Glenorchy Capital

Complete mayhem! These two words were the best we could come up with to describe the market’s behaviour last week. Over the last 10 days, especially the last few, we have been watching with interest the rapidly growing bearish consensus with the stock and commodity market and the Euro.

From our years of experience in the markets we have found that when a crowd becomes “unanimous” in its belief that a bear market has taken hold it coincides with the major market indices having already registered multi-week lows. Given the level bearish tone coming through in the popular press one could be forgiven for thinking that the S&P and Dow were trading well below the levels they were trading at in September/October. However, both indices are merely trading at mid November levels and still well above levels that would present “technical” breakdowns (1030 on the S&P). OK to cut a long story short – the crowd is too bearish. Major downside generally only occurs when there is complacency towards risk. Given how quick the “risk” trade has been thrown out the window over the last 10 days we think that the crowd is now far from being complacent towards risk.

It does seem like a repeat of late 2008/early 2009 but on closer inspection there are some notable differences. US treasuries have barely moved over the last three weeks or so. In fact they are only trading at mid December levels!

There is no question that the commodity market has been “crushed” over the last three weeks, but has it? Yes in USD terms it has (although no technical support level has been broken), but in Euro, GBP and AUD terms the CRB is only trading at November/early December levels. Until we see commodities registering multi-week lows in both USD and non USD terms we have trouble concluding that the rally in commodities is over.

There has been no material downside in real estate stocks to suggest a change in trend, yet we still find few believers in the prospects of the real estate sector. Markets follow the path of least resistance!

There can be no question that the USD Index is looking bullish and any technical analyst would tell you that this chart is going higher. Well higher it may go, but hear this for the week ended Tuesday, the CFTC said the net spec short position in the Euro (this translates to bullish positions on the USD) reached a record high dating back to its introduction in 1999. Given that the Euro has sold off dramatically since Tuesday it would be safe to presume that a new record has been set for bearish positions on the Euro.

If you want to get bearish on the Euro now odds firmly suggest it is too late…….which also suggests that being short the equity and commodity market and long “safe haven” markets/securities is a high risk proposition! Big call but someone has to make it!

We have always maintained that the best way to understand the mood of any stock market is to look at the behaviour of small caps. Small caps have a wonderful tendency to trend with relatively little volatility which makes depicting the true trend of the market considerably easier. Furthermore, due to their relative lack of liquidity their action forewarns or leads the behaviour of large cap indices.

We would like to draw your attention to one of the hottest equity markets in the world, Moscow! Look at the behaviour of the MICEX Small Cap index. It is at a multi-week high and gives every indication that it wants to move higher. Of course it is somewhat difficult to invest in Russian small caps themselves but for the average investor the ETF RSX will suffice.

If the market was “seriously” bearish then shouldn’t more junk rated bonds be entering a stressed condition? Well yes that would be a logical conclusion but it appears that there is no material increase in the number of junk rated bonds trading at more than 1000 basis points above the yield of US treasuries as the Bloomberg TRACE index below depicts.

Perhaps the graph above suggests that the US Economy is not in trouble as the recent behaviour of equity and commodity markets suggests.

My goodness! If last week wasn’t bad enough this week was horrid! There just seems to be no escaping the wrath of Mr Market unless of course you were short commodities, equities, and long treasuries and the USD (where have we seen this before). Anyway we have no problem with a pull back in the “market” (yield/carry trade) for a week or two or even a month or two, providing of course that it is just that – a pull back/correction in long term up trend.

Where we tend to lose sleep is when we have these little “panic attacks” that maybe this is the start of a reversal in the trends we saw develop in the in late 2008. OK so if this was the start of another “big one” what would we typically expect to see? Well let’s go back to the start of September 2008 (before Lehman’s went bang) and observe what the risky assets of each asset class were doing relative to the least risky assets. Well have a look at the four charts below – they were being pounded on no uncertain terms and had been so for at least four months.

Now fast forward to the present. The tone of the popular press would have us believe that the “risk trade” has already broken down to multi-week lows. But, seemingly against all odds, they haven’t! From the graphs below you will observe that they have merely given back the gains made in December.

Of course this begs the question, is the behaviour of the market depicted in the charts below suggest that the fall in equities and commodities is just a temporary setback (like in June/July and October last year), or is the behaviour of equities suggesting something big to the downside is about to happen in risky assets? Not being ones to sit on the fence we place our faith in the former.

Now touch wood the Aussie dollar holds out……but even if it breaks to a multi-week low it is not exactly a train smash for the carry trade, to us the behaviour of junk and emerging market bonds relative to US treasuries is more important, well it was last time around at least. Maybe puts on the AUD would be a good hedge for long positions in equities and commodities at least.

My goodness! If last week wasn’t bad enough this week was horrid! There just seems to be no escaping the wrath of Mr Market unless of course you were short commodities, equities, and long treasuries and the USD (where have we seen this before). Anyway we have no problem with a pull back in the “market” (yield/carry trade) for a week or two or even a month or two, providing of course that it is just that – a pull back/correction in long term up trend.

Where we tend to lose sleep is when we have these little “panic attacks” that maybe this is the start of a reversal in the trends we saw develop in the in late 2008. OK so if this was the start of another “big one” what would we typically expect to see? Well let’s go back to the start of September 2008 (before Lehman’s went bang) and observe what the risky assets of each asset class were doing relative to the least risky assets. Well have a look at the four charts below – they were being pounded on no uncertain terms and had been so for at least four months.

Now fast forward to the present. The tone of the popular press would have us believe that the “risk trade” has already broken down to multi-week lows. But, seemingly against all odds, they havn’t! From the graphs below you will observe that they have merely given back the gains made in December.

Of course this begs the question, is the behaviour of the market depicted in the charts below suggest that the fall in equities and commodities is just a temporary setback (like in June/July and October last year), or is the behaviour of equities suggesting something big to the downside is about to happen in risky assets? Not being ones to sit on the fence we place our faith in the former.

Now touch wood the Aussie dollar holds out……but even if it breaks to a multi-week low it is not exactly a train smash for the carry trade, to us the behaviour of junk and emerging market bonds relative to US treasuries is more important, well it was last time around at least. Maybe puts on the AUD would be a good hedge for long positions in equities and commodities at least.

If the risk, high yield, carry trade (call it what you will) was in genuine trouble wouldn’t one reasonably expect that the cost of insurance for default be on the rise? That is, Credit Default Swaps should already be trading at multi-week highs for high risk assets such as junk grade debt and emerging market debt? Yes that would be a logical conclusion especially when you take into account the level of “bearish” talk on the street. However, that is not the case. CDS spreads have hardly budged over the last few weeks and are trading below where they were in early December. Does this suggest that the smart money remains bullish? Does this mean that the market is merely trying to shake out the weak hands? We think so and consider the weakness in equities and commodities and commodity currencies as a buying opportunity.

On the face of it commodities appear to be in trouble. The big three; gold, silver and crude are all looking somewhat sick. Needless to say the big commodity ETFs (like DBC, DJP, GSG) are also taking strain. So we can only sympathise with the average investor as he begins entertain bearish views on commodities. However, there appears to be a tale of two cities in the commodities market, on the one hand the futures market of the commodity market is depressed but the spot prices of commodities are trading at multi-week highs.

We have long felt that the futures market for commodities is heavily manipulated and hides the true behaviour of the commodity market in general. So we constructed out own proprietary index of vital industrial commodities for which there is not a market conducive to speculative activities. The components of this index are; polyethylene (plastic), coal, wool, pulp, and rubber. Compare the ETF DBC with our Proprietary Commodity Index!

One of these charts is telling the true picture of the trend in commodities. We suspect it is not the picture depicted by the ETF DBC!

The essence of a bull trend is a series of higher highs and higher lows. Just a few days ago equity markets as per narrow definitions (like the Dow) and more broad definitions (like the Value Line) were trading at multi-week highs. Markets looked so bullish that we struggled to find any bearish activity which we could take seriously. Perhaps not surprising there were few bears and what appeared to be a lot of bulls (perhaps that was the problem).

Now we find a situation where markets have fallen hard for two days (Thursday and Friday) last week. Now it appears that the bears have all re-appeared, so much for how genuine the bulls really were! However, on what “technical” justification can one maintain a bearish stance? There has been no evidence of a lower low as yet, that is, all the lows of October/November remain intact. If you can see a “technical” breakdown please let us know because we cannot.

OK so the fundamentals have changed you might say, but are you sure they have changed? If you found yourself bullish on the 1^st of January and now find yourself bearish is it merely because the market has fallen by 5% in as many days?

So earnings have disappointed you might say? Oh that is interesting because it does not appear that way. Out of the 540 companies that have reported out of a universe of some 6000 (less than 10% but still a representative sample) 246 have had positive earnings surprises and 87 negative surprises – not exactly “disappointing” overall.

Be careful as to the reasons why you might be bearish on equities…….if you are bearish make sure it is based on your own judgement and not someone else’s! This may well be another trap laid out by Mr Market. We remain bullish on equities and see this weakness as a buying opportunity rather than cause to sell.

The seemingly about reversal in world financial markets over the last few weeks has been rather dramatic but has anything changed? We think not. There has been no breach of any technical support/resistance level, furthermore there has not been enough of a lapse of time that would signal a change in underlying fundamentals.

The Value Line remains well above “support” at the 2000 level. Note how strong the Value Line has been relative to the S&P 500. This indicates the broad strength of the market. Whatever is driving equities remains strong, two days do not change things one iota.

The “Old” CRB Index remains in a strong up trend. It is difficult to determine exactly where “support” lies but we would think that if it breached the 430 level it would signal a multi-week low and a clear breach of trend. It is interesting to note that whilst the CCI Futures index has weakened a little over the last few weeks the CRB Spot indices have gone to new highs!

Simply put (no pun intended) the US Treasury market needs to do a lot of work before breaking its down trend. We are still of the belief that the next leg down in treasuries will be large because once TLT trades at a multi-week low the yields on the 10, 20, & 30 yrs will have moved to multi-week highs and we all know that selling begets selling – although in this case we think that it is fundamentally justified.

We remain bearish on the USD in general, but have to concede that the USD Index conceals a lot. The strength in the USD Index is primarily a result of the breakdown in the Euro. I thought we would never say it but we would rather hold USDs than Euros!

Against all odds the Real Estate Sector remains one of the better performing sectors. We don’t expect that the weakness currently occurring will transpire to anything material.

Until proven otherwise broad macro trends that took hold in late 2008 remain in place. Go counter trend at your risk!

The behaviour of Crude, Gold and Silver as of late would have the casual observer believe that the whole commodity “story” is under serious threat. However, beneath the scenes nothing could be further from the “truth”.

Real commodity prices, that is spot prices or those for immediate delivery, are only a fractional percentage from their multi-week highs and the inflation premium between TIP 10yrs and non inflationary protected 10yrs is more or less where it was just one month ago. Either which way there certainly has not been enough of a change in spot commodities or inflation premiums to suggest that a “fundamental” change has taken place in the commodity story. Until proven otherwise commodities are still in a bull trend.

Therefore it would appear that the fall in commodity “heavy weights” such as oil, crude, and silver are not justified and that the weakness should be seen as a buying opportunity rather than the start of a material move to the downside.