Titan Inv Partners – Equity markets continue to ignore geopolitical issues, but for how much longer?

A spate of doom laden headlines this weekend highlighting the worrying developments in various flashpoints around the globe and which increased in intensity last week stood out like a beacon on a dark night to me in the face of continued lofty equity prices. Scanning through various newswires and newspapers, here is just a sample of the stark headlines:-

Crisis gauge rises to record high as swaps avoided

China and Japan on brink of third world war

Ukraine tells Russia Invasion means war

Britain could be on warpath with Russia to stop “invasion” with Ukraine

In contrast, the US stock market managed to notch up yet another all-time high this week with the S&P 500 toeing the 1870 level and now up a stunning near 280% from the lows of the devil’s number itself 666 that was printed in March 2009. In fact, in just over week’s time, we shall hit the 5 year anniversary of the bull market that commenced on March 9^th 2009.

With margin debt at the New York Stock Exchange rising to an all-time high of about $451.30 billion in January from $444.93 billion in December, and bullish sentiment once more rising as the chart below illustrates, it seems that there is absolutely nothing that can break this bull market.

QE withdrawal? No problem. Renewed weakening in U.S economy? No matter. Rising interest rates around the corner in the UK? Pah they say! Continued pressures building in the Chinese banking system with a weakening yuan and credit out of control? No effect. A frenzy of IPO listings eager to take advantage of the elevated valuations being ascribed to businesses (witness AO World being valued at 6 times sales while other online retailers sell at less than 0.5 times!) and that should be seen as “smart money” getting out together with another “market top” signal with the FB takeover of Whatsapp for a stunning $19bn and which, to us, doesn’t seem to have a cat in hells chance of ever making money? But mere flies in the bull market swatters sights! The list goes on and on and on and on… Bears don’t just have egg on their faces, they veritably have a whole battery of hens!

What we are here at Titan however, if nothing else, is nimble. After positioning ourselves short at the very birth of 2014 (see here – http://www.spreadbetmagazine.com/blog/titan-investment-partners-why-we-have-moved-to-a-maximum-net.html) and covering this towards the lows, we moved back to a neutral and net long stance in late Jan. The figures below illustrate how we have performed YTD against our benchmark, and with very modest leverage of less than 2 times overall too.

So, what next for markets? The 2 charts below are instructive to us.

What this appears to paint is a “reverse head and shoulders” formation that has an implied target of 1940. The 1840-55 region on the S&P has proved to be stubborn congestion this last week and, interestingly, whenever the market fell back towards this region (including late Friday), the level of Put buying increased dramatically. What this means is that there is a material amount of hedging that has occurred at this point and so it can act as a good floor for prices. Of course, if the market breaks through here then the sellers of options will need to “delta hedge” and this will likely pressure equity prices much more sharply IF such a move occurs. A break of 1840 on a closing basis is the level to watch for those of a bearish inclination. We plan to play such a move via Put Spread.

Take a look at the following chart:-

We covered the correlation between the USDYEN FX pair and the S&P 500 in mid Feb, pointing out the correlation break and suggesting in fact that the way one could play this was via a “pairs” trade on the Nikkei (going long) v the S&P (going short), commenting – “How to play this? An S&P Nikkei pair perhaps. If the USDYEN pair surges then the Nikkei, which is presently sharply oversold, will likely tear back above 15000.”

We can see below that this initially played out well and we did indeed scratch 15000 on the Nikkei shortly after but, in recent days, the pair has given back this  outperformance.

Has the correlation therefore broken in the USDYEN V S&P? Or, is it a signal once more that the Yen is to weaken and the Nikkei will thus outperform the S&P or, in the 3rd alternate, that the S&P is again going to fall back sharply? Our proprietary algorithms that we use to measure the probability of the markets direction in the short term tell us that the latter is likely to occur. In fact, the NYSE has now produced over the last 3 weeks one of the longest streaks of rising stocks v falling ones in our dataset, and which goes back several years. Intriguingly, this type of price action is nearly always seen at the beginning of a bull market and not the end…

What does this mean then?

Of course we do not have the answer, but taking all the pieces together – renewed bullish sentiment, rising risk on the geopolitical front and yet not being reflected in the VIX, an over extension of the equity market that remains in place relative to its 37 month ema that we have touched upon before and short term overboughted-ness, we are of the opinion that the reverse head and shoulders pattern highlighted above is in fact likely to be a false breakout and the warmongering by China, Putin and Japan is likely to have an impact on markets in the forthcoming weeks.

The beneficiaries? Well, no prizes for guessing that we believe that gold and silver will continue to push on. It seems the rally of almost 10% over the last 2 months in these metals has prompted some profit taking and although the COT positioning data appears to be a little worrying for the bulls, we rather suspect that the data due out this week will show a sharp drop in bullish bets. If this is the case, then we can expect gold to push back towards $1350 – $1370/oz and take the precious metals miners with them. Below is a table of our returns here in our precious metals fund and again being achieved with extremely modest gearing.

IF YOU’D LIKE TO RECEIVE OUR TOP 3 THEMES FOR 2014 PDF THEN CLICK THE BANNER BELOW.

You should not take this piece as an advocation to trade in any of the instruments mentioned and should always take professional advice in relation to your own personal circumstances.

All Titan Funds operate within a spread betting account which means gains or losses are currently free of tax. However, legislation can change in the future. Spread betting is a leveraged product which could result in losses of some or even all of your initial deposit. Ensure you fully understand the risks.