Market Outlook | October 25, 2010

“Chaos often breeds life, when order breeds habit.” - Henry Brooks

Characteristics

Besides the short-term traders seeking gains in smaller executions, there seems to be two kinds of participants that contribute to this current uptrend. Like any product, generating a buy idea requires someone who is in a positive mood or someone who is willing to take risks. Secondly, the buyer is mostly focused on the promising “feel” while understanding that various big picture worries are never-ending. Perhaps, these traits are worth noting as broad indexes are getting closer to spring 2010 highs. And there are shrewd participants who find a way to grasp details, mechanics, and discrepancy while capitalizing on existing inefficiencies. Simultaneously, there are also plenty of observers that watch the quest of risk takers with an overly skeptical view. However, as markets continue to reward risk takers, observers keep coming back for actionable ideas. The S&P 500 and Dow Jones are up over 6% for the year, and that serves as a campaign for developing strength. At the same time, the trick remains in navigating through a moody market. It’s there that devising a plan is challenging and old habits become less effective in generating returns.

Macro Radar

Talking about recent habits, buying Gold is a global phenomenon with an overly bullish consensus view. Last week, Gold prices declined by 3.04%. This is something that has not been seen in a while. In contrast, a slight jump in the US Dollar might set the stage for a surprise, especially for those daring participants. Short-term charts would suggest that this profound multi-year, inverse relationship is difficult to bet against, given the Federal Reserve’s anticipated game plan of quantitative easing. Meanwhile, rise in interest rates has not been a concern in the past few weeks. However, along with US Dollar appreciation, a rude awakening in rates can be impactful in early 2011. Before then, the brewing currency issues will need to be resolved among foreign policy makers.

Attractive Ideas

Technology-related themes have contributed to an overall stock market recovery based on innovation and discussions for Merger & Acquisitions. Rovi Corp (ROVI) is a Digital entertainment company, and with its stock prices, it consolidates between $48-50. Earnings result this week can provide a better read on investors’ expectations and create a short-term response. Nonetheless, the multi-week positive momentum can entice long-term buyers. Similarly, Aruba Networks (ARUN) provides products related to mobility solutions, and it is focused on existing wireless trends. The company reflects an innovative company with a solid sales growth, which can provide a relative outperformance. Finally, internet security companies are witnessing higher growth rates. For example, Sourcefire, (FIRE) maintains its uptrend while trading near all-time highs. The story is compelling not only to investors, but also to potential large cap technology companies that are looking to acquire and grow their empire.


Article Quotes:

“The reopening of the junk-bond market has also afforded medium-sized firms access to credit again. The businesses that have tapped the market are a cross-section of corporate America: airlines, clothing manufacturers and retailers, health-care providers, drug firms, restaurant chains, oil-exploration firms, and semiconductor manufacturers. Some of the new issuance is by firms looking to lock in long-term financing on good terms….The market’s revival has been helped by fewer defaults on high-yield bonds. The default rate on junk bonds stayed above 8% for 14 months in 2009-10.” (Economist, October 21, 2010)


“Someone buying the 10-year bond is locking in a likely ‘real,’ post-inflation yield of just 1.2% a year. Someone buying the 30-year bond should expect maybe 2.5% a year over inflation. And these are pretax rates. It is perfectly possible that some investors, without realizing it, have just locked in a negative real yield—in other words, they have made an investment that guarantees they will lose money after taxes. … The problem is that they, and their advisers, are apt to separate "asset allocation" from investing—in other words, they first decide to invest in bonds and then send money to a bond fund. The hapless bond fund manager then has to go out and ‘put that money to work,’ even in an overvalued market.” (Wall Street Journal, October 22, 2010)

Levels:

S&P 500 Index [1183.08] – Upward trend is established, and nearly a 14% run since late summer illustrates the strength of this two-month recovery. Minor pullbacks can attract buyers at 1160 or 1140.

Crude [$81.69] – Current price is in line with the 15-day moving average. Next key upside target is closer to $85.

Gold [$1322] – Early, but a natural pause following recent acceleration. If pullbacks continue to persist, in upcoming weeks, then chartist will watch $1300 and $1280 to gauge overall buyer’s appetite.

DXY – US Dollar Index [77.41] – Barely recovering from annual lows, but a glimpse of a reversal. Setting up for an upside move, especially if favorable GDP and other economic data this week.

US 10 Year Treasury Yields [2.55%] – Stabilizing around 2.40%, while attempting to bottom here. A move above 2.80% can spark further momentum if reached in the near-term.



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