Market Outlook | May 21, 2012

“We all live in suspense from day to day; in other words, you are the hero of your own story.” Mary McCarthy (1912-1989)

Continued Apathy

One way or another, tolerance for risky assets is slightly less vibrant today than last May. Recent patterns continue to reignite a frenzy mode, which is visible in several pockets of the market. For example, emerging market (EEM) and small cap (Russell 2000) indexes are lower than last year’s levels by 26% and 10% respectively. It merely reemphasizes what seems a never-ending demand for risk aversion, as confidence restoration is a much longer process than envisioned by optimistic observers. Perhaps, this is not much of a surprise when considering that the New York Stock Exchange volume dwindled to extreme lows in February this year. Meanwhile, the same holds true for the declining trading activity in April 2012. We’re in an era of lower participation rates in stock market speculation despite the overhyped initial public offering witnessed last week. Basically, the overall message is that retail investor participation is slowly diminishing.

A lukewarm appetite for risk taking is much talked about and loudly heard when viewing the strength of the US dollar patterns year over year. Similarly, increasing demand for safety is visible when observing the US Treasury yields closing at 1.73% – very low indeed. Surely, this marks another year in this ongoing period of the “desperate for yield” theme that plagues investors of all kinds. This contributes to risk-aversion behavior for now, despite the strong first-quarter stock performance and gradually improving economy. However, market jitters find a way to express less enthusiasm when several unknowns dampen the commitment levels of experts, veterans and of course capital allocators.

Commodities evaluated

Ongoing thoughts of speculating in oil stocks have lost their luster, as (OSX) reminds us, given its 23% decline extending from February to May 2012. Similarly, crude, which was around $100 a year ago, is now trading closer to $90, as the commodity trading community weighs the balance. For gold-related investments, a hopeful crowd awaits a recovery, but speculators have a lowered buying appetite. According to data (ending May 8, 2012) collected by the Commodity Futures Trading Commission (CFTC), the number of speculators betting on rising gold prices fell to its lowest level since December 2008. Some may argue an inevitable gold recovery is slowly underway, but sideways to down behavior provides us with noteworthy hints. In upcoming weeks, the broad demand for commodities will be revisited, especially with limited options within popular financial vehicles.

Uncertainty accustomed

If the word “uncertainty” felt overused last year, it may turn out to be a commonly used phrase this year, too. Sure, at times, bad news (or current reality) is exhausted until it resurfaces again into actionable thoughts of selling. Now, global indexes wrestle to preserve annual gains as each downside move frightens most people into following patterns seen in summer 2011. Plus, furious elections pending in Europe and the US easily stir up emotional near-term patterns.

The search for a stable Europe, a reliable financial system and sustainable natural growth has not been achievable at political influencers’ desired pace. Perceptions may change here and there, but convincing participants to heavily bet positively is a daunting task, or at least not as easy as was seen last decade. Surely, uncertainty is beyond directional guesses, but subject to shifting moods and changes in some perceptions. For now, the jump in volatility displays further edginess. After all, frustrations arise in financial circles over adjustments from opaque systems to current realities. As wagering on election results creates a summer buzz, the impact of taxes and regulatory measures can provide further guidance for clarity. Perhaps, a collaborative stimulus by central banks may serve as a mild wild card to this inflection point. Yet, the crowd has seen and heard that story before.

Article Quotes:

“And one more point of note for the ‘What, me worry?’ crowd: Just because bond markets in countries perceived as safe, such as the U.S., are blasé about the debt load, it would be a mistake to ignore the lessons of history. ‘Those waiting for financial markets to send the warning signal through higher interest rates that government policy will be detrimental to economic performance may be waiting a long time,’ the authors wrote in their paper. Now for some of the details, starting with a definition. The economists define a ‘debt overhang’ as a five-year period when gross public debt exceeds 90 percent of gross domestic product. According to this metric, Italy, Greece and Japan are charter members of the club, with their most recent episodes beginning in 1988, 1993 and 1995, respectively. The U.S. isn’t in the debt doghouse just yet, given that it first breached the 90 percent threshold after the 2008 financial crisis. But it’s on the waiting list, along with Belgium, Iceland, Ireland and Portugal.” (Bloomberg, May 16, 2012)

“The financial world is more accident prone than ever – thanks in large part to the Internet, the mother of all interconnections. Not only has the Internet supercharged financial innovation and created high rates of growth, but it lies at the heart of many financial normal accidents in the 21st century. In the case of Iceland, the country was welcomed into the European Economic Area, which enabled Icelandic banks to operate throughout the continent as long as they had deposit insurance. At the time, Iceland had a gross domestic product of less than $20 billion. Yet its banks mushroomed in size. By 2008 they had over $100 billion in assets as investors raced to capitalize on high interest rates and the rising value of the Icelandic kronur. Iceland's online banks sucked in $6 billion in deposits from consumers in Britain and the Netherlands in a few years. But when investors lost confidence in the Icelandic economy, it triggered a normal accident. Money that had flowed in over electronic networks, fled at Internet speeds – an electronic run on the banks. There was no way the Icelandic Deposit Compensation Fund could meet its commitments to depositors. Iceland had created banks that were too big to fail in a country that was too small to save them. The kronur went into free fall, and lost half its value.” (The Atlantic, May 18, 2012)

Levels:

S&P 500 Index [1295.22] – From its intra-day peak on April 2, 2012, the index has dropped by 15%. The 200-day average is a few points away at 1278.22, which will be a discussion point to determine if a relief rally is pending.

Crude [$91.43] – For over three months, the sharp declines in crude confirm sustained weakness. First glimpse of bottoming awaited around $90.

Gold [$1589] – A very early sign of a recovery this week from slumping levels. Buyers’ interest showcased below 1550, similar to late December 2011. However, an inevitable bounce needs to prove a sustainable trend.

DXY – US Dollar Index [81.29] – A strengthening statement since May 1. In fact, the dollar index is approaching its multi-month highs achieved in January 2012. Since May 2011, the index is up nearly 12%.

US 10 Year Treasury Yields [1.72%] – A few points above September 2011 lows of 1.67%. Stuck between a bottoming process and an established downtrend. Attentively watched at these very fragile levels, as the risk-aversion participants finds shelter.



Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed