Investment Postcards from Cape Town

Government bonds have been trading sideways since the middle of last year as market participants wax and wane about the prospects of the nascent economy recovery. Also, it has not quite been the one-way traffic for yields many pundits have been forecasting as seen from the US Treasury being able to sell paper across the yield curve at lower-than-expected yields. It should be interesting to see how the bond vigilantes handle next week’s auction of $118 billion worth of Treasuries, tying for the largest auction on record.

Not subscribing to a meaningful economic recovery under his “new normal” scenario, Bill Gross, the manager of the world’s largest bond fund, last month increased the exposure of the Pimco Total Return Fund to US government debt to 35% from 31% - the first increase since October 2009. Interestingly, $409 billion from a total inflow of $507 billion into US mutual funds over the past year ended up in bond funds.

The chart below, courtesy of the latest Commitment of Traders report (via David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates), shows the net speculative short position in 30-year US Treasury Bonds. The net short position last week was 107,382 contracts (with a face value of $100,000 per contract). This is at the high end of the range and, according to Rosenberg, “perhaps explains why bonds refuse to sell off - anyone who can sell them already has.” He added: “What is truly striking is that even though Treasuries were among the best-performing asset classes of the past decade, the noncommercial accounts spent 80% of that time being short the bond market. Yikes!”

Source: Gluskin Sheff & Associates - Breakfast with Dave, March 18, 2010.

Turning to technical analysis, the short-term picture for the ten-year Treasury Note yield is undecided, showing a symmetrical triangle. However, monthly data, going back to 1998, conveys an important message when considering the two momentum-type oscillators (ROC and MACD) at the bottom of the chart below. The ROC reversed course (crossing the zero line) in October last year for the first time since a buy signal was given at the beginning of 2007, thereby flashing a primary sell signal. The MACD provided a similar indication in June 2009.

Source: StockCharts.com

Lastly, while on the topic of long-term data, actually all the way back to 1850, the graph below featured in a recent report by Pring Turner Capital Group asking: “Are you prepared for a secular bear market in bonds? Bond owners beware”. As shown, the yield is just below its secular down trendline and it would not take a large move in yields to mark the end of the almost 30-year secular decline. What will this do to the US’s debt burden, the economic recovery and stock market valuations?

Source: Pring Turner Capital Group

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The markets have created their own gold standard because of uncertainties regarding other asset classes, Marc Faber, author of The Gloom, Boom and Doom Report, told CNBC on Thursday.

“I think we already now have a gold standard … created by the market place. We have the exchange traded funds that have proliferated and we have more and more physical buying of gold,” he said.

Source: CNBC, March 18, 2010.

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David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, yesterday made the following observation: “To be sure, the Case-Shiller index has yet to roll over. But it has slowed, and being a three-month average, it may take time to show deflation again. The LoanPerformance home price index is down for four months running. Freddie Mac’s conventional home price index fell 0.7% in Q4. RadarLogic’s 25-city house price index is down for two months in a row and in four of the past five.”

A useful source for some guidance on the prospects of real estate is Robert Cambell’s Campbell Real Estate Timing Letter (via Dow Theory Letters) from which I have excerpted the paragraphs below.

“Now is not the time to jump into the real estate market because some analysts are telling you we’ve hit a bottom. NOT only are my timing models telling us that the market hasn’t turned yet, but if the Fed stops buying mortgages via its quantitative easing at the end of the month, and if the government allows its tax credits to expire as planned in June, chances are good that we’ll see lower housing prices through the rest of this year - not higher prices.

“Lifting caps on Fannie and Freddie: Do you wonder why? On December 24, 2009 - in a kind of Christmas Eve surprise - the Treasury decided to lift the caps on how much bailout money the failed mortgage giants, Fannie Mae and Freddie Mack could receive in order to stay in business. The previous caps were $400 billion for both companies. Not anymore. Now the US taxpayers are back on the hook for unlimited financial support to keep Fannie and Freddie functioning - which could amount to as much as $8 trillion in taxpayer liability.

“Why did the Treasury do this? Because today, the FHA, Fannie and Freddie government agencies fund 90% of all U.S. mortgages and guarantee 97% of them. And in January, Fannie and Freddie reported combined losses of $94 billion for 2009. In other words, if Fannie and Freddie can’t keep providing hundreds of billions of dollars worth of mortgage financing, the real estate market will likely collapse.

“Mortgage delinquencies are still sharply rising - which is why these ailing mortgage giants require an extended bailout of more capital to cover anticipated future losses and stay afloat. At Freddie, 4.03% of its single family mortgages were at least 90 days past due at the end of January 2010, up from 1.98% in January 2009. Fannie is even worse: 5.38% were 90 days past due in December 2009, up 2.42% in December 2008.”

This is decidedly bearish commentary and leaves me wondering whether the SPDR S&P Homebuilders ETF - ticking all the boxes of a cyclical bull market - is getting it wrong. Then again, the same question can be asked about the US stock market.

Source: StockCharts.com

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The comments below were provided by Kevin Lane of Fusion IQ.

We remain cautiously optimistic with the trend up, internals strong, the Russell 2000, the NASDAQ and now the S&P 500 at new recovery highs. Skeptics remain the loudest people in the room and while their concerns may be valid we have learned that the market rewards the minority and confounds the majority.

As seen above the S&P 500 cleared its previous resistance peak near 1,150 (lower red line) and now looks to challenge the 1,200 level. Although there may be some back and filling along the way, we have long argued that there would be one last move up driven by investors who skeptically avoided the market. The fear and greed continuim is always at play and the market somehow has a way of prying all liquidity off the sidelines eventually. We think the last holdouts are now deploying cash, believing the economy has turned the corner. (The market has been flashing the economic recovery signals for quite some time by its strength.)

We believe this current move could be a melt-up phase and once completed a move to cash would make sense. However, for now investors need to ride the wave, albeit with tight stops!

Source: Kevin Lane, Fusion IQ, March 18, 2010.

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“We’re going to have another recession, I guarantee you … By 2012 say, it’s time for another recession,” Jim Rogers, chairman of Rogers Holdings, told CNBC. “The next time it’s going to be worse because we’ve shot all of our bullets,” he added.

Source: CNBC, March 17, 2010.

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As reported over the weekend (via US Global Investors), the latest Chinese inflation figures surpassed the one-year deposit rate of 2.25%. Negative real interest rates may provide an additional incentive to drive asset prices higher, increasing the likelihood of the Chinese central bank raising interest rates from a five-year low.

Source: US Global Investors - Investor Alert, March 12, 2010.

Fears of further monetary tightening in China have recently been weighing on the Chinese stock market. Of all the bourses, the Shanghai Composite Index (3,046 at the time of writing) is the only one trading below its 200-day moving average (3,059), albeit after yesterday’s good performance by only 13 points. Clawing back to above this key line and also breaking its high of March 4 (3,097) would be bullish signs. However, the February low of 2,935 must hold in order for the cyclical bull market to remain intact.

Source: StockCharts.com

The Chinese stock market was the first to turn the corner after the credit crisis sell-off - a full five months before the majority of indices bottomed in March 2009 - and is being watched closely to ascertain whether this market would be the first to spell danger for global stocks, i.e. the proverbial canary in the coalmine.

No reason to be overly concerned yet, argues David Fuller (Fullermoney) from across the pond: “People fear China’s credit tightening might trigger another significant sell-off in world markets. China’s monetary policy authorities need to get the balance right if they are to stem property speculation without overkill. This can be a fine balance but they have every incentive to succeed and their gradualist (baby-steps) approach to monetary policy tightening seems prudent. They will make some mistakes, like everyone else, but this is a medium-term risk and should have little effect on China’s long-term potential.”

He added: “Meanwhile, global stock markets have recently shown more evidence of a melt-up than a meltdown. Investors are climbing the ‘wall of worry’. I will worry more when they sound euphoric.”

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