Market Outlook | June 4, 2012

“There is no wisdom in useless and hopeless sorrow.” (Samuel Johnson, 1709-1784)

Collective breakdown

Through the weekend, the echoes of fear are felt vibrantly for the majority of social and economic observers. It appears too easy to yell about the unpleasant job numbers, especially when they are below expectations. This feeds into the risk-aversion theme which has taken even a new twist, leading to all-time low yields in US treasuries. Similarly, gold aficionados slowly reawaken, at least for a week or two. Considering the current landscape, it is convenient for an impulsive pundit to point fingers at the system or at political leaders. These are contentious times indeed, but the ups and downs are becoming ever so familiar in this shaky era. Worn-down optimists are facing heightened tests for grit in various financial assets.

Interconnected feel

Fund managers who found comfort in emerging markets are now faced with realities of slowing growth. The Purchasing Manger’s Index (PMI) of larger economies confirmed further weakness. Even before the US job numbers were announced on Friday, the global markets were digesting China’s struggles in the service sector. That was enough confirmation to reignite concerns broadly, and below-consensus estimates did not paint an attractive picture.

Last May, the CRB (commodity) Index peaked and has since declined by more than 27%. This offers an early clue to how crude, copper and other soft commodities have stalled in their price appreciation. Perhaps, we should not be surprised at stalling emerging market growth. Naturally, commodities have been strongly linked with emerging market growth, a tone set last decade. Recent emerging market declines confirm for a relative edge of US markets, and that thought is sour now but bound to change with pending political and macro events.

Managing the unknowns

What's known is not pleasing at an early glance and what's unknown is disturbing for most within these panic levels. Summer months stir other fireworks where pleasant surprises seem too far to find. Considering that it’s an election year, and the lack of good news in several weeks, it’s not a bad idea to seek purchasing quality assets. The S&P 500 index ended last week only up 1.7% in 2012. Impressive first-quarter gains are nearly erased, and buyers will get a second chance to evaluate opportunity versus safety. Odds-makers might quickly point out the hopeful setup, and the appeal of contrarian viewpoints seems very timely. After all, fund managers are not paid to dodge risk or to dump assets into “safe assets.” These lessons have played out for the last two years, where the lows for the US equity markets took place in the summer. To repeat near-term history for the third consecutive time might be plenty to ask. Yet, one has to wonder whether there is further room for panic after the escalating turbulence in the last two months.

Article quotes:

“The European authorities had little understanding of what was happening. They were prepared to deal with fiscal problems but only Greece qualified as a fiscal crisis; the rest of Europe suffered from a banking crisis and a divergence in competitiveness which gave rise to a balance of payments crisis. The authorities did not even understand the nature of the problem, let alone see a solution. So they tried to buy time. Usually that works. Financial panics subside and the authorities realize a profit on their intervention. But not this time because the financial problems were reinforced by a process of political disintegration. While the European Union was being created, the leadership was in the forefront of further integration; but after the outbreak of the financial crisis the authorities became wedded to preserving the status quo. This has forced all those who consider the status quo unsustainable or intolerable into an anti-European posture. That is the political dynamic that makes the disintegration of the European Union just as self-reinforcing as its creation has been. That is the political bubble I was talking about.” (George Soros speech in Italy, June 2, 2012).


“For instance, Calpers, the largest US public pension plan, this year cut its assumed rate of return from 7.75 per cent to 7.5 per cent. The fund’s actuary had recommended a cut to 7.25 per cent. Official estimates for US public pension shortfalls range from $500bn to $1tn. Critics have suggested the true number is closer to $2.5tn. Regulations for US corporate plans, and for European and Canadian plans, calculate liabilities based on the prevailing level of bond yields. In 1990, 10-year Treasury bonds paid more than 8 per cent, but have since fallen to below 2 per cent. As interest rates fall, the size of a pension plan’s ultimate liability rises. But rather than lower expectations which might raise contribution requirements, public pension funds have increased allocations to risky assets: from 53 per cent of total assets in 1992, to almost 75 per cent now.” (Financial Times, May 28, 2012)

Levels:

S&P 500 Index [1278.04] – Slightly below the 200-day moving average, as staying above 1250 serves as a near-term test.

Crude [$83.23] – Sharp drop in prices reflecting the slowdown in commodities. Since March 1st, crude has dropped nearly 25%.

Gold [$1606.00] – The last few trading days showcased a bottoming process around $1550. A rejuvenated spike back to $1600 can confirm how gold is perceived as a safe asset

DXY – US Dollar Index [82.89] – At annual highs continuing the strength established in October 2011. If this is a sustainable movement, the next noteworthy level is around 86-88, last reached in summer 2010.

US 10 Year Treasury Yields [1.45%] – All-time lows. Last noteworthy lows stood at 1.65% in September 2011. Before that,1.95% in 1941 marked the multi-generational bottom from a historical point of view.


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