- Positioning by futures market participants has correlated with peaks in asset prices in stocks, bonds and oil since the Great Recession.
- There is a consistent message suggested now by those positions across all three investment types.
- This message suggests a bond-friendly move lower in both stock and oil prices, though the stock market may be poised for a nice rebound.
Background: The folks at FINVIZ allow us a look at basic measures of positioning of large and small speculators ("specs" herein) on the commodities exchanges, versus the positioning of commercial hedgers. These are shown, respectively, as red and blue lines, versus a green line. The positioning volume (quantity) long or short (plus or minus) of the two classes of speculators equals that of the commercials. Thus it is convenient to look at the green line to see the big picture regarding positioning. A green line above the zero line indicates that hedgers are net long and specs net short the commodity. The reverse is the case when the green line is below zero.
The question arises as to whether past patterns in these positions has any value in predicting the future. That cannot be known regarding the future. However, this article will show certain recurring patterns that together suggest to me that this one indicator, the "Futures Markets Indicator," is forecasting bullishly for Treasury bonds and bearishly for stocks and for oil. Thus the possibility is raised that 2014 could look like 2011.
Introduction: The advent of futures markets for stocks and bonds has opened the way to gambling and hedging strategies that inter-relate to the real world of pricing, selling and trading these securities. These regulated markets provide us information with a brief lag. Just as I accept that the trend is your friend until it ends, so do I want to think that the trend of an indicator is worth paying attention to until it stops working. Thus I humbly present for your consideration a few charts of certain key "commodities" with discussion of each of them, followed by some big picture comments.
Treasuries: I am going to focus on the key one from an economic, not gambling, standpoint. This is the 10-year bond (OTC:NOTE). Net hedger/speculator positioning is virtually identical to the set-up seen before every important surge up in price (down in yield) of the bond since Lehman failed. Here are the approximate 1 year and then 5+ year charts of the 10 year bond (click to enlarge):
As we can see best from the first chart, speculators have been short the 10-year for some time, basically going back to last spring's bond market rout. This is best seen by looking at the upward movement over a number of months for the green line (commercial hedgers). When this has occurred for this duration ever since 2008, an important rally followed. This set-up may be continuing, as the long-term downtrend in long-term interest rates remains intact for both the 10-year and 30-year bonds. The 10-year has peaked at right around 3%, and the 30-year has peaked right around 4%. If these hold, the following pattern suggests a move back to or even through the record lows in yield set in 2012. Here is the dramatic move in the 30-year, with the 10-year looking similar:
Not shown, but the various moving averages for the 30-year are setting up very nicely for a full bearish-to-bullish transition.
Bonds are generally feared, mistrusted and even hated. This is understandable, given that the government agency known as the Fed is busily monetizing debt and promoting inflation as its formal policy. This has been the case at least since 2001, yet look what has happened to interest rates.
The best-known vehicle for investing in the bond market is the iShares fund, the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT). (Right now, I favor the 10-20 year similar ETF from BlackRock's iShares (NYSEARCA:TLH), based on the yields of the 10 and 30 year bonds.)
So, for whatever reason(s), contrarian analysis of the futures markets suggests that the amazing bond market structural bull trend may have longer to run. As the Eagles said, (perhaps) "they just can't kill the beast."
I note the surprising accuracy of the small speculators in the e-mini contract versus the contrarian view to be taken from the positioning of small specs in the regular size contract, shown above the e-mini. If you look at the first chart, covering a year or so, the former group has gotten it right and has moved in net positioning virtually contrary to the small specs in the regular contract. Note the major positioning changes in recent months.
On a longer time frame, the same thing is seen. For example, the small specs on the e-mini contract bought the 2011 correction/bear market and the first 2012 correction, and tended to buy the fall 2012 correction as well; meanwhile they have tended to scale out of extended rallies. Meanwhile, the small specs on the regular contract have tended to do the opposite. So the recent gyrations in positioning suggest to me that, oversold conditions notwithstanding, it may be premature to call the end of this sell-off in stocks.
A similar bearish trading message may also be coming from the world's most important traded physical commodity, oil.
Oil: This particular commodity is West Texas Intermediate oil, which is no longer the world benchmark. So it's imperfect, but it's what I have. From FINVIZ, the shorter-term and then multi-year charts:
What my eyes see is that ever since the crash in oil prices which began in mid-2008 (well before Lehman, and while the recession was gathering steam), speculators have been trending more and more bullish on oil. This has happened in bursts, and each burst of bullishness, with the green line dropping to yet lower lows, has been accompanied first by a rise in prices but then a drop of some note.
I am therefore looking at the latest surge in bullishness from the specs and recent rally in prices as something to fade on a trading basis (and I have sold my trading positions in all energy companies).
Metals: Of course, I've looked at similar charts for the precious metals and other traded metals. They are indeterminate right now as I see them.
Other sentiment surveys: CNNMoney shows a "Fear & Greed" index which is currently showing "Extreme Fear;" this index whips around a good deal. It does suggest to me that a good buying opportunity is near, for traders. But is it merely yet another opportunity for large gains, as the SPY powers on to higher highs?
My thought is to doubt that the answer is an actionable "yes," though of course it could be so. One reason is that the Citi "Other P/E" (panic-euphoria) index was euphoric almost continuously from last November through the interview with Citi spokesman Tobias Levkovich in March. This has tended to have a fair amount of stability. It also has a good track record in predicting difficult markets. For example, that index surged into the euphoric range in the spring of 2008 after Bear Stearns was bailed out by the Fed and JPMorgan Chase (NYSE:JPM). It looked to many veterans as though an important market bottom had been made, but obviously it was just a minor intermediate bottom, as the bear was just beginning to really growl. Combined with the rich valuations of the market based on historical trends, I'm reluctant to buy rather than rent this particular dip based on the length of highly optimistic, risk-seeking behavior from market participants.
A different form of sentiment "survey" relates to insider buying and selling. This has been looking dicey recently, per Mark Hulbert's reporting last fall and again this March. However, he reported something similar in mid-2009 (!), a great time to buy stocks for the years ahead. Nonetheless, I think there is some validity to these latest articles of his. Along with not fighting the Fed, I don't like to fight executives.
Discussion: Given unattractive interest rates throughout the yield curve, stocks have been the only game in town ever since gold and other physical commodities crashed and burned after peaking in 2011. By some measures, stocks have gotten as high as or even higher than their peak 1929 level (see CAPE, which has been higher than in 1929). This suggests caution on a macro scale.
My own view is that the continuing evidence of an orderly bond bull market may allow the continuance of the "virtuous cycle" in which rising bond prices, i.e. lower interest rates make yet higher stock valuations appear justified. We know that stocks can potentially be a great asset class if, as in the 1950s and '60s, interest rates and nominal GDP trend upward. What can also be the case is that the "Goldilocks" scenario of high corporate profit margins and slow nominal GDP growth, stocks can trade higher and higher. Eventually, the conflict between ever-lower interest rates and ever-higher stock prices ought to become an impossible situation, and one or the other asset class will crack (or both), but it's not clear that this dynamic that has been going on since 1982 cannot continue for longer.
Summary and final comments: Based on the latest public data on positioning of speculators, I read the bond, stock and oil markets as consistent with each other in pointing to more downside risk for stocks, more downside pressure on interest rates, and the potential for a reversal of the recent uptrend in domestic WTI oil prices.
I do not look at this in isolation, and every sharp down-move, especially in hard-hit sectors such as biotech, tends to cause an opposite reaction. But overall, the stock market has tended toward euphoria for months, as Citi's panic-euphoria measure has suggested, and it would not be a surprise to see a meaningful reversal. Thus, since one never knows, it is possible that the recent stock market highs could end up being more important highs than any of us can know yet, just as they were in 2000. After all, a recession was a year away in March 2000, when the NASDAQ peaked and the S&P 500 made its first top of a double top formation, but that major top was already in well before the mild recession arrived around April 2001.
Therefore I have taken profits in stocks, mostly in the "safe havens" that have been spared the selling and that money has gravitated toward. These are mostly insurance/reinsurance companies and electric utilities, though without deserting the sectors entirely. In contrast, great growth companies such as Qualcomm (NASDAQ:QCOM) and Gilead Sciences (NASDAQ:GILD) appear reasonably valued with fine prospects, and I have seen no point in selling them. I'd rather look for entry points to add to my positions should the markets get into a deeper funk. As CNN's Fear & Greed shows, demand is very high now for safety, but utilities are guaranteed low/no-growth vehicles with inherently insecure dividends, so I'm happy to sell them if their prices go high. So it's unclear if that sector is "return-free risk" now.
Meanwhile, one can purchase great growth companies with stronger finances than most electric utilities at lower or equal P/Es; this area is where I think the relative sweet spot of the U.S. financial markets lies. Nothing much is cheap, but these appear to be the least expensive.
Unless the U.S. has entered into an unrecognized recession, then this article is suggesting that this is another period such as has been seen many times since the 1980s in which interest rates may be resetting even lower, aided for a while by lower oil prices, eventually with at least short-term favorable effects on the economy and stock prices. If that scenario occurs, this dynamic of both higher stock prices and higher bond prices is becoming increasingly stretched, though, and thus my macro market concerns would increase.
As a final summary, the recent bear move in stocks may have gone too far for now, but a deeper move in stocks, bonds and oil, such as that seen in the summer of 2011, is a reasonable possibility. I am trading accordingly, though what I view as "safety" in the stock market is more along the lines of strong technology stocks rather than the highly-valued "yield" plays of electric utilities that of late have been attracting scared money.
Disclosure: I am long GILD, QCOM, TLH, EDV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: Not investment advice. I am not an investment adviser.