Market Outlook| October 4, 2010

“Courage is resistance to fear, mastery of fear - not absence of fear.” - Mark Twain (1835 - 1910)

The strong month of September might have surprised those who heavily relied on average historical returns. Traditionally and statistically, the month of September is known to produce less than attractive returns .Perhaps, this time around, the anticipation of the unknown is even more thrilling, given that pessimistic views were becoming tiresome. Yet, a quick reminder, that relying solely on odds presents some dangers and neglects the mindset of investors. Despite a neutral to down weekly finish, the overall stock market showcased an impressive strength this early autumn. Another part to this puzzle is the waiting game and search for guidance from the election season. That clarity is missing, which has kept the bigger trends intact. On the other hand, there are pending issues in this new era of Financial Markets. Managers are adapting to new mechanics changes, which include exchange policies as a result of the flash crash earlier this spring. Clearly, various legislative changes to asset management, along with shrinking liquidity, are issues that can influence overall transactions. Finally, the past few weeks offered a relief rally, but sorting out European credit worries is unclear, which impacts the fragile sentiment.

Same Old Gold and Dollar Story

In terms of big macro drivers, there are not many changes to these decade-old themes. Specifically, the current established trend of strength in Gold prices, lower rates, and declining US Dollar. This relationship is highly publicized and remains dull, while failing to create a sense of excitement for aggressive investors. The weakness in the US Dollar is interlinked with various financial assets and in the radar of policy officials. Conversely, the momentum in Gold prices reemphasizess the movement towards risk aversion. That said, in the month ahead, currency policies are poised to set the tone for international relations as well as market behaviors. The lack of major shifts in macro trends for several years begs the question: why fight the existing trend? However, there are speculators that are active in the guessing game, in a period where most are discouraged to make gutsy bets. The surprise element finds a way to attract those eagerly waiting for an inflection point. However, at this point, the force behind a weaker Dollar (increasing Gold prices) remains too powerful. Each season, those betting against these trends are dwindling and failing to attract contrarian fans.

Few Positive Trends

Mergers & Acquisitions is a promising theme that’s gaining some traction and mainstream attention in that past few years. According to Bloomberg, “The jump in deals in the third quarter brings total announced takeovers to $1.48 trillion in the first nine months of 2010, compared with $1.76 trillion in all of 2009." This showcases that cash, waiting on the sidelines, is seeking new opportunity and emphasizes the bias toward further strength in large cap companies. Much of M&A discussions are centered on technology and other innovative-based groups. Many wait if larger companies plan to acquire growth-related companies. For those searching for company specific bets, there are opportunities, especially in cell phone technology – for example, Skyworks (SWKS), a company benefiting from the growing handset market, while projecting solid revenues. Interestingly, the shares of Skyworks rose nearly 500% since December 2008, illustrating the impressive outperformance. Other companies in a similar area include TriQuint (TQNT) and RF Micro (RFMD). On a similar point, biotech and medical equipment showcase fundamental strength, and they are poised to attract longer-term investors.

Article Quotes

“The crisis was followed by the slashing of interest rates in the developed world. These have had a limited effect in reviving lending in Western economies. But they have encouraged Western investors to buy higher-yielding assets, like emerging-market equities. Emerging-market equity funds have already received inflows of $45 billion this year, according to EPFR Global, a research group. And low rates will also boost credit creation in those developing countries that import American monetary policy via managed exchange rates.” (Economist, September 30, 2010)

"An 'international currency war' has broken out, according to Guido Mantega, Brazil's finance minister, as governments around the globe compete to lower their exchange rates to boost competitiveness. Mr Mantega's comments... follow a series of recent interventions by central banks, in Japan, South Korea and Taiwan in an effort to make their currencies cheaper. China, an export powerhouse, has continued to suppress the value of the renminbi, in spite of pressure from the US to allow it to rise, while officials from countries ranging from Singapore to Colombia have issued warnings over the strength of their currencies.” (Financial Times, September 27, 2010)

Levels

S&P 500 Index [1146.24] – Consolidating near 1140 range, which begs further question about sustainability. Interestingly, the index ended the week closer to the higher range of this summer’s trend. A 13% rise since the lows reached on July 1, 2010.

Crude [$81.60] – A series of sharp upside moves, which were sparked by a weaker US Dollar. The commodity closed the month on a very strong note. It currently is not far removed from August 4th highs of $82.97.

Gold [$1317] – Explosive momentum remains in full gear. Psychologically breaking the 1300 mark sends a strong message of strength and potentially attracts addtional wave of new buyers in the current cycle.

DXY – US Dollar Index [78.08] – Since June 7, 2010, the US Dollar Index has declined by 12%. It ison the verge of giving up the annual gains witnessed earlier part of this year.

US 10 Year Treasury Yields [2.51%] – Further weakness as Yields attempt to hold above 2.60, which now seem rather fragile.


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