Liquidity Cycle

An interesting week just past, as there was enormous anticipation around three scheduled events, each with the possibility of moving markets. Early in the week implied volatilities were advancing modestly as participants made new bets or hedged old ones. First was FOMC, then ECB Chairman Draghi following up his week earlier comments of irreversibility, and then on Friday the release of monthly non-farm payrolls in the US. (A number so useful it will be revised approximately 42 times in the next decade.) So what did we getdrumroll here: FOMC- the oratorical equivalent of a crime scene cop saying break it up, everyone go home, there is nothing to see here. This was mildly disappointing but we still had Draghi coming up and he had promised some action. ECB- Whiff! There was no joy in Euroville the mighty Draghi did strikeout. Nothing new from ECB and the market sagged. Payrolls- Friday morning payrolls delivered a better than expected jobs number but some rather confusing internals all stirred together with a potpourri of seasonal adjustments. The initial reaction was choppy but then the market seemed to gather itself, find a rainbow, and take off after the pot gold. Equities rallied strongly the rest of the day. Contributing to the rally was talk that Draghi had said more than was obvious, that he was forcing Euro finance ministers to take action and that some of even the coalition parties in Germany were supporting his bond buying suggestion and the call to initiate the ESM. Goldman issued a comment that the ECB had something up its sleeve that was unexpected. I have no idea whether to credit these stories but, it seems the markets were willing to believe because the rally was substantial and plurality was broad.

The next chart is the S&P again the point is to illustrate that the big movement days are leaning to the bullish side of the market. During the May /June correction the dynamic bars favored downside movement but the last 2 months look more like the period of advance earlier in the year though the net movement over time has been smaller.

Note the Liquidity Cycle Indicator has kept turning up and the LCI 31 week rate of change corrected its oversold condition and is starting to rise again. Perhaps the divergence we have seen in the past several weeks is going to close in favor of the equity index. The ECRI Weekly Leading Index is also turning higher with the LCI and the SPX.

Following are three charts of intraday implied volatility movement over the week primarily to demonstrate just how correlated markets have been acting. These three are the SPY, the 30 yr bond and the Euro currency etf.

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These profile charts are of the past 5 days also and clearly show that despite all the back and forth, the markets are not far from where they started. It is hard to draw a conclusion from these charts.

Value is accumulating in these zones and volatility should be quiet till the markets breakout one side of these ranges.

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Implied Volatility in the Indices is well matched to Realized volatility in most markets, with the notable exception of the IBEX (Spain).

Emerging and Less Developed country ranks favor Turkey, Philippines, Mexico and Malaysia.

Developed Country ranked returns favor Norway, New Zealand, USA and Singapore.

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SECTORS
The top row is the defensive sectors which have been the strongest lately and they finished the week with little drama. The last two rows all show sectors challenging or breaking recent highs. Leadership needs to come out of these groups if this equity advance is to have legs.

In Europe Draghis London remarks led to relief but faded quickly on lack of reality.

Fixed Income
The profile chart earlier showed we did not have a large move in rates this week but these markets did come of the extremes and are holding recent support. Central Bank policy is supportive but a break below these levels would begin to signal the market realization that central bankers have only one real tool left, currency debasement. Such an environment is not profitable for a bond holder.

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Commodities

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THIS COMMUNICATION IS INTENDED ONLY FOR THE USE OF INFINIUM CAPITAL MANAGEMENT, LCC AND ITS EMPLOYEES TO WHICH IT IS ADDRESSED AND CONTAINS OR MAY CONTAIN INFORMATION THAT IS PRIVILEGED, CONFIDENTIAL OR EXEMPT FROM DISCLOSURE UNDER APPLICABLE LAW. If the reader of this communication is not the intended recipient (or the employee or agent responsible for delivering to the intended recipient), you are hereby notified that any dissemination, distribution, or copying of this communication is strictly prohibited. If you have received this communication in error, please immediately inform Infinium Capital Management, LLC and then disregard and delete this communication. Do not disseminate or retain any copy of this communication.

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Energy

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FX
Net movement over the week in the crosses to USD was very small. Compare to the one month changes in the second chart. Like many of the other markets volatility fell sharply once the central banks had finished saying nothing provocative. The table shows vol declines on Friday.

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Growth in Foreign ownership of us treasuries is falling but not collapsing Chinese reserve accumulation has slowed down rapidly. As a result the growth of foreign ownership in US treasuries (USTs) has fallen. The global liquidity pump of Bretton Woods II, in which pegging emerging markets are recycling their increase in foreign exchange reserves into US treasuries in order to keep their currencies stable against the USD, has slowed, but not stopped altogether. Even as the economy has slowed, Chinese FX reserve growth has slowed, and so have its holdings of USTs.

Information & Articles of Interest.

Credit Suisse: Outlook Over the Next 3-6 Months Global Economics: While we continue to hold the view that global GDP growth will be stronger in the second half than the first, the ongoing downswing in cyclical momentum is becoming more concerning as the slow path of many economies gets even slower. Risks to our outlook still seem tilted to the downside barring a more prompt and definitive resolution of Europes financial architecture crisis. See: Developed Economics & Emerging Market Economics. Global Fixed Income Strategy: The risk appetite rally has stalled, but we think short-term uncertainty has eased somewhat in China, Europe, and possibly Japan, paving the way for a trough in global IP momentum. Global Equity Strategy: We remain positive on equities on a 3-6 month view: we think there will eventually be an appropriate policy response in the Euro area, the global macro environment has begun to weaken but central banks remain dovish, global excess liquidity should lead to a modest rerating, valuations relative to bonds are attractive, positioning is still extremely cautious. Market Strategies: The current macro backdrop suggests a central case of low(er) rates, low(er) rate volatility and stable funding markets. We think it makes sense to take advantage of relative stability in markets to earn carry in rates, MBS, and credit markets. Technical Analysis: Global Risk Appetite momentum continues to trend lower. 10yr Spanish yield risk stays bearish while above 6%. Brent Crude and Aluminium complete medium-term tops. We remain bullish the USD, and look for EURUSD to eventually test 1.20/1.1876. 10yr US yield risk still seen lower for 1.44/40%, and eventually 1.13/11%. Global Demographics & Pensions: We review demographics and asset price linkages, highlighting weaker predictability of stock prices and stronger predictability of bond yields based on demographics alone. We draw attention to other factors that explain cross-country differences too. Reports on assessing Asias future demographic promise and widely heterogeneous demographics underlying EU growth present a different perspective. Accounting & Tax: Pension plans continue to be in bad shape, a headwind to earnings and drain on cash flow. Plans continuing to de-risk can put pressure on yields and equity volumes. Global Index & Alpha Strategies: The Extreme Flow Indicator (EFI) continues to recommend a Risk-Off portfolio stance for the coming month. US Small Cap Equity Strategy: Our year-end 2012 R2000 target remains 850, for a 15% gain; we expect conditions to stay choppy, but remain buyers on dips; we see both positives (valuation, M&A) and negatives (money flows, earnings revisions) for US small caps; several neutral/mixed signals (sentiment, economy); on the economy, current CS forecast of +2% real GDP still calls for double digit, annual R2000 gains and we suspect economic disappointments may have bottomed; desire for domestics helping small caps recently relative to mid/SMID, similar to late 2008; stimulus/ tax policy/Presidential election are key uncertainties. Global Quantitative Analysis: We expect large-cap to outperform small-cap over the next quarter. After benefitting from the January effect, smallcap indices have underperformed large-cap indices over the past two months. A shift to quality and growth on renewed concerns from Europe, high correlation, and demand for yield will likely benefit large-cap. We are currently in a high and increasing IPC regime, and based on our IPC for Factor Selection report, we expect the Historical Growth, Profit Trends, and Accelerating Sales factors to outperform and Expected Growth to underperform.

As the pace of growth has slowed, and if we assume a continuing propensity of the US government to run large deficits, domestic savings may be called upon to finance the sovereign.

In other words, financial repression. Still, we caution assuming too abrupt a shift in the financing of the US treasury market. Especially, we would note that even after two rounds of QE, there is still scope for the Fed to increase its purchases. Currently the Fed holds only 11% of total debt outstanding which is well below eg the BOE, and also below the BOJ (assuming current asset purchasing plans).

Negative government bond yields in Europe not necessarily predicting deflation Core European government bond yields continue to fall and are now outright negative in many countries. Traditionally, this would suggest a stern message from the fixed income market that deflation is around the corner. But there could be other explanations.

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Firstly, government bond yields may be negative due to positive momentum and short term positions which are maintained independent of long term capital preservation aims and negative long term returns. Secondly, financial oppression is now a structural feature of the economic system which means that yields may stay lower for longer and even move into negative territory. Captive buying by financial institutions is likely now a structural feature of government fixed income markets. This is especially the case as it is now no longer impossible that senior bond holders in European banks may take losses which leave sovereigns as the last port of call. Thirdly, some economies such as Denmark and most recently Japan announcing the removal of the lower floor of the BOJ refi rate have to open the door for negative yield due to currency considerations and the risk of hot money inflows. In a world where the ECB is now sending a serious message that Euro deposits may at some point carry a negative carry, it is only natural that fixed income instruments denominated in euros price in such an eventuality.

The following are a few comments and associated charts from The Bank Credit Analyst

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Kirk Sorensen: A Detailed Exploration Of Thoriums Potential As An Energy Source Kirk Sorensen, NASA-trained engineer, is a man on a mission to open minds to the tremendous promise that thorium, a near-valueless element in todays marketplace, may offer in meeting future world energy demand. Compared to Uranium-238-based nuclear reactors currently in use today, a liquid flouride thorium reactor (LTFR) would be: Much safer - no risk of environmental radiation contamination or plant explosion (e.g. Chernobyl, Fukushima, Three-Mile Island) Much more efficient at producing energy - over 90% of the input fuel would be tapped for energy; vs <1% in todays reactors Less waste-generating - most of the radioactive by-products would take days/weeks to degrade to safe levels, vs centuries Much cheaper - reactor footprints and infrastructure would be much smaller, and could be constructed in modular fashion More plentiful - LFTR reactors do not need to be located next to large water supplies, as current plants do Less controversial - the byproducts of the thorium reaction are pretty useless for weaponization Longer-lived - thorium is much more plentiful than uranium and treated as valueless today. There is virtually no danger of running out of it given LFTR plant efficiency Most of the know-how and technology to build and maintain LFTR reactors exists today. If made a priority, the US could have its first fully-operational LFTR plant running at commercial scale in under a decade. Much more to this article including video at ZeroHedge.

European problems continue to dominate markets and require that we pay attention to what is or is not happening there. But other very serious concerns are being overshadowed and need attention as well. The do nothing Congress and the fiscal cliff (largest combined tax hike ever and it is not confined to the rich) are approaching a point of no time to revise. The Chinese leadership did not anticipate the magnitude of the European slowdown and have allowed money supply growth to slow for far too long. The list continues but these are the biggest and most immediate problems because these all contribute to slowing of global growth prospects. On that cheery note, have a good week choosing where to allocate your assets. Or do like this guy in this clip. Bruce Lawrence August 5, 2012

Capital Economics table on Asset Returns

There are some pretty substantial swings in those numbers. Definitely pays to have ones assets in the right place.

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