My 17 Lehman Systemic Risk Indicators are Now Flashing Yellow…
Quote from my speech at the Rand Merchant Bank Fixed Income Currency & Commodity Conference, Cape Town, South Africa, February 10th, 2012.
Special thanks to:
Rand Merchant Bank
IBM Business Analytics
Calamos Investments & Mutual Funds
for inviting me to speak at events in the coming months.
In the Newsletter sent on New Year’s Eve, I made a bullish call on the US Financials and European Stocks.
Likewise, December 28th on CBNC I said, “financials will massively outperform” in 2012. Squawk Box host Andrew Ross Sorkin asked me, where I would put my money in 2012? I said “European stocks,” buy em when nobody wants em.
The US financials ETF, the XLF, is up close to 14% in 2012, while the S&P 500 represented by the SPY ETF is up some 8.6%. The Euro Stoxx 50, which represents blue chip companies in Europe is up 11% this year, almost double the return of the Dow Jones Industrial Average DJIA’s 6% gain. US jobless claims hit a 4 year low last week while the DJIA touched a 4 year high.
Year to Date Winners in 2012
Hang Seng +16%
DAX Germany +15%
Nasdaq + 13.5%
Nikkei Japan +11%
CAC France + 8%
FTSE UK +6%
DOW + 6%
Interesting to note the German DAX, up 15% this year, has managed to hold above the 10-Day SMA for the entire 2012 thus far but could be poised to convincingly close below.
Is this Beautiful Run for Global Stocks about to End?
US stocks are still cheap by historical valuation metrics, the S&P 500 is trading at 14x this year’s expected earnings, 13x if you account for the colossal amount of cash on corporate balance sheets. It’s the risks in Europe & Iran that can change everything.
How do you effectively measure the growing risks?
Over the last 3 years I’ve developed a list of 17 “Lehman Systemic Risk Indicators.” I talk about them in my speeches because I think they’re extremely important in today’s investing climate.
You see, the bottom line is the closer you are to a systemic risk event like Lehman Brothers collapse, the wounds investors wear are still fresh and it takes years to get over them. Investor psychology is so much different today than it was 2002-2007. The 2008 scars are still there, investors are much more likely to pull the trigger and reduce risk in their portfolios at the slightest signs of trouble. This is why we’ve had an extended period of high volatility and the student body left, student body right investing mentality.
My Lehman Risk indicators have moved from extremely bullish for stocks in December 2011 to neutral today. They are not screaming sell, but they are clearly saying there is a potential villain lurking around the corner, waiting to take a bite out of your portfolio.
As I said on Bloomberg TV in December, without the problems in Europe, the Dow Jones Industrial Average would be 1000 points higher. Like it or not Europe is there and it presents the greatest potential threat for a systemic risk event since Lehman’s collapse.
Low Volume on the NYSE a Sign of Complacency?
During the week of February 10th, I was looking at volume New York Stock Exchange. I was shocked to see not one day did more than 800 million shares trade. This has not happened during a non holiday week in a very long time. Last week’s NYSE volume was down 23% year over year. Why is volume so low??? Less than 800 million shares a day on the NYSE is dreadful vs the 1.5 billion a day a few years ago. Not even a 7 handle? Only 683 million shares traded on the New York Stock Exchange NYSE February 13th, the lowest trading day of the year.
High Yield Underperforming Equities
Interesting that High Yield, as measured by the JNK, the SPDR barclays Capital High Yield Bond ETF, has been significantly underperforming equities since Jan 26th. On the year it’s up 2.6% vs. 8.5% for the S&P 500. My research shows that when equities outperform high yeild bonds for an extended period, it’s a sign to lighten up on stocks. Equities are much more liquid than junk bonds, thus underperformance of the latter may be a sign that high yield bond holders are taking down risk while the stock market parties on.
A Reversal in Leadership
It will now take a cool 280% move higher and for Google GOOG to catch Apple $AAPL in market capitalization. Thanks to Apple, technology companies now account for 20% of S&P 500 market capitalization, making tech the first single sector to do that since the dreaded financials Q1 2007.
Taking a look at Apple’s AAPL heavy Interday Reversal on Wednesday, February 15th. The reversal on Apple AAPL is meaningful becuase of the stock’s colossal presence in major US equity indexes. If a leader of this size stumbles, take notice. Apple closed at $497, below the previous day’s low of $502, that was after hitting at all time high of $526. At one point she was up 30% on the year. Don’t forget Apple makes up 3.8% of the S&P 500, that’s 2.3x more than GE’s stake. In the QQQs, she makes up 16.4% of the ETF, that’s 5.5x more than Amazon.
Is Greece Bear Stearns and Portugal now Lehman Brothers?
Portugal’s 4.375% bonds due 2014 have made 4 round trips between the low 70s & low 80s over the last 9 months. They’re up 15 points in February, these are colossal moves for the bonds of a country! The bonds are offered near 82, that’s a 13.96% yield to maturity, +1364
gspread over US Treasuries. I have my eye on Portugal’s $13 billion bond maturity on June 15th.
Their total debt outstanding is $135 billion ish. Total debt maturing in 2012 is in the $29 billion neighborhood. So almost half of this year’s maturing debt comes due on one day in June.
Portugal’s jobless rate rose to 14% in the three months through December, that’s the biggest increase since the country joined the euro. The unemployment rate increased from 12.4% in the third quarter — the sharpest gain since at least 1998 — and from 11.1% in the fourth quarter of 2010, the Lisbon- based National Statistics Institute said last week. Don’t you think it’s kind of hard to gage the possible outcome of a PSI (debt restructuring) in Portugal with that kind of sequential move in joblessness. How on earth do you estimate tax revenues with that kind of a move in unemployment? The Troika, financial police body of the EU, IMF and ECB, will be in Portugal over the next two weeks. I expect some drama when they announce their findings.
The Weakest Links in the Global Economic Recovery
Last week we learned there’s an official double dip recession in Italy, in Q4 2011 there was a -0.7% economic contraction, worse than expected. Year over year, -0.5%, missed badly as well (-0.2% analysts were expecting). The Netherlands, Italy, Portugal, and Greece were all in recession in Q4. Spain is very close. The big winner in the eurozone economic sweepstakes, Germany saw 2011 economic growth of 3.0%. Another bright spot, with all the drama in Europe last year, France’s Q4 ’11 GDP actually toped forecasts, up 0.2% on the quarter, investment and consumption were solid. Brings growth for year as a whole to 1.7%, almost double that of the UK.
So 50% of Europe is officially in recession. This is is not helpful for economic expansion in China. Their love affair with exporting to Europe is starting to wane as the EU’s ongoing financial woes curbs retail spending.
Shipping specialist Lloyd’s List says container traffic through the Port of Shanghai fell by 100,000 boxes or 4% in January from a year earlier while volumes fell by over one million tonnes. The biggest falls were on the Asia-Europe trade route.
Bank’s Trust in One Another Has Improved in a Big Way, but Stalling
Last Wednesday, Euribor, a measurement of bank trust in one another accross Europe, fell for the 41st consecutive day, longest run since April 2009. The important rate at which banks lend to each other for 3 months moved down to 1.041% from 1.045%. Other indicators such as Libor, the TED spread and the 2 year Swap Spread all have moved from bullish for equities to neutral in recent days. Two year swaps, are at their highest level since Jan 30th. Bank Trust: I heavily weight these risk indicators in my basket of 17, they are very significant in today’s investing climate. They have improved dramaticly from November’s stock market lows but the rate of change in their improvement is now at stall speed. This section of indicators were screaming “buy stocks” in December, now they’re Neutral.
A Slight Breakout in Correlation is Significant
Correlation is one of my Lehman Risk Indicators, she broke out of a recent trading pattern last week, MACD or moving average convergence divergence, clearly has turned as well — not a good thing. This means expect higher correlation associated with sell-offs.
The 50-Day correlation of S&P 500 stocks to gains or losses in the full index increased to a record 0.86 in October 2011. It was 0.83 in the days around Lehman’s failure. It must be clear that high correlation is a lagging indicator, it’s the reversal of the trend that is important to watch. Correlation has been trending down since October, this has been bullish for equities. It’s that trend which is now showing it’s first signs of reversal.
A level of 1 would mean all 500 stocks moved together.
Today, correlation is still low relative to last October, but it’s reversed from a recent bottom.
In August-September 2008 and Summer 2011, high correlation existed across all asset classes. A breakout in the ICJ, the CBOE S&P 500 Implied Correlation Index, which occurred on July 11th, 2011 & September 2nd, 2008, was very bearish. Since 2008, the closer we move toward a systemic risk event the higher correlation marches on. In my mind, higher correlation is a sign that the market feels we are moving closer to a significant event.
In the 1990s and 2004-2007 there was very little correlation amongst all asset classes & equities.
My Trip to South Africa
South Africa, now I know why so many people fall in love with this place. The trip was life changing in many ways, I’m so grateful to Rand Merchant Bank for the invitation.
It was our first anniversary for me and Mrs. McDonald so we decided to do a four day Safari at the Londolozi Game Reserve. It’s is one of the original pioneering Private Game Reserves of the ecotourism industry in South Africa and an unashamedly family run, stand alone operation. They do a magnificent job at making the experience one to remember.
It is situated on the Sand River in the very heart of the Sabi Sands Game Reserve. This reserve in turn forms part of the Greater Limpopo Transfrontier Park, a vast and growing area, currently covering 6 million acres and incorporating the famous Kruger National Park. This rich, wild wonderland assures exceptional game drives and a true wilderness experience.
Breeding herds of elephant and buffalo roam throughout the Londolozi area, while white rhino and lion concentrations are amongst the highest recorded on the African continent.
In my mind, there is a truly remarkable relationship which has developed over three decades between wild free ranging leopards, lions and rangers & trackers. This makes Londolozi world famous. There is no disputing that viewing the leopards of Londolozi is one of life’s truly treasured experiences. We were able to spend time with 4 leapards in four days, wow. We were fortunate enough to see 12 different lions and lioness. The one you see above walked within 10 feet of us.
At the end of each day I reflected on life out there in the “bush” or as some call it the “great savanna.” Everyday you must manage risks with the highest stakes on the line, life. Every decision you make has multiple possible outcomes, you must choose them wisely.
I was amazed at how animals in the ecosystem do the same and they way they all work together. High in the air the monkeys share critical intellegence with the impala below, which they pass it along to the zebra and giraffe. Thousands of years of education in managing risks against the King & Queen of the Jungle, the great lion & lioness. It was something to behold.
Just like looking at the global markets today, you can’t see the risks but they’re there. You must look for the clues. This is the vision in helping investors, my 17 Lehman Systemic Risk Indicators provide hints as to what’s around the next turn in the road.