Liquidity Cycle

The SP500 moved higher again over the week but in a very narrow week of trade. Most of the up move was made on Tuesday with sideways ranging the rest of the week. The steady move higher in January has lost some pace and February has so far been more congestive which is consistent with seasonal patterns. Plus many sentiment indicators were beginning to get elevated, leading to some caution. But the market has still been tracking the Global Growth Expectations index, which has been very strong for several months now. The Liquidity Cycle Indicator is pictured in the second chart with the Global Growth Expectations index and there is a clear divergence in the behavior of LCI since late January. Computationally the cause for this divergence is related to weak tech sector and strong health sector performance in the short term. But the allocation decisions driving that mixed performance seem related to the looming next round of the Washington circus as the previous can runs off and they are confronted with sequestration and budget issues once again. Hard to be optimistic based on past performance.

The next chart is the Eurostoxx 50 and the LCI ,which are tracking rather well. The Eurostoxx lost momentum just when the LCI did. That happened to be when Draghi began to talk the Euro back in late January as the optimism was carrying the currency a bit too high especially as the Yen was falling sharply. German export is the core of the Euro economy and the Euro/Yen move was changing those terms very significantly. So Draghi damped enthusiasm a bit.

This chart is the Euro Yen currency (rising is strong Euro weak yen) and the pink line is the Global Growth Expectation index which has been reacting very strongly to statements by non-US central banks that they intend to pursue easier policy. When Draghi made the do what it takes speech in midsummer the European markets bottomed, and the Euro began to strengthen, and the GGE index shot higher. Not much reaction in mid-September to the Fed and Qfinity. But in November as Abe began to really press the idea that Japan was going to inflate aggressively the GGE really began a climb and global equities went along. The second chart shows how the Nikkei has responded to the Japanese money printing news.

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But as the next chart also from Bespoke shows Equities have had some very good annualized gains when the VIX was below 15%.

This Bespoke chart is interesting for several reasons. First is the same point illustrated previously, which is the big move in the Nikkei Index (red) since the Yen weakened. Second, notice the Nikkei in dollar terms merely matched the SPX index. So the real gain in the Nikkei is merely reflecting the change in the exchange rate rather than a statement of the condition of the economy in Japan. Third, be aware that equity (or asset) price gains due only to weakening of the currency are an illusion. The price may have changed but the purchasing power represented by that price is unchanged. Inflation of the currency is how the politicians steal from and ultimately destroy the middle class. Here are a few charts just for perspective on current conditions. Carl Swenlin of Deceisionpoint.com produces the next chart, which includes the cash holdings of mutual funds and the ratio of bull to bear fund assets at Rydex. The bullish reading is very high right now. Not a sell signal but a caution flag.

The low volatility illustrated in the previous chart is echoed in the VIX index.

Alan Neumann who writes the Crosscurrents newsletter compares the mutual fund cash levels to the Dow Industrials and also notes the points of very high margin debt readings in the following chart. More caution flags.

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Fixed Income These charts from Yardeni Research and Yardeni.com

The chart below has the Citi Economic Surprise Index in the top half along with a very faint overlay of the SPX Index in yellow. In the bottom section to be more visible is the 100 day rate of change of the SPX to more clearly reveal turns in the direction of the SPX Index. I put this in to show how useful the surprise index can be for monitoring market.

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One estimate of consensus forecast for the 10yr in 2013 is to range between 1.8% and 2.20%. That implies some decent price declines in the treasury price during the rest of the year to create that range. A slow rhythmic rise in rates is not behavior I would anticipate except in the short term. The massive size of un-hedged interest rate exposure is far more likely to produce occasional frenzy than calm steady patient adjustment. Keep an eye on France.

Volatility Environment Only Schatz, Euribor, Euro, Yen are volatile at moment.

The MacroTrader.com put out this chart of the weighted global yield curve which has clearly broken through the downtrend line and is sending signs of better economic activity and rising long rates. The market I heard most about this week was Gold after the sharp drop. Long term as long as the price of gold is not rising as fast as the balance sheets of the central banks I would continue to own some as insurance against the printing presses. And as a short term trade? I have no idea, but, I will not be going home short.

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Commodities

Agriculturals on previous page, Metals below

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Volatility: Implied, Implied to Realized, and Skew Indices

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Note high implied to realized among European markets especially.

Commodities Currencies

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I still believe the Equity markets globally are in an uptrend that should carry at least until April, barring a glaring misstep in Washington. The economy is improving slowly, but advancing just the same. The Yen will remain in its weakening trend. The Fed, BOJ and ECB will keep policy ease in place. But the bond market investors must look ahead and when they do, they see the need to begin to protect themselves against downside risk. That hedging will initiate the first steps to higher rates. The Fed will be behind the market as rates finally move up. I also believe the equity market will be marked by a significant number of take over and take under moves as the financial mavens work to use high cash levels on balance sheets to acquire assets cheaply. The Dell example is probably a good template. All of this is subject to political action in the next few weeks, as the sequester and budget decisions come to the fore again. I am not optimistic about the quality of the upcoming debate. President Obama was just on TV blaming Republicans for not proposing a viable solution to the budget problems. But in my understanding of how things used to work, the majority party and the President propose legislation and propose budgets, while the minority party is to oppose and prevent excesses. Obama will not take the criticism proposing a budget exposes him to. He wants anyone else to take responsibility so he can just sit back and criticize them. At least in the case of the fiscal situation he is abdicating leadership in favor of blame casting and name calling. The Democrats in Congress are stymied because they have no leadership to follow and this is ultimately the reason for the inability of Congress to achieve any progress. Good trading Bruce Lawrence February 18, 2013

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