The German DAX Longer term view

So the German DAX had an amazing year so far rising up in an euphoria move in 2015. However on the longer term basis there are things I see which makes me very nervous about the European markets , just as the US markets.

1. As I see it , cycle wise we might be close to a major top , not just a small one.

2. The sentiment for many months now on the DAX has been that we can only see small corrections before going higher , nobody really expects any further sell off other than a small bump before we go higher. (So sentiment is bullish)

3. Also we have margin debt at highest level which is usually a bearish signal if we look at it longer term , people borrowing like never before to speculate in mkts – not safe imo for longer term players.

4. We got clearly 5 waves up from the lows on DAX too , arguing for possible 12-13.000 on DAX being a bull market top (very possible) if its going higher I dont see us go much higher than here.

5. We are entering the worst 6 months statistical and this could also bode more trouble for mkts as the USA has not been going up much in the first best 6 months.

This could VERY possible be a TRANSITION from bull / to bear , people who are not patient saying why we do not crash here and now , well sometimes it takes TIME , and MONTHS before we start the real sell off. I think especially US mkts had a lot of trouble in the past 6 months when going higher with Europe.

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And I thought New York real estate prices were crazy…………..

Breadth: I have discussed the importance of the advance-decline line many times before . The simple fact is breadth remains positive. Lowry Research Corp., a technical market-research service, observed that several of its advance-decline indicators “are all confirming the April market highs.” From my perspective, I find it extremely helpful to be able to put this into context for those who have a low tolerance for volatility. It also is nice to know where we might be from a cyclical perspective. If you are a long-term asset allocator, willing to ride the ups and downs of volatility, this probably doesn’t mean very much to you. But if you are a trader, this may well mean that there more gains to be had.

Employment:  It is a very noisy number and subject to significant revisions. The broad trend is what matters much more than any single month’s data. Was the weak showing for March a one-off, or was it the beginning of a new, deteriorating trend? We won’t be certain for a while, but Friday’s numbers didn’t suggest a weakening employment pattern. Unemployment fell 0.1 percent to 5.4 percent and wages rose slightly (0.1 percent). The data also show that long-term unemployment — those people who are unemployed for more than 27 weeks — continues to head lower. It is now 29 percent of total unemployment, down from 45.5 percent in April 2010. This, along with little increase in wages, has been the most stubborn negative about nonfarm payrolls.

Gross Domestic Product: Your view of growth is highly dependent on your frame of reference. If you use the post-World War II recession recoveries as your data set, then this recovery is stubbornly slow, with mediocre job creation and weak wage gains. However, compared with other post-financial-crisis recoveries, this one is a little better than average.

Retail Sales: Modest wage growth has translated into modest retail sales gains. Low gasoline prices help, but they only go so far. It is noteworthy that sales remain highly dependent upon credit availability. Where credit is easy, sales are strong; where it’s tight — such as in mortgages — they are much softer. Credit has been readily available for automobile purchases. Not surprisingly, car sales have been robust. Cheaper gas helps demand for more-profitable SUVs and pickup trucks, which are now 54 percent of all auto sales. It doesn’t hurt that gasoline still costs about $1 a gallon less than it did a year ago.

Cars are selling at a seasonally adjusted annual rate of 16.5 million compared with about 9 million in early 2009 during the financial crisis. Give credit to, well, easier credit for auto buyers.

Psychology: It’s a bubble, it’s going to end badly, the NFP is a fraud, it’s all driven by the Federal Reserve’s irresponsible easy money policy, blah blah blah. My only comment is that I can’t find a single bubble that ended with so much blather about a bubble about to end. If the crowd is right about a bubble, it might be the very first time the herd identified a bubble in real time.

Valuations: Speaking of which…Fed Chairwoman Janet Yellen surprised markets with a 1996-like “irrational exuberance” comment. Of all the many things I don’t care about, the Fed chief’s perspective on equity valuation tops the list. I don’t believe the Fed understands equity pricing or the wealth effect, and it hasn’t proven especially prescient when it comes to forecasting (though Yellen seems to be better at it than most Federal Open Market Committee members).

Let me point out that the infamous irrational exuberance speech by former Fed chief Alan Greenspan was 3 1/2 years ahead of the bursting of the dot-com bubble. If you or your clients were content to not participate in the 1996-2000 bull market, then you probably can afford to sit out whatever move 2015–2019 has in store for us.

Bond Yields: Yellen’s comments are likely more significant for bonds than they are for equities. The Fed’s zero-interest rate policy is going to end eventually, likely sooner than later. Whether that means it is this September or in January is almost irrelevant. Unless the data changes significantly, we are now in the seventh or eighth inning of low yields. Please close your trays and put your seat in the full upright position for landing.

The reason for looking at these items? They all flow through to investor sentiment. Psychology drives retail and capital expenditure decisions; changes affect corporate revenue and profits; and these elements ultimately drive stock prices.

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The market loves to fool the most amount of people……………

Crowded trades get unwound and popular bets get taken to the woodshed. The story you’ve told yourself has been told so many times that there is no one on the other side. “Oil is dead money at best” and “The euro is headed to parity and beyond with the dollar” and “biotech is where all the earnings growth is” were great stories. They made perfect sense. They still might. But everyone knew these stories and had placed their bets accordingly.

The Wall Street Journal this morning, on what happened in April:

The euro strengthened 4.5% against the dollar in April after tumbling 11% in the first quarter.The U.S. benchmark crude-oil price soared 25% after declining 11% in the first three months of the year. The Nasdaq Biotechnology Index fell 2.8% in April after jumping 13% in the first quarter. Yields on German government bonds bounced higher after nearing zero last week.

25 cents of every dollar that went into an ETF in the first quarter had gone into a foreign equity ETF that was currency-hedged. Analysts spent the first quarter slashing their targets for crude oil in half. Biotechs became 35% of the health care sector and almost 20% of the Nasdaq index. Everyone was in.

And then the fever broke.

Narratives don’t tell you when a trade is maxed out. Guesses might. Technicals may act as a guide. But it’s never easy.

The hard part is not figuring out what the most crowded trades are or knowing which stories are being most heavily bet upon. It’s knowing when ideas have been taken too far or something else has happened which will change things. And then getting the timing right.

Most people can’t do it every time. They nail some and then miss the others. You’ll only hear about cases of the former when you talk to them.

Try to keep that in mind.

Just when you think you have it figured out…it becomes really obvious to everyone else and then everything flips.

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ECB policy too loose if no “Grexit”

In its October 2014 World Economic Outlook (WEO), the IMF downgraded its Eurozone growth forecast and warned of a 38% risk of a recession. Its pessimism was representative of the consensus at the time but was viewed here as groundless, because monetary trends were signalling an improving economic outlook.

In its latest WEO, the IMF raised its 2015 GDP growth forecast to 1.5%. Its estimate of recession risk, however, remains high, at 25% between the second and fourth quarters of 2015. This assessment, on the face of it, is inconsistent with current positive economic and monetary trends.

A likely explanation is that the IMF expects a Greek default and / or EMU exit and views this as a significant risk to the emerging economic upswing.

Concern about a negative shock from “Grexit” probably played a key role in the ECB’s decision to launch QE. The ECB’s economists monitor monetary trends closely and will have recognised the signal of improving prospects in late 2014. The sharp fall in inflation, meanwhile, was clearly due to external commodity price weakness, with the “core” rate – excluding energy, food, alcohol and tobacco – remaining stable. This suggests that ECB President Draghi’s claim of heightened deflation risk, promulgated by useful idiots in the media, was a smokescreen to push through QE, the main purpose of which was to protect other peripheral bond markets from contagion from a Greek default / exit.

The IMF / ECB concerns about the threat posed by a Greek crisis cannot be dismissed. Major defaults are often a harbinger of a sustained deterioration in financial and economic conditions. Such defaults, however, are usually the result of increased borrower stress due to a tightening of liquidity conditions rather than a voluntary decision to repudiate debt.

Current ECB policy is calibrated to deal with a possible financial crisis and is excessively accommodative relative to current economic and monetary trends. If “Grexit” is avoided or its fall-out contained, Mr Draghi’s dismissal of QE tapering is likely to prove “premature”

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Setting a stop loss

You may have heard that when setting a stop loss you should allow more room for volatile price action; you should widen your stops on the basis of the volatility of the underlying stock. I strongly disagree.

Most often, high volatility is experienced during a tough market environment. During difficult periods, your gains will be smaller than normal and your percentage of profitable trades (your batting average) will definitely be lower than usual, and so your losses must be cut shorter to compensate.

It would be fair to assume that in difficult trading periods your batting average is likely to fall below 50 percent.

Once your batting average drops below 50 percent, increasing your risk proportionately to compensate for a higher expected gain based on higher volatility will eventually cause you to hit negative expectancy; the more your batting average drops, the sooner negative expectancy will be achieved.

At a 40 percent batting average your optimal gain/loss ratio is 20 percent/10 percent; at this ratio your return on investment (ROI) over 10 trades is 10.2 percent. Interestingly, expected return rises from left to right and peaks at this ratio. Thereafter, with increasing losses in proportion to your gains, the return actually declines.

Armed with this knowledge, you can understand which ratio at a particular batting average will yield the best expected return. This illustrates the power of finding the optimal ratio. Any less and you make less money; however, any more and you also make less money.

If your winning trades were to more than double from 20 percent to 42 percent and you maintained a 2:1 gain/loss ratio by cutting your losses at 21percent instead of 10 percent, you would actually lose money. You’re still maintaining the same ratio, so how could you be losing?

This is the dangerous nature of losses; they work geometrically against you. At a 50 percent batting average, if you made 100 percent on your winners and lost 50 percent on your losers, you would do nothing but breakeven; you would make more money taking profits at 4 percent and cutting your losses at 2 percent.

Not surprisingly, as your batting average drops, it gets much worse. At a 30 percent batting average, profiting 100 percent on your winners and giving back 50 percent on your losers, you would have a whopping 93 percent loss in just 10 trades.

If the optimal result is achieved by having a 48 percent/24 percent win/loss ratio at a 50 percent batting average, what do you think happens when your percentage of profitable trades drops to only 40 percent? The following figure may surprise you by showing that the optimal level (gain vs. loss) drops to 20 percent/10 percent respectfully.

If you’re trading poorly and your batting average is dropping off below the 50% level, the last thing you want to do is increase the room you give your stocks on the downside. This is not an opinion; it’s a mathematical fact.

Many investors give their losing positions more freedom to inflict deeper losses. Their results begin to slip, and they get knocked out of a handful of trades; then they watch the stocks they sold at a loss turn around and go back up. What do they say to themselves? “Maybe I should have given the stock more room to fluctuate; I’d still be in it.” This is just the opposite of what you should do.

In a difficult market environment, profits will be smaller than normal and losses will be larger; downside gaps will be more common, and you will most likely experience greater slippage. The smart way to handle this is to do the following:

• Tighten up stop losses. If you normally cut losses at 7 to 8 percent, cut them at 5 to 6 percent.

• Settle for smaller profits. If you normally take profits of 15 to 20 percent on average, take profits at 10 to12 percent.

• If you’re trading with the use of leverage, get off margin immediately.

• Reduce your exposure with regard to your position sizes as well as your overall capital commitment.

• Once you see your batting average and risk/reward profile improve, you can start to extend your parameters gradually back to normal levels.

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Why have stock-picking fund managers had it so tough over the last few years?

Why have stock-picking fund managers had it so tough over the last few years? A lot of people would say high correlation in the stock market, but that’s only part of the story. According to Goldman Sachs strategists, the real culprit is low dispersion.  Dispersion is a measurement of how stocks act in relation to each other, not just to the overall market.

A high-dispersion environment is where a large number of stocks are zigging and zagging drastically. This means that returns and risk factors are all over the map, which, in theory, would allow skilled stock-pickers to greatly differentiate themselves. In a low-dispersion environment, which is what Goldman expects to continue throughout 2015, it’s harder to select stocks that will move meaningfully based on individual company micro-drivers (fundamental changes, news, etc).

The two charts below show how the stock-pickers struggle when dispersion is low and alpha grows scarce:

Screen Shot 2015-03-31 at 8.48.33 AM

You’ve also likely noticed that funds have trouble outperforming during bull markets generally.Strategist David Kostin & Co ran an analysis that measured the S&P 500 stocks for dispersion potential and the tendency to move independently.

They find that the stocks with the potential for high dispersion are most likely to fall into either the information technology or consumer discretionary sectors. This makes intuitive sense – consumer disc companies see radical changes in stock price as a result of the capricious preferences of shoppers while in technology, individual-company innovation is the big driver. Energy, materials and staples – with largely commoditized products to sell – tend to see the lowest amount of dispersion among their stocks.

GS emphasizes that picking stocks with high-dispersion tendencies will be the key to outperformance this year, long or short. The best hunting grounds are in the retailers, techs, biotechs and luxury brands.

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Two ways to manage negative rates

Some believed that the race towards monetary easing had reached its climax with quantitative easing (QE) and the zero interest-rate policy. Yet against all odds, a further stage occurred with the introduction of negative interest rates in the eurozone, Denmark, Sweden and Switzerland.

In the process, the yield to maturity of sovereign and corporate bonds has also fallen below zero. In mid-February, some 8% of the bonds in the Bloomberg fixed-income universe, or $7.2trn of debt outstanding on a total of nearly $89trn, stood on a negative yield to maturity. For euro-denominated paper, the proportion of such bonds reached 19%, for Danish kroner 51%, for Swedish kronor one-third and for Swiss francs no less than 43%.

This situation is historically unprecedented. It raises many questions and unknowns about the medium-term effects on the financial system, including pension funds. And some very difficult dilemmas arise for holders of cash as much as for diversified investors.

Holders of liquidity in these currencies may be tempted to hold banknotes rather than cash balances. However, holding banknotes is by no means cost- or risk-free, especially as regards tax. Notes must be stored in a safe place and are never totally secure from loss, theft or destruction, for example in case of fire. Moreover, governments can tax banknotes, for example by establishing a system of paid stamps to be affixed to notes to extend their validity, as advocated in the United States in 1933 by the US economist Irving Fisher. However, one can reasonably rely on the fact that the ability of the public to hold various forms of cash or alternative currencies still constrains the ability of central banks to lower interest rates below zero.

For investors, the predicament presents new choices.The cost of making an allocation to defensive assets in terms of lower expected returns from a diversified portfolio is an extreme deterrent, especially after tax. On the other hand, equity markets are not cheap historically, and their value may fluctuate significantly in the short term as we were brutally reminded in 2002 and 2008. This poses a difficult dilemma for the investor: to choose between a small certain loss and a hypothetical gain or loss.

Faced with this situation, we see at least two paths to consider. First, diversification into true alternative strategies of the market-neutral type seems very attractive at this point, given the current structure of bond yields. We reflect this in our portfolios through an allocation to this investment style. Second, from a portfolio invested 100% in equities, one can create the risk profile of a balanced portfolio by employing a simple dynamic hedging strategy for part of the market risk.

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DUMBO. Draghi’s Unrealistic Monetary Bond Operations

Mario Draghi’s PSPP is just barely off the ground and we’re already beginning to get answers to some of the tough questions the ECB faced regarding the program’s implementation. For instance, we wondered how the central bank intended to treat the losses it was bound to incur as a result of purchasing billions in EMU debt carrying a negative yield. The answer: try to avoid that paper for the time being. Another issue raised here (and elsewhere) revolves around the ECB’s ability to source willing EGB sellers. EMU banks — which hold some 20% of PSPP-eligible paper — are the most likely participants according to Goldman:

Our view remains that the main sellers of EMU bonds to the ECB will be the commercial banks. These institutions, which in the major EMU countries own about one-fifth of the stock of government bonds outstanding, tent to care more about their intermediation margins rather than about beating a hurdle rate they have promised policy holders. Furthermore, they will face regulatory pressures to reduce the concentration of risk towards the sovereign in the country of residence. Over time, their allocation to government bonds should converge to the ECB’s portfolio composition – roughly corresponding to the GDP weights of EMU constituents.

Nevertheless, sourcing €1.1 trillion in purchasable assets isn’t easy, especially when sellers have limited options for where to park their proceeds (pay the ECB 20bps or reinvest at rock-bottom yields). Here’s Nomura via Bloomberg:

Because new bond supply “is not enough to fulfill the ECB’s targets, a substantial portion of the €1 trillion [the ECB] intends to buy over 2 years will need to come from a reduction in current investor holdings.Overall we see €25-50 billion coming directly from euro-area investors seeking higher yields abroad while the lion’s share call it €125-150 billion will come from foreign sellers.

Of course, as Goldman notes, it’s “hard to tell” what price non-euro area holders will charge, meaning the ECB may well have to pay even more of a premium than they already plan to pay, putting their balance sheet in an even more precarious state.

This is compounded by the fact that thanks to central bank largesse, high quality collateral is becoming more scarce by the day:

How much depth has the market lost? A year ago, you could trade about $280 million of Treasuries without causing prices to move, according to JPMorgan Chase & Co. Now, it’s $80 million.

But as it turns out, Mario Draghi may have a solution to the supply issue: buy “small” amounts.

Via Bloomberg:

  • Rates trader in London says Eurosystem is purchasing bonds in trades of EU25m-EU50m.
  • Another trader in London says QE purchases of EU15m- EU25m are going through.
  • NCBs are buying govt bonds in “small clips,” Sunrise Brokers strategist Gianluca Ziglio says in e-mailed comments, citing market contacts.

Needless to say, if the ECB is unable to meet its monthly asset purchase targets (which, at €15-50 million dribs and drabs, looks likely), expect chaos, as the market has spent the last several months front running PSPP and would be absolutely horrified if DOMO (Draghi-open-market-operations) has to be downsized. Not to worry though, says Soc Gen’s European rates strategy chief Ciaran O’Hagan:

Via Bloomberg:

“…the amount bought may be small to start with, but this will be like a pressure cooker. They’ve just switched on the heat and we will need some time for the pressure to mount.”

*  *  *

For reference, below is a list of EMU sovereign bonds that were eligible for purchase just before Draghi unveiled the details of DOMO (note that Citi thought to create a list of 2- to 30-year EGBs yielding -0.20 and above a week before the details of the program were announced).

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Why Trading is Like a Triathlon

Trading is a three-dimensional competition that requires the management of three continuous, simultaneous, endurance disciplines. While a variety of trading methodologies and systems exist, profitable trading involves management of the trader’s psychology, attention to risk control, and dedication to trading a robust system over an extended time period.

Many traders make the mistake of thinking that simply knowing the right methodology will guarantee their success. In actuality, it is a three event marathon consisting of more than just entries; psychology and risk management have much more influence over longterm success. Entries have no meaning without the right exits, and no system is a winning system without the discipline to follow it.

Here are the three events in the trading race:

A trader’s psychology has to be one of confidence in order to trade it with discipline. Confidence comes from doing homework, back testing, chart studies, and experience. A trader has to trade position sizes that turn down the volume on their emotions. They must have the mental discipline to follow the plan that they carefully crafted when the market was closed, when the market is open. When a trader drifts into greed, fear, and ego, they will likely wreck on the rocks of reality. A successful trader needs the psychology of an entrepreneur, cultivating the fortitude to get through the small losses so they can make it to the big wins.

A trader’s risk management will determine their short term and long term success. Trade too big and the trader will give back all past profits with just a few losing trades. Trading huge position sizes insures that a trader will eventually give their whole trading account away to disciplined risk managers. If risk is not managed, no trading method will lead to profitability because some string of losses will eventually be too much to bear.

A trader’s methodology should be robust enough to have an edge over the markets and other traders. High probability entries and set ups based on historical price action is a good place to start. Planned exits to lock in profitable trades when right, and knowing where to get out if proven wrong, is critical to success. A good trading methodology is trading with a plan that defines entries, exits, and position sizing. Implementing a strong methodology increases the likelihood that a trader’s overall wins will exceed their overall losses within the timeframe for expected profitability.

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These ETFs are telling you the economy’s in trouble

When the U.S. dollar is strong, commodity prices drop since they’re priced in dollars.

But recent commodity price declines are excessive. The dollar DXY as measured by the PowerShares DB US Dollar Index Bullish Fund UUP has surged, but not nearly as much as commodity prices have fallen. These commodity drops indicate a serious decline in demand, which in turn has translated to weak global GDP growth.This decline is already evident, as recessions are visible in many developed markets (Europe) and also emerging markets.

Normally under such conditions, recession and deflation are in the cards.

The only thing protecting markets from a severe recession has been central bank money printing. But as the charts show it’s done nothing to raise commodity prices or inflation, which central banks argue is the primary purpose of QE policies. The ECB now has taken the QE baton from the Fed with the stated goal of increasing inflation. It won’t work to defeat deflation but may lift stocks prices for a time. Seeing yields at these low levels for a debt instrument with this much duration should communicate fears of deflation or recession to investors. Perhaps this is just a new era where central banks are now in full control. But let’s face it, prices for oil and other energy markets are down nearly 60% more or less from routine highs in the summer of 2013. The Saudis may be responsible for the deliberate waterfall decline in crude oil prices to defeat North American production, but collapse in demand reflecting global GDP weakness can’t be discounted.

Copper prices are another area of concern regarding economic growth. For many years the commodity has been referred to as Dr. Copper, since many believe it has a PhD in economic forecasting. Now it’s declined 40% over the past two years.

The primary agriculture ETF, PowerShares DB Agriculture Fund DBA displays a variety of products showing deflationary tendencies and has declined 30%.

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