Market Outlook | May 24, 2010

“Where we have strong emotions, we're liable to fool ourselves.” - Carl Sagan (1934 - 1996)

The established spring hiccup is bringing on more worries, while frustrating those that are seeking a turnaround. Ahead of an extended holiday weekend, volume, along with conviction, is bound to slowly dwindle. Interestingly, S&P 500 at 1080 seems like a favorable area for a short-term recovery, at least when viewing chart patterns. In fact, the S&P 500 closed slightly above the “flash crash” lows.

The thought of a sustainable upside move is hard to convince those who’ve witnessed the Volatility Index (VIX) spike by 216% since April 12, 2010. At this point, Volatility has more than doubled in a very narrow timeframe. Perhaps, additional time is needed to digest an eventful 6 weeks, which have revisited a crisis mindset. The list of worries has expanded from European credit conditions to an unknown pace of an economic recovery. However, explaining the why will challenge analysts and should occupy headline topics. Nonetheless, the downtrend message is clearly visible, and markets are driven by emotions.

Veteran participants have been taught by experience to relentlessly seek ideas for future purchases. Similarly, value hunters are digging deeper to find company specific ideas. Both approaches will require focusing on fundamentals and avoiding distractions from macro events. The challenge ahead is to position one’s portfolios with quality companies ahead of a recovery. For example, industrials, such as Raven Industries (RAVN), continue to benefit from cost cutting and increased sales in agricultural and military products. Secondly, consolidation in the technology sector creates some opportunities for speculators. Finally, innovation in healthcare can stimulate buyers who are eager for momentum driven plays. The above points can also benefit from money, out-flowing from themes, related to China and Crude. In other words, odds favor creative companies with new growth stories, which might attract assets that have been flown away from risky assets.

Simply, an election year filled with financial regulatory discussions can cause obvious apprehension. A low interest rate environment for many months encouraged betting or risky assets. As usual, periods of a market correction showcased a shift towards risk aversion, as seen by rotation into US Dollar and Gold. Basically, last year, investors felt the fear of missing out on a recovery rally. This year, the urgency to buy is not there, and the argument for undervalued asset pricing is not that compelling. The current environment will require patience, especially until rational senses begin to slowly take center stage.

Levels:

S&P 500 [1087.69],at this point, is giving up gains from February to April 2010, based on the current sell-offs. Interestingly, around 1060 investors will watch closely for further hints.

Crude [$70.04], following an exaggerated one-day move, found a way to close at $70. However, given recent weakness, many wonder the commodity’s ability to stay above these levels.

Gold [$1179.75] is retracing from yearly highs, while maintaining its positive cycle momentum. Appears like a potential down to sideway action is highly likely in the days ahead, based on technical patterns.

DXY– US Dollar Index [85.31] continues to maintain its near- and long-term uptrend, benefiting from a risk aversion trade as well as a cycle shift.

US 10 Year Treasury Yields [3.23%] has failed twice in the past month to hold above 3.40%, which confirms ongoing weakness. Yields have round tripped back to December lows of around 3.20%.

Article Quotes:

“Very low interest rates and readily available money encourage risk-taking and leverage; if, as in the United States since 1995 or as in the EU since 2002, those policies are pursued for a number of years, the risks will become enormous and the leverage will increase to a suicidal level. The even lower interest rates imposed on the global economic system since 2008 have increased the incentives for leverage still further, making the need for bailouts even more urgent and their size even greater.” (Asian Times, May 19, 2010)

“In 1996, Sir Martin Jacomb, then chairman of the Prudential, set out with great prescience in two pieces for The Sunday Telegraph why a European single currency, without full political integration, would end in disaster…..’A country, which does not handle its public finances prudently, will find its long-term borrowing costs adjusted accordingly,’ Sir Martin predicted. ‘Although theory says that default is unlikely, nevertheless, a country that spends too much public money, and allows its wage costs to become uncompetitive, will experience rising unemployment and falling economic activity. The social costs may become impossible to bear.’" (Telegraph, May 20, 2010)


Please note: The next Market Outlook will be published on June 7, 2010.

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