Dr. Copper: Prognosis Negative

Dr. Copper, aptly named for the metal's ability to gauge the strength of the global economy, is not giving the most upbeat prognosis at the moment. In fact, with today's weakness the intermediate term trendline is being tested. A decisive breach of this important trendline would likely lead to a testing of the low made last June and would probably be accompanied by rising concerns of deflation and slow global growth.

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And unfortunately, the Point & Figure chart of copper doesn't look too promising either.



We wish we could say that trader positioning and sentiment were at negative extremes (portending some sort of rally), but that isn't the case either. In the first chart below we show the commitments of traders in copper futures. Both the commercial traders (smart money) and large speculators (not so smart money) are showing neutral positioning (no extreme net long or short positions). In the second chart below we show investor sentiment towards copper futures and we find a similar level of neutrality. Rallies in copper over the last several years have typically been associated with extreme short positions and negative sentiment. We are not there yet.

Money Supply Points to Deflationary Pressures

Like most, with the onset of quantitative easing in the US, we have had to adjust our money supply models. The main adjustment relates to the accumulation of excess reserves held at the Federal Reserve and the higher than average preference for liquidity (cash).  In the chart below, we take the standard M2 and make a couple of adjustments: 1) we start with M2 (the dark blue line) and then, 2) subtract currency in circulation (red line), and then 3) subtract commercial bank deposits held at the Federal Reserve (light blue line).



The key takeaway from this chart is that the long-term component of M2--ie, private credit growth--has been stagnant for five years.  This reflects the continued contraction in the shadow banking system as well as weak loan growth.  Below we convert the levels in the chart above to a one year rate of change.



Private credit growth is contracting at an almost 5% annualized rate, which is highly deflationary.  In the chart below we show the one year change in our adjusted M2 (subtracting out currency + commercial bank deposits at FRB) and compare it to the S&P 500.  Since mid-2012, we have been in a highly unstable condition that somewhat resembles the vicious deleveraging of 2008-2009.

The Yen Carry Trade Rules The Day (Again) as USD Gains and Gold Tanks

The JPY/USD cross is once again going tick for tick with S&P 500 futures as investor appetite for risk did a 180 overnight:



With the euro selling down to 1.355 vs the USD, the USD is the big winner on the day:



As gold struggles:

US Pending Home Sales Falls Off A Cliff In December

Pending Home Sales Index fell by 8.7% month-over-month compared to expectations of only a -0.5% decline. Pending home sales have now dropped every month since making a four year high in May. Unfortunately, weakness was across the entire country. The West leads the way down with pending sales down nearly 16% year-over-year. This does not know bode well for an already soft existing home sales series in January as pending home sales generally leads by a couple months. 

Comparing Emerging Market Selloffs: 2010-2014

As the emerging world experiences its fifth broad stock market selloff in as many years we thought it timely to review just what happened during the previous four selloff instances so we can have a better idea of what to expect from both EMs and DMs in the current rout.

In the below chart we have plotted the price in USD of the MSCI EM Index (red line, right axis) and also the price of the S&P 500 (blue line, left axis). We also added black lines delineating the beginning of the EM decline and green dashed lines delineating the start of the acceleration, or "waterfall", phase of the decline. The idea here is to take note of the magnitude and duration of the total decline as well as the "waterfall" portion of the decline. Right below the chart we complied some statistics related to each EM selloff episode from which we'll make the following points:

• In each of last four EM selloff episodes the total peak to trough decline of the MSCI EM Index was between 17-31%
• During the current episide, which actually began on October 30th, 2013, the total peak to trough decline has so far been 10%
• In each of the last four selloff episodes the acceleration, or "waterfall", phase of the decline accounted for the majority (75-88%) of the cumulative losses experienced
• Assuming the acceleration phase of this selloff started on January 22, 2014, the current "waterfall" has only accounted for 42% of the cumulative loss
• The average number of calendar days over the last four selloffs is 112 vs the current reading of 89 in this instance
• The average number of calendar days in the "waterfall" phase of the selloff is 38 vs the current reading of 7 in this instance
• The "waterfall" phase of previous selloffs has accounted for between 20-55% of the total number of calendar days of the total decline
• Having just started, the current "waterfall" only accounts for 8% of the total duration of this selloff
• In each case the S&P 500 declined less than the MSCI EM Index
• In each case the S&P 500 relative decline diminished with each subsequent EM selloff (excluding the current, unfinished EM selloff)

Based on this simple analysis it becomes rather clear that there is a high probability the current rout in EM stocks has more to go before it's finished. Based on the last four selloff instances in this market cycle, we'd expect another 3-8 weeks of turmoil and the cumulative loss increase markedly from the 10% peak to trough decline we've seen so far. If we are in fact in the "waterfall" phase of this decline, we should expect almost daily losses until it is over. Previous experience also suggests the S&P 500 will be more resilient than the broad EM stock index, but by how much is uncertain.

North American Growth Counter-Cyclicals Outperforming So Far In 2014

We like to break out stocks based on their cyclical or counter-cyclical nature and compare what "type" of stock is outperforming on a relative basis. We break cyclicals into three baskets (early, late, and hyper) and we break counter-cyclicals into two baskets (interest rate sensitive and growth). 

In North America, growth counter-cyclicals significantly outperformed stocks no matter how we sliced it (relative to North American cyclicals, all MSCI North American stocks or all MSCI World stocks) from February 2011 to April 2013. For the remainder of 2013, growth counter-cyclicals steadily lost ground. Since the calendar flipped to 2014, this relationship has flipped once again and growth counter-cyclicals have outperformed by a little over 3% relative to cyclical stocks. 

Aluminum and Gold Lead European Sub-Industry Performance

'Aluminum and Gold???' you say, doubtfully.  And your instincts are correct. At first glance, the ranked performance of sub-industries in MSCI Europe puts these two materials groups in the top three so far in 2014:



Closer inspection reveals, however, that each of these sub-industries is comprised of just one company-- neither of which looks very appealing when we take into account a longer term view of relative performance:




Incidentally, neither of these companies passes our knowledge leaders screen as a result of two factors:
1. too little investment in intellectual property and
2. insufficient margins (gross margin in the case of Norsk Hydro and FCF margin with respect to Randgold)

Japanese Pharma Works In Rising Yen Environment

As the risk environment has heightened since the beginning of the year, one of the effects has been a stronger Japanese Yen.  The Yen has risen some 3% so far this year, a reversal of the 2013 trend of double digit declines.



One of the beneficiaries of this reversal is Japanese pharmaceutical companies.  Below is yesterdays performance of Japanese pharma companies, measured in USD.



The group is statistically cheap using our valuations metrics that adjust for corporate intangible investments. On an adjusted cash flow basis, many companies sell for less than 10x cash flow, and in some cases at a discount to book value.

Intangible Adjusted Valuations


When compared to the MSCI World index, relative valuations look pretty cheap as well.  As a group, Japanese pharma sells for a 40% discount to MSCI World index cash flow or book value, and at the same time, yields 90% of the index.

Relative Valutations

European Luxury: LVMH

As LVMH Moet Hennessy prepares to report fourth quarter earnings results on Thursday (following a disappointing Q3 release), we thought we'd take a closer look at MSCI Europe's largest luxury retailer.

One of our favorite indicators is how much a knowledge leader invests in research and development, advertising, and firm specific resources.  LVMH stands firmly in the middle of the pack versus its European peers:

When we take a longer-term view, however, we see that the company's capital investment as a percent of sales has remained stagnant over the last decade-- a distinct difference versus competitors that have, in some cases, tripled their efforts:

LVMH has below average levels of cash and higher than average debt:

For the group as a whole, net debt as a percent of total capital has fallen from an average of 7.0% in 2001 to a low of -10.9% in 2011, however:

The company's net margins and ROIC are both about twice what they were a decade ago but neither distinguishes LVMH as a leader in the sub-industry :

And valuations (in this case, P/CF) have nearly doubled from lows in 2007:

Looking forward, analyst estimates are for average growth in sales and earnings:

LVMH has been the worst performer in the group over the last one- and four-year time periods, a trend that has eased somewhat more recently as other peers have begun to struggle:

Whether this underperformance is the result of slowing trends in luxury spending among Chinese consumers or is the result of some kind of fundamental issue remains to be seen.  We will be closely watching the next area of support in our point-and-figure charts for any breakdown in relative performance:

(versus the MSCI World)

(versus MSCI Europe)

House Price's Losing Some Momemtum

The Case-Shiller Home Price Index reported home price statistics for November this morning. The report indicates that housing prices have lost some momentum two thirds of the way through the final quarter of 2013. For the first time since March, there were several cities that saw prices decline from three months earlier. Dallas and Denver remain the only two cities that are tracked that have surpassed their pre-Great Recession highs. New York City continues to have the weakest rebound from trough prices since the recession.

Is The Divergence In Durable Orders Telling Us Something?

In retrospect, in 2007-2008, the divergence between US total durable goods orders and non-transportation orders signaled a deteriorating outlook for equities.  Between January and October 2007, with a backdrop of rising stock prices, total durable orders pulled away from non-transport durables.  Then by November 2007, stocks took notice of this divergence and began falling.  With today's report on durable orders, we may see the same pattern playing out again.  In the chart below, the dark blue line is total durable orders and the light blue line is non-transport durables.  While total durable orders made a new cycle high today, non-transport durables are slightly down from December 2011.



One explanation for the performance is the taper.  Below we plot the 3-month change in the Fed's total assets against the 6-month change in non-transport durable orders.  With non-transport durable orders down 1% over the last six months, perhaps the taper is already weighing on the economy.

Developed Market Stocks Are Down, But Far From Oversold

With stocks around the world selling off pretty much in tandem over the last week we thought we'd review what our indicators of market breadth are telling us at the moment. In a nutshell, even though most markets suffered 2-3% losses last week, global stocks in general are far from being oversold. As always, we are working with the roughly 1600 stocks in the MSCI World Index in our analysis.

We'll start with a blunt tool showing the percent of stocks that are trading above their 200-day moving average. This reading still shows 64% of stocks trading above their 200-day moving average. Good oversold readings will see only 20-30% of stocks trading above their 200-day moving average.



The percent of stocks making new 200-day lows in price currently stands at 2% relative to good oversold levels that are typically in the 8-30% range.



The number of advancing stocks (averaged daily over the last 200 days) shows a reading of 61 compared to levels well under zero at decent oversold instances.



The 1-quarter cumulative number of 5% down moves in individual stocks (a measure of selling pressure) is currently only 359. The best times to buy stocks over the last 4 years have been when this indicator is greater than 1000.



Finally, and maybe the most convincing of all the above indicators, is an analysis of the percent of stocks that are making new 200-day highs in volume. We saw only 2% of stocks make a new high in volume on last Friday's selloff (not very emotional). At emotional lows we usually look for at least 10% of stocks to register 200-day highs in volume.