Market Outlook | January 31, 2011

“What you perceive, your observations, feelings, interpretations, are all your truth. Your truth is important. Yet it is not The Truth.” - Linda Ellinor

Bigger Picture

For a long while, geopolitical worries have stayed relatively silent for casual headline followers and slightly-impacted invested participants. Yet, the rising food price is one issue that’s been well addressed and potentially a key catalyst for some turbulence-like conditions. Now, in terms of markets, global tension may serve as an excuse to sell. It should be noted that regardless of political instability, this market was setting up for a consolidation or, at least, a much needed breather. In the past year, inflation in emerging markets and weakness in some European economies presented some minor setbacks to the existing asset appreciation. A downtrend here is not much of a surprise. However, the magnitude of declines provides a better read on market feel.

Previous Clues

Technical observers have pointed out the increasing odds of mean reversion, given the extended broad indexes and commodity markets. Interestingly, Gold prices showcased an early hint of a slowing momentum since early December 2010. On the other hand, Crude strengthened in past few weeks as some expect a further rise in periods of unrest. Obviously, each commodity has its own sensitive response to news. Therefore, identifying few trends in turbulent times remains tricky in the weeks ahead. Meanwhile, the spike in VIX (volatility index) from 16 to 20 last Friday can hardly go unnoticed. Perhaps, a key tipping point and how this plays out is of interest to observers and participants alike. Finally, investment managers may shift focus in the search for hedging tools and attempting not to overreact on the near-term unknowns.

A Wider Perspective

From one angle, the general sentiment has relatively improved from an overly fearful state of March 2009. The existing uptrend has been in place for nearly two years. This run is driven by low rates, increasing complacency/low volatility, and optimism in the decisions of policymakers.

Global investors face few options in the current environment:

- Seek higher-yielding instruments

- Add to trending long-term themes (i.e. commodities and China related)

- Selectively pick quality and monitor some stocks specific ideas

- Stay cautious by managing cash and currency shifts

In addition to these above, legislative response to taxes and business related laws are awaited by those looking to put capital to work. Also, the response of policymakers to interest rates, serve as better guidance to the matters stated above. These issues are at the forefront of financial decision makers and affect general participants as well. Points associated with economic improvement and credit expansion are bound to be scrutinized closely, especially if a sour mood begins to resurface. This is a harsh reminder that navigating in the post 2008 crisis requires increased nimbleness and immediate actions. Veteran pundits are noticing that it takes much work these days to protect capital, while dodging periods of sharp sell-offs.

Article Quotes:

“The catalyst for a resumption of periodic crises came with deregulation in banking and capital markets in the 1970s, together with the emergence of wholesale money markets. With ready access to funds, banks embarked on a dash for growth across the developed world. Property-based financial crises ensued in the mid-1970s in the US and UK; in the mid-1980s in America; in the early 1990s in Japan, the Nordic countries and the UK again; then once again in the English-speaking countries along with Spain from 2007. What lies beneath this increasing tendency for property-induced trouble? ‘The most likely explanation,’ says Lord Desai, emeritus professor at the London School of Economics, ‘is that innovation dried up.’ Property, that is, has acted as a sink for excess liquidity when industry’s demand for funds has been weak.” (Financial Times, January 26, 2011)

“If history is any guide, the price of oil will not rise in a straight line, and the secular uptrend will be punctuated by severe economic recessions. After all, the cure for a high oil price is a high oil price! At some point during the course of this business cycle, as the price of oil continues to rise, it will (once again) cause economic pain for the overstretched citizens of the developed world. When that happens, consumption will slow down and we will experience demand destruction in some parts of the world. In our view, the next economic recession will be caused by yet another spike in the price of oil and during the next business slowdown, crude will get whacked again. This is the reason why we will liquidate all our energy related investments prior to the onset of the next economic recession.” (The Daily Reckoning, January 29, 2011)

Levels:

S&P 500 Index [1276.34] – After a range bound trading pattern, the decline last Friday (Jan 29) was noticeable. Breaking below the 15-day moving average of 1284 serves as the first sign of retracement.

Crude [$89.11] – A downtrend appears to develop after peaking on January 3, 2010—mostly in the $88-90 range and struggling to make new highs. The momentum from last year faces some resistance, but it’s too early to call any top.

Gold [$1334.50] – Noticeable break below $1350. Safe to say, the commodity in entering a consolidation period from escalated levels. However, it remains above its 200-day moving average of 1278.75—a move below that level can create a response.

DXY – US Dollar Index [78.13] – Barely holding above 78. No major significant improvement in the dollar as it awaits policymakers’ decision to stir a catalyst.

US 10 Year Treasury Yields [3.32%] – Finding a steady range between 3.30% and 3.45%. The odds of those levels holding is suspenseful for most.

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