Market Outlook | October 26, 2009

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“Believe those who are seeking the truth. Doubt those who find it.” - Andre Gide (1869 - 1951)

Balancing Act:

Global assets continue to climb higher as participants show willingness for risk acceptance, yet money managers are faced with balancing long-term recovery with shorter-term declines. Now, observers will glare and focus at last Wednesday’s highs of 1101 in S&P 500. For some, this is a compelling and early indicator for sell-offs. However, worrying and betting on the collapse of markets has been costly. Recent S&P 500 pullbacks include a 7% decline from June 11 to June 23. This was followed by a 5.57% retracement from September 23 to October. Again, broad market indexes have yet to correct 10%, which reinforces an upside buying bias. In both cases, simple indicators implied overbought conditions. At the same time, some pundits pointed out increased odds of heavy selling pressure, yet the markets have worked their strength. Perhaps, it is tempting for most to call market tops, but the evidence is not that clear. Now, as a potential retracement looms upon us, investors are forced to weigh and make a decision.

Monitoring Themes:

The key theme this year is increased risk-appetite that favors commodity based themes, globally. Of course, this partially coincides with the dollar weakness and lower yields. Strength in Crude and Gold define a positive momentum and matches stock direction as well. Money market funds have declined by $458 billion, and this displays additional evidence that favors riskier assets (Invesco Co). At this stage, decisions by policymakers remain unclear, despite increasing headline exposure. Generally, there are concerns of the unknown in the political climate, especially with growing government interventions. However, a simple glance of charts remind us of a steady, multi-month rise. In looking ahead, the Federal Reserve actions, along with business related policies, are factors to consider for a trend shift. Also, active participants will examine the magnitude of increase in volatility as an early clue for a market pause.

In terms of stocks, overall healthy earnings are leading to increased upside expectations. Technology reinforces overall strength by gains in Microsoft and Amazon. This partially explains the relative outperformance of Large Cap Growth last week. Interestingly, some companies witnessed solid revenues, but stock price declined in value due to profit taking. Therefore, differentiating between long-term investment and stock specific reasons is critical. In other words, buyers are likely to seek better pricing for re-entry, given extended markets. Plus, as the month draws to a conclusion, additional clues need to materialize before major commitments are fully reflected.

Issues related to credit markets are still worrisome, especially with looming bankruptcies. Similar to 2007, the catalyst for market downturn resides in financials. Also, the Federal Reserve holdings of mortgage backed securities exceeded treasuries. This unsolved matter seems to create a higher risk for opportunists. Importantly, there is hesitancy in Financials, which makes investors relatively underperform. However, other sectors present better opportunities, especially if the macro climate continues to offer lower yields and declining dollar.

Article Quotes:

“Asia's rich are again favoring the leveraged investments that backfired on them during last year's market turmoil,’ according to the head of DBS Group Holdings Ltd.'s wealth management unit. 'Investors have short memories,' Amy Yip, who oversaw Hong Kong's $245 billion foreign-reserves fund before joining Southeast Asia's biggest bank in 2006, said... 'Many of the Asian clients are back in the very aggressive leveraged posture that they had adopted in the fall of 2008.' Rich investors in Asia are borrowing more to fuel returns, spurred by record-low interest rates and a stock market recovery.” (Bloomberg, October 22, 2009)

“The fact that so many of the sectors are trading in neutral trending modes, reflects the fact that we are in a multiday trading range. I thought Friday's early action was noteworthy, in that the market could not work higher on positive earnings news and housing data. I also thought it was noteworthy that the selling on Friday could not take out the Thursday lows.” (TraderFeed, October 25, 2009)

Levels:

S&P 500 [1079.60] Trading few points away from annual highs. The index would need to rally 46% to climb back to 2007 highs. In the near-term, consolidation forming between 1050-1100.

Crude [$80.50] Stabilizing around $80, while confirming an uptrend. At this range, Crude is 36% removed from its 200 day moving average. This is explained by the strong run up that began on September 25.

Gold [$1061.75] Closed the week at all-time highs. Solid uptrend this month after breaking a key $1000 mark. Buying frenzy is building as the commodity benefits from a shift away from fragile financials.

DXY– US Dollar Index [75.49] Negative sentiment continues to establish the downtrend. Approaching annual lows reached this March at $70.69.

US 10 Year Treasury Yields [3.48%] Sideway pattern for the past 5 months. Yields are slightly above their 50 day moving average of 3.39%. No signs of a trend shift at this point.

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