Change in technology

The information technology sector has risen about 45% from it’s low in March 2009. A good representation of this is Barclay’s iShares XIT. The top holdings are Open Text (25%), Research in Motion (22%), CGI Group (20%), Celestica (17%) and MacDonald Dettwiler & Associates (13%).

Looking at XIT on a technical basis, the current price crossed the 50-day and 100 day moving average on March 25, 2009 and the 200-day moving average on April 9, 2009. Until recently the technology sector hasn’t looked back. On Friday June 19, 2009 we saw the current price drop below the 50 day moving average with a spike in volume and the moving average convergence divergence signal looking bearish.

Some headlines in the Globe and Mail this morning include:

“Nortel Networks is no longer publicly traded”
“The World Bank gave global markets a rude awakening Monday, cutting its forecast for global growth”
“Consumer confidence edged up but Canadians are holding back on major purchases”.

Despite the gloomier outlook, many technology companies have a lot of cash, low debt and great balance sheets. Some would argue that technology would lead us in this economic cycle into recovery ahead of the end of the recession. In his article on Saturday June 20, 2009 in the Globe and Mail, “Riding the economic cycle through history”, David Parkinson provides research by Mr Levkovich looking at the past nine economic cycles dating back to 1950 in the US. Mr Levkovich found that in the late contraction stage, several highly cyclical sectors generated superior returns including technology. David Parkinson further argues, “The findings of this study increase our conviction that the downside risk has substantively subsided, given the likely position of the economic cycle.” That would suggest we are at the end of the bull for technology. “By the time fading recessions transformed into budding expansions, the leadership had changed. Tech stocks have historically become laggards.” The recent rally melted everything up over the last 3 months not withstanding technology. Maybe now would be a good time to look at pulling in the reins on the recent rally as it looks like a reversal may be in the works. The only question is where are we at in the economic cycle.

The Bug is on the crawl

Could we see gold prices crawl above $1000 per ounce? Gold rose to almost $950 recently and has maintained its position above $940 per ounce this week. Its rise from $910 was largely driven by inflation fears partly due to a rise in oil and partly due to a rise in debt issued by the US Government. After a rise above $70, oil has pulled back due to supply concerns and a bearish report by the IEA. Nick Vincour reported in Globeinvestor that “A cautious approach to risk kept global stock markets in check, while crude held under $70 per barrel following a bearish report on demand from the IEA, sapping gold’s appeal as a hedge against oil-induced inflation”. Based on this, some analysts believe gold is set to drop. The other side of the argument is that if markets sell off, gold will rise as a hedge against risk.

Let’s look at what has occurred over the last year and how it has reacted relative to the TSX. A good example would be to look at XGD. XGD replicates the performance of the S&P/TSX Global Gold Index and is managed by Barclay’s iShares. Some of the companies that make up the top ten holdings of the index are Barrick Gold Corp, GoldCorp Inc., Newmount Mining Corp, Anglogold, Kinross Gold Corp, Agnico-Eagle Mines and Yamana Gold Inc.

Since October 2008 XGD has doubled from $10 to $20 while the top 60 stocks (XIU) moved from roughly $14 to $15.95 over that same period. You have to be careful taking a point in time to measure results because there is a lot of volatility and time series distortion, however, it does suggest that with perceived risk, gold tends to do well. With the exception of a few brief periods Gold has been trading above its 50 and 200 day moving average since December 15, 2008. On June 24, 2009 the current price crossed the 50-day moving average with a spike in relative strength and a positive signal from MACD (moving average convergence divergence). Although these indicators are positive, there has been a decline in volume, which is not positive.

A great quote in John Mauldin’s recent article “The end of the Recession” is that “in the short run,” St. Graham said, “the market is a voting machine. In the long run it is a weighing machine.” He goes onto explain that he voting is based on current sentiment, but what the market weighs in the long run is earnings. I would argue the recent rally in the TSX is more supported by sentiment vs. earnings and while the market is weighing in we may see gold crawl past the $1000 again. Let’s see what happens after this quarter ends June 30, 2009.

"Luctre et Emergo"

A saying that means struggle and emerge. Since the peak of October 2007, emerging markets have struggled with this financial crisis. Is it time they emerge ahead of the more developed economies?

In and article published June 7, 2009 in the Financial Times in London entitled “Emerging market equities outperform west”, David Oakley points to evidence that supports a belief in a structural shift in the world economy. “The resurgence of emerging markets this year has reignited a belief in decoupling – the theory that these economies can continue to grow strongly in spite of a sharp slowdown in the developed world.” The FTSE emerging market index has risen 41.1% since the start of the year and 60.8% since the beginning of March. This compares with a rise for the FTSE All World developed markets index of 7.2% since the start of the year and 31.4% since the start of March. Jim O’Neill, chief economist at Goldman Sachs, expects China and India to grow strongly this year in defiance of recession in most rich nations. “Over the next five years, there is a genuine chance that both China and India could show domestic demand growth of 10% at the same time.” On the other hand some analysts would argue that emerging markets rely on developed world demand to support their economies. Nigel Rendell, senior emerging markets strategist at RBC Capital markets, said: “The emerging markets are a geared play on the developed world.”

From a technical perspective we can look at EEM, which is traded in the US and provided by Barclay’s iShares. This is a representation of the MSCI Emerging Markets Index. Since the low of about $20 in March this index has risen to about $34 dollars of late, which is a 70% return. The current price crossed the 50-day moving average on March 16, 2009 and the 200-day moving average on April 28, 2009. The current price has maintained it’s upward momentum above these two indicators, which is very bullish. Relative strength is about 58, which appears not overbought. We would view a number of 70 plus to be overbought. The move upward is not on increasing volume so we really haven’t seen any big money come to the table.

Despite all the bullish technical indicators, I would have to lie in the camp of caution with emerging markets because I believe emerging markets are reliant on developed markets for demand. Emerging markets are still developing on developing data. Some may question the reliability of the information of the companies and government data being disseminated. Emerging markets traditionally have been more volatile in their price movements so typically what goes up by more than average comes down by more than average. If we are on a W or L shaped recovery vs. a V shaped recovery we could see more struggle than emerge from the saying.

The long, short and steepness of bonds

IShares CDN Bond Index Fund (XBB) is a close proxy of the DEX Bond Universe. It has 236 holdings with a weighted average term of 8.87 years and a weighted average duration of 6. Duration is a risk measure that factors in weighted cash flows discounted to today to give you a sense of price movement with an increase or decrease in the portfolio. For example, a 1% rise in current interest rates would mean a 6% drop in price of the portfolio. The current weighted average yield to maturity is 3.59%. Roughly 70% of the holdings are government and provincial bonds while 30% are corporate bonds.

Over the last year, the price closed as low as $27.84 in October of 2008. In November, the current price rose above its 50-day moving average and rose above its 200-day moving average in December 2008. Since these points in time, the price has remained above the 200-day moving average and flirted on both sides of the 50-day moving average. On Friday the price finished off at $29.30 with no real guidance from a relative strength basis or moving average convergence divergence. The moving averages are bullish towards bonds in XBB.

The yield on a 10-year government bond has risen significantly in the last 6 months. The 10-year yield is currently at 3.49% in Canada and 3.74% in the US. Six months ago, the yields were closer to 2%, which means the increase was over 85% in the US. This is one of the fastest and sharpest rises in history due to a record increase in supply of treasuries. Recently volatility has been high with the market trying to decide which direction to bet on. In their monthly review & commentary – May 2009, ScotiaMcLeod indicated that “Volatility also remains high as the tug of war between record increased Treasury supply, (negative for bonds and causing yields to rise) versus the reality of the poor economy and government quantitative easing (positive for bonds, causing yields to decline) continues.” TD Economics reported in the Weekly Bottom Line, “As equity markets gained this week, bond yields also continued their climb, on the back of decreasing risk aversion and anticipation that inflation pressures from a quicker-than-expected recovery might force the Fed’s hand to raise interest rates sooner.” We even saw the rise in mortgage rates in Canada in various terms.
In the short term, if we have a sell off in equities, bond yields will likely fall and prices will rally (good for XBB). In the longer term, as the economy recovers yields on bonds will continue to go up and the curve will continue to steepen. Therefore, after a fall in equities you may want to shift to a more short-term bond structure (XSB). Scotia Economics changed their forecast recently, predicting a very different outlook for the next 12 months. They are calling for rising yields across the entire maturity curve, and predicting the Bank of Canada will, along with the U.S., begin raising its overnight rate as early as the first quarter of 2010. Given this outlook, long bonds (10-30 year maturities) do not look attractive and they now recommend active investors remain in the shorter end of the maturity spectrum. In particular, 2-year bonds present decent value if the Bank of Canada is indeed on hold for the duration of this year.