Watch The Stems - February 17, 2016

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Greetings,

It looks like the cavalry is on its way. Central bankers are now responding to deteriorating market conditions, and it appears we’re looking at a bounce. On Monday, while US markets were closed, Draghi grabbed a microphone to reassure investors, saying if there are further “downward risks to price stability, (the ECB) will not hesitate to act.” You’ll recall he made similar a proclamation last October, only to disappoint markets in December with secondary rate cuts and an extension of QE – not an expansion. In theory, Draghi will have learned that talk is cheap for the ECB’s March 10th meeting, but in the meantime investors will likely let their imaginations run wild and buy risk assets.

The Chinese are also getting in on the act. The PBoC, closed last week for the Chinese New Year, reopened with a splash on Monday, fixing CNY +1.2% stronger against USD – a huge move. The appreciation was justified considering the sell-off in USD last week, but this could be perceived as a shot at speculators who grew a little too comfortable shorting the Chinese currency. It was also revealed that loans from Chinese banks exploded in January, setting fresh all-time highs. Total social financing, an indicator of China's credit expansion, rose to 3.42T CNY in January up +88% M/M from December.

Chinese bank lending usually spikes in January as banks, which face limits on how much they can deploy each year, squeeze as much lending as possible into the first month to protect their market share. It also could be due to Chinese companies making early repayments of their foreign-denominated bonds to reduce their currency exposure after CNY weakened. But this feels different, almost like the Politburo is quietly firing up its stimulus machine. Medium-and long-term loans to households were up +45% Y/Y in January, and lending to companies jumped +73% Y/Y.

There are other reasons to be bullish. Banks, a big source of anxiety, look better after Deutsche Bank (DB) bought back some debt and Jamie Dimon is buying $27 million worth of JPMorgan (JPM) stock – a big vote of confidence. The charts look like we’re due for a rally as well. AUD/JPY, a fantastic barometer of risk appetite that correlates nicely with stocks, left a very bullish candlestick stem last week. Nothing works 100% of the time, but it will be hard to take out that low in the short-term.

Having said all that, looking at the data, there’s little reason to believe this will be a sustained rally. On Sunday night, the Chinese released trade data from January that looked abysmal. Total exports were down -11.2% Y/Y and imports were no better at -18.8% Y/Y. Retail sales in the US looked decent, but the UMichigan Consumer Sentiment Index looks like it’s rolling over. And the 5-10 year inflation outlook from consumers is down to +2.4% - a new all-time low. Deflation is a psychological phenomenon and these one-off stimulus measures aren’t going to change that. Recent developments might be enough for stocks to rally for a month or two, if only because of extreme pessimism, but we’re far from out of the woods in 2016.

The Cup & Handle Fund is up around +3.5% YTD, and +12.0% Y/Y. The portfolio is back to its high since inception in August 2014, although I’m not sure it will stay there. The book is relatively balanced and has gone up steadily this year through rallies and declines with few major changes. I think the market will rally here, but don’t feel the need to play it. I’d rather stay patient and wait for the inevitable and more sustainable decline. In essence, I’m going to stick with the 2016 Playbook that was laid out in our February letter. If you’d like to start receiving these letters click here.

With that I give you this week's letter:

February 17, 2016

As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

Until next time, tread lightly out there,

Michael Lingenheld

Managing Editor – Cup & Handle Macro

Posted to Cup & Handle Macro Research on Feb 16, 2016 — 1:02 PM
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