Market Outlook | January 11, 2010

“The more you know, the less you need.” - Aboriginal Saying

Another week of rising markets reiterates the established theme of strong markets and a weak labor environment. At the same time, there are growing temptations among pundits to call for downside moves as part of growing anxiousness. In looking ahead, quarterly earnings reports should reveal the mood for the first quarter. Also, economic results and a much anticipated Federal Reserve policy on interest rates are on the radar.

Delicate Territory:

Charts suggest that we are extended in the near-term and poised for moderate sell-offs. This causes investors to assess the possibility of losing out on gains during this recovery. Of course, the comfort level has increased on each higher point move. Right now, as indexes reach 52- week highs, some are considering backing off, while others will look to hedge. For those waiting for cheaper stock prices, even a 10% pullback might be viewed as healthy. However, pullbacks since March 2009 have failed to drop significantly. Importantly, the multi-year cycle recovery is a powerful force, and it should not be underestimated, as learned in 2009. However, a few questions, regarding this trend, will have to be answered in the weeks ahead.

First Quarter Feel:

A casual observer may guess that earnings can possibly present the first glitch towards this uptrend. Basically, this season of earnings provides a reality check and another perspective in gauging sentiment. In other words, the status of the company balance sheet can either convince sideline participants to buy or calm the nerves of those already heavily invested. To fuel this ongoing rally, one must examine the potential data output and interpretations. Now, for most investors, the leaders of this ongoing uptrend are becoming clearer, and only a small amount of portfolio reshuffling may be required. In other words, risky assets have worked, such as high yield bonds, higher beta stocks, and China related groups. Of course, the risk of adding to an existing trend is either missing the right security or an inverse impact from declining broad markets. However, surprises between now and then will determine the direction and mood around early spring. For now, the bullish bias is intact, even though skepticism lingers and trading volume remains low.

Recent Clues:

Technology and Emerging Market related stocks have showcased relative leadership for the most part of this rally. Now, if weakness persists, bargain hunters would seek to add to both groups. In the same way, small cap has been outperforming large cap, especially since late November 2009. Interestingly, in the same period, the US Dollar is strengthening as well. Perhaps it is a coincidence, but it is an intriguing relationship for those looking for new trends within the second phase of this recovering rally.

Article Quotes:

“’The [Chinese] government also approved margin trading and short selling,’ the China Securities Regulatory Commission said in a statement on its website today. ‘It may take three months to complete preparations for index futures,’ the regulator said. Index futures, agreements to buy or sell an index at a preset value on an agreed date, may help ease fluctuations after the Shanghai Composite Index doubled in 2007, then slumped 65 percent in 2008 before rebounding last year. Until now, Chinese investors could only profit from gains in equities.” (Bloomberg, January 8, 2010)

“Even as some would have you believe that you have to be insane to buy stocks heading into 2010, there are many positive factors that investors can point to as reasons to be bullish. However, one that you won't hear being cited is valuation. Based on trailing earnings, the average P/E ratio of the S&P 500 during the decade that just ended was higher than any other decade in its history. Even after declining since the turn of the century, the average P/E ratio for the '00s rose to a record high of 20.2, and, at the end of December '09, it stood at 27.9 (on an operating basis).” (Bespoke, January 5, 2010)

Levels:

S&P 500 [1144.98] is 13% removed from its 200-day moving average, and it extended in the near-term. However, a shallow correction points to the first key point at 1080. Secondly, around a 10% correction places the index around 1040-1030.

Crude [$82.75] is surpassing previous highs, after a 21% rally that started in mid December. It is setting up for a short-term pause.

Gold [1126.75] attempts to revisit $1212, which marked annual highs in 2009. Buyer interest around 1100 appears to hold.

DXY– US Dollar Index [77.47] is pausing after a late 5% run in the late part of last year. Confirmation is needed to solidify this recent trend reversal.

US 10 Year Treasury Yields [3.82%] has not had much movement since last week. It is stabilizing at current levels after a significant run up.
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