Market Outlook | June 18, 2012

“Apprehension, uncertainty, waiting, expectation, fear of surprise, do a patient more harm than any exertion.” (Florence Nightingale 1820-1910)

Newer Focus

With a lack of many growth stories, attention has shifted to election outcome, stimulus efforts, and collaborative problem solving. All three factors serve as stimulants or depressants for anxious participants depending on the day—a new environment for fund managers used to chasing momentum in flourishing companies. These days, those remaining in financial services are engulfed in deciphering legal and political risks, which in turn influence the day-to-day movements. In some ways, investors appear fed up with the increasing list of unknowns and the complexity of justifying loses. Investors continue to grapple with the ongoing reminder of fearsome headlines. The acknowledgement of “global recession” is a reoccurring discovery for some, but let’s remember markets get over things quicker than imagined.

Clearly, there is no escape from sluggish economic realties and increased monitoring of government related decisions. At the same time, cheerleading election results in Greece certainly cause a fast reaction to uplift deflated moods. Similarly, easing expectations by central banks is alive and well:

“More than $1.5 trillion was added to the value of global equity markets in the past two weeks on speculation the Federal Reserve will join central banks in bolstering growth at its policy meeting this week” (Bloomberg, June 17, 2012).

Ongoing intrigue of stimulus efforts might create some suspense; however, the election outcome is too much of a wildcard for many money managers to take on bigger bets.

Trend Search

For the intermediate-term, there are few reasons to brush off these panic-like collapse theories. After all, the S&P 500 Index is bottoming here, offering a chance to speculate or even invest. The June 4th lows in broad US indexes and a peak in volatility slowly set the stage for a pending recovery. In fact, talks of further easing, combined with better than projected events, usually lead to surprising outcomes. A confused audience may mistake bad projections with worsening conditions and deteriorating asset prices. Surely as challenging as it maybe, avoiding thesis based on known apathy can be fruitful at this junction.

If four years ago felt so stunning with bail outs and near collapses, it would take plenty to convince one that things will turn out better four years from now. But with a world focused on shorter-term events, it’s even harder to convince participants of the advantages of long-term investment. Perhaps, capital allocators struggle to imagine significant money flowing to less liquid assets or aggressive risk taking. Mood swings are harder to quantify, and mind reading is not a certified profession either. Thus, this speculative climate overemphasizes the risks while underestimating rewards. The week ahead can test this train of thought.

Safety Overdone

Perhaps, the "safe asset" obsessions may take a breather in the second half of this year. At least, we can surmise a minor bubble that’s forming with the ongoing rush to safer instruments. Plus, owning US treasuries is getting too crowded when larger capital continues to allocate to familiar assets. Similarly, Gold is mildly awakening from annual lows and attempting to reenergize its fan base. There is a strong belief that Gold solves many risk management issues. That biased view is easily sold as fact, and that should concern owners. As confidence restoration shifts to traditional markets, there might be unexpected consequences for overpaying for more liquid and lower yielding assets. As unpopular as this scenario might be, it is worth planning for a surprise or two.

Article Quotes:

“Either we take stronger steps to ensure the integrity of the banking system on our own, or outsiders will press for more regulation and oversight. Or we have free markets that function effectively, or Congress, lawyers, and the Occupy Wall Street movement will keep the pressure on—and rightly so. On the whole, most US banks have taken intelligent steps since the financial crisis. They’ve doubled their capital, shed (mostly) poor assets, and increased liquidity. Yet you don’t hear much about this because such quiet progress has been overshadowed by a host of relatively minor misdeeds that reinforce the perception the playing field is tilted in favour of banks. Heads, they win. Tails, US taxpayers bail them out. And with each negative headline, the banking industry loses more control of the narrative. If those outside the financial sector take over the process of cleaning up Wall Street, it will be more unpleasant and indiscriminate. As banking becomes ever more complex, outsiders have correspondingly less insight into the internal functions of major global banks and are likely to use blunt and potentially less-effective tools to try to control these huge companies.” (Mike Mayo, Financial Times, June 18, 2012).


"Examples of investor demand for safe, liquid assets are not hard to identify. One source has been foreign official investors, mostly emerging market countries, which invested about $1.6 trillion in the United States in the four years preceding the crisis, largely in U.S. Treasury and agency securities. Much of this activity arose from the investment of foreign exchange reserves by countries running large current account surpluses. Some of these reserves were undoubtedly built up as a precautionary measure in light of the financial problems in emerging markets during the late 1990s, while others are attendant to policies of managed exchange rates. This official sector demand for safe assets was largely if not entirely focused on U.S. government securities, rather than cash equivalents. But this source of demand absorbed roughly 80 percent of the increase in U.S. Treasury and agency securities over the four-year period, potentially crowding out other investors and thereby increasing their demand for cash equivalents that appeared to be of comparable safety and liquidity." (Governor Daniel K. Tarullo, Federal Reserve, June 12, 2012)

Levels:

S&P 500 Index [1342.84] – Early signs of bottoming between 1280 and 1320. Better gauge of buyers’ enthusiasm awaits in weeks ahead.

Crude [$84.10] – Digging from annual lows of $81 reached last week. The sharp fall since March 1st will take a while to recover. In the near-term, attempts to reach $90 are bound to stir some attention.

Gold [$1627.25] – Buyers’ interest confirmed at $1550 and $1600. Observers await to see if sustainable buying will resume back to $1750.

DXY – US Dollar Index [81.62] – Dollar strength is retreating since June 1, 2012. Yet, the strength since May 2011 remains in place.

US 10 Year Treasury Yields [1.57%] – Stuck near all-time lows as demand for treasuries remains high. April 2010 marked a noteworthy peak at 4%, and since last summer, below 2.50% defined the range.

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