Market Outlook | June 7, 2010

“While grief is fresh, every attempt to divert only irritates. You must wait till it is digested, and then amusement will dissipate the remains of it.” - Samuel Johnson (1709 - 1784)

Approaching the midyear point presents a reflective stage. The results of a six week sell-off have turned the year-to-date performance returns to a negative for broad indexes . Generally, a pullback, greater than 10%, will naturally lead investors to reassess their thoughts and find new trends within existing themes. As expected, most summer worries mirrored winter discussions, such as overvalued emerging markets, a vulnerable Europe, and shaky sustainability for risky assets. Clearly, these factors resurfaced in several forms. In fact, observers are fixated on daily European credit news flow along with US economic and debt improvement. Perhaps, this is a good time to dig deep in other non-headline materials.

Mindsets

To understand investor behavior, it might help to categorize the thought process of participants into two mindsets. First, there are those whose core mentality treats markets like a “casino", mainly driven by the thrill and agony of seeking a short-term gain. At the same time, these are investors hoping for luck and are quick to jump into the dangerous zone of "sure bets". Secondly, there are those who are seeking opportunities with willingness to have an open mind and a flexible investment time frame and who are driven by the intellectual challenge of navigating the unknown.

Dangers of Group Thought

Generally, one can expect that when these two categories agree on an idea, then an explosive move is more likely to take hold. So this brings us to the current marketplace, where seekers of "sure bets" have been recently humbled and longer-term players are sorting through numerous potentials. The herd mentality proved to be wrong a few months ago, especially on betting on rising rates and increasing inflation, due to an expected economic growth. Perhaps, the low interest rate environment might have created a false optimism, which drove capital into risky assets. However, market corrections damaged highly sensitive areas, specifically ideas linked with China and Crude. Again, this was another reminder of the risks of herding and the importance of understanding market timing. Yet, markets teach us that various environments call for a different reaction; hence, the daunting challenge for a player of this game.

Imagining the Unimaginable

Credit related areas may present a sudden upside move, which can serve as a surprise. Any fundamental strength, such as increasing lending opportunities, can spark an infectious optimism. At this point, casual observers may not rush to seek turnaround in Financials, which remain globally unpopular, and positive signals are subtle to see. However, any marginal credit improvements could spark a positive reaction, especially in interest sensitive groups. This much discussed fear of the system can change at a rapid pace, just like investor’s moods. That said, the S&P 500 Index at 1060 can entice technical buying from a speculator’s perspective. Basically, money managers are offered plenty of assets that are deeply neglected at a discounted price. Interestingly, participation in the stock market will require management of near-term volatility, adjusting to pending policymaker decisions, and patience for further calmness from emotionally charged levels. Of course, these points above are hard to dismiss, even for the most bullish investor. However, staying open-minded for unfathomable opportunities is worth a strong consideration.

Levels:

S&P 500 [1064.88] showed early signs of bottoming around 1060, which can attract long-term buyers and speculators to observe closely. That said, a major hurdle awaits around 1100, based on previous weekly data. Perhaps, this is another confirmation to the current reluctance and growing fear.

Crude [$71.51] had a downtrend in tact below $75 as the commodity is trading very close to its 15-day moving average. Notably, in the past six months, Crude has traded in a range between $70 and $80, and it is removed from extreme levels.

Gold [$ 1203.50] is maintained an uptrend that was sparked by a reacceleration process around late March 2010.

DXY– US Dollar Index [88.23] had a recent surge that confirms the established strength. Like Gold, the late March recovery reflects a defensive posture by investors.

US 10 Year Treasury Yields [3.20%] is back to December 2009 levels, as the rate surge looks short-lived at the moment. Participants wait to see if the May 25th intra-day lows of 3.06% can mark an inflection point.

Article Quotes:

“As mentioned earlier, survey data shows that such measures of confidence continue to linger around the lowest levels seen in a generation. …Stock prices fall with growing government involvement in the economy or with rising inflation. The sharp rise in the government's share of output, in the last decade, and the threat of greater inflation, in the next one, are important factors behind the 30 percent decline in the inflation-adjusted Dow Jones Industrial Average since 2000. Eye-popping deficits of the past year have lowered optimism about the future, kept stock prices depressed, and reduced key elements in new investment spending. These negative side effects of the stimulus spending are certainly slowing down the recuperative process that market forces are attempting to generate.” (Cato Institute, May/ June 2010)

“The sad truth is that when the chips are down, regulators become reluctant to put their money where their mouths are—or more precisely, they become too eager to put their money where they said they would not. Few, if any, policymakers have been willing to let large banking organizations fail, thereby missing an opportunity to impose significant losses on failed institutions’ creditors. We know from intuition and experience that any financial institution, deemed TBTF, will not be allowed to fail in the traditional sense. When such an institution becomes troubled, its creditors are protected in the name of market stability. The TBTF problem is exacerbated if the central bank and regulators view wiping out big bank shareholders as too disruptive, extending this measure of protection to ordinary equity holders.” (Richard W. Fisher Federal Reserve of Dallas, June 3, 2010)

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