Market Outlook | August 2, 2010

“You must first have a lot of patience to learn to have patience.” - Stanislaw J. Lec (1909 - 1966)

Test of Patience

Despite a positive July finish (Dow 7.8% and S&P 500 6.9%), the story for US markets can be summarized as a robotic-like response in broad indexes without much flair, specifically, when the S&P 500 Index reaches a little above 1100, which triggers a signal of caution for participants, while suggesting that we’re too positive. And anywhere below 1080 appears to mark a selling point. Combining these factors, mostly explains the narrow trading ranges. These swings showcase the collective fuzzy feel and true test of patience for those willing to participate. In turn, this frustrates those trend seekers, while, at the same time, it challenges the skill sets of forecasters. In addition, it feels like there is a growing fixation on chart patterns and some emphasis on select economic indicators.

Basically, continual discussion on the current cycle downtrend is highly visible in headlines and day-to-day conversation. However, for money managers, the daunting task of finding emerging and distinguished ideas is still on high demand. The highly-documented recovery concerns are hard to ignore. In fact, interest rates remain very low, and the cost of borrowing continues to decline as measured by the US 10 Year Treasury, which is below 3%. Perhaps, for some, rates are too cheap to borrow, which can mean that not much activity is taking place. In other words, lower rates coincide with lower than expected confidence. However, volatility appears calm for the moment, and maybe it will fit the desires of global policymakers in an attempt to reach some stability. Interestingly, monthly declines in US Dollar and Gold provide an early clue to some risk tolerance and a slight move away from risk-aversion.

Jotting Down New Themes:

It was only two or three years ago, where "decoupling", began to dominate the thoughts of strategists and portfolio managers. The theory argued the potential of strength in emerging markets and weakness in developed markets. Interestingly, after an up and down moves market proved to be more correlated than usual. However, in looking ahead, divergence among global markets is inevitable as learned in previous years. The first step requires indentifying areas of fundamental growth that stems from natural growth and moderate legal structure, and secondly, picking out timely entry points in selective ideas without major disruption from macroeconomic events. That said, on the surface, it appears that high risk and very fruitful potential rewards are less available, especially given the sentiment in the past 3 months. That said, patient investors will notice that indexes of countries, such as Turkey and South Africa, are demonstrating relative strength. Turkish Index Fund is not far removed from its all-time highs, reached on April 16, 2010. Similarly, Istanbul Stock Exchange market reached record highs last week as it continues to develop and expand. Notably, most of the attraction is driven by foreign investors who appreciate the growth rate of manufactured goods and cheaper transportation cost for exporting to Europe.

Again, despite worries, some optimists might have to soon consider taking on heavier risk in an attempt to capture profound returns. The type of returns that attract long-term investors requires meaningful bets within a favorable cycle. Some veterans will simply argue that the point of this whole game is to seek multi-year favorable returns without guessing and stressing too much. As usual, the quest of finding that illustrious answer is a daunting task, involving more than average risk. However, those in the game will have to try their luck at some point.

Article Quotes:

Revisiting thoughts from the Federal Reserve from two summers ago:


“Structural changes in emerging market economies have helped these countries during the recent period. One change in particular is the strengthening of the policy environment. With improved economic and financial policies, emerging market economies are more flexible and less subject to internal and external shocks that scare investors and disrupt asset markets. Inflation rates have come down dramatically since 1995, in part, as a result of better monetary policy, assisted in many cases by more flexible exchange rate regimes that allowed monetary authorities to focus more intensively on domestic price stability. Fiscal balances are much improved, and many emerging market economies are running current account surpluses. Improvements in the policy environment have helped reinforce perceptions that emerging market assets, on average, are less risky than in the past and are less likely to be sold off in the event of financial disruptions and generalized retreats from risk, such as we have seen since August. As evidence of this, as I noted earlier, emerging market credit spreads have become less sensitive to movements in industrial country corporate spreads, and this trend has been ongoing even prior to the events of the last year.” (Speech by Donald L. Kohn, June 26, 2008)


“It's common to hear concerns that the U.S. economy faces a Japan-style lost decade. But as I've documented, when it comes to employment, income growth, market performance, and fiscal management we've already had a lost decade. The period between 2001 and 2008, characterized by easy fiscal and monetary policy, lax regulation, and low taxes on capital gains, dividends, and income produced pathetic results—and then ended in the worst debacle since the Great Depression. And the macroeconomic performance of our last decade turns out to be worse than we thought. In this release, the BEA revised growth figures for 2007, 2008, and 2009. In 2007, instead of growing 2.1 percent, the economy grew only 1.9 percent. In 2008, instead of growing 0.4 percent, it didn't grow at all. And in 2009, instead of shrinking 2.4 percent, it shrank by 2.6 percent.” (Slate, July 30, 2010)

Levels:

S&P 500 Index [1101.60] is, once again, attempting to climb and hold significantly above 1100. Interestingly, the index is trading at nearly a midpoint between the 50-day and 200-day average. Perhaps, this is evidence that investors are highly skewed to technical indicators and computer driven models.

Crude [$78.95] is mostly in-line with its 200-day moving average of $77.81. This reconfirms the 3-month sideway range as most await an external catalyst for price movement.

Gold [$1169] closed out a negative month of July, after peaking on June 28, 2010. Long-term buyers will watch closely as the behavior of Gold nears 1140 and 1120.

DXY– US Dollar Index [81.53] is nearly in a 2-month decline, which most likely coincides with non-impressive economic numbers.

US 10 Year Treasury Yields [2.90%] continues to maintain a defined downtrend with no early signs of a recovery. Yearly lows stand at 2.85%, reached on July 21, 2010.

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