Market Outlook | December 20, 2010

“Industry, perseverance, and frugality make fortune yield.” - Benjamin Franklin

The overall optimism is slowly rising among investment circles, given the positive market performance. Clearly, the early divers and risk takers acknowledge the rewards today. Meanwhile, majority pundits are compelled to recommend buying, and that is after the evidence of further appreciation is presented. Now, participants should be wary of hearing and reading calls that are too optimistic. Instead, it might be wiser to acknowledge that future turbulence is part of the equation even in a positive environment. Despite the connivance of making annual predictions, the mood and pattern of the first quarter sets up the psychological outlook. Therefore, surviving the early part of 2011 without a severe damage should be a key goal to consider in managing longer-term portfolios.

The next six weeks present a tricky climate for making investment decisions. Therefore, observing these issues below might be fruitful:

- Lower trading volume around the holiday season creates a difficult gauge of high conviction movements.
- Potential selling or capital preservation in the first quarter is inevitable as managers reexamine ideas and wait to manage headline sensitive issues.
- Macro trend shifts find a way to transpire at the start of new seasons.
- Commodities appear to near a mild inflection point.
- Continuation of rising rates cast some doubts on rate sensitive instruments.
- Volatility is relatively low and can lead to misleading optimism.
- Assuming further decline in US Dollar is not necessarily a safe bet.

To expand on the thoughts above, analysts appear to be in agreement on a positive feel, which should make one take a step back. Interestingly, VIX (Volatility Index) is nearing annual lows, which suggest further complacency and a growing comfort on continuation of this uptrend. Yet, those can be riskier periods as the Volatility Index reached its lowest point on April 16, 2010, eventually leading to sharp sell-offs. Usually, patterns do not repeat themselves in the same form. However, some junction of a cycle calls for caution in timing and selecting specific ideas.

On the other hand, there have been several worrisome issues that received plenty of attention beyond the weakness of labor and economic growth. For example, the various concerns of European economics, such as Greece and Ireland, were debated for the most part of this year. Perhaps, this is a multi-year theme that is not easy to shake off. Thus, this leads to some realignment of capital among investment managers. Interestingly, in looking ahead, we should note that surprises are likely to occur as displayed in various cycles in market history.

The surprise element of a downturn is most likely to come from the least expected area. In other words, the European issues were highly publicized, and the impact dictated sell-offs and polices. Conversely, the potential of growing bubble-like patterns in Emerging Markets is less discussed and potentially an underestimated theme. Thus, the survival mode of the early part of 2011 should take this factor in strong consideration. Generally, outliers are not accounted for risk management tools and in the mindsets of groupthink. However, managing surprises and avoiding major hits on unknown events enhances the longevity of investors. Finally, let’s not forgot that attractive entry points are most likely to present themselves at least once or twice in any calendar year. Once these points are identified, then being aggressive makes relative sense.

Happy Holidays and a healthy New Year!

Article Quotes:

“The authorities are making at least two mistakes. One is that they are determined to avoid defaults or haircuts on currently outstanding sovereign debt for fear of provoking a banking crisis. The bondholders of insolvent banks are being protected at the expense of taxpayers. This is politically unacceptable. A new Irish government to be elected next spring is bound to repudiate the current arrangements. Markets recognise this and that is why the Irish rescue brought no relief. Second, high interest rates on rescue packages make it impossible for the weaker countries to improve their competitiveness vis-à-vis the stronger ones. Resentment between creditors and debtors is liable to grow and there is a real danger that the euro may destroy the political and social cohesion of the EU.” (George Soros Financial Times, December 15, 2010)

“In some respects, this historical sketch is reassuring. It suggests that, even when currency tensions appear to have degenerated into competitive devaluations in the past, the main motive for devaluation lay elsewhere, principally in the need to align the exchange rate with domestic policies. But that is also the bad news. It suggests that, unless politically thorny domestic reforms are tackled, currency tensions will continue to fester, and may escalate. Currency tensions could contribute to inappropriate macroeconomic policy responses, deterioration in international relations, and protectionism (though not necessarily in the form of competitive devaluations), especially if the global macroeconomic environment worsens. How can we avoid this? The answer takes two forms: encouraging greater exchange-rate flexibility and, more crucially, enacting domestic reforms in the core countries.” (VOX, December 20, 2010)


Levels:

S&P 500 Index [1243.91] – A climb above 1200, suggests the cycle recovery of the post credit crisis era.

Crude [$88.02] – A move above $85 solidifies stability and resurgence in buyer interest.

Gold [$1368.50] – Few weeks of trading showcase a trading range between 1350 and 1400. Much attention will be paid on the next move outside of these tight ranges. Overall, a breather here seems appropriate, given the uptrend for nearly 11 months.

DXY – US Dollar Index [80.73] – Nearly an 8% rise since November 4, 2010—a near-term recovery, but a longer-term stability. At this stage, a directional bias is not clearly defined.

US 10 Year Treasury Yields [3.31%] – An explosive rise here in the fourth quarter, possibly setting up for a near-term correction. However, recent move is highly noteworthy in terms of grasping the longer-term cycle.

Please note: The next MarketTakers will be published on January 3, 2011.


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Dear Readers: The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.