- Latest EPFR fund flow data shows that Bonds recorded the highest ever weekly inflow. The bond bubble is definitely approaching its maturity, so those who are piling into these assets right now will most likely be "slaughtered" in the up-and-coming months and quarters. Having said that, the majority of investors view this as a contrarian buy signal for equities, but in my opinion those investors aren't doing their homework. The majority of the retail fund inflows are going into the Corporate & Junk bond sectors, which indicates retail investors chasing risky assets. In particular, due to euphoric inflows (and record issuance) into the Junk Bond sector, high yield is now reaching all time record low interest rates. It should be noted that these riskier bond assets correlate very positively with equities. With that in mind, the bursting of the Bond Bubble will actually spell disaster for corporates, especially the high yield junk market, as well as mark the end of the equity bull market that started in March 2009. We are late in the business cycle and on the edge of a recession, as corporate revenues start disappointing with margins mean reverting.
- Despite upbeat consensus forecasts, I remain in the recession camp for the 2013/14 period. Globally, capex is falling (usually the first sign of a recession), with manufactured capital good orders in contraction mode for the G3 economies. While the Eurozone is already in a recession that is about to get worse next year, I am also of an opinion that the other G3 economies will follow down the same path. De-coupling has always been a dangerous word and it is not used in my forecasts. The world's third largest economy - Japan - is witnessing a rapid fall in industrial production, with machinery orders signalling the country could already be in a recession. With two out of the three G3s already in a slowdown, it is only a matter of time before the US becomes affected too. The first signs of major weakness came as US durable goods orders collapsed in September. Furthermore, inventories are now becoming a net drag on growth, for the first time since 2008. Global growth is at stall speed at best with global demand for goods falling, as already seen by Asian export growth. In my opinion, the current release of "upbeat data" is not to be completely trusted, especially because good news tends to be published around leadership change overs (US & China) to smoothen out the transition - a perfect example of Machiavellianism.
- The latest CFTC Commitment of Traders report showed that Small Speculators, also known as Dumb Money, are shorting Sugar as of Tuesday of last week. At the same time, the Daily Sentiment Index (DSI), a measure of optimism from futures traders, is approaching single digit readings. From a contrarian point of view, these sentiment readings indicate that Sugar could be close to an intermediate bottom. Furthermore, as already discussed in a recent in-depth article, Sugar's prolonged bear market, which is currently almost two years old, is creating a good demand & supply equation as farmers cut production, while demand returns with price down more than 45% from the February 2011 peak.
- The chart above shows how ever year consensus forecasts have been too bearish and consistently wrong on the Japanese Yen. I personally believe that the Yen will surprise consensus once again, as the global economy slows and eventually enters a synchronised recession sometime next year. Despite a powerful bull market since 2007, according to the recent Merrill Lynch survey, global fund managers remain least exposed to the Japanese Yen out of all the major currencies. Furthermore, recent CFTC Commitment of Traders report showed that hedge funds are now pilling into bearish bets against the Yen. Furthermore, small speculators also known as Dumb Money, now sit on all time record high net short bets against the Japanese Yen. Historically, these market participants have been a great contrary indicator. Finally, from the technical perspective, the Japanese Yen is currently oversold and most likely in a process of putting in an intermediate bottom.
Other short term breadth measures I usually track are shown in the chart above. They are the percentage of stocks above 50 day MA, McClellan Oscillator and daily TRIN readings. All three indicators have a basic oversold level and all three indicators are not signalling oversold conditions. Verdict: in my opinion we are not there yet.
Longer term breadth measures also show the same picture. The long term advance decline line, averaged over 21 days or one month of trading, shows that we are currently at neutral readings and nowhere near oversold levels. Verdict: in my opinion we are not there yet.
The percentage of stocks above the longer term 200 day moving average is also nowhere near oversold levels. As a matter of fact, the smoothed 21 day average of the readings above, shows that the breadth strength is now rolling over and starting to narrow. Furthermore, we can see that a bearish divergence between lower breadth readings and higher stock prices into September 2012. All of these are usually typical signs of a downtrend at its beginning and not at its end. Verdict: in my opinion we are not there yet.
Moving away from breadth and towards basic technical price action, we can see in the chart above that we have a classic non confirmation in the Dow Theory. These usually get resolved to the downside, especially when stocks remain in a long term secular bear market. Verdict: in my opinion we are not there yet.
Finally, away from the stock market indicators, the bond market readings of future inflation expectations, also known as Break Even rates, have been overheating for a few weeks now. That tells us the current inflation trade is looking somewhat overcooked and mainly a consensus bet. Historically, a deflation trade (long Treasuries, Dollar, Yen, VIX) surprise tends to be just around the corner, as market participants start cutting risk exposure rather quickly. Furthermore, I personally think the Fed engaged into QE3 prematurely, instead of waiting for Break Even rates to fall back down to 2% range. This has now most likely topped the risk on trade, just like we saw in April 2010, November 2010 and between February & May of 2011. Verdict: in my opinion we are not there yet.