Market Outlook | March 14, 2011

“Acting is illusion, as much illusion as magic is, and not so much a matter of being real.” - Laurence Olivier

Beyond Events

The global markets were poised for minor corrections before external political or natural events. In the shuffle of events, these points are easy to forget. The appetite for risk-aversion changes at a rapid pace, and thus, observers will stay plugged in to the day-to-day news. Yet another reminder, it was only two years ago when key US indexes bottomed and reignited the post crisis recovery. Heading into this spring, the set up has quietly warned of a natural market breather. After all, the S&P 500 is up 95% since the lows of March 2009. Of course, this does not necessarily suggest a major downside move as seen in the late 2008 crisis. However, this leaves us pondering the magnitude of near-term moves and the required next steps for risk adjustment.

Technical indicators are mildly stretched, and there are fewer positive surprises—both create short-term hurdles in continuing this run. Some will argue the uptrend is shaken and not broken. That view is valid for now, since fundamentals are not overleveraged or as deeply overvalued as they were in 2007. In fact, the worry of being reckless is less applied to the private sectors these days. Instead, the attention is centered on new financial regulation and government officials’ abilities to manage policies. The current political climate sets the tone on taxes and attitude towards business. These factors are not as easy to identify, but the details are being examined by longer-term investors.

Looking Ahead

Most analysts would point to interest rate behavior along with the Federal Reserves’ policy as the next major catalysts. It is evident that business models are changing in the current cycle, and revenue expectations are difficult to gauge. Meanwhile, fund managers are searching for innovative ideas for growth, while investors are desperate for higher yielding instruments. From a decision maker’s perspective, the challenge is finding quality ideas, which appear scarce at the moment. This task is challenging especially in isolating the noise from the existing macroeconomic chatter. Clearly, the Bank of Japan’s attempt to stimulate the economy along with euro zone’s solution for debt crisis can spark noticeable trends. Importantly, this will raise questions about the sustainability of a stimulus driven market. This can change the market feel towards fear based responses as we all eagerly await.

Article Quotes:

“Beijing greatly values this stability, even at the expense of capital misallocation, and is in no hurry to give it up by opening up the financial markets and, what’s more, for political reasons, I think local governments will resist ferociously any further corporate governance reform. …The most obvious major countries in the region that can help the process of RMB internationalization—Japan, Russia, India, Korea and to a lesser extent Vietnam and at least one or two others—have a deep mistrust of China and are unlikely to assist the process beyond some minimum level. Remember that one of the reasons sterling never achieved the dominance that the dollar has today is that the French and the Germans, not to mention some other European powers, actively undermined its role in favor of their own currencies. I don’t see why this won’t happen again.” (CreditWritedown.com, March 12, 2011)

“The attractive home price and mortgage rate situation has not resulted in the typical improvement of housing market conditions largely due to a worrisome employment situation. The gains in hiring recorded in February raise expectations of a near term improvement in the housing market. But, other reports from the housing market raise the level of concern. According to CoreLogic, 11.1 million homes or 23.1% of residential mortgages outstanding had negative equity in the fourth quarter of 2010, up slightly from the third quarter. This problematic situation combined with the existence of numerous foreclosed residential properties makes a strong case for the Fed to maintain the current easy monetary policy stance in the months ahead.” (Northern Trust, March 9, 2011)

Levels:

S&P 500 Index [1304.28] – Declined for the week by 1.29%. It’s barely holding its 50-day moving average as near-term investors watch the resilience around 1300.

Crude [$101.16] – After a speculative event driven explosion, a retracement to rational levels is taking place. Betting that this sharp uptrend continues might not be sustainable. The March 7, 2011, intra-day high of $106.95 is the new high. Meanwhile, the 50-day moving average is at $92.

Gold [$1411] – Once again, maintaining a trend above 1400 seems to be a difficult challenge.

DXY – US Dollar Index [76.40] – It stands at a fragile state as a move below 76 signals a deteriorating dollar.

US 10 Year Treasury Yields [3.40%] – Revisiting 3.40% highlights a key inflection point. Interestingly, the 5 and 50-day moving averages are at 3.45%.


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