Market Outlook | February 20, 2012

“The poetry is all in the anticipation, for there is none in reality” Mark Twain (1835-1910)

Collective rising

Since October 2011, crude and stocks (S&P 500 Index) prices have recovered from the summer losses to revisit levels last reached in May 2011. This is an interesting observation for two main reasons: First, this illustrates the synchronized movement in prices of major asset classes. Secondly, last spring ended up being a precursor to violent summer months. Now, these actions draw similar comparisons and trigger a question: Are investors are too complacent? If so, it is assumed it will justify further price declines. Plenty to be seen before that is answered. In terms of market tops, the current setup does not quite match the 2007 pattern, in which the phrase “synchronized sinking” marked a global peak. Surely, it’s a hard case to claim that markets are geared to mildly crash when overall volume is so low; trust in the system is mostly fragile, while skepticism has yet to evaporate.

For the past few weeks, price corrections have been long awaited in global markets. For example, the Nasdaq 100 index continues its noteworthy move by rising over 27% since August 2011,(led by Apple and IBM). Speculators wonder if this sharp move needs a breather, along with broad markets. Many continue to point out that investor sentiment is picking up, but betting against top performing stocks has mainly backfired against sellers. Clearly, macro catalysts are mostly centered around Europe's ability to fight through issues and China's level of slowdown from persistent growth. However, these fears are not a new discovery but create near-term suspense.

Beyond Business

Much of today’s market action is focused on anticipation of financial reforms, speculating on Federal Reserve actions, and the big reward lies in comprehending the tax and political structure. Asset managers in the post-2008 era face beyond the business-as-usual tasks of identifying growth, conducting value from distressed assets or conducting their own pricing methodology for appropriate pricing. Overhanging legal changes create suspense and reemphasize the value of managing and adjusting to legal risks and costs. “America’s share of initial public offerings fell from 67% in 2002 (when Sarbox passed) to 16% last year, despite some benign tweaks to the law. A study for the Small Business Administration, a government body, found that regulations in general add $10,585 in costs per employee. It’s a wonder the jobless rate isn’t even higher than it is.” (The Economist, February 18, 2012). Again, legal changes in financial services create near-term worries but eventually, this will take its course in a new era.

Resolve

Quite evident without clarity of the new rules of engagement, there is noticeable reluctance by business owners to make aggressive decisions. Similarly, investors have not fully committed to risky assets while awaiting confirmation on strengthening labor data and election results. However, the points above are both well known and confusing for the causal observer in day-to-day headlines. Importantly, there is scarcity in quality ideas, and picking the right one presents upside potential. Perhaps the complacency is more applicable to money managers who struggle to overcome hesitancy and fear. Eventually, risk-aversion is not a growth solution or an ideal form of risk management. Thus, the existing sideline capital will have to take on further risk to get competitive returns.

Article Quotes:

“Why are Chinese households buying a defensive asset [gold] in a time of rapid growth? One reason could be the fear of inflation, which peaked at 7 per cent in mid 2011. But gold-buying by households has increased over the past two years regardless of inflation numbers rising or falling. … A better explanation could be the lack of alternatives for households that are the best savers in the world. In an economy lacking financial sophistication and depth, options are limited to savings accounts, which offer negative real returns, stocks listed on one of the two national exchanges, or else property. … Property is the other alternative. But Chinese knew of the country’s infamous ghost cities long before the international media. Knowing that yield was irrelevant, as many of these properties will never be rented out, locals knowingly bought them as speculative capital assets. Now prices have collapsed in many areas, locals are much more wary of pouring capital into an asset that may never offer a reliable return.” (Financial Times, February 16, 2012).


“Steubenville is one of scores of new boom towns springing up along the American Appalachians, from Ohio and Maryland, to West Virginia, Pennsylvania and New York, all of them beneficiaries of the shale gas revolution, a new technology that allows access to abundant reserves of natural gas trapped within the rock. The results are startling. It’s not just the mini-boom in business investment. It’s also meant that for the first time in more than 40 years, the US is close to achieving its goal of energy self-sufficiency. Energy costs have fallen so sharply that Methanex Corporation, the world’s biggest methanol maker, recently announced it was dismantling its factory in Chile and reassembling it in Louisiana, perhaps the biggest example yet of the new found fashion for “onshoring”. This is just one of any number of similar decisions that stem from the shale gas revolution. Dow Chemical plans a new propylene unit in Texas by 2015. Formosa Plastics similarly proposes a $1.5 billion investment in ethylene-related plants in the same state, while both US Steel and Vallourec are planning multi-million dollar investments in new steel capacity to meet demand for shale gas extraction.” (The Telegraph, February 18 2011)


Levels:

S&P 500 Index [1361.23] – Few points removed from May 2011 intra-day highs of 1370.58. Uptrend is well established.

Crude [$103.24] – Early signs of a breakout after a dull multi-month sideways patter. Breaking above $105 might get buyers enticed to revisit last spring’s highs of around $114.

Gold [$1711.50] –Most near-term trading falling between $1610 and $1750 price range. A break above or below this range can provide a definitive trend picture.

DXY – US Dollar Index [79.33] – Consolidating in the near-term. Trading in line with its 50-day moving average, demonstrating lack of movement.

US 10 Year Treasury Yields [2.00%] – About a year ago, yields stood between 3.40-3.60% range, which showcases a significant decline in rates tied to federal reserve polices.


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