Market Outlook | December 6, 2010

“Real wealth is ideas plus energy.” - Richard Buckminster (1895-1983)

At this junction, the broad index points to a simply stronger finish to an already positive 2010 performance. The stock and commodity markets were in cooling off mode heading into last week. Mostly, the November downtrend can be classified as an inevitable decline following the autumn rally. However, risk appetite is slowly coming back as the S&P 500 Index rallied nearly 3% for the week, commodities are resurging, and volatility estimates are more tamed. Now, the labor numbers might fail to tell a similar optimistic story, but as usual, this may not impact the forward looking markets.

Reading overall sentiment is tricky since, for the most part, key asset classes, such as corporate bonds, emerging market stocks, and commodity related investments, project a healthy appetite in the mindset of investors. Meanwhile, we are in a period where investors are presented with various niche areas and several financial vehicles. An example of usage of various instruments is demonstrated here: “The value of currency derivatives worldwide doubled in the past three years to $3.2 trillion amid the 'turbulence' of the credit crisis” (Bloomberg, November 30, 2010). This potentially exemplifies further investor usage of various tools, while showcasing enhanced demand for hedging. Thus, reading fear is confusing when markets erupt and psychology leans toward caution.

Beyond the Worries

As daring investors look to either take profits or redeploy capital into new ideas, the casual observer is left deciphering few questions. Only few days ago, the European credit problems escalated from headline chatter into sensitive market responses. In other words, there is no shortage of worrisome issues, such as bubble-like patterns in emerging markets and the fragile status of certain European economies. Even heading into year-end, one can assume that credit and economic concerns have not fully vanished. This, in turn, suggests that risk takers are still offered some reward.

Basically, from money managers’ views, as long as consensus is not too bullish, the work is in finding attractive ideas while grasping the associated, less known details. Similarly, other big picture unknowns, such as taxation and regulatory impact, are bound to entice investors to speculate in upcoming weeks. On the other hand, finding themes less affected by government decisions are worth identifying. Those ideas might be limited, given significant policymaker influence in this environment. However, the key message here suggests that the unsettled market opens up opportunities across various timeframes and caters to an assortment of risk tolerances.

Specific Ideas

There are opportunities in momentum driven areas that have excelled in niche areas. For instance, Interactive Intelligence (ININ) presents an attractive story, and the shares are even more appealing on pending pullbacks. The company is in the software business, and their service arena ranges from voice-over Internet protocol to workflow management. In terms of investors looking for innovative themes into next year, ININ is worth a look as it provides exposure to phone center automation and enterprise IP telephony. In other words, the line of business fits into global themes of interest to expanding businesses. Importantly, any sell-off in the near-term can be viewed as a purchasing opportunity for longer-term investors.

Companhia de Saneamento Basico do Estado de Sao Paulo (SBS), a water and sewage service provider, is one way to bet on expanding Brazilian infrastructure. SBS maintains its uptrend, and as shares consolidate between $46-50, there are opportunities for timely buy points. In addition, those seeking long-term investments might find the utility sector attractive, and few find this stock appealing ahead of the World Cup in 2014.

Article Quotes

“Consider the measurement of unemployment. The unemployment rate has currently settled in at roughly 10 % for the past three years, yet the employment to population ratio is at its lowest level in thirty years and has declined from 64% to 58%. So what is more important? The fact that 10% of a smaller population is not working? Or that the employment rate has dropped so precipitously? Can the 10% number, alone, allow anyone to make any conclusions about anything?.... Housing represents roughly 30% of the "core" Consumer Price Index. However, its computation is based not upon actual rents, but on the statistical modeling of "rent equivalents." This device has failed to capture the recent transformation of housing from an item of consumption to a speculative asset.” (Reuven Brenner, Forbes, December 1, 2010)

“Both the S&P Midcap 400 and Smallcap 600 made new bull market highs this week, while the largecap S&P 500 remains below its November closing high. Smallcaps and midcaps have both begun to distance themselves from their largecap brethren in terms of performance as the end of the year approaches. …the Midcap 400 is up 21.56% so far in 2010, while the Smallcap 600 is up slightly less at 20.19%. The S&P 500 is up just 9.34%. As shown in the two smaller charts below the big chart, the spreads between the YTD performance of the Smallcap 600 and Midcap 400 versus the S&P 500 are at their highest levels of the year.” (Bespoke Investment Group, December 3, 2010)

Levels

S&P 500 Index [1224.71] – Explosive recovery contributes to a move that’s almost near yearly highs that were reached in early November. Mostly a reestablishment of positive trend appears to resurface to close out the few remaining trading days.

Crude [$89.10] – A breakout above $85, after several weeks of sluggish back and forth trading— an early resurgence that can attract long-term observers. However, some will note that nearly a 6%, 1-week move might require a breather.

Gold [$1403.50] – A short-lived pause, as re-acceleration is underway. The momentum continues to build and feeds into the ongoing trend, inviting new investors to reconsider.

DXY – US Dollar Index [79.37] – As expected, increase in commodity prices lead to an inverse response for the US Dollar. The index is struggling to hold above $80, which serves as a multi-year barometer on near-term sentiment.

US 10 Year Treasury Yields [3.00%] – The recent behavior has yields revising the 3% level for the first time since mid-summer—a sign of normalization after a period breakdown.

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