Tuesday, 6 April 2010

APRIL 2010 Investment Outlook

What a difference a month makes.  Back in early March, markets had taken a beating from the correction I signalled in December and January, and were just beginning a healthy rebound.

A month on we find that prices and sentiment in many areas have again ballooned to unsustainable extremes.  And so, for investors willing to take a short-term trade, opportunity knocks once more. 

In property, the budget has thrown some scraps to hungry first-time buyers - should they bite?  And as the new tax year begins, we'll see how my recent case for switching into cash and savings has found a mighty ally.




A gradual confluence of technical indicators is suggesting that we are approaching a short-to-medium term peak.  These indicators measure:

  • Investor sentiment, which has become extremely bullish.  Contrary to popular belief, this is a consistently bad sign for share prices going forward

  • Market breadth, which has reached extremes consistent with previous market corrections similar to the one in January

  • Price momentum, which has weakened markedly despite prices inching up

  • Risk appetite among options traders, which has spiked to extremes regularly consistent with corrections

It's possible that, as happened after my alert in December, the market refuses to fall straight away but edges up a little more as the dumbest investors get suckered in.  This will not mean the risk of a correction has lessened - it will mean the risks have heightened.  In other words the ensuing down-leg will likely be more violent when it finally does occur and will probably strike when you least expect it.  Therefore, if you are thinking of investing in stocks in the near future, I would strongly suggest waiting for lower prices.


Whilst I am expecting the stock market to form a long term top in 2010 I still don't think we have quite reached that point.  It seems more likely that, after a period of a few weeks (or perhaps months) in which the market corrects 10% or more, a final high will be reached later in the year.  There is also a chance, though small, that the ultimate peak may not be hit until early 2011.

This means there could well be another opportunity, at the low of the coming pull-back, to invest for another short-to-medium term rally.


Given the environment of heightened risks I've written about in many previous posts and numerous headwinds on the domestic front, I expect the economic situation to deteriorate rapidly later this year and make further progress in stocks impossible.  In fact, when viewed in the long term context of my most recent analysis, the possibility of a major top being formed in the next few months is high.  As the S&P500 index flirts with the 1200 level and the Dow with 11,000, investors with current positions should be well rewarded by lightening up markedly, or buying protection through options and hedging strategies. 



  • An extremely significant move has been stealthily taking shape in US government bonds.  And when I say shape, this is what I'm talking about:

This is what chart watchers call a 'reverse head and shoulders' pattern, and it's carving itself out in the big daddy of world bond markets, the US 10 year treasury note. 

Like a bat hanging upside-down, it features a left and right 'shoulder' with a lower 'head' in the middle, and a 'neckline' running across the top of the formation.  It is, of all technical patterns that chartists watch for, the most consistently reliable: studies suggest a success rate of over 70%. 

What it normally leads to is a break out of prices above the neckline, followed by a move higher which is equal to the distance between the neckline and the bottom of the head.  Prices have, in the last two weeks, broken out above the neckline and confirmed the pattern.

In this case what we are now looking at is a 70% or higher probability of a rise in US 10 year bond yields from just below 4% to approximately 6%.  If you are a long bond holder (ie. 10 years+, though all but the shortest-term bonds will also be hit), such a move would lead to a very significant fall in the value of your bonds.

The reasons for this are varied, but it partly reflects a fear among investors of inflation, of an end to the easy money policy of the Fed and of US sovereign debt risk.  A continued edging up of rates over 4% would be a potentially critical development, for these reasons:

  1. The costs of borrowing across the board would rise, including the cost of refinancing business loans, $$hundreds of billions of which are due in the next several years, creating more bankruptcies and another step higher in unemployment
  2. US mortgage and refinancing costs would rise, crippling the housing market yet again and leading to another leg down for prices and for banks who still have those toxic loans on their books
  3. It would affect world bond prices as the effect ripples through the system, raising the cost of borrowing globally
  4. It would increase the cost to the US government of servicing their debt, enforcing an unwelcome tightening of fiscal policy and a potential raising of taxes
  5. The risks of a chain reaction involving UK and European sovereign debt crises and the so-called China Syndrome, mentioned in my February post, would come much closer.

Take another good look at that chart: because unless US bond yields fall back below approximately 3.7% in the near future - and stay there - it's highly likely you're looking at the source of the next big crash in the world economy. 

  • If rates do rise, it is likely to be a slow process initially, which then accelerates as bond investors wake to the dangers and stampede for the exits.  If your portfolio or pension is invested in longer-term government bonds, please refer to the section entitled 'Ring of Fire' here and I'd also point you toward this newsletter and others in his archive by Bill Gross, CEO of Pimco, the world's largest bond fund. 

  • Corporate bonds are highly correlated with Treasuries and would certainly sell-off in sympathy with government bonds.

  • You still have time to reallocate into safer instruments ie. short-term bonds (3m - 1yr) in the least indebted economies, or into cash.



  • Nevertheless, prices overall edged up in March according to Nationwide (consistently the most optimistic survey)

  • In the Budget, Alistair Darling made it a couple of grand less expensive to buy a place for under £250,000.  Respected and prescient independent property analyst Henry Pryor says: 'don't be fooled'.

  • Darling ratcheted up the cost of buying a property over £1m (but not until next year, sparking a potential rush to buy high-priced homes in the interim). 

  • In the US, there are growing signs that homeowners who are underwater (25%+ are now in negative equity) will increasingly choose to abandon ship

  • Finally, a reminder of my thoughts from the conclusion of last month's benchmark OntheMoney post: the markets will signal, within a year or two at most, whether this recovery in housing and the economy is sustainable or not.  There may be a major downdraft ahead: if you don't have to buy now...wait.



  • For those who didn't catch last month's special section on savings, here (under the section 'Why cash will soon be king once more') is the key insight: if more than eighty years of data can be trusted, investing in high-interest cash deposits over the next two years will almost certainly beat share price returns and with virtually zero risk.

  • Top AAA-rated UK fund manager Philip Gibbs makes a dramatic and highly unusual switch out of stocks, into cash.  Why should we care?  He was one of the very few who went to cash when he saw it all coming in 2008

  • The state-owned banks are so desperate they're now pickpocketing their owners' tax-free accounts.  If you've got one of them, get off your arse and find a better deal!



  • General interest rate conditions for gold, however, are supportive as US inflation-adjusted T-bill yields remain negative

  • Major move imminent in Chinese market, signalling a breakout - or breakdown - for commodities:

Strong manufacturing figures just released in China have prompted a jump in the Shanghai stock market after eight months of consolidation. 

This type of pattern normally sees a breakout to the upside - and if that happens it's likely to lift oil, copper and industrial metals along with markets like Brazil which supply them. 

But I'd wait for a clear and unambiguous break up - plus a break in the commodities index up through its 200-week average - before buying what would be a big move higher.  Because if the Chinese market breaks down instead, look out below...


That's all folks.  The UK election is a real wild card and could open up some juicy opportunities in the weeks and months ahead; meantime we watch, wait and vote.  Outlook returns with its razor-edged verdict on Sunday May 9th... 

Meanwhile don't miss my UK election OntheMoney special posted below, or here.  Have a great month!