Money Clip

Blog by Matthias Paul Kuhlmey


Matthias Paul Kuhlmey is a Managing Director & Partner at HighTower Advisors, where he serves as wealth manager to High Net Worth and Ultra-High Net Worth Individuals, Family Offices, and Institutions.

Monthly Archives: June 2011



QE3 Is Here!

Friday, June 24, 2011

Posted By:  Matthias Paul Kuhlmey

 

While we wondered how Quantitative Easing (QE) would be continued in a more camouflaged fashion after the official end of QE2, in an act of brilliance, our answer has arrived! Yesterday’s announcement to release 30 million barrels of Oil from the Nation’s Strategic Petroleum Reserves acted as a powerful market mover. During market hours, the price of Oil was down more than 5%, trading below USD 90/barrel for the first time since February. Interesting to note that it is only the third time the International Energy Agency (IEA) has tapped reserves; the first time was in 1991 during the Gulf War, and the second was when Hurricane Katrina had severely limited Oil production in the Gulf of Mexico in 2005.

 

What an act of desperation. Mr. Bernanke and team knew that something had to be done. Just on Wednesday, the Federal Reserve Chairman reinforced his concerns about a weaker U.S. economy; this on the backdrop of an equity market that had had fallen quite considerably over the past weeks, and a real estate market that is, for lack of a better description, shattered. The only “card to play” was to help lift equity markets at any cost, as these are closely linked to the perceived well-being of the U.S. consumer (Wealth Effect).

 

Interestingly, yesterday’s intervention into the Oil market may actually work – for now. The event can be compared to a global coordinated rate cut. Lower, and continued lower, Oil prices will benefit consumption and consequentially support the domestic economy (consider that every time pump prices spiked over USD 3 per gallon, the U.S. economy experienced an offsetting drop in consumer confidence). Emerging Markets, on the other hand, will experience less of an inflationary threat to their respective economies, which has been a drag on growth and equity performance in the region in recent months.

 

All in mind, global equity markets remain at a very critical juncture; if the support of March 2011 will give way, market participants could easily  experience another -10% drop in prices. Should, however, the current support line hold (around 1257 in the S&P 500), a significant rebound may be forming. We have quietly removed our hedges yesterday morning, when the world looked all too miserable, but we are prepared to add this downside protection back to accounts, if the situation deems it necessary. 

 

Good bye QE2, hello QE3.

 

Suspicious

Wednesday, June 22, 2011

Posted By:  Matthias Paul Kuhlmey

 

To follow-up on our recent commentary, the market, in fact, was ready to “bounce.” The positive momentum over the past trading sessions was further improved by the Greek Government passing a crucial confidence vote to further support Prime Minister Papandreou. One may think this is the time to “go all in,” and deploy those Dollars sitting in Money Market Funds. Our clients, however, know that we have concluded differently and have even left accounts partially hedged. The following are important points of consideration:

 

Mr. Papandreou’s victory needs to be put into perspective. Greece, as a country and economy, has not moved out of the “danger zone.” In fact, the vote is only the first step to allow Mr. Papandreou to introduce austerity measures that, already today, are not supported by nearly 50% of the population. An increasingly larger group of fund managers suggest that the vote of confidence and legal passage of the austerity plan will only be temporary measures, and that most market participants are accepting the default of Greece. What matters, when this day arrives, is how the situation will be managed.

 

Related to the above, it is worth noting that, in April 2010, the World MSCI Index peaked around 880 and then traded back on fears over Greece and the end of QE1. In November 2010, the Index, once again, pulled back from that level, as Emerging Markets were not considered the force leading global markets and economic activity higher. In March 2011, following the disaster in Japan, the World MSCI fell to 876 before rebounding significantly; today, the Index is trading at the same level, but below its 200-day moving average. If the market cannot rally from here, then we are clearly facing a very different kind of investment environment (Source: GaveKal).

 

Another piece to the puzzle is China’s money-market rate, which has climbed to its highest level in more than three years, as a worsening cash crunch prompted the Central Bank to suspend a bill sale. The seven-day repo rate increased 0.47 percentage points to 8.81%, according to a weighted average rate compiled by the National Interbank Funding Center. The rate, during trading, touched 8.93%, the highest level since October 2007 (Source: Bloomberg); this, in addition to the fact that the Chinese Market (China Shenzhen A Share Index) is down more than -15% (local) for the year and continues to fall, should make investors pause.  

 

All things considered, the current market recovery appears to be suspicious to us and may offer attractive levels to re-allocate to more risk-averse positioning.

 

Update: Current Markets

Thursday, June 16, 2011

Posted By:  Matthias Paul Kuhlmey

 

As per our last writings, the assessment of an imminent market correction was accurate. Equities in the U.S. have, on average, lost -10% over the past two weeks. Markets abroad, especially in emerging economies, have been under even greater selling pressure.

 

The question is if current levels offer potentially attractive entry points for investors, and if we are prepared to re-deploy liquidity that was raised over the past weeks.

 

From a valuation perspective, it has been our long-standing conviction that equities in the U.S. are overvalued by 30-40%. This morning, our friends at Wolfe Trahan Research point out that over the past days, the “stocks-are-cheap bulls” have come out of the woodwork. While the Price/Earnings Ratio of the S&P 500 is marked several points below its long-term average of ~15x (since 1985), current valuations may still not offer a (much needed) catalyst for equities. In fact, Price/Earnings Ratios have been marked below long-term averages since 2005. One may conclude that today is a good time for buying, with P/Es having fallen in 80% of S&P 500 constituents since May, but we tactfully disagree. Valuations need to be considered in context of an economic environment, not against historical reference points.

 

From a technical perspective, the market may be positioned for a “bounce.” The 1250 area in the S&P 500 offers strong support (1265 as of market close June 14, 2011). The stock market at its current state is quite oversold, with major averages along with many sector indices that have fallen to levels (price support from January or March and rising 200-day moving averages) that stand a decent chance of lending support to prices (see also Knight Research).

 

On a related note, according to a report by Dow Jones, Hedge Funds have engaged in significant bets against the Euro on growing fears of a Greek debt default: “Emboldened by deepening concerns about Europe’s sovereign-debt crisis, funds are increasingly willing to wager big money on the chance the Euro may sink toward parity with the Dollar.” Whereas we do not agree with this bleak outlook, chances are for a much weaker Euro in the near future.

 

Fata Morgana

Thursday, June 9, 2011

Posted By:  Matthias Paul Kuhlmey

 

A Fata Morgana is an unusual and very complex form of superior mirage, which, like many other kinds of superior mirages, is seen in a narrow band right above the horizon. A mirage is a naturally occurring optical phenomenon in which light rays are bent to produce a displaced image of distant objects or the sky. In contrast to a hallucination, a mirage is a real optical phenomenon. Fata Morgana mirages tremendously distort the object or objects on which they are based, such that the object often appears to be very unusual, and may even be transformed in such a way that it is completely unrecognizable (Source: Wikipedia).

 

By now, it should be clear to everyone that the elusive recovery of the U.S. economy, fueled by trillions of Dollars in stimulus funds, is not working as anticipated. With this in mind, we are convinced that Mr. Bernanke will initiate additional stimulus, as “this (according to legendary investor Jim Rogers) is the only thing he knows.” As stated last week, we will most likely experience a camouflaged version of stimulus, and in this respect an interesting thought comes from our friends at GaveKal Research. A possible support for the housing market, which remains to be one of the leading concerns and drag on the recovery, could include stopping the GSEs (Fannie Mae, Freddie Mac, FHA) from liquidating their housing inventory (which is fuelling the current price declines), and/or using the FED’s balance sheet to more directly support the housing market (Source: GaveKal Ad Hoc Comment, June 8, 2011).

 

Another concern we may share is that bank stocks have been under severe pressure over the last trading sessions. Judging from past history, this is never a good sign, and several significant stock market consolidations were preceded by price declines in the banking sector. Note that Moody’s Investors Service recently placed the ratings of Bank of America Corporation (A2 senior), Citigroup Inc. (A3 senior), Wells Fargo & Company (A1 senior), and their subsidiaries on review for possible downgrade.

 

We do hope that you have taken our cautious advice (as published last week in “Party Pooper”), and reduced risk assets prior to the sell-off in financial markets that has occurred ever since. If conditions continue to be difficult, it is easy to anticipate that the idea (or the actual fact) of QE3 could resurface and in consequence, propel stocks to new highs – regardless of valuations, and more as a function of an “inflation trade.”  As repeatedly stated, investing in such environment has not much to do with a solid approach to value, but tactical trading. It may work, but let’s not forget that at the end of the day, we are dealing with a very complex form of mirage.

 

Conditions may be in place for a bounce, but caution is necessary.

 

Party Pooper

Wednesday, June 1, 2011

Posted By:  Matthias Paul Kuhlmey

 

Before deciding on the title of this blog, I had to inquire with my respected colleagues about the adequacy of such undertaking. It appeared to be OK. By rather informal definition, a Party Pooper is a person whose behavior or personality spoils other people’s enjoyment (Source: Collins English Dictionary, HarperCollins Publishers).

 

With above in mind, let us have a look at some of the aspects of the U.S. economic recovery.

 

As reported yesterday, the U.S. Housing Market remains in severe condition. On a seasonally adjusted basis, the Home Price Index, as composed by Case-Shiller, marked its ninth decline in a row, with 12 of 20 observed cities marking new cycle lows. We have already made the case in our last Economic Update, Fairytales, that in absence of advances in the stock market, the balance sheet of private households would present itself as a more than bleak picture, with about USD 7-8 trillion in (peak) value lost. The decline in values, when measured on a non-seasonally adjusted basis, was even more significant, with prices now at 2003 levels, and below the “bottom” made in 2009. The data confirms that this is the most severe national real estate crisis ever experienced (see D. Rosenberg, GluskinSheff).

 

Something does not add-up.  Last week, the Standard & Poors 500 Index (S&P 500) had breached its 200-day moving average to the downside, and the market appeared to be in full consolidation, yet recovered within days. This initial downturn of the S&P 500 occurred accompanied by a partial recovery of the U.S.-Dollar (USD), especially when compared to the EUR, but also against other major currencies. Over the same period, the 10-year Bond in the U.S. rallied, leaving rates at around 3% (technically with room to trade to 2.5%); this aspect is indicative of market participants bracing for an economic slowdown, with bonds being the better allocation choice. Not even aspects of a (pending) U.S. default affected the bond market (rates would have to go up, not down). In addition, the situation in Europe, particularly regarding Greece, remains entirely unresolved, and a “patch-up” will only delay real issues.

 

We may, once again, be too early with our assessment, but it appears as if stock markets are losing support, as numerous economic indicators (globally) are pointing to the fact that the recovery is on pause. It is very possible that there will be additional stimulus (QE3 or “camouflaged” forms), but the political support for this approach is weakening. The FED is also aware that further monetary easing will prove counterproductive to the consumer, mainly as a result of a weakening USD and a related rise in commodity prices (impacting cost of agricultural goods and energy).  Further, considering that the recent correlation between the FED stimulus (QE2) and U.S. stock market performance has been around 80%, it remains questionable if thoughtful, fundamentally-driven investors will be tempted to abandon conservative allocation choices for riskier equities.

 

We suggest reducing risk-assets, holding more cash than usual, and observing the U.S. Dollar very closely. Whereas the case can be made for a much weaker currency, also considering the technical picture, we may experience a counter-rally and a stronger Dollar as a result; this would be a “game-changer,” especially in the much-favored and quite crowded commodity markets.

 

 
 
 
 

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