Market Update 11 April 2013

I am now back in Dubai and have an opportunity to update current market conditions.

From my last post, I indicated the Cypriot situation was going to be a "gut check" as to how strong world stock markets truly are.  Given the market advance over the past week, it would appear the markets have successfully shrugged off the Cyprus event.

It is obvious Central Bank manipulation through massive injections of liquidity is behind the current rally.  A very good summary from Thomas J. Feeney of Mission Management & Trust Co. of the latest market action based upon worldwide Central Bank manipulation:

Japan’s recent pledge to double its monetary base in an attempt to extricate itself from a two decade old deflationary cycle earns it a preeminent membership in the growing currency debasement club. The world is experiencing the greatest explosion of new money ever. Ostensibly, the exercise is designed to revive dormant, declining or barely growing economies. Since the 2007-09 financial crisis, the flood of new money has been singularly unsuccessful in promoting strong growth. At least in the United States, however, it has been eminently successful in pushing up stock prices.

Fed Chairman Ben Bernanke has made it clear that higher stock prices are a prime goal of current Fed policy. Observing Bernanke’s success in rallying stocks, other central bankers and government officials have taken their cue from Ben.

Mario Draghi’s “whatever it takes” pledge did marvels for stock prices throughout most of Europe until recent weeks. China Securities Regulatory Commission Chairman Guo Shuqing indicated even more specifically that it’s necessary to intervene in China’s stock market at “key moments” to accomplish government goals.

The Bank of Japan has attacked the problem most directly by pledging to flood the markets with new money, not just by buying bonds but by purchasing REITs and equity ETFs as well. I, among others, believe that our Fed has had a more direct influence on stock prices than it has acknowledged. In any case, it has so far convinced investors that, like Draghi, it stands ready to do whatever it takes to keep prices rising.

While Bernanke still controls a majority, other Fed governors are becoming increasingly uncomfortable with unlimited quantitative easing. Governor James Bullard yesterday called for an easing of the currently scheduled bond-buying program. Several other Fed voting members have voiced similar sentiments in recent weeks.

Some question the efficacy of the current program and readily admit to far less confidence than Chairman Bernanke that the Fed will be able to unwind this high-stakes experimental monetary policy. Voices from outside the Fed are getting louder as well. Among others, economists at the Bank for International Settlements, who claim their warnings of a credit bubble were ignored before the mid-decade financial crisis, are again pointing to unhealthy outcomes from seemingly uncontrolled monetary expansion.

Bernanke himself has admitted that his unconventional policies might not work “as well as we have hoped.” At a recent press conference, he added, “We’ll be learning over time how efficacious they are.”

Central bankers have apparently painted themselves into a corner. Debt levels have grown so immense that the Fed feels compelled to push interest rates close to zero so that debt service costs don’t overwhelm borrowers. They have tried to accomplish that objective across the yield curve by buying unprecedented amounts of fixed income securities, thereby increasing total debt levels. It is, of course, nonsensical to attempt to solve problems precipitated by excessive debt by adding more debt.

The lunacy of the current government approach is apparent as we observe monetary authorities now encouraging banks to ease their standards for real estate and automobile loans to include borrowers whose weak credit levels precipitated the prior crisis. The Fed is pulling out all stops in an attempt to avert a recession that would lead to another round of bankruptcies and foreclosures.

Former Fed Chairman Paul Volcker warned Monday about potential dangers from what he calls “unorthodox” and aggressive moves by central banks around the world. The King Report highlighted Volcker’s comments that central banks, including the Fed, could eventually inflict more harm by “what they’re doing with their portfolio to save the world economy…. Central banks are no longer central banks.”

The report added Black Rock’s Rick Reider’s contention that: “Fed policy has had a distorting effect on capital allocation decisions of all kinds at virtually every level of the economy.” Finally, Dallas Fed President Richard Fisher added a final condemnation, arguing that the Fed’s programs are not working, are benefiting the wrong people, and may even be counterproductive.

I would agree with all the above and would add that, like the housing bubble created by the Fed (2003-2006), this current equity asset bubble created by the Fed (2009-?) and other Central Banks is also going to end very badly.  The question then becomes one of:

a)  do I stay in and play the game knowing the music could stop at any time, or

b)  do I get out and wait for the house of cards to collapse (which could take years).

Having spoken to clients recently, it appears the common misconception is because of the huge market advance over the past 4 years it is time to exit to the sidelines.  Ironically, the funny thing about markets is they tend to do the opposite of what you would expect.  As such, using "feelings" to make investment decisions is the equivalent to using "feelings" to fly IFR in cloud as opposed to flying on instruments.  Using your "seat of the pants" approach to flying would get you killed very quickly whereas relying on instrumentation allows you to maintain control irrespective of current weather (market) conditions.  Hence the need for investment "instruments" via technical analysis in helping with investment decisions as opposed to using "gut instinct".


CLICK ON ALL CHARTS TO ENLARGE:


ACWI Monthly chart:

The 1st chart I want to review is the long term monthly chart of ACWI (iShares MSCI Index Fund ETF; the proxy for the Emirates Provident Scheme equity funds).

As noted previously, all technical indicators on this chart remain bullish.  Specifically the following are positive:

-price broke above the previous 2008 high at 49.60 and has retested successfully in both Feb, Mar and currently April.  This is very bullish.

-price remains above both the 8 + 10 month moving averages.  As long as this is the case, we are bullish long term.

-a steep ascending channel is in place within the long term rising trend channel.  There is still plenty of room to rise to the top of the current long term channel.

-the MACD is still strong as indicated by the monthly rising bars on the MACD histogram.  This pattern has been in place since July 2012 and continues to present.  As such, momentum to the current advance remains intact.

Given the above, there is NO need to become bearish and move to cash currently.  Technically this remains a very healthy market.  HOWEVER, there are overbought indications on the chart and some bearish indications that would suggest now would not be the time to significantly increase exposure via large scale purchases (beyond normal monthly ongoing systematic monthly purchases as I have done for the history of my accounts and discussed previous).  Specifically note the following detracting technical indications:

-the StochRSI is still at overbought levels as is the RSI (2).

-the Stochastic is topping near 100 and appears to want to roll over.

-the volume on the current advance is decreasing rapidly.

-the Force index is showing a negative divergence.

Given the above, what can be said in general over the long term is technically we remain within a bull market from 2009 with no long term technical indications the current bull market is ending.  There are several indications we need a "pullback" to alleviate overbought conditions but nothing to indicate there is a requirement to exit equities currently.


ACWI Weekly chart:

The medium term weekly chart of ACWI amplifies what I have said previous.  Medium term the market remains bullish.

It is interesting to note how the overbought condition medium term has been somewhat alleviated by the weekly consolidation over the past 11 weeks (shown by the blue box on the price chart).  Unlike previous instances when the overbought condition resulted in a decline of approximately 5% (to at least the Bollinger Band midpoint as per Oct 2010 & Feb 2011) this time it appears price consolidation (ie. time) has achieved the same result without a significant price decline.  This is very bullish and indicates a strong underlying market.

However, without a significant pullback this consolidation has left the RSI at a still relatively high level.  As such, there is room for only a slight advance before overbought conditions are again encountered (I would ideally  have liked a pullback to the BB midpoint along with an RSI decline to around the 50 level to increase exposure).

Momentum over the intermediate term is declining (as shown by the blue dotted lines on the Stochastic, ADX +DI line and Force Index) which would be expected given we are pushing the upper limits of overbought once again.


ACWI Daily chart:

The short term daily chart returned to bullish on Tuesday, 09 April as shown by the green vertical line.  Short term technical indicators have all turned positive.

Price broke to new highs on Wednesday, 10 April (as shown) but volume was extremely low.  This shows there was little market conviction to the move and as such the breakout must be watched closely over the next few days to ensure it was not a "bull trap".

Since the Nov 2012 short term bottom price has produced 3 distinct uptrend lines.  Each time price has not descended to the swing lows for the trend (as shown by the green horizontal dotted lines) therefore each new high has produced a new trend line.  The current swing low for the current trend line is at 49.77 and this pattern has created a "3-Fan formation".

Given the current trend, it would now take a closing price below the current swing low to change the short term trend to negative (a decline of 3.17% from current).  Until such an event occurs, it must be assumed the short term trend remains up but the appearance of the 3-Fan formation indicates the current short term trend is in its final stages.


ACWI vs SPX Year to Date:

One interesting aspect of this year so far is the out performance by the "Rest Of The World" (ROTW) relative to the U.S. until Feb and the dramatic under performance of the ROTW relative to the U.S. since.

As can be seen, the S&P 500 index has returned almost double the return of the ACWI since the start of the year (which of course is the same in the Provident Scheme funds available).  This highlights the importance of being able to target specific countries/asset classes as opposed to a general equity fund.  Unfortunately the "general fund" is all that is currently offered in the A+B accounts but some discretion is available to investments in the C account.  I plan to offer more information on those possible investments soon.

Breaking the ROTW down into just the U.S. vs Europe, note how Europe (in red) was a significant out performer from the start of the current short term uptrend in Nov 2012 but peaked and has been in decline since the end of Jan 2013.  This "non-correlation" is shown at the bottom of the chart but over the past few days it appears the correlations are returning (a correlation > 0.50 is required to confirm).  As such, going forward the U.S. and Europe appear to be reconnecting and moving in the same direction (UP).


Bottom Line:

It appears there has been some confusion amongst readers as to my current market position and outlook.  I hope the above technical picture clarifies my outlook and is summarized below:

-long term we remain in a bull market.  The current long term is overbought so it  is not the time to add large scale purchases (or large switches from cash/bonds into equities) to provident fund accounts based upon potential risk to reward.

-medium term we remain bullish and in an uptrend.  The recent medium term overbought condition has been alleviated by virtue of time (as opposed to price) over the past 11 weeks therefore we remain at elevated levels near overbought.  Medium term the advance should be limited and the potential for a more sustained decline has increased.

-short term we are on a new buy signal without conviction.  A possible bull trap might be in place and price will need to hold the breakout level over the next several days to confirm the breakout as being real.  Short term bullish "trading" would be fine under current conditions.

Given the above, it should be clear to everyone that your time perspective, trading vehicle and investment opportunities determines investment decisions.  In longer term investment accounts such as the Provident Scheme it is impossible to trade shorter term signals.  As such, you must rely on the medium and long term signals to guide investments (not applicable to the monthly A+B contributions which should always go into equities).

Those medium and long term signals say we are still in a BULL MARKET and there is no reason technically to reduce current exposure (whatever yours might be).  HOWEVER, the overbought nature of the markets currently precludes me from increasing my exposure significantly beyond current 50% levels until I see a significant pullback.  A pullback of 10-15% would have me much more interested in doing so on a risk/reward basis but we have yet to get that pullback.  Until then the market has forced me to maintain a 50% exposure (which I am very comfortable with) at current.

Short term the markets have been great.  I am currently up approx 10% this year in my trading accounts based upon the trading strategy I employ.  I plan on detailing that strategy soon for those who might be interested but in no way should that strategy be confused with long term investing within the Provident Scheme.

My current exposure within the A+B accounts remains at a tactical 50% equity/50% USD cash position as follows:

-Russell Global 90 Fund: 40%

-Fidelity International Fund: 10%

-Russell USD Liquidity II Fund: 50%

(Obviously actual percentage allocations will fluctuate based upon daily/weekly/monthly based price movements and ongoing monthly A+B account systematic equity purchases)

Recent bond movements have me interested in reducing my USD exposure in favour of bond funds.  I will produce a subsequent post if/when I make a switch into bonds.



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