Market Outlook | August 13, 2012

“In times of change learners inherit the earth; while the learned find themselves beautifully equipped to deal with a world that no longer exists.” (Eric Hoffer 1902-1983).

Revisiting cycles

It was four years ago when the crux of the financial crisis ferociously shocked the system and quick decisions had to be made to avoid a crumbling series of events. The residues of bailouts and distrust continue to re-ignite the day-to-day trading patterns. In the historic collapse of 2008, it was hard to visualize where we would be today. In hindsight, there are a few points to consider. For one, markets have stabilized despite low volume. Secondly, performance in major indexes is not as bad as was thought. Thirdly, the relative strength of the US stands out despite well-publicized lists of worries filling up pundits’ time.

On the other hand, the stability of banks is still a fragile discussion point as the Federal Resereve continues to demand “recovery plans” from the largest banks. Although less discussed, disaster aversion remains a common practice and occasional worry. Lessons from the 2008 crisis continue to force the regulators to require contingency plans with the hopes of avoiding controversial “bailouts.” Perhaps, confidence restoration is an ongoing challenge.

Meanwhile, calming banks’ vulnerability was intended to restore the system where lending can drive up economic activity. Mild as it may be, lending activity appears to pick up for now:

“Banks in the U.S. are lending the most since the recession ended in June 2009, supporting an economy burdened by 8.3 percent unemployment. Fed policy makers including Chairman Ben S. Bernanke weighed the results of the survey at their July 31- Aug. 1 meeting at which they said they “will provide additional accommodation as needed” to support the economy.” (Bloomberg, August 6, 2012)

Reassessing

A year ago, the US downgrade awakened the markets while hardly altering the contentious political landscape. Yet, for those who bailed on equity markets, there was 27% appreciation in the S&P 500 Index. A year later, the strength of broad markets is less talked about, especially in a period of low yields. Instead, attention is consumed with endless discussions of a pending downfall, especially by those incentivized to use markets for a political barometer rather than a pure ‘money-making’ instrument. Thus, one must be meticulous in not mixing real returns with cheap talk when it comes to US markets. At the same time, seeking attractive alternatives is not easy to spot, either.

In looking ahead, the challenge begins. For example, if asked today, “Where is attractive growth?” many would stumble to answer with a high or any level of certainty. The global slowdown has been revealed in emerging markets as well as Europe in recent months. Thus, the ongoing slump is not news anymore, as the search for solutions and specific viable ideas continues.

Pricing courage:

The wild card may be in figuring out how much downside is already priced-in in this risk-sensitive environment. As usual, information is processed faster than headlines would have one imagine. Of course, it seems a little strange (in terms of odds) for one to predict the anticipated events of further easing, election results and corporate earnings growth. Three vital unknowns linger for the upcoming weeks. Believers in an ongoing rally are less visible and not loudly portraying their convictions. Not surprisingly, plenty take the safer route in deferring to election results for reexamination of risk taking. Amazingly enough at this junction, the continuation of the status quo (rising equity markets) might end up being the courageous move.

Article Quotes:

“There are a number of questions now confronting London's status as a financial center: firstly, it is clear that politicians in continental Europe would like nothing better than destroying the city's pre-eminent position in financial services. Partly this effort is so that European politicians could push through certain anti-market principles such as the financial transactions tax (the so-called Tobin tax being promulgated by the French) and a ban on certain types of financial transactions such as sovereign credit default swaps that they believe are centered in London. There is of course the deep envy that German regulators feel about the sheer irrelevance of Frankfurt as a global financial center, not to mention the deep resentment felt in France that even banks that survive due to government bailouts end up having significant operations, particularly those involving higher-paying jobs out of London. Then there is the whole question of how financial regulators have operated in the UK, essentially being accused by their colleagues elsewhere in the world (Switzerland, the US, Germany, Italy to mention a few) of allowing roguish behavior from bankers peddling fairly dangerous financial instruments …” (Asian Times, August 11, 2012)

“If one has to take a position, it may be reasonable to argue that the Beijing Olympics in 2008 symbolically marked the peaking of Chinese power. Everything began to go downhill afterwards. Caught up in the global economic crisis, the Chinese economy has never fully recovered its momentum. To be sure, Beijing's stimulus package of 2008-2009, fueled by deficit spending and a proliferation of credit, managed to avoid a recession and produce one more year of double-digit growth in 2010. For awhile, Beijing's ability to keep its economic growth high was lauded around the world as a sign of its strong leadership and resilience. Little did we know that China paid a huge price for a misguided and wasteful stimulus program. The bulk of its stimulus package, roughly $1.5 trillion (with two-thirds in the form of loans from state-owned banks), was squandered on fixed-asset investments, such as infrastructure, factories, and commercial real estate. As a result, many of these projects are not economically viable and will saddle the banking system with a mountain of non-performing loans. The real estate bubble has maintained its froth. The macroeconomic imbalance between investment and household consumption has barely improved.” (The Diplomat, August 9, 2012)

Levels:

S&P 500 Index [1405.87] – Revisiting the 1400-1420 range last reached in April. Interestingly, that marked the previous peak, which begs the question of a repeat or a stall.

Crude [$92.87] – Since bottoming on June 28, 2012, the commodity has managed to spark an uptrend. The ability to stay above $95 will determine the near-term buyers’ momentum.

Gold [$1618.50] – For over three months, the narrow trading range has been clearly defined between $1560-$1620. A breakout above $1620 could restore a long-awaited enthusiasm among gold aficionados. Yet, it’s safe to say an inflection point is here.

DXY – US Dollar Index [82.70] – The dollar strength theme has been alive and well for over a year. In recent months, an anticipated pause around 82.

US 10 Year Treasury Yields [1.65%] – Some visible relief since the extreme lows of July 25 (1.37%). Hints of rising rates, but a follow-through is desperately needed to reach above 2%.


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