July Sentiment Summary


Chart 1: Managers exposure towards equities is now “all-in” mentality!

Merrill Lynch Fund Managers Equity Weighting Source: Short Side of Long

  • This months Merrill Lynch Fund Manager Survey equity exposure came in at 61% overweight, relative to last months reading of 48%. Managers have pushed their exposure towards global equities to second highest levels in surveys history. Last time we saw exposure this extreme was in February 2011, just as the Euro Crisis was starting. As we approach the time of the year usually considered seasonally weak and the Federal Reserve finishes up the taper, equities look rather vulnerable. If you believe in surveys contrarian signals, today is probably not the best time to be buying equities… to say the least!

Chart 2: Bullish sentiment isn’t euphoric, but complacency dominates

Market Sentiment Source: Short Side of Long

  • Summarising various the equity sentiment survey readings for the month, we can observe in the chart above that bullish sentiment has pulled back from last months readings. In general, bullish sentiment hasn’t been all that extreme on either end, but the major story in the recent months has been the lack of volatility and total complacency, which has therefore lead to complete lack of bears. Other sentiment surveys such as Consensus Inc, Market Vane and NAAIM actually show a much higher level of bullishness that usually link to a possibility of a price pullback.

Chart 3: July is shaping up to be 1st major monthly outflow in two years

Equity Fund Flows Source: Short Side of Long

  • This month’s fund flows report by ICI showed global equity funds showed a first estimated monthly outflows of -$9.4 billion, after so many consecutive monthly inflows. The chart above contains red dots, which show time periods in the last seven year history where retail investors pulled money out of mutual funds for the first time, after several monthly consecutive inflows. First occasion was in early 2007, just as the market was near its peak. Second occasion was into late 2009, just after a powerful rebound. Markets stalled over the coming months. Third occasion was into middle of 2011 just as the market was near its peak. And finally, here we are today…
Chart 4: Skew Index has remained above 135 for the last several weeks!

Skew Index Source: Stock Charts (edited by Short Side of Long)

  • Summarising this month’s options & volatility conditions continue to remain in a very complacent zone. Obviously, this isn’t a major worry for the time being, until volatility starts picking up and investors start getting worried. A market trader with a keen eye should have already noticed a pick up in the VIX, as it diverges with large cap indices such as S&P 500. Furthermore, while not perfect, another indicator is also flashing warning signals. Skew Index, seen in the chart above, is used to predict a possible pick up in volatility. The 10 day moving average of the indicator has remained above 135 for several weeks now, which according to CBOE indicates almost 12% chance of a 2 standard deviation move.
Chart 5: Margin debt peak postponed as the stock market rally continues

NYSE Margin Debt Source: Short Side of Long

  • According to NYSE’s latest monthly report, investor margin debt increased by $25.8 billion to $464.31 billion. While we did see two consecutive monthly declines in leverage, margin debt has now recovered in a very robust fashion. Without a doubt, the extremes still remain in place and warn that investors are overly exposed to equities, however there is yet no proper sign of de-leverging (as seen by red circles in Chart 5).

Cash & Bonds

Chart 6 & 7: Retail investors push cash exposure towards lower levels!  

AAII Cash Allocations Source: Short Side of Long

  • Recent monthly AAII Asset Allocation Survey cash exposure fell towards 17.1%, compared to last months reading of 19.2%. As stated last month, usually low cash levels have almost always signalled intermediate stock market peaks, however the current rally has earned a nickname of “teflon market” and therefore no extremes have yet impacted the price of the uptrend. Moving along to other cash indicators, this months Merrill Lynch Fund Manager Survey cash exposure remained at the same level of 4.5%. With no change, readers should refer to last months report to view the chart again.

Chart 8: Managers further pressed their underweight bond exposure… 

Merrill Lynch Fund Managers Global Bond Weighting Source: Short Side of Long

  • This months Merrill Lynch Fund Manager Survey bond exposure came in at 64% underweight, relative to last months reading of 62% underweight. The bond market continues to rally and yet global fund managers exposure towards this particular asset keep falling. Merrill Lynch explains this by stating that a large majority of managers believe central banks are now anticipate a rise in short term interest rates. Moreover, investors should take notice of the fact that the exposure spread between long equities and short bonds is at one of the highest levels in surveys history.

Chart 9: Fund inflows continue with corporate bonds near record highs

Bond Fund Flows Source: Short Side of Long

  • This month’s fund flows report by ICI showed taxable bond funds had estimated inflows of $8.17 billion in the month of July. This compares to a total estimated inflows of $9.7 billion in the month of June. Abundance of recent commentary has focused on the superb performance corporate grade and junk grade bonds have achieved over the last several quarters, and the chart above shows the ongoing capital flowing towards corporate bonds.

Chart 10: Despite this years powerful rally, funds aren’t positioned long!

Treasury Bond COT Source: Short Side of Long

  • This month’s commitment of traders reports shows that small speculators remain rather neutral in the Treasury Bond market. If we refer to the chart above, we can see that bearish bets really stood out in August 2013 and again in December 2013, both marking intermediate lows for the Long Bond. However, despite a very powerful recovery rally this year, speculators have not yet turned net long. This is quite puzzling in a similar way that is also seen in the Merrill Lynch FMS, where exposure to bonds has been falling despite rising prices.


Chart 11: Fund manager exposure towards commodities has improved 

Merrill Lynch Fund Managers Commodity Weighting Source: Short Side of Long

  • This months Merrill Lynch Fund Manager Survey commodity exposure came in at 15% underweight, relative to last months reading of 18% underweight. Commodities have undergone a strong rally in the first half of the year, as they outperformed equities and bonds. Therefore, it is no surprise that managers have been chasing the price by improving exposure towards this asset. Continuous Commodity Index has now almost completely reversed the rally, so I would anticipate a deterioration in commodity exposure from global funds in coming months. Furthermore, from a pure technical perspective, commodity index in Chart 11 failed to break out and post a higher high, so at this point we officially still remain in a downtrend.

Chart 12: Funds are getting out of Agricultural commodities in a hurry!

Commodity COT Source: Short Side of Long

  • This month’s commitment of traders reports showed that hedge funds and other speculators  continue to cut their net long exposure towards commodities. Custom COT total net long contracts (refer to the chart in last months report) stand at 393,000, compared to last months reading of 599,000 net long contracts. If we observe Chart 12, we can clearly see that the 3 month rate of change in net long contracts is one of the lowest in the last six years. In plain English, hedge funds are cutting bullish bets on commodities at an extremely fast rate and the main culprit for this has been the Agricultural sector.

Chart 13: Agricultural sentiment surveys have completely collapsed!!!

Grains Sentiment Source: SentimenTrader

  • I have been focusing on the extremely disliked and disowned grains sector on the blog in recent posts. As it currently stands, futures positioning as well as sentiment surveys are pointing to possibility that panic selling is very close to ending. Corn, Wheat and Soybeans are extremely oversold and over the last 3 months, have declined by 26.9%, 28.3% and 17.4% respectively. Even more importantly, many of these agricultural commodities are having some of the worst two year returns in decades. Corn is down 54% over the last 24 months, while Wheat has suffered a 42% loss within the same time period. At current depressed prices, it is hard to see farmers rushing out to build up global inventory levels in coming years. Therefore, keep a close eye on the price, as we could be very close to a bottom.

Currencies & PMs

Chart 14: USD has held support & might be ready for another leg up… 

US Dollar COT Source: Short Side of Long

  • This month’s commitment of traders reports have shown a slight increase in positioning. This months custom COT total stands at $12.8 billion of net long contracts, compared to last months level of $10.9 billion of net long contracts. Majority of the bullish bets are coming from the Euro Dollar exchange rate pair, where speculators see further weakness for the European currency. According to the chart above, sentiment isn’t anywhere near extremes just yet, as we have Dollar shorts held against the Pound, Loonie, Aussie and Kiwi. As always, higher prices in the USD Index will entice more speculators and trend followers to chase prices higher.

Chart 15: Japanese Yen is about to make a large move in either direction

Japanese Yen COT Source: Short Side of Long

  • Over the last couple of months, Japanese Yen has been identified on this blog as a very decent opportunity, more so for traders then longer term investors. The volatility on the currency is at a multi-decade lows, and periods of low volatility are usually preceded by periods of high volatility. The technical price pattern resembles a pressure cooker right now and something has to give very soon. Disclosure: Short Side of Long newsletter subscribes would already know that I have been expecting the Yen to break out on the upside, however as of Friday I have been stopped out of the trade for a very small -0.1% loss (I tightened my stop loss in accordance with the triangle pattern). From a short term trading perspective, I am now ready to go either long or short as soon a first real hint is given.

Chart 16: Caution is advised as funds pile back into Precious Metals… 

Gold COT Source: Short Side of Long

  • This month’s commitment of traders reports have shown substantial increase in Precious Metals net long positioning yet again. Gold COT stands 161,200 net long contracts (39.5% of OI) in the month of July, compared to last months level of 131,600 (33.5% of OI). In the Silver market, COT stands 58,300 net long contracts (35.9% of OI), compared to last months level of 42,900 (27.1% of OI). As we can clearly see in Chart 16, Gold is consolidating in a sideways pattern right now. While bulls have been piling into the sector and busy pushing prices higher, they have failed to push the price into higher highs pattern known as an uptrend. The current level of bullish sentiment is extremely high for a market that remains in a price downtrend, so I would advise caution right now. Obviously, I would change my mind on the current short term direction, if and when Gold was to break above $1,400 per ounce.

Flattening Yield Curve

Chart 1: Long maturity end of the bond market has rebounded in ’14… 

Long Bond Performance  Source: Short Side of Long

Coming into 2014 just about every trader, investor, economist, financial forecaster, the whether man and their dogs were anticipating a further rise in interest rates. However, when everyone thinks the same… chances are… no one is really doing any thinking and something complete different will happen. So after selling off sharply throughout 2013 and suffering one of the worst rolling annualised performances in the last 20 plus years, the Treasury Long Bond has rebounded strongly in the first half of 2014, surprising the consensus.

Chart 2: …while the short end has sold off, flattening the yield curve!

US Yield Curve Source: Short Side of Long

However, not all of the maturities performed as well as the 30 Year Long Bond. As we can clearly see in Chart 2, the main story of 2014 has been one of flattening yield curve. As the market started to anticipate a potential Federal Reserve hike in interest rates, the short end of the curve has began to sell off (interest rates have risen). At the same time, the rebound in prices from the long end has now flatten the yield curve to some of the lowest levels in years (Treasury 5s & 30s).

What does the second half of 2014 have in store for the US bond market? Where do you see interest rates going? Tell us in the poll below and we will review it on 31st of December 2014!

Where do you see interest rates going in the second half of 2014?
pollcode.com free polls 

Quote Of The Day: Agriculture

On CNBC Asia’s “Squawk Box,” the author of the Gloom, Boom and Doom report singled out the agriculture sector, Chinese and Hong Kong stocks and precious metals as places he thought investors should put their money into.

“In general I like plantation companies – I like everything to do with agriculture,” said Faber, who is also widely known as Dr Doom. “Now agriculture prices have tumbled – corn, wheat, soybeans and so forth, but in the long run we have a global population that has more than doubled since 1960. We are now seven billion people and we will still grow. I think resources are very stretched and food will become very important,” he added.

Source here.

Euro Breaking Down!

European Euro has started to weaken and possibly enter a downtrend against the US Dollar. I first started discussing possibility of Euro weakening in early May, as a sharp technical reversal occurred in the currency. In hind sight, the super large daily outside reversal occurred during ECBs meeting and proved to be a strong signal of a top.

Afterwards, in late June with a post titled “European Euro Bulls vs Bears“, I continued to warn investors of a major decision point in the Euro Dollar exchange rate. I was swaying towards Euro weakness and at the time wrote:

So we are now building towards a major decision point. If the currency breaks its uptrend line, it will be a sign that bears are once again starting to dominate. On the other hand, if the Euro manages to bounce in coming days and weeks, it will be respecting the uptrend still in progress.

Personally, I think it is looking more and more likely that eventually a breakdown will occur. Nevertheless, before I take any positions in the currency exchange rate markets, I will let the price break either direction first.

Chart 1: Euro is breaking down against Dollar, after a two year uptrend! 

Euro COT Source: Short Side of Long

Those interested in shorting the Euro should pay attention to this weeks breakdown of a two year downtrend, as seen in the chart above. Technically, the currency is now entering a downtrend. The ECB and European policy makers insist that the currency weakness further, as they think devaluing a currency boosts exports and thus improves economic growth. What can you expect from academics, who wear suits and have been on high social salaries all their lives?

Nevertheless, we focus on the price. So while shorting the breakdown might make sense right now, timing is always an issue. Investors should pay attention to risks associated with group-think, as other traders are also piling into shorts as well. Bearish bets continue to grow and sentiment surveys are turning rather negative. Furthermore, the exchange rate has become slightly oversold from the short term perspective (not from the long term), as the price trades two standard deviations away from the 50 day mean.

July Market Breadth

The last market breadth update was written in June, with a theme of main internal indicators pushing towards overbought levels. The report showed how NYSE High Low Ratio, Advance Decline Line and Percentage of Stocks Above 50 & 200 MAs were all signalling that the rally was overextended.

Chart 1: Market breadth summary looking at various internal indicators

Breadth Summary Source: Short Side of Long

After the report was published, majority of the main US indices paused, as the price action has been consolidating in a sideways manner throughout majority of July. During the consolation, we have seen a slight pullback in indicators that were overbought the month before (as seen in Chart 1), but not enough change to write an in-depth summary. At the time of writing, HL Ratio and Stocks Above 200 MA both remain around 90% readings, which is considered overbought. This is still not a time to be making long term investments.

Chart 2: Nasdaq’s internals are weakening since the beginning of year!

Nasdaq HL Ratio Source: Short Side of Long

One interesting condition that does stand out as a cautionary signal is seen within the Nasdaq Composite internals. While the overall index remains in a bull market and continues to higher highs, one should be able to observe that since the beginning of the year internals measured by New Highs vs New Lows have been showing signs of deterioration. We have seen a similar condition during peaks in both 2007 and 2011.

I will definitely be keeping a close eye on the conditions of Nasdaq’s internals in the future newsletter posts focusing on market breadth. As the volatility picks up, I am sure market internal picture will get more interesting and posts more in-depth.

Global Stock Markets

On Friday I wrote an article titled “Geopolitics Influencing Prices” which outlined just some of the assets I am looking at with a possibility of geopolitical tensions developing even further in coming weeks. Something similar chart wise today, but here we will just focus on stock market indices and some huge divergences that are present around the world. I picked out just a few that stand out to me, but I am sure you could do a lot better job.

Chart 1 & 2: US stocks have outperformed the world for 3 years running

S&P 500 US outperforms the World Source: Stock Charts

Chart 1 & 2 show very clearly how strong the US equity market rally has been and how well the US has done relative to every other region in the world. Starting with Chart 1, we can see that S&P 500 has almost doubled since October 2011 and has barley spent anytime below the 200 day moving average since January 2012.

Chart 2 does a great job showing us that US equities have outperformed MSCI World Index; Eurozone equities; Japanese, Chinese and rest of Asian stocks, Latin American indices, Eastern European equities and Africa stocks. Outperformance ranges from 25% to 80% over a three year rolling period.

Chart 3: FTSE has stalled at the important 7000 physiological resistance

FTSE 100 Source: Stock Charts

UK stock market FTSE 100 rally has paused near the all important 7000 point physiological resistance zone for a year now. Whether the market is discounting the strength of the local currency (British Pound) or future dire economic prospects is unclear at present (it could be both), but one thing is for sure – while the S&P 500 has risen almost vertically in recent quarters, the UK counterpart has stalled out.

Chart 4: Bears are fascinated with China & yet the market isn’t falling…

Shanghai Composite Source: Stock Charts

When discussing risks in the global economy and macro investments, majority of the fund managers agree that China is the biggest worry and one majority lose sleep over. The bearishness has actually been intensifying over the last few years, and yet the Chinese stock market has actually failed to fall lower. Volatility has completely died out in 2014 and it seems a big move is coming soon.

The truth is, Chinese mainland stock market is incredibly oversold. After peaking in 2007 at around 6000 points, the index finds itself 66% lower 7 long years later. Furthermore, since 2009, Shanghai Composite has failed to staged a multi-quarter rally. Constantly bombard by bad news and a sideways trending market, investors have surely forgotten that Chinese stocks can actually go up, too.

Chart 5: Korean KOSPI has done absolutely nothing over the last 3 years

Korean Kospi Source: Stock Charts

So there we have it. A market thats rising almost vertically and extremely overbought (US), a market that is meant to be rallying and yet has stalled out for a year now (UK) and a market just about every investor is negative on and yet it refuses to fall (China). Matters wouldn’t be complete without picking a market that has done absolutely nothing for 3 years now (South Korea).

Fund Managers All In…

Chart 1: Fund managers are pilling into equities at fastest pace since ’11

Merrill Lynch Fund Managers Global Equity Weighting Source: Short Side of Long

According to the recent Merrill Lynch Fund Manager Survey, global fund managers are overweight equities by 61%. This is the highest equity exposure since February 2011, just as the Eurozone Crisis and global equity bear market was starting. Merrill Lynch report writes:

Improving investor sentiment on global growth, inflation, equities and risk-taking are all testament to a potential macro normalization in the second half. This could eventually feed into a normalization of rates. If growth does pick up, volatility will rise too,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Research.

Global Asset Allocators overweight on Equities rose to highest reading in over three years. The reading of net 61% OW is the second highest reading in the surveys history. Merrill Lynch warned that any summer “melt-up” in stocks, “is likely to be followed by an autumn correction. This aggressive positioning for recovery in H2 reflects a significant increase in investors’ inflation expectations,” the survey said.

I’ve included both the shorter term and the long term charts for viewing pleasure. At the same time, I would like to make a further observation that exposure towards bonds continued to decrease as per the survey. The question now is, with majority of the fund managers overweight equities, are we seeing the start of a stock market correction?

Chart 2: Managers hold the 2nd highest exposure to equities in a decade

Merrill Lynch Fund Managers Global Equity Weighting Source: Short Side of Long

Geopolitics Influencing Prices

I have been hinting at possibility of further escalation in geopolitical tensions on the blog all year long. As debt levels continue to rise, countries around the world are playing a very strategic game of chess and hotspots everywhere are flaring up. Major issues continue to be East & South China Sea, Ukraine Russia boarder and the overall instability in the Middle East.

In recent developments overnight have seen Israel send troops into Gaza, while in Eastern Europe yet another Malaysian plane has crashed and was apparently shot down over Ukrainian airspace. All of these events have put pressure on the financial markets, impacting various asset classes. Here are a few charts I am currently looking at (no particular order):

Chart 1: Yen could benefit from geopolitical tensions and risk aversion!

Japanese Yen Source: Bar Chart (edited by Short Side of Long)

Chart 2: Euro has been falling since ECB cur deposit rate to negative… 

European Euro Source: Bar Chart (edited by Short Side of Long)

Chart 3: Gold continues to consolidate sideways since crash in April ’13

Gold Source: Bar Chart (edited by Short Side of Long)

Chart 4: S&P 500 has spent 87 weeks above the 200 day moving average

S&P 500 Source: Bar Chart (edited by Short Side of Long)

Chart 5: US stock market internals show a deterioration in participation!

Stocks Above 50 & 200 MA Source: Short Side of Long

Chart 6: Russian equities have been caught in the middle of it all, again!

Russian Equities Source: Bar Chart (edited by Short Side of Long)