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  • The Biotech Cloud - March 31, 2015

    Greetings,

    Last summer, Janet Yellen warned that valuations in certain corners of the stock market like biotech were getting "substantially stretched." Proving yet again that she's a better economist than market-timer, the biotech sector has proceeded to rally more than 50% since her words of caution. However, there's no denying that valuations in this sector do seem excessive. Less than 50% of the stocks in the NASDAQ Biotech Index are expected to make money in the next fiscal year, rendering valuation metrics like price-to-earnings irrelevant. According to Credit Suisse, biotech has done something that no other sector has done before, which is outperform for 5 years in a row.

    It's impossible to have a rally of this magnitude without attracting some "weak hands," also known as speculators. It wasn't surprising that these speculators jumped ship last week when the broader market dipped lower. Ostensibly, the sell-off was caused by Saudi Arabia entering the fray in Yemen, which we'll touch on later, but, in my opinion, the market simply returned to the levels it was trading before the latest Fed meeting - where there were few substantial developments. Not surprisingly, biotech shares bore the brunt of the decline.

    (click to enlarge)

    The technical signals don't point to an imminent rally, either. The number of stocks in the biotech index trading above their 50-day moving average (NYSE:MA) plunged to 50% from more than 80% in the previous week. The last time conditions deteriorated so quickly, in February 2009, fewer than 20% of the group ultimately held above their 50-day MA.

    It goes without saying that I don't advise investors to load up on biotech shares at these levels. This is not a "buy the dip opportunity," but it is important to monitor this sector going forward. When it's clear that speculators have abandoned biotech, that might be a signal the broader market is headed for a correction. There are several reasons to believe the stock market is overvalued. The Office of Financial Research, the agency in charge of financial stability, released a paper last week showing the stock market is "dangerously overvalued." The CAPE ratio, Q-ratio and Buffett Indicator are all approaching two standard deviations above their historical mean. Like market commentary from Janet Yellen, these indicators don't say when the market will correct, but they do seem correct in their conclusion that it's overvalued.

    Editor's note: Cup & Handle will not be published on April 7 due to a hectic schedule. Apologies in advance.

    The Cup & Handle Fund was down around -1% last week, but still +13% since August. Foreign currencies is usually my go-to asset class for sustainable trends, but there are not many clear, directional bets at the moment. There is a good chance some relative value bets will start entering the portfolio, but I need time to do some homework. I still haven't settled on a recommendation for April yet, but my track record is looking much better after my picks from February and March. If you'd like to start receiving these letters click here.

    Today's letter will cover several topics, including:

    • Saudi Arabia's Military Stimulus
    • UKQE?
    • Made From Concentrate
    • Chart of the Week

    As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

    Until next time, tread lightly out there,

    Michael Lingenheld

    Managing Editor - Cup & Handle Macro

    Saudi Arabia's Military Stimulus

    (click to enlarge)

    The Saudi Kingdom's decision to attack Yemeni militants last week has created an almost perverse form of stimulus for the country's stock market. Egypt, Pakistan, Morocco, Jordan and Sudan were also part of the air strikes, but Saudi Arabia is clearly calling the shots. Gulf nations are taking more assertive military stance as their economies struggle with the falling oil price. The six-nation Gulf Cooperation Council is home to a third of the world's proven crude reserves, and Saudi Arabia is the world's largest exporter.

    Yemen is just the latest battleground in an ongoing Islamic proxy war between Shia-Iran and Sunni-Saudi Arabia. The Saudi's are now moving heavy artillery to areas near its border with Yemen, indicating Riyadh might be drawn into an extended conflict. It's not clear if the military intervention will have a significant impact on the Saudi economy, although it's sure to rattle some retail investors. However, the skirmish did give a boost to oil prices, which finished the week nearly 5% higher.

    Assuming the local economy isn't effected and oil prices continue to rise due to geopolitical uncertainty, investors could be buying Saudi shares on the cheap here. The opening of Saudi Arabia's stock market to direct foreign investment is only months away, and demand is expected to be strong. BlackRock (NYSE:BLK) even has plans to launch an ETF for Saudi shares sometime this year.

    (click to enlarge)

    Conversely, the bear argument would go something like this: The Saudi's have pegged their currency, the Riyal (NYSE:SAR), to USD since 1986, meaning the rapid appreciation of USD is tightening domestic monetary conditions. 12-month USD/SAR forwards are below levels from earlier this year, but have started moving higher. If USD continues to rise and oil prices slide again, the country's monetary policy would be entirely inappropriate and stocks would suffer.

    The government is rapidly trying to diversify the economy because over 90% of its revenues come from oil, but that will take years to complete. While the Kingdom has huge financial reserves to withstand temporary turmoil, an extended conflict that hurts confidence could be problematic. Few investors have a firm view either way, but Saudi equities are one of the world's most intriguing and volatile markets.

    UKQE?

    If you're unfamiliar with the UK's weekly PMQ's (Prime Minister Questions), I highly recommend watching this video from March 18. The 30-minute Wednesday gatherings often include shouting, booing, animal noises and name calling. Prime Minister David Cameron is running to be re-elected in the national elections scheduled for May 7, but perhaps his constituents would be better off questioning the Bank of England.

    The Bank's chief economist, Andy Haldane, recently said it was possible that there had been a permanent downward move in inflation and that he could easily envision cutting rates from their current record low of 0.5%. Inflation in Great Britain seems certain to turn negative next month, and while other BoE officials believe (hope) inflation will turn higher, the threat of rising real interest rates should make the UK's indebted households nervous.

    (click to enlarge) (click to enlarge)

    In theory, the falling prices are being driven by the decline in energy prices. In fact, the BoE calculates that around 75% of inflation's deviation from the 2% target can be explained by the fall in oil and gas. But it doesn't help that Britain's currency, the Pound (GBP), has appreciated more than 12% relative to its largest trading partners in the EU.

    The BoE, along with the Federal Reserve and Bank of Japan, was one of the early adopters to QE after the financial crisis. The ECB, having just implemented QECB this month, was late to the party but their asset purchases will continue at least through September 2016. Besides the looming property bubble in London, the British economy's recovery has been lackluster but if these price trends don't reverse soon, expect the BoE to strongly consider another asset-purchase program.

    Made From Concentrate

    Illiquid markets and volatility go hand-in-hand. With a notional value of $316 million, the orange juice futures markets is small but often produces spectacular price swings. The fundamental outlook for Florida's crop is extremely bullish as many groves have been stricken with disease. The USDA recently estimated Florida's orange production to be 102 million boxes this year, which would be the (click to enlarge)smallest crop in 47 years.

    However, OJ futures have really become a proxy bet on the Brazilian Real (BRL). Producers in Brazil, the world's largest exporter, tend to increase sales when BRL declines because they take in more US dollars. BRL has been the world's worst-performing major currency this year, leading to record short positioning in the OJ market. Since March 18, when the Fed was ambiguous on the timing of interest rate hikes, BRL has rallied more than 5% - triggering a 20% rally in OJ as traders cover their short positions. Commodities usually have strong rallies based around a change in fundamentals, but in this case currencies have manufactured a bull market.

    Chart of the Week

    Premier Li Keqiang says defense spending from the central government will rise 12.2% this year, bolstering China's more assertive stance in regional disputes. The key phrase in that sentence is "from the central government," because many believe there is more taking place behind the scenes. China's increased military spending comes as the US is cutting back. The proposed Pentagon budget for 2015 would reduce the Army's personnel by 6%, smaller than the forces available on September 11, 2001.

    (click to enlarge)

    Having said that, while the growth rates are clearly in China's favor, the US still has a sizeable lead in nominal spending. The chart above shows the combined defense spending from China, Russia, Saudi Arabia, France, Great Britain, Germany, Japan and India is only 95% of America's budget. That's not to say that China's military isn't a growing threat. It was recently revealed the Chinese have acquired a second aircraft carrier with plans for up to four. Again, the US already has 14 in service, but these vessels are key to China maritime ambitions. Each year, $5.3 trillion of trade passes through the South China Sea; the US accounts for $1.2 trillion of this total. Surely the US has a vested interest in patrolling those waters.

    Reader Question:

    **Editor's note: Every week we'll try to answer at least one reader question. If you would like to submit a question, please send us an email at info@cup-handle.com. We'd love to hear from you! **

    Q: Thoughts on the Heinz-Kraft merger? - JM

    A: 3G Capital once again teamed up with Warren Buffett for this transaction, creating one of the world's largest consumer conglomerates with combined revenues of $28 billion. It strikes me as odd that Buffett, known from backing companies with stable management, is investing in a company with notoriously impatient executives.

    As recently as 2007, Krafts Foods spun out of Altria (NYSE:MO) - a company that derives 96% of its revenue from the sale of cigarettes. After that, in 2010, then CEO Irene Rosenfeld bought Cadbury for 11 billion GBP. Then, in 2012, Kraft was broken up into Mondelez, which includes Cadbury. I assume Buffett will be unwilling to tolerate that many corporate actions going forward, but 3G Capital has a strong track record in the food business thus far.

    My biggest objection is that 3G Capital isn't concerned at all about the Department of Justice or FTC blocking this merger. Five companies now account for almost half of supermarket food sales in the US. That's what economics professors would call an oligopoly. If only the regulators were paying attention.

    That's all, see you next week!

    For any questions or comments, please email us at: info@cup-handle.com

    Please visit our website.

    Follow us on Twitter: @cuphandlemacro

    Disclaimer: None of the information contained in this publication constitutes a recommendation that any particular investment, security, portfolio, transaction or investment strategy is suitable for any specific person. This publication may contain news, information, speculation, rumors, opinions and/or commentary. Cup & Handle Macro Research, LLC ("C&H"), is not permitted to offer personalized trading or investment advice to subscribers. C&H is not a broker/dealer, an exchange or a futures commission merchant and is not subject to regulation by the U.S. Securities and Exchange Commission, the U.S. Commodity Futures Trading Commission or any similar regulatory authority in connection with its activities. C&H does not act as an investment adviser or a commodity trading advisor and does not provide any investment advice or commodity trading advice. The information, statements, views and opinions included in this publication are based on sources (both internal and external) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness, including without limitation, any implied warranties of merchantability, fitness for use for a particular purpose, accuracy or non-infringement. Use of any information obtained from or through this publication is entirely at your own risk. C&H does not routinely moderate, screen or edit any third party content. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.

    SUBSCRIBERS SHOULD VERIFY ALL CLAIMS AND DO THEIR OWN RESEARCH BEFORE INVESTING IN ANY INVESTMENTS REFERENCED IN THIS PUBLICATION. INVESTING IN SECURITIES, PRECIOUS METALS, AND OTHER INVESTMENTS, SUCH AS OPTIONS AND FUTURES, IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK. SUBSCRIBERS MAY LOSE MONEY TRADING AND/OR INVESTING IN ANY SUCH INVESTMENTS. ALL USERS OF THIS PUBLICATION ACKNOWLEDGE AND AGREE THAT NO PERSON OR ENTITY INVOLVED IN THE PUBLICATION OF THIS PUBLICATION SHALL HAVE ANY LIABILITY FOR ANY LOSS OR DAMAGES, INCLUDING WITHOUT LIMITATION, CLAIMS FOR LOSS OF MONEY, ERRORS, DEFAMATION OR OTHER EXPENSES, RELATING TO ANY PLACEMENT OF CONTENT IN THIS PUBLICATION, OR ANY RELIANCE ON ANY INFORMATION CONTAINED HEREIN, OR THROUGH ANY LINKS CONTAINED IN THIS PUBLICATION OR THE SITE.

    Employees and/or affiliates of C&H may give advice and take action with respect to clients and/or investments that differs from the information, statements, views and opinions included in this publication. Nothing herein or in the subscription agreement shall limit or restrict the right of employees or affiliates of C&H to perform investment management, advisory or other services for any persons or entities. In addition, nothing herein or in the subscription agreement shall limit or restrict employees or affiliates of C&H from buying, selling or trading securities or other investments for their personal or other related accounts, or for the accounts of their clients. Employees or affiliates of C&H may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. C&H shall have no obligation whatsoever to recommend securities or investments in this publication as a result of its employees' or affiliates' investment activities for their own accounts or for any other accounts.

    This publication is proprietary and intended solely for the use of its subscribers, and is protected by domestic and international copyright laws. No license is granted to any subscriber, except for the subscriber's personal use. No part of this publication or its contents may be copied, downloaded, stored, further transmitted, or otherwise reproduced, transferred, or used, in any form or by any means, except as expressly permitted under the subscription agreement or with the prior written permission of C&H. Any further disclosure or use, distribution, dissemination or copying of this publication, or any portion hereof, is strictly prohibited.

    There is no guarantee that this site will operate in an uninterrupted or error-free manner or is free of viruses or other harmful components. This publication assumes no responsibility for any omission, interruption, deletion, defect, delay in operation or transmission, communications line failure, theft or destruction or unauthorized access to, or alteration hereof. The publication is not responsible for any technical malfunction or other problems of any computer, telephone or other equipment, or software occurring for any reason, including but not limited to, technical problems or traffic congestion on the Internet or at any site or with respect to this publication or combination thereof, including injury or damage to any person's computer, mobile phone, or other hardware or software, related to or resulting from using or downloading any content hereof.

    Tags: IBB, BLK, KRFT
    Mar 30 9:57 AM | Link | Comment!
  • Buying Time - March 24, 2015

    Greetings,

    Time is the most valuable commodity in the world, especially if you're a central banker. Last week Janet Yellen bought the Federal Reserve some time by opening up the possibility of a rate hike as soon as June, while simultaneously lowering expectations for further increases down the road. The median path of the projected fed funds rate stands at 0.625% at the end of 2015, 1.875% at the end of 2016 and 3.125% by December 31, 2017. This unlikely scenario would be the most gradual tightening cycle in US history. The Fed also anticipates the unemployment rate leveling off while economic growth accelerates - again, this scenario has never occurred in US history. However, it's what the market wanted to hear in order to grant the Fed more time.

    It's the same story in Europe. This is an actual headline from Friday: "Greece - a deal was reached to comply with the old deal, which itself was not an actual deal." That's a good example of what makes investing in these markets so treacherous. ECB President Mario Draghi famously said he would "do whatever it takes" to save the Euro in 2011. It turns out he didn't have to do anything until 2015, when QECB was initiated, but those words bought valuable time.

    (click to enlarge)

    It's still unclear when time will expire and central bankers are forced to confront massive imbalances in the global economy. At the moment it looks like the clock is ticking on the FX market. The Deutsche Bank Currency Volatility Index reached the highest levels since 2011 last week.

    As I've said before, the biggest impact from the Fed's QE program(s) was the smothering of volatility across the board. When asset prices are stable, it gives investors the confidence allocate capital into risky markets. The problem is that when volatility appears it's rarely confined to one asset class. I can easily envision a scenario where currency volatility spreads into credit markets - particularly those in emerging markets - before finally reaching the stock market. When that happens it will be time for central bankers to face the music.

    The Cup & Handle Fund was up roughly 3% last week, back to flat on the year, and +14% since August. My last two investment recommendations, from February and March, have performed exceedingly well. The energy stock (yes, energy) from February is up nearly 30% since the letter went out on February 16. I'm almost disappointed because I wasn't able to build more of a position. The March letter was sent out eight days ago and the ETF selected has rallied more than 11% already. I haven't settled on a recommendation for April yet, but the bar is set pretty high. If you'd like to start receiving these letters click here.

    Today's letter will cover several topics, including:

    • Euro: On Sale
    • Higher Wages or Bust
    • Big Data
    • Chart of the Week

    As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

    Until next time, tread lightly out there,

    Michael Lingenheld

    Managing Editor - Cup & Handle Macro

    Euro: On Sale

    Last week I mentioned that European ski resorts are expecting an increase in American visitors due to the Euro's 12% decline against USD this year. However, tourism is hardly the only sector expected to receive a boost from the weaker currency. Luxury goods makers, for example, are expected to benefit in several ways. First, they're able to gain market share from international competitors as their products become more competitively priced. It also gives them the ability to attract shoppers from abroad. And finally, international sales should help improve their bottom-line by increasing the value of foreign revenues when converted back to EUR.

    (click to enlarge)French fashion house Chanel said last week it would increase handbag prices in Europe while cutting them in China to shrink price gaps between the two markets. In other words, the company is eliminating an extremely profitable arbitrage for Chinese tourists operating in the black market. Other brands like Gucci are experiencing a similar phenomenon. Alibaba's (NYSE:BABA) Ebay-like subsidiary, Taobao, has seen a huge increase in black market luxury items purchased in Europe and shipped back to Mainland China since the EUR's decline began in earnest.

    (click to enlarge)

    Champagne sales, which typically act as a proxy for consumer sentiment, are also expected to get a boost. The US is the largest alcohol consumer in the world, but, according to the chart below, we can expect the British and Swiss to load up on champagne this year. The EUR has declined significantly against GBP, as well as CHF, although the exchange rate has yet to impact prices. That's because the vast majority of champagne is shipped between September and November, in time for the holiday season. The ECB will continue with its QE program for at least another 15 months, and if the EUR keeps trending lower, the bond market won't be the only thing that's bubbly.

    Higher Wages Or Bust

    The Japanese economy has been stuck in a deflationary trap for decades now. The country's refusal to embrace immigration has created a demographic time-bomb that will increasingly burden future generations unless policymakers can jumpstart the economy in a big way. Reversing the downtrend in prices is vital to get the economy going again, and there was good news on that front last week.

    Prime Minister Shinzo Abe has been pressuring the business sector to raise workers' pay, a critical component of his Abenomics reform package. Last Wednesday, some of Japan's most prominent companies like Toyota (NYSE:TM), Panasonic and Hitachi announced their biggest pay increases in years.

    (click to enlarge) (click to enlarge)

    These companies can certainly afford it. According to the Bank of Japan, corporate cash holdings stood at $1.9 trillion at the end of December, the most on record and 4% increase over last year. Similar to WalMart wage increases spreading to other retailers like TJ Maxx and Target, economists say pay at companies like Toyota is a benchmark for other businesses; meaning more of Japan's large companies are likely to follow suit.

    The combination of a weaker Yen, falling energy prices and rising wages has several prominent strategists saying the Japanese stock market is poised for a rally. However, looking at the chart above it's clear that further gains will need to be accompanied by a weaker Yen. Abe may have convinced employer's to raise wages, but at this point their margins are driven by currency fluctuations more than anything.

    Big Data

    Bridgewater Associates, the world's largest hedge fund, is slated to launch a new artificial intelligence unit this month that will trade based on algorithms that make predictions based on historical data and statistical probabilities. Advances in artificial intelligence are unlikely to help the individual investor anytime soon, but "Big Data" is helping to improve the inputs traders use to make decisions. Economists at MIT are undertaking an academic initiative called "The Billion Prices Project," which scans the Internet daily capturing online prices of… everything.

    In essence this is a real-time way to monitor CPI, economic data that is released monthly. The chart above indicates that CPI released this morning (before publication of this note) will likely dip further into negative territory. However, the Billion Prices Project, or PriceStats, shows that prices have been on the uptrend of late. That is likely explained by higher gasoline prices, which turned higher in February after declining for 123 consecutive days. It's only a matter of time before "Big Data" improves other important metrics like unemployment, but I think the next advances will come in areas related to consumer sentiment.

    Chart of the Week

    I've written extensively about Brazil's dramatic fall from burgeoning superpower to the weakest link in emerging markets. What's gone unnoticed, however, is Mexico emergence as a manufacturing leader. The chart below shows that Mexico is the only major EM country to increase its trend GDP since the financial crisis. Obviously part of Mexico's appeal to multi-national corporations is its proximity to the United States, which has emerged as the world's strongest economy, but there are other factors driving growth.

    (click to enlarge)

    For instance, Mexico is part of 10 different free-trade agreements, encompassing 45 countries. The deals give Mexican exporters duty-free access to markets that contain 60% of the world's economic output. Automakers and parts suppliers alone have invested more than $20 billion in factories south of the Rio Grande. Embattled Mexican President Enrique Pena Nieto has faced protests for alleged kickbacks and his inability to clamp down on drug lords, but he clearly understands what makes economies grow. The long-anticipated privatization of Mexico's oil industry is expected to see a big push this year, which will only encourage investment. Pena Nieto's approval rating might be low, but the same could be said of Brazilian President Dilma Rousseff. At least his economy is growing.

    Reader Question:

    **Editor's note: Every week we'll try to answer at least one reader question. If you would like to submit a question, please send us an email at info@cup-handle.com. We'd love to hear from you! **

    Q: What do you make of Ray Dalio's comments? - KT

    A: I wasn't able to obtain a copy of the Bridgewater newsletter that got so much attention last week, but there was enough information in the popular press to understand his points. It's hard to disagree with Dalio's assessment, as the economy is essentially navigating unchartered waters. The note says:

    "If one agrees that either a) we are near the end of the developed country central bankers' ability to be effective in stimulating money and credit growth or b) the dollar is the world's reserve currency and that the world needs easier rather than tighter money policies, then one would hope that the Fed will be very cautious about tightening."

    Part B is almost indisputable, but I'm not as confident about part A. Central bankers still have plenty of levers to pull in order to encourage credit growth. Negative interest rates are proving to be extremely effective at weakening currencies and elevating prices. Whether the market retains confidence in central banks as they pull these maneuvers is another matter.

    That's all, see you next week!

    For any questions or comments, please email us at: info@cup-handle.com

    Please visit our website.

    Follow us on Twitter: @cuphandlemacro

    Disclaimer: None of the information contained in this publication constitutes a recommendation that any particular investment, security, portfolio, transaction or investment strategy is suitable for any specific person. This publication may contain news, information, speculation, rumors, opinions and/or commentary. Cup & Handle Macro Research, LLC ("C&H"), is not permitted to offer personalized trading or investment advice to subscribers. C&H is not a broker/dealer, an exchange or a futures commission merchant and is not subject to regulation by the U.S. Securities and Exchange Commission, the U.S. Commodity Futures Trading Commission or any similar regulatory authority in connection with its activities. C&H does not act as an investment adviser or a commodity trading advisor and does not provide any investment advice or commodity trading advice. The information, statements, views and opinions included in this publication are based on sources (both internal and external) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness, including without limitation, any implied warranties of merchantability, fitness for use for a particular purpose, accuracy or non-infringement. Use of any information obtained from or through this publication is entirely at your own risk. C&H does not routinely moderate, screen or edit any third party content. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.

    SUBSCRIBERS SHOULD VERIFY ALL CLAIMS AND DO THEIR OWN RESEARCH BEFORE INVESTING IN ANY INVESTMENTS REFERENCED IN THIS PUBLICATION. INVESTING IN SECURITIES, PRECIOUS METALS, AND OTHER INVESTMENTS, SUCH AS OPTIONS AND FUTURES, IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK. SUBSCRIBERS MAY LOSE MONEY TRADING AND/OR INVESTING IN ANY SUCH INVESTMENTS. ALL USERS OF THIS PUBLICATION ACKNOWLEDGE AND AGREE THAT NO PERSON OR ENTITY INVOLVED IN THE PUBLICATION OF THIS PUBLICATION SHALL HAVE ANY LIABILITY FOR ANY LOSS OR DAMAGES, INCLUDING WITHOUT LIMITATION, CLAIMS FOR LOSS OF MONEY, ERRORS, DEFAMATION OR OTHER EXPENSES, RELATING TO ANY PLACEMENT OF CONTENT IN THIS PUBLICATION, OR ANY RELIANCE ON ANY INFORMATION CONTAINED HEREIN, OR THROUGH ANY LINKS CONTAINED IN THIS PUBLICATION OR THE SITE.

    Employees and/or affiliates of C&H may give advice and take action with respect to clients and/or investments that differs from the information, statements, views and opinions included in this publication. Nothing herein or in the subscription agreement shall limit or restrict the right of employees or affiliates of C&H to perform investment management, advisory or other services for any persons or entities. In addition, nothing herein or in the subscription agreement shall limit or restrict employees or affiliates of C&H from buying, selling or trading securities or other investments for their personal or other related accounts, or for the accounts of their clients. Employees or affiliates of C&H may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. C&H shall have no obligation whatsoever to recommend securities or investments in this publication as a result of its employees' or affiliates' investment activities for their own accounts or for any other accounts.

    This publication is proprietary and intended solely for the use of its subscribers, and is protected by domestic and international copyright laws. No license is granted to any subscriber, except for the subscriber's personal use. No part of this publication or its contents may be copied, downloaded, stored, further transmitted, or otherwise reproduced, transferred, or used, in any form or by any means, except as expressly permitted under the subscription agreement or with the prior written permission of C&H. Any further disclosure or use, distribution, dissemination or copying of this publication, or any portion hereof, is strictly prohibited.

    There is no guarantee that this site will operate in an uninterrupted or error-free manner or is free of viruses or other harmful components. This publication assumes no responsibility for any omission, interruption, deletion, defect, delay in operation or transmission, communications line failure, theft or destruction or unauthorized access to, or alteration hereof. The publication is not responsible for any technical malfunction or other problems of any computer, telephone or other equipment, or software occurring for any reason, including but not limited to, technical problems or traffic congestion on the Internet or at any site or with respect to this publication or combination thereof, including injury or damage to any person's computer, mobile phone, or other hardware or software, related to or resulting from using or downloading any content hereof.

    Mar 23 10:38 AM | Link | Comment!
  • Lonely At The Top - March 17, 2015

    Greetings,

    It's always lonely at the top, especially if you're the United States. These days the US seemingly loses a long-standing ally every week. Most recently the White House admonished Great Britain for its subservient behavior towards China, notably its decision to become a founding member of the $50 billion Asian Infrastructure Investment Bank, which will compete with the Washington-based World Bank and IMF. The reprimand was a rare breach in the "special relationship" that has been the backbone of western foreign policy for decades.

    This comes on the heels of Benjamin Netanyahu's speech to Congress, which highlighted Israel's fall out with Washington. Israel is worried America's potential nuclear agreement with Iran threatens Middle East security. As US and Iranian diplomats made progress on Tehran's nuclear program last week, Saudi Arabia quietly signed its own nuclear-cooperation deal with South Korea. The Saudi's have given America the cold shoulder for several years, but now they're threatening to kick off a nuclear arms race in the world's most volatile region. Germany, Russia and China, accounting for 20% of global GDP, have all had a bone to pick with the US in recent years.

    (click to enlarge)

    However, there's one reason these countries can't stand up to the US in any meaningful way: the US Dollar. USD is the world's reserve currency and there's not even a close second. The US has the world's most powerful military, rule of law and a credible/independent central bank. The idea that the Chinese Renminbi is about to overtake USD as the currency of choice in global trade is crazy. China just announced plans for deposit insurance and floating interest rates last week. In fact, if China were to declare war on America right now, the US's most potent weapon might be the Federal Reserve. A sudden rate hike to 5% would cause a recession in the US, but it could create a revolution in China where jobs are increasingly scarce.

    No country understands America's clout in global finance better than Brazil. Two years ago Edward Snowden exposed American spying on Brazilian companies and politicians. At the time Brazil's President, Dilma Rousseff, cancelled a state-visit and demanded an apology. The apology never came, but now, facing a severe recession, Rouseff is planning a state-visit for this year - where she's expected to come hat-in-hand looking for a trade deal. Money does not equal power, but when it comes to geopolitics the US has both.

    Marketfy upgraded its portfolio system last week, but there were several bugs and I was unable to complete several trades. Meaning: I really don't know what the Cup & Handle Fund's performance was last week. Most of the positions went in my favor, so I expect we made money. I sent out my March investment letter yesterday - if you'd like to start receiving these letters click here.

    Today's letter will cover several topics, including:

    • Swiss Watch
    • Chairlift To The Top
    • Biotech Bubble?
    • Chart of the Week

    As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

    Until next time, tread lightly out there,

    Michael Lingenheld

    Managing Editor - Cup & Handle Macro

    Swiss Watch

    Swiss National Bank (SNB) President Thomas Jordan must feel as though he can't get a break these days. The SNB reports a record $39.3 billion profit in 2014, and the proceeds were distributed to the country's various federal and regional governments. Most of these profits came from foreign currency gains as the SNB defended the floor placed under EUR/CHF, which had been in effect since 2011. Jordan famously ditched the floor in January sending Swiss Francs (CHF) to an all-time high against the Euro. Now, Swiss lawmakers are re-examining the SNB's independence as governments worry about their payments for 2015.

    (click to enlarge)

    What these lawmakers are failing to take into account is that Jordan made a great move dropping the EUR/CHF floor when he did. The announcement was made of January 15, less than a week before the ECB officially outlined its plan to launch a QE program. The ECB only started buying bonds last week, but the EUR is in the midst of a breathtaking decline that keeps accelerating as time goes on.

    Can you imagine the pressure Jordan would be under if the SNB had decided to maintain the floor? They'd be buying hundreds of billions of EUR to weaken a currency that was doing very little to stoke inflation. In other words, Thomas Jordan avoided the fate of Robin Leigh-Pemberton, who presided over the Bank of England when George Soros famously brought the bank to its knees.

    (click to enlarge)

    Having said that, the SNB is still in a very tricky spot. CPI is well below zero and the stronger currency will likely keep prices under pressure for some time. While Switzerland may avoid a deep recession, exporters are struggling mightily. According to a February survey of 2,800 Swiss companies, both export and domestically oriented manufacturers expect to slow down production and cut jobs this year.

    On January 15 the SNB also dropped LIBOR rates to -0.75%. Negative interest rates have actually been very effective in weakening CHF, which is back above parity against the US dollar - and essentially unchanged since the EUR/CHF floor was removed. Thomas Jordan is doing what he can, but it's unclear whether that's enough to save his job or the SNB's independence.

    Chairlift To The Top

    While the East Coast has been pounded with record snowfall and freezing temperatures, ski resorts in the West have struggled. Mt. Baker in Washington State, a resort that regularly scores the world's biggest snowfall each season, has had to close temporarily for lack of snow. This raises concerns for drought-stricken California, which relies on snowpack as a significant supply of fresh water. Despite the tough conditions, shares of Vail Resorts (NYSE:MTN) have been taking the chairlift higher leaving some to wonder if they're overvalued.

    (click to enlarge)

    Last Thursday the company said its earnings rose 95% last quarter, driven by strong season-pass sales and spending on other items like meals, lessons, etc. Management also increased the dividend by 50%. However, there's reason to believe that underlying growth does not support shares trading at 30 times forward earnings.

    For starters, total skier visits declined -0.3% last quarter, and the conditions at mountains in Lake Tahoe were described as "challenging." Vail also must now contend with a dramatically weaker Euro, which makes ski trips to Europe more appealing - especially to East Coasters. The average destination guest to Vail has an annual income of $295,000. A 50% dividend increase is a sign of confidence, but investors should realize that it's a slippery slope for companies with such optimistic valuations.

    Biotech Bubble?

    It's hard to appreciate what's taking place in biotech, because, after all, we're not scientists. The NASDAQ's Biotechnology Index is approaching 3,600 having appreciated more than 500% since the stock market bottomed in 2009. Including dividends, the biotech sector has returned 500% to shareholders since 2011, versus 97% for the NASDAQ's internet stocks. Biotech companies are trading at 10x annual sales, compared to 2.3x for the overall index.

    (click to enlarge)

    A big part of the attraction to the biotech sector is the willingness to go public. While "start-ups" like Uber and Snapchat hoard venture capital before going public, investors looking for access to growth markets have plenty of biotech stocks to choose from. More than 25% of the 275 IPOs launched last year came from biotech. These may be signs of a bubble; it's hard believe that any sector up this much is not overvalued. However, many of these companies are making revolutionary breakthroughs. It was very telling that AbbVie (NYSE:ABBV) paid a 40% premium for its $21 billion acquisition of Pharmacyclics a few weeks ago. Investors are always willing to pay up for growth and this is one of the few sectors providing it at the moment.

    Chart of the Week

    This is the second consecutive week a Bitcoin related chart has been featured in this section, but I think this is an important development. A study from Goldman Sachs reveals that 80% of Bitcoin exchange volume is being conducted in Chinese Yuan (NYSEARCA:CNY), up from 50% at the beginning of this year. Bitcoin has long been seen as a loophole around China's vaunted capital controls, and it's proving to be effective considering the Chinese government banned banks from handling Bitcoin transaction in 2013.

    (click to enlarge)

    If the Politburo wanted to rid deter citizens from using digital currencies there are many options. One option, although it's unlikely to happen anytime soon, would be to open up the capital account and allow fiat currencies to flow freely. Or, alternatively, they could simply raise interest rates. Real deposit rates in China have been negative in 15 of the past 22 years, so there's little to be gained from storing savings in bank deposits. With that being said, China's rapidly slowing economy does not warrant higher interest rates at the moment, meaning Chinese demand for Bitcoin is unlikely to decline anytime soon.

    Reader Question:

    **Editor's note: Every week we'll try to answer at least one reader question. If you would like to submit a question, please send us an email at info@cup-handle.com. We'd love to hear from you! **

    Q: Thoughts on gold here? - RH

    A: It may not seem like it, but I think gold has held up fairly well having declined less than 3% YTD. Especially since the US dollar is up nearly 11% since January 1. Gold priced in Brazilian Real set a new all-time high last week, and it's up on the year relative to Euro's and British Pounds.

    There really hasn't been much interesting news on the gold market of late. Gold bugs got excited in late February by the headlines "Apple buying a third of world's gold to meet demand for iWatch," but those figures are extremely optimistic. While each gold iWatch contains 2 troy ounces of gold (worth $2,500), the $10,000+ price tag and limited battery life should dampen demand forecasts. Apple would need to take a 50% market share in the world's luxury watch market for that headline to be true, and I just don't see it happening.

    That's all, see you next week!

    For any questions or comments, please email us at: info@cup-handle.com

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    Tags: UUP, MTN, CAF
    Mar 16 10:50 AM | Link | Comment!
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