Market Outlook | September 10, 2012

“Society is always taken by surprise at any new example of common sense.” Ralph Waldo Emerson

Common sayings

The three common prevailing themes these days circle around re-accelerating gold prices, overvalued stock market and weakening Euro. As to how these themes materialize remains an art form that will play itself out. Deciphering the chances of all three themes having an unexpected or inverse result is even more appealing then the currently presented conventional thinking.

The thought process of high gold prices, lower stock market and weakening Euro stems from daily reminders of economic slowdown and ongoing efforts of easing by central banks. This collective growth concern has plagued large (especially China) and smaller nations in recent months. Thus, the inescapable nature of interconnected markets creates a gloomier outlook for those shaped by current events. These fragile growth related issues may reinstate further thoughts that all three themes will play out in a "logical" manner. At least, experience teach us the power of self-fulfilling prophecies should not be underestimated. However, accepting a gloomy outlook because it is a good or logical story is not prudent for a participant looking to capture trends.

A Multi-purpose idea

From a participants point of view, having clarity of the “instrument” is a good start. As in, is gold a commodity or a currency or both? Is it a speculative instrument or a long term investment? Perhaps all of the above is the sentiment that is being felt and those forces are unpredictable in their waves. Yet, staying weary of these so called "obvious" statements usually ends up rewarding the skeptical observer. These days gold is popular not only as an investment tool but a political tool as a commodity that has rustic appeal and historical appeal. Plus, gold is a hedge for gloomy outlook or system breakdowns that are pending. Perhaps, there is a comfort in holding in a perceived safe instrument.

Gold aficionados are sensing a bottoming process form over the summer. That encouragement is fueled by an 11% rise in gold prices since mid-July. A much anticipated gold rally lurked in the background and reawakening the gold bugs. Yet, the goal of diversification away from major currencies is not to be confused with gold price appreciation. In other words, fear of dollar and Euro depreciation might be compelling to look for some gold exposure. Sure, that’ s a portfolio management decision to hold some the same way central banks manage their balance sheet. Sometimes confusing a hedge with an investment does not have a pleasant outcome. In the near-term, the higher gold prices go the higher the conviction of those awaiting this commonly accepted expectation.

Sustainability doubted

Observers are noticing the rise in stock markets and ongoing strength of corporate earnings and asking the question: is this sustainable?

It is a logical question that begs for increased clarity, but the uptrend is too difficult to dismiss or ignore. Of course, some pundits remind us that The S&P 500 index keeps making its stride towards the 2007 highs led by technology but wide participation is visible – even banks are recovering. The well followed stock indices are up 14% for 2012 and if one was too busy reading the “slow down” headlines then these gains would’ve been harder to visualize. For a focused trader, all the noise of market concern has been the loudest distraction, but fundamentals have been solid.

Bank analysts (ie. Bank of America and RBC) are beginning to send out cautious forecasts for equity markets between now and year-end. This is hardly surprising and somewhat predictable for veteran observers. As volatility remains low these conditions invite the contrarian crowd to bet against all global markets. That bet has been mistaken several times this year in which some envisioned increase turbulence leading to stock demise. The set up for a stock market correction may be plausible but evidence is not quite as visible as desired by most naysayers. Thus, the positive momentum remains in place.

Undesirable challenge

Much of the discussions and cautious investor sentiment centers around a fragile European stability. Importantly, there is an ongoing assumption that Europe can not solve its problems and the Euro currency is bound to collapse. Yet, the preservation of the Euro appears to be a priority despite a mountain of complex challenges. For risk takers, the erosion of the Euro value has not materialized as expected. Obviously, the political mess for resolution and increasing unemployment is discomforting in the Eurozone. The emotional responses to these events is visible as Greece enters the fifth year of recession. Now, the contemplation of Greece leaving the Euro is on the table but impact on currency might be another story. As an editorial reminded us this weekend: “If Greece, the weakest link, is forced out of the monetary union, that would actually strengthen the currency. The result would be so chaotic for Greece that the other debtor countries, observing the wreckage, would do whatever it took to avoid the same fate, cutting their deficits even more quickly and accelerating other reforms.” (Washington Post, September 7, 2012). Thus, the fate of the Euro may not be as clear as some point out and, as usual, the timing is tricky for observers and costly for participants.

Stimulation continued

Intense anticipation of further easing by the Federal Reserve is understandable but the unintended consequences stir up additional suspense and colorful opinions. The unfolding events trigger this question: Does QE3 provide further economic spark or does it showcases further economic desperation?

Guessing how participants react from a psychological point of view is more noteworthy for speculators than QE3’s impact. The US jobs number translated to an overall weak result but sparked a curiosity in the pending easing announcement. The impact of all stimulus efforts seems mysterious to most and too early to tell its success. Importantly, tracking inflation expectation remains a vital barometer that will shape investors mindset. Closely watched indeed. Rising inflation most likely is set to reinforce that the recovery is taking place and potentially not fully recognized by the marketplace given the infestation of “gloomy” outlooks. If that’s the case then inflation expectation remains the rewarding surprise for those betting on increasing stock prices. Perhaps, then one would have a better idea on Gold, stocks and currencies.

Article Quotes:

“The campaign to change German attitudes will therefore have to take a very different form from the intergovernmental negotiations that are currently deciding policy. European civil society, the business community, and the general public need to mobilize and become engaged. At present, the public in many eurozone countries is distressed, confused, and angry…..Currently, the German economy is doing relatively well and the political situation is also relatively stable; the crisis is only a distant noise coming from abroad. Only something shocking would shake Germany out of its preconceived ideas and force it to face the consequences of its current policies. That is what a movement offering a workable alternative to German domination could accomplish. In short, the current situation is like a nightmare that can be escaped only by waking up Germany and making it aware of the misconceptions that are currently guiding its policies. We can hope Germany, when put to the choice, will choose to exercise benevolent leadership rather than to suffer the losses connected with leaving the euro” (George Soros, The New York Review of Books, September 7, 2012).

“The National Development and Reform Commission last week approved 25 urban rail and 13 highway construction projects, and a number of water schemes. The problem is one of financing. Few details were released. Asset quality is fast deteriorating among Chinese banks as bad debts emerge from the latest round of misspent stimulus. That will damp their will to lend. And local government finances are in tatters. Beijing estimates that their debts stand at Rmb11tn, or a quarter of China’s output. Moody’s thinks the debts could be Rmb3.5tn higher. Granted, China has Rmb19tn in foreign exchange reserves and a strong official fiscal position. But converting reserves into renminbi to spend at home will destabilise the exchange rate. And disguised indebtedness in local governments could put the debt-to-output ratio far north of its official 17 per cent…. Urbanisation remains a long-term play. About 70 per cent of China’s 100-odd cities with a population of 5m or more do not have a metro, HSBC notes. But in today’s tougher funding environment, big spending announcements will not translate into guaranteed growth.” (Financial Times, September 9, 2012)

Levels:

S&P 500 Index [1437.92] – Broke above the spring highs of 1420 and now making new yearly highs. Positive momentum continues despite chatter of a peak that’s overly anticipated.

Crude [$96.42] – Last 15 days trading action suggest a narrow range between $95-97. Near-term momentum waning despite the explosive run from $80 to $96 in recent months. Appears that participants are waiting for a catalyst to dictate the next noteworthy move.

Gold [$1728.00] – For few months the commodity traded in a narrow range between $1550 and $1650. Now the recent lift above $1700, creates a momentum and increasing expectation to elevate above or to $1800.

DXY – US Dollar Index [82.59] – Noticeable downtrend since late July in which the index has fallen by nearly 5%. Some of the decline may be linked to anticipation of further easing.

US 10 Year Treasury Yields [1.68%] – Stuck in the familiar range below 2%. Increasing odds in days ahead where yields stay around the 1.60% to 1.80% zone.
http://markettakers.blogspot.com

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