So far this year I think my most hated new term is “The Great Rotation”.  Supposedly stocks are moving higher as money is flowing from the overpriced bond market and into equities.  Since the term has gone ballistic, also known as annoying, we decided to look into it.

Here is a chart from Google Trends showing how search volume has gone crazy. Until the past few months it barely existed although it was moving higher into year end but more on that in a minute. (Click on chart to enlarge)

Looking at the performance of stocks versus bonds we can see part of the reason why the term was becoming popular.  Without reading too much into it stocks were moving higher while bonds were moving lower…..most of the time. (Click on chart to enlarge)

While stocks have indeed been outperforming bonds over the past few months the other side of the case for “the great rotation” was that money was coming out of bonds and going into stocks.  Well thanks to the ICI we have data that allows us to look at this idea.  Stocks funds saw a large increase in assets of 5.2% from December to January but Bonds also saw in increase in assets. (Click on table to enlarge)

We are not sure exactly where the rotation is here so we then broke down the weekly data to see if we could discern this rotation pattern in the data.  Well what we found was that year end and beginning of the year investment trends have a strong seasonal pattern.  Want to guess what the pattern is?  If you said mixed into year end and positive at the beginning of the new year then you win.  Here is the weekly data for equities from the beginning of 2007 to now.  We decided to show data from the beginning of October through the end of February in order to give the rotation argument as much rope as it might need. While 2013 has definitely seen the largest January flows  since 2007, the reality is that every single January sees positive flows.  (Click on chart to enlarge)

What about bonds?  Well we already spoiled that surprise earlier with the ICI table so you know that bonds saw inflows but guess what we found?  If you said seasonality you win…again.  Not surprisngly the past seven years have seen net inflows to bonds the majority of the time but the flows are a lot smoother at the beginning of the year as investors obviously put a lot of money to work each and every January. (Click on chart to enlarge)

Here is a chart of the cumulative in and outflows for both equity and fixed income funds.  As you can see bond funds have been the asset gathering champions of the past 6+ years as they have seen huge net inflows almost the entire time. At the same time equity funds have been net asset losers.  What of course sticks out to us is that over the past little while equities have indeed made some inroads but that there is zero rotation going on. Let me repeat that-there is zero rotation going on.  (Click on chart to enlarge)

We know that we have not accounted for ETF’s, Closed End Funds, Hedge Funds, etc.  but from the data we have seen, with one exception, we are seeing the same thing.  Namely that equities are getting more more money but that fixed income is still getting net new money.  What is the one exception?  We have come to the conclusion that the vast majority of the new money has come from two places: money market funds and all the special one time dividends that got paid out at the end of last year in anticipation of higher dividend taxes this year.

If you want to call a slight drop in assets in money market funds a great rotation go ahead but just know that you are full of it.  Which gets us to our last point, this is all marketing.  I don’t know where this meme originated but we would put money on it being from an equity shop that was sick of losing assets both in absolute as well as relative terms while the fixed income guys were killing it over the past six years.  We have not seen a slew of advertisements for the rotation yet but here is a classic ad that you can refer to anytime your broker, advisor, etc. calls you up with a pitch so that you maintain a healthy degree of skepticism. (Click on ad to enlarge) 

Stocks can go up or down while bonds go up or down and there can be great reasons to buy or sell either but “The Great Rotation” is not one of them.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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Lately we have been doing some research into stock buybacks and have come to a few conclusions.

-Probably the most significant finding is that share buybacks, using data on the Russell 3000 universe,  have resulted in almost $3 Trillion in shares disappearing from the market.  Want to know why we have declining trading volumes over the past several years with NYSE average total volumes dropping -52%?  The first culprit is not HFT but instead the great shrinkage in shares outstanding. (Click on chart to enlarge)

-Between companies buying back their shares, private equity taking companies private, as well as natural selection (at least where the government allows it) and you have several reasons why trading volumes are lower. There is less trading volume because there is less to trade.

-Sadly one aspect of share buybacks that didn’t really come as a surprise was how poorly companies are at valuing their shares.  Warren B has said in the past that buying back shares can be a good thing as long as you are not overpaying.  Well based on this it is safe to say that corporate America is indeed no Warren B.  Management apparently found their companies woefully undervalued at the top in 2007 as they repurchased record amounts of stock and then woefully overvalued at the bottom in 2008.  (Click on chart to enlarge)

-It would seem as though many executives have a hard time figuring out how to spend their cash or the debt that they have raised.  Instead of investing in their businesses they have decided to just raise the earnings per share by taking shares out of the market.  If they were doing it when their stock was cheap it would be a good thing but instead it points, at least to us, as a lack of ideas for real growth.

-Another interesting though maybe not completely surprising thing we found is that the buyback phenomenon is entirely a large-cap thing.  When we pulled data for the Dow Industrial’s we found that those 30 companies accounted for 44% of all $3 Trillion that we saw in the Russell 3000.  (Click on chart to enlarge)

-Breaking it down a bit further we found that if you take the top 50 companies by capitalization in the Russell 3000 they account for 52% of all buybacks.  The smallest of the top 50 is Northrup Grumman which is a $15.8 Billion dollar company.  While some smaller companies do indeed buyback their shares it is largely a large-cap thing.

-Another interesting thing we are looking at is where the buybacks are occurring.  Breaking down the cumulative buybacks by sector we can see that technology and financials have seen the majority of the benefits while utilities, telecom, and materials have seen almost none of it. (Click on chart to enlarge)

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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We track volatility across asset classes and throughout this year, especially the second half, have been amazed and the consistent volatility compression across assets.  Here is our Average VIX where we take a simple average of several different volatility indices.  Right now we are sitting at levels last seen in mid-2007 and we are struck with the complacency in the marketplace.(Click on chart to enlarge)

Are the potential risks really so small that no one finds it worthwhile to buy protection?  A short list of potential risks would be the sovereign debt issues, fiscal cliff, Europe, Japan, China, Italy, Middle East, etc.,we can almost literally go on forever.  Our current list of risks is as high as it has ever been and yet volatility is getting lower and lower from already low levels.   While the Bernanke put has some power we question whether it is really the holy grail of safety nets.  Just something to think about as we watch European stocks breaking out and US equities moving higher while at the same time Treasuries continue to catch a bid.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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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 .

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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.

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We follow several different types of indicators to include economic, valuation, sentiment, technical, etc. but one of the most important and powerful family of indicators would be monetary indicators.  Monetary indicators allow us to measure liquidity which of course affects all markets.  Historically some of the best gauges of liquidity have been interest rate trends, interest rates, margin debt, public offerings, money supply, etc.  One of the most powerful indicators is Fed policy and the tools it uses to put their policy into effect.  We have all heard the saying “dont fight the Fed” and while many market sayings are cliche this one carries weight.

During this cycle the Fed, in addition to its zero interest rate policy ZIRP, has been using quantitative easing to inject money into the economy in an effort to “prime the pump” and get people spending.  Unfortunately there is little if any evidence that any of this money has been finding its way to main street. Instead it has been going into financial markets and in the process has helped fuel some bubbles.  While the term bubble has been overused as of late we are using it in the sense that without QE1 and QE2 most financial markets would be a lot lower then they are today or a few weeks ago.

All of this brings us to the current situation.  As you can see in the chart below whenever the Fed is actively buying or selling securities the market goes up or down.  From mid 2005-2007 the Fed was buying small quantities and the market, already in an uptrend, continued higher with muted volatility.  Later during the early stages of the crisis, and after the Bear Stearns breakdown, the Fed decided in all its wisdom to sell some of its securities taking liquidity out of the market at the exact time that they should have been adding it.  While not the cause of the crash it did further enable it.  In early 2009 the Fed began QE1 at the same time that the government passed TARP.  Between these two massive stimuli the market was able to shoot higher.  While the argument can be made that the pump was primed and brought investors back into the market it is hard not to notice what happened once the Fed stopped buying.  As you can see the correction in mid 2010 coincided with the end of QE1.  As this correction got going and with the backdrop of high unemployment and a still sluggish economy the Fed embarked on QE2.  As you can see the market once again started to move higher.  Well guess what?  Since the Fed stopped buying the market has consolidated and as you have likely noticed over the past few weeks has started to crash moving down 18% in just two weeks.  (Click on chart to enlarge)

POMO and SP500

While it is true that there are other factors at work it is obvious to everyone except maybe the Fed that they have been the buyer and until the economy really does improve the risk markets will fall anytime that they back away.  With the statement earlier this week that the Fed is going to maintain a ZIRP until at least 2013 we are also led to expect an eventual announcement of QE3.  While we don’t think that it will help the economy and might actually hurt it, we do think that in the framework of Helicopter Ben’s mind this is the only course of action.  If we break lower by 5-10% expect the Fed to come out and announce another round of purchasing.  Oh and one more thing, don’t fight the Fed.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT  and gold via GLD.

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.

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Click on chart to enlarge

Nikkei and NASDAQ (NASDAQ is set 10 years and 2 months back)

Happy Trading,

Dave@TheMacroTrader.com

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

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As of late we have heard a lot about how sentiment was too bearish and that this justified the market rally.  While we no doubt got a rally, we have to question the idea that sentiment is overdone to the downside.  In the world of sentiment indicators there are more then a few ways to look at things.  You can look at polls like Investors Intelligence or the AAII numbers, you can look at anecdotal indicators like covers at the magazine rack or listening to your shoeshine boy, and finally you can look at market derived indicators.

Looking at poll data alone would have you thinking that either the world is coming to an end or that we are due for a large counter sentiment trade.  The first chart here is of the Investors Intelligence Bulls to Bears ratio popularized by Marty Zweig.  As you can see in the chart it is hitting lows not seen since 2008.

Investors Intelligence Bulls Bears Ratio

If you want an equally extreme way to look at it below is a chart of the Investors Intelligence percent bears.  As you can see we are spiking to new highs not seen since the dark days of 2008.

Investors Intelligence Percent Bears

Looking at just these two charts makes the trend followers short and happy, and the contrarian leveraged long.  Of course we have a lot more tools at our disposal then just the Investors Intelligence poll data.  We like to check the poll based data against the market based data to see if it is inline with what investors are actually doing.  Usually it is, but sometimes it gets out of line.  As you can probably guess now is one of those times.  In the chart below we have taken the VIX and overlaid the percent bears.  As you can see both indicators usually move roughly to the same beat but lately the poll data has been getting more and more negative while the market derived data, data that actually shows where people are putting their money, has been getting more positive.

VIX and Investors Intelligence % Bears

Because of this disconnect we think that sentiment is not overdone to the bear side and that there is still some room to the downside.  In fact one of our short term sentiment indicators is showing exactly that as the 5-day equity only put call ratio hit .55 yesterday.  This level is significant as it has done an excellent job of showing when things are in fact too optimistic and has a good record calling tops in the equity market.  So while we aren’t calling for some Dow 1,000 crash, our analysis which includes sentiment data, does show room for more downside.

5-Day Equity Only Put Call Ratio

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In our model portfolio we are long some SPY puts.

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

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