Market Outlook | May 10, 2010

“In these matters, the only certainty is that nothing is certain.” -- Pliny the Elder (23 AD - 79 AD)

Theatrical Feel

In some ways, it felt like 2008 crisis again, at least for two key reasons. First, the crisis in Europe reflects worries that are driven by lack of confidence. Secondly, the action in the US markets showcased a historic day of a tremendous shock. Of course, this is all taking place in a period where the schedule for congress testimony features key players from the previous credit bubble as lawmakers consider some resolutions. For storytellers, it was rather an exciting time, while money managers face the issue of protecting capital, while calmly finding opportunities within the current chaotic landscape. An emotional response can dominate the market environment, especially in upcoming days as logic takes time to settle in.

A Step Back

From a clear-headed perspective, the S&P 500 Index reminded us that most investors were not comfortable above 1200. Previous peaks above 1200 in April, served as early clues for a much needed breather. When combining this mechanical observation with the headline concerns of Europe, the high volatility is partially explained. Not to mention, previous turbulence in the Volatility Index, especially in the past eight months, were setting up for a tipping point. In addition, minor worries regarding China that were resurfacing are creating further downside pressure. It wasn’t too long ago that skeptics questioned the lack of volume of this ongoing rally. As for interest rates in the US, near-term data argues for downside momentum, despite the consensus of rising rates. As global central banks readjust interest rates, some await results in political shake outs. Basically, sorting out a few macro issues, such as the stability of the Europe, can shape the new cycle. So far this year, the defensive investor reaction has greatly helped the US Dollar, mostly sparked by Euro weakness. Once again, there are too many macro issues lingering, for those seeking clarity, in search for the next mega trend.

Period of Adjustment

Few changing dynamics in the global marketplace are worth noting, especially in this new decade. These moving parts range from technological advancements in trading mechanics to pending financial reforms in an interconnected world. Globally, a new plan for Europe should slowly materialize. and currency markets most likely need to adjust to the needs of growing economies. At the same time, investors are eager to find out the verdict on the reacceleration of emerging markets; a theme that significantly outperformed last decade. Also, the characteristics and tolerance of market participants is changing as well. That said, investing is requiring severe patience and an open mindedness to navigate an emotionally charged market.

Article Quotes:

“In the mid-1990s, authorities in the fast-growing countries of East Asia explained that their success was due to "Asian values". The crisis of 1997-1998 changed that tune. Similarly, senior U.S. officials spoke confidently in 2006 as they basked in the glow of the "great moderation," as economists called the easing of business-cycle fluctuations over the prior two decades. Financial institutions were rock solid and not leveraged; we were told. Financial markets were resilient. And housing prices would never decline nationwide. Who would have listened 12 months ago to someone asserting that an E.U. member would teeter on default?” (Washington Post, May 9, 2010)

“These incidents demonstrate that our markets are dangerously unprotected against an electronic meltdown. We depend on slow-moving humans at our exchanges to monitor our markets and take actions, such as calling a trading halt when things go haywire. Our markets now react in milliseconds to events but are monitored by humans who respond in minutes. In the time it takes a human to respond to a problem, billions of dollars of damages can occur. It is extremely messy to unwind botched trades after they occur.” (Forbes, May 7, 2010)

Levels:

S&P 500 [1110] previously struggled to hold above 1200. Currently, it’s barely holding above its 200- day moving average of 1095. Near-term indicators suggest that the sell-off is reaching exhaustion at least from a mechanical perspective.

Crude [$75.11], similar to equity markets, had a sharp sell-off near the 200-day moving average. The commodity is back at familiar ranges between $74 and $78.

Gold [$1202.25] is strengthening from previous week as momentum remains positive. At the same time, new, annual highs and slowly approaching recent highs last reached on December 2, 2010.

DXY– US Dollar Index [84.45] had a sharp spike, driving the index to new, yearly highs. This is a reactionary move by investors to rotate towards a defensive currency. Near-term trend might be overdone at a first glance. However, the Dollar Index continues to maintain its strength since bottoming on November 25th.

US 10 Year Treasury Yields [3.42%], after hitting 4% in early April, yields have sharply fallen to 3.50% range.




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