Small Caps Ready To Break Out?

Chart 1: US small caps could be poised for a break out on the upside… 

Russell 2000 Source: Stock Charts

I discussed US small caps sector just recently, in an article titled “Small Caps Ready To Catch Up?” While bears will argue that the index is extremely expensive (and they aren’t wrong), the tape is still signalling that it wants to go higher. This was confirmed even more so last night, with a strong breadth thrust and a huge 3% rally of the 200 day moving average. The fact that the price continues to consolidate below a major resistance zone most likely means that a break out is in the cards sooner rather then later…

China Is Outperforming

Chart 1: GEM stocks are trading at the same level as in October 2009

Emerging Market Stocks Source: Short Side of Long

During the recent stock market sell off, MSCI Emerging Markets Index fell by almost 20% from intra day high peak to the intra day lows. As we can clearly see in Chart 1, the index is now trading at the same level as it did in October 2009 (not including dividends). We find prices oversold in the short term and sitting at an important support level. With the VIX spiking a bit too quickly over the last several days, I wouldn’t be surprised to see a rebound in global stocks including MSCI EM ETF.

Furthermore, one of the most interesting developments during the current sell off was the fact that China didn’t go down as much as other emerging markets. As a matter of fact, China outperformed just about every EM index on relative basis and currently sits very close to its 52 week highs. Compare this to the likes of Brazil, Russia, Mexico and a couple of other EM countries, all of which are at or near their 52 week lows. This is most likely due to China being an under-eprformer for such a prolonged period of time (refer to strong orange line Chart 2 again).

Chart 2: During recent sell off China has shown strong outperformance!

Emerging Market Indcies Source: Short Side of Long

Personally, I continue to hold a view that Chinese shares are a good investment opportunity right here, right now (obviously with a tight stop loss as previously discussed). On the other hand, markets such as US large caps (S&P 500) seem overvalued to me on many different metrics. While US equities might also continue to rally and become even more overvalued, I would prefer to be invested in markets that have lagged behind and appear cheap. Chinese stock outperformance most likely hints that there is a possibility of further interest rate cuts by PBOC, while the current crash in Crude Oil should benefit the slowing economy – all of this hopefully pushing stocks higher.

Global Stock Correction – Part II

Since the last article was written, more selling has occurred in global stocks. This is especially true when all majors are priced in US Dollars, as global currencies remain quite weak. MSCI World Index peaked in June of this year and continues to consolidate. Bears argue that we are witnessing a topping pattern, while bulls argue this is a pause before further upside. The truth is, both bulls and bears are correct. It is just a matter of speaking in the right context.

For example, let us refer to Chart 1. Notice that US equities continue to outperform and have barley fallen since peaking in recent days. On the other hand, European and Japanese stocks (priced in USD) have been struggling for awhile. Japanese stocks have done well, but the currency has been awful. Here, it is probably important to buy stocks with a currency hedge.

Chart 1: Global equities are consolidating with GEMs under pressure!

Global Equities Source: Short Side of Long

In the emerging markets sector, there is just as much variance between the good, the bad and the ugly ones. India has done very well until recently, while China has outperformed during the recent correction. On the other hand, Brazil and Russia are about to test their March 2009 lows. Due to the currency weakness, Russian stocks are in full blown capitulation. Yesterdays volume spike on the Russian Stocks RSX ETF was insane. Obviously, these countries are suffering from commodity fall out. Imagine if the economy and currency suffered as much in the US. and S&P traded at 666, where it was almost 6 years ago…

Finally, I have noticed that the VIX is getting quite high now, as we approach close to 25. Also bonds are outperforming stocks by quite a few standard deviations. Keep an eye out on these indicators, because a mean reversion is coming soon.

Global Stocks Still Correcting

Chart 1: Global stock markets have been volatile since summer months

Global Stock Markets Source: Short Side of Long

The stock market correction has been with us since the summer months of this year. US centric readers will probably be thinking what a hell I’m on about, because only several days ago S&P 500 was trading at record highs. However, focusing on the global picture, we can see the situation is slightly different.

Chart 1 shows major equity indices from the largest economies around the world. We have USA, Germany, Japan and China (HK listed Chinese shares). Over the last few years US has been a strongest leader and out-performer, while China has been a laggard stuck in a prolonged consolidation pattern. From the shorter term perspective, Japanese stocks have gone through the roof in recent weeks. Apart from China, all major developed markets are at or near bull market highs.

Chart 2: GEMs stocks are down 14% since the beginning of September

GEM Equities Source: Short Side of Long

However, the picture isn’t as bullish elsewhere. Consider that emerging market stocks have been under pressure since the start of September and are currently down 14%. This stock market is quite cheap and has recently fallen on an important support line. It will be interesting to see if buyers step in at this level or if we are about to break down even lower. Now, judging by recent blog comments, most readers might assume that buying emerging markets is not wise and there is a reason why they are cheap.

Ok, fair enough. But if someone was to tell these same readers that US stocks will also drop 14% like their emerging market counter parts, all hell would break loose and a huge argument would happen. Since both S&P and GEM indices are priced in US Dollars, remember that we are comparing apples and apples instead of apples and oranges.

So… let us imagine a 14% correction in the S&P 500 from its September highs. At the beginning of September, US equities were trading just about 2010 points so a 14% drop would mean a current price of 1,730 points. This is almost unimaginable for most people, who are so used to record high after record high in the US.

Chart 3: Only 30% of global equity indices are trading above the 200 MA

Global Stock Market Breadth Source: Short Side of Long

Finally, according to all of the major indices I follow in my personal data, only 29% are trading above their respective 200 day moving averages. This is also confirmed by the MSCI World Index, which itself peaked in June of this year and currently also trades below its 200 day MA as well. Out of its most important components only US, China, India, Turkey and Thailand are still considered to be in an uptrend. Note: all index data is priced in USD and from MSCI.

Chart Of The Day: Crude Oil… How Bearish Are You?

Chart 1: Sentiment has turned so negative on Oil, it’s a repeat of Lehman

Crude Oil Sentiment Source: SentimenTrader (edited by Short Side of Long)

At the end of November, I wrote an article called “Panic In Crude Oil Prices“. I specifically stated that  I didn’t know when the bottom will be approached so “the most prudent thing to do is to just sit, wait and watch as the selling pressure exhausts itself”. Well, I have been sitting, waiting and watching and the selling still keeps going. Today’s Chart Of The Day shows just how negative sentiment has become on the black gold. This asset comes second to maybe only Japanese Yen, as the most hated by global investors. I will continue to sit and watch but I have to say, we must be getting very close now…

Update On Gold

I wrote a quick article at the beginning of the month, called Could Gold Surprise Us All? In the article I asked if all of us Precious Metals bears could be wrong and stated that:

Let us be honest here for a second. Almost every Wall Street Strategists has been expecting Gold below $1,100 this year and even below $1,000 next year. Every trade has been positioning for the breakdown below the all important support level of around $1,200 per ounce and gross shorts are currently at very high levels. Every media outlet from Bloomberg to CNBC has been talking about how much of a poor investment Gold has been. Many sentiment surveys, including the Daily Sentiment Index, reached record low levels on the recent decline. Even I have been expecting prices towards a $1,000 physiologically important support level. Could all of us be wrong?

Chart 1: Gold has crated a false break down and reversed powerfully… 

GLD vs Physical Holdings Source: Short Side of Long

Well, according to the recent price action the so called “easiest trade in the world”, which was shorting Gold as it broke below the eighteen month long $1185 support, has now totally reversed on the bears. My experience is very limited as young man, but usually when the market fails to hold a break in one direction, it tends to trap all of the group think mentality and swings powerfully the other way. We have a technical wedge in place, with a very defined support and resistance levels. The question is, with everyone expecting Gold at $1000 per ounce, can Gold now break out on the upside? Majority will still say no, despite recent price action.

But before you do that, I would like to make one final observation. Just for one second, think about this: policy makers and market participants seems to be obsessed with deflation fears right now. At the same time, since June of this year, US Dollar has gone through the roof. Currencies such as Euro, Yen, Aussie and many others such as Russian Ruble have collapsed. Furthermore, commodities such as Crude Oil have also collapsed by almost 50% in 6 months. The strong Dollar rally is putting pressure on everything, everything apart from Gold. Despite all these deflationary forces, Gold still trades above $1,200 like nothing happened – the same level it traded in June 2013.

If fundamentals are so awful for the yellow metal, ask yourself why isn’t it dropping? Maybe because, when it’s obvious to the public… its obviously wrong.

Small Caps Ready To Catch Up?

Chart 1: After an October correction, small caps are ready to break out!

Russell 2000 Source: Fin Viz (edited by Short Side of Long)

Just a quick update on US small caps, which I successfully shorted during the months of September and October. I was lucky enough to cover my Russell shorts right at the bottom of the powerful correction, but little did I know that the reversal to the upside will be just a powerful. To me, the tape is singling that the bulls are firmly in control of this stock market in both the short term and medium term.

Firstly, consider Chart 1, where last nights action was extremely bullish. Russell 2000 posted a very strong bullish reversal, despite the fact that global markets were dropping like a rock all this week. Secondly, if we observe Chart 2, we should notice the consolidation below the resistance levels over the medium term perspective. In my opinion, small caps are gearing up for a break out to new record highs.

Bears point to the recent pattern as a market top. They say that we have a topping process similar to 2011, while others say the topping process is also similar to 2000 or 2007. I do not have a crystal ball, so I’m not going to say this is wrong or right. But personally, I trust the tape. I believe, at least presently, that the tape is saying higher… and we shouldn’t argue with the tape!

Chart 2: Many believed ’14 was a repeat of ’11 but they might be wrong

Russell 2000 ETF Source: Bar Chart (edited by Short Side of Long)

Chinese Yuan Weakens

Chart 1: Chinese currency has once again began to weaken against USD

Chinese Yuan Source: Bar Chart

PBOC has recently cut in interest rates for the first time in over two years. While Chinese central bankers continue to talk the talk, saying that further monetary policy movements will stay on course for now, it seems that the participants within the currency markets have started to discount even more easing ahead.

Chinese Yuan, also known as the Renminbi, has began to weaken against the US Dollar once again. Since early October, the exchange rate has fallen from $6.10 towards $6.20 and if the trend continues, there will be more to come. From the technical price perspective, a rise in the USD vs Renminbi above $6.26 would indicate a higher probability of a downtrend. I guess you cannot blame the Chinese, when the Bank of Japan and the ECB have pretty much crashed the Yen and the Euro all the way back to levels not seen in years.

Precious Metals Breaking Out?

Chart 1: Precious metals could now be ready to break out on the upside

Gold & Silver Source: Fin Viz (edited by Short Side of Long)

In recent weeks, I have focused on the overbought and overextended rally in the US Dollar. Personally, I have been apart of this trade by shorting the Aussie Dollar for awhile now, as well as the fact that I hold just about all of my cash in USD right now. And while US Dollar might rise more, from the short term perspective, a correction could be looming. This is especially true with the Japanese Yen, which seems to be incredibly oversold right now.

One of the beneficiaries of the falling Dollar could be the Precious Metals sector. As I write this article, it seems that Gold and Silver are attempting to break out on the upside. As already discussed last week, the tape has turned rather bullish, after a five month downtrend. For those short term traders amongst you, pay attention to the resistance lines and follow the price trend.

December Economic Update

Leading Indicators

Chart 1 & 2: Global manufacturing still expanding… but at slower pace!

Developed Markets PMI Emerging Markets PMI Source: Short Side of Long

  • Recent Global Markit Manufacturing PMI data for the month of November showed some of the slowest global expansion in over a year, but nevertheless growth remains intact for now. Eurozone continues to be disappointment within the developed markets, while Brazil and China remain in stagnation within the emerging markets. Surprisingly, Russian manufacturing is showing slight signs of recovery at present. Current developed economies PMI readings stand as following: US at 54.8, Japan at 52.5, Germany at 49.5 and UK at 53.5; while emerging economies PMI readings stand as following: China at 50.0, India at 53.3, Russia at 51.7 and Brazil at 48.7. Observing all of the charts above, Markit analysts highlight the following summary:

Global manufacturing production expanded at the slowest pace for 15 months in November, as growth of new orders hit a 16-month low and the trend in international trade volumes stagnated. The forward- looking orders-to-inventory ratio also edged down to its weakest level since the end of 2012. At a 14-month low of 51.8 in November, the J.P.Morgan Global Manufacturing PMI nonetheless signalled a further expansion of the sector.

North America was a key growth engine. Canada was in joint-third place of the Output PMI growth rankings, a position it shared with the Netherlands, while Mexico and the US were in fifth and sixth places respectively. This was despite the US seeing a sharp growth slowdown. The UK and Japan also reported solid expansions.

Apart from the slower US expansion, the weakness in the global manufacturing sector also mainly reflected stagnation in China and further subdued growth in the eurozone. The lacklustre performance of the euro area came despite it having three of the top-ranked nations (Ireland, Spain and the Netherlands), whose solid expansions were offset by weaker growth in Germany and contractions in Austria, France and Italy. Elsewhere, Brazil, Indonesia and South Korea also reported lower output.

Chart 3: Chinese equities & OECD LEI showing a possible improvement

China H Shares vs OECD China LEI Source: Short Side of Long

  • Recent OECD Leading Indicators for the month of November showed a modest expansion in the US, while Eurozone and Japan continued to show slight deterioration. Interestingly, after many quarters of below trend growth, China seems to be showing signs of a potential recovery. Could the Chinese stock market, seen in Chart 3, know something we don’t? It is attempting to break out to there year highs. Summarising the overall report, OECD states that:

Composite leading indicators point to continued weak growth in Europe but stable growth in most other major economies and in the OECD as a whole. Amongst major economies stable growth momentum is anticipated for Canada, the United States, Brazil, China and Russia. The CLI points to growth losing traction in Japan though this may be related to one-off factors.

Within the Euro Area, the CLI continues to point to a loss of growth momentum, with stronger signals of a slowdown in the case of Germany and Italy. In France however the outlook continues to suggest stable growth momentum. The CLI for the United Kingdom indicates that growth may ease, albeit from relatively high levels. India is the only major economy where the CLI points to a pick-up in growth momentum.

Chart 4: US leading economic indicators are giving us a mixed picture

S&P 500 vs ECRI & Jobless Claims Source: Short Side of Long

  • United States is still by far the largest and most important global economy. That is why following US domestic leading indicators should be very influential in decision making for all global investors. The high positive correlation between S&P 500 equity index, ECRI’s Weekly Leading Indicator and the Weekly Jobless Claims data has broken down in recent weeks. The stock market has gone vertical since middle of October, towards record highs. At the same time, ECRI’s Weekly Leading Index has been falling rather sharply. Majority of this weakness is coming from the recent increase in volatility and credit spreads. So far this has not had much impact on the stock market, however it is important to monitor coming developments closely. After all, let us not forget that the ECRI’s WLI turned down before the stock market peak in 2000 and 2007.

Business Confidence

Chart 5: United States business confidence is booming similar to 2011

US Philadelphia Fed Business Activity Source: Short Side of Long

  • United States Philadelphia Fed Business Activity is currently in “boom town” territory, similar to what we saw during early parts of 2011 . The current reading of 40.8 is one of the highest in surveys history, and definitely the highest reading in the last two decades (refer to Chart 5). The recessionary fears, created by Eurozone Debt Crisis and China slowdown during 2011/12, is now clearly behind us. With stock market so elevated and business confidence so high, I wonder if anything could surprise us on the down? Note: Just like consumer sentiment data, business confidence is one of the better contrary indicators to time long term equity purchases and sales. Philly Fed Index has averaged 8 over the last few decades, with a very high reading of 40.8 in November 2014 and very low reading of -39.6 in February 2009 (days before a generational low in the stock market).

Chart 6: German business confidence recently fell due to Russia issues

German lfo Business Climate Index Source: Short Side of Long

  • German lfo Business Climate Index has been deteriorating since April of this year. The current survey readings for the month of November sit at 104.7, which is the first uptick in eight months. While business confidence did fall due to an economic slowdown as Ukraine & Russia Crisis, the DAX 30 seems to have gone through a necessary correction and has now returned towards record highs. I would listen to the stock market here and view the recent confidence drop as a contrary indicator. Note: Just like consumer sentiment data, business confidence is one of the better contrary indicators to time long term equity purchases and sales. lfo business condition readings have averaged 102 over the last two decades, with a very high reading of 115 in February 2011 (just prior to a EU Crisis and DAX 30 crash) and a very low reading of 84.6 in December 2008 (during the GFC and two months away from the generational stock market low).

Chart 7: Weakening the Yen has created optimism in Japanese economy

Japanese Tankan Manufacturing Conditions Source: Short Side of Long

  • Japanese Tankan Manufacturing Conditions has been steadily improving since Abenomics took over in late 2012. With a recent vertical move by the Nikkei, I would assume that coming survey data will show business confidence at even higher levels, mimicking that of the US. However, I would like to remind my readers of two important points here: 1) business confidence is usually a good contrary indicator; and 2) Nikkei is now reaching a major resistance zone from 2007. It reminds to be seen whether or not the stock market will keep rising at such a fast velocity. Personally, I am not betting on it right now. Note: Just like consumer sentiment data, business confidence is one of the better contrary indicators to time long term equity purchases and sales. Tankan conditions has averaged -3 over the last two decades, with a very high reading of 26 in July 2004 and a very low reading of -58 in March 2009 (right around the time the Nikkei 225 put in a 30 year low).

Chart 8: Chinese business confidence has been deteriorating since 2010

China Business Confidence Source: Short Side of Long

  • Chinese Business Confidence has been struggling since late 2010 and continues to show no signs of improvement just yet. Current quarterly reading is at 119.0, relative to readings of 137.0 in October 2010 (prior to the Chinese slowdown) and 94.6 in October 2008 (depths of the Lehman saga). Out of all the major economies we have had a look at today (US, Germany, Japan), Chinese business confidence has been suffering the most since the global slowdown started in 2011. However, after such a prolonged downturn, we should entertain the idea that just maybe the recent breakout attempt in the stock market could be an early sign of an improvement in economic activity. Note: Just like consumer sentiment data, business confidence is one of the better contrary indicators to time long term equity purchases and sales. Chinese Business conditions has averaged 123 over the last 15 years, with a very high reading of 143.1 in June 2007 (just prior to the start of Global Financial Crisis) and a very low reading of 91.7 in June 1999 (in the aftermath of Asian Financial Crisis).

Monthly Commentary

Today we focus on a lagging economic indicator in the form of US credit growth. I want to make it crystal clear that indicators like this shouldn’t be used on their own for investment purposes and timing of markets. We have to remember that markets are a discount mechanism and anticipate the future by at least 6 months (if not more), so looking at lagging economic data is like driving a car by looking at only the rear view mirror. For example, this is why 60 out of 67 economists who predicted rising rates in 2014 were complete wrong. All year long, interest rates just fell lower and lower… and lower. Their models and lagging data failed to anticipate any of that.

Chart 9: United States annual credit growth remains robust for now… 

US Annual Credit Growth Source: Short Side of Long

Nevertheless, looking at such data from time to time can be useful, because we can see longer term underlaying trends. After a huge credit contraction in 2008, the worst since the The Great Depression, at present we notice a decently robust annual credit growth. In particular, US consumer revolving credit (red line in Chart 9) is showing that credit cards, bank overdrafts and line of credit accounts are being used more. In other words, debt is being run up to higher levels. While this development might not be healthy in the long run, it boosts demand at present and therefore will most likely increase company earnings. Having said that, the two most important questions you should be asking yourself are: 1) how much of this is already discounted by evaluated US equity markets; and 2) will this credit growth trend continue into 2015?