Alpesh B Patel

Hedge funds are making a big bet that commodity prices will rise. This is revealed by the US commodity futures index. Sugar and Corn are the biggest bets and the largest bets for falls are in copper and natural gas. But bewarned – oil options show a bet that oil will fall in the next 6 weeks to $50. BP and Shell would suffer, BA would benefit.

If oil rises, so will stocks.

The graph above shows the spread between the Sensex, – the Indian benchmark index, which soared this year, versus the Dow. The spread or differential between the two has rarely been wider. If we short the Sensex and go long the Dow, we should see a profitable trade. The ratio is 1.6 Dow to each Sensex.

The monthly Nifty chart shows the Nifty approaching an inflection point (the MACD) approaching its signal line. The buy signal would probably be with a break to 4000.

The weekly chart above with the stochastic declining suggests that there will be a retracement of recent gains. I would say to about 3,200.

With the longer term trend likely to be up the riskier trade is to go long at 3,200 and the safer option to go long at 4,000.

GDP – off a cliff!

Debt to GDP for the UK does not look horrendous.

“Another way of approaching the model is to use the current equity prices to infer the equity risk premium (ERP).  Using the current risk-free rate, long-term GDP growth, and a S&P 500 index value of 852, the implied equity risk premium is 6.6%. This is undoubtedly very attractive compared to the average historic return from equities (3.8% according to the 2009 edition of the Barclays Capital Equity Gilt study) and implies huge upside to current prices.

However, a very different picture emerges if the same methodology is applied, but the assumptions are changed to reflect with a 7% risk-free rate and long term compound earnings growth. In this instance the ERP falls to 3.35, substantially below the long-term average, which would imply that stocks are considerably over valued.”

“We know this by taking the FTSE 100’s earnings yield (earnings per share divided by the share price) and comparing it with the yield (what you get as a dividend) on 10 year government bonds. The rationale holds that investing in the stock market becomes more attractive when the yield on stocks is higher than the yields that investors can gain on risk-free government bonds. Interesting theory… when the payout on a stock is worth the risk of potentially losing your capital, investors switch from the safety of a bond and into the opportunity of a stock. The Fed model sent a clear Sell signal on European equities in June and July 2007, well before the market finally cracked. Of course, the Fed model’s most famous calls were in the 1987 and 2001 market crashes. Both times this model called the top of the market according to data from ING Research. Currently, the Fed model is very bullish for stocks. In fact, it is at record levels. With the forecast earnings yield on the FTSE 100 at 10.1% and the current yield on 10 year government bonds a lowly 3.6%, the risk premium is now a mammoth 7.1%. This is much greater than the long-term average, according to data provided by Citigroup, of 4.5%.”

The Interbank Spread Measure – ie are banks willing to lend?

“The interbank premium to borrow three-month euro funds over anticipated policy rates as measured by Overnight Index Swaps (OIS) fell to 66 basis points on Thursday, the lowest since just after Lehman Brothers collapsed in mid-September last year.

It costs 2.25 percent to borrow overnight funds from the ECB and banks only receive 0.25 percent interest from depositing cash overnight at the central bank, making banks think twice before simply hoarding liquidity provided by the ECB

The two-year U.S. interest rate swap spread, a key measure of broader banking and financial market stress, narrowed by around two basis points to 54 basis points. That's within a few basis points of its lowest level since the global financial crisis errupted in August 2007

This past week: The lowest-ever setting for the benchmark London Interbank Offered Rate, or Libor.

Eurodollar futures are tied to expectations for movement in the three-month dollar-denominated Libor, which also serves as a guide for floating rate lending worldwide.  The cash Libor fixing was at a record low of 1.0725% on Friday. Libor has moved lower for 19 straight days, suggesting banks are less reluctant to loan money to other financial institutions.

Still, the three-month dollar Libor is abnormally high when compared with the overnight effective U.S. federal funds rate, which was at 0.17% Thursday night. Before the credit crunch intensified in the summer of 2007, the three-month dollar Libor was typically about 10 to 15 basis points above the funds rate. Thursday night, the spread was at about 90 basis points, or 9/10ths of a percentage point. The wide spread is emblematic of continued concern about the health of the banking sector”

Source: Citigroup

Where are we? Phase 2. Earnings are bottoming, some are still worse than expectations, but it is surprising how many are holding up.

Not smoking the wacky tabbacky…but here is the case for Dow all time high

The Dow is going to 9,000 if it moves above this month’s high. 9,000 is a recent high. The MACD on the above weekly chart

shows a bullish divergence.