Market Outlook | March 19, 2012

"History shows that where ethics and economics come in conflict, victory is always with economics. Vested interests have never been known to have willingly divested themselves unless there was sufficient force to compel them" B. R. Ambedkar (1891-1956)

Resilience

Dismissing the political banter and shortsighted stalemates, the US stock market is restoring its bull form. It takes time to alter the fear-driven mindsets, as the real economy is adjusting to a recovery that’s hard to gauge through an eyeball test. The magnitude of labor and manufacturing improvement might be hard to feel, but even analysis that accounts for political biases would confirm that the economy is better than before. “In the three months to the end of February employers added 734,000 jobs, which is the best result since April 2006 if you exclude from past figures workers hired temporarily for the federal census” (The Economist, March 17, 2012). Political egos and opinions aside, confidence restoration is quite visible.

Meanwhile, applying the word resilience to describe recent stock market strength is appropriate, especially when considering the fragile state of the financial service sector three years ago. There is some lingering stigma associated with financial firms, especially when it comes to public relations. However, that has not stopped the bank stocks from restoring value to shareholders and playing a significant role in a collective US market strength. At a quick glance, the perception-driven S&P 500 index continues to generate profits for long-term and patient buyers. These appreciations, mostly sparked by low interest rates, create an environment that’s friendly for equity owners.

Not fully sold

Generally, when buyers become too eager and cheerful, it is common for critics to build skeptical arguments stating that the run-up was "too fast, too quick" or “unsustainable,” or a warm-up to an "eventual demise." Whether these are part of clever excuses or (politically driven) fear tactics, the debate lives on. However, there is a wearisome market thesis that has dominated headlines and common chatter for months. Emotion-filled opinions have missed the rally while waiting for heavy sell-offs. Money managers know too well, you get paid for today’s market (if the price is right) and not for pondering on the great unknown of tomorrow.
Interestingly, trading volume is relatively low as exchange dynamics fail to match up with the surging broad index prices. In fact, last Monday (March 12), US markets displayed the lowest volume for the year. “Trading volume has been declining since October as customers of U.S. stock mutual funds withdrew more than $68 billion through January even as the S&P 500’s valuation has recovered by 14 percent.” (Bloomberg, March 12, 2012). Although technical patterns argue a lack of conviction, the low volume might suggest more participation ahead. In other words, lack of alternative investment options should drive rotation into stock markets for months ahead.

Vibrant

Are early autumn buyers satisfied with accumulated gains or ready to cash in during the upcoming weeks? For now, given the lack of undiscovered reasons (or risks) to sell, there is a case for riding this trend. Some ask, are there enough buyers for significant selling? At this point, not enough, since the process of forming a bubble takes time and needs widespread participation. Plus, investor appetite for doomsday scenarios and skeptical views has not vanished completely. Therefore, more discussions of a 2008-like crisis appear to be feared by many, which ironically ends up benefiting buyers. In other words, the lack of a major surprise element of expecting downward moves actually lessens the odds for a dramatic sell-off. We’re in a period of overemphasis of risk management, pondering of further financial regulations and fear of US market leadership. Perhaps, these three might be overblown. Apparently, the real fear should be channeled to missing growth opportunities that resurface here and there. Simply, failure to adjust to new market conditions is painful in most cycles.

Article Quotes:

“The Bureau of Labor Statistics closely tracks how an average American spends their money in an annual report called the Consumer Expenditure Survey. In 2010, the average American spent 34% of their income on housing, 13% on food, 11% on insurance and pensions, 7% on health care, and 2% on education. Those categories alone make up nearly 70% of total spending, and are comprised almost entirely of American-made goods and services (only 7% of food is imported, according to the USDA). Even when looking at physical goods alone, Chinese imports still account for just a small fraction of U.S. spending. Just 6.4% of nondurable goods – things like food, clothing and toys – purchased in the U.S. are made in China; 76.2% are made in America. For durable goods – things like cars and furniture – 12% are made in China; 66.6% are made in America. Another way to grasp the value of Chinese-made goods is to look at imports. The U.S. imported $399 billion worth of goods from China last year, which is 2.7% of our $14.5 trillion economy. Is that a lot? Yes. Is it most of what we spend our money on? Not by a long shot.” (The Motley Fool, February 12, 2012)

“People in the West want to believe that China's economy will go on growing fast because the fragile recovery in Western economies depends on it. Twenty years of 10 percent-plus annual growth have made China the engine of the world economy, even though most Chinese remain poor. But the engine is fuelled by cheap credit, and most of that cheap money, as usual, has gone into real estate. Take the city of Wuhan, southwest of Shanghai and about 500 km in from the coast. It is only China's ninth-largest city, but in addition to a skyscraper half again as high as the Empire State Building it is currently building a subway system that will cost $45 billion, two new airports, a whole new financial district, and hundreds of thousands of new housing units. It is paying for all this with cheap loans from state-run banks. Last year Wuhan municipality spent $22 billion on infrastructure and housing projects although its tax revenues were only one-fifth of that amount. The bank loans were made to special investment corporations and do not appear on the city's books. The only collateral the banks have is city-owned land, and that is not a reliable asset in current circumstances.” (Japan Times, March 15, 2012)

Levels:

S&P 500 Index [1404.17] – Achieving new multi-year highs, as the positive momentum continues to build. Staying above 1400 is a near-term challenge, but strength confirmed.

Crude [$107.06] – Several months of a positive trend continues, although a break above $110 can trigger the next-wave move.

Gold [$1658.00] – Neutral pattern established between $1610-$1750. Several catalysts needed to determine if buyers’ demand reignites at current levels. In the last 6 months, enthusiasm has waned.

DXY – US Dollar Index [79.78] – Mostly unchanged week over week, but significantly up since the summer lows around 72.

US 10 Year Treasury Yields [2.02%] – A significant spike last week from the usual “2%” range. Surpassing the 2.41% range is the next noteworthy point for trend followers.


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