Market Outlook | October 11, 2010

“A strong positive mental attitude will create more miracles than any wonder drug.” - Patricia Neal

The US 10 Year Treasury Yields closed near 2.30% last Friday and serves as further illustration of a dominant theme of low rates. Just a year ago, rates hovered around 3.41%. Basically, these low yields are not too attractive for money managers seeking alternative solutions. Perhaps, this explains the increase in sales of speculative bonds that saw $98.9 billion inflow last quarter. In addition, weakening Dollar continues to reach new lows. Inversely, the strength of Gold is a defined uptrend and a uniformly accepted investment idea. Perhaps, this begs the question of potential instability in foreign relations, which are closely tied to currency policies and issues among nations. This is a discussion point that’s bound to spark a sensitive response in global relations.

Meanwhile, volatility appears relatively low, and it is not a major factor as expected by most at the start of the year. Considering the points above, the Federal Reserve has a tricky task ahead, along with fragile belief of the current financial system. As for US stocks, broad indexes are slowly ticking up, and they trigger some hope of reaching back to spring highs. Emerging market funds continue to accumulate assets versus US stocks, which are seeing further outflow. According to EPFR Global, emerging markets accumulated more than $6 billion last week. Once again, individual investor sentiment is weak, and retail desire to own stocks continues to dwindle.

Generally, optimism is one “selling point” of those in financial services, seeking out new investors. Now, some government officials will face that challenge of restoring confidence. Importantly, the hype of promises might not live up to the substance, especially when examining recent trends in labor data. Therefore, to produce a sustainable recovery, sideline investors need to get involved and overcome ongoing day-to-day hesitancy. Simply, that’s understandable given suspenseful tax laws, unclear shift in power, and pending financial regulations. Larger firms are focused on holding cash or buying back their own shares rather than implementing expansion plans. In other words, corporate confidence for capital investments is not too optimistic. Yet, the major issue for leaders is to gauge the consequences of regulatory risk – a murky puzzle.

In finding investable themes, one might look towards new discovery and efficient products. However, auto parts companies are trending higher and reaching peak levels for 2010. For example, Dana Holding Corporation (DAN) survived going bankrupt a few years ago and continues to strongly outperform. A similar pattern is visible in BorgWarner (BWA) and Autoliv (ALV). The group benefits from strong cash balance and low debt, which the market is currently rewarding. This theme exemplifies slower consumer spending and reflects the macro attitude. Meanwhile, this showcases investor willingness to buy companies with predictable cash flows.

Article Quotes:

“Sitting on these unprecedented levels of cash, U.S. companies are buying back their own stock in droves. So far this year, firms have announced they will purchase $273 billion of their own shares, more than five times as much compared with this time last year…. Microsoft, for instance, borrowed $4.75 billion last month by issuing new bonds at rock-bottom interest rates and announced it would use some of that money to buy back shares. The company already has nearly $37 billion in cash….The tech company is reluctant to repatriate the money, because it would get hit with a huge corporate tax bill.” (Washington Post, October 7, 2010)

“The excess reserves of private banks parked at the 12 Federal Reserve Banks exceed $1 trillion. Nonfinancial corporations have an aggregate liquid asset ratio running at a seven-year high; cash flow from current production is running above total investment expenditure; cash as a percentage of market cap is extraordinarily high. Credit availability remains a challenge for small businesses, but only 4 percent of small businesses surveyed by the National Federation of Independent Business reported financing as their top business problem. And reports of lagging receivables or the stretching out of payment terms that were so prominent only one year ago in the corporate supply chain have become as scarce as hens’ teeth.” (Federal Reserve of Dallas, October 7, 2010)

Levels:

S&P 500 Index [1165.15] – After bottoming around 1140, the index is establishing a recovery. Those expecting a rally will use April highs of 1219 as a benchmark on strength of a pending rally.

Crude [$82.66] – Establishing a new trading range above $80, which is overall, in a sideway range while gaining near-term momentum.

Gold [$1341] – Intra-day highs of 1346 were reached last week, which was a continuation of an explosive run that reignited in early September. Interestingly, Gold is 13% above its 200-day moving average.

DXY – US Dollar Index [77.32] – Closed at annual lows as the currency closely mirrors the lower rate pattern, reaching extreme bearish levels, especially below 80.

US 10 Year Treasury Yields [2.39%] – Struggling to hold above 2.50%, which signals a beginning of a new downtrend. As a perspective, the lows of fall 2008 stood at 2.03% at the height of the credit crisis.



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