Market Outlook | November 12, 2012

‘Man maintains his balance, poise, and sense of security only as he is moving forward.’ Maxwell Maltz (1927-2003)

Rebuilding

Elections marked a close to one big picture suspense while policymakers’ decision is being mildly confronted. Surely, tax implication and sustainability of the current recovery creates a speculative and potential edginess for those assessing risk. In terms of sentiment, excessive worries remains contained for a while since last summer and emotional responses are inevitable. We are entering a stretch that requires patience for investors in Europe and other emerging markets as well. The possibility of a collective recovery for an inter-connected markets is setting up as myriads of clues surface between now and year-end. This weekend observers noted that Chinese export surged by 11.6% reflecting a pick up in global trade. Perhaps, an early sign of positive movement in larger economies.

The U.S. economic recovery is slowly recognized while few have contemplated the odds of further recession ahead. Current pace of recovery showcases a visible strength in housing.

‘Construction spending in September climbed to a nearly three-year high at an annualized rate of $852 billion, as increased spending on houses, apartments and private nonresidential projects outweighed a continuing downturn in public construction.’ (Associated General Contractors of America, November 1, 2012).

Next year pundits will reassess the impact of housing while the Federal Reserve guidance on mortgages will be attentively watched. Improving labor numbers are needed to support housing and overall growth. Thus far, recent month’s labor results have reshaped gloom and doomers to re-think the ugliest scenario.

Digesting retracements

Since mid-September US stock prices, as measured by broad indexes, have declined. A two month pause triggered around the announcement of QE3 and the decelerated price action as a result of slowing corporate earnings. Adjustment to new earnings expectations presents challenges for shareholders seeking to add further risk exposure. According to Factset: ‘only 40% of companies have reported sales above estimates. This percentage is well below the average of 55% recorded over the past four quarters.’ (Factset Insights, November 9, 2012). Interestingly, the resurgence in Europe and Emerging markets remains vital since larger U.S. companies rely in overseas markets for earnings growth.

Room for surprises

Thus far, any sings of domestic hope has yet to impress analysts such to produce cheerful projections. Instead common expert thought calls for a weaker outlook:

‘Economists expect the economy to grow at an annual rate of 1.8 percent in the current quarter, down from the previous estimate of 2.2 percent growth, according to the Philadelphia Federal Reserve's fourth-quarter survey of 39 forecasters.’ (Reuters, November 9, 2012).

This collective expectations presents some upside surprise in GDP numbers given analysts lowering their expectations. Perhaps, the fist half of 2013 is the next suspenseful period to assess the speed of current expansion.

The bullish argument today, in some ways is not as appealing (since stocks have rose significantly ) as March 2009 dismal lows. Yet, the hurdle of averting suspected sovereign risk both in U.S. and Europe can trigger further, but substantial optimism. Simultaneously, the economic recovery in the U.S. needs to pick up the pace in a favorable direction. Recent Midwest drought and Northeast storm will play a role in economic numbers for near-term observers. Nonetheless, the business cycle favors an economic recovery when isolating noise within the business cycles. Not to mention, recent pullbacks in S&P 500 Index were needed and relatively healthy to have a breather. In due time, investors will have the choice to revisit entry points in riskier assets.

Article Quotes:

‘ If past-year food price information is relevant for inflation expectations, then we expect respondents who, prior to receiving the selected information, are less informed about it to find the information more valuable and to be more responsive to it. Therefore, to gauge respondents’ familiarity with the selected information, we ask: ‘Over the last twelve months, by how much do you think the average prices of food and beverages in the U.S. have changed?’ The respondents who were randomly assigned to receive the selected information (the information group) were then informed that food/beverage price inflation in the U.S. had been 1.39 percent over the last twelve months, based on data from the Bureau of Labor Statistics. Respondents in the control group did not receive this information. We measure respondents’ ‘Perception Gap’ as the difference between the objective information value (1.39 percent) and respondents’ prior beliefs; a negative perception gap corresponds to overestimation of past food/beverage price inflation. We find that respondents have inaccurate perceptions of past changes in food and beverage prices. The average perception gap in our sample is -4.92 percentage points (meaning respondents report past food/beverage price inflation, on average, to be 6.31 percent). We find that nearly 40 percent of our respondents believe past-year food and beverage price inflation was 7 percent or more, when, in fact, the published measure has not risen as high as 7 percent since 1981.’ (Federal Reserve of New York, Nudging Inflation Expectations: An Experiment, November 5, 2012).

‘In recent weeks asset managers within Japan have scrapped plans to launch funds that had aimed to raise a combined Y67bn ($840m) to invest in shares in Shanghai, according to analysts at Lipper. In the latest monthly survey of individual investors by Nomura, Japan’s largest brokerage, the renminbi fell to an all-time low rating as investors were asked to select one currency as an ‘appealing’ investment target over a three-month timeframe. Since Tokyo nationalised a disputed chain of islands in the East China Sea in mid-September, Japanese businesses such as Shiseido, the cosmetics company, and watchmaker Citizen, have experienced steep falls in sales in China, as consumers in China steer clear of obviously Japanese branded goods. Now households in Japan are responding in kind, say analysts, by checking flows of investment into Chinese stocks, bonds and bank accounts…. The dispute ‘has cast a pall’ over Japan-based funds investing in China, said Yoshihiro Hamada, head of product development at Diam Asset Management in Tokyo, which has struggled since October to find Japanese banks and securities companies willing to market its Rmb94m ($15m) bond fund.” (Financial Times, November 11, 2012)

Levels:

S&P 500 Index [1379.85] – The downtrend since mid-September is in place. The index is slightly below 200 day moving average which catches the attention of technical observer.

Crude [$86.07] – Back to familiar range around $85-86, a level that has triggered upside moves twice in 2011 (February and October) and earlier this year.

Gold [$1738.25] – The near-term question lingers on the commodities ability to revisit and surpass $1800. A growing possibility given last weeks action.

DXY – US Dollar Index [81.05] – Since mid October, the dollar index is strengthening modestly. A reflection of slight risk adjustment, but not quite a big move to cause a trend shift.

US 10 Year Treasury Yields [1.60%] – Ongoing zig-zag between 1.80-1.60% continues. Now at the low end of the 3 month trend reinforcing the low rate theme.

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