Market Outlook | December 12, 2011

“Although our intellect always longs for clarity and certainty, our nature often finds uncertainty fascinating.” - Karl Von Clausewitz (1780-1831)

Reflective Period

We are counting down to close out a year that felt like 2008, in which all challenging setups were on the brink of happening. Meanwhile, the perception of a doomsday scenario did not fully materialize as scripted by the most fervent skeptics. The word “crisis” is appropriately used at times, while overused or misunderstood at some junctions. Notably, the July and September collapses this year were not overnight downturns, and the drivers of those shocks seem bound to resurface down the road.

Three years after the bailout of US banks, the historical pattern is glaringly revisited in Europe. This fragile period can be described as persistent global panic. In between, there are more than a few up days creating breathing room from the gloomy suffocation. Perhaps a glimpse of stability will begin to welcome early thoughts of a surprising and promising year in 2012. However, that’s an extreme and unconventional view as most anticipate further recession from Emerging Markets.

Investor’s Angle

An investor cannot afford to be a spectator during crucial inflection points, especially when buying opportunities loom in selective areas. In other words, the noise from political crowds, constant naysayers, and sensational headline creators is known to overstate the fear while understating the power of the unknown. Clearly, the sharp rise and fall of the volatility indexes showcases the disbelief in spurts. Thus, long-term implication risk may not be reflected in broad indexes, and the impact of good or bad policies are not quite measurable. Innovative driven ideas are desperately worth pursuing for those policies.

An edgy and fatigued financial crowd is now watching the S&P 500 index flirting with a positive finish for the year, a noteworthy result for scoreboard watchers. Most nations will struggle to claim a positive stock market return. So far this year, Brazil (EWZ) shows -22%, India (INP) is far worse at -34% and Emerging Markets (EEM) stands at -17%. The fact that the US is ahead of the crowd, and relatively attractive, might be one positive takeaway. Picturing any stability in broad indexes may not have been easy to visualize in early October, especially if thoughts were guided by headlines. However, there is no comfort in expecting the bad news to die down; yet resolutions are bound to be reached just enough to calm the screams of fear. Navigating quickly and dodging major falls is puzzling, and enhance the challenge for those managers measured on a monthly basis.

Governance & Confidence

During the debt ceiling saga, we learned bickering by government officials does not create a favorable market environment. In the summer, Congress’s resolution created a “super committee” which bought more time while failing to tackle the issue, given political constraints. Similar traits were echoed last week towards a resolution for Europe, where real fixing is postponed for now. Delay tactics are becoming business as usual; eventually, anticipating policymakers’ call ends up spooking or calming markets at different times. The debt crisis era provides plenty of reasons to trigger risk-aversion, but awaiting government decisions contribute to headaches for intermediate-term investors. Perhaps it is another reminder that government officials’ interests are too focused in the short-term. Not only that, money managers and the doubts of future consequences do not leave the minds of strategist and long-term investors.

The charged debate of government involvement has intensified and will live on, especially during election cycles. Yet, for any recovery there is a crowd willing to credit the stimulus to actions to the Federal Reserve. Perhaps the end of QE2, in the end of June, illustrated that wounds do not heal fast and “medication” is necessary. The recent operation twist or chatter of further easing contributes to dependence on interventions, whether direct or indirect. Meanwhile, the other camp yells “deception” to address the handling of sovereign debt concerns. Those lacking confidence in the policymakers’ decisions continue to buy into the Gold story. As convenient as it may be, Gold prices have slowed down in recent weeks and resurgence in momentum will be cautiously awaited as a vital macro event.

Article Quotes:

“Unlike the U.S. bubble, a bubble burst in China wouldn’t spell doom for the homeowner – in China, real estate investment is a vehicle for saving, not borrowing, and required down payments are 30 percent to 40 percent, limiting debt levels. Instead, local governments will take the brunt of the slowdown or bubble burst as result of their heavy reliance on real estate revenues. As mentioned, local governments will experience a significant loss of revenue, and not just from a decline in land sales: local governments also rely on income from construction and the production of raw materials that goes into construction. In 1994, fiscal decentralization reformed China’s revenue sharing system, effectively reducing local governments’ share of the central revenue stream while increasing their responsibility for providing social goods…. Though mortgage defaults would be rare, social discontent would likely blossom over lost equity. Social instability would also have political consequences for local governments. As important as growth rates are in promotion calculations, levels of social unrest may play an even bigger role – large and visible protests are a sure way to get demoted in the Chinese political system.” (The Diplomat, December 10, 2011)


“As part of a currency-swap plan active from 2007 to 2010 and revived to fight the European debt crisis, the Fed lends dollars to other central banks, which auction them to local commercial banks. Lending peaked at $586 billion in December 2008. While the transactions with other central banks are all disclosed, the Fed doesn’t track where the dollars ultimately end up, and European officials don’t share borrowers’ identities outside the continent. The lack of openness may leave the U.S. government and public in the dark on the beneficiaries and potential risks from one of the Fed’s largest crisis-loan programs. The European Central Bank’s three-month dollar lending through the swap lines surged last week to $50.7 billion from $400 million after the Nov. 30 announcement that the Fed, in concert with the ECB and four other central banks, lowered the interest rate by a half percentage point.” (Bloomberg, December 11, 2011)

Levels:

S&P 500 Index [1255.19] – Surpassing 1260, and around the 200 day moving average, serves as a short-term hurdle. The fall rallies have yet to showcase a sustainable breakout which remains a talking point from daily traders.

Crude [$99.41] – $95-100 range has become a familiar place in the past several weeks. It is hard to ignore the developing uptrend.

Gold [$1709] – Attempting to settle down before a potential reacceleration. Currently the commodity is in a 3+ month decline.

DXY – US Dollar Index [78.06] – Current pricing is in line with the 5 and 125 week moving averages, suggesting the lack of a major move despite currency discussions.

US 10 Year Treasury Yields [2.06%] – Barely moving week over week as the 2% range is becoming quite normal.




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