Year of the Snake

Global markets continue to move higher in developed markets and some Asian markets. Of emerging markets, only Brazil appear to be on the decline, though that may present investors with a few buying opportunities, namely multinational companies headquartered in Brazil. The S&P 500 continues to make new 5 year highs, with an interday high of 1524.69 on 13 February 2013. The NASDAQ composite index reached a new 10 year high above 3200, while the DowJones Index crosses above 14000. Resistance points to watch on the S&P 500 are the 1535 and 1555 levels, still below the all-time closing high of 1565.15 set on 9 October 2007 and the interday high of 1576.09 on 11 October 2007. Shares in many companies have already peaked, so it is difficult to imagine that we might see new all time highs on the S&P 500 in 2013. There are indications that the market is overbought, so it would not be surprising to see a pull-back in the near future. On our indicator indexes we can watch the weekly chart cross-over on SPXA50R, which would indicate that more shares on the S&P 500 are moving downwards than above their 50 day moving averages. The high point on SPXA50R was on 22 January 2013, though this index does slightly lead the market. We should continue to watch other correlations with indicators mentioned in previous articles, such as the 10 year and 30 year Treasuries. Even with the continued gains in stock markets, activity this week might not be a good indication of a continued trend, since many Asian markets have holidays this week. Tradingvolumes will be lower this week as markets in China, Singapore, Japan and Hong Kong close for holidays.
The lack of much movement in 10 year and 30 year US Treasuries dispels the rumour of a Great Rotation from bonds into stocks. Despite this lack of confirmation of a rotation of funds, Barron's came out with yet another article interviewing little known fund managers touting the Great Rotation. While there are some good investment ideas in some of the companies mentioned, in this article Barron's follows their usual pattern of being late to feature a trend. We may almost consider a mention of a rally in Barron's to be a contrary indicator. One of the more interesting mentions in that article is Robert Half International (RHI), who are a major international company involved in managing temporary workforces. Matthew Sauer of Lateef Investment Management mentions that RHI grew their temp business by "double digits" for 10 consecutive quarters. It is tough to find agreement on his premise, that "temporary hiring is a leading indicator of full-time employment", because the numbers reported by analysts and various agencies that track employment point towards a growing different trend, which is the growth of a long term temporary work-force. There are advantages for some companies to have temporary workers, though the greatest advantage are exemptions to get around regulations, including health care and unemployment insurance. Michael S. Derby in the Wall Street Journal argues that regulations have not held back hiring, and makes note of a Federal Reserve Bank of San Francisco (FRBSF) study to make his point. While that Federal Reserve study does not address temporary employment, the important factors they do mention includehousehold debts levels and consumer spending. Redbook Research indicated in their latest report that US same-store sales increased 2.4% in January 2013 compared to a year ago, and sales continued to move upwards 1.1% in the first week of February this year compared to January. As consumer sales have improved, hiring an employment have improved. In that FRBSF study, financing and interest rates were not found to be much of a barrier for businesses in hiring, though that does lead to the question of why Federal Reserve monetary policy targets interest rates and access to funds. The other aspect of household debt levels has changed as the housing market continues to recover, though as the FRBSF indicate the effects are more local than regional or national. The continued Federal Reserve policy of purchasing Mortgage Backed Securities (MBS) does seem to address that trend, and may be one area of policy that has some potential to increase employment. Despite a slight decline in the yield of MBS seen recently, the average yield of 2.6% is still better than the 10 year US Treasury. The next possible area the Federal Reserve may target is money market funds, especially with all 12 Federal Reserve presidents indicating support for reform.
The US Trade Balance fell by $10 billion in December 2012 as export growth outpaced import growth. Petroleum products trade deficit declined by $4.7 billion to $18.7 billion, the lowest level since 2009. This change in trade balance should be reflected in an improved GDP. If this proves true, then the Congressional Budget Office (CBO) may need to reassess their latest projects of the economy slowing in 2013. The CBO also expect the US deficit to fall under $1 trillion this year, though that is based partially upon automatic spending cuts set to phase in on 1 March 2013. As Reuters analysts point out, recovery from recession to prior peak GDP levels often takes 4.5 years. So while the numbers continue to improve, there is still some uncertainty, and many possible risks that could derail recovery. The US January 2013 Budget Surplus came in at $2.88 billion compared to an expectation of a $2 billion deficit. In comparison the 2012 deficit amount was more than $27 billion, though with receipts increasing from $272 billion compared to $234 billion in 2012, most of the change is due to higher revenues.
We continue to see improvements in consumer spending and in housing markets in most regions of the United States. In a new trend identified by research agency Core Logic, home equity lines of credit are increasing, despite a large number of mortgages that remain underwater. Despite the increased attention on tapping into home equity, the overall amount is well below the peak of $28 billion in 2006. Part of the reason behind the trend may be an increase in confidence of the ability to repay. There is some indication that these funds are going towards home improvements. Investor interest moved towards Residential Mortgage Backed Securities (RMBS) throughout 2012 as hedge funds bet on a recovery in housing. A newer trend now emerging is investor interest in Commercial Mortgage Backed Securities (CMBS). Commercial real estate and debt on commercial mortgages are lagging behind a recovery in residential mortgages. While commercial property values have recovered 45%, gains in commercial debt have only increased barely 12%, which suggests some remaining upside potential. More funds and large investors are now showing greater investment moves tied to commercial mortgage and commercial properties. Many investment firms have substantially increased their holdings in CMBS recently. The largest mall operator in the United State, Simon Property Group (SPG) reported a 21.9% increase in earnings for the fourth quarter of 2012. SPG plan to spend up to $5 billion on development and redevelopment over the next three to fours years, in a sign of growing confidence in retail properties. All this comes at a time when activity in residential mortgages may be slowing. The Mortgage Bankers Association note that mortgage applications declined 6.4% for the week ending 8 February 2013, compared to a 3.4% increase in the prior week. Refinance activity remains 78% of total applications, with adjustable rate mortgages only 4% of total applications.
In the week ahead, there will be a G20 meeting and a return of open markets as Asian holidays end. Despite activities of many central banks, there has not yet been a derisive statement from any G7 country about active currency devaluation. It appears almost obvious that we are seeing an active currency war, yet not one country wants to confront another about currency devaluation. Japan's new government has pushed their central bank the most recently, so it should not be a surprise that there have been several resignations at the Bank of Japan over the last several weeks. We can see evidence of Bank of Japan policies through the increased volume of Japanese Yen (JPY) in forex (foreign exchange) markets, with much of the carry trade flow going through Euro and Yen (EUR/JPY) and the US Dollar and Yen (JPY/USD). Nomura Research point out that despite a weaker Yen, higher inflation rates in the United States means that Japanese exports should still be able to gain higher prices in the US. If this is true, then we should see little change in the trade balance between Japan and the US, despite a weaker Yen. So far Japan has not gained any trade surplus, but we will need to watch longer through this year to judge the effectiveness of recent Bank of Japan policy changes. The companies who may benefit the most from these policy changes may be Japanese banks, rather than electronic and automotive manufacturers. These policies may come under pressure if conditions in Europe worsen, especially with the very real possibility that Greece will once again request debt restructuring. It seems that in these times of global currency wars, only the emerging markets see much complaining about devaluations, especially Venezuela after a 32% devaluation of the Bolivar against the US Dollar. Hugo Chavez has not been seen nor heard since travelling to Cuba for more cancer treatment on 11 December 2012. Should he step down, or otherwise vacate office, Venezuela must hold elections within 30 days. This is the fifth time in nine years Venezuela has devalued their currency, and it makes the 2012 movement of gold reserves back to Venezuela of great interest. Turmoil in Venezuela could affect oil prices globally. Annual inflation in Venezuela is now running over 22% and food prices are soaring. There is demand for "safe haven" currencies, namely the Swiss Franc (CHF), Norwegian Kroner (NOK), and New Zealand Dollar (NZD), and so far only the Swiss central bank is acting to curb the rise in the Franc. In the case of New Zealand, Finance Manager Bill English indicated before Parliament that New Zealand is a "small country" and not prepared to take risks with taxpayer money to affect exchange rates. In the longer run, that policy may find New Zealand in better shape, though with some increases in the New Zealand housing markets, a rise in interest rates may be enough to avoid future problems. As we usher in Chinese New Year and the Year of the Snake, we can see that snakes in China are considered good omens and that families will never starve. As the tale goes, the snake is good at business, so he is always able to feed his family. So as wise and savvy long term investors, may the snake bring you good fortune this year.
G. Moat