I am not a big believer in market analogies, but the current environment bears an eerie resemblance to the summer of 2011. Here are the similarities (click to enlarge):
Heavy insider selling
I wrote back in early February (see Insider selling, it's baaack!) that insider selling was surging. Vickers reported that [emphasis added]:
Looking at a longer time frame paints a bearish picture as well. The eight week sell-buy ratio from Vickers stands at 5-to-1, also the most bearish since early 2012. What's more, the last time this ratio was at these levels was June 2011, just before another correction in the stock market took place.
Apparently, insider selling has gotten worse since that report. According to Charles Biderman of TrimTabs (via Zero Hedge), the ratio of insider sales to buys is skyrocketing, though I am unsure of how to compare the Vickers sell-to-buy ratio to the TrimTabs one as I don't know the differences in their methodologies:
While retail is being told to buy-buy-buy, Biderman exclaims that "insiders at U.S. companies have bought the least amount of shares in any one month," and that the ratio of insider selling to buying is now 50-to-1 - a monthly record. "So far the mass delusion is holding."
By contrast, Bloomberg reports a three-month average insider sales-to-buy ratio of 12 to 1, a two year high:
There were about 12 stock-sale announcements over the past three months for every purchase by insiders at Standard & Poor's 500 Index (SPY) companies, the highest ratio since January 2011, according to data compiled by Bloomberg and Pavilion Global Markets. Whenever the ratio exceeded 11 in the past, the benchmark index declined 5.9 percent on average in the next six months, according to Pavilion, a Montreal-based trading firm.
Regardless of differences in methodology, the results are an ominous sign for the bull camp.
US political gridlock
Another similarity between today and the summer of 2011 is the rising anxiety over the consequence of political intransigence in Washington. Then, we saw the debt ceiling crisis of 2011, which led to the loss of the AAA credit rating from Standard & Poor's.
Today, we have $85 billion in overnight sequestration cuts to the federal government and a looming debt ceiling crisis on March 27, about three weeks away. Fed chair Ben Bernanke projected that sequestration will likely slice 0.6% from GDP growth in 2013:
However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO's estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.
A 0.6% slowdown in GDP growth could very well mean that the economy stalls and keels over into recession. What's more, another debt ceiling debate with a drop-dead deadline of March 27 will pour gasoline on the fire and could lead to further market anxieties.
News cycle turns down in Europe
In 2011, the ECB's announcement of its LTRO program stabilized the markets. Mario Draghi's "whatever it takes" remark in July 2012 and the ECB's subsequent OMT program contributed to further stabilization. Today, the market consensus has evolved to the view that the ECB has taken tail-risk, or the risk of a European sovereign debt or banking crisis, off the table. The ECB, it seemed, had built a financial castle wall around the eurozone again.
Read the fine print. The OMT program depends on member states submitting to the ECB's "conditionalities", namely austerity and structural reform programs. The rise of anti-euro forces in the recent Italian election shows how fragile the ECB's castle walls really are.
I fear that the news cycle is about to turn down in Europe. Consider these stories that are appearing:
- The divergence between German and French economies (via Business Insider). This divergence is starting to raise the question of the viability of the French-German partnership in the EU. These are the two principal founding partners in the European Union and brings up the question of wage and productivity differentials between the two countries. If the two economies can't converge and Germany is unwilling to subsidize France, the euro is cooked. Nothing else matters. It doesn't matter what happens to Greece, Spain, Ireland, etc.
- Political turmoil in Spain. The FT reports that Madrid is pushing for a constitutional challenge to Catalonia's bid for independence, which puts the spotlight on political stability in Spain:
What's more, Business Insider reports there are rumblings that the Army may not stand idly by and the possibility of a coup d'etat is raising its ugly head. While I believe that these risks will ultimately resolve themselves in a benign fashion, these stories are just further signs that the news cycle is turning negative in Europe.
The Spanish government has launched a legal challenge against Catalonia's recent "declaration of sovereignty", in the latest move by Madrid to halt the region's march towards independence.
The government said it would ask Spain's constitutional court to nullify the Catalan parliament's January declaration, which stated that the "people of Catalonia have, for reasons of democratic legitimacy, the nature of a sovereign political and legal subject".
- Questions about Italy. In the wake of the political paralysis created by the recent Italian election, anti-euro populist Beppe Grillo wants an online non-binding vote on Italy's membership in the eurozone. Stories like these serve the purpose of turning up the heat on the bulls and embolden the bears.
Recall that in 2011 we had angst over Greece and the implications for the eurozone. We saw endless summits and crisis meetings until the ECB stepped in to stabilize the situation. Today, the fragile peace that the ECB has put together is starting to unravel. Europe is in recession and the tone of the news stories is turning negative.
These kinds of stories have a way of not mattering to the markets until it matters, especially when the market is in risk-on mode. Now that the tone seems to be moving away from a risk-on to risk-off, the market has a way of focusing far more on this kind of negative information.
A positive divergence
In 2011, the SPX cratered about 17% in response to these anxieties. While I am not saying that the downside could be the same, it is nevertheless a warning for the bulls. The key difference between the market weakness in 2011 and today is how the Fed acted then and now. In 2011, the Fed's QE program was just ending, while we are seeing QE-Infinity today. The actions of the Federal Reserve today may serve to cushion the effects of the speed bumps that the equity markets are likely to experience.
Nevertheless, the current environment is likely to be more friendly to the risk-off crowd than the risk-on crowd.
Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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