Market Outlook | May 3, 2010

“A good listener is not only popular everywhere, but, after a while, he gets to know something.” - Wilson Mizner (1876 - 1933)

General market feel and simple investor psychology favored increasing odds of a market correction. This inevitable retracement led to a -2.5% weekly decline for the S&P 500 Index. As to this awaited decline, it was only a question of when. Therefore, it was hardly a surprise last week to see a sharp fall, given the mixed messages of over a 1 year rally. Before recent trading days, it was becoming difficult to deny the uptrend smoothness of risky assets, especially global stock markets. Combining technicals along with human elements creates impactful responses. However, at this stage, one should be careful in claiming of a new trend or discovery.

In looking back, pundits will have to carefully navigate when analyzing stock price appreciation with improving economic numbers. In some cases, others might declare victory and conclude that we’re in a period in which stability is being restored. This is a tricky balance as usual. As the first trading day in May begins, one must wonder and revisit early year thoughts. Currency markets echo similar messages to stock in signaling a defensive posture; specifically, credit downgrades in Europe are partially causing relative weakness of the Euro and strengthening the US Dollar.

Short-lived spikes in volatility have silently hinted of a potential lack of stability. Just viewing historical charts doesn’t paint the picture of extreme worries. However, in the last 8 months, there have been five noteworthy spikes in the Volatility Index (VIX). Despite these clues of turbulence, risky assets in global markets continued to appreciate.

Listed below are percentage gains and periods in which the VIX index jumped from lows to new highs.

33.21% September 23, 2009 – October 2, 2009
58.80% October 21, 2009- November 2, 2009
66.13% January 11, 2010- January 22, 2010
38.61% February 2, 2010- February 5, 2010
52.33% April 12, 2010- April 27, 2010

Article Quotes:

“Higher rates in the United States would encourage investors to move assets into dollars to earn a better return, causing the euro to fall even more. A weaker euro would be good for Greece and European exporters in general by making their products less expensive in foreign markets. But the downside is that a weaker euro would increase the cost of oil and other commodities, which are usually priced in dollars. Higher energy costs would feed inflation, adding pressure on the central bank to raise rates.
For now, that risk seems to have eased after the Fed signaled Wednesday that it was in no hurry to raise rates.” (New York Times, April 30, 2010)

“The European Central Bank keeps the Continent's banking system functioning day by day through short-term loans to commercial banks. In these cases, the ECB usually accepts the banks' holdings of government bonds as collateral. Greek debt is now rated as junk by S&P: Under current ECB rules, Greek bonds can't be used as collateral by the ECB if Fitch Ratings and Moody's Investors Service (MCO) cut them to junk as well. The Frankfurt-based central bank may have to dilute its collateral rules to keep the Greek banks operating. The ECB's problem of securing solid collateral for its loans will expand greatly if Spain and Portugal lose their investment-grade status, too.” (Businessweek, April 29, 2010)


Levels:

S&P 500 [1186.69], in the last few weeks, witnessed the struggle to stay above 1210 and a clear sign of peaking. Next key levels will be eyed by investors around 1090, near the 200-day moving average.

Crude [$86.15] has had a choppy pattern, between the $82 and $86 range, as oil remains upward trending.

Gold [$1179.25] had a recent recovery and has produced by over an 11% gain since February 5, 2010.

DXY– US Dollar Index [81.86] is trading near ranges last seen at the end of March. Multi-month trend remains positive, and few points removed from annual highs.

US 10 Year Treasury Yields [3.65%], in April, showed a dramatic reversal for yields after peaking at 4%. Next key level is around 3.57%, where the current 200-day moving average stands.

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