Market Outlook | January 24, 2011

“Patience and perseverance have a magical effect before which difficulties disappear and obstacles vanish.” - John Quincy Adams


The synchronized upside movement in key asset classes is bound to witness some correction in recent months. As highly documented, for a while, the commodity run seems to need a breather along with broad stock market indexes. Gold and other metals are setting an early tone given recent declines. This pattern has some wondering if food related commodities are the next to see some price adjustments. In other words, the ongoing appreciation in agricultural themes is visible from cotton to corn as demands continue to rise. On a similar point, a few volatility indicators suggest that the period of calmness faces some near-term challenges as one should not discount the odds of minor turbulence. In addition, last week, small cap indexes sharply declined at a faster pace than the S&P 500 Index. For strategists, that signals a lesser tolerance for risk. Finally, earnings season presents investors with various data points to digest. However, the attention is most likely to refocus on macro issues rather than the stock specific factors.

During these periods, money managers will have to consider hedging or selling to take actionable steps on the early hints of a directional shift. As usual, surviving key turbulent cycles is applied by preserving quality and seeking to produce consistent return, especially for those measured by annual returns. Now, the decision making process for a portfolio manager is beyond going with the flow (momentum driven), which has been the case since the summer months. Basically, any fear driven sell-offs can present opportunity to buy innovative ideas at cheaper prices. Similarly, there are fundamental arguments that create a case to sell some overvalued assets linked to basic materials and emerging markets. Of course, longer-term investors are not going to easily bail out on short-term pauses in oil prices and vulnerable trends in the Chinese markets. In some cases, investors with a 5-10 year time frame might be less willing to follow the week to week moving parts while requiring further confirmation of a slowdown. Yet, glancing at pending investor reactions is of interest to all.

In conjunction to price driven adjustments, the interest rate environment can provide valuable clues as to the nature of the next move. Clearly, the interlinked nature of markets is a factor that is felt for active traders. For example, the US 10 Year Treasury Yields have risen from 2.33% to 3.40% since October 2010. In the same period, the BKX (Bank Index) has risen 13%. This is a notable trend that is worth watching to evaluate the correlation of rising rates and appreciation of bank stocks. Simply, the rest of the winter months offer a chance to handpick select financials for those looking for higher risk/reward profiles into the spring and summer months. Once again, the value of closely observing at inflection points helps to accumulate ideas for future entry points. However, a confusing landscape creates further doubts, and this can begin to play out in the days ahead.



Article Quotes:

“Unlike in the mortgage crisis, state debt has not generally been repackaged into opaque, complex securities. Furthermore, and contrary to what many pundits suggest, state governments cannot simply declare bankruptcy. Bondholders are also privileged creditors in almost all states. It is thus difficult for states to default: they would generally have to stop paying employees before they stopped making debt payments. At the local level, however, the situation is different. Many US cities can declare bankruptcy – and given their numbers a severe crisis in at least one major city is both feasible and quite possible...But even if the relevant state government decides not to step in, and a city is forced to default, the direct macroeconomic consequences are unlikely to be substantial – unless that default triggers others to follow.” (Financial Times, January 20, 2011)


“Social Security's nonmarketable bonds are merely markers for actual Treasury bonds, which must be sold, and for which interest must be paid. Thus, Social Security is entirely dependent on the Treasury's sale of new bonds for its future solvency. If interest rates spike or global buyers become wary of buying trillions of dollars in U.S. T-bills, costs for that borrowing will skyrocket, crowding out all other federal spending. As a result, U.S. taxpayers are now paying twice for their Social Security benefits: Once through payroll taxes, and again when the Treasury uses their taxes to pay interest on the bonds it sold to fund Social Security.” (Daily Finance, January 20, 2011)




Levels:

S&P 500 Index [1283.35] – Establishing a new range above 1200 while maintaining an uptrend. Friday’s closing price is 11.24% above the 200-day moving average.

Crude [$89.11] – Near-term pause is forming within a tight range between $88-92 in the past two months.

Gold [$1367] – After holding in above $1350 (key support level), Gold prices have witnessed ongoing declines. A break below $1350 potentially creates further selling pressure.

DXY – US Dollar Index [79.16] – Struggled to break above 81 on two occasions and remains in a fragile territory, given the ongoing downtrend.

US 10 Year Treasury Yields [3.40%] – Holding in near multi-month highs as a rise in rates is becoming an accepted trend in recent weeks. The 50-day moving average stands at 3.16%, which demonstrates an early hint of established strength.

---

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.