Market Outlook | February 27, 2012

“Conviction is worthless unless it is converted into conduct.” (Thomas Carlyle 1795-1881)

Positivity Justified

For a while, sellers have pointed to concerns, but the collective markets’ upward movement persists. Since October 2011, stocks have proved to be relatively attractive, despite muted cheerfulness among experts. Simply, the scoreboard is what keeps all participants honest. Plus, overall volatility remains calmer than in previous months. Secondly, an outlook of crisis, collapse and financial disaster resurfaces from idea generators, but is not fully playing out in practice.

Inaccurate Blames

This junction in the business cycle remains mysterious to some seeing improvement in the economic data and suspenseful to others who witness a rising stock market. The ongoing blame-the-Fed game, reliance on politicians or speculating on election outcomes add further theatrics but fail to paint a full picture. Plenty of myth is identifiable in the crowd engulfed with a "collapse" scenario. Similarly, clinging to feel-good bravado of invincibility is too common and tiresome, even beyond the US political arenas. In fact, this theme of deciphering a balanced view sounds too familiar to traders, much as it does for political observers.

Reading "market moving” materials easily creates a mixed message. The challenge of sorting out the data and messages from overly biased, politically driven sources intensifies in an election year. Surely, there are splits in opinions, which deviate from a required balanced view on topics such as sentiment or nature of the recovery or grasp of Americans’ edge in the global economy. Neutral observers such as money managers are paid to filter headlines while betting on high conviction that goes far beyond toxic banter.

Truth Confronted

At this point, plenty of folks have warned of a lack of overall system stability. Yet, no system is perfect, mindsets are mostly fickle and risk is not easy to assess in any market. Importantly, betting against this market for the last six months has been a losing proposition for managers and analysts. Skeptical managers are forced to readjust their global view from one-sided, fear-driven projections. Unfortunately, admitting fault by most “experts” is unfashionable and works against investors’ interests. For example, much of the worry is around sustainable corporate profits; however, the impact on markets presents a different story. “Mr. Ramsey [Leuthold Group] has studied market performance going back to 1938, and has discovered that in the 16 best years for stocks, eight actually coincided with declines in corporate earnings. And profits rose in 13 of the 16 worst years for stocks.” (New York Times, February 25, 2012).


Near-term awareness:

Pullbacks are not to be feared, as chart observers and odds-makers eagerly anticipate a slowdown. Now, the rising Crude pattern is a convenient catalyst for sellers, but observers have seen this before. Investors are witnessing a collective appreciation in asset classes, in equities as well as commodities. Clearly, there is demand for risky assets and equally, there is a lack of alternatives, given low global yields. In terms of the big picture, the shortage of investable ideas is the reoccurring theme, regardless of pending price declines. The challenge has not changed, as usual. It mostly comes down to picking the right assets while taking the risk of timing it close to “right.”

Article Quotes:

“The improper application of the theory is one of the things that fueled the spectacular growth in over-the-counter derivatives, from $60 trillion in 2000 to more than $600 trillion in 2008. This growth took place while the economists and regulators using bricks and mortar logic were arguing that derivatives distributed risk, when in fact massive amounts of derivatives concentrated risk. The fat tails played a starring role in the bankruptcy of Lehman Brothers and the $182 billion bailout of AIG. Merton's theory was right when certain assumptions held, and wrong when they were applied in an overconnected environment. … Economists, policy makers, and presidential advisors have to get it right. Their influence is so great that when they get it wrong, tragedy often ensues. As Robert Heilbroner explained in his classic book, The Worldly Philosophers, the impact of Adam Smith, Karl Marx, John Maynard Keynes, John Stuart Mill, Thorstein Veblen, and Joseph Schumpeter has been immense” (The Atlantic, February 23, 2012)

“Bond issuance in the U.S. declined in 2011 to $2.13 trillion, down from $2.56 trillion in 2011, according to Dealogic. The volume of syndicated loans rose to $1.87 trillion last year, from $1.13 trillion the year before. The shift has occurred despite the fact that rates on corporate bonds are hovering in the 3.3 percent range, near a record low....The Volcker rule and Basel III will also have unintended consequences. For example, a reduction in the inventory of bonds may spur a shift toward the use of more derivatives. ‘Asset managers already use CDSs to manage credit exposure, and in the future, they may use more CDSs as an alternative to credit,’ McPartland says. While the use of CDSs is not necessarily going to make the markets riskier, the expansion of the CDS market is hardly one of the goals of the Dodd-Frank law. The effect of boosting the CDS market is difficult to predict, especially in the event of a crisis.” (Institutional Investor, February 23, 2012)


Levels:

S&P 500 Index [1365.74] –Quickly approaching May 2011 ranges around 1370. Resumption of the upturn since March 2009.

Crude [$109.77] – A very sharp run in last few weeks. Questionable if the current run can get to $114 before exhausting.

Gold [$1777.50] – Nearing the $1800 mark set up a mixed feeling of strength and doubtful follow-through. For now, trading in a familiar trading range between $1600-1800, as seen in the last seven months.

DXY – US Dollar Index [78.35] – Short-lived dollar rally stalled in January, and that continues to be the near-term trend. Yet, the dollar index is 6% higher than its summer lows.

US 10 Year Treasury Yields [1.97%] – Once again, dropping below “2%,” which serves as an emphasis of low yields.


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