Market Outlook | January 4, 2009

Market Outlook | January 4, 2009

“Not only is the universe stranger than we imagine, it is stranger than we can imagine.” Sir Arthur Eddington

Big Picture | Rates

For most of last decade, forecasts of Crude prices by analysts and economists provided numerous moments of suspense. That was an eye -grabbing topic that had many investors watching closely. Interestingly enough, the idea worked on the upside and quickly became a mainstream issue. These debates among forecasters were over the ability of prices to stay around $30 or exceed $100. Beyond those forecasts, the intrigue of geopolitical factors created uneasiness and growing curiosity. This made sense, given the global nature of the commodity and a favorable multi-year cycle.

Now, a similar set up is taking place regarding interest rates. At the moment, expectations call for rates in the US 10 Year Treasury as high as 5.50% and some below 3%. Interestingly, with all extremes views, the truth finds its way somewhere within that range. We can always leave some room for extraordinary events. Either way, these speculative chatters are not breaking news, but they can mark subtle shifts in investor psychology. It simply suggests that rates are a key driver of financial markets. As usual, there are uncertainties in behaviors of those funding US debt. Perhaps, major changes in these dynamics can serve as a catalyst for rate spikes. The political nature of this call, combined with Federal Reserve policies, reiterates how rate direction leads to sensitive investor response, especially in the first half of this year. These factors ignite some of the complexities and challenges for money managers, who are looking to adjust their bets after a smooth sailing 2009.

Stock Market vs. Economy

Improving economic conditions are expected by many, and they are setting up higher expectations. At this point, if outlook matches reality, then investors will have to rethink their overall stock market view. For example, even weakening economic data did not stop the S&P 500 from rallying in the spring of 2009. Now, this begs the next question, what happens if positive economic conditions fail to trigger positive broad market returns? As we maintain a bullish market momentum, any minor turbulence can cause uneasiness and higher volatility. Again, the S&P 500 measures performance of larger US companies, and it is not a barometer for the well-being of the country. This is a distinction that is easily confused. Therefore, broad market indexes serve as a gauge to track a segment of financial markets. That said, beyond being a score keeping tool, these instruments shape one’s mood and plan of action. Currently, the sentiment indicators of investments are very positive as well as leading contrarians to worry of blindside surprises.

Connecting Dots

As highly publicized, China’s policies can strongly influence US interest rates, emerging market assets, and currency related policies. This is a powerful force in an intertwined global marketplace that crosses various, asset classes. Similarly, the speculative nature of Gold is reached unstable concerns, especially in emerging markets. For example, Vietnam is halting gold trading, due to frenzy demand, which contributes to increasing global imbalance. At the same time, regulatory decisions are expected to cause some reactions by investors. This leaves money managers to commit lightly to themes, while keeping another eye open to the collective attitudes of lawmakers.


Article Quotes:

“Let me quote from a classic paper by the late Paul Samuelson, who more or less created modern economics: ‘With employment less than full ... all the debunked mercantilistic arguments’ — that is, claims that nations who subsidize their exports effectively steal jobs from other countries — ‘turn out to be valid.’ He then went on to argue that persistently misaligned exchange rates create ‘genuine problems for free-trade apologetics.’ The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.” (New York Times, December 31, 2009)

"Fannie Mae and Freddie Mac, the linchpins of the American housing market, continue to bedevil the U.S. financial system. In February 2003, their regulator issued a report saying the companies were taking on too much risk by using implicit government backing to plunge deeper into the mortgage market... Five years later, regulators seized the mortgage-finance companies. Since then, leaders... have argued the companies can't be sustained in their dual roles -- a for-profit enterprise beholden to shareholders and a tool of housing policy -- and should be nationalized or sold. Nothing has happened. Instead, Fannie Mae and Freddie Mac, which buy home mortgages from banks and package them into bonds sold to investors, have been bailed out with $1.5 trillion in direct and indirect government aid." (Bloomberg, December 28, 2009)

Levels:

S&P 500 [1115.10] Index is up nearly 30% since July 8th 2009, which marked the second meaningful buying opportunity. In the last two months, 1100 has showcased to be a key stabilization level.

Crude [$79.36], in the past few months, has demonstrated strengths around $65 and $70. A sharp recovery, in the past two weeks, confirms a positive trend as prices near 2009 highs of $82. However, the sustainability of short-term moves will be tested.

Gold [$1085] has an inflection point that resides around $1050. A key point that should provide a better read on buyer’s enthusiasm. Importantly, a confirmation is needed to solidify early December run up.

DXY– US Dollar Index [77.95] has early phases in the recovery process. The next upside target is around 80.

US 10 Year Treasury Yields [3.83%] have rallied, twice in a three month period, above 3.20%. Once again, investors will watch the 4% as a turning point.





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