David Fuller and Eoin Treacy's Subscriber's Comment of the Day.
Wednesday 14th March 2012
Legal ethics losing out to bottom line - This article by Andrew Ross Sorkin for the NYT and IHT discusses some of the conflicts that too often besmirch the financial industry. Here is the opening:
NEW ORLEANS- "We are all totally conflicted - get used to it."
The best way to curb this, in my opinion, is not with heavy handed regulation which penalises the honest majority, but to expose unethical practices in the mainstream media. Reputations matter and a history of questionable practices, to put it mildly, will eventually hurt the perpetrator's bottom line.
Greece's bond exchange was successfully tendered with almost 86% participation among private Greek-law bondholders; coercive collective action clauses raised participation to near 96%, placing Greece in technical default. This wiped out only about one-third of Greece's debt since the ECB, EU and IMF took no write down. With Greece's new bonds trading at 75% of face value, reflecting ongoing investor skepticism, private bondholders had a bad week. Another default seems unlikely in the near term given Greece's (newly) low debt servicing costs: 2% through 2015 and 3% through 2020. More problematic is a yawning budget deficit that will require either more public support from official creditors and/or further austerity, both politically contentious. We think the determination by all parties to work towards an orderly write down of unsustainable sovereign debt laads in the Eurozone reduces systemic risk. This supports our pro-stock, pro-high yield bond, anti long-term Treasury bond positioning. However we do not think investors should expect double-digit stock gains from current levels in 2012.
My view - It would be nice if we had heard the last of Greece's problems, if only for the sake of that battered little country's sake. Greece faces a tough road ahead but Fullermoney maintains that its crisis has been contained, in contrast to many forecasts to the contrary, and the paragraph above explains why.
For international investors, this means that Greece's problems, while significant for Greek citizens, have been scaled-down to Greek-sized proportions for the global community. In a few years' time they will most likely wonder what all the fuss was about. Time moves on and we face new preoccupations and problems, some of which qualify as 'old friends'.
The spinning plates of high and plateaued long-dated government bond prices have suddenly begun to tumble. This means that bond yields are pushing up out of probable base formations. Suddenly the 'safe haven' is looking more like the bubble that a number of us have been talking about, although the west's various crises have delayed a partial bursting.
The implications of rising yields in government bond markets will not be viewed favourably by central bank and treasury officials, especially in the UK and USA. It would mean higher financing costs at a time of economic underperformance and high unemployment so they may try to delay the inevitability of rising government debt yields for a while longer. We will see.
Meanwhile, the powerful corporate Autonomies which Fullermoney favours for our portfolios have been preparing for this day by paying down old and expensive debt, building cash reserves, including borrowing more cheaply while they could, whether then needed the money or not. They are in a strong position to weather future economic storms and profit handsomely during the good times. We know they can do this because we have seen how they have dealt with adversity since 2008. More of these companies are likely to become Dividend Aristocrats.
(See Eoin's bond market review below.)
Both gold and silver have gone off piste, in terms of their prior trend consistency, as I have mentioned before, commencing with the accelerated (Type-1 as taught at The Chart Seminar) peaks in April and August 2011, respectively. Consequently, I make no apologies for saying in this review that the post-peak analytical challenge remains considerably more difficult. This reflects the tug of war between buyers and sellers, and the inevitable uncertainty that it produces. At such times one's analysis will not be helped by faith-based bold forecasts. Most of the forecasts that I have heard or read from other commentators are predicting anything from $2200 to $1200 this year.
No one knows but what we can say is that having failed near $1800, disappointing the bulls, gold is now in search of its next floor. Whether it finds it above or below the September and December lows in the $1533 to $1522 region will have short to medium-term implications. A lower low which is sustained for more than a few days would suggest another downward step to follow. Conversely, a higher low, confirmed by a significant bounce, would indicate support building prior to another test of $1800, a level that must be crossed and gains retained before we will have tangible evidence that a medium-term demand-dominated environment really has returned.
Fundamentally, one can certainly make a good case that with all the money printing and low real interest rates, gold's secular bull market should remain intact. In other words, there is a lot more fiat currency sloshing around which could be channelled into gold, than bullion available to accommodate that demand at anything close to current price levels.
Personally, I do not doubt this but the question is when? For perspective, the last major correction for gold, prior to the August/September 2011 peak, occurred following the 2008 acceleration above $1000. Shown on a semi-log scale chart, this is very similar in overextension to last year's peak. The subsequent correction faced the full force of 2008's asset liquidation. We are unlikely to experience a similar route anytime soon, in my opinion, having gone through last year's 2H smaller convulsions. Nevertheless, the gold price is considerably higher today than in 2008 and the consolidation which followed lasted eighteen months before the overall uptrend resumed. Since we have yet to complete seven months in the present correction, long-term holders of gold bullion may have to remain patient. As in 2008-2009, gold will have to establish another progression of higher reaction lows before we can conclude that demand has regained the upper hand.
Elsewhere, with futures prices in long-dated government bonds breaking downwards I opened a short in JGBs (historic, weekly & daily), selling the June contract at 141.59. I know that there is a very big graveyard out there piled high with the bodies of traders who have paid the price for their failed bear positions in JGBs, and I also carry a scar or two from this market. Nevertheless, to paraphrase a well know saying: Cometh the hour, cometh the trend. Has Japan finally arrived at a Grand Conjunction, in which the yen is actively weakened, opening the door for a meaningful stock market recovery, to which Japanese investors contribute by switching some of their savings from JGBs to equities? That is what I am betting on.
My thanks to a subscriber for this timely report on Japanese equities. It offers a good summary including lists of shares and some investment vehicles which should do well in the current environment. For the first time in a long time I do think that globally diversified investors should consider some investments in Japanese shares.
The Blind Questioner – At The Chart Seminar, we recommend delegates identify consistency characteristics by imagining they are describing the price action to a blind person. This allows us to develop an unvarnished perspective of what prices are actually doing. With this information we can then go on to plot a strategy and how an ending might eventually form. I thought that considering the important movements in the sovereign bonds markets recently it would be instructive to go through such an example using US 10-year Treasuries.
Blind Questioner: “Is the market in a major bull or bear market phase?”
Factual Interpreter: “The last major bull market in yields (bear market in prices ended in 1981 and yields have been in a secular bear market since (bull market in prices).”
Blind Questioner: “Is it trending or ranging?”
Factual Interpreter: “Yields collapsed from the peak between 1981 and 1986 and entered a rangy downtrend over the last 26 years. When we look at the log scale chart we see that the decline accelerated in 2008 and again in 2011. The yield halved on both occasions. This introduced more volatility than seen in the course of the prior 25 years. In tandem with this war between supply and demand real interest rates are negative since CPI is currently 2.7% and the 10-year yield is 2.15%.
Factual Interpreter: “I agree, a total return index should offer some additional insights. If we examine the Merrill Lynch 10yr+ US Treasury Total Return Index we are presented with a well-defined view of the almost 30-year demand dominated environment for US Treasuries.”
Blind Questioner: “Is this chart trending or ranging?
Factual Interpreter: “The Index has been trending higher since its inception in 1983.”
Blind Questioner: “Is the trend consistent or inconsistent?”
Factual Interpreter: “It has been mostly consistent. There has been a series of quite lengthy ranges over the last 28 years but the broad upward bias has remained intact throughout.”
Blind Questioner: “What are the consistency characteristics?”
Factual Interpreter: “There is an unbroken progression of higher major reaction lows over the course of the 28-year uptrend.
“A series of higher rally highs is also evident.
“The Index has found support in the region of the 200-day MA on successive occasions.”
“Almost all of the major ranges have been posted one above another.”
Blind Questioner: “Tell me more about the ranges”
Factual Interpreter: There has been a rhythm to the way this trend has unfolded. An almost unbroken succession of medium-term ranges, one above another is evident since 1983.
Here is a table depicting the size and duration of the ranges.
“Without going into the minutiae of each of the ranges, what is now apparent is that while the ranges are not persisting for longer that ‘normal' they are becoming larger.”
“Relative to the previous 25-years this is an inconsistency.”
Blind Questioner: “How has the Index performed relative a trend mean such as the 200-day MA?”
Blind Questioner: “I now have a clear picture of the index's long-term consistency characteristics. You mentioned that the reactions have tended to become larger over the last few years. Can you tell me more about that?
“It then broke upwards again in May 2010 and rallied to a peak near 1800. The subsequent unwinding of the overextension relative to the MA was quite sharp but prices again found support in the region of the 200-day MA.
“Despite the increased size of the reactions since 2009, they continue to reside one above another.
“The mostly rangebound environment of the last six months has at least partially unwound the overbought condition. A swifter pullback, such as that seen following a similar ranging phase in 2009 cannot be ruled out.”
Blind Questioner: “On a commonality basis, if we return to the price action of the underlying bond futures, how is the US 10-year Treasury future performing relative to other sovereign benchmarks?”
Factual Interpreter: Following a six-month ranging phase most are currently experiencing some weakness. The US 10-year Treasury price chart has broken downwards from its range. The Japanese 10-year has done the same. German, UK, Swiss, Canadian and Australian 10-year futures are also pulling back so there is a high degree of commonality in the sector at present.
Blind Questioner: Let me summarise. The primary consistency characteristics are that the market has been in a secular bull for the last 30 years. Yields have been declining but not in a particularly consistent fashion and two separate accelerations have occurred in the last few years. The total return index reflects a much clearer representation of the bull market with a progression of higher reaction lows, almost every medium-term range has formed above the last and the Index found support in the region of the 200-day MA on successive occasions. Overextensions relative to the 200d-ay MA of approximately 10% have been relatively frequent.
“What would now need to happen to question these broad consistency characteristics?”
Blind Questioner: What strategy would now be most appropriate?
Factual Interpreter: The most logical course of action would be to have a short position in Treasury futures. If history is any guide, the total return index is more likely than not to overshoot the MA, which suggests additional downside potential for Treasury prices. If the market subsequently continues to deteriorate one would be in the position of not having to chase. The risk is that today's breakdown from the six-month range fails and prices push back up into the range.
I opened a short in the decimalised US 30-year Treasuries June future this morning at 137.715 including spread-bet dealing costs.
Email of the day – on the emergence of Africa:
“I've been considering expanding my portfolio to include more African investments. This interview might add some more background to readers who might be considering doing the same.”
My comment – Thank you for this interesting interview which rhymes with my experience of witnessing Africans in China's wholesale markets sourcing goods for a budding consumer sector back home.
The UK listed Africa Opportunity Fund trades at a discount to NAV of 12.55%. It has rallied over the last two months to break the yearlong progression of lower rally highs and sustained move below 0.8 would be required to question medium-term scope for additional upside.
San Diego MTA chapter on April 3rd between 4 and 5pm. The mostly likely venue depending on numbers will be the UBS offices in Del Mar/Carmel Valley. .
“To Hoard or to Horde: risks and opportunities from participating with the crowd.” Will be the topic of my talk to both these associations.
CFA Institute San Francisco April 12th 3-5pm. The venue will be at the CFA's classroom at 300 Montgomery Street, 11 th Floor. T he topic will be “Differing patterns of development, comparing the USA & UK with China & India.” Non-members are welcome to attend and can expect to pay a fee of between $20 and $30.
The TSAA-San Francisco April 13th. The venue will be Golden Gate University 536 Mission Street. Venue, room 5207 on the fifth floor from 3pm to 5pm. The title is “Fire or Ice: Will inflation or deflation win the race?” Non-members are welcome to attend and can expect to pay a fee of $20.
A fee of $20 will be levied on non-members who wish to attend.
If you would like me to speak to your local chapter or organisation in California or New York please contact your respective chairperson and ask them to contact me.