The Macro Trader 03 03 2015

March 3, 2015
Commentary-2
Model Portfolio-13
Indicators and Tables
US Equities-14
Foreign Equities-19
Fixed Income-21
Commodities-25
Currencies-27
Disclaimer-30
Tuesday, March 03, 2015 Page 1 of 31

www.TheMacroTrader.com
The Macro Trader
Global Macro Research and Analytics
March 3, 2015
Commentary-
Looking Ahead
Although the power of the markets to see the future is probably overrated, the
reality is still that markets are forward looking. They don’t always see the right
future but more often than not they do. Right now one of the biggest themes in
the mainstream financial space is that the global economy is in deflation and that
with this year’s decline in economic expectations things are going to hell in a
hand basket, or something along these lines.
We think that the reality is less doom and gloom and more decent/muddle along
and continue improving. Let’s first look at economic expectations. In the chart
below we have the Citi economic surprise index for the US. On this chart we
plotted each year from 2010 to now. As you may be able to see is that since the
market bottomed we have seen a weaker than expected first half, followed by a
stronger expected second half. So far a lot of pundits are saying “2015 is seeing
the weakest first half in years” and as you can see in orange (and we circled it)
this is indeed the case.

Of course what this fails to answer is what will happen over the next few months.
We think that the answer that many seem to be coming to is incorrect and that
instead the markets are currently correct on the next 3-6 months as they are
hitting new highs every few days and weeks.
Before we show why we think the market is right and that things are improving, or
at least about to improve, lets first look at what we think is driving the current
doom and gloom.
Inflation and inflation expectations have both gotten killed over the past six
months. What too many prognosticators seem to be forgetting is that most of this
deflation, at least in the US, has been driven by energy and commodities getting
killed. As you can see in the chart below of the PPI components these are the
two groups that have led everything lower.
We are not oil bulls by any stretch but it is clear in the chart below that oil prices
whether they have hit a bottom or not have, at a minimum, slowed their rate of
decent. This alone will do a lot going forward to slow the decline in inflation.

Not only has the descent of oil slowed but the market is starting to price in rising
inflation. Using either the five or the ten year breakeven rates we can see that
they have put in at least a short tem bottom with the low being hit seven weeks
ago. Stock market is hitting new highs and the bond market is saying that while
still low inflation is likely to rise a bit. We call this a clue.
Finally, at least on the inflation front, we have both core and headline inflation.
As you can see in the chart below there is a reason that the Fed has in the past
highlighted core inflation over the headline number. Over time they both trend in
the same direction but in the shorter term the headline number is far more
volatile as it includes both energy and food. With the rate of decline in oil having
slowed and possibly stopped we will see a rebound in headline CPI that will likely
catch back up to core CPI.

In addition to the drop in inflation being temporarily induced via the crash in
energy we think that there are other reasons to be moderately bullish on the
economy and inflation. Looking at two of our favorite leading business cycle
indicators we can see things are picking up.
As you can see in the chart below the rate of change in personal spending is
finally seeing an uptick. Part of this is likely due to the decline in oil and
consequent savings at the gas pump, but looking at the trend things were
improving anyways.
Furthermore we have the rate of change in real average hourly earnings ticking
higher. If the consumer has more money they will spend it more. They might not
spend all of their gas savings at first as they pay down debts and increase their
emergency savings but the longer it goes on the more they will spend. As you
can see not only have we gotten a shorter term increase likely due to the drop in
oil but this “pop” was also in the context of an uptrend in earnings.

We are definite believers in the idea that the consumer leads industrial
production which in turn leads capital spending and not the other way around. If
the plight of the consumer is improving than we can expect both industrial
production as well as capex to improve as well. This is anything but deflationary.
Not only are consumer earnings and spending increasing but we are seeing
improvements in credit as well. In the chart below you can see how the rate on
year over year credit demand had been flat for almost two years. Well as you can
also see it has broken out over the past few months and is advancing at a decent
rate. This is inflationary NOT deflationary.
Remember this chart of the commercial loan to deposit ratio? As you can see
commercial loans dropped like a rock from 2009 until leveling out towards the
end of 2014. We think that this measure has probably bottomed and will be
headed higher over at least the next few months.

Part of the confidence in the loan to deposit ratio improving is due to looking at
the individual growth rates of each measure. As you can see in the chart below
over the past several months deposit growth has been in a steady downtrend
while loan growth has been in a strong uptrend. Believing than trends tend to
continue we tend to think that the loan/deposit ratio moves higher for at least the
next 3+ months.
To be fair not everything is roses and butterflies as there are still some
concerning signs. One of them, as you can see in the chart below, is the huge
decline in retail sales growth.

While retail sales and a few other indicators are indeed giving bearish signs we
think that with the strengthening consumer, as well as improving energy price
stability, that both the economy and inflation will likely be stronger in the coming
months than they appear to be right now.
Of course just because we don’t see the end of the world does not mean that we
are wildly bullish, but instead that we are not wildly bearish. What really concerns
us in the US is not the economy but instead valuations.
Each week we show four different long term valuation gauges in the US Equities
section of our indicators and tables. All of them show that the market is on the
high side if not outright bubble territory. One of them, the VLMAP-Value Line
Median Appreciation Potential shown in the chart below, is showing a potential of
35% over the next 3-5 years. This puts the current potential in the 96.80%
percentile which means that the market has only been higher valued 3.2% of the
time since 1968.
Other indicators such as the Shiller CAPE, Hussman Peak PE, Morningstar Fair
Value, and market cap/GNP all show the same thing in regards to valuations.
They are on the rich side but are not screaming bubble.
What this tells us is that you need to be more cautious than usual. It also says
that this is a stock pickers market. Some people hate that term but we think that
when the market is just screaming higher it is far easier to just be long the
market. At the turns, also known as when uncertainty is high, is the time where
individual stocks can shine as they are not just being lifted by the overall
economy but actually differentiate themselves via management, products, etc.
For an asset allocator this is a time when I would either be going to cash or going
to active managers for my US equity allocation.
For the active investor, whether hedge fund or otherwise as well as our model
portfolio, we are instead far more excited about foreign equities. Going global
has been a huge theme of ours for the past year and over the past few months
the benefits are finally being seen.

With Europe and Japan both expanding their monetary policies as well as having
far lower average valuations we think that the “easier” trade right now is to be
long in those regions. If you are an avid reader of the financial media, and we
think most of you are, then you might think that this is a consensus view. If this
describes you then ask yourself this “Are you currently overweight European and
Japanese equities, and is your mother and your brother?” If your answer is NO
than you have your answer.
We think that the US is close to a peak in the current cycle. Sometime in the next
two years it will hit a recession, and although we are not expecting a global
financial crisis type event, we still don’t want to be huge holders of US equities
coming into that.
Europe on the other hand is closer the bottom of its current cycle than to any sort
of top. Consequently, and again ECB policy is a HUGE kicker, we expect things
there to gradually improve. Notice how we said improve and not necessarily
become healthy. Despite our relative bullishness on Europe we cannot deny that
they have boatloads of hurdles in front of them. Demographics, attitudes, weak
form capitalism, etc., are only a small list of them and that is before bringing up
the biggie which is of course their crap currency union. Yes, we still think that at
some point the current EU is disbanded or at least reorganized to the point of
being unrecognizable next to the current union. And yet despite this we think that
things will improve for the next year or two or even longer and we want to be long
in this environment.
In summary we are neutral on US equities and bullish on foreign equities

with an emphasis on Europe, especially very cheap areas like Spain and
Italy, and Japan. In both cases we think that it will pay to be currency
hedged, at least for the next several months. We are looking to buy, or buy
more, on dips and consolidations. We expect this to be a major theme for
the next 1-3 years.

USD/JPY
One of our currency themes of the past few years has been our bearishness of
the Yen as well as our bullishness of the USD. Last week we showed how the
options market is pricing in a move of the USD/JPY to 140 and beyond at a
probability of only 5% and that this is our base case.
In addition to this bullish positioning/odds setup we are also starting to really like
the current technical setup of the USD/JPY. In our FX table we have a few
indicators, some well-known and others not so much. One that is probably
underused is that of the 10/180 day historical volatility ratio. By comparing the 1-
Day with the 180-Day volatility measure we can see when the market is very
complacent and when it is crazy. A reading of 100% would mean that the 10-Day
reading is directly in line with the 180-Day reading. We highlight extremes by
making readings of 50% or lower green and readings of 150% or higher red.
As you can see in the chart below the Yen complex is under 100%, meaning
relatively complacent, almost across the board with only one exception. We
made ovals around the sub-50% readings indicating a very low reading in 10-Day
vol relative to 180-day vol.

What this does is help us find areas to buy/sell options and/or opportunities to
trade breakouts from consolidations. Consolidations of course are a huge
component to most of my favorite chart patterns. As you can see in the chart
below the USD/JPY is in a three month long triangle in the context of a medium
as well as long term uptrend. Consequently, and combined with our fundamental
view, we are looking for a breakout to the upside.
We like this trade but currently our book is already a bit oversized in the long
USD department. We are still looking at buying some Yen puts with a 2-Yr time
horizon. For today however we are sitting aside.

Inflation Watch

Model Portfolio Trades

Indicators and Tables
US Equities-
SP500 Reversion to the Mean
SP Sector Trading Data
SP Sector ETF’s

Industry Group Rankings

Value Line Median P/E and 10-Yr SMA 18.4 Percentile Rank 90.00%
Value Line VLMAP and 10-Yr SMA 35% Percentile Rank 96.80%
Hussman SP500 Peak P/E 19.65

Shiller SP500 Cyclically Adjusted P/E 27.36
SP500 VIX
US Equity Risk Index 90.00%

Global Equities-
Global Stock Model

Global Momentum Rankings

Percentage of Foreign ETF’s above 40-Wk SMA 43.48%
GDP Weighted Global Yield Spread

Fixed Income-
30-Year Reversion to the Mean
MOVE Index

Money Market Spreads
UST 10-2 Yield Spread

Government Bond Yield Trend Model

5-Year TIPS Breakeven Rate 1.40%
10-Year TIPS Breakeven Rate 1.76%
Fixed Income Risk Index 71.43%

Commodities-
OVX-CBOE Crude Oil Volatility Index
Goldollar Index

GLD Volatility Index
Precious Metals Risk Index 20%

Currencies-
G10-Intermediate Term Trend Following System
TD-Countdown and TD Sequential Counts
FXE EUR/USD Volatility Index

JPM G7 VIX
JPM G7 and EM FX Volatility Indexes

Conclusion-
We hope that you have enjoyed this and every issue of The Macro Trader.
This newsletter is relatively new, and we would like your feedback. What do you
like and what do you not like? What would you like to see more of and less of?
If you have any questions regarding the content of the newsletter, subscriptions,
or anything else just send us an e-mail at Editor@TheMacroTrader.com
By the way we occasionally get requests for data from some of our charts.
We keep several well-known as well as obscure data sets and in most cases are
more than willing to share with our subscribers. If you are looking for a data set
for your own research let us know and we can probably help you find it.
Have a Profitable Week,

The Macro Trader

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March 3, 2015

Indicators and Tables

Tuesday, March 03, 2015 Page 1 of 31

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In summary we are neutral on US equities and bullish on foreign equities

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SP Sector Trading Data

Tuesday, March 03, 2015 Page 14 of 31

Tuesday, March 03, 2015 Page 15 of 31

Hussman SP500 Peak P/E 19.65

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US Equity Risk Index 90.00%

Tuesday, March 03, 2015 Page 17 of 31

Global Stock Model

Tuesday, March 03, 2015 Page 18 of 31

Tuesday, March 03, 2015 Page 19 of 31

GDP Weighted Global Yield Spread

Tuesday, March 03, 2015 Page 20 of 31

30-Year Reversion to the Mean

Tuesday, March 03, 2015 Page 21 of 31

UST 10-2 Yield Spread

Tuesday, March 03, 2015 Page 22 of 31

Tuesday, March 03, 2015 Page 23 of 31

10-Year TIPS Breakeven Rate 1.76%

Fixed Income Risk Index 71.43%

Tuesday, March 03, 2015 Page 24 of 31

OVX-CBOE Crude Oil Volatility Index

Tuesday, March 03, 2015 Page 25 of 31

Precious Metals Risk Index 20%

Tuesday, March 03, 2015 Page 26 of 31

FXE EUR/USD Volatility Index

Tuesday, March 03, 2015 Page 27 of 31

JPM G7 and EM FX Volatility Indexes

Tuesday, March 03, 2015 Page 28 of 31

Have a Profitable Week,

Tuesday, March 03, 2015 Page 29 of 31

The purchase of securities discussed by TheMacroTrader.com may result in the loss of

We recommend that you consult a stockbroker or financial advisor before buying or

All information provided by TheMacroTrader.com is obtained from sources believed to

No security featured in this newsletter has paid a fee, or otherwise compensated

Tuesday, March 03, 2015 Page 30 of 31

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