Market Outlook | August 16, 2010

“Truly successful decision making relies on a balance between deliberate and instinctive thinking.” - Malcolm Gladwell

Last week, the message from the Federal Reserve further triggered worries, along with other factors, that suddenly shifted the calmness of volatility. Yet, glaringly, interest rates continued to decline, even lower than the much discussed 3% on the US 10 Year Yield. The negative stock market tone was supported by a weekly decline of nearly 4% in the S&P 500 Index. Basically, this shakes up the overall comfort zone, while emphasizing the lack of sustainability of early July’s buy signals. Over the halfway point of the year, broad indexes are showcasing negative annual returns, which, as usual, raise the stakes for outside observers. In other words, the concept of purchasing at current prices is less enticing and continues to lose its appeal, at least, momentarily.

Dilemma of Buyers

Earnings season usually causes a sensitive response, since company specific results are scrutinized at a higher level. In addition, technical indicators are suggesting that some areas are overpriced, while other momentum clues provide a sell signal. Perhaps, this contributes to a mentality of waiting until election time to buy shares at possibly lower prices. Interestingly, the moods of investors in the next few days can provide analysts withthe overall magnitude of resurfacing fright. Interestingly, even contrarians need heightened fear to take the brave approach of buying, while the panic sets in. Perhaps, we’re at a confusing state, where real economy data, fundamental business cycle, and psychology are pointing in a similar direction.

Investors Challenge

Money managers now face the challenge of finding asset classes, or company specific stocks, in hopes of gearing up for the next four months. That includes a traditionally turbulent month of September, ahead of mid-term elections. In addition, earnings results seem less likely to produce collective upside surprises. As we’ve seen over the years, catching surprises is where big turnaround bet becomes highly rewarding. However, at this phase, those actively involved in markets will have the challenge of seeking returns in sideways pattern while staying loose to hedge undesired, or less expected, moves. That, in itself, sounds reasonable at first, but it can become hard to execute. At least, conviction levels will be tested, keeping market participants more enthused.

A Balancing Act

Those accustomed to trend-following, from previous years, have to accept the growing importance of understanding government policies in the investment decision making process. Veteran participants are forced to readjust to those lessons, especially in the past two years. Of course, this is highlighted by the GM IPO, which is bound to cause political, financial, and social reactions. This public offering is a symbol of the continuation of bailout plans, and it sends a bigger message of the required adjustment in the current era.

Clearly, trend following alone is not the sole answer for outperformance. And this year has taught us that one has to isolate ideas to specific regions, companies, or concepts. Yet, investing in a relatively narrow idea creates liquidity issues in hopes of attaining higher return. For example, according to EPFR, “Funds investing in emerging-market local-currency debt have attracted $16.9 billion of net inflows so far, more than triple the record annual intake of $5 billion recorded in 2007” (Bloomberg, August 13, 2010). This reconfirms recent strength in specific emerging markets as seen by the strength of Chile, Turkey, and South Africa. Again, there is a balance between seeking huge returns and investing in relatively liquid instruments. The art of balancing the two is the goal of wise managers. Importantly, high conviction ideas seem to be always required, rather than going with the flow, as witnessed in several previous cycles.

At the same time, larger participants are desperately seeking higher yields, which naturally weigh heavily on influencing market response, and it changes the complication of the investing game. Perhaps, this explains why, “Hedge fund managers now account for a fifth of all trading volume in the $10,000bn US Treasury bond market” (Financial Times, August 11, 2010).

Levels:

S&P 500 Index [1079.25] failed to hold above 1120, and it fell even below the other key level of 1100.

Crude [$75.39] had a recent short-term rally near $83, which failed to attract buyers. Currently, it is in a sharp decline mode, yet odds are increasingly favorable to hold between $72 and $74 ranges. There is a strong possibility that the strengthening of the dollar contributed to declining crude prices.

Gold [$1214] is trading slightly above the 50-day moving average, which showcases that the commodity is trading in-line within a defined pattern.

DXY– US Dollar Index [82.94], this month, suggests an early rebound from the summer’s deceleration. However, the weekly recovery is not convincing of a sustainable rally.

US 10 Year Treasury Yields [2.67%] showed a 33% decline in rates after topping on April 5, 2010. Last Friday, it marked the lows for the year. Questions are expected at the next stop around 2.50%. To put some perspective, reaching near 2.50% was last witnessed during the height of the credit crisis of fall 2008.


Article Quotes

“True, central banks talk to a lot of practitioners in the financial markets and the real economy and have a good insight into the short-term money markets from their own operations. But beyond that, they are usually working off the same numbers as everyone else. Yet in times of great uncertainty, investors will cling on to anything they can to form a view about the economy, including assuming the Fed knows more than they do….. There is no such obvious disagreement between government and central bank in the US. But divisions elsewhere are destroying the coherence of fiscal policy. A stimulus-phobic Congress is blocking the White House. And with the recent departures of senior officials Peter Orszag and Christy Romer, there are signs of division and exhaustion within the administration’s economics team.” (Financial Times, August 13, 2010)

"Korea Teachers Pension, the nation's second-largest public pension fund, favors bonds and stocks of Brazil, China, Indonesia, and Malaysia over developed countries because their economies are expanding faster. 'We may invest more there,' Chief Investment Officer Lee Yun Kyu, who oversees 8.3 trillion won ($7.1 billion), said... 'Emerging nations, relatively free from the sovereign debt crisis, will be in good shape.’” (Bloomberg, August 11, 2010)








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