Market Alert - Reducing Allocation to EU Bonds from 50% to 30% & Introducing Allocation to Absolute Return Bonds

Our model portfolio overweight position in EU bonds has worked well this year but the time has come to bank some profits and shorten the duration of the bonds we hold. The end of this multi-decade bull market in bonds is finally coming into view. German 10 year yields have reached 0.89%, while Dutch 10-year yields are trading at 500 year lows. There simply is little room left for yields to fall and therefore limited upside for bond prices. As a result, we are making the first change to our model portfolio in quite some time, introducing a 30% allocation to absolute return bonds. To fund this position, we are reducing our existing bond allocation by 20% and also investing 10% from cash. The model portfolio is now invested 20% equities / 30% 5+ year Eurozone government bonds / 30% absolute return bonds. / 20% gold.

 

German 10 year yields broke below 1% in August for the first time in decades. In the last couple of weeks, yields have started to move higher, particularly in the US, where the Federal Reserve has backed off sharply on their money printing / QE strategy. The Fed has been printing money and buying bonds for years, driving yields sharply lower in the process. Now that QE is ending (for the time being), bond yields have started to rally.

We should expect a similar though less dramatic rise in yields in the Euro zone in the months ahead as global bond markets normalize and government bond yields start to adjust to reflect improved economic growth conditions and the potential threat of rising inflation in future.

 

Market Alert - Japan Cracks

The Japanese stock market cracked on Wednesday, plunging -7% in one session. Money printing is not a risk-free solution to unsustainable government debts and deficits. The Nikkei 225 Index of Japanese stocks rallied over 80% in local currency terms in the space of 6 months and ended in a parabolic upside move that broke down and mini-crashed this week. Accelerations higher (or lower) are typically ending patterns in stock markets.

Nikkei surged 80% higher in 6 months following the Bank of Japan's announcement to start printing money at lite speed.

The JPY/USD currency rate has also had an enormous move, in the opposite direction. The JPY has plunged by over 30% versus the USD over the same 6 month time frame. These are historic moves and a sign of things to come for capital market investors.

The Japanese Yen has plummeted by 30% versus the USD since November 2012.

Japan's gross government debt/GDP is over 230% and rising. Efforts made by the Bank of Japan to create enough inflation (targeting 2% p.a.) in order to reduce the nominal value of the debt they are carrying could have disastrous consequences if Japanese government bond yields rise above the 2% level. Above 2%, the tax revenues collected by the Japanese government would be insufficient to meet the interest payments on Japanese government bonds as they fall due. Yields have spiked from 0.30% to 1.00% over the past six weeks. If this upward trend continues, we may see fireworks across a whole range of global equity and bond markets. In the end, money printing is no panacea for fiscal irresponsibility and creates many more problems than it solves.

Japanese government bond yields have surged from 0.30% to 1.00% in 6 weeks. A rise above 2% bankrupts Japan.

Market Alert - Gold

Record Net Short Position and Record Bearish Sentiment Fuel For Next Rally

The latest Commitment of Traders report shows that the small speculators in the gold market are now all crowding together on the short side of the market. They have now established a record short position against gold. These dramatic events often occur at major trend changes and provide the fuel for major rallies. If gold starts to move higher from here, and I expect that it will, a lot of short sellers will be trapped on the wrong side of the market and we could see fireworks as they all try to unwind at once.

Meanwhile, the 'smart money' commercial traders (the bullion banks), who usually short gold as a hedge against their clients' (mining companies) long positions, have closed almost their entire short position. The commercial traders recognise the gold market has been completely sold out and the next move is likely higher.

 

Gold commercial traders are almost flat now while the small gold speculators have a record net short position in place. 

Public opinion on gold is now at a record bearish extreme.

Market Alert - US Dollar

USD Sentiment Stretched at 77% Bullish Extreme

Public opinion has now reached a bullish level of 77% on the US dollar, coincident with prior peaks in the currency over the last ten years. Any sustained decline in the USD in the coming weeks could provide the necessary fuel to awaken the commodity sector, which has been under constant pressure for the past two years.

Public opinion on the US dollar is reaching a bullish extreme and consistent with prior levels where the dollar topped out.

Market Alert - Precious Metals

The action in the precious metals markets over the last couple of days is suggesting a turn may be just around the corner. On Sunday night, the silver market opened and silver was clocked for -10% in about 5 minutes. Usually when this happens (silver is a small market and can be pushed around by aggressive pit traders) the weakness follows through into the next day's session and the rout typically spreads to the silver miners and across the precious metals sector in general. 

This time however, silver retraced the entire decline and closed +3% on the day and the mining stocks followed suit with across the board gains (Monday 20th May). If this rally sticks over the next few days it could signal that the painful 2+ year correction in the sector is finally at an end. The next leg in the bull market in precious metals could be about to kick off.

The 2-year bear market in silver could be over, which means the next leg of the bull market is about to start and a test of the $50 area is likely.

The 2-year bear market in precious metals is close to ending, which means a challenge of the 2011 all time highs could lie ahead later this year or in 2014.

Market Alert - Precious Metals

The Hulbert Financial Digest recently reported that newsletter writers focused on the precious metals sector are now recommending that investors take a 44% net short position in gold, an all time low. Jason Goepfert at Sentimentrader tracks the data and has posted the following chart this week.

Gold sentiment has reached an all time low

Market Alert - Equities

Newsletter writers are now recommending a 71% net long position in stocks, the highest since 2002

Mark Hulbert of the Hulbert Financial Digest tracks stock market recommendations of multiple newsletter writers. Hulbert recently reported that newsletter writers are now recommending a net long position in stocks of 71%, the highest level since January 2002 and the 10th highest level ever since 1997. 

Hulbert Stock Sentiment approaching highest level since January 2002

Market Alert - Equities

Stock market breadth remains healthy though stretched

The advance/decline line (ADL) is recognised by many investors as an accurate measure of the health of the stock market. The ADL simply measures the number of rising and falling stocks on the NYSE. When the ADL is rising, the majority of stocks on the exchange are in an uptrend; when the ADL is falling, the opposite is true. Usually, the ADL forms a peak ahead of the stock market. As fewer and fewer stocks participate in the rally, the trend in the ADL reverses and starts heading lower, usually weeks or months before the stock market tops out and prices reverse lower. Today, the ADL is making new all time highs suggesting that the strong momentum move higher will continue in the months ahead.

Market Alert - Precious Metals

Investors are betting against the precious metals for first time since 1990

Sentiment levels against the precious metals has reached a historic extreme. Small speculators, for example, are throwing in the towel en masse. For the first time since 1990, small speculators in the futures market are now betting against the precious metals. Small specs have moved from holding a net long position of 85,000  contracts in October 2012 to a net short position today.

Small speculators betting against the precious metals for the first time since 1990.