Equities

Mutual fund flows once again experienced large outflows, which indicates that retail investors are panic selling. In the first three weeks of June we saw the accumulated monthly outflow of $16.6 billion. That is the second worst reading since the March 2009 market low and the monthly data hasnt even finished yet. With so much fear out there within the retail investor crowd, contrarians should not be surprised at the powerful rally equities have put in this week.

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Retail investors (AAII) remain neutral, while newsletter advisors (II) and fund managers (NAAIM) remain quite bearish, despite the powerful rally we saw this week. We do not yet know if the bull market top occurred at the February and May tops, as sentiment was very bullish during those times. Looking at the current market action, probability favors new market highs.
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Retail options traders remained more neutral this week, as the readings move towards the mean of the last five years. However, the recent binge of put buying should put in a stock market bottom, at least in the short term. With so much put buying out there during June, contrarians should not be surprised at the powerful rally in equities this week. Over the last 5 years, a huge jump in puts worked as a contrarian indicator to trade a rally, every single occurrence apart from September 15th 2008 when the Federal Reserve let Lehman Brothers go bust.

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The Citigroup Economic Surprise Index shows that economists expectations towards future high frequency data remains two standard deviations below the mean of the last seven years. Despite conventional wisdom most retail investors tend to get out of riskon assets, such as equities, when the economic news becomes worse than expected whereas contrarians should do the opposite by buying. The market responds more to how numbers post up against economists expectations rather than the actual numbers themselves.

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Looking at the statistics of the current bull market, we can see that the current correction hasnt officially ended yet. This was ninth decline of more than 5%, since the bull market began on 09th of March 2009. The average correction over the last two years and two months has approximately been 7.6%, taking almost 18 trading days to find a low. Comparing that to the current correction, shows us that while the market did decline 7.2%, which is close to the average, the correction actually took twice as long than we have averaged over the last couple of years.

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Bonds

Flows into equities remain quite negative in June (as stated above), while mutual funds experienced very strong inows towards bonds again. According to ICI, Taxable Bond funds saw estimated inows of $1.48 billion, while municipal bond funds had estimated inows of $403 million.

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This weeks move shows a sharp rise in the long rates (10 Year Note), compared to the much smaller move at the short end of the curve (2 Year Note). US Treasury Yield Curve (2s10s) remains very steep, compared to the levels we saw during 2000 as well as the 2006 - 2007 period, when the Yield Curve became inverted.

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The Citigroup Economic Surprise Index shows that economists expectations towards future high frequency data remains two standard deviations below the mean of the last seven years (discussed above). Despite conventional wisdom most retail investors tend to get into safe haven assets, such as Treasuries, when the economic news becomes worse than expected whereas contrarians should do the opposite by selling. The market responds more to how numbers post up against economists expectations rather than the actual numbers themselves.

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During the recent correction, longer dated Treasury Bonds have rallied much more than the fall in the equity market. US CPI ination reading stands at 3.6% over the last 12 months, while the 10 Year Note was yielding as low as 2.87% just one week ago, reecting negative real interest rates throughout the majority of the yield curve. We saw a sharp reversals within both asset classes, where the 10 Year Note yield jumped from 2.87% to 3.18%, while the S&P 500 jumped from 1,268 towards 1,339 within a week. The old stocks vs bonds debate continues between inationists and deationists. It is my opinion that to justify buying long dated Treasuries here, you must be very bearish looking at a potential deation scenario in the US economy. Investors who are pessimistic and believe in this case scenario should also note that during this potential event, the Federal Reserve could engage into QE3 thereby devaluing the currency even further. This would therefore make Dollar dominated Treasuries even less attractive.

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Commodities

The shakeout in the commodity bull market continues, as weak hands are forced to liquidate long positions due to the current correction. Speculators cut bullish contracts on the overall commodity complex to the lowest level since early August 2010. The cumulative bullish contracts stand at about 842,500, which is 44% lower than the 1,488,000 contracts recorded in early January. Commodities included within the Cumulative Futures Positions by CFTC in the chart above are Corn, Wheat, Soybeans, Rice, Crude Oil, Gasoline, Heating Oil, Natural Gas, Lean Hogs, Live Cattle, Cotton, Cocoa, Sugar, Coffee, Copper, Gold, Silver, Platinum and Palladium.

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Speculators are cutting bullish bets on Corn, Cotton, Crude Oil, Copper and Gold; while majority are now shorting Wheat which is now down almost 35%.
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Speculators jumped back into the Silver market last week, thinking that the price bottomed. Within the next three days, Silver lost another 7%. This week, speculators reduced bullish bets on Silver again, to the lowest level since early 2009. Silver price itself keeps moving towards the magnetic 200 day moving average line. The correction within the bull market continues, and with prices down over 30% - a buying opportunity could be coming soon. Patience is the key here, as parabolic moves take time to correct and consolidate.

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After trading as much as 30% away from its 200 day moving average in late April, Crude Oil has endured a 20% correction in the last two months and is currently testing this psychological line. The secular commodity bull market continues, so a long term investor shouldnt be too bearish on commodities, like crude oil, due to favorable demand and supply fundamentals.

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Currencies

Speculators reduces their bearish bets on the US Dollar this week. We are still in an unwinding process since the inection point in early May. Obviously, if the rally continues this is one of the major headwinds of the risk-on trade for equities, commodities and high yielding currencies.

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Speculators are cutting bullish bets on the Yen, Franc and Aussie; while they were net short Canadian Dollar by Tuesday, resulting in the strong reversal!
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During the last decade, the weakness in the US Dollar has resulted in a strengthening of equity and commodity prices. The rally into the US Dollar has led to equity and commodity corrections or bear markets. The trade weighted US Dollar is currently on the brink of breaking its 2008 panic low. The two questions are: 1.) Will this be a bear trap which will turn into a potential US Dollar rally, sending commodities and currencies even lower from current levels; or... 2.) ...will the US Dollar keep moving lower and therefore resume its secular downtrend, which started in early 2002?

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While the US Dollar Index has been showing some strength as of late by bouncing of the 2008 lows, in an attempt to answer the above question; we could look at my personal indices which track the commodity currency complex (CC Index) and the Asian export currency complex (AEC Index). It seems that the weak Euro and Pound are masking the overall broad US Dollar weakness and the indices above are potentially conrming a break below the 2008 low.

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Economy

The recent results from the Bank of Japan Tankan Business Conditions Survey showed a deterioration in condence. This is a perfect contrarian signal as it looks like the Nikkei 225 has nally put in a strong bottom around the 9,300 level.

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Global Economic Indicators (GEI) continue to show potential weakness as Jobless Claims show a 4 week spike above 400,000. The ECRI is irting with its moving average and German Business Condence remains at elevated levels. On a bright note: Dr. Kospi, Dr. Copper & the S&P 500 all currently remain above their trend lines and are in a primary bull market.
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In Focus This Week

The focus this week is on the equity market rally and the bearish views in the advisors, economist and fund managers camp. S&P 500 put in quite a strong rally this week. As a matter of fact, this was the most powerful one week advance in almost two years, since July 2009. The following contrarian indicators remind us that we should always be on the opposite side of expert advisors, economists and fund managers. The amount of newsletter advisors that remain bullish remains below 40%, which is a far cry from the 55% plus seen consistently during late 2010 and early 2011. Economists have also turned pessimistic, some of which are calling for a double dip recession. This is completely opposite to the strong conviction they held towards economic growth in February 2011. F i n a l l y, fund managers have the least amount of exposure to equities since July 2010, which was the last time S&P 500 put in a strong bottom.

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