If You’re Looking To Outperform US Bonds, Try This
The big news in financial markets is the emergence of
job growth and of rising inflation. This news has hit global
bonds hard, given the
dollar a boost in its bear-market rally, and along with Chinese
margin slippage, allowed for a correction in gold
and commodities. What investors need to realize is that on the path from
reflation to inflation, evidence of sustained growth and CPI inflation will tend
to hit bonds and interest-sensitive stocks, while news that shows lack of
sustainable growth quickly translates into fears that the liquidity-induced
economic gains are falling apart.
Increasingly, the markets are moving up a narrowing path that includes inflation
on one side and deflation on the other, and the happy middle of the path where
markets can rally without volatility is narrower and narrower. The mini-cycles
we talked about
last week are dominated by the psychological and sentiment shifts of which
worry is dominating investors’ preoccupations. This makes the markets in 2004
much more volatile, much more risky, and much less positive a place to park
significant allocation.
Bonds and
interest-sensitive vehicles got pummeled on the combined job-growth/increased
CPI inflation news. US bonds are likely to find support between here and last
year’s lows for some time though, because the Fed will be slower to raise rates
than the market is currently expecting. The Fed WANTS
more inflation, and it is now starting to see evidence that it is getting
it. Greenspan’s testimony before Congress next week should give us a better
indication of how quickly he will move to re-normalize rates, but our suspicion
remains that he will go slow and not move much beyond a possible token rate
increase until after the election. Investors should short global bonds (US,
Gilts, and JGB’s) on rallies, avoid bonds if possible, and if exposure is
necessary move to shortest possible duration. Euro bonds are likely to
outperform US bonds.
And inflation is
unlikely to force the Fed’s hand before 2005. Higher energy prices, the end of
Asian deflation being imported, higher resource prices, and excess liquidity
demand will turn inflation around eventually, but such pressures are not likely
to be sufficient to FORCE the Fed to move for some
time. Inflation will likely creep slowly higher, but will be much more
sustainable and difficult to attack than the markets are currently anticipating,
in the absence of shocks.
The growth in global
growth has likely peaked, as we have been repeating, but this is so far likely
to be just a deceleration and not a resumption of recession. The US, Japan, and
Asia are in self-sustaining recoveries. Yet Japan, Asia, and the US have not
fully pulled their feet off of the liquidity gas pedal. The pace of reflation
has slowed, but reflationary policies are still being implemented, and Europe is
likely to have to cut rates this summer to prevent further economic
deterioration.
^Next^
The dollar has
benefited from stronger-than-expected domestic growth and anticipation of higher
interest rates, as well as extremely depressed sentiment. Sentiment has not
corrected normally yet, but the dollar is approaching weekly trend channel
resistance and 200-ma resistance levels, and its correction may be nearing an
end beginning at these levels. The dollar is still slightly overvalued, and the
US current account deficit is still exploding. We look for the euro to get
support and build a tradeable low in the 1.14-1.19 range. Asian currencies
should be the strongest against the dollar initially, and commodity currencies
the weakest. Gold, the global currency, should also get support in the 375-390
zone eventually. Investors should watch for lows in currencies and gold and
then evidence of accumulation patterns. We suspect that money market funds
denominated in foreign currencies (www.everbank.com
or private European banks), gold and GBS.LN, and investments that short the
dollar will be good investments later this year.
Silver has spiked
and corrected, though Palladium continues to hold up well. But the rest of the
industrial commodities are in bull-market correction mode, as sentiment and
buying pressure got too strong too fast in these markets. China is most likely
to experience a rocky soft-landing, but manufacturing activity is already
cooling, which is reinforcing the corrective activity in resources. Many
industrial commodity and mining shares are already reaching 200-day ma support
levels. We advise investors to look for basing action and clear breakout and
accumulation strength before re-initiating positions here. It is not clear
whether this correction will be weeks or months and market action will tell the
tale. It would help if sentiment in key areas like the dollar, gold, copper
would revert toward at least the 50% range.
Top global themes
include Russia and Japan (where we would tighten stops and have taken some
profits this week), cash palladium, lagging resource stocks like papers, coals
and chemicals, E&P energy stocks, Eastern Europe, and EM’s/Developed, Eastern
Europe over Europe, global small cap value, Energy/tech, health care/consumer
discretionary, Korea, interest rate spreads, and short JGB’s. Investors need to
be very flexible and nimble to make good profits this year.
Instability in Iraq
and in the global terrorist war continues to provide a wild card that makes
risks and uncertainty even higher that would normally be the case.
So far our US long/short model has been relatively inactive
during 2004 (only one official short TRMS and one official long this week CLB),
and we continue to suggest investors use some caution until stocks meeting our
criteria expand in breakout breadth. Investors should continue to cautiously
add stock exposure as trade signals are generated that meet our strict criteria,
as well as allocate to our favorite segments on breakouts and signals as advised
above. Our model portfolio followed in TradingMarkets.com with specific
entry/exit/ops levels from 1999 through May of 2003 was up 41% in 1999, 82% in
2000, 16.5% in 2001, 7.58% in 2002, and we stopped specific recommendations up
around 5% in May 2003 (strict following of our US only methodologies should have
had portfolios up 17% for the year 2003) — all on worst drawdown of under 7%.
This did not include our foreign stock recommendations that had spectacular
performance in 2003.
This week in our Top RS/EPS New Highs list published on
TradingMarkets.com, we had readings of 66, 77, 56, and 6 with 11 breakouts of
4+ week ranges, one valid trades and one close call (both in E&P). Upside
breadth deteriorated to neutral with a positive bias AGAIN this past week.
Position in valid 4+ week trading range breakouts on stocks meeting our criteria
or in close calls that are in clearly leading industries, in a diversified
fashion. This week, our bottom RS/EPS New Lows rose from the depths,
registering readings of 4, 11, 18, and 20 — not yet at levels consistent with
good shorting opportunities, but improving markedly.
For those not familiar with our long/short strategies, we suggest
you review my book
The Hedge Fund Edge,
my course “The Science of Trading,”
my video seminar,
where I discuss many new techniques, and my latest educational product, the
interactive training
module.
Basically, we have rigorous criteria for potential long stocks that we call
“up-fuel,” as well as rigorous criteria for potential short stocks that we call
“down-fuel.” Each day we review the list of new highs on our “Top RS and EPS New
High List” published on TradingMarkets.com for breakouts of four-week or longer
flags, or of valid cup-and-handles of more than four weeks. Buy trades are taken
only on valid breakouts of stocks that also meet our up-fuel criteria.
Shorts are similarly taken only in stocks meeting our down-fuel
criteria that have valid breakdowns of four-plus-week flags or cup and handles
on the downside. In the U.S. market, continue to only buy or short stocks in
leading or lagging industries according to our group and sub-group new high and
low lists. We continue to buy new long signals and sell short new short signals
until our portfolio is 100% long and 100% short (less aggressive investors stop
at 50% long and 50% short). In early March of 2000, we took half-profits on
nearly all positions and lightened up considerably as a sea of change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since, and did not get to a fully allocated long exposure even
during the 2003 rally.
We continue to advise keeping allocations low until the trend is
more certain and emphasize global leaders noted above until more trade signals
are generated and the trend is more certain. On the short side, we like the
official trade from weeks past,
(
TRMS |
Quote |
Chart |
News |
PowerRating), and on the long side some of the
energy E&P breakouts.
Mark Boucher