The positive message in the charts today

In this week’s Money Makers podcast Jonathan Davis spends 40 minutes talking to the market strategist Eoin Treacy about his latest views on equity markets, bonds, currencies and the outlook for inflation.

Jonathan has followed Eoin’s work for many years, thanks to the must-read daily global strategy service (Fuller Treacy Money) which he produces in partnership with the veteran market analyst David Fuller. Others may know Eoin from his book Crowd Money.

Having recently moved to live in Los Angeles, Eoin specialises in “macro behavioural technical analysis” – Jonathan asks him to tell us what that means at the outset of the podcast – and also runs a global equity fund and writes a specialist newsletter about new technology investment opportunities. The talk covers a lot of ground.

Notebook: taking stock post Brexit

This is one of my regular round ups on the state of the markets, this time following the Brexit vote, but keeping an eye primarily on the medium to longer term context. It is easy to get sidetracked by the excitement of a new event into losing sight of the important longer term trends. Get the right side of the longer term trends and you can survive any number of short term shocks and setbacks. There is also some value in looking to spot opportunities created by excessive moves.

The charts are from Fuller Treacy Money and reproduced with thanks. They are correct as at midday on 7th July 2016. The lighter line on the main panel in each chart represents the 200-day moving average. The RSI at the bottom of each panel represents a standard 14 day momentum measure (overbought above 70, oversold below 30, in broad terms). Further notes will look at some of the more dramatic individual stock and sector moves and the behaviour of some model portfolios.

Sterling‘s decline has been the most obvious impact of the Brexit vote. Against the dollar, it has fallen to its lowest level since the 1980s, at the height of the miners’ strike. It is down 40% since its pre-crisis peak in 2007.  Short term it now looks oversold, but it is impossible to rule out further declines, at least until there is some clarity on how and when negotiations for Brexit are likely to begin. But note that sterling has been in decline for more than two years, long before Brexit.

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Bond yields have fallen together right along the yield curve. I show here both the 10-year and the 30-year yields on conventional gilts. Both are trading at all-time lows, though also appearing oversold on a short term basis. The yield curve remains upward sloping for now. An inverted yield curve, when longer term yields are lower than short term one, is a traditional warning of impending recession, but we are yet to see that materialise.

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The fall in yields has produced some remarkable increases in gilt prices, particularly at the longer end of the curve (which is inherent in the structure of the market when yields are already ultra-low). It is important to remember that yields have been falling all round the world, with at least three countries (the latest being Switzerland) now able to sell 50-year bonds at negative interest rates – an unheard of phenomenon. There is no better indication of the fact that the world is trapped for now in a low growth, low interest rate, deflationary environment.

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It is not just conventional index-linked gilts that have done well. Index-linked bonds, a core component in the Money Makers model portfolios, have also performed well. With inflation still at very low levels, real (inflation-adjusted) yields have also declined – another global phenomenon. That in turn has helped the price of gold, which normally does well when real yields are falling and is also benefiting from its traditional safe haven status. As geared plays on the price of precious metals, mining shares have more than doubled from their lows.

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The contrasting fortunes of the FTSE-100 index (whose members derive 70% of revenues overseas and whose earnings are boosted by sterling’s decline) and the wider UK equity market (predominately opposed of domestic companies) has been marked since the referendum vote. Here are the Footsie and 250 indices over five years. The latter has fallen further in percentages terms than the former, which ironically, in the light of all the dire pre-vote warnings, is higher today than it was when the referendum campaign began, although still below its high around the end of Q1 2015. Both the FTSE 250 and most smaller cap indices had a long period of strength between 2012 and 2014. The recent setback needs to be seen in that longer term context.

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Looking further afield, the US equity market (S&P 500) has been trading sideways for some time, but until the Brexit vote was finally threatening to break out of its trading range to the upside. The economic data looks reasonable, despite one recent, possibly rogue, monthly jobless figure.  Emerging markets, which have sold off sharply since 2012, have meanwhile recovered strongly, helped by the recovery in commodity prices and (for UK investors) the strength of sterling. I have added to my position in Murray International, the global investment trust, and one of the prime beneficiaries, more than once since the start of the year.

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Volatility, although it spiked after the Brexit vote, has fallen back to a relatively low level, well below those seen during the global financial crisis in 200708 and the more recent eurozone crises.
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Conclusion: almost all these charts, with the exception of the last, point to either short term oversold or overbought conditions, which is what typically happens when the markets react to a surprise event. It is reasonable to expect some retracement from here in both equity and bond markets, creating trading opportunities. Commodities and emerging markets look to be establishing significant rebounds, and are trading above their 200-day moving averages. However, given how many issues about Brexit remain to be resolved, the uncertainty is likely to put a brake on any sustained equity market recovery in the UK until the autumn. If as expected Theresa May wins the Tory leadership campaign, the risk of political instability and/or some form of constitutional crisis will be eliminated, at least for now.

Notebook: the yo-yo on rates continues

Friday’s poor jobless figures in the United States have thrown the markets another curveball. Just as investors had convinced themselves that a second interest rate increase was finally imminent, along comes the latest disappointing payrolls numbers to cast that expectation into doubt once more. What is more, it seems certain to rekindle fears that the US economy has run out of steam and may be heading for recession – an idea that was last being thrown around at the start of the year. Expect another wave of “told you so” bearishness.

Well, we will see how right that turns out to be. Analysis of the markets’ recent history of making interest rate calls only allows for one conclusion: that nobody has any real idea where interest rates are heading (and, to be honest, it is often like this). Market-implied interest rate expectations have been consistently way off, and move so rapidly from one day to the next as to have little practical value. The correct response to anyone who tells you they are extremely confident that interest rates will or will not rise a few months hence is simple: “stop kidding yourself. You have no idea”.

Having said that, there is no doubt that the Federal Reserve would love to be able to raise interest rates and continue the process of normalising the yield curve after so many years. We could all heave a sigh of relief if that were to happen, but there is no doubt either that normalisation still looks a long way off. Even though there are tentative signs of inflation returning in the US, UK and even Japan, it still remains everywhere below the central banks’ target rate of 2%.

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While the two-year Treasury yield has been edging up in snail-like fashion over the past four years, consistent with a slow but steady tightening of conditions, the yield curve (the structure of yields over time) has been stubbornly flattening. It is not yet inverted, which happens when long term yields fall below shorter term rates, a traditional warning sign of an imminent recession, but it is certainly not suggesting either that investors are expecting an imminent start to a positive interest rate cycle.

As far as the prospect of a recession goes, foolishly or otherwise I spend a lot of time looking at a range of indicators that attempt to highlight when a recession may be imminent. The jobless/employment figures are certainly not one: unemployment is a lagging variable, so its predictive power if very limited. A comprehensive survey of conditions provided by an organisation called Recession Alert, although far from perfect, summarises more than 50 different potential indicators and as yet provides no reason to panic, as the chart below suggests. Neither it nor other well-known publishers of leading indicators suggest that recession is imminent. But clearly nor does it paint an overly positive picture. Conclusion: real vigilance is needed.

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There was not that much time on Friday for the markets to digest the implications of the poor jobless figures – there were knee-jerk reactions in gold and the dollar – so it will be interesting to see how they react over the course of the coming weeks. As far as portfolio positioning is concerned, in the current environment, my view is there is no option but to adopt the same stance as the Federal Reserve: watch the data carefully. This is no time to be making all-or-nothing bets.

Having taken on some more defensive ballast a year ago, but within an overall risk-tolerant portfolio, I am sitting pat for now. One positive factor to note however is that the often useful advisors’ bullish sentiment index in the States is currently recording a very low reading, often a contrarian short term signal to buy the market. The UK market in particular continues to look potentially attractive ahead of the Brexit referendum vote, with commodity prices stabilising and a lot of fear priced in.

For those of a more cautious frame of mind, Numis last week produced a useful summary of the generalist investment trusts which have performed best in up and down markets over the last nine years. The charts below show the average percentage rise or fall in NAVs in months when the market has risen and fallen. Although there are no great surprises in it, it is reassuring to see that the likes of Capital Gearing, Personal Assets and RIT, which all feature in the Money Makers core portfolios, are still doing the job that they set out to do. (Whether RIT’s characteristics will change if it succeeds in its surprising merger approach to Alliance Trust is an issue that we will be returning to shortly).

Funds in up-down markets May 2016

 

 

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