Archive for June, 2011

Bond Market in Wonderland

Friday, June 24th, 2011


Keep your head! This is a new one for me…

On the image above, you can see that the one-month T-Bill is now yielding a negative -.005. I can’t recall ever seeing a time when, if you purchase a treasury security, you have to pay the government to loan them money instead of the other way around.

When I see things like this, I want to know if there is a wider problem in the world that is causing a rush to safety – something that has the potential to topple the world’s financial systems and crash the financial markets, for instance. To answer my question, I always refer to my trusty friend the TED Spread.


Regular readers of the blog know that i believe this is one of the most accurate and important charts to follow. Whenever there is an event that has the potential to topple the world’s financial systems, this graph will start to have peaks – much like you see on the left half. Those peaks on the left represent the precursors to the sub-prime debacle and the Lehman Brothers bankruptcy.

If you look at the right side, you see that we are steady-as-she-goes. This tells me that whatever is inducing people to invest their money for one month in treasury securities and pay the government for the privilege of doing so, it is not likely the start of something that will ultimately cause a stock market crash.

So, what could it be? My best guess is that its a bunch of hedge funds buying treasuries to put up as collateral against their margined position. The current correction is likely putting pressure on their positions and they need to add collateral or be cashed out by the margin clerks. The demand for the short-term paper is great so the yield has dropped to ridiculous levels.

This means that the current situation is likely temporary while everyone sorts out what it means to have the end of the Fed’s program of quantitative easing. I think the lack of clarity for investors was doubled down upon earlier this week when the Fed Chairman gave his press conference and seemed notably confused himself as to the likely course the Fed would take given the unprecedented situation it is in.

If only the men on the chessboard could bet up and tell the Chairman where to go…

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“You’re gonna need a bigger boat.”

Monday, June 20th, 2011

Equity Put Call Ratio

Well, at least I hope we’ll need a bigger boat if everyone jumps on board the rally that these two technical indicators say is coming.

The graph above shows you the Equity Put/Call Ratio. You can see that we are clearly in over-sold territory with the ratio of Puts to Calls at a 2-year high. This is one of those contrary indicators that tells you since investors are buying so many puts (insurance against prices falling) compared to calls (a gamble that the market is going higher) the bad news is already priced into the market and it should go up.

You can see that our current level is extremely high, and generally when the crowd all goes in one direction, the market goes in the other.

Percentage of Stocks Trading Above

This graph shows you the percentage of stocks trading above their 50-day moving average. The 50-day moving average is a key trend line to watch for equity investors – on the graph above you can see that I’ve annotated it to show you the extreme levels. When a significant number of stocks are trading below their 50-day moving average (you can see the green line that denotes the significant level) the market is generally set for a move higher.

On this graph, I’ve over-laid the S&P 500 index in purple so you can see the movement in stock prices compared to the indicator. I’ve also circled in green the over-sold levels (below the green line) and the corresponding low in the market. I’ve also annotated the over-bought levels (above the red line) and included red circles to show you the highs in the market that correspond to the indicator.

These are obviously short-term indicators. They can indicate simply a bounce higher in stock prices that corrects an over-sold condition in the indicator before a return to a downtrend or it can be the beginning of a more significant move higher. And naturally the opposite can also be the case relative to short-term selloffs and more protracted moves lower.

Earlier this year, I wrote on the blog that this year we’d trade in a range of 1200 to 1375 on the S&P 500 Index. As the year has progressed, 1250 has become a key level for the index.

S&P 500 Index

You can see that 1250 is roughly the current level of the 200-day moving average (the red line on the graph above). The market indicators above coupled with the 200-day moving average moving up to converge with the market price gives us a pretty critical situation. If this is just a bounce and the market can’t move toward the 50-day moving average (the blue line on the graph above) we have a fairly significant technical problem. A break below the red line would indicate the market would be in for a serious correction potentially back to 1050. A move above the blue line would mean a move back toward the 1375 level.

The fundamentals will give us the magnitude of the move. Right now, the market is shaking off the perceived impact of the end of the Fed’s program called QE2 (their most recent episode of printing money to stimulate the economy). Some smart people say that QE3 is already set to be unveiled with the name Operation Twist (in this program, the Fed will target either the 2-year or the 10-year treasury bond and not allow the yield to go above some pre-determined level, buying as many bonds at the treasury wants to issue in order to keep that yield below target).

If equity investors see that the Fed is continuing to stimulate the economy with Operation Twist (as Bill Gross says in inevitable) then look for stock prices to move higher. If Operation Twist is not in the cards and the economy continues to soften while unemployment continues to rise, then look for stock prices to move lower.

Our current strategy is to take some of the cash we’ve cash we raised in client portfolios and put it to work in some areas that look more oversold than other areas. As the bounce moves stock prices up, we’ll start to sell off some things that look like they have seen their best days. The 1250 level on the index will be key for us – if the market moves below there, we will raise additional cash in client accounts as the 1050 level will be in play.

We had 6% to 8% cash levels in accounts but have been putting some of that to work in the past few trading sessions. If we can move up toward the 50-day moving average, this will turn out to be a successful tactical move for our clients.

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Since one of my favorite movies was released on this date 36 years ago, I had to find a way to tie it into today’s post. Oddly, this movie came out before many of the critically important people that work on my staff were born, yet I can clearly recall sitting in the theater 36 years ago seeing it for the first time and being scared out of my socks when the shark came out of the water.

Sorry its been several days since the previous post – I was dealing with a case of kidney stones and was out of commission for a few days.

Thanks for reading, and keep checking back here for more analysis of the market at this critical juncture.


And The Market Says

Monday, June 6th, 2011

McClellan Oscillator and Summation Index

Given that we’ve had a really ugly June – even the defensive stocks that lured so many people into them last month are down – I thought it would be interesting to take a look at what the major technical indicators are saying.

Above is the graph of the McClellan Oscillator and of the Summation Index.

The Oscillator gives us short-term indications of whether the market is over-bought or over-sold. Readings above the orange line tell you that you are getting over-bought and readings below the orange line tell you that you are getting over-sold. You can see that over the last year, this indicator has only been more over-sold on three other occasions.

The Index is clearly above its orange line but it has been bouncing off of the 400 reading six times since December – and you can see that the bounces are getting weaker. This represents a weakening of the intermediate trend and based primarily on the negative economic news we’ve seen in the past few weeks.

These are telling me that we should get a positive move up in the market soon but that the intermediate trend needs something positive to happen or the move will be short-lived.

There is a lot of negative economic news out there – weakening industrial production numbers, worsening unemployment, a new low in housing – coupled with the situation in Greece and the other weak economies in Europe, and you have a lot of headwinds that have investors fearful of a drop-off in corporate earnings.

I’ve been reading some analysts who say that a default in Greece on their national debt will be worse for the world than the Lehman Brothers bankruptcy. We all know that situation preceded the 2008 stock market crash. So, I thought it was important to look at the TED Spread which I’ve written about here in the past as being my warning sign of impending disaster.

You can see the big spike up in the middle of the graph which preceded the Lehman Brothers bankruptcy – this graph is the tell-tale heart of indicators and right now it is telling me that at this point in time there is no indication that the situation in Greece will lead to an implosion of the world’s financial markets and cause a return to the crash-level lows.

So, at this time, it looks like we have a garden variety correction. Those are times to reposition portfolios, cull the companies and investments that likely won’t perform well in coming months and to move funds toward undervalued investments (particularly those that have sold off more than fundamentals dictate) in preparation for an end to the correction.

Since today is the anniversary of D-Day I thought some might like to hear some history in the words of someone that was there:

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“Forget It Jake, It’s Chinatown”

Friday, June 3rd, 2011

Water Use Graph from UN Water
Water Use Graph from UN Water

One of my favorite long-term investment themes is the growing importance of water. 97% of the world’s water is salt water and only 3% is fit for human use. As the world population grows, more water is needed for consumption, but an even greater amount is needed for production of food – the chart above shows that 70% of water is currently used for irrigation.

The estimates I have seen for world population growth show that we will have 9.2 billion people on Earth by 2050.

World Population 1800-2100 from Wikipedia

Most of that population growth will happen in the developing world. This is the same developing world whose demographics are following the pattern set by the US and Western Europe after WWII, with the Middle Class providing a producing and consuming society that grows GDP. With the growth of GDP and the Middle Class come expectations for more meat and dairy in the daily diet.

Water Use Percentage from UN Water
Water Use Percentage from UN Water

The production of meat and dairy requires much more water usage than eating rice. It requires 1800 gallons of water to produce one pound of beef according to National Geographic. As

So, as the population grows and as the Middle Class swells in the developing world, the need for fresh water will increase faster than the percentage growth in the population. Because of this, companies that have proficiencies in desalination, water flow, efficient water distribution, etc., will have a Macro earnings catalyst behind them that should propel them forward in the years to come.

Water wars have happened in the past. According to an article from the Wharton School: “Water has always been linked to economic development, political maneuvering and the threat of violence, even in ostensibly stable places far from the desert and the agricultural economy. In the early days of American independence, New York and Philadelphia battled to be the new nation’s dominant city. One reason New York emerged victorious: It purchased the rights to much of the water between the city and Canada, bringing it into town via an elaborate system of aqueducts, and rendering the city a safer, cheaper and more hygienic place than its erstwhile competitor.

“Later, as the American population spread into the parched far west, the politics of water created and lost fortunes. Modern Los Angeles was made possible in large part by the 1913 opening of a 233-mile aqueduct that brought water from the Owens Valley in the Sierra Nevada Mountains; one of the city’s most famous streets, Mulholland Drive, was ultimately named for the engineer of the project. The graft-ridden manner in which the water rights were acquired led to violent clashes with Owens Valley farmers that became known as the California Water Wars.”

Our clients own some companies, large and small, that have water divisions focused on varying aspects of the water industry:

Itron, Inc. [ITRI]:
Itron, Inc. (Itron) provides a portfolio of products and services to utilities for the energy and water markets worldwide. The Company, along with its subsidiaries, is a provider of metering, data collection, and utility software solutions. It has two segments: Itron North America and Itron International. Itron North America generates its revenue in the United States and Canada and offers meters and data collection and communication systems for electric, gas, and water utilities. Collection and communication systems include advanced metering infrastructures/automated meter reading (AMI/AMR) systems and a range of utility software and services. Itron International generates its revenue in Europe and South Africa, South America, and Asia/Pacific. Itron International offers a range of electricity, gas, water, and heat meters, AMR and AMI systems, software, and services.

Nalco Holdings [NLC]:
Nalco Holding Company provides integrated water treatment and process improvement services for industrial and institutional applications, combining chemical products and equipment, and on-site service and expertise. It operates in three segments: Water Services, Paper Services and Energy Services. The Water Services segment serves the global water treatment and process chemical needs of the industrial, institutional, and municipal markets. Paper Services segment serves the process chemicals and water treatment needs of the global pulp and paper industry. Energy Services serves the process chemicals and water treatment needs of the global petroleum and petrochemical industries in both upstream and downstream applications.

Northwest Pipe Co. [NWPX]:
Northwest Pipe Company is a manufacturer of large-diameter, high-pressure steel pipeline systems for use in water infrastructure applications, primarily related to drinking water systems. The Company’s pipeline systems are also used for hydroelectric power systems, wastewater systems and other applications. It manufactures water infrastructure products through its Water Transmission Group, which during the year ended December 31, 2009, generated approximately 76% of its net sales. In addition to manufacturing water infrastructure products, it also manufactures other welded steel products through its Tubular Products Group, which in 2009, generated approximately 24% of its net sales. The Company’s Tubular Products Group has the capability to manufacture a range of small-diameter, electric resistance welded (ERW) steel pipe for use in a range of applications, including energy, construction, agricultural, industrial, and traffic signpost systems.

Watts Water Technologies [WTS]:
Watts Water Technologies, Inc. is a provider of water quality, water conservation, water safety and water flow control products for the residential and commercial markets in North America and Europe. The Company operates in three segments: North America, Europe and China. It distributes its products through three primary distribution channels: wholesale, do-it-yourself and original equipment manufacturers. The Company also sells products for the residential construction and home repair and remodeling industries through DIY plumbing retailers, national catalog distribution companies, hardware stores, building material outlets and retail home center chains and through plumbing and heating wholesalers.

Keppel Corp Ltd [KPELY]:
Keppel Corporation Limited is a Singapore-based investment holding and management company. The principal activities of the Company along with its subsidiaries consist of offshore oil-rig construction, shipbuilding and ship repair and conversion; environmental engineering, power generation and network and logistics; property development and investment and property fund management, desalination, and investments.

From the standpoint of near-term performance, some of these companies have performed better than others. However, each of them attacks a part of the problem and should over the long-term outperform the broader market on average through a combination of earnings growth and P/E expansion. At least that is the theory we are working from at this time.

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