Market Outlook | May 23, 2011

“There are things known and there are things unknown, and in between are the doors of perception.” - Aldous Huxley (1894-1963)

Picking Spots

Analyzing markets or specific ideas in broad terms are too tricky these days. For the most part, the first half in the US can be described as positive and favoring a recovery. When reverting to multi-month charts of broad indexes, one can quickly get the feeling of the market being too synchronized. However, select pockets of the economic sectors are more attractive than others. For example, “According to the Goldman Sachs study, some 47% of the aggregate equity assets of the hedge funds is invested in stocks with market capitalizations of more than $10 billion as of the first quarter of this year” (Forbes, May 20, 2011). Clearly, this points to a bias towards big cap and does not necessarily tell the full story.

Perhaps, making this adjustment is the challenge ahead. As the summer season is upon us, it might be easy to forget that the S&P 500 has declined for three consecutive weeks. On the surface, there are milder excitements building similar to the tech rally of 1999, and the welcoming of risk mirrors the 2007 era. Most notably, short-term profits appear feasible in recent private placement and public offerings in technology, as well as ongoing momentum in commodity related investments. As usual, the spin on the current climate can be simply applied by headline makers or politics alike. The trouble lies in trying to ignore the noise and map out a 6 -12 month plan, especially for those judged by the performance game. Sustainable ideas and themes are becoming scarce, which makes the next few weeks rather eventful. Meanwhile, piling on to winning ideas seems to serve as a short-term cure for those fearful of not participating in recent winners. It is only human nature to favor the working sectors, as contrarians have to take a brave angle to go against the trend.

Driving Forces

Most financial decision makers have (correctly so far) aligned with the central bank induced rally. Money managers have increased their risk appetite, and that has paid off. In addition, the crowd is relatively infatuated with Gold, which appears to make more sense in the fragile currency environment. Basically, it is hard to ignore the low rate environment that has propelled investors to move towards stock and junk bonds. The congruent message of global central banks has impacted investor behavior and remains the most prevailing theme impacting interest rates and the perception of risk. Simply, looking at the volatility index once can strongly argue that money managers are humming to the same tune of higher stock prices and low turbulence. Of course, surprises lie ahead, but the question is on the magnitude of any pending correction that may alter short-term behavior.

Article Quotes:

“The International Monetary Fund recently estimated that Iraq’s gross domestic product grew 2.6 percent last year — nearly as much as the struggling American economy did — and it projected astonishing increases, exceeding 11 percent this year and next. Some say Iraq’s economy — estimated at roughly $80 billion today — could expand six or seven times in the next decade as it increases oil production to a level rivaling Saudi Arabia’s….Today, in the new Iraq, the Shamara Holding Company builds power stations and steel mills. It is expanding into pipelines, refineries, and other services for the various multinational corporations that in 2009 won the first contracts to exploit Iraq’s oil and natural gas, in what was one of the single biggest energy auctions in history.” (New York Times, May 18, 2011)

“Adjusted for inflation, prices are close to their long-term trend after the bubble years of the 1990s and the first years of the 2000s….Vacancies for apartments tumbled in the first quarter of the year and are now at a three-year low. Rents have been rising, and analysts expect them to increase by over 4% this year and next. Rent rises typically support house prices by making home-ownership more attractive. The credit markets are healing. Mortgage borrowing actually rose in the first quarter, according to the Federal Reserve Bank of New York. New foreclosures were 17.7% lower in the first quarter than they had been at the end of 2010, and household delinquency improved for a fifth consecutive quarter. Mortgage rates have fallen back to historic lows, tracking declines in yields on American government bonds.” (The Economist, May 19, 2011)

Levels:

S&P 500 Index [1333.27] – Pausing between 1300 and 1340 range. This slight breather begs the question of an acceleration versus a further sideway pattern.

Crude [$99.49] – Stabilizing around $99 in the past few weeks. The early May correction has served as a significant blow to reignite buyer interest.

Gold [$1490.75] – Taking a breather after rising 16% from late January until early May 2011. Long awaited reacceleration will be tested.

DXY – US Dollar Index [75.43] – Slowly hinting at a recovery but failing to show significant movement from last week.

US 10 Year Treasury Yields [3.14%] – Continuing its downtrend from the early year peak of 3.76%. Approaching the 50-day moving average of 3.07%



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