Market Outlook | May 31, 2011

“I believe in the imagination. What I cannot see is infinitely more important than what I can see.” -Duane Michals

Flow and Rhythm

After a minor pause in commodities and stocks, there are early signs of further acceleration in both indicators. The established trend is uniform and appears to be comforting for trend followers. Each minor sell-off seems short-lived and the buyers’ momentum grows stronger, especially for larger cap companies. The lighter volume around the holiday weekend has not distorted much of the message from the first message in 2011. The obvious, but important, election season will have its influences either in market movement or shaping the outcome of the election—an intertwined phenomenon indeed. Thus, the market behavior will be watched attentively by forecasters as much as political pundits. Either the bad news is bound to be postponed for future years or a reality check can sneak up quickly.

The ‘Supply Shortage’ Theme

Supply shortage is a common theme in several areas of the marketplace. For example, investment options leave many with a lack of high growth ideas for the risks taken. Others leaning toward fixed income may not be quite pleased with lower yields of bonds or traditional CDs—thus, the movement into riskier assets, such as junk bonds. In the commodity world, much of the discussion revolves around scarcity of food, not to mention the long term constraint argument of Crude as reflected in several reports arguing for further appreciation ahead. In fact, Goldman’s and Morgan Stanley’s Crude upgrade contributed to a lift in pricing last week.

In terms of currency, the US Dollar continues to erode in value, but a lack of alternatives keeps the Dollar vibrant for international circulation. In Europe, the smaller economies are restructuring to recover from crisis mode, leaving few places such as Germany or France. The premise of limited availability may be a near-term matter in most cases. However, consensus has accepted and mostly agreed with these above points in making decisions. When these dynamics begin to change, then one can declare an attitude shift while preparing for the consequences.

The element of surprise is the suspenseful part of a lethargic period of a cycle. The last few weeks have slightly questioned the logic and merits of ongoing price appreciation. If there are mood swings, one should watch the fragile areas of the market: emerging markets, small caps, and interest rate sensitive groups. This synchronized upside move is partially fatiguing, yet, timing turbulence can be a costly task in a low rate environment fueled by policymakers.

Specific Ideas

SPTN (Spartan Stores): This grocery distributor offers favorable fundamentals as it raised its dividends by 30% as profitability remains healthy. Improvement in sales and economic recovery, especially in the Midwest, can further contribute to stock appreciation. Meanwhile, the technicals illustrate a bottoming process in stock price as it breaks above 200-day moving average.

HST (Host Hotels & Resorts, Inc): A real estate investment trust with exposure to high-end hotels continues to demonstrate profitability and further growth in its outlook. The company reinvested in several renovation projects while maintaining a steady room booking pace. First quarter earnings were net positive. The recent private placement transactions along with slight increase in dividends contribute to further investment interest.

ATVI ( Activision Blizzard): Relatively quiet and stagnant the last few weeks. In looking ahead, appealing entry point based on charts, especially ahead of the new game release in November 2011. Meanwhile, the recent quarterly earnings were mostly positive and set to beat expectation. Majority of the capital in the video gaming space has chased ERTS (Electronic Arts) in recent weeks, but a rotation back to ATVI (Activision) is appealing in the next 3-6 months.

Article Quotes:

“Another, and potentially more important in the long run, is the reduction in China’s competitive advantage over the U.S. real wages have been more or less stagnant in America, and several manufacturers are emerging from the recession with sharply increased productivity. Leading American companies are taking their next round of expansion at home rather than risk having their intellectual property filched by the Chinese, for which there is no redress; face the regime’s demand that they turn over technology in order to have access to the Chinese market; lose markets because of buy-China policies by government agencies; and cope with unusually severe energy shortages resulting from the government’s fear of allowing electricity prices to keep pace with mounting coal prices. So much for one of the dollar’s potential competitors.” (The Weekly Standard, May 28, 2011)

“Finance seems to be a polytheistic rather than a monotheistic faith. The objects of veneration change on a regular basis from emerging markets through internet companies to commodities. These enthusiasms often have a cult-like quality with adherents inclined to pour scorn on unbelievers who “just don’t get it.” It is striking that the cults often involve asset classes that do not deliver much in the way of immediate cashflow. Dividends will be paid far into the future, long after the likely holding period of the average investor. It is a little bit like the promise of an afterlife.” (The Economist, May 26, 2011)

Levels:

S&P 500 Index [1331.10] – Odds are setting up for near-term recovery while pausing between the 1300 and1340 range the past few weeks.

Crude [$100.59] – Attempting to re-accelerate after stalling in the past few weeks. Next key target stands at 50-day moving average of $105.

Gold [$1533] – Climbing back while approaching May 4th high of 1541. Overall, positive momentum is in full force.

DXY – US Dollar Index [74.95] – After a short-lived Dollar appreciation, the momentum is becoming stuck.

US 10 Year Treasury Yields [3.07%] – A four month decline is establishing a downtrend in yields. It’s trading at the 200-day moving average. The magnitude of further declines serves as a key macro indicator.

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