Market Outlook | April 18, 2011

“A lie gets halfway around the world before the truth has a chance to get its pants on.” - Winston Churchill

As usual, at an early glance, US markets are up for the year; interest rates are low; commodities are higher; and the economy is mixed (open to interpretation). The dominant themes above are recreating an established trend in which the fundamentals or perceptions are accepted as truth. There is plenty of skepticism among pundits, but capital is buying into risk. In other words, the current stimulus driven market finds a way to go higher, while demand from resource based groups is not declining. This is understandable, since parking money at the bank through traditional means does not yield much. Thus, the appeal of investing in risky assets is an easily sellable point, and by nature, ‘growth’ ideas are favored as long as they’ve been working. Perhaps, this is one explanation to why the Small Cap Index (Russell 2000) made new highs earlier this month. On a similar point, volatility is pointing to a calmer state, while nearing comfortable levels last seen before the 2008 crisis. The final piece to this puzzle looks ahead to the nearing presidential election, which is known to find ways of prolonging an optimistic trend or cleverly highlighting convenient data points. In fact, monetary reform can become a bigger political slogan than previously witnessed in recent elections

At a deeper stare, this positive set up invites contrarians to look in and question the accuracy of the picture reflected. The dollar weakness is well documented, like the debt issues of Western economies. The word “bubble” is commonly used by writers and editorial contributors. Perhaps, the phrase is losing some authenticity from the casual observer. For example, the bubble related issues are discussed relating to commodities, Chinese real estate, and even higher education. For money managers, having a suspicious view is not as important as being on the right side of a self-fulfilling prophecy. After all, most managers are measured by performance, especially in a period of higher investor demands and increased competition for asset management. Thus, staying focused between perception and truth is vital but even harder these days. Near-term breathers should not be confused with cycle downturns—a lesson that was clear last decade as correction can be short-lived. Nonetheless, the message from skeptics is worth tracking and questioning.

A few back up plans may be required for participants. If this “smooth sailing” current trend changes its course, then one should look at not the images that are currently presented but adjusting for what’s ahead. Mainly, most liquid assets remain mostly correlated and vulnerable. Holding cash alone seems less favorable when evaluating risk-return models. Importantly, tax policies, along with regulatory outcome, take a while to seep through the system. Equally, improvements or changes in inflation continue to vary based on interpretation. Given increased government investigations and deliberation, it may be wise to hold on to high conviction bets. That said, a major shift in attitude has yet to take place. Interestingly enough, liquid markets have resorted back to pre-crisis-like behavior, despite all the chatter of reform. Therefore, seeking investments in alternative asset classes and frontier markets appear to make sense. At least, that is one back-up plan.

Article Quotes:

“For a start, many analysts over-estimate Germany’s economic dynamism. Although it has enjoyed strong recent performance in economic growth and exports, its longer-term record is unimpressive. Germany has a strong export sector, but its domestic economy has performed poorly in the two decades since reunification. A related problem is that in effect Germany has subsidised purchases of goods by the weaker countries. Low interest rates made it cheaper for peripheral nations to buy German exports, while the existence of the eurozone helped them to tap the capital markets. In effect, there was a vendor financing relationship between the core of the eurozone and much of its periphery (Ireland was different from the others). …At the root of the problem were the difficulties that the whole region was suffering, to a greater or lesser extent, in generating new rounds of growth. (Fundweb, April 11, 2011)

“Permanent jobs are created by the private sector. Businesses, large and small, publicly or privately held, have a duty to earn a return on investment for their shareholders. In a globalized, cyber-ized world, they need not invest or expand their payrolls in the United States; they are free to go practically anywhere on the planet. This is the result of one of our greatest accomplishments as a nation: We won the Cold War. Before the demise of the Soviet Union and the death of Mao, we lived in a world of mutually assured destruction; today, we live in a world of mutually assured competition. This is what we spent an entire generation of blood and national treasure to achieve. Now, those with the power to levy taxes and direct spending must get with it and adjust to the new world as they seek to incentivize job creation through businesses that, thanks to monetary policy, now have the financial means to put Americans back to work right here at home.” (Federal Reserve of Dallas, April 8, 2011)

Levels:

S&P 500 Index [1319.68] – Hovering around the 50-day moving average. In the short-term, the index is setting up to challenge the 1300 range.

Crude [$109.66] – Recent behavior suggests growing buyers’ interest at $105 as momentum remains intact.

Gold [$1476.00] – After holding at $1420, another explosive run showcasing the herd-like following and lack of sellers, even at escalated levels.

DXY – US Dollar Index [74.61] – Further weakness in recent weeks, highlighted by breaking below 76. This recent downtrend wave is a continuation of a decline that began in the summer of 2010.

US 10 Year Treasury Yields [3.40%] – Showing shades of stabilization, as evidenced by the 50-day moving average of 3.47%.


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