Market Outlook | November 28, 2011

“The most important American addition to the World Experience was the simple surprising fact of America. We have helped prepare mankind for all its later surprises.” - Daniel J. Boorstin (1914-2004)

The General Feel

Most of the second of half of the year, there have been screams of a further rush to safer assets. This is typical when markets digest the alarming discovery of causes and effects of the credit crisis. Those results have adversely played out in various assets. Inflection points were overly anticipated and discussed by pundits, but the clear message is a global downturn. The selling floodgates that opened in July 2011 persist and stick in the minds of those contemplating investment.

As usual, jittery participants and confused pundits are most likely to blend the European issues with US political deadlocks and other social displeasures. Images can influence collective thoughts, but at some point the existing wounds open up wider, or heal faster, than expected. In fathoming the least visible, the European crisis is somewhat progressing since the harsh reality is being confronted. Eventually pending measures to stop the bleeding are inevitable, as the ECB attempts to provide liquidity. Yet for a buy and hold investor, the cost (based on perception) may seem very hefty when assessed by present behaviors. Perhaps unconventional thought of a recovery will be tested in the next few weeks, starting early this week. After all, further downgrades of sovereign rates, combined with the lowering of growth projections is to be expected. Both are barely a shock or new discovery.

Message Heard

October’s market appreciation was followed up by a mass exodus by previous holders. Simply, sellers dominate the daily market action and news flow is overly focused on the accumulated challenges of the credit crisis. At this junction of the year, the S&P 500 index is down nearly 8% for the year. Along with poor broad index performance, the themes causing disruption have resurfaced in various forms.
Investors have voiced their displeasure:

• Demanding more liquidity: Staying liquid is even more appealing during escalating volatility, and widening European sovereign spreads. All year, observers witnessed a continual rotation to US Dollar and US treasures, especially in periods when “all hell breaks loose” (relatively speaking of course). This relative US edge argument seems mystical at times, but has proven to be real in several panic sessions.

• Favoring liquidity over yield: The recent investor attitude suggests that earning very small gains in cash is better than get burnt by hope. Basically, the average investor’s conclusion is that it’s too blurry for comfort when speculative grade bonds are linked with default fears.

• Hesitancy in illiquid assets. Investors are not at ease with duration risk in long-term assets, given the uncertainty and scarcity in capital. Unless there are deeply discounted prices, larger firms are less willing to navigate value oriented opportunities in less liquid areas. Plus, an increased capital requirement for banks, (i.e., Basil III) allows less flexibility.

Little Room for Surprises

These weak points above are poised for turnout to reverse into upside contrarian play. This dislocated environment has dismissed traditional patterns, while reversals continue to fail. Interestingly, there is an eager crowd willing to buy cheap or desperately looking for catalysts that can capture collective minds.

For one, the talks of quantitative easing 3 (purchase of treasuries or mortgage backed securities) are resurfacing at times. In the months ahead, further stimulus is not off the table. Secondly, value investors who have watched for a better entry point are weighing the bargains after the declining month of November. In addition, the commodity/dollar relationship is displaying early shifts as well. Finally, deadlocks find a way to disentangle. If Eurozone leaders, key members in Congress, or Federal Reserve decision makers reach a bold agreement then the results can seep through financial markets. Yet despite the daily dose of fear projections, it’s in the best interest of powers that be to restore calmness to this inevitable reform. Basically, surprises ahead are easier to visualize than betting on surprises, which is a courageous and highly neglected theme.


Article Quotes:

“The strategic nature of competition between China and the US in the Asia-Pacific will be murky for the time being. However, China has gained more stakes when dealing with the US. It is hard to say whether the US holds more advantages in China's neighboring area. The potential for economic cooperation between China and its neighboring countries is great…. Naval disputes are only a small part of East Asian affairs. The US and other countries seek to defend private interests by taking advantage of them. As long as China increases its input, it will make countries either pay the price for their decision or make them back the doctrine of solving maritime disputes through cooperation…. No one dominant force is wanted. China has more resources to oppose the US ambition of dominating the region than US has to fulfill it. As long as China is patient, there will no room for those who choose to depend economically on China while looking to the US to guarantee their security.” (Global Times China, November 18, 2011)

“Technically, one can solve the problem even now, but the options are becoming more limited. The eurozone needs to take three decisions very shortly, with very little potential for the usual fudges….European Central Bank must agree a backstop of some kind, either an unlimited guarantee of a maximum bond spread, a backstop to the EFSF, in addition to dramatic measures to increase short-term liquidity for the banking sector. That would take care of the immediate bankruptcy threat…. European Commission calls it a “stability bond”, surely a candidate for euphemism of the year. There are several proposals on the table. It does not matter what you call it. What matters is that it will be a joint-and-several liability of credible size. The insanity of cross-border national guarantees must come to an end. They are not a solution to the crisis. Those guarantees are now the main crisis propagator…The eurozone needs a treasury, properly staffed, not ad hoc co-ordination by the European Council over coffee and dessert.” (Financial Times, November 27, 2011)


Levels:

S&P 500 Index [1158.67] – Several down days in a row showcase a severe selling period this month. The peak of 1277 on November 8, 2011 established a noteworthy downturn.

Crude [$97.41] – An explosive two month run is slowing. Consolidation around the 200 day moving average creates a near-term tug of war between buyers and sellers.

Gold [$1685.50] – It is fair to conclude that the momentum run is facing a mild pause. Buyers seemed interested at $1600, and their appetite to purchase is soon to be tested.

DXY – US Dollar Index [78.06] – Nearly up 10% since the lows of May 2011. An explosive rise in the dollar is noticeable especially in early September,

US 10 Year Treasury Yields [1.96%] – Below 2%, but not quite 1.67% as seen in late September. Trading at deeply oversold levels, suggesting a near-term recovery in yields.



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