Market Outlook | October 15, 2012

“The quality of expectations determines the quality of our action.” (A. Godin 1880-1938)

Reevaluating strength

The ongoing but subdued bullish stock cycle is constantly tested with familiar big-picture concerns. At this point, the fear-driven questions are tiresome but almost nothing new for this resilient market. The current wave of concerns is focused on companies’ ability to sustain the earning growth. A quick browse across traditional financial articles will quickly remind us that this earnings season is expected to underperform or set up to disappoint. This somewhat implies an intense and decisive outcome for risk managers who are now deeply digging in the third quarter earnings results. Certainly, this usually comes down to a game of meeting expectations. Perhaps, the emphasis is tilted toward shorter-term outcomes and can mislead the more patient investors.

Momentum vs. Fear

On one hand, improving labor and housing results showcase restoration out of fragile conditions. Interestingly, number crunchers and analytically minded economists are grappling with the bottoming process of a sluggish economy. In a subtle manner, there is momentum that’s building from jobless claims that were low and closer to numbers seen before the 2008 crisis. Similarly, consumer confidence (University of Michigan), hit a five-year high. Economic data is slowly catching up with established bullish stock markets. The evidence of growth is slowly piling up month after month for those willing to dig a bit deeper.

Banks are reshaping and strengthening their books, the US energy sector remains strong and other innovation-driven themes present a closer look. Sure, skepticism is healthy and needed. Nonetheless, data has pointed to the US edge in leading out of this recovery, regardless of directional debates.

Conversely, there is another school of thought. After the stock market run-up over three years, it may appear difficult to ignite additional enthusiasm. Thus, if the housing and labor recovery is confirmed further then the upside catalysts may face some limitations. It’s a legitimate concern that’s plaguing those who’ve increased risk exposure to risky assets. Plus, the element of waiting for another stimulus via quantitative easing is now less of an option. If further easing is not in sight, then many ask: Can the markets sustain its strength? This is a noteworthy but multifaceted point that lacks directional clarity.

Deliberating

In considering both set-ups, there is a disconnect between stock behavior, general economic performance and investor sentiment. Grasping this chaotic and not-always-logical message is more of an art than science. It is a statement and observation that many would not like to admit or decipher. As a start, when viewing the trading activity relative to last September (2011), one can make the case for low appetite for equity market participation:

“The New York Stock Exchange is off 30.9% from a year ago, at 1.2 billion shares. Its NYSE Arca and NYSE MKT exchanges are off 49.3%, to 219.0 million shares, according to SIFMA” (Traders Magazine, October 12, 2012).

Despite the low volume, the market strength has accelerated as a new cycle has formed since March 2009. In the near-term, there are few noises to settle. Heightened “uncertainty” has felt like the norm for a while, but a consensus view continues to anticipate turbulence in the months ahead. Of course, election results can provide some “clarity” for years ahead. Then there are the macro factors that have bombarded market participants, such as a Euro zone solution, slowdown in emerging markets and other thoughts related to escalating commodities prices. For now, digesting valuable data points is the key before making claims of changes in trends.

Article Quotes:

“The number of homes for sale has fallen back to its long-term average of 2m. Yes, there is a larger “shadow inventory” of homes that are in foreclosure or carry delinquent or defaulted mortgages. However, many of these are distressed, in that they have not been physically maintained. This means that the supply has become two-tiered – quality homes and distressed homes. For most buyers, only the first of these two markets is relevant and the supply there is approaching its lowest level since 1992. According to JP Morgan, this rate was steady at about 1.4m annually from 1958 up to 2007. But, it plunged below 500,000 for the three years following the financial crisis, as young people moved in together or lived with parents. Now it has doubled from that level and estimates of pent-up households are at an all-time high. Most expect formation rates to rise much further still, exceeding the 50-year average for a few years.” (American Enterprise Institute, October 14, 2012).

“Blue-chip issuers such as AT&T, JPMorgan Chase and ExxonMobil will increasingly be vying for investor attention against the likes of América Móvil of Mexico, Banco do Brasil or Petrobras of Brazil and a host of other emerging markets companies. Dollar-denominated investment grade bonds from foreign issuers, known on Wall Street as ‘Yankee’ bonds, now account for about 40 per cent of all issuance by value and the figure will top 50 per cent by 2015. Three of the five largest investment grade bond issues in the US this year have come from foreign-owned companies, and American investors’ search for higher-yielding assets has encouraged issuers from Latin America and Asia to raise money in the US. High quality global journalism requires investment. … Investment-grade Yankee issuance has hit $330bn so far in 2012, according to Dealogic, putting it on course for the biggest year to date. Yankees accounted for 15 per cent of overall issuance in 2002, and have risen to average about 40 per cent for the past three years. UK borrowers remain the largest foreign issuers of US debt.” (Financial Times, October 14, 2012)



Levels:

S&P 500 Index [1428.59] – Following a 16% run from June to September, the start of this month has led to a pause. The index closed almost exactly at its 50-day moving average. A slight decline from annual highs of 1470 might stir early pullback concerns.

Crude [$91.86] – For more than two years, the trading range has formed between $84-$98. Now the price is stuck in between the common range, showcasing a lack of momentum.

Gold [$1766.75] – A step back reminds us that surpassing $1800 has been challenging for more than 12 months. The near-term focus is on the commodity’s ability to stir buyer demand at $1750.

DXY – US Dollar Index [79.66] – Unlike the summer months, staying above 80 remains a challenge. Yet, no noteworthy move will be seen in the near-term.

US 10 Year Treasury Yields [1.65%] –Like the currency, range-bound patterns persist. Since May, the trend reinforces a steady movement below 1.80%.


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