Market Outlook | March 12, 2012

“Doubt is not a pleasant condition but certainty is an absurd one.” Voltaire (1694-1778)

Hard to deny:

The multi-month uptrend in stock prices and improvement in labor numbers continues yet again . As gloom and doomers ease off from the ugly script, current economic numbers are in line with expectations. The mindset is slowly changing to the point where upside estimates are not viewed as a dramatic revelation but as moderate growth. Yet these rosy pictures are not enough to cleanse numerous doubts resurfacing from investment committees and spectators. In other words, some financial circles view further good news as already ‘priced into’ market pricing. Meanwhile, as political observers remind us, the race to election season has its influences on shaping perception. It’s only natural to expect that, but politics aside, the strength is quite visible despite lukewarm participation and low exchange volume.

This weekend, few headlines reminded us of the 3-year-old anniversary of this bull market in the US stock market. After all, March 2009 seemed bleak, following bailouts and escalating fears at alarming rates. Surely, near-term memories are tricky and often biased to selective memories. The main question remains: How much confidence restoration is left ahead? A question that strategists are wrestling with while weighing the justifications for adding or decreasing risk. Anticipating pullbacks has been a common form of thinking for several months, and that has yet to come to fruition. Interestingly, markets are not too friendly for common thinking, and a daring approach has its rewards. Despite the fear of stock prices rising too quickly , there is another perspective:

“Nine quarters of earnings growth have outpaced the index’s advance, leaving valuations 14 percent below the five-decade average of 16.4. The price-earnings ratio hasn’t been this low while the index was at a 52-week high in 23 years” (Bloomberg, March 5, 2012)

Next set of worries:

There is a consensus and established theme resurfacing. It circles around restructuring in Europe, recovering in America and potential overheating in emerging markets. Clearly, these are interlinked economies, but at different stages of a cycle. In fact, factors impacting these trends are at the core of decision makers’ minds. In the near-term, the sustainable growth in emerging markets is a wildcard and sparks thought-provoking debates. Plenty of pundits have waited for a while for a slowing grow rate in China and Brazil. These realizations beg for further confirmation and require investors to adjust expectations from last decade’s capital allocation. As usual, worry of rude awakening lingers in the psyche of risk managers. As we’ve learned in recent years, when cycle shifts take place, it takes time after early shocks to readjust. Thus, deciphering the real GDP in China and assessing the sustainability might provide the essential clue to this decade’s trends. Last week, China set its GDP target at 7.5% (in real term) for 2012, showcasing a scaled-down expectation not seen in several years.

More to go:

However, confidence in developed markets’ growth is not overwhelmingly comforting, either. Perhaps, from all developed markets, America’s strength has not vanished and is poised to stand out. Fund managers seeking moderate returns with attractive liquidity can cling on to the well-known and established US financial system. As hard as it may be for outside observers, the relative strength of large US companies’ growth is appealing and not fully appreciated.

Article Quotes:

“Take Brazil. Were managers rewarded with a quintupling of its stock market over the last decade because they cleverly spotted structural reforms? Or were they simply lucky to invest in Brazil during a period of falling global interest rates and the mother of all commodity booms? They will never know. What can be said, however, is that the amazing set of circumstances that helped many emerging markets to prosper may be nearing the end. Brazil’s gross domestic product grew just 2.7 per cent last year, its second-worst performance in almost a decade. Only by pumping the economy in the fourth quarter (aided by a 275 basis point cut in benchmark interest rates by the central bank since July) did the newish government avoid presiding over a technical recession. All of which is taking the fizz out of stocks. The local Bovespa index is flat over 12 months and, after leaping about like float dancers during carnival, many of Brazil’s biggest stocks, such as Vale, PDG Realty and Itau Unibanco, are roughly where they were four years ago. Petrobras shares are the same price now as at the end of 2005.” (Financial Times, March 9, 2012)

“Congress seems comfortable with this reduced role. We don't realize that by authorizing entitlement programs – perpetual mandatory spending – and hiding some of our biggest expenditures in unaccountable tax loopholes, we have diminished our constitutional duty to appropriate funds (Art. I, Sec. 9). In fact, we hide our biggest problems by keeping them off-budget, exempting ourselves from normal accounting rules. Congress has legalized its own budget blindness. Very few legislators have ever had to eat their own cooking, to run a business governed by the cumulative weight of the laws and regulations they supported. The most famous example is George McGovern who, after years as a liberal U.S. Senator from South Dakota and an unsuccessful presidential campaign, retired to run an inn in Connecticut. He wrote an article for The Wall Street Journal decrying all the useless regulations that burdened his business. This, of course, delighted his conservative critics but did nothing to lighten the regulatory burden.” (The Atlantic, March 8, 2012 -Jim Cooper is a Congressman in the U.S. House of Representatives)

Levels:

S&P 500 Index [1370.87] – Nearly unchanged from last week’s close. March 2, 2012 highs of 1378 remain intra-day highs. Buyers’ conviction tested above 1300, given the strong multi-month run.

Crude [$107.40] – New trading range forming above $105.00. More than a five-month trend of price appreciation. Observers await a revisit to last May’s highs around $114.83 to confirm the strength.

Gold [$1687.50] – Several evidences of waning buy demand around $1750. From previous patterns, some suggestions of buyers around $1600. A clearer picture to this setup requires some time.

DXY – US Dollar Index [80.04] – Hovering around an all-too-familiar point. The 50- and 5-day moving averages are around 79.00 showcasing the lack of major movements.

US 10 Year Treasury Yields [2.02%] – In the last 100 days, an established range between 1.80% and little above 2%. Confirmation of lack of movement in either direction while being stuck around all-time lows.

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