Friday 28 June 2013

Could we finally see the beginning of the so-called "Great Rotation"?

Up to now, there has been little real sign of the much-vaunted Great Rotation this year, supposedly out of bonds and into stocks & shares. It simply has not happened: judging by data on fund flows in the US and UK for this year, we have seen investors putting new money into BOTH stock and bond funds over the months up to April. 

So no sign thus far of any flight from bonds and into stocks, then. However, today I stumbled across this headline in the Financial Times:


With government bond yields rising sharply given the fears over central bank withdrawal of monetary stimulus, it is true that bond investors have had a rough time since early April, as can be seen from the chart of the UK gilt ETF below, whose price dropped from a peak of 1212p to just 1136p now, losing investors over 6% in the process. Given that UK 10-year government bonds yield 2.4% currently, that is a lot of money to lose in less than three months...

UK Gilt ETF Drops Sharply
Source: Bigcharts.com
Interestingly, a relatively defensive sector like Healthcare is roughly flat over the same period, not only offers a 4%+ dividend yield but also offers the prospect of dividend growth to boot, something that bonds can never offer. 

Which sectors can benefit from rising bond yields?

Historically speaking, when long-term bond yields have risen faster than short-term interest rates (in technical speak, a "steepening of the yield curve") as is happening now, the sectors that have outperformed have been:

1. Media
2. Autos
2. Mining

Well, clearly Mining is not working, as it is the worst-performing sector so far this year. However, Media is outperforming nicely, led up by TV, advertising and newspaper stocks (ProSieben Sat1, ITV, Daily Mail, WPP). 

Who gets hurt by rising bond yields?

Rising bond yields could spell trouble ahead for bond-sensitive sectors such as Utilities, Infrastructure stocks and Telecoms. 

A nice mixture of dividend yield (income) and dividend growth: Dividend Aristocrats

If you are a bond investor looking to rotate out of government or corporate bonds and want some easy stock income growth funds to buy instead, I would suggest that you have a look at the following two Dividend Aristocrat ETFs from State Street, based on S&P Dow Jones Indices:

1. SPDR Euro Dividend Aristocrats (EUDV)
2. SPDR UK Dividend Aristocrats (UKDV)

Both contain an interesting blend of dividend yield plus potential dividend growth, and tend to hold a lot of low volatility stocks, so should benefit over time from the better risk-adjusted performance of low volatility stocks versus the overall stock market. 

Interestingly, both have held up very well during the recent market volatility, and look ready to move higher once again:

UK Dividend Aristocrats regaining ground

Good luck and bon weekend!
Edmund



Surprisingly, Market Trend Indicators Still Largely Positive!

28/06/2013

Why I have not (yet) given up on stock markets for now

At times of volatility such as we have recently undergone, I find it helpful to consult a number of market trend indicators that have served me well in the past, and which have a relatively good track record in marking major trends in stock markets, plus potential turning points. 

I have three such indicators that I favour:

1.  The Cumulative advance-decline indicator (The balance between how many US stocks have advanced during a given day, minus how many stocks have fallen, added up day by day from early 1965).

2. The New 52-week highs-lows indicator (The balance between how many US stocks have hit a new 52-week stock price high, minus how many have hit a new 52-week low in a given day, added up from start in 2003). 

3. The High Beta/ Low Volatility oscillator (The S&P 500 High Beta index divided by the S&P 500 Low Volatility index), looking at this oscillator index versus its own 3-month moving average. 

In each case, if the indicator is above its own moving average, then it gives a positive signal for stocks, if below then it gives a negative signal (meaning you should prefer bonds or cash to stocks). 

What do these three indicators flag up as of yesterday?

1. Advance-Decline: Still Positive for Stocks

2. New Highs/New Lows: Also Still Positive for Stocks


3. High Beta/Low Vol: Still Thumbs up for Stocks
Source: Unicorn, S&P Dow Jones Indices


Conclusion: Despite the rocky ride in stocks, bonds and even precious metals over the last few weeks, the current uptrend in stock markets does not look to be over just yet, at least according to these three trend indicators. 

Which sectors to prefer?


The four European stock market sectors still showing good relative strength (i.e. which are still outperforming the overall stock market) remain:

1. Healthcare (e.g. Roche, Sanofi)
2. Technology (e.g. Nokia, Alcatel)
3. Media (e.g. ProSieben Sat1, )
4. Insurance (e.g. Aviva, Delta Lloyd)

However I would be very wary of sectors which have les the stock market lower over the last few weeks, including:

1. Utilities (particularly electricity-related stocks)
2. Oil & Gas
3. Mining
4. Banks

Regional Preferences: Italy and Spain look vulnerable

And on a regional front, peripheral Europe is once again underperforming as their bond spreads over core Europe widen out once again, so be careful of:

1. Italy
2. Spain

On the other hand, Ireland continues to show impressive stock market outperformance, so I would stay with Irish stocks such as Ryanair and Greencore. 







Tuesday 25 June 2013

Well what a torrid week! Has the bond market definitively cracked? What next...

25/06/2013  A Tough Week for Investors

After a torrid week for pretty much all financial assets (stocks & shares, bonds, precious metals...), we can perhaps let the dust settle to see where we really are. 

Central banks have clearly dominated the investment landscape, with mounting fears over the US Federal Reserve starting to "taper" their reinvestment of cash in US government Treasury bonds some time from September this year, and also the People's Bank of China tightening up on credit standards in order to cool the growth in credit there. 

Volatility has awakened, but not yet near 2012 highs

The volatility in equity markets has evidently spiked as a result of the drop in stock and bond prices over the week, with the 3-month implied volatility level on the US S&P 500 index back up above 20 as of yesterday. 


S&P 500 3-month implied volatility back above 20, 
but still a long way from 2012's highs
Source: St. Louis Fed

Bond markets have been hit by the central bank fallout

Bond markets have clearly suffered too, with bond yields rising (and thus bond prices falling) to their highest levels this year. This fact has prompted many calls for the end of the 30-year bond bull market, with some even declaring the arrival of "a lost decade" for bond investors, i.e. a decade where bonds will make no money at all for investors. 


Yes European bond yields have risen, but are still very low by historical standards
Source: iShares/Blackrock

That said, let's not lose sight of the fact that the interest rate effectively paid by large European companies to borrow money over a number of years in the bond markets remains, at an average of only 2.3% for investment-grade companies and 4.2% for high-yield rated companies, still close to record lows. Thus while I DO believe that the majority of government and corporate bonds represent fairly poor value right now, I would not think that the rise in yields that we have witnessed recently is in any way catastrophic for investors or indeed, for the wider economy. 

Some sectors look ugly...

Within the European stock market, there are a few industries/sectors that are in a clear down trend, most notably those sectors linked to commodities, like the Oil & Gas sector and Mining:


Oil & Gas (SXEP) has been trending down for the past year...

 As has the Mining sector (SXPP)
Source: bigcharts.com


But at the same time, not all is lost for the stock market investor! There aare still quite a number of industries that look promising to those looking to invest on this market correction, including various areas of technology such as Semis and Nokia:

Semiconductors are just pulling back to a clear support level...

 Nokia is slowly recovering too
Source: bigcharts.com

And don't give up on Japanese equities either just yet...

The Japanese Nikkei index is starting to recover after a sharp sell-off
Source: bigcharts.com

All in all, the so-called carry trade (explanation here: WSJ: The carry trade ripping across Wall Street) has been unwinding at a rate of knots as worried investors retreat from equity, bond and precious metal investments in the wake of Fed President Bernanke's recent pronouncements. 

However, think of this: the higher that US government bond yields go, the higher that long-term fixed mortgage rates also go, potentially stalling both the US housing market recovery and US consumer confidence, in the process hurting US economic growth at a time when it is still relatively fragile. 

So, the higher that bond yields rise off the back of the fear of the Fed withdrawing monetary stimulus support for the US economy, the more likely it becomes that the Fed has to keep all of the monetary stimulus in place to prop up faltering economic growth as US housing weakens. All in all, judging by economic indicators such as the rate of employment growth, the ISM manufacturing survey and capital spending growth, the US economy is not at all in a robust growth mode right now (see for instance, What's Capping Capital Spending?). 

Conclusion

Stock markets in Europe have pretty much now given back all of their gains for this year to date (although not so bad for mid-caps), offer good value in terms of P/Es and dividend yields, and may now be stabilising. Investors need to be selective about which sectors to put their money into from here, particularly given that May has passed and we are now in what is traditionally the poorer 6-month period (June-October) from the point of view of stock market returns. 

I would personally stick with Technology, Healthcare, Luxury Goods and Insurance, but would avoid the likes of Oil & Gas, Mining, Utilities and Food & Beverages (all of which have ugly-looking 1-year charts). 

Edmund

Friday 14 June 2013

The Bank of England Doing a Sterling Job?

14/06/2013

The Bank of England Doing a Sterling Job?

Despite the seemingly singular focus of financial markets on the Fed and "Will They, Won't They (start withdrawing Quantitiative Easing in September)", I have been somewhat surprised by the turnaround in the Greenback over the last few weeks.

US Dollar Index - A Failed Breakout, 
Now Heading Back To 1-year Lows


Source: Bloomberg

The chart above would seem to suggest that the US has lost a lot of fans of late, backed up by the fall in US Treasury bond prices over the last month or so:

US 20+ Year Treasury Bond ETF Has Slumped


Source: Timetotrade


But before we get carried away bewailing the end of government bonds and a rising trend in bond yields, let's not forget that this is only a relatively short-term trend, and that it is not yet evident that bond yields are in a steadily rising trend (pointing to steadily falling bond prices given their inverse relationship).

UK Gilt Yields Still Very Low By Historical Standards



Source: Bloomberg

I have been pleasantly surprised by the better stream of economic newsflow coming out of the UK: unemployment continues to decline slowly but steadily, the recent monthly CIPS survey of services activity pointed to a stronger level of services activity than had been widely expected - according to Markit, the May figures highlighted a "sharper rise in activity as new business grows at fastest pace for over three years". 

UK Services Activity Growing Quickly



Source: Markit, ONS

So, What's The Trade?

I think the following is likely to be true:

1. the Fed WILL NOT start tapering or withdrawing monetary stimulus of any sort in September, or even at all over the rest of this year. The US economic data just is not strong enough to warrant it - the key ISM manufacturing survey for May points to contraction in US industrial activity (a 48.6 reading, below the 50 break-even level). 

2. The UK economy will continue to slowly improve, despite the best efforts of the UK government to torpedo economic momentum with their austerity policies. The Bank of England is key here in continuing to support the economy, the vital housing sector remains relatively buoyant - helping boost consumer confidence - and you might even start to get some results from the boost to business lending coming through sometime soon. 

3. The rising trend in trade-weighted Sterling looks likely then to continue, so long as this more positive economic trend in the Albion continues...

Trade-Weighted Sterling On The March Upwards Within Long-Term Range

Source: Bank of England

All in all, Cable (Buy Sterling, Sell US Dollar) looks good to me at this point, as it seems to have broken above the threshold of a double bottom formation on the chart below, suggesting further potential gains ahead:

GBP/USD Heading Back towards $1.60+?


Source: IG Group

Bon weekend to all, fingers crossed for a good trading week from Monday!

Edmund


Thursday 13 June 2013

Après le Déluge... What to do now?

13/06/2013 

Après le Déluge...

What do do now after what has been an impressive spike in volatility across financial markets over the last few weeks? 

First of all, DON'T PANIC! 
After such a good start to the year in risky assets like equities, it is hardly surprising that markets have corrected somewhat. Let us not forget one salient fact: that we are NOT in a normal market environment, with interest rates and liquidity manipulated by central banks globally in the aftermath of Financial Crisis...

So where should we be looking to invest? Certainly, no-one wants to be "catching a falling knife", i.e. investing in shares or bonds, just to see them sink even further straight away...

US S&P 500 index has not broken any support levels - still in an uptrend

If the most recent horizontal support line (on the top right of the chart above) holds for the S&P 500 index, then we will likely make further gains and potentially new year highs, not just in US equities but also in Europe. 

What I like right now

My personal strategy is to continue to buy selected stocks that are:

a. Relatively good value in fundamental terms (a good dividend yield, moderate P/E, low price/sales or low price/book) 

b. with decent profitability (e.g. judged on return on capital employed), and 

c. most importantly whose share price has recently broken to new multi-year highs, thus showing strong price momentum. 

I prefer stocks that have also recently reported strong or encouraging financial results, thus where the strong price momentum is supported by improving profit momentum.

I am looking at sectors and investment styles that continue to exhibit relative strength (i.e. that continue to outperform the benchmark indices like the FTSE 100 or Euro STOXX 50), including but not limited to stocks in the UK small-cap, European Healthcare and US Technology spaces:

  • British Polythene (BPI: UK small-cap)
  • Creston (CRE: UK small-cap)
  • Inland Homes (INL: UK small-cap)
  • Glaxo SmithKline (GSK: Healthcare)
  • Tribal Group (TRB: UK small-cap)
  • Hewlett Packard (HPQ: Technology)
  • Alcatel-Lucent (ALU: Technology)
  • Merck (MRK: Healthcare)
  • Sanofi (SAN: Healthcare)


What to buy if/when stock markets clearly rebound

I would add a number of other regions and sectors to look at once stock markets start to show clear signs of rebounding:

  • Japan (e.g. the iShares MSCI Japan yen-hedged ETF - IJPH)
  • Insurance (e.g. Munich Re, Delta Lloyd)
  • Asset managers (Aberdeen, Man Group)
  • Broker/dealers (IG Group, ICAP)


All of these regions/sectors show clear medium-term share price uptrends, but are clearly geared to the general level of risk tolerance of investors. As investors get more confident on the rebound in stock markets, these four areas should all benefit to a greater extent. 

Sectors I would avoid

There are a number of sectors which I think remain vulnerable to the threat of slowly rising bond yields, or which may well suffer worsening profit outlooks due to difficulties/disappointments in home markets or even in emerging markets:

  • Food & Beverage (Tate & Lyle, Heineken)
  • Utilities (National Grid, SSE)
  • Telecoms (Vodafone, KPN, Telefonica)
  • Mining (Anglo American, Glencore)
  • Disruptive technology shifts (ARM, Imagination Technologies)


Overall, I remain a keen trend-follower in terms of methodology, and on top of that I believe that central banks overall will be adding rather than pulling back on monetary stimulus (ECB, Bank of Japan in particular). On this basis, then, I think that stock markets have a much better chance of recovering substantially from here at least close to year highs, rather than falling much further. 

Good luck out there!

Edmund