Liquidity Cycle

The week past saw 5 year highs in US equity markets generating calls of a new bull market from some and cautionary warnings from the other side. But the more significant action is happening in the fixed income market. The long bond bull market is littered with the bodies of short sellers who have seen this market move to yields that no one but Gary Shilling predicted. But there is now a whiff of concern that the holders of debt securities may want to get a hedging plan in place just in case the Fed indicates a possibility that someday there could be a chance that exorbitant monetary ease could, possibly, eventually, maybe not be optimum. When that happens it will look rather like the start of the Boston Marathon. In reality that is of course not how move to higher rates will happen. The Fed wont lead, it will be pulled along kicking and screaming by self-interested holders of fixed income paper try to get ahead of the stampede and end up starting it. I could be wrong, of course, but Im not. First equities and indices and there is some repetitiveness in these charts but this is an attempt to see things from multiple angles. The first chart showing the SPX Index with an overlay of the Liquidity Cycle Indicator has developed a sudden divergence that is worth noting, though I believe this is largely attributable to tech shares and Apple in particular. The uptrend in the LCI is still in force though this is not yet a fail. The chart following which instead has the Global Growth Expectation is more supportive.

The bull/bear reading from AAII does seem to indicate a little more elevated bullishness than the previous chart. So chalk one up for the minor correction or congestion crowd.

The biggest reason to be bullish in the medium term is central bank easy money- dont fight the Fed as the saying goes. But as Kyle Bass pointed out recently Zimbabwes stock market was the best performer this decade - but your entire portfolio now buys you 3 eggs.

Global Growth Expectation has broken out of a minor down trend in concert with the rally in SPX (and with the World Index in next chart) reflecting improved optimism.

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Source: Barry Bannister, Stifel Nicolaus, Marc Faber

Marc Faber included the chart above in his most recent letter and I find it a fascinating chart. The current situation suggests good things for stock prices relative to commodities though crashing commodity prices could rally the chart just as well as rising stock prices. I have to spend some more time thinking about this chart.

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FIXED INCOME Bespoke had these comments and the following chart in their weekly report this week. I reprint it here because I agree with their analysis.

SECTORS Defensive sectors and technology have been soft to weak on a relative basis during the rally lately. Financials, Discretionary and Industrials have led. But note in financials it is only the big caps which have rallied hard.

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Previous chart is from a CITI report and came with the following commentary: Each low was 5 year apart Each low on the channel base Each low approximately 100 basis points below the previous cycle low (average of 104 basis points) Each low was also a V bottom which means a blow out move before a quick reversal which we have not seen here in this cycle (yet) Medium term resistance is around the 2.40% area and a weekly close above that would lead us to seriously question the idea that a lower low can be seen. Bottom line: The recent move of higher yields has not been as aggressive as those seen around this time of year for the past three years At this stage we have tested resistance at 2.00% and are noticing momentum waning While a stretch higher towards 2.09%or 2.15% is still possible in the short term, it would not change the overall trend of lower yields. We would need to see a weekly close above the 2.40% area before questioning the idea of a move to lower lows What we are seeing is a short term squeeze which we believe will be followed by a final leg down towards the 1.00% area this year before a major turn that could see yields as high as 3.5%-4.00% over a 12-18 month horizon. Source: CITI The second chart above reinforces the link between Fed buying; pushing rates lower has been powering strength in the equity market as well. When the fixed income didnt respond the equity market backed off. The divergence the last couple of weeks is worth noting. Bund chart is similar.

The Ten year treasury is challenging the last little bit of resistance from the past 2 years. If rates move above this level take a few sniffs because the first whiff of fear may be arriving. This long move to lower rates may have one more good surge down in it but it is late in the game now. Look at the remarkable rhythm of the move down in 10 year rates.

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Following are some yield curve charts of various countries. Note that Green was Friday Feb1, Red is one month ago, and the yellow is a Year ago. Recent steepening appears in many of these as the market starts to guess about the timing of Fed policy change. United States

Germany

France

UK

Spain

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Italy

Volatility Environment Seeing volatile fixed income contracts for the first time in a good while.

Japan

Australia

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Commodities are getting short shrift tonight but here are a few charts with the curves. Green is from Friday, Blue is one week ago, and Red is one month ago.

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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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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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Closing up now but I will put in a couple more charts because I left them out earlier. These are just markets I am looking to short when the background falls into place. I remain short the Yen though it feels a tad over done short term. I would buy good solid dividend stocks on pullbacks in the individual stocks. A little seasonal weakness in equities is common in Feb, though we did not see it last year. March and April are strong into tax day on a seasonal basis. I also like relative trades like the one I have had recently in ALF/SPY.

Have a great trading week. Bruce Lawrence Feb 4, 2013

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