Market Outlook | May 7, 2012

“We should not expect all the present to be as good as the best of the past.” (Lewis Korns, Thoughts 1892)

Interlinked brake

Leading up to this spring, several discussions resurfaced on global slowdown themes, which appear to coincide with peaking or consolidating commodities prices. Although this link is not always directly correlated, there are a few issues to ponder in connecting the dots between major macro indicators. At least, early signs of slowing commodity prices are igniting thought-provoking questions.

The overall available oil supply mildly shocked participants making a noteworthy move last week. Crude prices broke below $100, signaling a sharp weekly decline of 6%. The rise in US crude inventories showcased a trend that has continued for over six weeks. Recent price patterns did not quite live up to the chatter of Middle East disruption, which was causing worry about escalating crude prices. Refuting common groupthink thus far, this trend alerts us to lessen the emphasis on political chatter but refocus on more fundamental matters.

Vitally deadlocked

To grasp most of the mechanics in the commodity pricing requires linking a few puzzles. One key sensitive topic relates to recent awareness of emerging markets’ sluggish outlook. Again, as the facts and evidence reveal themselves, the decade-old commodity momentum is facing similar scrutiny as other risky assets. Recent crisis-mode behaviors have showcased synchronized downside movements in recent years. Amazingly, short-term memory will play psychological games for capital allocators.

The connection between gold prices and the US Dollar presents a noteworthy impact to market dynamics. Both heavily cited barometers have been stuck in a trading range lately, enhancing curiosity and discouraging trend followers. Gold has not found compelling reasons to spark an appreciation for several weeks. Meanwhile, the same applies for the US Dollar, which remains suppressed into customary low ranges in the last three months. These indicators are usually known (at least in conversations) to move in the opposite direction. However, the commodity and the currency are equally deadlocked in a period flooded with less certain events. This poses a hint in itself, of a pending inflection point.

Other observers will point out how a destabilized environment causes a rush into safer assets. In that scenario, the Dollar proved to be in higher demand in 2008 than gold. Similarly, the faith of quantitative easing will dictate whether further policies “eroding” the US Dollar’s value continue to benefit gold prices. If further easing is off the table, then gold may not sustain its leadership, despite its appeal as a reserve currency to central banks.

Benefiting by default

Considering the troublesome emerging markets, along with impactful election results in Europe, the US market seems poised to benefit from a lack of stability. Yet, the US monthly labor numbers were not as cheerful as a result of increasing growth expectations. Similarly, keeping up with previous solid quarterly earnings outcomes is not easy to deliver. “The percentage of companies beating earnings estimates has been just 53% over the last three days [last week], dropping the overall beat rate for all of earnings season down to 61%.” (Bespoke Investments Group, May 4, 2012). Perhaps a warning that ongoing solid surprises are not sustainable for a charged-up crowd Fatigue of a good stock market run is normal and it wears down the enthusiasm for a short period. It takes time to restore a collective resurgence. All that said, preparing to add exposure to US stocks is a valuable exercise, especially given the lack of better alternatives from all sides.

Article Quotes:

“Stock trading now accounts for 16 percent fewer customer trades at TD Ameritrade than it did in 2009. ‘We’ve had instances where it looked like things were clearing up,’ said Mr. Quirk. The company’s clients in some recent months tiptoed back into stocks, he said, ‘but then they rather surprisingly just quit.’ Among the broader population, the most common investment in stocks has been through mutual funds. The most conspicuous sign that these investors have grown disenchanted with American stocks has been the flow of money out of domestic stock mutual funds, which were drained of more than $400 billion since the start of 2008, compared with an inflow of $52 billion in the four years before that, according to the Investment Company Institute. The outflow has continued into 2012. The shift is partly attributable to the growing number of seniors moving from stocks to bonds, which is typical in retirement. But surveys by the institute have shown that investors young and old have grown less willing to invest in domestic stocks, even with interest rates on bonds at record lows in recent years.” (New York Times, May 6, 2012)

“The Lewis Point refers to the gradual disappearance of an unlimited rural labor supply that happens when a country develops. This, along with the commensurate rise in labor wages, is certainly happening in China, and as this World Bank blog post notes, could cause a decrease in FDI as China becomes a less attractive manufacturing destination. The characteristics of the workforce are also changing – more and more Chinese are going to college, creating a workforce more suited to skilled tasks than factory work. The middle income trap, as explained by this excellent New York Times article, is when a country’s growth starts slowing once per capita income has reached between $5,000 and $15,000. Once a country has reached a certain economic level, it becomes harder to grow further, in a situation analogous to the law of diminishing returns. Additionally, China is reaching the end of its demographic dividend, the disproportionate number of working age people that allowed it to leapfrog growth.” (The Diplomat, May 3, 2012)

Levels:

S&P 500 Index [1369.10] – Staying above 1350 is a near-term challenge; yet, a retest around 1360 is too familiar.

Crude [$98.49] – Sharp collapse below the $100 level. Appears like a knee-jerk reaction at first. However, this offers confirmation of slowing momentum in recent weeks.

Gold [$1643.75] – Barley changed from last week. Although a neutral territory is glaringly established, an anxious move awaits.

DXY – US Dollar Index [79.19] – Like gold prices, in the last 50 days or so, the index has not moved much. Importantly, the dollar has not made or retested new lows.

US 10 Year Treasury Yields [1.87%] – Short-lived run above 2% proved not to be sustainable. Yet, hovering at 2% is nothing unique or surprising.

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