The Daily Trading Report

It is all too easy to get caught up in the panic surrounding the Euro debt “crisis”. The media are having complete field day with the drama surrounding the Greek debt crisis (call it whatever crisis you will). They are conjuring up every reason in the world why the Euro is going to zero, how the Greek crisis is going to systematically spread across the Eurozone nations……and the list goes on. Given the tone of the commentary coming out of the media of popular opinion one could be forgiven for thinking that equity markets have already entered a bear market or at least a material correction. However, as at time of writing, the major market indices in Europe have yet to break critical pricing levels – just take a look at the Stoxx 50 index below. Yes that support level is a little too close for comfort, but really how sick is the average listed stock?

Stoxx 50 Index

We don’t place too much faith or importance on large cap indices mainly because everyone else looks at them so looking at them is hardly going to give us an edge. Also large cap indices are heavily weighted to the performance of a few mega caps which can provide rather misleading behavior.

A bull market is defined as one where the average stock or the broad market is rising. We have found that the best representation of the behavior of the broad market is small cap indices. Now take a look at how the MSCI Europe Small Cap index is behaving. If one was to take away the behavior of the last two days then it is only a few percent away from a multi-week high! This is quite contrary to what you would think based on the media banter! It has got someway to go before it breaks any critical pricing level which would signal the start of a bearish phase.

MSCI Europe Small Cap Index

Bear markets are supposed to sneak up on you when you are least expecting, when your attention is focused else. If this is the start of a material downturn in the market it is certainly not typical!

All technical or behavioral aspects of this market aside, has anyone sat down and looked how cheap large caps are in Europe? Well below are a few fundamental metrics of the members of the Stoxx 50 index. As simplistic as it seems (and that is the way we like it) you can now pick up the big multi-national stocks (like Bayer, Nestle, BASF, Daimler, LVMH, Nokia, L’Oreal, and Danone) on a forward P/E of 10x and a Price/Book of 1.25X……….maybe this will be 1.20 within a few days! These stocks are as global as any of the Dow components, and one can only wonder how much more competitive they have just become given the breakdown in the Euro!

Wasn’t it Rothschild who said “buy when there is blood on the streets”…..wasn’t it Getty who said “when they are yelling I am selling and when they are crying I am buying” ok it might have been Rockefeller or JPM……but I know it was Templeton who said “the time to buy is at the point of maximum pessimism”! I say no more.

We bought the Stoxx 50 yesterday. Judge us by our actions not words.

Our wealth creation portfolio is up around 25.70% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

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It has been some 12 months since we first highlighted the bullish build up in coal stocks. Since then the coal sector has been one of the best performing sectors in the US.

However, since about mid October last year the coal sector has more or less gone sideways. Does this lack of action suggest that the good fortunes of coal stocks are about to change? We think not. If one observes the chart below of the CSX coal price it too went sideways from mid October 09 until about four weeks ago. However, during April it has again taken off.

CSX 1 Month Delivery Coal Price

Given how depressed the coal price has been for the last 18 months material upside may well be in the offering. We have a number of contacts in the coal industry in Australia who act as agents between suppliers and buyers in the far east. They are finding it very difficult to source coal at the moment and they have informed us that they would not be surprised to see coal prices advance another 50% before year end!

The Global Financial Crisis resulted in a near total shut-down in mine expansion and maintenance for almost 12 months (essentially due to the inability to obtain financing). Of course this shut down has meant that mining capacity is just not there. It is relatively easy to shut down capacity but it takes considerable time to bring it back up. So perhaps a dramatic increase in the price of coal over the coming months is not out of the question.

CSX 1 Month Delivery Coal Price

Note how close the Bloomberg US Coal Mining index is breaking higher. Are coal stocks expensive? Well that entirely depends on the price of coal. We think that coal prices are going to surprise on the upside and therefore coal stocks are likely to have dramatic earnings surprises over the coming quarters.

Bloomberg US Coal Mining Index

We would use any weakness in coal stocks as a buying opportunity.

Our wealth creation portfolio is up around 25.70% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

We are not currently taking new subscribers. Please enter your email address if you would like to follow our commentary and be notified when we open our service for subscriptions.

Everyone these days seems transfixed on the behaviour of the Baltic Dry Index, perhaps too much so. Does anyone realise how the Baltic Dry index is calculated? In essence there are four dry bulk carrier classes ranging from the super large Capesize class to the smaller Handysize class. There are relatively few capsize vessels compared to handysize vessels. So demand and supply of capsize vessels can vary dramatically relative to that of handysize vessels. Now the Baltic Dry index is made up of the largest of the four shipping classes (capesize, panamax, and supramax), the smallest class (again handysize) is not included. So what is the point of all of this? Well don’t take too much notice of the Baltic Dry Index, it is often misleading due to the erratic demand supply behaviour of capsize vessels. You would be much better off studying the demand and supply characteristics of the Baltic Handysize Index instead.

Now doesn’t the behaviour of the chart below (the ETF SEA) look remarkably like the Baltic Handysize Index! Of course beauty is in the eye of the beholder………..to us simple folk it looks like shipping rates are set to move higher and along with it shipping stocks. Perhaps it does not take a rocket scientist (economist) to work out that commodity prices are also set to lift-off over the coming weeks!

The after-hours earnings announcement from Alcoa that topped analysts’ estimates suggests that resource stocks are in all probability still cheap. It is quite likely that steel stocks such as Nucor and US Steel will also beat estimates if Alcoa’s results are anything to go by.

We have been watching the behaviour of the ETF SLX over the last few months and have been rather surprised at how strong it looks from a technical perspective and given the average price to book ratio of the constituents at 1.28x we still believe that the steel sector offers compelling value.

Take careful note of the ETF SEA. A break above the 14 level will generate a powerful confirming bullish signal for the steel sector. We believe that it is only a matter of days before the ETF SEA breaks through given the recent behaviour of Baltic Freight Rates

Our wealth creation portfolio is up 16.20% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

We are not currently taking new subscribers. Please enter your email address if you would like to follow our commentary and be notified when we open our service for subscriptions.

It appears that capital flows into emerging markets remain strong and there is no credible evidence that the strong absolute and relative (to developed markets) trends are about to come to an end anytime soon.

Emerging equity markets are now higher than they were at the time of the Lehman’s collapse and have yet to show any deterioration in upward momentum. We believe that there is more upside to come in equities because the underlying breath of the market is strong. Small cap emerging equity indices are only a few points away from multi-week highs suggesting that even the highly risky “rats and mice” stocks are continuing to make new highs. Usually prior to any significant correction the underlying market turns down. From a relative perspective emerging market equities continue to outperform the S&P 500, with EEM less than a 2% away from a multi-week high against the SPY.

Emerging bond markets also show no deterioration in upward momentum from both an absolute and relative perspective (relative to US investment grade bonds). The relative outperformance of emerging market sovereign bonds (to US investment grade) also suggests that the appetite for risky assets remains “positive” for whatever reason.

On the emerging market currency front CEW is less than 1% away from another multi-week high signalling a new high for emerging market currencies in general against the USD.

Note the appearance of the two foundation members of the emerging market universe. The South African Rand and Brazilian Real are more or less at multi-week highs. Having spent considerable time in both countries over the last 10 years we question as to how they can still be regarded as “emerging”. Anyway we think the classification of “emerging” is merely semantics.

Given that equity, bond and currency markets are all confirming each other with levels either at or very close to new multi-week highs, we think that more upside is likely in anything emerging market cover the coming weeks. We don’t know what the future holds, but we do know that markets move in trends and we know a strong trend when we see one.

Our wealth creation portfolio is up 16.32% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

By the time the average investor wakes up the greatest buying opportunity for real estate stocks in recent (if not modern) history may well be over. There is something powerful and broad based which is driving real estate and related stocks higher. The big real estate ETF IYR is getting closer to pulling back all the losses incurred since the collapse of Lehmans some 12 months ago. Furthermore, IYR is now clearly outperforming the Dow (and the S&P 500).

Could this be just another dead cat bounce for real estate stocks? Given that anything with a real estate/home building connotation is flying right now (take a look at the performance of the Russell 2000 real estate and home building indices) we think that the real estate sector has entered another bullish phase. Obviously this won’t sit well with many fundamentalists who would argue that consumers are still maxed out with respect to credit……but it is happening!

Our wealth creation portfolio is up 19.06% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

There has been considerable debate as of late regarding the prospects of shipping stocks (albeit lack thereof). We are very interested in shipping stocks due to their “out of favor” nature and cheap valuations. Most shipping stocks are trading below their book value, obviously for good reason. From the charts below one notes that on an absolute and relative basis shipping stocks (using the ETF SEA as a proxy for world shipping stocks) are virtually unchanged since October last year.

One really needs to see some sort of evidence of a bullish breakout before getting too excited about the prospects of shipping stocks. However, that being said, we believe that the next big move for shipping stocks is to the upside…..and big it is likely to be (given that SEA has tracked sideways for almost 11 months. We are reasonably confident that a break to the upside will occur given the behavior of coal and mining stocks (as per the charts below). Over the long term at least we find it difficult to believe that basic materials and coal stocks can keep rising without associated advances in shipping stocks.

It is interesting to note that the ETF SEA now has options attached to it. So exposure can also be gained via options trades.

Our wealth creation portfolio is up 17% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

A pull back is necessary to shake the weak hands out of the market. From mid July to mid August US stock markets have advanced in a rather parabolic fashion with barely a negative day worth noting. So a pull back in the market should be seen as necessary and healthy. In fact we would not be “moved” if there was at least another 5% downward movement in the S&P (to the 950 level), and would see the weakness as a buying opportunity rather than selling.

What would make us “scared” about the longer term prospects of the stock market? The key to understanding the true intention of the market is to observe how markets work off an overbought or oversold position. With respect to a bull market, if the pull back in the major market indices is accompanied by a lack of conviction in the overall market (i.e. the advance decline line holds out or at least shows a general reluctance to participate in the downside of the S&P 500) then we would conclude that the weakness in the S&P 500 is merely a short term correction and unlikely to result in any material (albeit tradable) downside.

Below is the NYSE Advance Decline Line and the Value Line Index. Note how the Advance Decline line is virtually unchanged and the Value Line has already pulled back all of Monday’s losses. If the market was genuinely bearish then we should have already seen a breakdown in the AD line and the Value Line should not have been so quick to pull back the losses sustained on Monday.

Granted it is still early days but given how the market has behaved over the last few weeks we see the weakness in the S&P 500 as nothing more than a correction in an “ongoing” bull market.

Our wealth creation portfolio is up 17% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

With major market indices registering multi-week highs it does not take a rocket scientist to figure out that equity markets have probably moved into an overbought condition. From a technical perspective we find the best indicator of the degree to which a market is overbought or oversold is the 200 day moving average ratio (the ratio of stocks trading above their 200 day moving average). In the past whenever the NYSE and NASDAQ moving average ratios moved above 80% there was a better than even odds of the major market indices closing lower 6 months hence. Currently 88% of stocks on the NYSE and 75% of stocks on the NASDAQ exchange are trading above their 200 day moving average.

So do these ratios suggest a bearish stance towards equities? Given that 200 trading days ago takes us back to mid November which was one of the low points in the S&P 500 it would not have taken much for 80% of stocks trading in the US to move above this point. So it is difficult to argue that, even with more or less 80% of stocks in the US trading above their 200 day moving average, the US stock market is in an overbought condition. Indeed at this time there has been no deterioration in the underlying momentum of the market with the equally weighted Value Line Index registering another multi-week high last night. We would begin to worry about the medium term outlook for equities when there is a divergence between the performance of the NYSE Comp and the NYSE 200 moving average ratio. Currently both indices are confirming each other.

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Wait for the average man in the street to start talking about stocks, although a growing number of economists are walking on the bullish side of the fence we have yet to see any evidence of the average man in the street getting bullish about the prospects of the US stock market, yes this is a subjective statement but don’t forget, unlike the physical sciences, we are not dealing with an objective “science” or subject matter.

Our wealth creation portfolio is up 18% since the beginning of this year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

Market internal indicators continue to suggest that equity markets are likely to move materially higher over the coming weeks. The Advance Decline Line and New High new Low Indices for the NYSE, AMEX and NASDAQ are more or less at new highs. Usually weakness in the major market indices, such as the Dow, S&P 500 and Nasdaq is preceded by a break down in market internals. We would be worried about the sustainability of the advance in the S&P 500 if the recent highs in the S&P 500 were not being confirmed by new highs in market internal indicators, obviously this is not the case.

A quick way of looking at the health of the underlying market is to look at the relationship between small caps (the Russell 2000) and large Caps (the S&P 100). If small caps are outperforming large caps then it is reasonably safe to conclude that market internals are healthy. OK so how would we define small caps outperforming large caps? We use the 120 day Rate of Change of the relative of the Russell 2000 and S&P 100. If the 120 day ROC is positive it denotes outperformance. The graph below clearly suggests that the Russell has been outperforming the OEX since mid April and last night the relative closed at another multi-week high. This is all supportive for continued upside.

Whilst market internals remain healthy we see any weakness in the major market indices as a buying opportunity rather than selling.

Our wealth creation portfolio is up 18% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.