Market Outlook | January 18, 2010

“Do not fear to be eccentric in opinion, for every opinion now accepted was once eccentric.” - Bertrand Russell (1872 - 1970)

Current Feel:

At this stage, US markets appear extended after a strong multi-month run. In the near-term, a bumpy road is ahead with technical pausing, upcoming decisions by the Federal Reserve, and quarterly earnings results. The current bullish bias remains feasible from a cycle perspective. Now this long-term view will be challenged as participants become overly sensitive to the bad news affecting day-to-day trading. Options expired last Friday and showcased a slight increase in volatility. For the most part, it was inevitable and to be expected. Of course, volatility has remained low, nearing levels that were last seen before the crux of the financial crisis. In addition, stocks and commodities are moving lower as tightening liquidity is becoming an interest for global policymakers. For example, China is increasing its bank reserve requirement as another tool of easing the ongoing bubble of overheating assets.

The US 10 Year Yields recovered recently, but the sustainability of rising rates remains doubtful. Interestingly, there is anxiety in regards to rising interest rates. This behavior is visible as investors rush to raise money from bond markets. This panic-like response towards rates might be an overreaction and worth watching closely. That said, more attention will focus on macro inflection points where, collectively, investors await catalysts to result in a trend shift. Similarly, at this junction, investors are realizing that timely entry points are tricky, versus spring 2009.

Big Picture Trends:

Trends are favoring small cap and innovative based areas in the past few weeks. Non large cap themes were showcasing a positive momentum, mainly at the end of last year. Beneficiaries of this strength include Technology and Healthcare, which require company specific picks for fruitful outperformance. In addition, multi-year cycle favors these sectors, despite a pending broad market correction. Similarly, small to mid size companies are subject to consolidation, especially with increasing talks of Merger & Acquisitions. Therefore, at the end of earnings season, observers can distinguish leaders and reposition into companies, gaining fundamental strength. Innovative companies within smaller caps can be attractive, especially with solid earnings growth. Selecting ideas that fit these themes might be favorable in Biotech, Semiconductors, and Communication based areas.



Vulnerable areas:

Decade long winners are highlighted by emerging markets and commodities, which are not cheaply valued in traditional measures. Adding these ideas into portfolios has greater risks and the fear of limited upside moves. Some observers are noticing that these escalated levels present a fragile point with rising expectations. However, given the 2007/08 correction, it paints a picture that we’re still removed from all-time highs. In other words, optimists believe that previous highs will be revisited and potentially surpassed. As usual, investors need more confirmation, mostly for psychological comfort. And, certainly, government intervention will play a big role as investors react based on news flow, government policies, and regulatory events. In terms of stocks, fundamentals for Energy related areas are expected to decline, and, if that materializes, it can then trigger a market sell-off. That said, in the days and weeks ahead, material and commodity based companies can lead on downside moves.

Article Quotes:

“Even so, we believe a full-blown dollar crisis — involving a collapse in our currency and an inability to pay our debts — is unlikely. Fears over the dollar often surface during times of fiscal stress, only to fade when conditions ease. As a Goldman Sachs report recently noted, "fears over demise of the U.S. dollar seem to resurface every 10-15 years." And here they are again. Indeed, we've been hearing for years the dollar is already in crisis. But as the chart shows, the trade-weighted dollar index shows the greenback is actually higher than during the 1990s Internet boom. Foreign investors hold trillions of dollars in U.S. debt. They could decide to dump them, putting severe pressure on our currency. But that would also do damage to their own balance sheets.” (Investors Business Daily, January 15, 2010)



“The 50 biggest stocks in the S&P 500 are up an average of 2.4% year to date. The 50 smallest stocks in the index are up an average of 6.5%. In general, the bigger the stock, the smaller the gain so far in 2010.” (Bespoke Investments, January 14, 2010)



Levels:

S&P 500 [1136] is recently showing signs of stalling around 1150 and is due to pause closer to the 10-day moving average of 1140.

Crude [$78.00], retraced from January 11 highs of $83.95, highlights the recent peak. Multiple timeframe analysis suggests increasing odds of pending pullbacks.

Gold [1128] is trading between a defined trend of around 1100-1150. Long-term trend is positive but not a favorable entry point.

DXY– US Dollar Index [77.32] is attempting to maintain its recovery around $77. In the next few weeks, events should determine the strength and legitimacy behind a stronger Dollar.

US 10 Year Treasury Yields [3.67%] is slowly declining after a strong run in late December. In the past 8 months, yields have failed to surpass the 3.80% range. Once again, a similar set up is taking hold. Next key support levels reside at 3.60% and 3.40%.




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