14 March 2012

Macro Strategy Update

Positive Outlook Maintained

Another month has passed and the bears are being forced to admit that they had underestimated the strength of the rally. Global equities were up 4.8% in February, and have rallied 21% since the October 2011 lows. Naturally a pull-back is in store, which we are currently witnessing. Reading the tea leaves seems to point to further gains, frustrating the bears even more and raising the anxiety of those still left on the sidelines.

Notable bears have been left licking their wounds after predicting a very short relief rally in equities. After clocking another month of gains, equity markets are now on track to regain their 2011 highs (eg. the US markets). While the recent weakness in markets may begin to test the nerves of bullish investors, we see it as a healthy correction to address overbought conditions.

From a technical perspective, there are signs that equity markets are entering a correction or consolidation mode. Short term momentum waned as the market trended higher in February as indicated by both the RSI1 and MACD2 (Figure 1) failing to catch up. Hence a short term downtrend in markets should not be a surprise.

Figure 1: Global equities consolidating since March.

More importantly, the longer term trend remains positive. Both the RSI and MACD continue to point to upside momentum (Figure 2). This indication is also confirmed by the positive signals we get from other asset markets.

Figure 2: Technical readings still positive on a weekly basis.

Cyclical stocks continue to lead the market while defensive stocks lag. A good example is the performance of the consumer discretionary versus the consumer staples sector (Figure 3). A continued rise in the relative performance of consumer discretionary stocks is a positive development for bullish investors. The fact that this is occurring in the midst of oil price hitting triple digits is even more notable. One could conclude that consumers are able to adapt to higher energy prices for now. With retail stocks at an all time high whilst oil is at $106 is a testament to the resilience of the consumer (Figure 4).

Figure 3: Consumer discretionary stocks continue to rise against staple stocks.

Figure 4: Retailing stocks making a new high despite high energy prices.

The bond market has also indicated continued interest in risk taking. There has been no secret flight to safety as investors continue to view high yielding bonds favourably against Treasuries (Figure 5). In the funding markets, TED spreads have been stable and LIBOR rates have declined (Figure 6). This is largely due to central banks' action, which has flooded the financial system with abundant liquidity.

Figure 5: High yield bonds outperforming US Treasuries

Figure 6: LIBOR rates on a decline.

On this note, it is clear that policy makers are concerned about the risk of a recession and are buying insurance against it even though recent data has been rather positive. The FED extended its loose monetary policy to 2014, while the ECB held a second round of LTRO, lending out 529.5 billion Euros. Joining the party is the Bank of Japan, with its plan to buy 30 trillion yen of assets in a bid to stoke inflation. All in all, a total of one trillion US dollars is in the process of being created, and this liquidity comes cheap. It is no wonder that markets are picking up on this and luring investors from the sidelines to join in the party.


We still need a stream of positive news from the global economy and continued stability in Europe to cheer the markets on. The latest PMI readings are quite positive, with the major economies showing signs of expansion while Europe continues to recover. The IMF looks likely to upgrade global growth now that they may have under-estimated US growth3. While some think that greater market gains from here are hard to justify, we think a recovering jobs market4 in the US and nascent signs of recovery in the housing market could push investors to bid markets higher once the correction is over.

Portfolio Positions

After our last round of rebalancing, we are already slightly overweight equities so there is no change to our portfolio positions.

1. For an explanation of RSI, please click here.
2. For an explanation of MACD, please click here.
3. IMF's Lagarde Says U.S. Growth Outlook May Be Revised Upward. Mar 9 2012, Bloomberg News
4. U.S. Payroll Gain Caps Best Six-Month Job Growth Streak Since '06: Economy. Mar 10 2012, Bloomberg News

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