Thursday, March 28, 2013

You just don't understand Europe...

In the wake of the disappointing market reaction to the Cyprus deal, I just want to repeat the comment I hear from some of my European contacts: "You just don't understand Europe."


Don't be fooled by the theatre
Europeans elites do their deals behind closed doors and what we see in the headlines is mostly theatre. By contrast, Americans focus much more on process and headlines - and that's where they go off the tracks when analyzing the eurozone crisis. That's why we get alarmist comments, like John Mauldin's Thoughts from the Frontline: You can't be serious in which he worried about the precedences set by the Cyprus deal and the effects on European banks:

Basel III standards require European banks to increase their deposit ratios. This European response to Cyprus is going to make that harder for banks in smaller European countries to accomplish. Very tiny Luxembourg has banking assets 13 times the country’s GDP. Yes, I know that Luxembourg’s banks are the very epitome of solid banking and that the majority of those assets are loans to central banks and other credit institutions, but there is no way on God’s green earth that Luxembourg as a country could even begin to think about backing its banks. Of course, everyone knew that before this crisis, but if you are the treasurer of a large corporation, how soundly do you sleep at night after Cyprus? And God forbid you have an account in one of the peripheral countries. In the case of Ireland, the lesson was that the money would be found to back the banks, even if taxpayers suffered. But now? New rules for new times. And then you open The Financial Tim es this weekend and read (emphasis mine):

The chairman of the group of eurozone finance ministers warned that the bailout marked a watershed in how the eurozone dealt with failing banks, with European leaders now committed to “pushing back the risks” of paying for bank bailouts from taxpayers to private investors.

Jeroen Dijsselbloem, president of the eurogroup, was speaking after Cyprus reached its 11th-hour bailout deal with international lenders that avoids a controversial levy on bank accounts but will force large losses on big deposits in the island’s top two lenders.
By contrast, I was recently relatively sanguine about Cyprus (see Don't get too excited about Cyprus and More of the usual Eurocrisis drama). I wrote that a Cypriot solution is specific to Cyprus:
I believe that bailouts of other eurozone countries, should they be necessary, will conform to a different template of conditionality other than the imposition of a tax on bank deposits. For example, the ECB has made it clear that it will backstop Spain, but on condition that the government undertake structural reforms and austerity. In the case of Spain, Rajoy has yet to swallow the bitter pill that comes with an OMT bailout.

Don't forget Draghi's Grand Plan
To explain, the real agenda of the European elites consists of three components:
  1. Push for structural reform long term;
  2. Austerity in the short-term; and
  3. The ECB stands by to hold everything together if the above two steps are taken.
Mario Draghi revealed this Grand Plan in February 2012 (see Mario Draghi reveals the Grand Plan) in a WSJ interview. Here are the key quotes from that interview [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.
Unlike Dijsselbloem, who is a rookie, Draghi is an experienced central banker who chooses his words carefully and he reveal his agenda in February 2012. Investors looking at Europe should remember that.

If you understand the Draghi Grand Plan, then you will understand how the eurocrats are likely to react when the next sovereign crisis occurs. First, the ECB will "do whatever it takes" to save the eurozone, but help from Frankfurt (the ECB) and Brussels (EU) comes with strings. In all likelihood, the eurocrats will believe that the country seeking help needs austerity and structural reform. In such a case, be the price to be paid will be paid is austerity and structural reform and the solution will not to stiff bank depositors (think Spain as an example as Rajoy's reluctance to embrace Draghi's "conditionality").

The kind of "conditionality" demanded by the ECB and is therefore highly situation specific. Cyprus was truly a unique case. Don't expect the same template to be used for Spain or Portugal. That's where outsiders make the mistake.


Investment implicationsLast week, I wrote that I was watching the relative returns of Greek stocks to eurozone stocks as a barometer of the level of stress in Europe, largely because of the Greek-Cypriot link and because Greece is the high beta play in Europe. When I looked last night, GREK had tanked relative to FEZ and had violated an important level of relative support.



The Athens Index had also dived relative to eurozone stocks. Though the degree of relative performance was not as bad, it is nevertheless a cautionary signal for the risk trade in Europe.



The French elephant in the room
The negative market reaction over Cyprus suggests to me that we are going to go through a "the glass is half empty" cycle in Europe and traders should be prepared accordingly. The key indicators to watch is the performance of France. France is the elephant in the room. The French economy is suffering a negative divergence with Germany. Consider this graph of French and German PMI (via Business Insider).

The eurocrats can deal with Italy, Spain and Ireland, but France is at the core of the EU and impossible to save. The Economist described France as the time bomb at the heart of Europe:

European governments that have undertaken big reforms have done so because there was a deep sense of crisis, because voters believed there was no alternative and because political leaders had the conviction that change was unavoidable. None of this describes Mr Hollande or France. During the election campaign, Mr Hollande barely mentioned the need for business-friendly reform, focusing instead on ending austerity. His Socialist Party remains unmodernised and hostile to capitalism: since he began to warn about France’s competitiveness, his approval rating has plunged. Worse, France is aiming at a moving target. All euro-zone countries are making structural reforms, and mostly faster and more extensively than France is doing (see article). The IMF recently warned that France risks being left behind by Italy and Spain.

At stake is not just the future of France, but that of the euro. Mr Hollande has correctly badgered Angela Merkel for pushing austerity too hard. But he has hidden behind his napkin when it comes to the political integration needed to solve the euro crisis. There has to be greater European-level control over national economic policies. France has reluctantly ratified the recent fiscal compact, which gives Brussels extra budgetary powers. But neither the elite nor the voters are yet prepared to transfer more sovereignty, just as they are unprepared for deep structural reforms. While most countries discuss how much sovereignty they will have to give up, France is resolutely avoiding any debate on the future of Europe. Mr Hollande was badly burned in 2005 when voters rejected the EU constitutional treaty after his party split down the middle. A repeat of that would pitch the single currency into chaos.
The lines in the sand
I am watching closely this ratio of the CAC 40 to Euro STOXX 60 to see which way it breaks out of the relative consolidation range.


If it rallies through upside relative resistance, then any crisis is just more theatre and can be regarded as a buying. On the other hand, if it breaks to the downside, there's going to be trouble.


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.

Sunday, March 24, 2013

An uncomfortable bull

I suppose that I should be happy. I correctly turned bullish on a tactical basis (see Give in to the Dark Side). I correctly called the Cyprus mini-crisis (see Don't get too excited about Cyprus and More of the usual Eurocrisis drama). As I write these words, the news of the Cyprus deal is sparking a modest risk-on rally.

Over here on this side of the Atlantic, the American economy continues to chug along, despite the sequester and payroll tax hike. I agree with Tim Duy when he writes that the recovery is real.


Sector performance signal caution
When I reviewed my charts on the weekend, I came away vaguely dissatisfied. The relative performance of industries and sectors reveal a market whose leadership that is increasingly turning away from cyclical groups and toward defensive sectors and a "negative beta" group.

If we are seeing such a bullish outlook (Europe, US economy), why are cyclically sensitive sectors not doing better. Consider the relative performance of Consumer Discretionary stocks against the market. This sector is currently seeing a sideways consolidation after stalling out of a relative uptrend that began last August.


Industrials are also displaying a similar pattern as Consumer Discretionary stocks: Stalling out of a relative uptrend followed by sideways consolidation:


The same could be said of homebuilding stocks:


The only cyclically sensitive group that I could find that is still in a relative uptrend against the market are the transportation stocks, which is a relatively narrow group:




Defensive sectors taking the lead
On the other hand, defensive sectors are starting to take the leadership position. Why are they outperforming when the stock market is advancing?

Consider, as an example, the relative performance of Consumer Staples, which is staging a relative strength rally:



Health Care, another sector thought to be defensive in nature, is already in a shallow, but well-defined relative uptrend after staging an upside breakout through relative resistance:



Utilities are forming a relative saucer bottom against the market:



Golds: The negative beta play
What's more, gold stocks are showing signs of revival. The Amex Gold Bugs Index has rallied through a relative downtrend line against the market, though the longer term relative downtrend (dotted line) remains intact:



HUI has already staged a relative turnaround against bullion as it has strengthened through the relative downtrend against gold.


Gold and gold stocks have somewhat defensive characteristics as they have had a zero or negative correlation against the SPX in recent weeks. Their revival could be a warning sign for stock bulls.


Be very, very careful out there
As I wrote in my recent post Give in to the Dark Side, my inner investor was already skeptical about this most recent rally:

My inner investor continues to be concerned about this market advance. He believes that the prudent course of action would be to move his portfolio asset allocation to its policy weight, i.e. if the policy weight is 60% stocks and 40% bonds, then the portfolio should be at 60/40.
At the time, my inner trader wanted to throw caution to the winds and get long the market. Now, my inner investor is telling him, "I told you so." Under these circumstances, my inner trader is getting very, very nervous and he is tightening up his trailing stops. The behavior of these sectors is flashing warning signals that if even if this market were to rally further, the advance could be very choppy.

Until we see some evidence of upside relative breakouts of consolidation ranges in cyclical sectors and industries, these market internals should make anyone who is bullish an uncomfortable bull.




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, March 21, 2013

More of the usual Eurocrisis drama

So the Cypriot parliament has rejected the terms of the Troika's rescue deal. Their finance minister is in Moscow and there were stories floating about that the quid pro quo for a Russian rescue of Cyprus would be a Russian naval base (via Business Insider). Should the EU and NATO be concerned?

I don't think so. The Russians had a chance to expand their geopolitical footprint in November but they passed. Here is what I wrote back then (see Europe dodges another bullet (Not the Catalan election)) [emphasis added]:

The wild card that I had been watching for is for Greece to turn to Russia instead of the Troika for financing. What if the Greeks got tired of the pain and turned to Putin for relief? Moscow has long had a historical desires for the warm waters of the Mediterranean for centuries. A financing deal could have shook up NATO and significantly shifted the geopolitical balance in the Eastern Med.

The test case was Cyprus. Russian nationals have a large presence on that island. As its banks got into trouble because they were stuffed full of Greek debt, the Cyprus economy was in peril. As the New York Times reported in June:

The Russian government last year gave Cyprus a three-year loan of 2.5 billion euros, or $3.1 billion at the current exchange rate, at a below-market rate of 4.5 percent to help it service its debt. Cyprus now needs at least 1.8 billion euros, or $2.3 billion, by the end of this month to buttress its ailing banking sector.
Instead of turning to the EU, they turned to Russia [emphasis added]:

Now many on this tiny island nation, whose banks and government are facing economic insolvency, are hoping for financial salvation from Russia rather than Germany and the European Union.

“I would much rather be saved by Moscow,” said Elena Tsolia, 30, an attendant at the department store Debenhams, where Russian shoppers snap up bottles of Dior and Chanel perfume. “We are a small island and we don’t want to be owned by Germany.”
I speculated that Russia could have not only rescued Cyprus, but Greece in return for naval basing rights:

Cyprus would have been the test case of Russia flexing its financial and geopolitical muscle in the Eastern Med.

Today Nicosia, tomorrow Athens? Can you say "Russian Black Sea fleet base in Athens, or Crete"?
So what happened? Cyprus turned back to the Troika instead of Moscow:

A little noticed announcement came across my desk. The headline was CYPRUS Government - Troika reach agreement:

The Government of the Republic of Cyprus informed on the 25th of June 2012 the appropriate European Authorities of its decision to submit to euro area Member States a request of financial assistance from the EFSF/ESM.
Any talk of a rescue from Moscow is likely just that - talk. The Russians demonstrated their lack of interest in November when they had the chance.


Cypriot crisis tripwires
Here is what I am watching for as signs that the markets believe that the Cyprus crisis is getting out of hand. The chart below shows the relative return of the ETF of Greek stocks (GREK) against large cap eurozone stocks (FEZ). The GREK/FEZ ratio has declined and it is testing a relative support zone. Should it break support, then it's time to get more cautious.



I use this ratio for two reasons. Cypriot banks are highly exposed to Greek debt. As well, the Greek stock market is the high beta "canary in the coalmine" of risk in the eurozone.

Looking at a similar ratio of the Athens Index to the Euro STOXX 50, it gives me further comfort that the market isn't overly concerned about the Cyprus situation. This ratio isn't even testing the relative support level yet:



So take a deep breath and relax. The headlines represent the usual European negotiation drama in a crisis, with one or both sides leaking stories of catastrophe should there be no agreement.

On the other hand, the message from the markets is that this crisis will be resolve in a relatively benign manner. Listen to the markets. Calm down.




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, March 18, 2013

Don't get too excited about Cyprus

The financial markets sold off early Monday on the news of the weekend bailout of Cyprus, but while the risks of a financial meltdown, while real, they are overly exaggerated. As I write these words, US equities have recovered most of their losses and shrugged off the Cyprus news.


What happened?
To explain what happened, Cypriot banks got in over the heads with too much Greek debt and had to be rescued. The EU stepped in with a €10 billion rescue package, but with the conditionality that the government impose a 6.75% one-time levy on bank deposits under €100,000 and 10% for deposits over €100,000. The deal has yet to be ratified by the Cypriot parliament. If it isn’t, banks in Cyprus are certain to collapse and there are reports about how the deal is going to get modified.

The knee-jerk reaction was instantly negative. The fear is that if this can happen in Cyprus, it could happen elsewhere. What if Portugal, Spain or Ireland had to get bailed out, would depositor funds be at risk there too? What’s to stop the Portuguese, Spanish and Irish from pulling their euros out of their banks and putting into Deutschebank in Frankfurt, thus sparking an enormous bank run and threatening the health of the European banking system?


Bank run fears are overblown
I believe that any panic over a possible bank run in the eurozone is exaggerated. Wolfgang M√ľnchau (see Europe is risking a bank run in the FT) highlighted the risks of a bank run but admitted that there are institutional barriers to a bank run on retail deposits:

There are some institutional impediments against bank runs within the eurozone. Some countries impose daily withdrawal limits, ostensibly as a measure against money laundering. Nor is it easy to open a bank account in a foreign country. In many cases, you need to have residency. You may need to travel there in person, and you need to speak the local language – or at least English.
While it is possible to get around these rules, the risks of a bank run that threatens the health of the banking system are low.

In addition, ECB head Mario Draghi has said in the past that he would do “whatever it takes” to save the eurozone. However, he has also made it clear that rescues come at a price. The Cypriot rescue conforms with the EU and ECB principle of the imposition of “conditionality” on rescues. In the case of Cyprus, the banks had insufficient equity to withstand the shock of a write-down of Greek debt and it didn’t have enough senior bond holders to cushion the pain without rendering the banking system insolvent. The only ones left to take the hit were the depositors. It didn’t hurt politically that Cyprus was known as an offshore banking haven, mainly for Russian oligarchs. So it was easy for Angela Merkel to sell a bailout involving shared pain to the German people.

I believe that bailouts of other eurozone countries, should they be necessary, will conform to a different template of conditionality other than the imposition of a tax on bank deposits. For example, the ECB has made it clear that it will backstop Spain, but on condition that the government undertake structural reforms and austerity. In the case of Spain, Rajoy has yet to swallow the bitter pill that comes with an OMT bailout.

Based on my analysis, the worst fear of the pessimists, which is a bank run in the eurozone, will not materialize.


Key risks
However, there are two key risks to this forecast. First, I am assuming that the Cypriot parliament will approve the rescue package and approval isn’t fully assured. If the deal were not to be ratified, it would likely introduce a new element of risk to the eurozone banking system and possible contagion into the global banking system. In that case, all bets are all.

The second is the French elephant in the room. The French economy is negatively diverging from Germany and France needs to take steps to align itself with Germany and the core eurozone economies. While the EU can rescue Greek and Cyprus, France is at the heart of the EU and much too big to save.




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.

Will Cyprus spark a turnaround in metals and mining?

The blogosphere is full of comments about the Cypriot bailout on the weekend (for examples, see How to start a banking crisis, Cyprus edition and The Cyprus conspiracy II). Instead of writing about Cyprus, a topic that I have no special expertise in, I thought that it would be timely to write an update to my blog post on February 19 about the resource-based sectors (see Time to buy gold and commodity stocks?).

Since I wrote that post, the metals and mining stocks have begun to stage a turnaround. To recap, the mining group is showing signs of being overly beaten up and washed out. This chart of XME, the mining ETF, against the market shows that it is trading at or near investor capitulation levels relative to its long-term history.


Take a look at the shorter term one-year relative chart of XME vs. SPY. The miners are starting to show some positive relative strength against SPY. Is that the sign of a nascent recovery?



Similarly, gold stocks are highly unloved against bullion. I have not been a big fan of buying gold stocks for gold bulls (see Where is the leverage to gold?), but in this case a long gold stock/short bullion position is likely to have much better risk/return profile than any time in the recent past.



Shorter term, however, my inner trader is still watching this pair of a relative turnaround as the HUI/Gold pair remains in a relative downtrend.



On the other hand, I can't say I am overly bullish on gold itself. The silver/gold ratio, which is a measure of the speculative interest in precious metals, is stuck in the middle of its historical band indicating neither excessive bullishness nor excessive bearishness on the PM complex.


Nevertheless, I am seeing signs of a capitulation, or washout, in investor sentiment. Here in Canada, the chart of the junior Venture Exchange Index against the more senior TSX Index shows that the ratio is at or near levels indicating investor capitulation in the juniors, which are mostly junior resource companies.




Not enough energy in Energy?
In my last post on this topic, I was more constructive on the energy sector as the sector was showing signs of a relative strength turnaround. Since then, the sector remains range-bound against the market and appears to be consolidating sideways on a relative basis.


The price of Brent crude confirms my observation about the range bound, or sideways consolidation pattern shown by energy stocks.



At this point in time, the energy sector may not have enough energy, or momentum, to present itself as the new emerging leadership sector.

As I write these word, the markets have a risk-off reaction over the Cyprus news. EUR is plummeting against all currencies and against JPY in particular; USD is up: ES is falling and gold is up marginally but a base metal like copper is down. While the initial market reaction isn't necessary the sustainable reaction, the Cypriot event may serve as a catalyst for the resource sectors (and the metals in particular) to stage a turnaround and present themselves as the new market leadership. It will also prove to be an important market test for the price of gold (and the gold bugs), to see whether investors flock to USD assets or to gold in this instance of an unexpected eurozone confiscation tax of banking depositor assets.






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, March 16, 2013

Is the secular bull market in Vancouver RE over?

I don't generally comment on the local residential real estate scene, largely because the topic isn't within the scope of this blog and I don't have much in the way of unique insights. However, I have a personal interest since I live here. In addition, several items came across my desk that piqued my interest.

First, the Conference Board of Canada recently unveiled some research indicating a statistical link between Chinese GDP growth and Vancouver property prices:

Statistical analysis confirms the importance of China’s economic health to Vancouver’s housing markets. Standard tests find significant correlations between the country’s real GDP growth and three important market yardsticks: existing home sales, existing home price growth and total housing starts. By contrast, local employment growth is significantly correlated to none of these and the five-year rate related to only the resale variables. This could mean that a substantial proportion of Vancouver real estate purchasers do not need local jobs to buy any home (new or existing) and that many do not need a mortgage to buy a new home. On the other hand, better economic health in China gives its residents wealth to spend on Vancouver housing.
While statistical relationships do not indicate causality, anecdotal evidence suggests that Vancouver property prices have been buoyed over the last couple of decades by several waves overseas buyers. The first was from Hong Kong, followed by the Taiwanese and now the Mainland Chinese.


The future of foreign demand
I came across an item Friday in the WSJ indicating that the older generation of Mainlanders looked to North America if they intend to emigrate (or at least to get a foreign passport), but the new generation is considering other alternatives such as Singapore, Hong Kong and Cyprus (see video and article). In particular, this wave of "economic refugees" seeking foreign passports as a safety valve should things turn south at home are looking to troubled eurozone jurisdictions such as Cyprus, where you can get a residency permit if you buy property there (and apply for Cypriot, and therefore EU, citizenship after five years). Other eurozone countries like Spain, which saw the collapse of a property bubble, also has a residency for house purchase program.

Yes, I have heard the local real estate boosters. Vancouver is a "world class" city (yes, as "world class" as other Winter Olympics sites like Salt Lake City, Lillehammer, Turin and Sarajevo - can you find them all on a map?). It has a mild climate (as mild as Cyprus or southern Spain?)

So what happens if Mainland Chinese demand starts to decline?


What's the downside risk?
The Conference Board study indicated that the health of the local economy had little or no effect on local property prices. In other words, the locals have been priced out of the market. At what price does local demand start to put a floor on the market?

Here are some back of the envelope numbers. A typical single-detached house on upscale neighborhoods on Vancouver's westside goes for about $2 million, give or take. If you were to open up the career section of the local paper, a good paying job is roughly 50-80K a year. Let's assume that you have a couple with a combined household income of 200K a year - which would roughly puts them in the top 2% in Canada. Assume that they have no other equity from an existing home but have the 20% down payment, they can afford a house of $1.0-1.2 million range based on current interest rates.

That's where local demand starts to kick in.

With the news that Vancouver real estate market slump is continuing:
Sales recorded through the Multiple Listing Service dropped 24 per cent in February to 4,501 transactions compared with 5,895 a year ago, the report said. The provincial average price was $529,922 in February, down 8.1 per cent from February 2012.
...the concern is that the overseas buyer is looking elsewhere is a threat to the secular bull market in Vancouver residential property prices. Should that happen, market price trends will transform itself from a series of higher lows and higher highs to a more cyclically driven market where prices move up and down with the economic cycle.
Right now, I am watching China (for cyclical effects on Vancouver RE prices, as per the Conference Board study) and emigration preferences (for the secular effects).


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, March 14, 2013

Signs of global healing

In addition to the upside surprise shown by US February retail sales yesterday, I am seeing additional signs of global economic healing. South Korean exports, which are highly cyclically sensitive, are turning up (via Business Insider):


As well, the OECD reported on Monday that it was seeing signs of emerging growth in the eurozone, with (surprise!) Germany as the engine:

Economic growth was beginning to re-emerge in the 17-nation euro currency area, the Organization for Economic Cooperation and Development (OECD) said as it released key economic indicators Monday.

The recovery in Europe's biggest economy, Germany, had pushed up an OECD indicator for the eurozone designed to identify turning points in the business cycle, said the organization, which represents senior Western industrialized nations.
The economic clouds are lifting and such an environment is supportive of further gains in equities (see my last post Give in to the Dark Side).



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, March 11, 2013

Give in to the Dark Side

Further to my last post (see An unconvincing breakout), stocks have continued to move higher. I continue to be concerned about this advance. The negative divergence (update link here) that I outlined is still not confirming this rally. Moreover, heavy insider selling is generally not a good sign for the bulls (see Insider selling, it's baaack! and this update from Bloomberg).


Risks are fading
Nevertheless, stocks continue to move up and sometimes it's more important to analyze the reaction to the news event than to analyze the news event itself. The market has shrugged off concerns over sequestration cuts to the US federal budget, as well as concerns over how political paralysis in Italy might affect the integrity of the eurozone. In fact, the storm clouds are lifting.

First of all, the House of Representatives passed a bill to avert a March 27 government shutdown and kick the can down the road to September 30. No doubt there will be further horse trading in the Senate, but the risk of a near-term fiscal catastrophe is fading in the United States.

Across the Atlantic, the Italian "crisis" is resolving itself in a relatively benign fashion. An Italian court has sentenced Silvio Berlusconi to a year in prison for his role in a wiretap case. His brother Paolo got two years and three months. While Berlusconi will undoubtedly appeal the ruling and remains free for the time being, this development weakens him politically. In the meantime, Italian bond yields have begun to recede, though the decline has not reached the pre-election levels:


While I am concerned about the instability created by Beppe Grillo's Five Star Movement, Richard Gwyn, writing in the Toronto Star, made an insightful comment about Grillo [emphasis added]:

Grillo’s great accomplishment thus has been to make everyone think hard, Italians themselves most directly, but almost as much all the EU technocrats and attendant financiers.

Political eruptions, like that of Grillo and Occupy Wall Street, often don’t last. Very astutely, the playwright Fo has expressed the worry that what may bring Grillo down is flattery. Fo has said: “I’ve seen the glowing press and he must not fall for the adulation; it’s a honey-like trap.”
Perhaps that's what the bond market is saying: Grillo won't last.


Sentiment picture is improving
My inner trader is also pointing to an improvement in sentiment readings. The AAII sentiment survey (via Bespoke) shows that bullish sentiment collapsed in the wake of the Italian elections - a contrarian bullish reading.



A confusing market?
My inner investor continues to be concerned about this market advance. He believes that the prudent course of action would be to move his portfolio asset allocation to its policy weight, i.e. if the policy weight is 60% stocks and 40% bonds, then the portfolio should be at 60/40. In particular, he is worried about the bearish portends of insider selling. Even if equities were to advance here, Sam Stovall's analysis of what happens after the market hits a new high (via Business Insider) indicates that the upside is limited while downside risk is high.
If history is any guide, for it's never gospel, it may respond like the messenger from Marathon. In other words, the S&P 500 may have little time to rejoice following the setting of a new record high before collapsing again, as the median advance following the recovery to break-even from bear markets since WWII has been only 3% before stumbling and falling into another meaningful decline within only two months.


To chase stocks here would be giving in to the Dark Side.

Even Richard Russell, who "should" be calling for a Dow Theory buy signal after seeing new highs in the Dow Jones Industrials and Transports, is confused and he blames the Fed for his confusion [emphasis added]:

My only answer to this is that both D-J Averages produced something never seen before, namely new highs during a post-crash upward correction. My explanation of this unprecedented situation is that the advance to new highs was a direct result of never-before-seen manipulation by the Federal Reserve.

The Fed was able to engineer new post-crash highs in both D-J Averages. But I doubt if the Fed will be able to engineer a coming new era of prosperity in America. Thus, it will be an example of where the stock market will not be predicting the nation's economic future.

As a matter of fact, I believe this stock market is predicting a very mixed and confusing economic future for the US. As far as I can see, the Fed will be pumping in QE-to infinity for as long as it can get away with it. The only thing that might halt the Fed is rebukes from voting members based on it's outrageous 3 trillion dollar balance sheet. We're in uncharted territory in my opinion, and I expect to see a number of events in both the stock market and the economy which will be both surprising and upsetting.

One technical observation -- With the breakout and confirmation by the Industrials, this places tremendous psychological pressure on the 13.108 million shorts that are now positioned on the NYSE. As a result, we should see irregular spates of short covering or buying panics, depending on the fears and psyches of the short sellers. This makes shorting stocks in this market a risky game.

My view for the future -- erratic market action along with a disappointing US economy. Incidentally, I don't know if you noticed, but some of the heavily shorted stocks surged yesterday, due, in part, to frantic and fear-filled short covering.


Listen to the market
My inner trader, on the other hand, says to listen to the market and go with the momentum. The US economy seems to continue to improve despite concerns about the payroll tax increase and sequestration cuts. Last Friday's Non-Farm Payroll number was an unambiguously positive release. In addition, indicators such as rail traffic point to continued growth in the economy.

So it may be the time for my inner trader to take a walk on the Dark Side and get long this stock market, though with tight stops. I have a suggestion for those who want to take that walk on the Dark Side. While the logical course of action may be to buy cyclically exposed stocks and industries such as the Materials sector which seems to be staging a bottom (see Time to buy gold and commodity stocks), here is an even Darker suggestion.

Recently, Attorney General Holder admitted that big banks are "too big to jail":

U.S. Attorney General Eric H. Holder Jr. told lawmakers that some financial institutions have become “so large” that it makes it “difficult for us to prosecute them.”

Holder’s admission bolsters criticisms that federal prosecutors are deeming some banks “too big to jail,” a charge that lawmakers and consumer advocates have routinely made in the wake of recent bank settlements. Although the government has issued record multimillion-dollar fines in these cases, critics say without criminal charges, the agreements amount to a slap on the wrist.
Robo-signings? Banks are systemically important. Robo-foreclosures? It's just a few bad apples. LIBOR scandal? No problem.

That, my friends, is considered to be an unassailable competitive advantage for the financials. The real walk on the Dark Side is to buy the large cap financials, not despite, but because of their propensity for financial shenanigans. Consider this chart of the relative performance of the financials against the market. This sector broke out of a long-term relative downtrend in early 2012 and they have begun a relative uptrend.



The benefit of being long this sector is that it provides a less cyclical exposure to the stock market and will partially insulate the trader from a downturn in the economy. In any case, if you are going to take a walk on the Dark Side, you might as well go all-in.



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, March 5, 2013

An unconvincing breakout

Breakout or fakeout? The Dow hit an all-time high yesterday, but I found the breakout technically unconvincing as it was unaccompanied by negative divergences. First of all, the upside breakout was achieved on low volume and volume had generally been declining since this advance began on February 26.


In addition, the chart below of NYSE new highs - new lows is not confirming the advance either. The NH-NL differential achieved a recent high on January 24, but the current upside breakout saw a lower NH-NL differential, which is another negative divergence and a sign of bad breadth.



All in all, an unconvincing breakout. With AAII sentiment at two year highs (via Pragmatic Capitalism):



...indicating that sentiment at bullish extremes, these readings brings up the question of how much longevity the current advance is likely to have.




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.

An update on my Chinese "canaries"

In the past week, I have received several emails in the wake of the 60 Minutes story about the Chinese property bubble and the news that China had unexpected implemented curbs to limit property speculation (via Bloomberg:), the Shanghai market tanked.

China’s cabinet on March 1 told cities with “excessively fast” price gains to raise down-payment requirements and interest rates on second-home mortgages and ordered individuals selling properties to “strictly” pay a 20 percent tax on the sale profit when the original purchase price is available, a levy that is being easily avoided.

“The measures are much stronger than expected and will have more longer-term implications on the market,” said Zhao Zhenyi, a Shanghai-based property analyst at Industrial Securities Co., who downgraded the sector to neutral. “With the new tightening mainly on existing homes, buyers will not be able to take much leverage at all.’

The People’s Bank of China’s regional branches may implement the measures in accordance with the price-control targets of local governments, the central government said in a statement on its website. Cities facing ‘‘relatively large” pressure from rising house prices must further tighten home- purchase limits, according to the statement.
Given these inquiries, it was time for me to write a follow-up to my post about how to watch for signs of a crash in China (see The canaries in the Chinese coalmine), where I wrote that I was watching the prices of the Chinese state banks listed in Hong Kong for signs of financial stress:

Traders should be aware of these risks, but not panic. The current risk of an immediate meltdown is low and there is a timing tool available. I am watching my four canaries in the Chinese coalmine, namely the share price of the Chinese banks listed in HK:

  • Agricultural Bank of China Limited (1288.HK)
  • Bank of China (3988.HK)
  • Industrial and Commercial Bank of China Limited (1398.HK)
  • China Merchants Bank Co., Ltd. (3968.HK)
The chart patterns of all four banks are roughly the same. Here is the Bank of China as an example:


The share have pulled back a bit from its recent highs, but show no signs of cratering.

Let me make this clear, these stocks are barometers of trouble in the official and unofficial banking system in China and but they are only indicators of catastrophic breakdown. Don't be overly concerned until the share price at least probes its 2012 lows. The sign to head for the foxhole is when the shares start to test its all-time lows.

As I write these word, the Shanghai Composite is staging a rally and recovering some of its losses. So relax and don't worry about little squiggles in the share prices.



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, March 4, 2013

Is this 2011 all over again?

I am not a big believer in market analogues, but the current environment bears an eerie resemblance to the summer of 2011. Here are the similarities



Heavy insider selling
I wrote back in early February (see Insider selling, it's baaack!) that insider selling was surging. Vickers reported that [emphasis added]:
Looking at a longer time frame paints a bearish picture as well. The eight week sell-buy ratio from Vickers stands at 5-to-1, also the most bearish since early 2012. What's more, the last time this ratio was at these levels was June 2011, just before another correction in the stock market took place.

Apparently, insider selling has gotten worse since that report. According Charles Biderman of TrimTabs (via Zero Hedge), the ratio of insider sales to buys is skyrocketing, though I am unsure of how to compare the Vickers sell-to-buy ratio to the TrimTab's one as I don't know the differences in their methodologies:
While retail is being told to buy-buy-buy, Biderman exclaims that "insiders at U.S. companies have bought the least amount of shares in any one month," and that the ratio of insider selling to buying is now 50-to-1 - a monthly record. "So far the mass delusion is holding."

By contrast, Bloomberg reports a three-month average insider sales-to-buy ratio of 12 to 1, a two year high:
There were about 12 stock-sale announcements over the past three months for every purchase by insiders at Standard & Poor’s 500 Index (SPX) companies, the highest ratio since January 2011, according to data compiled by Bloomberg and Pavilion Global Markets. Whenever the ratio exceeded 11 in the past, the benchmark index declined 5.9 percent on average in the next six months, according to Pavilion, a Montreal-based trading firm.

Regardless of differences in methodology, the results are an ominous sign for the bull camp.



US political gridlock
Another similarity between today and the summer of 2011 is the rising anxiety over the consequence of political intransigence in Washington. Then, we saw the debt ceiling crisis of 2011, which led to the loss of the AAA credit rating from Standard and Poor's.

Today, we have $85 billion in overnight sequestration cuts to the federal government and a looming debt ceiling crisis on March 27, about three weeks away. Fed chair Ben Bernanke projected that sequestration will likely slice 0.6% from GDP growth in 2013:
However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO's estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.

A 0.6% slowdown in GDP growth could very well mean that the economy stalls and keels over into recession. What's more, another debt ceiling debate with a drop-dead deadline of March 27 will pour gasoline on the fire and could lead to further market anxieties.

Risk-off, anyone?


News cycle turns down in Europe
In 2011, the ECB's announcement of its LTRO program stabilized the markets. Mario Draghi's "whatever it takes" remark in July 2012 and the ECB's subsequent OMT program contributed to further stabilization. Today, the market consensus has evolved to the view that the ECB has taken tail-risk, or the risk of a European sovereign debt or banking crisis, off the table. The ECB, it seemed, had built a financial castle wall around the eurozone again.

Read the fine print. The OMT program depends on member states submitting to the ECB's "conditionalities", namely austerity and structural reform programs. The rise of anti-euro forces in the recent Italian election shows how fragile the ECB's castle walls really are.

I fear that the news cycle is about to turn down in Europe. Consider these stories that are appearing:
  • The divergence between German and French economies (via Business Insider). This divergence is starting to raise the question of the viability of the French-German partnership in the EU. These are the two principal founding partners in the European Union and brings up the question of wage and productivity differentials between the two countries. If the two economies can't converge and Germany is unwilling to subsidize France, the euro is cooked. Nothing else matters. It doesn't matter what happens to Greece, Spain, Ireland, etc.

  • Political turmoil in Spain. The FT reports that Madrid is pushing for a constitutional challenge to Catalonia's bid for independence, which puts the spotlight on political stability in Spain:
The Spanish government has launched a legal challenge against Catalonia’s recent “declaration of sovereignty”, in the latest move by Madrid to halt the region’s march towards independence.


The government said it would ask Spain’s constitutional court to nullify the Catalan parliament’s January declaration, which stated that the “people of Catalonia have, for reasons of democratic legitimacy, the nature of a sovereign political and legal subject”.
What's more, Business Insider reports there are rumblings that the Army may not stand idly by and the possibility of a coup d'etat is raising its ugly head. While I believe that these risks will ultimately resolve themselves in a benign fashion, these stories are just further signs that the news cycle is turning negative in Europe.
Recall that in 2011 we had angst over Greece and the implications for the eurozone. We saw endless summits and crisis meetings until the ECB stepped in to stabilize the situation. Today, the fragile peace that the ECB has put together is starting to unravel. Europe is in recession and the tone of the news stories are turning negative.

These kinds of stories have a way of not mattering to the markets until it matters, especially when the market is in risk-on mode. Now that the tone seems to be moving away from a risk-on to risk-off, the market has a way of focusing far more on this kind of negative information.


A positive divergence
In 2011, the SPX cratered about 17% in response to these anxieties. While I am not saying that the downside could be the same, it is nevertheless a warning for the bulls. The key difference between the market weakness in 2011 and today is how the Fed acted then and now. In 2011, the Fed's QE program was just ending, while we are seeing QE-Infinity today. The actions of the Federal Reserve today may serve to cushion the effects of the speed bumps that the equity markets are likely to experience.

Nevertheless, the current environment is likely to be more friendly to the risk-off crowd than the risk-on crowd.





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.