable). 

As such, in my personal accounts I will be switching before the end of February as follows:

Assuming a market neutral 50-50 portfolio (as is currently):

-Russell Global 90 Fund:  40%
-Fidelity International Fund:  10%
-Russell USD Liquidity OR Fidelity US Dollar Cash Fund:  50%

Assuming a risk-on bullish 75-25 portfolio (as discussed above):

-Russell Global 90 Fund:  50%
-Fidelity International Fund:  25%
-Russell USD Liquidity OR Fidelity US Dollar Cash Fund: 25%

I find it incredulous the company would agree to allow non-access to our personal accounts for almost 1 month to satisfy a simple change in BlackRock investment vehicles.  I would not accept this from my bank, I would not accept this from my brokers nor will I accept this from BlackRock.

I will blog when I've made the changes to my personal accounts.


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