Right now we think it highly likely that going forward we see an increase in the rate of economic deterioration.  Europe is already in a mess but the economy in the United States is now showing signs of its last gasp of growth.  One indicator that we track is the Citi Economic Surprise Index.  In the chart below you can see that economic numbers have been coming in very strong for the past few months.  Based upon previous history it is safe to say that we have peaked or are very near peaking and that economic numbers going forward should start to turn lower.

Citi Economic Surprise Index USD and G-10

Not only are economic numbers expected to turn lower but we are also seeing several signs that inflation is dropping.  One relationship that we follow closely is that of the CRB Raw Industrials Index against the SP500.  As you can see in the chart below the two are usually very correlated.  When the industrials are moving higher stocks usually follow and when they turn down stocks tend to do the same.  Right now there is a disconnect, one that we expect to be resolved with the SP500 moving lower.

CRB Raw Industrials Index and SP500

This relationship matters because if inflation moves lower the stock market will as well.  We can see this very clearly in the next chart where we have overlaid the weekly SP500 with the 10-Yr TIPS breakeven rate.  As you can see these have a very tight relationship.  What you can’t see is that this relationship goes back long before the crisis.  When inflation expectations rise the stock market rises and when they fall the market falls.

SP500 and 10-Yr Breakeven Rate

Other signs that inflation is not upon are that government bond yields are hovering around historic lows.  As you can see in the next chart the 2-Year Treasury yield has been low and headed lower.  Despite all the hype regarding hyperinflation we have not seen any of it, and based upon the messages from the bond market we are not seeing it anytime soon.  In case you are wondering we are seeing the same thing farther out on the curve with 10 and 30 year yields also near their lows.

2-Yr US Treasury Yield

Another sign that we have been following is this chart of the Shanghai composite and the CRB index.  As you can see the two indexes peaked within two weeks of each other and have been steadily working their way lower for the past eight months.  As the nation of commodity stockpiling has slowed down so have their stockpiles.  As this huge underlying commodity bid has vanished it has allowed industrial commodities to drop.

Shanghai Composite and CRB Index

Whether it becomes an all out crash, ala 2008, or not is not known but we are confident that the global slowdown will continue.  So what have we done with this view?  In our model portfolio we are short the AUD/USD as we expect the Australian Dollar to move lower as commodity prices and Asian demand continues to falter.  We are short the EUR/USD via options in a trade we placed back in August.  Recently we bought the USD/CHF as we expect the Swiss Franc to weaken considerably from here.  We are also short the SP500 via options and long the Lehman/Barclays Aggregate index which is highly weighted with US Treasuries and investment grade credits.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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While the crisis in Europe and the slowdown in the United States seems to get all of the attention lately, the other big story is of course China.  China has been a leading indicator for global markets for some time now and as you can see in the chart, and hopefully have noticed for some time now, they peaked over a year ago.  We are seeing the same signs in raw materials such as copper and oil just as we are seeing them in everything but US Dollars and US Treasuries.  Until we see a firming up in either the US, Europe, or emerging markets most notably China we won’t be seeing a lasting rebound in global equity markets.

Shanghai Stock Exchange and SP500

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Many new traders spend a lot of time looking for the holy grail of trading.  The secret Gann angle, the right wave count, the perfect valuation model, etc.  What we have found is that while a lot of new and even old traders spend countless hours searching for the holy grail very few, if any, successful traders have found it.  Instead they figure out at some time or another that instead of a magical tool they should spend their time looking for useful tools that do a reasonable job of either lowering risk, increasing return, or increasing their hit rate.

One tool that we have found useful in looking out towards the future is that of the ECRI Weekly Leading Index.  While by no means a holy grail it has historically done a fairly good job at forecasting stock market returns.  As you can see in the chart below it has been very accurate over the past few years as it has led the SP500 by several months at important turning points.  (Click on chart to enlarge)

SP500 Year Over Year % Change and ECRI WLI Growth Rate

So what is the WLI saying right now?  Going along with our long held deflation thesis the WLI is now pointing towards slower growth in both the economy and particularly in the so-called “risk markets”.  This of course matches what we are seeing in several other indicators and relationships that we follow.  We have covered a few indicators in previous posts such as how junk spreads point to higher unemployment claims and how the PMI is pointing towards slower growth.  In addition to these we are seeing many other signs such as the drop in commodities, take a look at the CRB Raw Materials Index, and in the rise of the US Dollar.  Of course none of these are holy grails, just signposts in the fog.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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We saw this headline-

August is another cruel month for hedge funds-(Reuters) – Most hedge funds lost money again in August as hundreds of managers, including some of the industry’s best-known names, stumbled when stock markets swooned anew.

-and then we laughed.

Hedge Funds are no more an asset class than mutual funds are.  There are several “general” classes of funds investing in anything from stocks to bonds to art.  Long, short, long and short, arbitrage, levered, etc.  There are a gazillion different strategies that are employed so headlines like the above are not helpful for much more then a useless sound bite.  But onto the part that we actually liked.

One line mentioned how Global Macro was up 2.16% for the month of August which would indicate something less then cruelty for hedge funds, including some of the industry’s best-known names, but hey that’s just us.  Anyways how is Global Macro actually doing?  Well depending upon which macro index you use the numbers will be a bit different but for the most part this specific corner of the market is flat give or take a percent or so.  While we, we being our newsletter The Macro Trader, do not try and hug our benchmark it would appear as though this year we have.  In the table and chart below we show how our newsletter had done against the HFRXM and SP500 indexes.  The table has the raw numbers and the chart has the performance of $1,000 year to date. (Click on charts and tables to enlarge)

Performance

$1,000 Invested Year To Date

How do we explain our relatively high correlation to the HFRXM Macro Index?  Well we think that the next chart probably does a good job of answering this question.  But in case the chart is not clear enough the answer is risk management.  Global macro as an asset class has long held up well in any market with a penchant for bad markets.  In other words we tend to outperform in bad markets and do decent in good markets.  In the chart below you can see how our drawdowns compare to the SP500. (Click on chart to enlarge)

Drawdowns Year To Date

A few other observations that may or may not have anything at all to do with the initial subject of this post-

-We have seen few opportunities this year that have warranted an oversize allocation

-The SP500 is way to risky for the returns that it generates

-If markets are efficient how was the SP500 above 1250 for almost a year and then at 1100 a few weeks later

-There is no reason that you need to do what everyone else is doing

-Bill Gross is smart but he too can be wrong

-Warren B is also smart and can also be wrong

-95% of news is noise but we read it all in hopes of recognizing the 5%

-Anyone with the nickname Helicopter Ben is just looking for reasons to drop money from the sky

-If you aren’t at least semi-comfortable in Excel there is a high likelihood that you do not even know what due diligence is

-It is clean looking but so far Google+ is not Facebook

-More Money Than God is a great book

-The New Market Wizard interview of Stanley Druckenmiller is read by this author at least once every month or two

-Major bottoms and tops take more then a few days to form

-Yellowstone is awesome and everyone in America should go at least once every five years

Have a great Labor Day Weekend!!!!!!!!!!!!!!

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long Friday both the day and the excellent song by Rebecca Black .

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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One group of indicators that we follow quite closely are yield spreads.  They work as great risk indicators as well as  economic indicators. In the case of junk spreads they tend to lead rather than coincide or lag the overall economy.  One area where they really shine is at the darker end of the economy.  As you can see in the chart below junk spreads tend to lead the initial unemployment claims by anywhere from two-five months.  For the past four months junk spreads have been inching higher and higher as the economy has noticeably weakened.  What does this mean?  Well if the correlation holds up then we would expect initial claims to move higher.  This would go along well with most of the indicators that we are seeing such as the various manufacturing indexes pointing lower, with the exception of the Chicago PMI, as most indicators whether economic or market are pointing to a weaker economy. (Click on chart to enlarge)

Junk Spreads and Initial Unemployment Claims

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries and Gold.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Remember the anti-drug commercials with the frying pan and the egg?  As of late it would appear as though investors have forgotten that you are supposed to say NO to drugs, especially during market hours.  In the chart below we have a rolling 21-Day Standard Deviation for the SP500 as well as the 50-Day moving average of that number.  On a one month basis we are at the second highest reading in over 10 years, second only to the crash of 2008.  Looking at the smoothed 50-day moving average we are actually at a new high. The close to close movement is running at an average of 2.34%. (Click on chart to enlarge)

SP500 Rolling 21-Day Standard Deviation

How can you use this information?  There are a few trading strategies you can investigate from this such as selling options or putting on some arbitrage positions betting the spreads will come back in.  For most investors however the more important thing to see here is that risk management is not only paramount to your investing/trading but it is a moving target.  As a general rule when volatility is high, or extremely high as the case may be, you would want to look at using relatively loose stops, scaling down your position sizes, lowering your leverage, raising cash, etc.  While most, maybe all, long time traders already use good risk management we have found that far to many new traders don’t adjust their trading when the market gets stoned.   Consequently they lose far more money then they have too.  Following tools like this can help you to smooth out your returns and stay in the game.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We always use risk management and own the domain name riskfreak.com.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Despite the countless hours spent by the media talking up the debt ceiling debates and its effects on financial markets the real concern amongst actual investors has been the prospects of actual economic growth.  As we have stated in the newsletter as well as in previous posts on the blog we do not think, and bond yields have agreed, that anyone is actually scared of a default.  So despite the misguided hand of the media bonds and other financial markets are moving based upon future growth potential or the lack thereof.

On Monday we got a PMI number that came in not just low but drastically lower than expected and very near the negative growth line.  The PMI index is a diffusion index meaning that if it is above 50 then the manufacturing sector is growing and if it is below 50 then the manufacturing sector is contracting.  So how bad was the number?  Well last month PMI came in at 55.3 and this month it came in at 50.9 which means that manufacturing is barely above the zero line.  You can see the drop more clearly by looking at the chart below. (Click on chart to enlarge)

ISM PMI

As you can see the drop from the February peak reading of 61.4 has been fairly steady and swift as the manufacturing sector has been slowing down despite many economists expecting strength in the economy and a continued recovery.  Of course as long time readers know we have been less than impressed with the economy ever since the bottom back in March 2009.  The market rebound was impressive but the real economy has been very mediocre.   All this has weighed heavily on the markets as of late and since February bonds have been moving higher.  At the same time and with the help of he sideshow in Washington the stock market has taken a hard and swift hit as of late and is starting to get more in line with the actual economy.

One chart that we like to follow is that of the SP500 year over year growth rate overlaid with the PMI data.  As you can see the PMI is a good rough business cycle indicator.  While not perfect by any means it does a great job of tracking what the market is expecting in the medium term.  As you can see right now the PMI is pointing lower and it seems as though stocks are following its lead. (Click on chart to enlarge)

PMI and SP500 YoY % Change

Right now many of our economic indicators are saying to lighten up if not exit equities all together.  While this has been the case for a while the market via trend, breadth, and sentiment is coming around to the same conclusion, and that is that the economy is weak and prospects are not good for a favorable risk to reward environment.  Do you really want to sit in a market hoping to eek out meager gains of maybe 5% over the next year but with potential and relatively likely downside of 15-20%?  We don’t and instead have been going into assets that do well in times of slow economic growth.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT and also hold some small long positions in US equities.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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The following was sent to subscribers Tuesday night but is still entirely relevant to the current market.

In a paper entitled “An Exploration Of The Nature Of Bull Market Tops” by Lowrys Research written in 2006 we learned that in previous stock market tops the day of the top saw only a few stocks in the major indexes hitting new highs.  Most of the constituents were down and many were down more than 20% from their highs.  Contrast that to major bottom when almost all the stocks are at or near their lows.

That brings us to Tuesday the 26th when the NASDAQ 100 hit a new high.  How many stocks closed at new highs?  If you answered three you are right.  How many are at least -10% off their highs?  If you said 51 then you are once again a winner.  And what about stocks that are at least -20% off their highs?  That answer is 19.  So almost 20% of the index is at least -20% off their highs, 51% of the index is at least -10% off their highs, and only 3% of the index is at new highs.  The average stock in the NASDAQ 100 is off -12.76% from its 52-Week High.  Is that the sign of strength that you were looking for?

Lets look at another index that should be a harbinger of things to come in the economy the SP100.  Also known as the OEX the SP100 is the mega-cap index that looks at 100 of the largest companies in the SP500.

With the SP100 trading just -2.3% off its cycle highs how is the breadth here?  Is the NASDAQ 100 just experiencing a tech sell off or is it more widespread?  Well 39% of the SP100 is off at least -10% and 9% is off at least -20%.  A better showing than the NASDAQ 100 but not exactly New Highs R Us either.  How many of the stocks hit new highs Tuesday?  Only Apple.  The average stock of the SP100 is off   -9.35%  from its 52-Week High.

In the following table you can see the NASDAQ100 and the SP100 side by side.  In the 52 Wk High column you will see the 52 week high on a close basis as of Monday the 25th.  In the % From 52-High column you see how far off the 52-week high the stock is.  In the case of AAPL and a few others they are blue and have positive reading denoting a new 52-week high made on Tuesday the 26^th.  Finally at the bottom is simply the max and the min for each index.

SP100 and NASDAQ100 52-Week High Table

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We have very light long exposure to equity markets right now.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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During the crisis you may remember that everyone started following the TED spread.  Where one year earlier only investment professionals even knew what it was during 2008 it seemed as though everyone and their dog were experts on all types of credit market indicators.  Well now that we haven’t seen anything in the news talking about the TED or other money market spreads for months, in a contrarion way it is probably a good time to pay attention to them.

In the chart below we have the TED, LIBOR-OIS, and Commercial Paper-T-Bills spreads overlaid.  As you can see they started to trend up a while back and that trend is still in force.  So is it the end?  Is the United States defaulting tomorrow?  No, nothing like that.  Instead it is a sign that investors are starting to acknowledge that all is not rainbows and butterflies and that there are some risks out there.  At current levels none of these spreads are saying anything other then that liquidity has tightened up a bit, but only a bit.

Money Market Spreads

So what to make of this?  Only that we need to start getting more cautious.  The Fed liquidity bull is slowing down ever so slightly as QE2 nears its end and that may bring with it rising volatility in the markets.  For now however the trend is up and new liquidity is being injected every few days, consequently we are long and medium term bullish on the risk trade.

Happy Trading,

Dave@TheMacroTrader.com

P.S.-We have obviously not posted to the site in some time and aim to correct this.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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First a bit of a disclaimer.  Most of the time when you see port data you are looking at Long Beach and/or Los Angeles as no other port in United States releases their data on a monthly basis.  That being said LA and LB account for almost 50% of all port traffic in the United States.  Finally this port traffic is comprised almost entirely of trade with Asia whether it be China, India, Thailand, Mongolia, etc.  If it ships from Asia it usually finds its way to one of these ports.

So what is port date showing?  Well at first glace the chart below shows that over the past few months trade has fallen off a cliff.  On further review however you will notice that there are very pronounced seasonal tendencies in port data.  From November through February each year port traffic slows down considerably.  That being said you can still see that even with the seasonality factored in, that trade is nowhere near where it was pre-crash.

Combined LA and Long Beach Port Data

The green line represents all trade both imports and exports.  It has yet to make a new high and is currently in a free-fall.  The blue line represents imports and it looks even weaker as it has yet to make a high since 8/1/06.  This tends to show that not only are we as consumers not consuming quite like we were but companies are not ordering like they were.  The much vaunted inventory rebuild of the past year was barely enough to take import levels back above the high in 2008.  Finally we have the red line which is exports.  In a way this number is actually looking the best as it is steadily climbing.   Still it is a long ways away from its peak formed in 8/1/08.

Port data is giving signals for a variety of things.  How does this impact China, India, and the rest of Asia?  How does this affect consumer discretionary stocks?  We know that Apple has almost all of these containers filled with I-Pads, I-Pods, and I-Phones   so who is not importing anything anymore?  How does this affect shipping stocks?  Why has the seasonality been so pronounced for so long?  Don’t corporate purchasers look at the data and try to game shipping costs by ordering a few months earlier?  And finally how is global trade going?  As we can see it has improved but have the markets gotten ahead of themselves?

These are all questions where port data can be used to arrive at a conclusion.  We are constantly surprised how few investors use these and other obvious, to us anyways, data points that can help you make an informed decision.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are long some stuff and short some stuff but none of it is directly related to port data.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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