Market Outlook | November 7, 2011

“To begin with, our perception of the world is deformed, incomplete. Then our memory is selective. Finally, writing transforms.” - Claude Simon (1913-2005)

The Collective Feel

The back and forth market movements are overly focused on the latest rapid paced events. Meanwhile, the nucleus of these issues stems from the serious and inescapable damage, mostly revealed in the fall of 2008. Another week passed with the usual Eurozone drama, as fear rotates from one nation’s solvency to the next. Basically, for financial or social observers, the message is not only grim, but also fairly exhausting as similar themes keep repeating in a different form. In other words, the last three years illustrate the ongoing discussions on finding a balance between government involvement and potential resolutions, amidst conflicted political constraints.

As for navigating through investment ideas, here and there observers will point to better than expected numbers, which stimulate some momentary or illusionary hope. However, beyond the day to day noise, the consequences for the next three to five years are puzzling and even more humbling for traditional forecasters. Perhaps the bigger surprise might be the lengthy denial by policymakers to make critical and painful decisions. Others feel that pessimism evaporates in due time, but that crowd is becoming harder to find in this marketplace. Frankly, trust in forecasters is diminishing, as finger pointing is the reoccurring theme. Historians contemplate the results of globalization and the realities that have materialized in this “New World.” Yet, the changing perception of the financial system is turning to a political matter which goes beyond the realm of traditional finance. This is unchartered territory for the generations in charge (in US and Europe), who can hardly recall a manual for problem solving in the previous business cycle challenges.

Unshakeable Turbulence

With few exceptions, most trading days since early August witnessed the Volatility Index (VIX) above 30. This reiterates the lack of market stability, even after the strong broad market performance in October. Additionally, this reflects a shaky perception of governance risk and confidence in private business expansion. Interestingly, frenzied periods are not offering clarity, as edgy minds struggle to find reasonable policymaking. The majority of attention in the US is focused on the economic front in light of the jobs issue, which appears to be more talked about than resolved. Emerging markets are not as shiny as pictured in last decade either. For example, China is confronting a domestic credit crisis of some sorts, which may go ignored by some. “An estimated $580-billion in private loans were handed out in the first 10 months of this year, a number almost 10 per cent the size of the Chinese economy…China – rather than being the country that can lead the world out of its debt woes – may be the next one headed for a hard fall.” (The Globe & Mail, November 6, 2011). There is simply no escape in this environment, as other findings are bound to unfold before year-end. Interestingly, human greed, desire for new growth, or the ability to deny harsh reality appears to be one of the very few constants.

Balancing Act

It is easy to be confused, or lost, in this turbulence; one may prefer to sit on the sidelines, which is the choice for most. Currency and commodity market trends remain in limbo. Meanwhile, owning company specific shares might work on a very selective basis, as the focus is on sensitive news flow. Year-end bets have been placed, mostly last month, as optimists await a recovery for a cosmetic and minor moral boost on a positive finish. Clearly, the stakes remain too high for managers executing on investment ideas, as well as central banks implementing policies. Yet, the odds of a substantive recovery might take longer than desired, and remain cloudy to imagine.

Article Quotes:

“First, the lower the interest rate, the higher the interest rate risk. As Calabria notes, in future years, mortgage rates will certainly rise. That will make the relative value of mortgages originated at ultra-low interest rates lower. It could even cause the bank to lose money on the mortgage if its cost of funds rises above the low mortgage interest rate. Second, interest rates help to compensate banks for risk. If banks were getting higher interest rates, then they might be more willing to provide consumers more credit. But at rates like 4%, those loans had better be pristine if the bank wants to ensure that its default risk is covered by the small amount of interest it receives. Very low interest rates are a reason why banks aren't providing many mortgages these days. Banks would prefer if mortgage interest rates were higher. You can see this by their recent efforts to avoid interest risk by adjustable-rate mortgages reemerging. In the first half of 2011, they accounted for 13.4% of all originations, up from just 6.3% in 2009.” (The Atlantic, November 2011)

“Germany -- still refuse to face up to the shattering implications of a currency that they themselves created, and ran destructively by flooding the vulnerable half of monetary union with cheap capital. We can argue over details, but the necessary formula – if they wish to save EMU -- undoubtedly entails some form of eurobonds, debt-pooling, fiscal transfers, and of course the constitutional revolution that goes with all of this. That would at least buy them time, though I doubt that even fiscal union can ever bridge the North-South gap. Italy’s travails have little to do with the parallel drama in Greece. This is not contagion in any meaningful sense. The country is suddenly under fire for the very simple reason that its economy is plunging back into deep recession, the predicable outcome of the EU’s 1930s fiscal and monetary contraction policies. The implications of a eurozone double-dip are dreadful for Italy, already grappling with a chronic loss of 40pc in labor competitiveness against Germany and a 70pc collapse in foreign direct investment since 2007.” (The Telegraph, November 6, 2011)



Levels:

S&P 500 Index [1253.23] – Holding above 1250 and facing a mild inflection point between now and year-end.

Crude [$94.26] – Facing resistance at the 200 day moving average ($94.84), as surpassing $95 is the next challenge for buyers.

Gold [$1749.00] – A tamed re-acceleration process at this point. Early fall highs above 1850 aspire buyers.

DXY – US Dollar Index [76.96] – Restoring some stability after sharp declines. It remains too early to declare a trend, given the ensuing macro events.

US 10 Year Treasury Yields [2.03%] – The 50 day average stands at 2.05% while the 5 day average equals 2.03%. Both emphasize the range bound trading in the past few days, while the big macro picture is less affected.

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