Friday, September 28, 2012

Could the Spanish protests be bullish?

On Wednesday, the news of protests and clashes with police in Spain and Greece spooked the markets and we saw a solid risk-off day. The protests, it was assumed, were a sign of popular unrest (true) and an indication that the governments of the day would be hard press to implement the harsh austerity measures demanded by the Troika.

Rather than seeing the glass as half empty, I think that it would be useful to think how this glass is half full. At about the same time, Spanish prime minister told the Wall Street Journal that he was eyeing the conditions for a bailout, but if bond yields were to tick up on a sustainable basis, there was no question that he would have no choice but to ask for the bailout:
Asked whether his government would apply for a bailout, Mr. Rajoy said, "At the moment, I cannot tell you." He said the government would need to determine whether conditions attached to the bailout are "reasonable."

He added, however, that if interest rates on Spain's debt were "too high for too long," thus harming the economy and raising the government's debt burden, "I can assure you 100% that I would ask for this bailout."
In other words, he is still negotiating with northern Europe. Given that the ECB's announcement of OMT has driven down bond yields, he is under little pressure to yield to the ECB's "conditionality", which would be draconian.
On the other hand, bad news is good news. The news of the protests and riots spooked the markets and could give the market what it wants, i.e. a bailout request. Indeed, , the Spanish 10-year yields tick up to the 6% mark on Wednesday (which is a level that is judged to be unsustainably high), though it did stage a minor retreat on Thursday.


At the about same time, the Spanish cabinet unveiled an austerity budget with numerous cuts demanded by the Troika and Bloomberg report that the budget may be enough to satisfy bailout conditions:
Spain’s plan “responds to country-specific recommendations and goes even beyond them in some areas,” European Union Economic and Monetary Affairs Commissioner Olli Rehn said in an e-mail sent while the ministers were speaking.

There are hints that it may be enough if and when the government goes cap in hand to the ESM:
The steps may be enough to ease demands creditor countries such as Germany and the Netherlands would make in exchange for a financial lifeline. The government won’t decide whether to request aid until it has all the relevant information available and has had time to study it, [Economy Minister] de Guindos said.

Reading between the lines, further protests that elevate the yield on Spanish paper is good news, not bad news because it will give the market what it wants.         Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.  

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Tuesday, September 25, 2012

What excessive bullishness?

There was a lot of comments over the weekend about how investor sentiment is getting excessively bullish and it is time to be more cautious about stocks. In particular, there was a lot of references to the Barrons Santoli article about too much complacency. One reader cited charts of Rydex cash levels, asset allocation, money market funds allocations and the VIX Index as reasons to be bearish.

Oh! How a week of sideways consolidation deflated bullish sentiment. On Monday, I woke to see that the Bespoke survey shows that there are now more bears than bulls:


The Tickersense blogger sentiment poll (to which I am a participant and voted "bullish" this week) shows the number of bulls retreating. A good analogue to the current period is the August 2010 when Ben Bernanke hinted at QE2 at Jackson Hole in August 2010. Back then, the number of bulls spiked to a crowded long reading the Jackson Hole speech. Bullish sentiment retreated soon after, just as it is doing today.

Tickersense blogger bull/bear sentiment history

I would also highlight the stock market response to past programs of QE (from dshort.com). I annotated (in red circles) the dates of recent ECB actions.



Similarly, Deutsche has a research note out (via Business Insider) that indicates long/short hedge funds aren't buying this rally. The implication being that we shouldn't depend on this group of hedge fund managers to push equities higher.

I beg to differ. Their own chart shows an uptick in equity beta that is similar to the initial market surge from the QE2 episode in 2010 [annotations in red are mine]:




The moral of this story is investor sentiment readings can be highly fickle and bounce around wildly. No doubt bullishness receded further because of Monday's downdraft.

While I remain concerned about excessive insider selling, the positive momentum from monetary stimulus and the beta chasing activity of underweight institutions and hedge funds are reasons why equity markets are likely to power ahead to further highs. The current episode of pullback and consolidation should be regarded as an opportunity to deploy cash and not a time to take profits.




Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, September 24, 2012

Not time to get nervous (yet)

I see that there has been a certain amount of hand wringing about the poor performance of the Dow Jones Transportation Average (see example here):
According to the basic version of this theory, if the Dow Jones Transport Average fails to confirm the strength of the Dow Jones Industrial Average, the market is headed for a correction. Industrials hit a fresh high Sept. 14 of 13,682 points. Dow transport stocks not only failed to confirm the gain, they lurched decidedly lower.


A tour around the world In isolation, the failure of the Transports to confirm the advance is a cause for concern, but a tour around the world shows that major averages are in solid uptrends. In certain cases, the advance may have gone too far too fast and some gaps may need to get filled in on a pullback. Let's start in the United States with the SPX. This is as solid an uptrend as ever and it is holding up above the key breakout level.    
  Across the pond, the FTSE 100 is showing a similar pattern of being in an uptrend.  
  The same goes for the STOXX 600, representing European stocks.  
  In Hong Kong, the Hang Seng Index is nearing the top end of an upchannel. The QE3 inspired rally produced a gap, which the index needs to pull back and fill.  
  South Korea's KOSPI is showing a similar pattern of a upside gap that may need to get filled. Otherwise, the intermediate term outlook also looks bullish.    
  The BRIC markets generally appear to be constructive. Brazil is in the middle of an upchannel and uptrend.    
  The same could be said of Russia.  
  India's stock market, which had been the source of some investor concern, has also rallied and is displaying the familiar pattern of being at the top end of an upchannel. It does, however, have the upside gap shown by some other markets.  
   The only exception is China's Shanghai Composite, which is in a downtrend.


What about inter-market analysis? Take a look at 10-year Treasury yields. They have stopped falling and they appear to be rising, which is signaling the end of the risk-off trade and the start of the risk-on trade that is equity-bullish.


Cyclically sensitive Dr. Copper has staged an upside breakout, though it does slightly over-extended and it is at risk of a near-term pullback.



Take a ride on the QE train
I wrote before that we are at the start of a global QE-induced rally by central bankers around the world (see Party on (but watch out for the cops)). This chart from dshort.com shows how stocks, bond yields and Fed Funds rates have responded to past episodes of quantitative easing. I also annotated (in red circles) the dates of recent ECB actions. If the past is any guide, then this stock market rally should have legs for a few more months.




Sentiment models supportive of more upside
What's more, the latest sentiment survey figures from AAII (via Bespoke) shows that while investor sentiment has gotten more bullish, readings are not at crowded long extremes.


I would also like to address the point from the Pragmatic Capitalism posting, which pointed out Mike Santoli's piece in Barrons highlighting insider selling and the excessive bullishness among newsletter writers as signs to be worried about. While I would be concerned excessive selling by insiders, i.e. the smart money, insiders have not always perfect at timing the market. As for the opinion of newsletter writers, I would argue that their excessive bullishness is actually bullish in this case as they provide buying power for the market. This is a case of watching what they do and not what they say. Anecdotal evidence from trading indicates that institutions and hedge funds have too little beta and they are in the process of beta chasing. BoAML strategist Savita Subramanian pointed out that Sell-Side Strategists were still extremely bearish on equities at the end of August:
The Sell Side Indicator, our measure of Wall Street bullishness on stocks, ticked up slightly in August for the first time in six months. However, this month’s improvement of 0.6ppt lifted the indicator to just 44.4, still at the lowest level in the history of our data (since 1985) apart from last month’s low of 43.9. This suggests that sell side strategists’ bearishness on equities remains at 27 year extremes. Given the contrarian nature of this indicator, we are encouraged by Wall Street’s lack of optimism and the fact that strategists are recommending that investors significantly underweight equities at 44.4% vs. a traditional long-term average benchmark weighting of 60-65%. The indicator remains firmly in “Buy” territory, a signal that it first flashed in May. Recall that we adjusted our Buy and Sell thresholds in November in an attempt to better incorporate secular shifts in equity sentiment.
Their positioning can be regarded as a proxy for how institutional portfolios are positioned. When these guys start to turn around, there is a lot of money to move markets around. Such a turn from a position of extreme bearishness tends to lead to short-term overbought conditions and excessive bullish sentiment model readings.


The fiscal cliff a non-issue?
The storm clouds are clearing, one by one. The ECB and Fed have taken tail risk off the table for now. Even the much feared fiscal cliff may not be a problem. The Washington Post reported last week that the Republican Senate's leadership conceded that they may have to compromise on taxes should Obama win the election:
Senior Republicans say they will be forced to retreat on taxes if President Obama wins a second term in November, clearing the biggest obstacle to a deal with Democrats to defuse a year-end budget bomb that threatens to rock the U.S. economy.

Republicans have long resisted tax increases of any kind. But taxes are a major battleground in the campaign between Obama and Republican Mitt Romney, Capitol Hill veterans say, and the victor will be able to claim a mandate for his policies.

“This is a referendum on taxes,” said Rep. Tom Cole (R-Okla.), a senior member of the House Budget Committee. “If the president wins reelection, taxes are going up” for the nation’s wealthiest households, and “there’s not a lot we can do about that.”
The weight of the evidence suggests that the path of least resistance remains up. While there are a couple of negatives, such as excessive insider selling and the poor performance of the Shanghai Composite, a tour around the world show powerful upside momentum in global equities, supported by a friendly macro environment and institutional buying.

Party on! It's not time to get nervous (yet).



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


Saturday, September 22, 2012

The hawks fight back

When the Fed launched QE3, Tim Duy recently wrote that the hawks on the FOMC have been marginalized by Ben Bernanke:
The hawks are all bark, no bite. They are more than overwhelmed by dovish-leaning policymakers, even if Bullard joins Kansas City Federal Reserve President Esther George in hawkish dissent. What remains important heading into 2013 (aside from the data, of course), is Federal Reserve Chairman Ben Bernanke. He can pull the moderates where he wants to go. And it obviously is not in a hawkish direction.


Bottom Line: Fed hawks are largely marginalized. Their views have not and will not have a significant impact on policy making. They will only appear to have an impact on policy if the data signals that a policy shift is needed. Given the current set of policymakers on the Fed, the hawks will only have a voice if Bernanke is replaced with one of their own. And that is when it would get interesting, as I am not sure that the moderates would follow a hawkish Chairman.
That view is only true if an analyst were to think in a linear fashion. Marketwatch reports that Dallas Fed's Fisher is leading the charge to change the Federal Reserve's dual mandate to a single price stability mandate:
Two top Federal Reserve officials who opposed the latest round of Fed asset purchases have waded into tricky political waters by suggesting that lawmakers could tie the Fed’s hands if they wanted to block more asset purchases.


“A future Congress might restrict us to a single mandate – like other central banks in the world operate under – focused solely on price stability,” said Richard Fisher, the president of the Dallas Federal Reserve Bank in a speech on Wednesday night in New York.

Earlier in the week, another regional Fed bank president, James Bullard of St. Louis, was even stronger, saying he supported restricting the dual mandate to a single inflation-fighting goal.
It seems that the hawks are upset enough to risk open warfare at the Federal Reserve and they have enlisted the Republicans in Congress as allies:
With the base of the Republican Party this year very anti-Fed, a Romney victory in November would likely spark efforts to limit the Fed’s powers in monetary policy and banking regulation, experts said.

“Many Congressional Republicans seem eager to tie the Fed’s hands and Bullard is playing into that,” said Joseph Gagnon, a former Fed staffer and now a senior fellow at the Peterson Institute for International Economics.

House Republicans have already introduced legislation to end the Fed’s dual mandate and vice-presidential nominee Paul Ryan has been advocating the measure in recent campaign appearances.

Rep. Kevin Brady, a Republican from Texas and a sponsor of one of the bills to limit the Fed’s focus to inflation, has said that the Fed would not have been able to launch its latest QE3 plan if his legislation had been enacted.

Buba's counterattack
Across the pond, the Bundesbank's Jens Weidmann was publicly making parallels of the ECB's actions to Goethe’s Faust:
In early scenes from Goethe’s tragedy, Mephistopheles persuades the heavily indebted Holy Roman Emperor to print paper money – notionally backed by gold that had not yet been mined – to solve an economic crisis, with initially happy results until more and more money is printed and rampant inflation ensues.

What is Weidmann playing at? Is this a last ditch offensive to forestall OMT? Is this Weidmann's Unternehmen Wacht am Rhein?

Should bulls be worried?

My inner trader tells me that I shouldn't be concerned about the hawks until 2013. In the case of Weidmann, he may be trying to influence the German elections that occur about a year from now in 2013. In the US, the response of the hawkish contingent within the Fed is certainly disturbing, but give Romney's poor electoral chances as shown by intrade, they are likely angling for one of their own as the new Fed Chair when he is appointed in January 2014 (but the fight will happen in 2013).

I wrote these words on Monday and I stand by them (see Watching for storm clouds on the horizon):
In the meantime, both the Fed and ECB are hosting a gigantic block party. There's lots of free food and drinks. I am sure that even the Chinese will be there. Go on and enjoy yourself. Just don't get so drunk that you get caught flat-footed when the cops raid the place.
As my inner trader tells me, "Don't worry, be happy!"


Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Thursday, September 20, 2012

How serious is the China/Japan dispute?

Ambrose Evans-Pritchard wrote a rather alarmist account of the Chinese/Japanese clash over the Senkaku/Diaoyu Islands. He drew parallels with an event in 1911 that eventually led up to World War I:
This is a calibrated crisis to test the strength of the US alliance with Japan. It reminds me of the Agadir Crisis in 1911, when Kaiser Wilhelm sent the warship Panther to Morocco to prevent French annexation, though there were a series of such seemingly preposterous episodes.

In a strict sense, the Kaiser was correct. The French were violating earlier accords. But his real purpose was to probe and weaken the British Entente with France (not quite a formal alliance) by picking on an issue where London had little natural sympathy for French actions.

The Japanese have walked straight into the trap. In fairness to the Democratic Party of Japan, it interceded to buy three of the five disputed islands to head off an even more dangerous move by the nationalist governor of Tokyo, Shintaro Ishihara.

And in fairness to Chinese government, they have sent paramilitary vessels to the islands rather than a naval squadron. That is a crucial difference.
He indicated that this incident could draw the US into a conflict that it doesn't want:
Washington guarantees Japan’s defence under its US nuclear umbrella. It uses military bases on Japanese soil as an unsinkable aircraft carrier. It works hand in glove with Tokyo in a tight military alliance.

The question is whether Washington is really willing to uphold the Japanese alliance as the going gets tougher. Will it let America to be led by the nose by Japanese nationalists into a clash that is not obviously – or immediately – in US national interest?
On the surface, this sounds very scary. Also scarier the account of how an angry Chinese mob attacked US ambassador Gary Locke's car:
A crowd of around 50 Chinese protesters surrounded the official car of the United States ambassador in Beijing, who escaped unharmed, a State department spokesman said.

The melee occurred outside the gates of the US embassy on Tuesday and security guards had to intervene to protect Gary Locke, 62. The protesters caused minor damage to the vehicle, a statement from the embassy said.

“Embassy officials have registered their concern regarding today’s incident with the Chinese Ministry of Foreign Affairs, and urged the Chinese Government to do everything possible to protect American facilities and personnel,” the statement said.
That headline sounds even more alarmist. Then consider this account buried in the same report [emphasis added]:
Meanwhile, the protests against Japan have now evaporated. The road outside the Japanese embassy in Beijing has reopened and there was no sign of any discord.

“It seems the protests in front of our embassy have subsided,” the Japanese embassy said in an email to Japanese citizens.

Beijing police sent out a mass text message telling the public not to stage any more protests, according to the Japanese embassy.
Then ask yourself, how serious is the Chinese government about this dispute if they are trying to rachet down the protests against Japan?

This is a tempest in a teapot. When tensions between China and Japan subsides, global risk premiums will fall as well and asset prices will respond accordingly.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Wednesday, September 19, 2012

To be in Europe this autumn...

Most of the buzz in the financial blogosphere has been focused on the actions of the Federal Reserve. As a result of Ben Bernanke's announcement of potentially unlimited expansion of the Fed's balance sheet, stock prices surged last week.

Let's step back for a moment and consider the following two relative return charts, which are relative to ACWI, the MSCI All-Country World Index ETF. I have deliberate removed the labels. Which would you rather own, this one?

Chart 1: Rally through a relative downtrend

Or this one?

Chart 2: Breakdown through a relative uptrend

I won't keep you in suspense. The first chart is the ratio of FEZ, the ETF representing the Euro STOXX 50, against ACWI and the second chart is the ratio of SPY, representing American equities, against ACWI. (All are US-listed ETFs denominated in USD, so there is no currency effects.)

Technically speaking, the rally in the past few weeks has been unusual. Despite all the hoopla about the actions of the Fed, it has been European equities that have begun to bottom and started to become the leadership. US equities have begun to weaken against global equities and started to lag. What's more unusual is emerging market equities, which has normally been thought of as a high-beta play, have not performed well.


American investors shouldn't be overly focused on just their own market and look for emerging leadership across the Atlantic. To be sure, there are sectors like the Homebuilders that remain leaders, as shown by the relative chart below. But this is a relatively small weight in the US market and this industry cannot be expected to carry the entire US market with it.


When I look at the heavyweight cyclically oriented sectors, such as Industrials (XLI) against ACWI, they appear to have broken down through a relative support level - which is not a sign of a healthy market.


The same goes for Consumer Discretionary stocks (XLY) against ACWI. XLY has formed a similar pattern as SPY of breaking down through a relative uptrend line.


Putting it all together, these charts suggest that global investors are far more worried about the fiscal cliff than any eurozone financial crisis. Given the giant party being thrown by the Fed and ECB, it seems that people are having a better time in Europe than America.


Full disclosure: Long FEZ, EWI.


Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Tuesday, September 18, 2012

Demographics and stock returns

Bloomberg/Businessweek recently featured a demographic debate about stock returns. On one hand, the author featured a bearish outlook from Harry Dent [emphasis added]:
An economics blog posted a depressing speech given by author and newsletter writer Harry Dent, called “A Decade of Volatility: Demographics, Debt, and Deflation.” “There is,” Dent says, “simply no way the Fed can win the battle it’s currently waging against deflation, because there are 76 million Baby Boomers who increasingly want to save, not spend. Old people don’t buy houses!”

He explains that the peak of the recent housing boom featured upper-middle-class families living in 4,000-square-foot McMansions. “About ten years from now,” he says, “what will they do? They’ll downsize to a 2,000-square-foot townhouse. What do they need all those bedrooms for? The kids are gone. They don’t visit anymore. Ten years after that, where are they? They’re in 200-square-foot nursing homes. Ten years later, where are they? They’re in a 20-square-foot grave plot. That’s the future of real estate. That’s why real estate has not bounced in Japan after 21 years. That’s why it won’t bounce here in the U.S. either. For every young couple that gets married, has babies, and buys a house, there’s an older couple moving into a nursing home or dying.”
On the other hand, the Echo Boomers are starting to come into their own and their peak savings years, which should boost stock prices:
Dave Wilson charted the number of Americans who were 35 to 39 years old at midyear, as compiled by the U.S. Commerce Department, with the Standard & Poor’s 500-stock index’s performance since 1980. At least where equity valuations are concerned, the picture does not lend weight to Dent’s inevitable-inexorable-deflation thesis.


For Josh Brown’s part, he and business partner Barry Ritholtz observed that the timeline of a boom in 35- to 39-year-olds “coincides perfectly with the time frame we’re guesstimating as the end of the secular bear market we’ve been in since 2000. (They tend to run 17 years on average.)”
Here is the chart.


Watch the interaction between generations
Who is right?

Actually, both are right. I continue to believe in my thesis that US equities will bottom around the bottom of this decade (see A stock market bottom at the end of this decade). I base my conclusion on two important demographic studies, the first from the San Franciso Fed (see paper here) and the second from academics, i.e. Geanakoplos et al (see paper here).

Dent's point is about the demographic headwinds posed by the Baby Boomers. Wilson focused instead on the Echo Boomers. Both the Geanakoplos paper and the SF Fed paper analyzed the interaction between the two generations. Geanakoplos concluded that a generational stock market bottom would occur about 2018, while the SF Fed put the timing of the bottom in 2021.

Harry Dent makes the same point in this graph below. Reading between the lines, he is projecting a stock market bottom about the end of this decade.

Don't just listen to the rhetoric, look at the data and make your own conclusions.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, September 17, 2012

Watch for storm clouds on the horizon

The financial skies are clearing and the storm clouds are dissipating.

The market likes to use the infantry analogy of the soldier against tank, so I'll stay with it: We thought that maybe Mario Draghi and Ben Bernanke would unveil bazookas. Instead, they each produced a radio and spoke the code word "unlimited" into it, which was the signal to call down carpet bombing air attacks.

Wow! Talk about beating expectations.

What's more, there is evidence of unit labour cost convergence in the eurozone (see An inflection point for Europe?).Even the French appears to be tackling their labour issues (see Hollande's Nixon in China moment?). Should this restructuring trend continue, it should alleviate many of the concerns about the productivity gap between North and South. The time that the ECB bought with OMT will be indeed valuable and part of the long-term solution.


Two dark clouds on the horizon
Even though skies are clearing, there are two dark clouds ahead that appear ominous for the investor, namely the fiscal cliff and the risk of a crash landing in China.

I am not that worried about the fiscal cliff. Most strategists have focused on its possible negative effects so the downside is well known. This is a situation where the market may not be prepared for a positive surprise where lawmakers craft a deal to kick the can down the road yet one more time. I refer you to Josh Brown's comment about "wealthy white people". While he was referring to Europe at the time, the principle applies to the Administration and Congress as well [emphasis added]:
But here's the part where I help you. Because while I have no special expertise or experience in forecasting the vicissitudes of core European diplomacy and socioeconomic policy, I do know white people. And I know wealthy white people, in particular. And wealthy white people, American or otherwise, can always be counted on to compromise at the last moment so as to preserve the status quo. And that compromise will typically involve whichever option is the least painful, even if it means that more work must be done in the future (the proverbial can-kick). And we know that euro printing, even if it means a bit of inflation for the German middle class to wrassle with, is probably worth it if the task is preserving the hegemony of the creditors, rentiers, landed gentry and aristocracy.

And so eventually, no matter how scary the headlines become or how volatile markets become in the short-term, you can expect a compromise that the wealthy and powerful elites (read: the markets) can live with. You can set your Swiss watch by it. Keep this in the back of your mind when the bullshit artists come on TV or puke their newsletters into your inbox. They are very intellectually intelligent, but they are also misanthropic social outcasts who do not and have not ever understood the way people work.

China is the wildcard
I am more concerned about China. The Chinese have taken steps to stimulate with the same-old-same-old techniques of infrastructure spending, instead of re-balancing growth to the Chinese consumer (see Buy Canada, sell Australia and China, beyond the hard/soft landing debate). These steps are creating tremendous stress in their financial system. Bloomberg reported that cracks are appearing in the Chinese shadow banking system:
China’s slowest economic growth in three years and a slumping property market, where many so-called shadow-banking investments are parked, are squeezing millions of Chinese who have invested the money of friends and acquaintances chasing higher yields to honor those payments. The slowdown also is putting pressure on the government to rein in private lending to avoid a spate of defaults that could increase the number of victims and lead to social unrest.   The shadow bankers are now disappearing, committing suicide or reneging on agreements, leaving thousands of victims in their wake. In the first half of the year, more than 58,000 lawsuits involving disputes over 28.4 billion yuan in private lending were filed in Zhejiang province, where Wenzhou is located, up 27 percent from the same period in 2011 and the most in five years, according to the provincial supreme court. One-fifth of the cases were in Wenzhou, where authorities have set up a special court to handle the surge.
The stresses are showing up in the official banking system as well:
Banks also are feeling the pinch. The industry’s nonperforming loans increased for three consecutive quarters through June to 456.4 billion yuan, the longest streak of deterioration in eight years, according to the China Banking Regulatory Commission.   Loans overdue more than one day jumped 27 percent in the first half at the nation’s five largest lenders, including Industrial & Commercial Bank of China Ltd., the country’s biggest, and Bank of Communications Co., according to data compiled by Bloomberg based on semi-annual earnings statements.
The current policy of growth at any price is putting the squeeze on profit margins (see Crouching tiger, hidden profit). The margin squeeze is putting additional stress on the Chinese corporate balance sheets and exacerbating the problems in the financial system. This is creating a negative feedback loop, where financial pressures are adding to operating pressures, which lead to more stress...

The adverse effects of the negative feedback loop is starting to show up in the political sphere. According to Ambrose Evans-Pritchard, China may be at risk of Tiananmen Square style turmoil [emphasis added]:
We all know by now about the simmering leadership crisis in China. The Bo Xilai affair has lifted the lid on a hornet's nest. I had not realised quite how serious the situation has become until listening to China expert Cheng Li here at the Ambrosetti forum of the world policy elites on Lake Como. (My hardship assignment each year.) Nor had anybody else in the room at Villa d'Este. There were audible gasps. 
The rifts within the upper echelons of Chinese Communist Party are worse than they were during the build-up to Tiananmen Square, he said, and risks spiralling into "revolution". Dr Cheng — a Shanghai native — is research director of the Brookings Institution in Washington and a director of the National Committee on US-China Relations. He argues that China's economic hard-landing is intertwined with a leadership crisis as the ten-year power approaches this autumn. The two are feeding on each other. "You cannot forecast the Chinese economy unless you have a sophisticated view of the political landscape and the current succession crisis," he said.
Malcolm Moore of the Telegraph wrote that incoming leader Xi Jingping, who recently disappeared from public view for about two weeks, was harshly criticized by party elders in early August and questions were raised about his leadership. The Politburo is split and the risk of a political rift is becoming serious.
Xi Jinping, 59, came under attack from party elders, who described him as "unreliable" and questioned whether he should be elevated to the pinnacle of Chinese power.

The attacks came at the beginning of August at a short and bad-tempered meeting in Beidaihe, a Chinese seaside resort, when senior party members gathered to negotiate and plan their once-in-a-decade leadership change...
"They called him unreliable and even brought up the idea of significantly delaying the party congress," said the source. "The fight was so harsh that Jiang Zemin [the former president] had to mediate."
Evans-Prichard added that the political uncertainty has resulted in capital flight [emphasis added]:
The worry is that the transition could go badly awry as 70pc of top cadres and the military are replaced, the biggest changeover since the party came to power in the late 1940s. "That is what is causing capital flight. All the top officials are trying to get their money out of the country," he said.
The local money has been selling while the foreign money has been pouring into Chinese equities, according to Bloomberg. Ask yourself this: Who would you consider to be the "smart" money and the "dumb" money here?

International money managers are lining up to buy stocks in mainland China at a record pace, even as a third year of equity losses spurs local investors to empty trading accounts like never before.

While overseas firms were granted $6.9 billion of quotas to purchase mainland securities since December, more than in any full year since the government program began, the number of Chinese stock accounts containing funds dropped by 788,000 to 56.3 million in the year to Aug. 3, the most for a 12-month period. A record 110 million are empty or frozen, according to regulatory data compiled by Bloomberg.

The Chinese banks as the canaries in the coalmine
This isn't going to end well for China, but these kinds of things have way of not mattering to the market until they matter. I am closely watching the price behavior of the Chinese banks listed in HK for signs of that the stress is becoming too much:
None of the shares of Chinese banks are showing signs of panic. Take, for example, the price chart of China Merchants Bank. I am watching for signs of price weakness. In particular, signs of the violation of multi-year support. Should the stresses in the financial system become serious by falling to all-time lows, then it will be the market's signal that the systems is either on the verge of, or undergoing, a Lehman/Creditanstalt style implosion.

China Merchants Bank (3968.HK)


In the meantime, both the Fed and ECB are hosting a gigantic block party. There's lots of free food and drinks. I am sure that even the Chinese will be there. Go on and enjoy yourself. Just don't get so drunk that you get caught flat-footed when the cops raid the place.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Thursday, September 13, 2012

Hollande's Nixon in China moment?

The Germans have blinked. In the last few weeks, Angela Merkel's acquiscence to more aid and more flexible aid terms for troubled eurozone countries have become clear. The Washington Post reports:
In both words and deeds, Merkel has in recent weeks signaled a willingness to embrace more-radical steps in the race to save the euro while sounding a more conciliatory note on the plight of Germany’s troubled neighbors. Her newfound pragmatism, observers say, could prove decisive in resolving a debt crisis that will mark its third anniversary next month.

She justified her volte-face to the German people by embracing Europe:
“European integration has allowed a dream of earlier generations to become a reality,” Merkel says in a video spot that is part of an “I Want Europe” campaign launched last month by corporate and cultural foundations here and aimed at frugal German taxpayers who are increasingly skeptical about the price they are paying to save the euro. Her words also seemed to harbor a message for other Europeans worried about growing German authority. “We have it to thank for our peace, our prosperity and our good understanding with our neighbors.”
As I wrote before (see An inflection point for Europe?), Merkel has managed to isolate the hardliners at the Bundesbank with the likes of ECB board member Joerg Asmussen. Another reason for optimism is the convergence in labor costs between the north and south.


Now it's France's turn
Perhaps this is all orchestrated, but the French seem to be bending too. French president Hollande addressed his nation on TV last Sunday to outline his economic plan for France. Much of the measures were to be expected from a left-of-center president, namely the refusal to shrink government staffing and tax increases:
Hollande said last week that by holding state spending steady next year in nominal terms, excluding debt servicing and pension payments, his government would save 10 billion euros in inflation-adjusted terms.

However, that would amount to just one third of the more than 30 billion euros in savings which Hollande says are needed to hit next year’s deficit target and stay on course to balance the budget by the end of his five-year mandate.

With his government refusing to cut staffing levels, the bulk of the adjustment will have to come from tax rises.

He said the remaining 20 billion euros would come from tax hikes on companies and wealthier households.
What was a surprise was his promise to take on the unions [emphasis added]:
Hollande said he expected unemployment, which is at 13 year highs, to begin to fall within a year as his proposals to create 80,000 subsidized jobs and to hire 60,000 people in the education sector as well as a so-called "generation contract" to encourage companies to hire young workers kicks in.

The new Socialist head of state has tried to break from his predecessor Nicholas Sarkozy’s pushy manner, promising to consult with social partners but gave unions until the end of the year to reach a "historic compromise" on labor reform or said the government would act unilaterally.
Hollande, being a socialist, is in a much better position to take on the unions than the right-wing Sarkozy and this may be Hollande's Nixon goes to China moment. Another signal of this shift was the release of a government study on PSA Peugeot:
French auto giant PSA Peugeot Citroen was Tuesday warned it must restructure urgently and tie up with a global group after posting sweeping losses due to strategic errors over two decades.

A damning government-sponsored report said Europe's second-biggest automaker after the VW group and which recently entered a limited alliance with General Motors of the United States, had missed the bus on globalisation.
Like Merkel, the French government has done an about face on its "core values" [emphasis added]:
The report was commissioned by the new Socialist administration of President Francois Hollande against the background of a plan by the group to close a landmark plant north of Paris and shed 8,000 jobs across France.

French Minister for Industrial Renewal Arnaud Montebourg, who had attacked the job cuts and PSA's corporate strategy, had conceded that it was "really in trouble" and needed "restructuring," a union official told AFP.

Franck Don from CFTC union said Montebourg would propose tripartite meetings between the state, union officials and the management to "review" the mass lay-offs and other plans.

"Therefore his position in July has been totally forgotten," he said.
All of these political shifts appear to be part of the Grand Plan outlined by ECB president Mario Draghi in a WSJ interview in February 2012. Certainly, Hollande's "generation contract" to lower youth unemployment sounds like a version of the Grand Plan, albeit with a French flavor. Back in February, Draghi sounded off on the structural rigidities of the European labor market that was creating a lost generation of young people [emphasis added]:
WSJ: Which do you think are the most important structural reforms?


Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.
He went on to say that the European social model was dead:
WSJ: Do you think Europe will become less of the social model that has defined it?

Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.

WSJ: Job for life…

Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.
One of the key steps to the death of the social model is to take on the unions. If French president Hollande is indeed taking steps to tackle that task, then it does represent progress in fixing the structual problems of the eurozone.


Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Wednesday, September 12, 2012

Momentum + Bull market = Chocolate + Peanut butter?

There has been a fair amount of research devoted to the effects of price momentum. I came upon a paper by a team of researchers at Cass Business School entitled The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation (h/t Mebane Faber). The abstract reads:
We examine the effectiveness of applying a trend following methodology to global asset allocation between equities,bonds,commodities and real estate.The application of trend following offers a substantial improvement in risk-adjusted performance compared to traditional buy-and-hold portfolios. We also find it to be a superior method of asset allocation than risk parity. Momentum and trend following have often been used interchangeably although the former is a relative concept and the latter absolute. By combining the two we find that one can achieve the higher return levels associated with momentum portfolios but with much reduced volatility and drawdowns due to trend following. We observe that a flexible asset allocation strategy that allocates capital to the best performing instruments irrespective of asset class enhances this further.
The academic researchers focuses primarily on the combination of price momentum factors with trend following models, but I came at it another way. Why does price momentum work?


My own momentum study
I reproduced the research of the Cass researchers but using a six-month price momentum factor (they used 12-months, but the results were similar) to form a portfolio of the top 3 sectors using sector ETFs within the 10 SPX sectors and benchmarking their performance against an equal-weighted benchmark of the 10 sectors. The 10 sectors are:
  • Consumer Discretionary
  • Consumer Staples
  • Energy
  • Financials
  • Health Care
  • Industrials
  • Materials
  • Technology
  • Telecom
  • Utilities
The study was conducted for the period from December 1999 to August 2012. The chart below shows the relative returns of the momentum portfolio against the equal-weighted benchmark.



Price momentum worked over the study period, but its relative performance is highly volatile. In particular, price momentum returns were particularly negative during bear markets.
   

Trend following models as a bull/bear market filter
If price momentum performs poorly as a selection factor during bear markets, then there a simple technique of filtering out prolonged bear markets. The technique is called trend-following. Josh Brown recently made some sensible comments about trend following systems as a source of risk control [emphasis added]:
A lot of guys who run money tactically make some use of the 50-day and 200-day moving average crossovers as their signals to buy or sell whole chunks of equity exposure for the clients. Which is good, not great. We pay attention to some of that but we certainly aren't living and dying by it absent other inputs.

There are no fool-proof timing signals that "always work" - at least that I'm aware of - but even having any discipline and systematic risk management approach is often better than none at all. Some of the simpler moving average crossovers have been shown to have saved people a lot of aggravation in 2008 (they had you out of the way when applied to the major indices, for example) but they don't always get you back in when you should be. They also are plagued by false signals and headfakes - just like any other system.

To demonstrate, I applied the following 50 and 200 day moving average trend following system to the SPX from 1950 to the present, using the following rules:
  • Buy when Index is in an uptrend, defined as the index greater than the 50 day MA and the 50 day MA is greater than the 200 day MA.
  • Otherwise, hold cash.
I made a number of simplifying assumptions:
  • Signals are generated at the end of day
  • Trades are done at next day's closing price
  • There are no trading costs
  • No dividends are paid
  • 0% paid on cash
The chart below shows the results of this simulation. The blue line represents the cumulative return of the buy-and-hold benchmark and the red line the trend following system. The trend following system didn't beat the returns of the buy-and-hold benchmark, but it controlled risk better. The major benefit of these models is they allow better risk control - they allow the investor to avoid the ugly drawdowns that accompany major bear markets.

In effect, these systems are filters for bull and bear markets. Investors who use them can cut losses quickly and allow winners to run.


Price momentum in trended markets
If price momentum acts well in bull markets and badly in bear markets, can using a 50/200 day moving average trend following system help?

The answer is an emphatic yes! The chart below shows the relative returns of the price momentum model as applied to the 10 sectors described above, when the market is in an uptrend, neutral trend and downtrend. As you can see, price momentum works beautifully for sector selection in trended up markets; results were slightly positive in neutral trends; and negative in downtrends.



Conclusion: Price momentum and bull markets go together like chocolate and peanut butter*.
* If you like that kind of thing.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.  

Monday, September 10, 2012

Party on! (but watch out for the cops)

In my last post, I wrote that dissecting the market's reaction to news was in some ways more important that the news itself (see Watch what the market does, not what pundits say). The preliminary verdict of the market from Friday's NFP release is clear, party on!

The signs of a cyclical turnaround were already in place. Now we have central bankers, first the ECB (and most likely the Federal Reserve next week), throwing a giant party.

The signs of a cyclical upturn were there if you were watching. The chart below of the relative returns of the Morgan Stanley Cyclical Index against the market bottomed out in late July and began turning up in August.


Likewise, commodity prices displayed a similar pattern of ending a downtrend and starting to turn up.


Indeed, JP Morgan economists (via Business Insider) have written a note indicating that global growth is bottoming and on the verge of an turnaround:
With this week’s August PMI release and new information on July activity, the DFM-Eco index estimate of current quarter growth rose to 1.8%. Interestingly, the rise in our nowcaster is driven by July activity readings that were stronger than what was anticipated by the July PMI. The index estimate is now in line with our bottom-up forecast (2%) that looks for a stabilization of global growth this quarter.

With growth bottoming, attention now turns to assessing whether private sector behavior and policy stances are aligned to deliver the modest lift built into the forecast. Our forecast does not expect much in the way of growth, with global GDP expected to accelerate only a touch to a still-subpar 2.4% annualized pace in pace in 4Q12. In this regard, the recent data have been mixed, raising more “maybes” than certainties. The news from consumers remains upbeat. Our estimates of current quarter global consumption growth was lifted again this week as July readings were firm and auto sales reports for August surprised to the upside. Although less broad-based, it appears that the pace of global inventory accumulation has slowed.

A rally on the horizon
Now we have the extra "juice" provided by central bankers to jump start the global economy. The anecdotal evidence from trading desks was a rush for risk. I had heard from multiple sources that, in the last few weeks, institutions had begun to fret that they had too little beta and were looking for to buy more risk.

Bloomberg reports that Lazlo Birinyi is forecasting more stock market gains as the bears capitulate:
More gains are likely as bearish investors give up and start buying, according to Laszlo Birinyi, president of Birinyi Associates Inc. in Westport, Connecticut.

“They realize it isn’t working,” Birinyi, an equity trader for Salomon Brothers Inc. in the 1980s, said in a telephone interview. “The excuses of no volume and earnings aren’t going to be good -- that’s not happening, and maybe it’s time to join the party.”
The European market action late last week was convincingly bullish. Equities melted up on Thursday in response to the ECB announcement and the follow-up strength on Friday was equally impressive. The combination of overly bearish positions in institutional portfolios and a sea change in risk appetite suggests to me that this rally is sustainable until at least the American elections in early November.


Wait for an entry point
I had expressed the opinion that the leadership was going to come from Europe (see An asset inflation signal) and I have been fortunate in my timing so far. For investors who missed the initial surge, I would be inclined to wait for a pullback before initiating (or adding) to European positions.

Consider the chart of the Euro STOXX 50 below. We just saw a bullish 50/200 day moving average crossover, otherwise known as a golden cross, on the index. Despite this intermediate term bullish signal indicating an uptrend, the short-term picture shows that the index is nearing trend line resistance from which it is likely to pull back. These conditions are indicative of some near-term weakness that could form the basis of a better entry point in the next couple of weeks.



I also indicated that the source of inflation was coming from Europe and referred to the CRB Index priced in euros. An alert reader wrote me to watch the euro-denominated gold price as well. While the USD denominated gold price, seen below, recently staged an upside breakout from a downtrend, which is constructive for bulls...



...the euro denominated gold price appears far more bullish as it is challenging resistance at its all-time highs. As with these key tests of resistance, I would expect that it would initially fail at resistance on its first try, which would be a useful entry point for the risk-on trade, and more likely overcome resistance on later tries.




A true turnaround or more "kick the can"?
As well, consider these relative performance charts of peripheral country equity markets compared to Germany. The IBEX (Spain) vs. DAX (Germany) chart, shown below, shows that Spanish stocks have rallied through the short-term relative downtrend to German stocks, but the long-term relative downtrend remains intact.



You can see a similar picture for the MIB (Italy) vs. DAX (Germany):


I have two conclusions from these charts. First, there is considerably more room for the peripheral markets to rally against the safe haven markets, such as Germany. This indicates that there is more room for the risk-on trade to run, which is consistent with the stories I heard from the trading desks (see above).

The longer term picture is more clouded. However, I had written about labor cost convergence in the eurozone as a long term positive (see An inflection point for Europe?) and Gavyn Davies highlighted the same issue in an FT column:
Spain remains the critical case. The ECB’s willingness to provide liquidity to a country like Spain is probably greater than the IMF’s willingness to help countries in earlier crises, but it is still limited by two factors. The first is Germany’s capacity to acquiesce to higher Target 2 credits. The second is the ECB board’s willingness to accept greater exposure to the Spanish sovereign on its balance sheet. Either of these factors could mean that the ECB’s tolerance for providing greater liquidity might not last for as long as is necessary for Spain to become self financing in private markets.

How long might that be? As in the case of previous IMF crisis interventions, that will depend on the market’s view on Spain’s competitiveness (or implied real exchange rate) within the euro area. The good news is that Spain has in fact improved its competitiveness markedly in recent years, as a result of the reductions in labour costs which have accompanied the recession and structural reforms in the labour market:


These improvements in Spain’s real exchange rate are probably greater than the markets have realised. The current account deficit should be eliminated in 2013. Admittedly, that deficit would soon re-emerge if Spain brought its unemployment rate down to more normal levels from the current 25 per cent rate, but Spanish labour costs are still improving quite rapidly, relative to the eurozone average, on an ongoing basis. This is encouraging, because it implies that the ECB’s provision of liquidity might not need to be as open ended in as the market currently fears.
If the eurozone can indeed conquer these long term challenges, then watch for a similar kind of convergence between the periphery equity markets and Germany. The long term relative downtrend should not pose a problem.

On the other hand, should the ECB's actions be another kick the can down the road exercise, then the rally in European equities will prove to be ephemeral.

In the meantime, the ECB (and likely the Fed) is throwing a big party. So don't worry and party on, but don't forget to watch out for the cops should the merriment get out of hand.




Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.