Market Outlook | March 21, 2011

“Unthinking respect for authority is the greatest enemy of truth.” - Albert Einstein

Digesting Thoughts

The natural and inevitable market correction took place at a rapid pace last week. Seasonal changes once again find a way to alter existing trends while shifting the moods of investors. The ability to navigate through this turbulence is what distinguishes a money manager in finding or protecting solid returns. Short-term memory can influence linking earthquakes and global unrest as the major drivers of this downtrend. However, it helps to acknowledge that internal financial issues were brewing even before the external worries. Even after this mild correction, it is not too comforting to place heavy directional bets. Importantly, we are recovering from the panic of 2008 in which several intervention and relief programs were needed for stabilization. Last decade’s bubbles have hardly evaporated and still linger in the fundamentals. That simply explains the low rates desperately needed to fuel the economy and ongoing hesitancy for risk among money managers.

Days Ahead

The intervention by finance ministers can fuel markets for a limited period of time, but the question is in its sustainability. Generally, during inflection points, the biggest down days of a cycle are followed up by significant up days. That’s the nature of market movement. In addition, these fallouts can be short-lived, while attractive, for volatility traders, especially given the spike and share moves in the past few days. Now that the rosy picture has been tested, the economic and corporate health will focus back to some data points. A little skepticism serves as a reality check and resets the playing field.

Unavoidable Trends

The following are prevailing themes that are worth noting for upcoming years:

• Aging population in developed countries
• Shift in some wealth towards emerging economies
• Increased regulatory climates in Western nations

These are well-documented social and political issues. These trends are relatively tangible when compared to other financial market estimates. Demographics and regulation cannot be easily dismissed as it eventually shapes the mindset of investors. For instance, “By 2030, the number of people older than 65 is expected to increase to almost 20%, up from about 12.4% in 2003” (SF Gate, March 19, 2011). Therefore, long-term investors have to stay cognizant of how demographics and regulation impact the balance sheets of companies at a faster or slower pace than previously imagined.

The less tangible issues are centered on interest rates and currencies. After all, both are highly impacted by perception and confidence. However, in upcoming quarters, interest rate behavior will provide a vital clue, while influencing risk and investment patterns. Japan, as the third holder of US treasuries, will be on the radar. Central banks will get a chance to respond under severe pressure. Importantly, let’s not forget that interest rates were on the radar at the start of this year.


Article Quotes:

“Businesses, like any other economic actor, will respond to immediate tax and regulatory incentives. But to make long-term investment decisions that create permanent, remunerative jobs, they must have confidence in the long-term prospects of where they invest. In my judgment, it will be hard to secure that needed comfort until Congress makes clear it will refrain from the errant fiscal ways of the past, changes the way it taxes and spends and regulates, and places the nation demonstrably, and unalterably, on a path of fiscal rectitude…. A large and growing government debt inevitably places pressure on the Federal Reserve to hold interest rates too low for too long, making it more difficult for the Fed to fulfill its dual mandate of price stability and full employment.” (Federal Reserve of Dallas, March 7, 2011)


“Fortunately for the world's poor, the speculative dynamic that has created a massive surge in commodity prices appears very close to running its course, as we see very similar "microdynamics" in agricultural commodities as we saw with oil in 2008. That's not to say that we have a good idea of precisely how high prices will move over the short term. The blowoff phase of a bubble tends to be steep, but so short-lived that it affords little opportunity to exit. As prices advance in an uncorrected parabola, the one-sided nature of the speculation typically gives way to a frantic effort of speculators to exit simultaneously. Crashes are always a reflection of illiquidity in two-sided trading - the inability of sellers to find eager buyers at nearby prices” (John P. Hussman, March 14, 2011)


Levels:

S&P 500 Index [1304.28] – A short-term hurdle closer to 1300 on a pending recovery bounce.

Crude [$101.07] – Pre-global political unrest, crude established a basing level between $85-90. In the past 20 trading sessions, the average is around $100. The near-term spike is unclear if justified by fundamentals; however, the violent swings have yet to subside.

Gold [$1420] – Interestingly, the commodity is reaching a critical level of 1420—a point that has been hard to break above for several months. For now, the all-time highs stand at 1437, which is not too far away. This set up suggests a critical turning point and a chance to read investors’ true feel.

DXY – US Dollar Index [75.71] – Broke below 76 and now entering a fragile point that reiterates further weakness.

US 10 Year Treasury Yields [3.26%] – Since early February, rates have declined significantly. Interestingly, the 200-day average sits at 3%--a key psychological level.

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