Market Outlook |November 15, 2010

“Certainly, there are good and bad times, but our mood changes more often than our fortune.” - Jules Renard

A Perspective

It feels like 2007 all over again, when tracking price appreciation in stocks and commodities. Or maybe it feels like April 2010, in a period when the S&P 500 Index closed near 1200 and Crude was priced at $85. In both cases, that marked a peak for key asset classes. Interestingly, both macro indicators are near those spring 2010 ranges as well. Perhaps, that subtly suggests a set up that favors further declines. The slow and steady stock market appreciation appears murky, especially when blending discussion of quantitative easing. In other words, the comfort level among investors in the ability to grasp Federal Reserve actions is not quite clear and bound to create political chatter and further debates

Short-term Landscape

A much needed breather in broad stock market indexes took place last week as selling dominated global investor mindset. It did not take too long for the markets to cool off from recent optimism that was driven by new stimulus policy. Some odd-makers and chart pattern observers were hinting the strong possibility of minor retracements. Now, the question is how one mood swing can contribute to greater uncertainty and spark another down trending momentum. It is vital to note that the European credit worries contributed greatly as a catalyst to late April sell-offs. In digesting the similarities, one can observe that the worries in European country economic stability are resurfacing as well. In addition, the real estate bubble in Australia and overheated emerging markets are on the radar of decision makers in money management. Yet, the current declines, along with reiteration of previously known facts, might require more evidence to classify as new information. Therefore, daring investors will be challenged to avoid the noise of headlines.

A Closer Look

As moods find a way to shift quickly, the Dollar and Interest Rates are showcasing a noteworthy response in the last few weeks. Both indicators have remained in a downside, multi-year cycle. That said, it is quite intriguing that the Dollar and US 10 Year Treasury Yields have risen in the past two weeks, despite the general sentiment and expectations. Usually, at year-end, some trends go slightly unnoticed given minor hints and movements. However, the sustainability of a recovery in rates and appreciating Dollar should not be underestimated. Similarly, the multi-month trend of tamed volatility (as measured by VIX index) is at an early stage of showcasing freight, which showcases a potentially chaotic response. Market historians remind us that sentiment changes quickly, and those looking for attractive opportunities might have to react as fast as those looking to exit. Therefore, this week can provide further clues of key trends for longer-term and sideline observers.


Article Quotes:

“Junk yields are at their lowest levels since October 2007. And the leveraged buyout market is back to paying 2006 levels of EBITDA (earnings before interest, taxes, depreciation and amortization) of 6 to 8.5 times, with the recent announcement of Carlyle Group’s reported 11 times EBITDA purchase of Syniverse Holdings echoing the peak of the precrash craze. As you know, buyout people do not typically acquire companies with a plan to expand the workforce, but instead with an eye to tighten operations, drive productivity, rejigger balance sheets, and provide an attractive payback, usually in shorter time than under normal corporate horizons. And the corporations I talk to that are eyeing possible acquisitions with their surplus cash and ready access to the credit markets are not given to thinking of strategic acquisitions as a way to expand payrolls.” (Speech by Richard W. Fisher, Federal Reserve of Dallas, November 8, 2010)

“The suggestion that speculators deliberately manipulate markets to earn profits through bubbles and busts simply does not hold water. The explanation for the sudden spikes in the prices of many commodities in recent years lies in nothing more sinister than the laws of supply and demand. A ravenous China, underinvestment in mining and agriculture, tight markets and unexpected disruptions to production are usually to blame for rapid price movements. When supply is tight, a small increase in demand can have a disproportionately large effect on price. Even if speculators do sometimes push prices out of kilter the fundamentals soon regain the upper hand.” (The Economist, November 11, 2010)

Levels:

S&P 500 Index [1199.29] – Retracing from last week’s highs of 1227.08, after being stretched in this recent rally. The 1200 mark is vital, since that is near the level where the market peaked and declined in April 2010.

Crude [$84.88] – Prices have struggled to stay above $85 for a significant period. A step back reminds us that Crude prices are in a wide trading range between $75 and $85.

Gold [$1388.50] – The commodity is up over 20% since bottoming on July 28, 2010 and stands 15% higher than its 200-day moving average. In the near-term, observers will be watching any pending weakness in which investors might consider buying at 1350.

DXY – US Dollar Index [76.54] – It remains in a consolidation phase and slightly above annual lows. Interestingly, the index is up 3.77% in the past seven trading days.

US 10 Year Treasury Yields [2.78%] – There are early signs of rising rates, especially in the past two weeks. The surge closer to 3% can spark psychological and practical responses from global managers.




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