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o a ac casse oca on
GTAAEquities
January 9th , 2010
Damien Cleusix
Clue6 First Quarter 2010
am en c ue .com
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1Executive Summary
Stocks
Valuations are now above levels where erformance oin forward will not lease the bu & hold crowd, even if we o
back to the good old days, the credit bubble stops deflating, growth reaches pre-2007 level in a sustainable manner ,.... At 1200
on the S&P 500 will be priced more expensively than all of the structural tops pre-2000 (well 1997-2000) except the final tail of
the 1929 move... This does not imply that the market will fall in the short or even the medium term but that a further rise
will only have speculative and no investment merit if bought. Our base assumption remains that we will fall to significantly
undervalued levels before a new secular bull market can start (in the developed world as you know we believe that we are in a
secular bull market in emerging markets). This currently implies a sub-530 level on the S&P 500 going up by 5-6% a year.
Option activity, insiders and most of the smart-money we follow are in a configuration where markets have struggled in
. ,
trend (higher highs and higher lows). This does not imply that the market can not continue to rise in the medium-term but morethat it should at least consolidate in the short-term. Small investors optimism has finally started to rise and is now deep in
overconfident territory…
Most of the breadth divergence we noted in November and December are now gone… Uniformity remains high...
On the liquidity side, inflows into US equity domestic funds remain low while the money is pouring into emerging marketequity fund. This has historically been followed by underperforming EM markets… We have seen a slight pick up in buybacks
but they remain very low while IPO’s and Secondaries have been plentiful with bubble reminiscent level in Hong Kong and
China…Monetary aggregate momentum is turning down and this could prove to offer some headwind to risk assets…
Pension funds’ funding status is deteriorating despite the rising equity markets courtesy of the rising present value of
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2Executive Summary
Seasonals are supportive even if one has to remember that the equities have relatively important (>5%) correction intra-month
in January, especially after strong starts…. Cycles are still supportive but the 20 weeks cycles should be topping in the very near
future…
Intermarket relationships have improved from the numerous divergences witnessed in November and December. The relative
good performance of defensive around the world is a worry as is the fed funds futures/equities co-movement but so far so good.e are more worr e a ou e me um- erm momen um o on s an commo es w c s n a con gura on w ere equ y
market productivity has been poor historically…Sovereign CDS will continue to need your attention…
The trend is up almost everywhere but we are at or near the top of the new rising channel. Correction to at least the bottom of
the channel ex ected before a otential resum tion of the u move but the rest of the anal sis oints out to somethin
potentially bigger than the correction we had since March…
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3Equities: Valuations – A Repeata ua ons are no use u or s or - erm mar e pro ec ons u are essen a n orecas ng
long-term returns. They become informative in the shorter term when they reach extremes .When they are very high one should not allow the other indicators in one’s arsenal to deteriorate
too much before pushing the exit button, the reverse is true when they reach very low levels.
US Earnings VolatilityChart 1
.
look at normalized price to earning ratios (normalized using an trailing reported earnings moving
average, average margins or peak earnings) and price to book value. We like to look at a historical
dataset as long as possible. It is also important to consider the quality of the data. One often
hears that valuations should be higher because the markets are less risky.
We disagree.
Main Street has clearly been less volatile in the past 30 years (well up to now), as has
inflation. The consequence is that companies have increased their leverage dramatically (cf.
’ “ ” ’ “ ”. . .
process earnings volatility has increased rapidly in the past 10 years (Chart 1). From the mid50’s to the mid 80’s, real annual earnings were rising or falling by 3.8% for every percent change
in annual real GDP growth. In the past 10 years if was 22%...
Source: R. Shiller, Clue
Table 1 Tangible Book Value
1. intangibles have become legion in some countries (Table 1) (ask a bondholder of a bankrupt
high intangibles company what intangibles are worth...),. Goldman Sachs has calculated that
the S&P 500 constituents asset/equity ex-goodwill has risen from 2.5 in the 80s to 4.4 today.
Source: Bloomberg, Clue6
. .
3. Assets' mark to market which increase their pro-cyclicality.
In brief, as often repeated in the past, we think market should be valued at lower levels, not
higher levels than historically.
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This is thus not surprising that AAA and AA bonds represented almost 60% of the BarclaysCapital Investment Grade Index at the end of the 70s while they only represent 25% today.
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4Equities: Valuations – A Repeat
Investors attach a lots of importance to what happen to earnings on the very short term
while they have a very negligible influence on the intrinsic value of the markets . Indeed even
if earnings were to be 0 in the next 2 years, this would not affect by more than a few percentage
S&P 500 and Middle to Young
CohortChart 2
points the intrinsic market value derived by a dividends or cash flows discount model.
Remember that markets are a claim on a very long-term stream of cash flows.
What moves market valuation around fair value in the short-term is investors’ risk appetite.This is what we analyze extensively in the Sentiment, Breadth, Liquidity, Seasonality and Cycle
section of our presentations.
In the long-term, we believe that the main driver of long-term generational fluctuation in
valuation ratios from very undervalued to very overvalued, is the reallocation of the stock of
wealth (as demonstrated by J. Tobin more than 40 years ago). One can see this phenomenon in
action loo ing at t e Saver/Spen er ratio or Mi le to Young co ort (C art 2).
This is the ratio of the population aged 40-49 years to 20-29 years (we will show graphs for other
markets later). For the US we think the time for the next structural bull market to start will be the
low made between 2014-2016 (with a preference for 2014).
Source: Census Bureau, Clue6
As we have said in the past 10 years, this does not mean that there won’t be cyclical bull markets
in between.
In the past we have showed that during structural bull markets the market rises around 85%
o t e t me w e n structura ear mar et t r ses approx mate y o t e t me…
So where do we stand now…
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5Equities: Valuations
For longer-term return projections (7 years), we use a methodology similar to Grantham, Mayo,
Van Otterlo & Co so let’s use their graphs (Chart 3 and 4). What is the performance of thevarious categories if in 7 years they trade at the average valuation normalized to average margin.
Another indicator we look at is the Value Line Median Appreciation Potential (VLMAP) which
Chart 3ears
Return Forecast
August 2009
P.Bernstein used in his valuation estimation of the market. It is the median price appreciation
potential estimated by Value Line of the all of the 1700 stocks they cover for the following 3 to 5
years. It fell below 60% which is at the bottom end of its history… One should start
accumulating stocks when it rises above 100%...
High quality stocks expected return has declined by more than 2% to 9.6%. This is where
we still would be greatly overweight (and as an aside valuation our macro scenario favor
"bunker-like" balance sheets).
As we will show in the next few pages, we think there is a non-negligible risk (it is a risk
Source: Grantham, Mayo, Van Otterlo & Co
identified and not a prediction…) that the market will make “THE” bottom at levels up to
50% below where the markets are now.
In 2000 we said that the S&P 500 would fall below 500 before the next structural bull market
starts, we still believe that this is a potential outcome (but we would add 5-6% a year to this
Chart 4 November 2009
objective going forward (would be a combination of extension and time for the correction I.E the
longer it takes the lower the required decline…)
But we also know that timing the exact bottom is impossible so we will automatically increaseour recommended allocation on declines once we fall below 700-750 on the S&P 500 and we
see breadth extremes without regard to the trend. The allocation will be increase along
price declines exactly as we did in March this year.
One need a plan to stick to in such environment and this is ours . We will also limit the extent
to which we take net short positions the closer we are to what we consider rock bottom
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va uat ons.
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6Equities: Valuations
US PBChart 5We have shown that the concept of book value haschanged in the last 15 years (Table 1 earlier).
This is especially true for the US and Europe.
Chart 6 Europe PB
In 2007, in our effort to convince clients of the
overvaluation of the market, we presented data
demonstrating that balance sheets had
experienced a radical mutation in the past 25
years. Not only i we see a ecline of t e
importance of the tangible assets, those were now
dominated by financial assets whose pro-
cyclicality was masking the potential problems
and over-leveraging.
We understand that in a service economy tangibleassets are not as important as when manufacturing
dominated (see the proportion of tangible assets in
emerging economies on table 3), but once more,
Japan PBChart 7 Chart 8 Japan Small Caps PB
Source: Bloomberg, ClueSource: Bloomberg, Clue
as yourse w a n ang es are wor n a
bankruptcy…
On the various charts the semi-transparent
area represent time when the market was
c eaper an o ay on a oo va ue per s a re
basis.
A cursory look at the graphs confirm that
valuations are not as attractive as they were just 6
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7Equities: Valuations
Asia ex Japan PBChart 9
The picture is less flattening if one looks at price to
normalized earnings or price to replacement value
Chart 10 Latin America PB
All in all we would estimate the US and European
markets to be overvalued by 30-40% with a fair
value between 750-800 (and do not forget that we.
feel comfortable (and in good company…J.
Grantham, A. Smithers, J. Hussman,…)
Japan remains undervalued and as said, the low
Eastern Europe PBChart 11
Source: Bloomberg, ClueSource: Bloomberg, Clue
mean revert to other countries standard now that Japan is slowly, but surely, becoming more
shareholder friendly.
...
excess liquidity pumped by central banks around the world and from the cheap USD but... The USD
won't fall forever and once you reach a certain level of valuation you are only counting on finding a
bigger fool. Trend change should definitely be acted upon from here on...
background... Buy aggressively on a return to 0.5-0.6 PB.
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Equities: Valuation 8
Chart 13USA and Europe Return on EquityChart 12e ng, enera an
Administrative Expenses YoY
Return on Equity is probably near a bottom in the US and there is still some work to be done in Europe which tends to lag by 12-18 months, as doearnings (Chart 12). Return on equity analysts projection which we qualified as overoptimistic earlier might come to pass for 2010 (well the one
Source: Goldman SachsSource: Morgan Stanley
they add a couple of months ago not the current ones.
At least US companies have been firing a lot of workers. The decline in nonfarm payrolls at more than 5% surpasses the decline in GDP... In
Europe we have only seen 1% decline...
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The consequence has been that the annualized Q2/Q3 growth of the business sector GDP has been 1% while profit have increased by 46% (thanks
to financials which represents again more than 35% of total profits…)
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Equities: Valuation 9
US Private Compensation/GDPChart 15US Profit/GDPChart 14
The reliance of margins in the US has been in good part due to the foreign profits margin (Chart 14) (more on this later) … Note also that the
Source: BEA, Clue6Source: Bloomberg, Clue6
…
Longer-term we are expecting to see a mean-reversion in the Private compensation to GDP (Chart 15) which will weight on margins which might
stay lower for longer and not reach the 2007 and even 2000 high for quite some time. This should be associated by a reduction in inequalities,...
But more on this very important and under discussed problematic later in 2010…
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Equities: Valuation – US Earnings 10
S&P 500 as Reported Earings and Margin Direction ModelChart 17US NIPA and S&P 500 Operating ProfitsChart 16
We have used the Chart 16 a couple of times in the past (2000, 2002 and 2007) to forecast a turn in the S&P 500 operating earning cycle. NIPAProfit leads by 2 to more quarters. This bodes well for at least the coming 2 quarters (at the top of the cycle accountants tries to mask the earning
Source: Clue6Source: Clue6
deterioration while at bottoms they do the reverse…)
A few remarks… First the big increase in the last quarters NIPA profit was mainly due to financials. Profits in the sector rebounded strongly
because of a decline in both charge offs… One has also to see that the current ratio of as reported (according to GAAP) to operating earning at 14%
is the lowest in history (last low was 60% during the 2000-2002 bear market). Accountant are working hard… Finally our basic margin model is
Clue6 First Quarter 2010
has recently turned negative… If earnings grow beyond Q2 2010 it will have to be supported by top line growth.
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Equities: Valuation – Style 11
Speculative vs. DefensiveTable 2Valuation Factor DispersionChart 18
There are many analysis one can use to time styles. One we use and have advised to use for many years, is factors dispersion. There are many ways
to calculate it… On Chart 18 you can see the calculation for both Europe and the US of the value factor dispersion… When dispersion is spiking
Source: ZeelotesSource: Morgan Stanley
g er, uy un stoc s we ave emonstrate n t e past t at t e est stoc s to uy a ter a ottom an t can a so e an nterme ate ottom n an
on-going bull markets) were the stocks appearing in short screens) when it is low, buy quality…
The messages are… the outperformance of simply buying low PB stocks vs. high PB stocks is likely to be much below average going forward
(until dispersion increase again but dispersion could decrease further before we would short them), speculative factors are likely to underperform
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un we ge e nex ou o ncreas ng spers on, w s a e grow , roc so a ance s ee , s ea y ncreas ng
dividends and book value per share and a moat…
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Equities: Valuation – US Future GDP Growth 12
Source: CBO,Clue6 Idea: J.Hussman
As said in the past, in the long run, earnings tend to grow slightly less than GDP. The above concept to estimate forward growth was first proposed
by J.Hussman. For the US real GDP to reach the CBO potential real GDP forecast in 10 years, the growth should be 2.7% which is one of the
lowest in history.
If one add that there is a non-negligible risk of deleveraging and overcapacity related deflation (if Central Banks and Government do not go all-in
Clue6 First Quarter 2010
where inflation might become a problem) this does not bode well for nominal growth which is what people and companies use for they investment
and consumption decisions…
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13Equities: Sentiment – Surveys
NAAIM Survey and S&P 500Chart 20Investor Intelligence Bull/Bear RatioChart 19
For the first time in a while, almost all of the Surveys we follow are indicating a very high level of confidence that the market will continue to rise…
Source: NAAIM, Clue6Source: Investor Intelligence, Clue6
On Chart 19 one can see the the Investor Intelligence Bull ratio which has recently reached its highest level in many, many years (with the Bearish
percentage at its lowest level since 1987, and thus 3 weeks in a row now…) The same configuration is starting to emerge when looking at the
American Association of Individual Investors survey with the bearish percentage at 23% (but it went below 10 a couple of times in the past)…
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e at ona Assoc at on o Act ve nvestment anagers a ocat on survey art s a so not are away rom past g s ur ng t e past
weeks… Markets have tended to struggle after such a long stretch of bullishness…
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14Equities: Sentiment – Surveys
TSP Survey and S&P 500Chart 22Greenwich Macro Managers Bearish%Chart 21
On Chart 21 one can see that the Macro Managers bearishness has abated but remains relatively highs (and we would not use it as a contrarian signal
Source: TSP, Clue6Source: Greenwich Alternative Investments, Clue6
at this juncture)
Finally the TSP Bull/Bear Survey (Chart 22) has recently moved sharply higher and has given a sell signal according to the methodology they use…
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15Equities: Sentiment – Surveys
ML Fund Managers Survey Percentage Net
Overweight Emerging marketsChart 24ML Fund Managers Survey Percentage
Net Overweight JapanChart 23
Source: Merrill LynchSource: Merrill Lynch
On a Country/Region basis there are 2 stand outs…
Everybody hates Japanese stocks (Chart 23) while the sky seems to be the limit for Emerging markets (Chart 24)…
2 potential surprises for 2010? Probably but the timing will have to be right with probably 3-4 phases during the year but with the Topix beating EM
by the end of the year….
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16Equities: Sentiment – Put Call Ratios
S&P 500 and Equity PC RatioChart 26S&P 500 and OEX PC RatioChart 25
Looking at option activity the picture is similar…
Source: Clue6Source: Clue6
On Chart 25 one can see that the OEX put call ratio rose above 2 4 times in the past few weeks… this is something very worrying.
At the same time the Equity put call ratio is hovering at a low level (Chart 26).
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ot were com ne on a s ng e grap , one wou see t e aw attern we ave scusse n t e past…
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17Equities: Sentiment – Put Call Ratios
S&P 500 and Small Traders Buy to Open Put/Call RatioChart 28S&P 500 and Small Traders Option ActivityChart 27
Source: OCC, Clue6Source: OCC, Clue6
, ,
16% of their total activity which is near an historic high while their call buy to open activity represents 36% of their transaction… not far from the
40-42% extremes reached in the past (Chart 27 and 28)…
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18Equities: Sentiment – Insiders
Footsie and InsidersChart 30S&P 500 and Russell 3000 InsidersChart 29
The number of sell transactions in the US is reaching a high level (especially given the fact that at year end activity usually abate somehow…) while
Source: ML, Clue6Source: Bloomberg, Clue6
buying remains low (Chart 29).
The same is true in the UK where the buy to sell ratio is historically low (Chart 30)…
But remember, insiders activity is especially useful in 2 configurations: lots of relative buying or increased selling when the market decline…
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19Equities: Sentiment – Insiders
Europe Directors’ Selling (in eur mio.) (transactions
capped at eur 1 mio.)Chart 32Chart 31 Europe Directors’ Buying (in eur mio.) (transactions
capped at eur 1 mio.)
In Europe we have seen a big increase in selling during the past 8 weeks consolidation (Chart 32) while buying has remained low (Chart 31)…
Source: Deutsche Bank ource: eutsc e an
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20Equities: Sentiment – Insiders
Global Insiders ActivityTable 4Global Insiders ActivityTable 3
Looking at other markets around the world, one can see that insiders have become increasingly bearish in Hong Kong notably (Table 3-4)…
Source: Bloomberg, Clue6Source: Bloomberg, Clue6
Note that the last quarterly ratios where already much higher than the very bullish (lots of insiders buying) that we witnessed at the end of 2008 and
the start of 2009…
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21Equities: Sentiment – Smart Money
S&P 500 and Leuthold Core Beta ExposureChart 34S&P 500 and Hussman Strategic Growth Beta ExposureChart 33
J. Hussman strategy here is clear. He buys small on weakness and re-hedge completely on strength. According to our calculation he is currently fully
Source: Clue6Source: Clue6
hedged and he has been out recently saying that a >20% correction is likely (but not certain…) to start in the next 8-12 weeks…
S. Leuthold, who has been bullish and right since early in 2009, has started to sound more cautious, at least for the short-term… His exposure is still
high though (Chart 34)…
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22Equities: Sentiment – Smart/Dumb Money
S&P 500 and Strategists Stock AllocationChart 36Nasdaq 100 and Non-Commerical Net Long Future PositionChart 35
Non-Commercial have dramatically diminished their Nasdaq 100 futures net long positions from an all-time high to approximately 2000 contracts
Source: Bloomberg, Clue6Source: Bloomberg, Clue6
(Chart 35).
Wall Street Strategists have dramatically increased their equity allocation recommendation in the past few weeks (Chart 36) and while it remains
lower than average if one look at the past 12 years history this would probably not be the case if a longer history was available…
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23Equities: Sentiment – Dumb Money
Analysts US Stock Recommendations 3 Months ChangeChart 37 Topix and Percentage Analysts Sell Recommendations JapanChart 38
Analysts recommendation momentum is not very informative here with both buy and sell recommendations being lower than 3 months ago (Chart
Source: Bloomberg, Clue6 Source: Bloomberg, Clue6
37)
In Japan after a pick up in sell recommendations at the end of 2008 we are seeing continuing decrease in the momentum of buy recommendations
(Chart 38).
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24Equities: Sentiment – Dumb Money
Topix and Shares Sold on Margin Profit/Loss RatioChart 40Topix and Shares Bought on Margin Profit/Loss RatioChart 39
In Japan analysts have access to the performance of the margin buyers and sellers.
Source: Bloomberg, Clue6Source: Bloomberg, Clue6
n art one can see t at w en nvestors are start ng to ma e money on t e stoc s oug t on marg n or even os ng ess t an , t e ra y s
usually very near a reversal…
The same is true on stocks sold short on margin (Chart 40)… when they start to make a profit, a reversal to the upside is not very far… we had a
good example in December…
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Margin traders are currently losing both way…
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25Equities: Sentiment – Volatility
S&P 500 and CFTC VIX Large Speculator Net PositionChart 42S&P 500 and Vix Time-SpreadChart 41
Our VIX Indicators are giving conflicting signals…
Source: Bloomberg, Clue6Source: Bloomberg, Clue6
The time-spread is at levels where market volatility has increased and markets have struggle to make sustain advances (Chart 41) while non-
commercials have an important net short position indicating that they believe the VIX will continue to decline in the near-term (Chart 42).
Remember that they are the smart-money here (but note that they were dead wrong with their highest net long position in December so…
Looking only at the VIX, the recent highs have not been confirmed by a VIX new low which is a negative while on the positive side it is still making
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lower lows and lower highs… A break above 23.5 followed by a higher low would be needed to change the trend…
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27Equities: Breadth
Nasdaq 100 and the New High New Low ModelChart 44S&P 1500 and its AD LineChart 43
After having showed sign of potential divergence in November and December, breadth is back in sync with the market…
The S&P 1500 Com osite Index cumulative advance decline line has now confirmed the market recent hi hs Chart 43 . The diver ence was due to
Source: Clue6Source: Clue6
the poor showing of small caps stocks which have performed extremely well since mid-December. We will have to see if the rebound is simply the
traditional small caps rebound during this time of the year or is a sustainable move (breadth-wise) in the weeks to come…
The Nasdaq New High-Low Model is still on buy (Chart 44).
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But one has also to keep in mind that volume remains anemic and that the up-down volume stats are not showing real buying behind the recent move
(real accumulation has been absent since October…)
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28Equities: Breadth
MSCI Asia Ex Japan and Normalized Advance-Decline RatioChart 46Topix and Normalized Advance-Decline RatioChart 45
Our Japanese normalized advance-decline ratio moved to an extreme oversold level (<-40) in early December and has since moved back to positive
Source: Clue6Source: Clue6
(Chart 45). You usually needs a move above 20 for the market to stale after such oversold readings…
In Asia, we did not have any breadth thrust in the past 3 months (Chart 46) and are slowly approaching the >5 levels where the market tend at least to
consolidate (if we expect the move out of extremely oversold level where it usually indicates continuation…)
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29Equities: Breadth
S&P 500 and Hindenburg OmensChart 48S&P500 and Fosback High Low IndexChart 47
Since we have started to write those presentations, many years ago, we have used the following 2 studies to warn of impeding cyclical trend change.
Source: Clue6Source: Clue6
On chart 47, one can see the Fosback High Low Index remains very low, indicating a lack of distribution. It is likely to remain low until mid-March
as many stocks plunged into March 2009 making a big rise in new lows unlikely.
We have yet to see any Hindenburg Omen triggered on any of the Major index (Chart 48)…
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30Equities: Liquidity
Flows to Emerging Markets Mutual Funds and Future
Relative performanceChart 50Equity mutual fund assets and net cashChart 49
Source: Nomura
Net inflows into equity mutual flows continue to be negative (Chart 49) in the US while we are continuing to see huge inflows into emerging market
Source: ICI, Clue6
oriented funds (and while US investors have been net sellers of equity mutual funds they have been net buyers of emerging market equity funds…)
Such important inflows have been historically followed by a substantial underperformance of Emerging markets (Chart 50)..
The NYSE margin debts has now exceeded the 2000 levels on a % of market cap basis…
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31Equities: Liquidity
Number of Buybacks Announced per Month in JapanChart 52Number of Buybacks Announced per Month in the USChart 51
Buybacks have picked up slightly in the US in the past 2 months but remains at a very depressed level (Chart 51)…
Source: Bloomberg, Clue6 Source: Bloomberg, Clue6
In Japan, we have seen a slightly more robust pick up (Chart 52) but we would like to see more to be convinced that management is more confident
on their company prospect and more interested in the well-being of their shareholders…
Note that we remain wary of too much buybacks which, in aggregate, still remains a sign of management “short-terminism”… and in Japan we
Clue6 First Quarter 2010
wou pre er to see stoc s oug t ac t an new unpro uct ve cap ta expen ture…
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32Equities: Liquidity
China + Hong Kong IPOs and Secondaries (US mio.)Chart 54US IPOs and Secondaries (US mio.)Chart 53
The Banks TARP repayment have caused a big jump in the amount of secondaries in December (Chart 53). The market digested them surprisingly
Source: Bloomberg, Clue6 Source: Bloomberg, Clue6
well with banks shares only underperforming slightly (but still far from their September highs)
In China and Hong Kong, management are taking advantage of the current rebound to flood the market with new shares (Chart 54)…
Remember that management sell stocks mainly for 2 reasons. First when they have to in order for the company to survive (what happened in the US
Clue6 First Quarter 2010
ur ng t e rst mont s o or w en t ey wou e stup not to e ac stone n u y , na an ong ong at t e en o an
potentially now…)
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33Equities: Liquidity
Japanese Middle to Young Cohort and Equity Funds
AssetsChart 56US Middle to Young Cohort and Equity Funds AssetsChart 55
The above 2 graphs are well-known for those who have been reading our research for a long-time.
Source: ICI, Census Bureau, Clue6 Source: BOJ, Japanese National Institute of Population and Social Security Research, Clue6
We believe that the long-term flows into and out of assets (the relative buying/selling urgency to be more precise as they are no money getting in or
out of the market… for each buyer there is a seller and vice-versa) have a demographic cause… It affects the assets relative value and can be best
seen on the secular trends in normalized valuation ratio.
In the US, one should not be surprised by the net outflows from equities into bonds, this is what should happen (Chart 55) while in Japan we should
Clue6 First Quarter 2010
see t e reverse (C art56)…
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34Equities: Liquidity
Middle Age Population Growth ForecastChart 58Chart 57
the Next 5 Years
On chart 57 you can see the countries which have the most positve demographic dynamic according to the Middle to Young Cohort hypothesis…
Source: Census Bureau, Clue6 Source: Census Bureau, Clue6
But should not only the “Middle to Young Cohort” but the absolute growth of the middle age population (Chart 58).
Combining both, one see that the picture is somewhat less bullish than it seems for Japan, Spain, Poland, Portugal and Greece
Clue6 First Quarter 2010
35Equities: Li idit
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35Equities: Liquidity
Middle Age Population Growth ForecastChart 60Chart 59
the Next 5 Years
On chart 59 one can see the countries with the most bearish demographic configuration according to the Middle to Young Cohort hypothesis…
Source: Census Bureau, Clue6 Source: Census Bureau, Clue6
The middle age dynamic of those countries is presented on Chart 60…
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36Equities: Li idit
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36Equities: Liquidity
Liquidity momentum has a slight tendency to lead markets, and this should be especially true given in the current environment…
M2 momentum is not supportive going forward…
Clue6 First Quarter 2010
Equities: Seasonality President Cycle and Monthly Seasonality 37
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Equities: Seasonality – President Cycle and Monthly Seasonality 37
Return since 1927)
Chart 63 US Monthly Return (S&P 500 Total Return since 1944)Chart 64
The four year Presidential cycle has been distorted by the huge fiscal and monetary stimuli of last year. The rational behind the presidential cycle
Source: Clue6 Source: Clue6
market…
The market has a tendency to perform slightly better in January (Chart 64) but in the past 10-15 years we have witnessed a good start followed by a
nasty correction intra-month so…
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Equities: Seasonality Sell in May and 38
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Equities: Seasonality – Sell in May and … 38
Average Return MSCI Indices 1970-1998Chart 65 Average Return MSCI EM Indices 1970-1998Chart 66
Source: The Halloween Indicator, S. BoumanSource: The Halloween Indicator, S. Bouman
“ ”
a date but we want a technical confirmation during a given time-window) are also on buy…
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Equities: Seasonality End of Month Anomaly 39
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Equities: Seasonality – End of Month Anomaly 39
US Day of the Month (S&P 500 Total Return since
1944Chart 67 Japan Day of the Month (Topix Total Return since 1979Chart 68
The day of the month continue to exhibit its historical pattern in the US and Japan (Chart 67-68) (the same is true for most markets as showed
Source: Clue6 Source: Clue6
…
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Equities: Seasonality – Cycles 40
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Equities: Seasonality – Cycles 40
NYSE Composite and the 20 and 40 Weeks CyclesChart 69 Super Cycle Economic SeasonsChart 70
The next 20 weeks cycle low is expected for the middle to end of March (Chart 69).
Chart 70, courtesy of B. Bronson, has been used in the past to depict the relative assets movement during the Long Cycle (Kondratiev wave). Many analysts have
Source: Clue6 Source: Bronson Capital Market Research
tried to define this cycle by applying a fixed number of years but, as we have long said, we think that this is more of a generational cycle of leveraging and
deleveraging (was visible on price up to the creation of the Fed and on money velocity since then…). People who were young in the 30’s were allergic to
borrowing during all their life, organizing parties to celebrate their final mortgage payment… The same is slowly happening now in the developed world (it will
likely accelerate in the coming years when the weak foundation of the current upswing will become clear to all…)
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, .
ask for more… It is followed by the Winter where interest rates and stocks valuations become highly correlated, both falling…
41Equities: Intermarket
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41Equities: Intermarket
S&P 500 and Nasdaq Composite Relative PerformanceChart 72S&P 500 and World Defensive Relative PerformanceChart 71
Defensive have been performing relatively well in the past3-4 months (Chart 71). To follow attentively in the next few weeks to see if they manage
Source: Clue6 Source: Clue6
to break out… This would be a negative for the market…
After having struggled, along with small caps in the past 5 months, the Nasdaq Composite has finally made a 52 weeks relative high against the
broader market (Chart 72). This is positive has the market tend to be most productive when the Nasdaq relative performance trends higher along with
the market as we have showed with various models in the past…
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42Equities: Intermarket
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42Equities: Intermarket
Chart 73
Performance
Corporate Bond Fund Net Asset ValueChart 74
Banks shares continued underperformance is worrying (Chart 73) as it is a logical consequence of our macro scenario but one could still say that
Source: Clue6 Source: Clue6
they performed relatively well given the huge amount of dilution they have to suffer in the recent past… and let’s not forget that they are in the
portfolio of quite a lot of the smart money managers we follow so…
High yield spreads are continuing to decline and junk bonds are making new price highs (Chart 74) despite the rapidly rising 10 years treasuries
which is impressive…
Clue6 First Quarter 2010
43Equities: Intermarket
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43Equities: Intermarket
Chart 75 S&P 500 and US 2 Years Treasury Bonds S&P 500 and Eurodollar ModelChart 76
Two years treasuries have spiked higher recently (Chart 75) and this should be associated with struggling market in the current environment…
Source: Clue6 Source: Clue6
e same s true or n at on expectat on…
We also like to look at the relative behavior of the equity markets and the Eurodollar future. On chart 76 you can see what happen to the market
when the eurodollar falls (higher rate expected) 2 days in a row and the market falls at the same time… We had an episode mid October… Another
one could mark an peak of significance…
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One of our most effective intermarket “consolidation forecaster” which simply looks at the combined medium-term momentum of bonds and
commodities is also flashing a warning signal…
Equities: Intermarket – US10 Years Govies against Stocks 44
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q g
Blue area indicates when the momentum
Chart 77 S&P 500 and US 10 Years Treasury Bonds S&P 500 and US 10 Years Treasury BondsChart 78
positive. In this period, stocks performed
when the momentum was negative.
Blue area indicates when the momentum
in 10 years government bond yield is
positive. In this period, stocks performed
when the momentum was positive.
We have long argued that one the characteristics of the current structural bear market (and we are talking US, Europe and Japan here...) was
Source: Clue6 Source: Clue6
.
But one has also to take into account the fact that while they are positively correlated, when yields have risen too much too quickly the stocks will
struggle. The sequence is usually rising rate, acceleration to the upside, yield starting to fall just before stocks do it to…
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Equities: Intermarket 45
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qChart 79 MSCI Emerging Markets and Dollar Index S&P 500 and Sovereign CDSChart 80
We already identified potential headwinds for emerging markets (Valuation, investor bullishness,…)
Source: Clue6 Source: Bloomberg, Clue6
Don’t forget to look at the USD… A rising USD has rarely been a positive for emerging markets (Chart 79)…
2010 or 2011 could be years of major sovereign negative surprises… on the next page one will find the countries to have especially an eye on…
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… …
Equities: Intermarket 46
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q
Source: RBS
Canaries in the coal mine candidates… To observe attentively in the coming months…
Candidates have been selected using the methodology of “Rules of Thumb' for Sovereign Debt Crises” by P. Manasse and N. Roubini, 2005
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47Equities: Graphs
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qS&P 500
Shoulder
Shoulder
Head
The S&P 500 continues its march upward inside a well-defined up channel. We continue to see higher highs and higher lows.
The inversed head & shoulders and June-July flag targets are still above us at 1200-1250 while the descending 2007-2008 channel
should offer resistance at the 1100-1130 levels.
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A series of narrow range day has usually been a warning of an impending correction in the past 12 month… Had the first on
Wednesday this week…
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qDJ Euro Stoxx 50
ShoulderShoulder
Head
Europe has been slightly underperforming recently but has now managed to make new cyclical highs. The head & shoulders target is at around
3300.
We would continue our strategy of selling strength (top of channel) and buying weakness (bottom of channel) until our tactical model becomes a
seller…
Clue6 First Quarter 2010
We would now move from selling upside volatilities to outright reduction of the equity exposure and even a small net short positions when
reaching the top of the channel…
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Topix
ShoulderHead
Shoulder
Shoulder
Shoulder
Head
The Topix reacted strongly by rebounding from its December oversold level… It has now formed an inversed head and shoulder
with a 1000 target…
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50Equities: Graphs
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MSCI Asia ex-Japan
Asia rose strongly at the in the past 2 weeks has everything which is associated with risk… As everywhere the gain have been made
on low volume…
Yet one has to respect a market making a new 12 months high after having consolidated during 4 months…
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To be honest it smells a bull trap but…
51Equities: Graphs
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MSCI EM Latin America
Similar as in Asia but with less impetus…
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52Equities: Graphs
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MSCI Eastern Europe
Eastern Europe still remains one of the least discounted "unavoidable accident" in the market today (it is was mostly discounted in
the Eastern European markets last year but the second round effects to ward other part of the world are not…… The stronger IMF
has voided the "end of their world" scenario, but…
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… …
things in the Czech Republic for example…
53Equities: Conclusion
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Valuations are now above levels where performance going forward will not please the buy & hold crowd, even if we go back to the good old
days, the credit bubble stops deflating, growth reaches pre-2007 level in a sustainable manner ,.... At 1200 on the S&P 500 will be priced moreexpensively than all of the structural tops pre-2000 (well 1997-2000) except the final tail of the 1929 move... This does not imply that the market
will fall in the short or even the medium term but that a further rise will only have speculative and no investment merit if bought . Our base
assumption remains t at we will fall to significantly un ervalue levels efore a new secular ull mar et can start (in t e evelope worl as you
know we believe that we are in a secular bull market in emerging markets). This currently imply a sub-530 level on the S&P 500 going up by 5-6% a
year.
Option activity, insiders and most of the smart-money we follow are in a configuration where markets have struggled in the past. But even if
sent ment s once aga n too gree y, t as to e put n t e context o t e recent a vance an mar et tren g er g s an g er ows . s
does not imply that the market can not continue to rise in the medium-term but more that it should at least consolidate in the short-term. Small
investors optimism has finally started to rise and is now deep in overconfident territory…
Most of the breadth divergence we noted in November and December are now gone… Uniformity remains high...
On the liquidity side, inflows into US equity domestic funds remain low while the money is pouring into emerging market equity fund. This has
historically been followed by underperforming EM markets… We have seen a slight pick up in buybacks but they remain very low while IPO’s andSecondaries have been plentiful with bubble reminiscent level in Hong Kong and China…Monetary aggregate momentum is turning down and this
could prove to offer some headwind to risk assets…
Pension funds’ funding status is deteriorating despite the rising equity markets courtesy of the rising present value of liabilities...
Seasonals are supportive even if one has to remember that the equities have relatively important (>5%) correction intra-month in January, especially
after strong starts…. Cycles are still supportive but the 20 weeks cycles should be topping in the very near future…
Intermarket relationships have improved from the numerous divergences witnessed in November and December. The relative good performance of
defensive around the world is a worry as is the fed funds futures/equities co-movement but so far so good. We are more worried about the medium-
term momentum of bonds and commodities which is in a configuration where equity market productivity has been poor historically…Sovereign CDS
will continue to need your attention…
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54Equities: Conclusion
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The trend is up almost everywhere but we are at or near the top of the new rising channel. Correction to at least the bottom of the channel expected
before a potential resumption of the up move but the rest of the analysis points out to something potentially bigger than the correction we had sinceMarch…
Clue6 First Quarter 2010
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