Market Outlook | August 29, 2011

“Courage is not the absence of fear, but rather the judgment that something else is more important than fear.” Ambrose Redmoon (1933–1996)

A minor breather to the summer turmoil, as the market held from hitting another new low. Overall, there transpired a desperately needed relief, with a near 5% weekly rally in the S&P 500 Index. Again, this upside move is part of a short-lived bounce, and not necessarily reflective of improving fundamentals. The long-term picture is too fuzzy for policymakers who are consumed with handling damage control. Crisis management includes European debt crisis that affects the Euro banking system while adjusting the currency imbalances. Speculating might be thrilling for some, or very costly for others, while investing requires no major rush.

The current realities still showcase fragile sentiment and waning trust in US and European policymakers. That’s difficult (but possible) to shake off with lack of visible growth, which makes owning shares not vastly appealing for less involved and longer-term participants. Increasing sensitivity, in the response to data points, can be frustrating especially with overall bias favoring declines. Surely, the downside risks maybe overhyped at times, or unknown, as an all-out panic continues to linger since late July. Of course, sentiment is hard to change overnight but known to sway in due time. At least for now, the focus is on “repairing” as much as “building;” a painful process that requires patience for growth seekers.

Even the optimist cannot deny the challenges of business cycle growth and policymaking constraints to reach a trending setup. When removing sensationalism and pending elections (at least for a second), the economic numbers paint a grim perspective. An estimate around 1% GDP growth in the US can trigger rude confirmation or surprises. Basically, the odds and definition of a recession are bound to be thrown around. These days, reigniting quick cheers by central bankers is not as easy, and political limits are less inviting for creativity as well. At some point, accumulating bad news becomes overly exhausted, yet it may take longer than envisioned.

Investment themes appear limited, given extreme behaviors in gold prices, yields, volatility, stocks, and sentiment. If the big picture is murky for the majority, and fear is priced at a premium, then an opportunity lingers for big risk takers. For now, three themes are worth watching between now and year-end.

I. Emerging Market Discomfort - For the last several months, inflation worries in China and Brazil have been a dominant, popular and pragmatic discussion points. More recently, long-term investors are reexamining the projected growth rate expectations, especially in China. If there are disappointments, then the relative argument is bound to benefit US markets to some degree. Clearly, it is not simple to overweigh one country versus another, given an interlinked global stock market. Many wonder if the slowness is already priced in, and a bottoming process is due. Again, the macro indicators will have a bigger influence in shaping the bias of this theme.

II. Currency and Commodity Patterns - The sustainability of Gold prices are on the list of suspenseful matters, after other commodities began their correction since the Spring. Minor pullbacks were witnessed last week in Gold. As usual, any decline in the metal begs many to ask “is this the top?” Premature as it might be, there will be lots of chatter on Gold’s ability to hold above $1800, versus achieving the next psychological landmark of $2000. Inversely, a recovering Dollar can readjust the mindset of stale consensus belief. Recent rotation into Swiss Franc needs to calm down, as well as concerns in the Yen. The macro clues can become clearer once the scrambling for a “safe haven” is fully established. For now, it remains too speculative with no trend reversal, as interest rates will play a role in this puzzle.

III. Bargain Hunting - In terms of picking up value, it may take time for ideas to materialize, as the pressure mounts to identify the right companies and catalysts. On the other hand, few trading ideas present themselves for the active participant. Banks recuperating from irrational sell-offs and some consumer based sectors (i.e. retailers) are poised to follow. This stems from overly depressed expectations of consumer driven areas. The Bank Index (BKX), at one point, traded 41% below its winter 2011 highs. Early signs of a recovery took place, as value oriented buyers debated the merits of the early recovery.

At this junction, if one is to take a bullish outlook for the rest of the year, then a very selective approach is required, along with close monitoring. Let’s say the conservative best case scenario is to make up the summer loses, then the broad indexes are about 6%-10 removed (1250-1300 on S&P 500 index). Of course, the odds for an upside surprise increases if volatility peaks at current levels. That can provide an extra boost for a much higher move. Therefore, it may be wise (from a reward perspective) to find unique ideas, as opposed to blindly betting on broad markets to capitalize on the limited opportunities.

Article Quotes:

“One of my inspirations for ‘Debt: The First 5,000 Years’ was Keith Hart’s essay ‘Two Sides of the Coin’. In that essay Hart points out that not only do different schools of economics have different theories on the nature of money, but there is also reason to believe that both are right. Money has, for most of its history, been a strange hybrid entity that takes on aspects of both commodity (object) and credit (social relation.) What I think I’ve managed to add to that is the historical realization that while money has always been both, it swings back and forth – there are periods where credit is primary, and everyone adopts more or less Chartalist theories of money and others where cash tends to predominate and commodity theories of money instead come to the fore. We tend to forget that in, say, the Middle Ages, from France to China, Chartalism was just common sense: money was just a social convention; in practice, it was whatever the king was willing to accept in taxes.” (Interview with David Graeber, August 26, 2011)

“From America's perspective, what may be the most important distinction between Japan then and China now is that Japan was a lever against which global pressure could be exerted on the Soviet Union as an ideological and economic opposite. This same rationale, that China could be leverage against the Soviet Union in the midst of the Cold War, was very much what initially motivated Henry Kissinger and Nixon to begin their dialogue with China. But now China's economic growth alone has made it the closest near-peer competitor to the US, and its ongoing embrace of authoritarian politics make it an easy proxy for the role of ideological foe which the Soviet Union long held. A country once used as leverage by the United States is now the country against which the United States most needs leverage.” (Asian Times, August 27, 2011)

Levels:

S&P 500 Index [1176.80] – Early pattern of stabilization developing between 1150-1200. Any significant move below 1120 can reignite a new wave of panic selling.

Crude [$85.37] – Revisiting ranges from late February around $85. Further evidence needed for the downtrend to slow down.

Gold [$1788.00] – Establishing a new mark around $1740-1800. This run appears extended in the near-term and due for some correction. On Friday, it closed 9% above the 50 day moving average.

DXY – US Dollar Index [73.81] – Around 74 marks a multi-month trading range. Barely any noteworthy activity for trend followers.

US 10 Year Treasury Yields [2.18%] – At the low end of its historic pattern. The yields today were last seen during the shock of 2008 and 1949-50 eras.


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