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The first three months of 2010 have come and gone and not much changed from the momentum and liquidity driven market of 2009. Volatility continues to hit lower and lower levels while the S&P 500 seems unstoppable toward that 1200 level which, when broken to the downside in 2008, ushered in an almost terminal stroke to our financial system.
In the first quarter, the S&P 500 benchmark produced a net gain of 4.84% while the Volatility Index (VIX) collapsed almost 20%. Among other benchmarks we follow, gold in its ETF format (GLD) put on a positive 1.53% and our beloved MLP sector roared ahead by 6.22% (AMZ index).
The equity market did have a sizable yet incredibly short lived correction which started – in full accordance with seasonality – in the second half of January. This 9% correction stopped short of the traditional 10% pull-back mark and a bit short of the 200 day moving average and produced yet another V shaped rally which took the indexes to new relative highs.
This rally has made stocks not so attractive on a fundamental basis. Discounted cash flow models such as the Morningstar Fair Value model are now oscillating between overvalued and fair valued. Also, the general rise in Treasury yields is not helping valuations as fixed income becomes more attractive and valuation multiples like P/E ratios tend to shrink in a rising interest rates environment.
Most sentiment driven indicators are now in overbought mode; the percentage of stocks above the 50 day moving average and most Put and Call ratios for instance. On the other hand, one input which indicates smooth sailing ahead was highlighted by Bloomberg today: only 28% of operating profits are now spent in buybacks (2009 numbers) by companies in the S&P 500, and the last time we saw such a low levels in buybacks equities rallied for four years.
The “risk trade” is on for most asset classes, except the Treasuries. When one looks at the 10 month moving average cross-over indicator US equities, global equities, commodities and real estate are all above the average and therefore in long term buy mode. However, 10 year Treasuries are on sell mode.
On the fixed income side, we happen to agree with PIMCO, and we favor inflation protected securities in countries with large deficits and traditional sovereign debt in surplus countries. In light of this analysis, we repositioned many accounts and increased exposure to inflation protected securities (via TIP) and German sovereign debt (via closed-end fund RCS whose largest single position is a 2015 German Sovereign bond).
In the emerging markets space, we still like Brazil and we still think this is the better place to be in the long term out of the BRICs. Brazilian fixed income is also very attractive but we have no positions in it at the moment.
The US Dollar also increased since the beginning of the year by almost 4% (DX). One of the biggest relative losers was the EUR which shed about 6% thanks to, among other reasons, its inability to produce a crisis management protocol to deal with situations such as the Greek farce. We think the EUR is still a sell but are careful at this level since the short position is dramatically large. We did not trade the EUR particularly well this past quarter and while our thesis was correct, our execution tried to be “too cute” and our attempt to trade on a short term basis the long side inside our core short position unfortunately backfired. We are not so hot about the Yen either as we think that Japan will continue to keep rates low while the US may be more proactive in normalizing.
On the commodity side, as mentioned earlier, the 10 month moving average indicator triggered a new buy signal confirmed by break-outs in crude and copper. This may reflect that inflation is starting to creep into the equation. TIPs anyone?
--Davide Accomazzo, Managing Director
(This article was written on April 5, 2010)
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