Bulls, bears and BHP

PORTFOLIO POINT: October is traditionally the month to batten down the hatches but I suspect the rot will set in sooner and last longer, with BHP the weather vane for short-term investment decisions.

The euphoria is over, the bulls did their best and now the bear is back. I said last week that investors should use any rallies to lighten holdings of stocks. I hope you did. I also think that now is time for traders to attack the market from the short side. More on that later.

The jobs number was a shocker; the street was expecting 68 000 but got zero. While this puts even more pressure on Obama to produce something tangible in his much talked about speech on Thursday, although I fear the market will just not listen. Two weeks ago the US dollar was weak and the US banking Index was strong. Last week the reverse was true.

The fact that the US dollar strengthened was significant. I was watching the jobs number on Friday night with great interest. The moment the number came out, I was fearful that as it was so weak, the US dollar may sell off because punters will assume QE3 is now a done deal.

This was not the case. The US dollar index in fact finished on its highs and the S&P500 finished on its lows. The above chart shows that last Wednesday the market tried to rally through 1224 (the 50% retracement level of the recent selloff) but it failed. The counter trend rally has now ended.

US banks were down 7% for the week and were not helped by the headline that Federal Housing Finance Agency (FHFA), which represents Fannie Mae and Freddie Mac, is suing Bank of America, Citigroup, JPMorgan and Barclays over their role in selling residential mortgage-backed securities that led to the 2008-2009 financial meltdown.

How this will end nobody knows, but I have a feeling it won’t end well.

It’s no wonder the Euro lost ground as it’s heading into a very important week. The European Central Bank is set to vote on their cash rate on September 8 and there is a major risk of a dovish tone which would be bullish for the US dollar. There are important developments taking place in Euroland which we all need to be aware of. Several weeks back Prime Minister Silvio Berlusconi announced a sweeping €45 billion package of austerity measures to help Italy stave off a sovereign debt crisis.

But each day since, there have been modifications and changes. Berlusconi is doing what Berlusconi does; he panders to special interest groups and his grip on the crisis is getting away from him.

Now if that wasn’t bad enough, the IMF now opposes European plans to force Greece to put up collateral in its latest bailout. “The use of collateral, a concession to win Finland’s backing for 109 billion euros ($155 billion) of loans pledged by euro leaders in July, would deny the IMF priority creditor status and violate Greek bondholders’ rights, said the people, who declined to be named because the talks are in progress. IMF objections threaten to snag Europe’s crisis-management effort'¦” (Bloomberg)

But wait there is more. IMF chief Christine Lagarde is saying Europe’s banks need urgent recapitalisation and what’s more crucial is Germany must pass a vote in the Bundestag (nation’s parliament) this month to determine whether Germany will give the thumbs up to the latest Greek bailout. The vote has been postponed until September 29.

None of the above is good and it will hang over the market like a bad smell. The stakes are huge; if the bill is not passed by the Bundestag then all bets are off and chaos will reign.

Before I move on to more domestic matters, my Offshore Funding Index remains elevated and remains at year highs. I need to keep highlighting this because we cannot expect this market to rally in any meaningful way until the cost of funds drop. We can also expect the market to fall hard if they rise materially from here.

The chart below of the ThomReuters/Jefferies CRB Index is not only interesting but also has ramifications for the Australian dollar and our local Index (the index consists of 19 commodities and is correlated with the Australian dollar).

As you can see the CRB has risen from its recent low, back up to its 200 day moving average and downward sloping trend line. The 60 day moving average has just crossed below the 200 day moving average which is bearish.

With the USD showing strength last week, commodities should struggle. I think the CRB Index will fail here and if it does it will weigh on the Australian Dollar. While it has cost me a lot of money trying to short it, I am wading in again and will sell the Australian dollar between US106.3c and US107c with a stop above last week’s high (US107.5c).

When it comes to currencies, the Australian Dollar is the poster child of the “risk-on trade”. It has shown astounding strength, particularly when you consider the diabolical state our government is in and the macro economic back drop. I think complacency reigns down under. The Australian Dollar is overvalued and over-loved.

The front page of one of the weekend daily newspapers was titled “What’s wrong with BHP”.

In short they were trying to work out why the BHP share price is trading below $40 when the street believes it’s worth $50. So what is wrong with BHP? All of the above is the answer. BHP is effectively a commodity exchange traded fund and if you believe world growth is just in a soft patch and will return with gusto, you should be buying with your ears pinned back.

If you believe like me that the macro economic back drop looks awful and we are still not close to being out of the woods in Europe then BHP is best left alone for now. Oh by the way, you remember I spoke last week about the ECRI Weekly Leading Index of US economic growth, which happens to have a good record of predicting recessions. For the third week in a row it printed a negative reading; it appears a trend is in place.

Last week I thought that perhaps any real downside in markets would not materialise until October. I have changed my mind. September is shaping up to be full of uncertainty and volatility and the risk is to the downside. This week will be no different. The world will be watching Obama, but he is a one-term President and the Republicans can smell blood.

Anything he says will most likely be dismantled and obstructed. Any rally in risk assets from this speech should be sold.

Investors should sell rallies and be staying defensive; traders (like me) might start buying US dollars in small amounts. I remain long my triple bear fund (TZA) that I purchased in April and will start to dribble some shorts out.

Tom Lovell is a strategist with London-based futures broker ICAP.