Corn is just the latest in a long stream of food (and other) commodities that have spiked recently as result of the unprecedented liquidity transfusion given the global economy in recent years. Simply put, when the money spigots opened, the results are, well revolutionary.
It's the emerging markets that are taking the brunt of the recent price trauma, and their markets, as a group, have reacted accordingly.
On average, emerging markets have moved sideways for the last three months, and in the worst cases, they've outright tanked. India and China, for example, are down 21% and 10% respectively since early November, and Brazil is off 12%, with much of the weakness in that country coming in just the last few days.
It's a puzzling thing.
On our side of the pond, the Dow and other broad market indices have been trucking higher with barely a pause since September.
Hmmm
Yes, the U.S. is exporting inflation (as are all countries who've resorted to currency devaluation as a medicine for the debt cancer). But as the chart below shows, maybe it's also just par for the course.
The chart depicts the Chinese, Indian and Brazilian Markets, three of the four BRIC nations (we deliberately omitted the Russian market as it's more or less a pure play on oil) cast against the Dow Jones Industrials. As you'll see, these emerging markets have been the proverbial canary in the global stock mine, trending higher and lower anywhere between one and six months before the Dow reversed and followed their lead.
At this point, each of the three EMs (top three lines on chart) have been in decline for three months, leading us to wonder when (if?) the Dow (bottom line) will follow suit.
But must Emerging Markets Always Lead?
Consider: today's global growth story is simply not being driven by the U.S., where best estimates are for 4% GDP gains for 2011. Nor will it come from Europe, where the continent's peripheral porcine problem portends a paucity of profitable prospects for a protracted period. (Sorry, couldn't resist.) As for Japan, any expansion there will likely also be limited.
Simply put, the engine of growth has to be the emerging markets, as it has been for over a decade. Yet in a growing number of EM nations we see:
- nascent inflationary sizzlings,
- rising interest rates,
- high flying food and energy prices, and
- growing labor and agricultural constraints,
All of which are putting strong pressure on growth.
The question of whether Emerging Market central banks will be able to tame the inflation monster without choking off growth altogether is the fundamental issue facing the global economy in 2011.
Or will the monster rise?
Either way, it shouldn't make a difference to commodity investors and those who trade in commodity-based currencies like the Australian and Canadian dollars. We expect that under best case scenarios (i.e., EM central banks engineer soft landings), commodities will drop and those two currencies will also come under pressure against the U.S. dollar. Any C$ or Aussie longs out there might want to consider repatriating into BuckNANKES in the near future.
Vujà Dé All Over Again
It appears investors are starting to catch on to the EM danger. Last week, for example, $7 billion was pulled from Emerging Market funds, the biggest such withdrawal in three years. Whether the worst has already been discounted on that front remains to be seen.
As far as figuring if the second U.S. equity shoe is also about to drop, consider the following:
1) Investor sentiment has now reached levels not seen since the fall of 2007, prior to the Lehman Bros. meltdown.
2) Insider sell vs. insider buy ratios are also at fall 2007 peak levels.
3) Money market fund assets have also returned to their paltry 2007 levels.
4) Mutual fund cash levels are now sitting at all-time lows.
Here's a long term chart of the Mutual Fund cash vs. the S&P:
Mutual Fund cash levels are likely the most important indicator of the bunch, because of the sheer quantity of resources they put into play. At current levels, we can assume that mutual funds have pretty much bought what they're going to buy. The remainder of their funds will likely be kept on hand to deal with redemptions.
Buck Up Against This, Pal
All that notwithstanding, we're not complacent regarding our bearish call. There are those who see what we see and are still bulls.
Jeremy Grantham is one of them. As one of Wall Street's more reasonable voices and the manager of over $100 billion in assets, Grantham has weathered the vicissitudes of the market (and the winters of Boston) for 40-odd years now. His longevity in the business speaks directly to his wisdom.
In Grantham's latest message to investors he offers the following shocker:
· Fair value for the S&P 500 is about 900 (30% lower than its current level).
· Despite that, it's likely that stocks will continue to rise, given zero interest rates and the current third year of the presidential cycle, in which governments do everything they can to get re-elected.
· When rates start to rise, says Grantham, the market will tank – likely in October.
We agree with the man that last fall's run was exaggerated. Unlike him, though, we just can't bring ourselves to be outright longs at this stage.
But if we are, indeed, at a 'risk-on' phase of the current rally, then it makes sense that the NASDAQ should continue to outperform the more staid (and relatively value-laden) Dow Industrials.
Two years' daily action shows investors' preference for the risky over the reliable:
Since the major bottom in March of 2009, the NASDAQ has outperformed the industrials by 30%.
Our trade is a zero premium spread. We're buying the February QQQQ 59 CALLS for $0.19 and selling the February DIA 123.75 CALLS, also trading for $0.19. Both options are currently 2% out-of-the-money.
If we continue to melt up, the NASDAQ should outperform.
Wall Street Elite recommends buying February QQQQ 59 CALLS for $0.19 and selling February DIA 123.75 CALLS in equal numbers. Both trading now at $0.19.
With kind regards,
Hugh L. O'Haynew,
Analyst, Oakshire Financial
