European And Asian Stocks Are Approaching Overbought Levels

Unlike the majority of this six year old bull market, European and Asian stocks are outperforming North American stocks in 2015 (yes even measured in USD). Asian stocks are nearly 12% higher, European stocks are nearly 10% higher and North America stocks are just about 3%. This surge in Asia and European are starting to hit overbought levels judging by the the % of stocks above its 100-day and 200-day moving average.

Three weeks ago, 89% of Asian developed market stocks were trading above its 100-day moving average. This has fallen back a bit, to 76%, but still remains at an elevated level. 75% of Asian stocks are trading above its 200-day moving average.





83% of European developed market stocks are trading above its 100-day moving average. This is basically the highest level reached for European stocks in a year and a half. 76% of European stocks are trading above its 200-day moving average.





Finally, we have the bull market leader North America. Here we are seeing a slight breakdown in momentum. 65% of North American developed market stocks are trading above its 100-day moving average and 66% of stocks are trading above its 200-day moving average.

Longer Term Trends Have Reasserted Itself In May

Remember back in April when we noted how equity trends had completely flip-flopped during the first several weeks of the second quarter and we wondered aloud whether this was a trend change or simply a counter-trend rally? Well, so far in May the market is signalling that equity trends observed in April may have just been oversold (and well overdue) bounce.

To quickly review, at the end of April the performing sectors were energy, telecom and materials. These had been three of the worst five performing sectors over the past four years. Conversely, tech, consumer discretionary and health care were the three worst performing sectors in April. Meanwhile, they had been the three best performing sectors over the past four years.

Through yesterday, bull market leadership has reasserted itself. The best performing sectors MTD are health care, tech, and consumer discretionary. And the two worst performing sectors? You guessed it, energy and telecom. Materials have bucked the trend so far in May and are the fourth best performing sectors in May.

Even with the weakness in the energy stocks in May, the energy sectors continues to have the best performance in the second quarter. However, YTD, the energy sector is still the second worst performing sector just ahead of utilities and just behind telecom. As we approach the final month in the second quarter, it will be interesting to see if long-term leaderships continues with its May momentum.

Equity Returns As Of Tuesday, April 28th


Equity Returns As Of Tuesday, May 20th

Smart Money Most Committed to Falling Rates Since The Last Peak in Long Bond Yields

Commercial traders (AKA the smart money) has massively flip flopped their positioning since the end of last year with respect to the long bond. In aggregate, commercial traders have moved from a net short position (benefiting when rates rise) of about 50K derivative contracts to a net long position (benefiting when rates fall) of 22K contracts. This is a delta of about 72K contracts in about six months. Aside from the rapid change in positioning, the commercial traders net long position in derivatives is the largest since the last peak in rates at the beginning of 2014, which led to a 1.8% decline in rates over the course of a year.

A Precarious Association

When the ECB announced plans for its own asset purchase program back in January, we commented on the big difference in the relationship between those purchases and equity performance when comparing the U.S. and Europe.  As the MSCI Europe Index hovers near decade highs (and asset purchases appear poised to expand at an accelerated pace over the next few months), this chart has us wondering whether or not we should brace for a rather unpleasant period in European equities:

Dr. Copper Is Down, Not Out

While it is too early to really get our hopes up, it is worth noting that Dr. Copper has clawed its way back above the long-term support that it violated earlier this year:



And though its efforts to overcome the downtrend seem to have faltered a bit today, the metal with a Ph.D in economics has clearly taken a peek at the view out above resistance:



As we said, this does not guarantee a sustained breakout (especially in light of our discussion about its rally and the relationship with Chinese growth)-- but the forces of accumulation have to start somewhere...

Breakdowns in the Health Care Sector

Health care stocks have been the leadership sector in the MSCI World, and many (such as biotech) have reached some pretty elevated valuations.  Most stocks in the sector have been in multi-year bull markets trends, outperforming the MSCI All Country World Index  significantly.

In our relative strength point and figure charts we take the daily price in USD of the individual stock and the MSCI ACWI.  We calculate the ratio and the measure changes in 2.5% increments.  Each X is a 2.5% relative outperformance and each O is a 2.5% relative underperformance.  We impose a 3-box reversal meaning that in order to shift from and ascending column of Xs to a descending column of Os, we must see a 7.5% shift in relative performance.  By measuring price movements in this way, we remove two sources of noise in the fluctuations in stock prices: the movements of a stock attributable to movements in the market as a whole (the beta) and the noise inherent in the movement of individual security prices.  Because trend reversals are a function of changes in relative price trends, time is not a variable.  A reversal can take 3 days or 3 months.  Time is marked in the top of the y-axis and as can be seen, the amount of reversals vary year by year. Generally a stronger bull market trend has fewer reversals in the midst of an uptrend.  Reversals are a proxy for risk, so these point and figure charts measure relative price vs. risk, rather than price vs. time like most charting techniques.

The benefit of our charting system is that it gives us an objective standard of performance.  All stocks are bought with the best of expectations and good fundamental reasons for the investment.  After the investment is made, none of this matters much anymore.  The only thing that matters once one owns a stock is how it performs.  A portfolio of chronically underperforming stocks is bound to underperform.  Managing the performance of a portfolio is relatively straight-forward with a systematic method of measuring the performance of the stocks in it.  Every stock has a role to play in a portfolio, and measuring how it is performing this role is an important element of portfolio management.

There are a handful of health care stocks that have recently broken down.  These stocks have been in multi-year uptrends and so are likely widely held in portfolios.  These stocks appear to be undergoing a major reversal of trend from a structural relative uptrend to a structural relative downtrend.  These stocks should be strongly considered as sources of funds.

Monetary Movements & Economic Mirage

While we entered 2015 with the Federal Reserve talking confidently about lift-off and how many rate increases there would be by the end of the year, the markets didn't seem to buy it.  As weak economic data began to surface, the Fed seemed to quietly backtrack first on the date of lift-off and then on the trajectory of the expected hiking cycle.

We always believe that Fed actions speak louder than words, and for this reason we measure high frequency monetary movements.  In the last couple months, the Fed seems to have arrested the decline in its balance sheet that began in 2014.  This has had positive impacts on liquidity in the banking system.  In the first chart, we show the three month change in total Fed assets.  The latest reading of $4.5 billion is in contract to the negative readings we have seen most of the year.



 In the second chart, we show the relationship between Fed assets and commercial bank liquidity.  Movements in commercial bank non-borrowed reserves mirror movements in Fed assets, but with more volatility.  So, in the last few months, as the contraction in Fed assets has ceased and turned positive, commercial bank liquidity experienced a much more dramatic swing.



This reversal in liquidity trends have fueled the latest stock market movements.  In the next chart, we show the same three month change in non-borrowed reserves as shown above, but this time we overlay the percent of stocks in the MSCI World index that are above their 200-day moving average. Clearly liquidity trends have a big impact on equity movements.



Will recent favorable liquidity trends be enough to propel stocks out of the current consolidation relative to bonds?  In the chart below, we show the total return of the S&P 500 compared to the total return of the JP Morgan 10 Year Government Bonds Index.



Two economic readings have us skeptical.  First, in the chart below, we show the S&P 500 compared to lumber prices.  Lumber is a good proxy for the strength of the housing market and, in turn, the housing market is a good proxy for the strength of the economy.  The plunge in lumber prices would suggest investors are skeptical on the strength of the housing market and, in turn, the economy.



Next, the Citi Economic Surprise Index keeps deteriorating.  The current reading of -73 is the weakest since the fall of 2011... and a 20% correction in stock prices.  We keep a one year running total of the Citi Economic Surprise Index, and its keeps falling.  Another month of weak data, and it is likely our indicator takes out the lows last seen in October 2011.



If the Fed has quietly decided to not only abandon any prospect of rate increases, but begin expanding its balance sheet again (in some stealth QE), stocks probably do propel out the year long relative strength consolidation with bonds.  But, if not, then stock managers should be particularly attuned to monetary movements and the economic mirage in the US.  Our simple model of the change in Fed asset compared to the total return of stocks vs. bonds, suggests the potential for significant bond outperformance if the Fed sticks to its plan of a 2015 lift-off.

Does the Pause in USD Strength Imply Stronger Equities?

As the U.S. Dollar takes a breather from its surge upward since the middle of last year...

And our diffusion index of purchasing power parities versus 18 other currencies hovers in neutral territory...

While individual PPP trends shift ever so slightly...

Europe

Asia

North America

Correlation with the USD has been the single most important factor in equity performance throughout the world over the last month:

If the relative importance of the correlation to the USD persists, this has noteworthy implications for various regions around the world.  North American equities, which tend to outperform during periods of USD strength, have languished in the face of a weaker dollar.  Meanwhile, Europe and EMEA--with the strongest negative correlations to USD performance-- could benefit from a pullback or further consolidation.

North America

Europe

Pacific

Latin America

EMEA

EM Asia

Stocks And Bonds Remain At A Historically High Correlation

For most investors, a negative or low positive correlation between equity prices and long-term bond prices is a preferred and time-tested way of keeping one's portfolio volatility low. However, this has been very difficult over the past two years as the four-year rolling correlation between the S&P 500 and US 10-year bond prices have remained around all-times (currently at 0.61). The recent past is in stark contrast to the 1966-2001 period when the correlation between equity prices and bond prices was consistently negative (and sometimes with a negative correlation that equal to today's positive correlation).