Sunday, May 26, 2013

Could this Weekend be a Turning Point?

In the US, as in other countries on other days, Memorial Day is set aside to honor those that have sacrificed their lives in war to protect our nation and its citizens. In observance of Memorial Day, US financial markets are closed.

Watch global markets before US markets opens on Tuesday

As of this writing, the Japanese market is down -3.5%. One reason that the market is lower is that the Bank of Japan leader indicated it could tolerate a 3% yield.  Another reason the market is down is news that Chinese leaders have announced that they are willing to grow more slowly. At the moment, US futures and the price of gold are weakening slightly. Also the Australian dollar is weakening against the US dollar.

With the US markets closed on Monday and relatively thin trading in much of Asia, prices could trade freely with sharp moves both ways. Unless the afternoon session in Tokyo reverses direction, the results may not be pleasant by the time New York opens Tuesday morning.

Positive views

There are mixed implications derived from what I have seen this past week.  First, let me deal with the positives.

Shoppers shop

In almost all countries of the world retail shopping is by far the largest sport in terms of involvement and money transferred and thus well worth examining. The Memorial Day weekend is considered the unofficial kick-off to the summer shopping season in the US. In our community the weather on Saturday was cool and wet. When we went over to the Mall at Short Hills, a very glitzy place to do our indoor walking and getting a bite of lunch, parking was difficult. We encountered crowds with large shopping bags. (Other weekends some of the aisles within the enclosed mall and a few entire stores could have been profitably converted into bowling alleys.) We walked and had lunch and returned home for me to read. My champion “black belt” shopper of a wife went back to the Mall and ran into friends who were also shopping. When she left she should have auctioned off her parking space which was in great demand. Her competitive shopping eye reported that the crowd was approaching those at Christmas time. Perhaps it was the unseasonable weather or advertised sales prices from an investment viewpoint; the key was a lot of people were spending money at good prices.

Borrowers borrow

Another example of people making investment decisions is that the size of margin debt (borrowed money) has just exceeded the old record established in June, 2007. A number of retail brokerage firms have commented that the proceeds of this debt have not been put into additional securities investment. My guess is that an important portion has been in “non-purpose” loans, probably used for real estate purchases. The brokers point out that it is easier and involves less collateral to use futures, particularly on ETFs (Exchange Traded Funds). Nevertheless buyers are buying.

Cash is trash

One of the reasons people are being led into using securities for their spare cash or buying power is that cash has become increasingly considered trash in their minds. Almost every day I look at the average rate being paid on bank money market accounts. This week it dropped to the lowest level that I can remember of 0.46%. The central bank manipulators around the world are driving people into the market, but looking at the large amount invested in money market funds and bank accounts, there is a lot more remaining.

Incomplete gravity

After the considerable rise we have seen and benefitted from this year, many of us had expected a correction. Some have been waiting for this expected correction and keeping their trash/cash on the sidelines before committing to the pressures by the monetary authorities. Thus we had two consecutive down days on Wednesday and Thursday. But on Friday, with light volume, we had a minor up day. There are two remarkable observations to make. The first is that lower prices did not bring more sellers or an increase in buyers to the marketplace. The second item is we have not had three consecutive down days for the last 100 trading days. My friends at Caltech assure me that what goes up must come down according to laws of physics. Market technicians would generally expect a trading correction in the range of ten percent of the prior rise before a subsequent gain. For whatever reason investors, are not now ready to leave the party.

The best market timers are now bullish

In this week’s Barron’s my friend Mark Hulbert noted that in his long study of market timing newsletters the ones that have had the best record of correctly getting turns in the market remain very optimistic. From my standpoint what is more important is that the timers who have gotten the turns wrong are relatively reserved, with significant portions of their recommended portfolios out of the market. The reason I believe that being mindful of the laggards is more important than the good prognosticators being bullish is that in my continuing study of mutual funds and other managers it is not unusual to see good records lead to occasional bad results. There appears to be much more consistency in poor predictors staying bad. Finding negative predicators is very valuable indeed.

Mutual fund buyers are beginning to believe

My old firm, now known as Lipper Inc., which is an affiliate of Thomson Reuters, measures mutual fund performance and net sales around the world. Using the first quarter and reporting in euros, funds sold to Europeans in Europe had inflows of 116.5 billion compared with the US’s industry inflows of 155.4bn. Perhaps more important was the gain in Germany of 7.3bn which may be a retail leader for the continent. Large net inflows were seen in Thailand, 16.2bn and South Korea, 12.1bn (all in euros).

The first quarter numbers predate both the turbulence in the Tokyo market last week and the prior surge in Japan created by its adoption of a highly charged “QE” monetary policy, which in May probably brought a tidal wave of money into funds investing in Japan not only from within the country, but also from the US, Europe, and the rest of Asia. My guess is that judging by the rise in the Tokyo market (until this week) we are talking in excess of $50 billion in positive fund flows. All of these flows indicate that individual investors, along with institutional investors, recognize and want to participate in momentum wherever they sense it.

There are important negatives

When the Chairman of the Federal Reserve indicated that its staff has been directed to study ways it could ease off in its Quantitative Easing (QE) policies, the US markets caught a slight cold (under 2%), but the Tokyo market got pneumonia, falling 7% in one day.  This decline demonstrated how dependent Japan is on US Quantitative Easing and how thinly traded the Tokyo market is.

In his May 25th long economic letter, John Mauldin focused on what the current government of Japan is attempting to do with its extreme QE policies, which until this week was working both in the local stock market and Japanese exports. Mauldin is a believer that QE won’t work in the long-term in that Japan has fired the first official shot in a currency war that will be met with Asian and perhaps other competitive devaluations. His real fear is that it will work for awhile and allow Japan’s share of the world’s wealth to get much larger on the back of absorbing all of the savings in Japan. When that is not sufficient to grow Japan out of its twenty year deflation and as its enlarged bubble bursts, it will materially hurt the US and others. The title of his piece sums up his views: “The Mother of All Painted-In Corners.”

“The Ghost of 1994 Haunts Financial Markets”

The Ghost of 1994 Haunts Financial Markets is the title of Moody’s latest capital market research report. In the piece Ben Garber reminds us what happened to the markets when the Federal Reserve unexpectedly and sharply raised interest rates. This led to some of the worst performance returns on record. While the Fed is conscious of this fear and that may be why the astute President of the New York Federal Reserve Bank is stating that it would take the Fed a number of months to decide to raise rates and a further number of months to effect the change. My concern and perhaps others fear that the need to make a change could be sprung on the Fed by unforeseen events, they do happen. Moody’s is also a bit skeptical as to whether Japan can accomplish what it needs to do to get some growth out of its economy without both a US GDP expansion and the cooperation of the currency markets. These are wise concerns.

What should we do now?

My recommendation is for long-term oriented investors to continue with their current policies. For those that believe in managing accounts through asset allocation changes, I would urge you to average in and out of positions. For those that have to report results this calendar-year, going to large cash position could be prudent. I believe we are in an emotional news cycle that can stampede markets on a daily basis without much total new movement this calendar year. The year 2014 also looks problematic until we see who will chair various committees in the US Senate plus the actual new policies by the leaders in Germany and China.

Do you have differing views?
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