Market Outlook | November 22, 2010

“Man cannot discover new oceans unless he has the courage to lose sight of the shore.” - Andre Gide

As the holiday season begins to slowly resurface, the minds of investors will be occupied on looking ahead to the first quarter of 2011. It seems appropriate to revisit future outlook as analysts gather to make estimates. Importantly, it is a good time to map out possible surprises as well. As we learn, almost every year, the unfathomable elements, versus consensus thoughts, are worth examining. For instance, inflation expectations appear very high, and meeting those expectations is rather questionable. Similarly, the enthusiasm for existing themes can begin to dwindle, such as commodity run, strong dollar, and lower interest rates. Of course, these are not only annual themes but have been visible for multi-year trends offering various waves.

Meanwhile, investor excitement for new ideas is quietly resurfacing, even though, at times, it is not visible to the broader audience. Despite the mixed market read, it is hard for one to argue that global markets have lacked optimism, especially in the last few months. In fact, the second half for savvy investors has presented opportunities. So far this year, the S&P 500 Index is up 7.6% and Russell Small Cap Index has gained over 15%. Simple scorekeeping is not enough to cease skepticism surrounding the Federal Reserve decisions and restoration plans. To sum up, in certain periods, the market performance is not to be confused with economic performance or other rhetoric.

Two years after the major crisis, the adjustment to a new era continues. In the United States, taxation impact, new policies, and persisting real estate worries can shape the overall trend. Interestingly, within this new cycle, periods of volatility are poised to be triggered by reactions related to central bank policy. In recent weeks, tension among economic leaders was displayed, which paints a prelude to testy global policies. This mainly relates to Europe’s economic and political troubles that require some time to shake off. Meanwhile, run up in asset prices and heating economy in emerging markets is bound to reach unsustainable levels. Like any topping process, identifying all risks is hard to quantify in advance. Thus, managing instincts and emotions will be vital for those deeply invested. In other words, money managers cannot justify selling due to an “unknown”, so at this point, observing is the practical, and occasionally painful, option.

Selective Approach

In terms of constructing a portfolio, a selective approach seems fruitful as there is a discrepancy between the broad index and specific ideas. The momentum of chasing commodities related investments has outpaced other areas. However, those owners of commodity related assets will have to look six months ahead. Therefore, innovative groups, such as healthcare and technology, present specific ideas. This serves as an alternative to pricey, valued, natural resources, given higher performance chasing by global investors.

In terms of healthcare, there is a trend in recent years of a growing number of hip and joint replacements. Specifically, Smith & Nephew (SNN) continues to see positive global growth and offers an attractive entry point. The company benefits from its advanced wound treatment as well as its core joint replacement business. In addition, a recovering economy can even tack on further gains to Smith & Nephew’s business model.

On the other hand, several technology stocks have lead this market recovery. Meanwhile, the intriguing area of personalized robots takes innovation a notch higher while presenting a cutting edge idea. Currently, the robot usage is applied for military use along with expanding products for consumers. One way to gain exposure to this theme is by owning shares of IRBT (iRobot), a publicly traded company that is showcasing strength and momentum. Importantly, the company is equipped for leadership in this niche sector.

Article & Research Quotes

“The average S&P 500 stock rose 18.43% from the start of September through November 5th. Since November 5th, the average stock has declined 2.75%. We broke the index into deciles (10 groups of 50 stocks each) based on performance during the rally and calculated the average performance of stocks in each decile since November 5th to see how the rally winners and losers have been doing during the recent pullback. It's almost always the case that the stocks that go up the most during rallies also pull back the most when the market corrects. Interestingly, this hasn't been the case during the current pullback. …The three deciles of stocks that did the worst during the rally have also done the worst since 11/5. Investors in the big winners over the past couple of months haven't really been hurt over the past two weeks. The losers, on the other hand, have remained losers.“ (Bespoke Investments, November 19, 2010)

“Greece is now under an EU protectorate, or the “Memorandum” as they call it. This has prompted pin-prick terrorist attacks against anybody associated with EU rule. Ireland and Portugal are further behind on this road to serfdom, but they are already facing policy dictates from Brussels, but will soon be under formal protectorates as well in any case. Spain has more or less been forced to cut public wages by 5pc to comply with EU demands made in May. All are having to knuckle down to Europe’s agenda of austerity, without the offsetting relief of devaluation and looser monetary policy.” (Telegraph, November 16, 2010)



Levels

S&P 500 Index [1199.73] – Basically, no major change since last week’s close. Trading pattern near 1200 will be watched and closely tracked for some additional hints.

Crude [$81.51] – Once again, there is less willingness among buyers around $85. A retest of $80 seems like a strong, short-term possibility.

Gold [$1342.50] – Staying above 1400 presents a near-term challenge after an explosive run, however, a longer-term trend.

DXY – US Dollar Index [78.50] – Stabilizing from annual lows driven by the recent run. The index is still significantly down from the summer as the downtrend remains in place.

US 10 Year Treasury Yields [2.87%] – Following a bottom at 2.40%, yields are noticeably rising this quarter. The next key range stands around 3%, which has not been seen since midyear.



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