Market Outlook after recent selling

Behavioral & Technical Aspects:

• Stock Markets around the world have been pushed back from their upper resistances. 
• After that, bad and some even worsening economic news from the U.S. have led to more serious selling.
• Market breadth is now deteriorating and the "Hindenburg Omen" has been triggered two times. 
• All this has led to increased volatility and investor irration has been increased.
• Attention: the market trend is sideways to down, so "buying the dip" is not as riskless as it was between May 2009 and May 2010.
• If S&P500 supports around 1060 to 1020 don't hold, there is an increasing risk of accelerated selling.

Fundamentals:

• Equity valuations are relatively cheap if earnings can be kept at this level.
• As the economic outlook bleakens, sophisticated investors are most likely demanding ever higher risk premium in order to engage in the markets again "big time".
• Bonds are highly overvalued and overbought and offer very little yield. The dividend yield for equities is becoming better, therefore relative equity attractiveness is slowly rising, while there is plenty of money available.

Bottom Line:

• We are looking for a buying opportunity later in the year, but we suspect that markets need to slide a bit more if valuations should be comfortable enough to attract institutional-size buyers again.
• We are staying within a risky environment.

Investors, listen to Charles Darwin...

"It's not the strongest species that survive, nor the most intelligent, 
but the ones most responsive to change".
Charles Darwin. 

This for sure also applies to managing your money and getting your asset allocation right.
I hope that there isn't any doubt that we are currently living through a period of massive global change.

Let me just list 3 key factors here that point towards a period of unprecedented change:

• The Credit Supercycle in the G7 countries has most likely come to an end. There is a large debt overhang that needs to be corrected, and there has been government overspending and overpromising that will most likely be corrected as well, as recent austerity plans in the U.K. and elsewhere show.
• Global economic and political power had been concentrated in the G3 and mostly Anglosaxon elite over the last 60 years. This is currently being redistributed: the rise of the BRIC countries and the establishment of the G20 make this structural shift visible. The fact that the Chinese government has become one of the largest holders of U.S. treasuries over the last 10 years should make us think.
• Few people realize the disrupting effects of the Internet and its increasing global penetration yet.  The possibility to get access to any kind of knowledge within seconds, and also the ability to disseminate real time information through tools like Facebook, Twitter, etc. on a global scale and through networks of trust will have profound implications on business, politics, science and most likely also on religion.

At the same time, global assets are still structured, distributed and managed in a way and with methods that are a direct result from a couple of other key factors that had been in place for a long time:

• The ideas of MPT (Modern Portfolio Theory): efficient markets, "rational investors", the homo oeconomicus, standard normal distributed asset returns, benefits of diversification between asset classes, etc.
• A special kind of environment that has been dominated by the U.S. dollar as the global reserve currency and a de facto role of the U.S. Federal Reserve as the global central bank.
• A special kind of environment with 30 years of falling interest rates and low inflation.
• A unique government security, i.e. the U.S. Treasury Bond, that didn't default for about 100 years, something quite unique in the history of government finance. If one goes back through history there are very few governments that never have defaulted. This has instilled a false sense of security regarding the quality of these debtors.

 So if we go back to our initial proposition, i.e. that we are living in a time of extraordinary global change, then we need to ask ourselves if the basic foundations and concepts regarding investing our money are still correct.
We need to anticipate change and the effects of change and ask ourselves how this massive global shift of power, economic structures and information flows will most likely affect asset returns, their correlations and likely future growth rates.

Let us listen to what Darwin said: it is not necessarily the strongest who survive, but those most responsives to change.  

Compass Capital helps you to identify these changes and to position yourself accordingly.

Risk aversion in the Secondary Hedge Fund Market

HedgeBay, "the Ebay" for illiquid Hedge and Private Equity Participations, i.e.an independent secondary market platform for trading illiquid fund shares, has just issued their latest index report, which shows again  further deterioration of investors willingness to take risks - despite record low yields on all other asset classes and mountains of cash sitting around:

"Activity for the month of July was average for this time of the year. The index decreased in value by a little more than 300 basis points to 75. Dispersion narrowed to 35 points. The lack of “near par” transactions was abundantly obvious again in  July with all of the activity taking place in gated, suspended or side pocketed assets. With investors continuing to put money to work on the primary side of the market in liquid funds, they continue to show their general lack of willingness to accept lock ups."

This is the accompanying chart of their index, which measures at which price their average transaction takes place relative to the Net Asset Value of each fund traded:

This is actually not good. As only sophisticated or larger investors participate in HedgeBay, this clearly shows a strongly deteriorating willingness of this investor class to engage in illiquid fund participations in private equity and hedge funds.

Of course, many of these are sidepockets that are unloaded, but it is quite telling that we are now - on average - trading at 73% to NAV compared to about 85% of NAV during 2009, and even lower than in March 2009, the bottom of the Great Crash!



Or - wait a minute - could this actually be a good contrarian signal ? 
As long as bond yields fall and equities go sideways to down, we have some doubts ...

 Link to HedgeBay's latest Report.

The "Hindenburg Omen" - trouble ahead for Stocks?

Yesterday, the so-called "Hindenburg Omen" has triggered. This is being touted by many technical analysts as one "sure" way to foretell an impending crash, especially if it gets triggered 3 times within 30 days. 
Yesterday was the first time.
 
1) Myth vs. Fact
While it is in fact true that almost every major correction was preceded by the "Hindenburg Omen", not every triggering of the "Hindenburg Omen" resulted in a major correction or crash - so let us not confuse correlation with causation.

Despite its mystical and threatening name, there is nothing special or magical to this "signal" - something which is true for every system or signal.  There is no no magic crystal ball for markets, only some tools that work a bit better than others. 

The "Hindenburg Omen" - very simplified - is an indicator which measures market breadth (how many stocks within an index are rising vs. falling) and compares that to the momentum of the market.

And by using that approach it has worked quite well - more often than not, and much better than most well-paid economists or other forecasters. So let's be cautious,  watch and see if it will be triggered again over the next couple of weeks.


2) Additional Clues from Intermarket Analysis
The U.S. 10 Year Bond yield stands now at 2.7%. Prices for Treasuries and Bunds have continued to go up over the last couple of weeks, while Gold has been in a broad consolidation, and commodities started to drop together with stocks.
These are mildly deflationary signals, and we need to be careful. Investors need to adjust their positioning tactically, which is admittedly not a simple task. 


3) Bottom Line
Here at Compass Capital, we have reduced our equity exposure again when markets refused to break out from their recent range (after the FOMC announcement), but it was by far not a very easy call.

But, as liquidity remains extremely stimulative, interest rates at historical lows and corporate earnings quite good and balance sheets very strong, we believe the relative attractiveness of equities (especially when compared to the overvalued and frothy government bond market) is high.

We therefore look for a tactical opportunity to get long again.
But maybe this will require a bit of patience.


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High Indecisiveness may dissolve itself in a substantial move

Global Equity markets are now hovering around resistance while analysis shows that indecisiveness of equity investors, as measured per our proprietary indicators, has just started coming down from a 2.5 year high despite a multi-week really.

But what does it mean?

Usually, this means that there is still huge "pent up" potential for a big move. Once investors and traders recognize the "true" direction, they will jump on it and create a trending move.

See FT: "Hot money investors hold on to their cash...
FT.com / Emerging Markets - Hot money investors hold on to their cash

And this Reuters article as well:
Reuters (at http://ow.ly/2md30): Uncertainty dominates!

The econ blogosphere speaks | Analysis & Opinion |

The economic blogosphere has spoken -- and it is not too happy with what it sees. The Kauffman Foundation has just published a survey of 68 economic bloggers on the U.S. economic outlook.

Are we therefore on the verge of a breakout to the upside which then could last into end August or even longer?

A high degree of scepticism, coupled with a bottoming equity market in China, encouring signals from Copper and AUD, very loose monetary policy and not-so-bad corporate earnings and good corporate balance sheet health around the world could provide for another upleg in "risk assets".

How could a risk-averse Investor Profit from this constellation?

One possible way to play this would be with an asymmetric risk exposure through 2/3 call options and 1/3 put options: If the markets break out to the upside, you will gain well, but if thre is a false breakout and subsequent collapse, your loss on the call premiums should be more than compensated for with the put returns.

Agricultural Prices "unexpectedly heating up"...

Even the Council on Foreign Relations acknowledges: "Fears about wheat supplies are sparking fears that price inflation in the wheat market could lead to a food crisis akin to the one in 2008, says CFR's Laurie Garrett."
CFR on "Food Fears" Link: http://ow.ly/2n41t

Not so big news to Compass Capital clients: In January 2010, we stated in our Annual Investment Outlook: "...increasing weather volatility combined with structural decline in harvest yields provide for a continuing upwards price pressure in Agricultural Commodities. Bottom Line: increase exposure on corrections". See our Asset Allocation Sheet on Page 4ff.: http://ow.ly/2n3ZU