Market Outlook | January 30, 2012

“If you do not expect the unexpected, you will not find it; for it is hard to be sought out, and difficult.” - Heraclitus of Ephesus (540 - 480 BC)

Neutral and Eager

The stock market is not trading quite as cheaply as it did last fall. However, it is not hovering at staggering bubble-like ranges either. Meanwhile, a slight suspense is building for the next macro catalysts, as moderate price declines are setting up for the days ahead. Although sentiment remains debatable, there is a growing neutral crowd that’s idle, given the wait and see mode produced by pending elections and European resolutions. Yet, the combination of lower interest rates, lack of liquid alternatives and the eventual shift away from “risk aversion” contributes to favorable long-term upside potential for the US stock market. For trend followers, the 22% increase in the S&P 500 index, from its October 2011 lows, is a sign of early strength. When eliminating the escalating hourly noise, it is hard to dismiss this message highlighting slight improvement from the broad indexes. The upcoming week will test the conviction of buyers while showcasing if there are enough sellers to drum up significant volume.

Labor Mystery

Interestingly, through these unfolding events and upward trending markets, there are plenty of concerns that have not escaped the minds of decision makers and observers. Rosy market performance, of the last few months, reawakens the stringent and very skeptical crowd, which is immersed in worrisome issues. This includes lack of trust in central banks, slowing growth in Asia, lack of sustainable global growth and a combustible social unrest environment. Surely, there is some truth in the concerns but over reliance on reported fears can be overly misleading. Similarly, the true improvement in the US economy remains mixed but certainly tricky since it serves a political issue. The fourth quarter headline growth in GDP of 2.8% does not tell the full story, but is intertwined with mystery. Deciphering the chance of a recession occupies money managers but the answer remains a wildcard. “Presently, we estimate that the effect of these [Seasonal] adjustments range between +2.1 million and -1.1 million jobs in any given month. These are strikingly large numbers compared with the typical range of forecasts that often surround the monthly employment numbers” (John Hussman, January 30, 2012).

Not too Unfathomable

Despite the ongoing tense environment in Europe a looming resolution is awaited, which is both partially misunderstood and mostly fatiguing. A surprise can cause a cheerful response that can drive markets higher than the normal best-case estimates. Of course, a true European resolution to existing wounds is not fully comforting, but after downgrades and further troubling system related discoveries, the downward pressures may subside for a little. Importantly, this crisis is not new at this point and the implication of mismanagement is too great. Politics and posturing aside, several steps for reform are being taken to reach a feasible resolution. Again, markets can translate minor improvements into sensitive upside responses.

Finding analysts with expectations of solid improvement is rare, thus the gutsy contrarians can look into owning banks and risk sensitive themes as a surprise. Once again, the bias against risky assets or increased shifts towards safer assets is quite visible. Gold is the prime symbol of safety, and new waves of buyers seem ready to begin investing in it. At same time, investors seem to require safety while desiring higher returns; a combination that is not practical. Meanwhile, the Federal Reserve’s language advocates betting on risky assets for yet another year. Clearly, for the investor community, to make a collective adjustment from a conventional mindset does and will take some time.

Article Quotes:

“In the meantime, the [European] crisis continues and may superficially appear to be insoluble. Yet, there are in fact several possible solutions to stave off a near-term meltdown when Italy and Spain begin their large bond rollovers in early 2012:
• Germany (and the other economically stronger Eurozone members) can write a cheque and agree to expand the European Financial Stability Facility/European Stability Mechanism and/or give it a banking licence;
• The IMF can write a cheque using new resources from the Eurozone and rest of the world to put together a sizeable new support programme for Italy and/or Spain; or
• The ECB can write a cheque and begin to purchase much larger amounts of the relevant sovereign bonds.

It remains to be seen which solution will be chosen. It is possible, indeed likely, that the ultimate package will combine parts of each of the above.” (VOX, Bergsten and Kirkegaard, January 26, 2012)

“From an innovation perspective, two facts about health care are of importance. First, a huge amount of health care spending is wasted. A strong consensus exists on this point from health care researchers along the political spectrum. Hundreds of billions of dollars are spent on health care today with little or nothing to show for it in terms of improved health. Second, although spending more on health care today doesn't get you much, spending more on health care research gets you a lot. The increases in life expectancy from fewer deaths brought on by cardiovascular disease over the 1970-1990 period, for example, were worth over $30 trillion. Yes, $30 trillion. In other words, the gains from better health over the period 1970-1990 were comparable to all the gains in material wealth over the same period.

Looking at the future, if medical research could reduce cancer mortality by just 10 percent, that would be worth $5 trillion to U.S. citizens (and even more taking into account the rest of the world). The net gain would be especially large if we could reduce cancer mortality with new drugs, which are typically cheap to make once discovered. A reduction in cancer mortality of this size does not seem beyond reach. Medical research spending is far more valuable on the margin than medical care spending yet because we lack an innovation vision, we endlessly debate how to divide the pie while we overlook potentially huge improvements in human welfare.” (The Atlantic, January 26, 2012)

Levels:

S&P 500 Index [1316.33] – Approaching mid-summer ranges between 1300-1350. Setting up for minor declines in the near-term.

Crude [$99.56] – Struggling to climb above the $100 range after several attempts. The 15 week moving average is around $94, showcasing mostly a trendless pattern.

Gold [$1726.00] – The last quarter of 2011 formed a bottoming process around $1600. Momentum favors an upside move that’s building as the next major target stands at $1895.

DXY – US Dollar Index [78.90] – Dollar strength is currently pausing after 2+ month run. It remains in a familiar range, while failing to breakout from its recent strength.

US 10 Year Treasury Yields [1.89%] – Since August 2011, yields have mostly stayed around 2%. Risk aversion is a message that remains in place.

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