Market Outlook | July 30, 2012

“Your neighbor's vision is as true for him as your own vision is true for you.” Miguel de Unamuno (1864-1936)

Neutrality beloved

The notion of "wait and see" remains a common saying in casual investor talk. Summer days pass by with one crowd waiting for elections while others sit back, awaiting clarity on the latest job numbers and sustainability of corporate earnings. It’s fair to say: Observing is preferred over speculating on the revival of the fragile financial system. Most US technical forecasters appear to subscribe to “range-bound” movements. More or a less a dull pattern is anticipated as we continue to witness calmer volatility in stocks. This reflects the limited directional conviction for the next 2-3 years. To no one’s surprise, risk-aversion is deeply rooted and interlocked in the minds of market participants as measured by some sentiment barometers.

However, getting comfortable with too much observation and resorting to narrower views may lead to opportunities missed. Surely, there’s no denying of deflated moods and lack of motivation for risk taking. Yet, nearly an ideal setup exists for a patient investor – even more intriguing for the few overcoming the clogged up and fatigued chatter around fear. In between the ramblings, one may stumble on themes such as cyber security, infrastructure and deeply discounted emerging markets, which present an attractive entry point. Certainly, with notable macro-related announcements this week, one can expect emotionally based reactions, but separating facts from noise is the challenge ahead.

Digesting opinions

Emphasis on the various sovereign challenges will remain part of the daily banter. Most of the catalyst of shorter-term market movements is credited to the heads of central banks or policy influencers.

If Germany promoted herself as Europe's top economy, then the recent downgrade is a mild wakeup call to stir thought-provoking points. Does saving the Euro make Germany more risky? At least leaders know that stability by all means is desperately needed. Perhaps, rating agencies opinion is usually leads to shorted-lived responses. However, the recent "downgrade" of Germany and her banks finds a way to play more into the existing uncertainty mania. Last summer, markets quickly got over the much-hyped (debatable) US downgrade faster than imagined. History does not exactly repeat itself, but the notion of credit agencies setting the tone for the long term remains questionable. On the other hand, the results of rating agent opinions shape investors’ mindset. Perhaps the week ahead will present another clue as the ECB faces pressure to deliver decisions.

Soft commodities clues

Hard commodity supporters are puzzled and disappointed despite the increasing hopes of a trend reversal, which has yet to materialize. For example, gold is nearly unchanged for the year, and the long-awaited recovery struggles to find a noteworthy pace. Similarly, silver and copper remain in a downtrend. Yet, the commodity index (CRB) is showing very minor and early sings of bottoming that began in late June. It’s hardly a definitive or a clear trend, but the driver of this trend circulates around agricultural-related commodities, which remain in high demand. Food prices (mainly wheat and corn) serve as a macro-indicator for the tense global landscape. Beyond complicated currency or interest rate management, food prices can influence behaviors and stimulus options. Perhaps, political or market turbulence can trigger the outcome of soft commodity actions. The contrast in pattern between hard and soft commodities is a prevailing theme worth observing in the months ahead.

Article Quotes:

“After 25 years in business trying to do the right thing for our clients every day, after 25 years of never using leverage and sometimes holding significant cash, we still are forced to explain ourselves because what we do—which sounds so incredibly simple—is seen as so very odd. When so many others lose their heads, speculating rather than investing, riding the market’s momentum regardless of valuation, embracing unconscionable amounts of leverage, betting that what hasn’t happened before won’t ever happen, and trusting computer models that greatly oversimplify the real world, there is constant and enormous pressure to capitulate. Clients, of course, want it both ways, too, in this what-have-you-done-for-me-lately world. They want to make lots of money when everyone else is, and to not lose money when the market goes down. Who is going to tell them that these desires are essentially in conflict, and that those who promise them the former are almost certainly not those who can deliver the latter? The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions. Success in the market leads to excess, as bystanders are lured in by observing their friends and neighbors becoming rich, as naysayers are trounced by zealous participants, and as the effects of leverage reinforce early successes.” (Seth Klarman, October 20, 2007)


“But there are more exotic methods that can push interest rates below zero. Lars Svensson, vice governor of Sweden’s Riksbank and a former Princeton colleague of Ben Bernanke, in 2009 implemented a negative interest rate on bank reserves of 0.25 percent. What that means, in plain English, is that banks had to pay 0.25 percent of the principal they parked at the central bank. Because the banks can’t keep their reserves in cash, they couldn’t just pull them out and avoid the penalty. The result was the strongest recovery in Europe. There are other ways to achieve negative interest rates. Mankiw has jokingly suggested invalidating all physical currency whose serial number ends with a certain digit. If every $1, $5, $10 etc. bill with a serial number ending in 7 were declared invalid, 10 percent of all paper money would be worthless — or, in other words, there’d be a negative interest rate on cash of 10 percent. Willem Buiter, formerly of the London School of Economics and currently of Citigroup, has proposed abolishing paper currency altogether. If all the money is in bank accounts, after all, the Fed can just shave off a certain percentage every so often. This is harder to do with paper money, absent a scheme like Mankiw’s serial number idea.” (Washington Post, July 25, 2012)

Levels:

S&P 500 Index [1385.97] – Choppy trading pattern in last few weeks. Closing above 1380 is encouraging despite the murky sentiment. June 4th lows of 1266 mark a key inflection point for now.

Crude [$90.13] – Attempting to hold above $90. Buyers have shown significant interest when prices traded around $84. Early signs of bottoming, however, increased skepticism around the $98 range.

Gold [$1618.00] – Seen in a range in the past three months between $1560-$1620. Now, an ultimate test for buyers’ conviction is here, during the climb back up to $1700.

DXY – US Dollar Index [82.70] – Climbed and peaked at 84, as last seen in the summer of 2010. Near-term pause is too early to declare a trend shift.

US 10 Year Treasury Yields [1.54%] – Trapped in a narrow range between 1.40-1.60%. while attempting to stabilize around all-time lows.

Dear Readers:

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