Market Outlook | January 17, 2011

“If we would guide by the light of reason, we must let our minds be bold.” - Louis D. Brandeis

At first glance, it seems rosy for those invested in domestic stocks and commodities. The returns of the last seven months (S&P 500 + 27.83%) indicate that going with the flow is a feasible option for now. In the minds of some veterans, a smooth-sailing market behavior has its rewards, but it is prudent to think and stay a step ahead. As usual, facts are needed to justify those worrisome thoughts, especially given the high cost of mistiming momentum. Interestingly, perception mostly tends to dominate financial markets, and facts can become the postmortem exercise. A US economic recovery is painted by leaders and some key data points. Perhaps, this recent pickup is felt in some regions and select industries. Yet, for many, there is a noticeable disparity between the general economy and financial markets that is too big to ignore. Perhaps, this is another age-old lesson that suggests not confusing the market recovery with economic well being.

Now, some ‘savvy’ participants are not cheerleading this glitter-like performance and acknowledging socio-economic factors, such as escalating agricultural prices and increasing regulatory pressures. Of course, money managers are simply asked to produce returns regardless of rhetoric or gloom-and-doom discussions. That being said, the current landscape requires balancing general sentiment while attempting to closely time potential hazards. Interestingly, some are waiting for the ideal entry point as a result of short-term panic. For the stock market, that last major point for a bold buyer was around March 6, 2009. Finding this set up in traditional assets is not an easy task, especially with the volatility index near its lows. Therefore, identifying themes where buyers are rushing to sell is not that obvious. From an opportunity standpoint, innovative ideas with a longer-time horizon are poised to present rewards. In other words, a brave approach in lesser known areas is one alternative to those wanting a better idea for a relatively easier method of chasing momentum.

The threat of inflation is on the radar, and it has become a global discussion from Brazil to South Korea. For the past several months, headlines featured Chinese policymakers taking several measures to cool the ongoing real estate boom. Clearly, the explosive run in emerging markets is hardly new material and heavily discussed in the investment circle. In fact, the FXI (China 25 Index Fund) is not trading all-time highs and is far removed from the October 2007 peak. This displays that investors have taken a closer look, and overall enthusiasm is more tempered than commodity markets. Finally, these above points are highly connected to interest rates and currency imbalances. Therefore, the first quarter should provide some answers in conviction levels and pending catalysts for a change in tone.

Article Quotes:

“Recent data make clear that the risks of a double-dip recession and deflation have ebbed and that economic growth and job creation are beginning to flow. Yet the ships of job-creating investment remain, for the most part, tied to the docks—or worse, choose to sail for foreign ports where tax and regulatory conditions are more favorable, very much in the same way that Ohio, Michigan, New York and California businesses and workers have navigated to Texas. I don’t believe this has much to do with the Fed. None of my business contacts, large or small, publicly held or private, are complaining about the cost of borrowing, the lack of liquidity or the availability of capital. All express concern about taxes, regulatory burdens and the lack of understanding in Washington of what incentivizes private-sector job creation.” (Federal Reserve of Dallas, January 12, 2011)

“There have been academics and analysts who have argued about the dangers of China’s economy overheating for some time. But for many, the fact that hedge funds, particularly those with track records on previous crises, are launching specific funds is the sign that the bubble is close to bursting. One academic said: ‘Economists have contrarian views all the time. But these hedge funds have their shirts on the line and do their analysis carefully. The flurry of 'distress China’ funds is a sign to sit up.’…Despite the vast population, the property is generally out of the price range for most. House prices are around 22 times disposable income in Beijing. The IMF has said that house prices in eastern cities have become “increasingly disconnected from the fundamentals” but so far has said there is no nationwide bubble.” (The Telegraph, January 16, 2011)

Levels:

S&P 500 Index [1293.24] – Closing at multi-year highs. Clearly, the index is at the highest point since the 2008 crisis.

Crude [$91.54] – The suspense is around the next target of $100 barrel as the momentum is net positive. A very short-term hurdle is at $92.58 set early this year.

Gold [$1367] – Since early November 2010, the commodity has failed to escalate above $1400 on three occasions. It’s in a consolidation mode, and charts suggest higher odds of buyers at $1350.

DXY – US Dollar Index [79.16] – Hovering between $78-80 the last few weeks. In fact, the 50-day moving average stands at $79.54. This illustrates the stagnant behavior in the currency.

US 10 Year Treasury Yields [3.32%] – Holding above 3.30%, a new short-term trend. The recovery since early October 2010 is still in full effect and worth noting as a turning point.

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