Market Outlook | March 7, 2011

“Courage is the discovery that you may not win, and trying when you know you can lose.” - Tom Krause

Not as Good as Advertised

A simple glance at traditional measurements of US economic health and corporate earnings translate to an overall positive message. This message is echoed by performance numbers and headline titles. However, when consensus leans towards comfort, then questions arise as to the legitimacy of this optimism. In fact, seasonal changes can spark inflection points more. Simply, the argument to purchase at current ranges is not too appealing without taking a pause and revaluating the fundamentals. Now, reading sentiment is an art itself, but the low volatility strongly demonstrates the growing complacency. Aside from the global turmoil, the vulnerable condition of European markets and overheating Asian economies should not be easily dismissed.

Early Spring Hints

The last decade showcased market declines in the period between February and March. Generally, a correction in late winter to early spring is not uncommon. For example, in 2007, the S&P 500 declined sharply from 1460 to 1380. In the same way, March triggered a selling point in 2004, 2002 and, of course, 2000 (the well-documented tech bubble). As we enter the new month, navigating through this downside move is worth pondering, especially for speculators and those looking to manage their risk. At the same time, bargain hunters can use this period to pick up value at a discount. In other words, the sell-off window offers fruitful entry point in indentifying specific opportunities. As usual, it is tricky to grasp the current dynamics fully. Timing is the least controllable variable and keeps participants either curious or frustrated. However, some hints invite daring actions more than others. The weeks ahead will test the courage of those aggressively betting on declining prices. Equally, this process can be nerve racking to those owning shares.

When the Dust Settles

Interest rates are a key macro driver that will force a reaction in currencies and risky assets . Central banks’ policies in US and Europe are setting up to strongly influence investor mindset and behavior. Interestingly, internal disagreement within the Federal Reserve is worth monitoring as well. The low interest rate environment has fueled the recent recovery, while reducing the borrowing cost for large corporations. There is plenty of posturing and political factors ahead, but the markets will be sensitive to any clues of rate hikes.







Article Quotes:

“If investors don't understand that this is, how QE2 is "working," they are likely to be as blindsided by the coming decade of weak investment returns as they've been over the past decade. It's notable that the weak returns achieved by the S&P 500 over the past decade were predictable, and our estimates of projected total returns have remained quite accurate in recent years. It bears repeating that our difficulty in 2009 was not that we viewed stocks as overvalued, but that we were forced to contemplate data from periods other than the post-war period, which had generally required much more stringent criteria for accepting market risk. At the 2009 lows, stocks were priced to achieve 10-year total returns in excess of 10% annually by our estimates. The problem is that similar expected returns were not sufficient to end prior declines during much lesser crises even in post-war data.” (John Hussman, February 28, 2011)

“Although Beijing has tightened monetary conditions to dampen inflation, which has been running near a two-year high, the construction projects already launched by local governments will require vast amounts of funding in coming years just to be seen through to completion. This will prevent China from implementing the more aggressive monetary tightening many analysts think is needed to truly stamp out inflation. And the investment does not come for free, even if it sometimes seems like that in China. Local governments have turned to banks to fund their largesse. Banks, owned by the state, have unsurprisingly answered their master's call—just the sort of non-commercial decision that can lead to loan defaults.” (Reuters, March 3, 2011)



Levels

S&P 500 Index [1321.15] – A few points removed from annual highs of 1344.97. It is in a minor consolidation phase while maintaining the uptrend.

Crude [$104.42] – Recent breakout is mostly event driven by emotionally based response. Following the reactionary response, a natural pullback to $100 to $95 is possible as part of a reality.

Gold [$1427] – Reignited strength is developing in Gold prices—a reiteration of the established strength and momentum driven run. It remains closer to the higher end.

DXY – US Dollar Index [76.40] – Over the last three years, the 76 mark has been noteworthy. The weeks ahead, can provide a directional swing, given this familiar territory.

US 10 Year Treasury Yields [3.49%] – In the near-term, holding above 3.40% suggests a sign of stability.


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