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Equity & Commodity Strategy

7th January 2015

Fulcanelli Report
Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

Exters Pyramid in play (and is Mar n Armstrong right?)


In a global debt bubble, it concerns us when the benchmark debt security s ll looks good value, albeit on
a rela ve basis.

Source: Bloomberg, ADMISI

In spite of this, the consensus is (once again) calling for higher US yields and FOMC li o. The two-year
Treasury yield has been pricing in the la er


Source: Bloomberg, ADMISI

1
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Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in val ue, investors should therefore be aware that they may not realise the ini al amount invested, and indeed may incur addi onal li abili es. These Investments may entail above average nancial risk of
loss, and i nvestors should therefore carefully consider w hether their nancial circumstances a nd investment experience permit t hem to invest a nd, if necessary, seek the a dvice of an independent Financial Advisor. Some s ervices described are not available to certain c ustomers due to r egulatory c onstraints either in the United
Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

but the ques on is what is the long end of the Treasury curve pricing in?
Slower growth and lower ina on, most likely. Risk of global contagion, possibly. That the FOMC makes
a mistake (in raising rates)maybe that too.
The Fed might be desperate to raise rates ahead of the next downturn (how embarrassing not to) but
this analyst would be surprised to see more than 1 or 2 token 0.25% increases and thats if things are
rosy.
As we know, the narra ve from central banks can change at the slightest hint of trouble, e.g. Ballards
QE4 comment during last Octobers sello. Watch the spin as the Fed portrays lower energy prices as
transitory and no reason to alter its desire to ghten, while the ECBs desire to ease only grows, even
though neither is achieving its mandate on prices.
Do what thou wilt shall be the whole of the law?
The key point is that you cant normalise rates in the Winter phase of a long wave (Kondra e) cycle.
There is just too much debt. Its debt that drives these cycles and eventually brings them to an end.
This is the fourth cycle since the Industrial Revolu on and the longest by far. The lack of a gold standard
has allowed the central banks to extend it through unprecedented credit crea on.
Here is our ming of these cycles:
17881843

56 years

18441896

53 years

18971933

37 years

(1937 was a policy error when recovery established in our opinion)

1934?

81 years

(and coun ng)

The next cycle doesnt begin un l the excess debt from the previous cycle has been purged. Historically
this has occurred via debt dea ons of varying length and severity. In a world of unlimited credit
crea on, ina ng the debt away remains an op on and we ques on whether renewed onset of debt
dea on will ul mately be dealt with via central bank-created ina on? Mr Abe and Mr Kuroda are
conduc ng such an experiment.
In the mean me, we see a possibility that the Fed could raise the Fed Funds rate in several months
me only for long-term Treasury yields to con nue their decline, while the ECB could ins gate
sovereign bond QE and long term sovereign yields (ex-Germany certainly) could risewhich was the
experience of the US (QE1, QE2 and QE 3 pre-taper).
Talking of a ening yield curves
Weve been looking at yield curves in the run up to the last two peaks in the S&P 500 in March 2000
and October 2007.
It basically doesnt ma er which part of the Treasury curve you choose in terms of 2s, 5s, 10s and 30s,
but spreads declined to roughly zero, or nega ve, prior to the equity market peaks.

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ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

Here is the 2s10s...

Source: Bloomberg, ADMISI

The 2s30s...

Source: Bloomberg, ADMISI

3
ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

The 5s10s.

Source: Bloomberg, ADMISI

And the 5s30s, although we could have added the 2s5s and 10s30s just for the hell of it.

Source: Bloomberg, ADMISI

4
ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

Could the same thing happen again in a structurally (much) lower interest rate environment this me
around?
Well 190 bp of a ening in the 2s30s might be pushing it, but 46bp in the 5s10s is certainly possible in
the fairly near future with the way things are going. Funnily enough, if the 10-year Treasury yield was in
line with the 10-year Bund, the 2s10s spread would be -8bp, i.e. close to zero.
While we expect the S&P to be lower at the end of 2015 than the beginning of 2015, our point is that
more a ening might be in order prior to a major correc on in equity markets like the S&P 500,
Footsie, DAX,, etc. In general terms, it also suggests that it might be too early to lose faith in bond
proxies such as U li es and some Consumer Staples.
A signicant further a ening in the curve is looking increasingly more likely...
Indeed, the major story for us right now is that the broad concept incorporated in Exters Pyramid is
in opera on. This something we men oned in Autumn last year and its occurring across currency and
credit markets and, to some extent, in equi es.
To recap, John Exter (a former Fed ocial, ironically) thought of the post-Bre on Woods nancial
system as an inverted pyramid res ng on its apex, emphasizing its inherent instability compared with a
pyramid res ng on its base. Within the pyramid are layers represen ng dierent asset classes, from the
most risky at the top down to the least risky at the bo om.
He foresaw a situa on where capital would progressively ow from the top layers of the pyramid
towards the bo om layers.
creditors in the debt pyramid will move down the pyramid out of the most illiquid debtors at the
top of the pyramidCreditors will try to get out of those weak debtors & go down the debt pyramid,
to the very bo om.
Below is his drawing of the inverted pyramid as he saw it in the late-1980s, when the riskiest assets
were Savings & Loans (thri s), Third World debt and (relevant to today) junk bonds, etc.

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ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

We think that Exters Pyramid went live in in late-June/early-July 2014 when the dollar index (DXY)
began to strengthen

Source: Bloomberg, ADMISI

along with junk spreads.

Source: Bloomberg, ADMISI

6
ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

The perfect illustra on of Exters Pyramid is across the credit markets (as seen via ETFs) with capital
owing from HY through IG

Source: Bloomberg, ADMISI

and from IG into Treasuries.

Source: Bloomberg, ADMISI

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ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

There is some evidence that this is happening intra-equity market.


For example, here is the chart of the S&P 500 High Quality Index versus the Low Quality Index, where
Quality is measured in terms of growth and stability of earnings and dividends.

Source: Bloomberg, ADMISI

The point about Exters Pyramid is that there is a large amount of capital in riskier nancial assets in the
upper layers of the pyramid which can ow downwards.
Consequently, the valua ons of perceived safe assets could obviously overshoot if there is no let up.
Capital ows into dollar assets are a major part of this process right now.
We havent men oned Mar n Armstrongs Economic Condence Model (ECM) for quite some me
but weve been thinking about it recently. The ECM, based on 8.6 year cycles, is o en very successful at
tracking turning points in the hot money ow of global capital.
Now is not the me for a detailed explana on, but for anybody not familiar with the ECM, Armstrongs
report Its Just Time (google it) from several years back is one of the best weve ever read and
provides excellent background.
The ECMs peak on 2007.15 (i.e. late-February 2007) picked out the emergence of the sub-prime
problems almost to the day. It did the same with the peak in the Nikkei Index in December 1989 and,
we know this because we checked, the Great Crash of 1929 (which was 7 x 8.6 years back from the
Nikkeis peak). The 1987 crash was an intermediate peak in the cycle which ended in 1989.
What is fascina ng is that the current ECM cycle peaks on 2015.75, i.e. at the end of September this
year. The low point of this cycle was 2011.45, i.e. June 2011 which Armstrong refers to as:
The 2011 bo om was the peak in oil and gold and the start of the breakout in stocks and the
beginning of the Euro Crisis in full bloom.

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ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

In contrast, we think that the 2011 low in the ECM marked the low in the dollarhere is the DXY again
back to 2010.

Source: Bloomberg, ADMISI

Furthermore, the intermediate peak of 2013.60 (July 2013) and the intermediate low of 2014.68 (earlySeptember 2014) also align quite closely with the dollar, as is obvious from the chart.
Armstrong is talking about this September 2015 being the peak in the bond bubble.
If our interpreta on is correct, the dollar AND long-term Treasuries could have further strong upward
moves between now and late-Summer 2015.

9
ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.

Equity & Commodity Strategy - Fulcanelli Report


Paul Mylchreest Email: paul.mylchreest@admisi.com Tel: +44 20 7716 8257

Investments in futures, op ons and foreign exchange can uctuate in value, investors should therefore
be aware that they may not realise the ini al amount invested, and indeed may incur addi onal
liabili es. Investments in futures, op ons and foreign exchange entail above average risk, investors
should therefore carefully consider whether their nancial circumstances permit them to invest and, if
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ADM Investor Services Interna onal Limited is authorised and regulated by The Financial Conduct Authority. Member of The London Stock Exchange. Registered oce: 4th Floor Millennium Bridge House, 2 Lambeth Hill, London EC4V 3TT. Registered in England No. 2547805 a subsidiary of Archer Daniels Midland
Company. Risk Warning: Investments in Equi es, CFDs, Futures, Op ons, Deriva ves and Foreign Exchange can uctuate in value, investors should therefore be aware that they may not realise the ini al a mount invested, a nd indeed may incur a ddi onal liabili es. These Investments may entail above average nancial
risk of loss, and investors should therefore carefully consider whether their nancial circumstances and investment experience permit them to invest and, if necessary, seek the advice of an independent Financial Advisor. Some services described are not available to certain customers due to regulatory constraints
either in the United Kingdom or elsewhere. 2014 ADM Investor Services Interna onal Limited 2014.