Market Outlook| August 9, 2010

“It is a bad plan that admits of no modification.” - Publilius Syrus (~100 BC)

Macro Factors

Interest rates and volatility were two factors that caught the minds of investors heading into 2010. Clearly, these are key macro drivers of financial markets across various climates. Interestingly, at the end of last week, global investors were reminded that US rates are still low and that volatility is calmer than expected. The first half of 2010 showcased that the speculators estimate of rising rates were gaining popularity, but they did not play out as expected. These low rates trigger further inquiry about deflation, which is becoming a much discussed topic among economists. In addition, lower borrowing costs are helping companies, as it is projected that $100 billion US corporate bonds will be sold this month (Bloomberg, August 6, 2010). Like declining rates, volatility has been well tempered. When combining worrisome results from 2008 and spring of this year, there was a growing fear of additional turbulence. Once again, the consensus thoughts might have failed to materialize, and these lessons provide a key takeaway of not being shaken up by circulating noise. Instead, preparing for surprises in these macro themes is worth a closer look.

In terms of currency, the Dollar remains weak, and economic numbers are not showcasing signs of improvement. Generally, investors seek to place capital in countries with higher interest rates. Perhaps, that mostly explains the two-month decline in the US Dollar as it reverts back to its multi-decade depreciation - a familiar pattern indeed. In fact, the Dollar Index has declined nearly 10% since June 7, 2010. Meanwhile, the disappointment of non-trending markets has contributed to capital inflow into Gold related investments. Yet, it is unclear if Gold has become the new “hot” money or a shelter against other speculative themes. This puzzle should be resolved in the months ahead as investors showcase overall conviction.

Another Inflection Point

On one hand, it’s quite evident that the increasing levels of pessimism in certain areas are justifiable. Now, gauging the confidence of investors is rather a tough read, given this period of disorientation and lack of trend. In a way, an inflection point is reoccurring here with sustainability of the July rally and possible improvement in “real” economic trends. Twice in the past 3 months, when the S&P 500 reached around 1120, it declined and failed to hold. Now, a similar set up is taking place and raises the questions as to which catalysts can spur buying interest or if new elements of confidence have resurfaced. Despite the difficulty of finding a market rhythm, there is an opportunity to bet on "turning points”. Specifically, managers will have to assess overall directional view of the stock market for the rest of the year. Secondly, those with strong long-term views on currency or interest rates might look to reposition overall holdings. Finally, those taking defensive stands need to gain more comfort in credit environments and government policies to create a cycle revival. These are lingering issues from the fall-out of not only the crisis of 2008, but also have deep roots that began in the end of the US bull market in 2000.

Developing Themes

Basically, the last decade focused heavily on hard commodities, such as Gold and Crude. To have a multi-year idea work, there needs to be an agreement of a speculative theme that is of interest to various global participants. The agriculture theme continues to soar, led by wheat prices. This fits into a trend favoring the rise in prices, soft commodities, and food related groups. Countries tied to agriculture, especially in emerging markets, will look to attract foreign capital, given the explosive food demand in Asian countries. At the same time, export policies by key nations will have a lot to say on the implication of rewards and risks associated to this trend. Given the theme of population growth and new emerging economies, this topic will hit the radar of money managers and politicians, given the fundamental social implication. Even in the United States, food related stocks are showcasing relative strength. For example, (BGS) B&G Foods, Inc., manufacturer of shelf-stable foods, has risen over 53% since November 2009. Similarly, Brazilian sugar producer, (CZZ) Cosan, Ltd., has increased by nearly 80% since the fall of 2009. The company’s revenue growth is greatly attributed to rises in sugar prices.

Levels:

S&P 500 Index [1121.64] is facing an inflection point near 1120. Last time, these ranges were revisited in mid July and lead to a downside move from a psychological view.

Crude [$80.70] closed near where we started the year, which is mirrored by the 200-day moving average of $77.81. Investors are awaiting a major directional shift.

Gold [$1207.75] shows further evidence of buyer interest at $1140-1160. Now, the next question is if those bullish views will come back to purchase more above $1220.

DXY– US Dollar Index [80.40] continues to stabilize around $80, and there has not been much movement in recent weeks following a two month downturn.

US 10 Year Treasury Yields [2.81%] had another finish resulting in annual lows. A noticeable weakness in rates after a failed attempt of stabilization at 3%.

Article Quotes:

“It takes years to discover and mine a new source of gold or nickel, but a farmer can plant different seeds and boost supply in just one growing season. If the price of wheat remains high, this will prompt farmers to plant more lucrative crops and supply will increase. This will lead to lower prices. So, the current price spike should not be a cause of great concern. But looking further ahead, there are reasons to worry. Global fundamentals are supportive of a long-term rise in the price of food. At the moment there are just under 7bn mouths to feed around the world. The United Nations (UN) believes there will be more than 9bn people by 2050. In fact, the UN's Food and Agriculture Organisation (FAO) forecasts that total world demand for agricultural products will jump 60pc between now and 2030 – rising much more rapidly than the population….. Demand for grains in emerging markets increases more than the population because of one simple fact – richer people eat more meat.” (Telegraph, August 8, 2010)

“First, we at the Fed must continue to comport ourselves in a manner that exorcises any lingering worries about our willingness to brook any political interference with our commitment to fostering price stability and maximum sustainable employment. We delivered on our duty to restore liquidity to the commercial paper, asset-backed securities, interbank lending, and other markets. We then closed out all of our extraordinary liquidity facilities, doing so without costing the taxpayer a dime (imagine that: a government agency that closes programs after they have outlived their usefulness!). We have worked hard to earn the respect of the marketplace and of the nation, and we dare not risk it at a time when there is so much uncertainty elsewhere. Second, our political leaders should muster the courage to pull up their socks and strike a better balance between the long-term need to keep government debt low and the short- to medium-term need for an appropriate level of fiscal stimulus.” (Federal Reserve of Dallas, July 29, 2010)



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