Market Outlook | May 16, 2011

“Delay is the deadliest form of denial.” - Cyril Northcote Parkinson (1909-1993)

The quote above comes from Cyril Northcote Parkinson, a naval historian and author who wrote several books on bureaucracy, especially during a period where the British Empire began to lose its power. Generally, the denial of harsh truth is applicable for irresponsible behaviors and decisions. Interestingly enough, this witty statement applies to the current market behavior. For astute participants, delaying the inevitable might have its consequences heading into the second half of the year.

An observer notes, “Money is not wealth; it is a commodity that we use as a temporary store of wealth. Real wealth is the products and services that are made possible by an initial balance of high-quality resources that can be transformed by human effort and ingenuity” (May 13, 2011, Minyanville). That said, the marketplace is not necessarily acknowledging this point.

Revisiting Old Lessons

In a mindboggling manner, history finds a way to reoccur in a different form. We are learning that one does not need to go back hundreds of years for previous lessons. It was only a few years ago in 2007 when the pending credit meltdown was fairly visible (to put it mildly) for insiders such as real estate executives, risk managers at banks, and manufactures of short-term products. The final result of the 2008 crisis left a major dent in the existing system for consumer activity and perception of paper assets.

These days, postponing reality is an art painted by policymakers in charge of the debt issues. Equally, key and large investment managers regurgitate this story to their investors—a risky proposition for those with long-term stake. However, transactional based players view this as means of paying short-term bills while capitalizing on certain incentives or fees. Clearly, politics are known to get in the way of logic and eventually lead to plenty of room for pitfalls. It is no accident that an election year is ahead of us, and the “going with the flow” market can produce positive year-to-date numbers for causal watchers. On the other hand, panicking and fear mongering is the opposing thought. If you read publications, fear of collapse is well documented and, at times, overblown. Perhaps, that’s a message with its own agenda as well. Yet again, the savvy investor has to carefully build a swift process. Ultimately, the market performance has the final say.

Fragile State of Mind

An early inflection point is quietly building some suspense on the actual magnitude. This month has seen a small recovery in US Dollar and stabilization in Yields which may trigger a macro change in investor mindset. Of course, the steep commodity declines sent a few shockwaves last week. For most, buying on weakness (stocks and commodities) has worked in the 2009-2011 cycle as comfort is setting in place. Clearly, an inflationary pressure persists globally, given food and energy prices—a topic that is hard to shy away from for central banks. At this point, the Federal Reserve might have injected enough stimuli into the system through quantitative easing (QE2). Refueling further confidence might be asking too much, but surprises are part of the game.

Article Quotes:

“What I want to say, then, is that trading equity derivatives is like playing a game written by programmers who got every mechanic exactly right. You might balk: "Of course they 'got it right' -- trading feels real because it is real!" But when you think about the bizarre circumstances of these electronic trades -- how they're simultaneously rooted in significant human commerce and yet so far abstracted from it -- and when you see your friend drag and drop real fortunes the way I might crop a Facebook photo, you come to believe that working on a modern trading desk is more like playing an excellent flight simulator than actually flying a plane…. Think of Predator missions in Iraq being controlled by joysticks in Southern California, or oil reserves being fractured and drilled by remote control.” (James Somers, The Atlantic May 9, 2011)

“The broader point made by critics of "shadow banking"-- that hedge fund managers are part of a vast, unregulated sector that threatens the stability of global financial markets -- is wrong too. Hedge funds do not inhabit the regulatory equivalent of the shadows. All the major jurisdictions where they operate -- whether in North America, Europe or Asia-Pacific -- regulate the industry rigorously. The only big jurisdiction that did not require managers to register with their regulator, the US, has now rectified that. Already significant levels of regulation are being further increased by legislation introduced since the financial crisis.” (Financial Times, May 15, 2011)

Levels:

S&P 500 Index [1377.77] – The recent hurdle is visible around the 1320 range, as the index continues to slightly stay above that mark. On a similar note, the 50-day moving average stands at 1323.20.

Crude [$99.65] – Turbulent movements in the past four months. For now, the majority of buyers seem willing to purchase, especially close to $95. If buyers lose steam at the $95 range, then further vulnerability ahead.

Gold [$1505.75] – Unshaken long-term momentum with no visible weakness at this junction. Further investor demand can elevate the commodity back to all-time highs of 1541 (May 4, 2011).

DXY – US Dollar Index [75.75] – Amidst a short-term recovery, sparked by a May 4th trend reversal. To claim the Dollar is recovering is a tiring story that many won’t buy into, especially after sharp declines. Slightly above the 50-day moving average, but not convincing yet.

US 10 Year Treasury Yields [3.17%] – An intriguing junction as Yields seem to bottom around 3.12%- 3.20%. A follow through in raising Yields can trigger macro shifts for a turbulent summer.

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