Market Outlook | December 5, 2011

“The only limits are, as always, those of vision.” - James Broughton (1913-1999)

Desperate and Desired Actions

Last week resulted in major moves and clever interpretations, leading to a positive twist in global markets. Debatable as it may be, the move by the world’s central bankers to add liquidity has been highly influential on asset prices and temporarily relieves tension. Eventually, growing political and business pressure in Europe should force bold resolutions.

For now, the mindset regarding long-term consequences appears less relevant. Decision makers in powerful positions, and the majority of money managers, are too focused on survival mode or merely capitalizing near-term opportunities. The daunting task for a money manager is not to simply follow the suspense of the real economy or chase ideas as a headline observer. Similarly, the “politics as usual” tactics of leaders adds flavor to the news interpretation. Yet this is not a novel concept, which suggests increasing public frustration may continue and play out on political fronts, given the impending election year. Mystical or practical, a “leadership” move projecting confidence is desperately needed, and a glimpse of faith is usually welcomed by participants. The psychology of markets is quick to accept forces related to perception and quick to dismiss substantive facts. This is mind twisting indeed.

Lingering Residue

The significant one week rally is bound to face few challenges. First, mechanical market practitioners will point out the lack of volume to support the spurts of appreciation. Secondly, those assessing policies claim stimulus efforts are desperate measures by central banks and politicians. Thirdly, the lack of improvement in labor numbers and noteworthy changes in the key fundamentals contribute to the issue. Finally, the angst and loss of confidence are risk elements which are not quite common for the current generation of leaders. In other words, as public sentiment loses hope when applying the familiar psychological game of illusionary numbers, it becomes difficult to spur creativity. Let’s not forget that pessimism among investors has yet to reverse at this point. “Bearish sentiment [according to AAII survey], expectations that stock prices will fall over the next six months, rose 1.1 percentage points to 39.4%. This is the highest level of pessimism since October 6, 2011. This is also the third consecutive week that bearish sentiment has been above its historical average of 30%.” (Forbes, December 2, 2011).

The Art of Facts

Mixed economic numbers, with favorable headline numbers, but with a fragile non-improving US labor market, left the crowd puzzled into the weekend. The post-Thanksgiving week began with trepidation as investors deciphered the consecutive down days from prior weeks. As a start, we were due for a stock market bounce, as a year-end push is up against the clock; while a practical resolution in the real economy cannot turn rosy on an overnight announcement. Regardless of working with illusion or facts, there is no real comfort in being a trend trader. Importantly, turbulence in equity markets has declined since October, despite all the crisis noise. Interestingly, the volatility index is not screaming of agitation and fear, unlike other barometers, as was seen in early July and late August of this year. The calming effect is being noted by outsiders who may look to chase returns while courageous risk-takers are trying to heal wounds.

Leaning on Surprises

The S&P 500 index is now barely positive for the year at 1.1%, as the surprise bet is to picture further upside moves that would extend into early to mid-2012. Presently, few observers wonder if financials and small cap indexes are able to climb into positive territory as well. Perhaps it is too much to ask for now. Of course, safety is scarce (nearly non-existent) as the confirmation of upside causes will be critical in weeks ahead. Actually, if bad news is truly exhausted this will be proven in the few days ahead.

Article Quotes:

“Demographically and economically, Germany is one third larger than either Britain or France. In the past ten years, this predominance has already been reflected in EU institutions, both quantitatively (Germany has the largest representation in the EU parliament) and qualitatively (the European Central Bank is a clone of the Bundesbank). But that’s apparently not good enough for Berlin, who has deliberately let the crisis move from the periphery (Greece and Portugal) to the center (Italy and France) in order to extract the maximum of concessions from the rest of Europe….Germany’s ideal, if unstated, goal? A constitutionalization of the EU treaties, which would irreversibly institutionalize the current “correlation of forces,” and allow German hegemony in the 27-member European Union to approximate Prussian hegemony in the 27-member Bismarckian Reich. German elites have become so fixated on this goal that they are now talking about changing the German constitution itself in the event the German Constitutional Court decides to get in the way of the New European Order.” (David Beckworth, Economonitor, December 4, 2011)

“The genesis of the recent funding problems for eurozone banks has come not from the euro markets, but from the dollar markets. In the boom years, these banks greatly increased their dollar assets (in the form of loans and securitised debt instruments), and funded these activities not by increasing bank deposits, but by short term borrowing in the interbank markets and the money markets. This is a vulnerable position, involving both a liquidity mismatch (long dated assets funded by short dated liabilities), and also the need for cross-border or cross-currency borrowing. In recent weeks, the deterioration in the eurozone debt crisis has undermined confidence in the solvency of eurozone banks, and dollar financing for them has dried up… This happened in a similar manner at the end of 2008, and at that time the Fed chose to alleviate the problem of dollar funding for foreign banks by increasing its swap facilities with foreign central banks, especially the ECB. This programme became very large, peaking at $580 billion, which represented about a quarter of the Fed’s total balance sheet at the time.” (The Financial Times, December 2, 2011)

Levels:

S&P 500 Index [1244.28] – Hovering near 1250 as the 200 day moving average stands at 1264.95. Signs of bottoming as the momentum shows early signs of turning.

Crude [$100.96] – Maintaining the uptrend established in early October. Flirting at the much talked about “$100” level, while confronting an infection point.

Gold [$1747.00] – After an autumn breather, the commodity is gearing up for a reacceleration. Climbing back to 1840 will be the next noteworthy point for buyers.

DXY – US Dollar Index [78.06] – Similar to 2008 and 2009, the dollar is attempting to recover. Previously, both periods of appreciation failed to hold. However, the dollar index is slightly positive for the year.

US 10 Year Treasury Yields [2.03%] – No major trend shift. Remains in a 30+ year downtrend while trading near the lows of the range.



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