Market Outlook | July 23, 2012

“A good traveler has no fixed plans, and is not intent on arriving.” Lao Tzu (600 BC-531 BC)

Observers are wondering why the market is not deteriorating at a faster pace. Is it the buzz of potential further easing (i.e. QE3) or the fact that corporate earnings were not as bad as expected that’s keeping stock markets higher? Investors who succeed within the rules usually know to trade what they are given, so patience may not hurt for those willing to adjust. However, risk-aversion persists in many and fatigued observers continue to recognize that it takes a while to dust off.

The rate journey:

Central banks’ master plan of lowering rates with the intention of increasing inflation expectations remains the ultimate hopes for stimulating growth. These efforts remain more suspenseful than usual, especially when growth is on the decline and cash remains on the sidelines. Perhaps, it is natural to worry and ask the following: Is there enough collective patience with the current central bankers’ plan? Certainly, we keep learning this is not an easy sales pitch. Even in some cases, the Federal Reserve is deferring to politicians to take action:

“The most effective way that the Congress could help to support the economy right now would be to work to address the nation's fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery.” (Chairman Ben S. Bernanke, July 17, 2012).

Rather a bold statement that is not pleasing to hear from the Federal Reserve. Yet again this summer, governance risk is at the forefront for money managers to dissect and ponder. In simple terms, pleading for leaders to make decisions for the health of competitive markets is not quite comforting. In some aspects, this fails to project broader confidence, even for the not-so-savvy financial observer. Basically, this alludes to the fragile state of markets, as stated by various indicators last quarter.

Marketing Risk

Perhaps, the vital capital that is too distant from flowing in the traditional economy is getting much more attention these days:

“A global super-rich elite has exploited gaps in cross-border tax rules to hide an extraordinary £13 trillion ($21tn) of wealth offshore – as much as the American and Japanese GDPs put together – according to research commissioned by the campaign group Tax Justice Network.” (The Guardian, July 21, 2012)

Clearly, anyone labeled “ultra-rich” may not see the need to risk capital given the chaotic nature of sentiment. Perhaps, taxes present more of a priority than risk for some groups. Interestingly, even the typical retail account is lowering exposure to stock markets based on weaker volume. On a similar note, S&P 500 companies are holding cash while struggling to move it toward growth-based investments as an ongoing trend. On this topic, the Financial Times points out: “It continues to be depressingly obvious that corporates cannot find anything very exciting on which to spend their money.” (John Authers, July 22, 2012).

Thus, by various measures, it is quite visible regardless of wealth amount or decision-making role that the current deadlock is “trust” based. Bailouts and interventions are a global theme, not a geographic occurrence, and unknown tax consequences and unpredictable government mindsets even fuel the level of discomfort for participants. Yet, the reward for risks taken now is shaping up nicely for those willing to bet on unknowns. However, it takes courage and vision to ignore the much-discussed concerns.

Rerouting

In the last decade, financial engineering such as derivative products have been in great favor versus real investments in core economies. Perhaps, innovation that was heavily saturated in financial services can shift to other areas, such as manufacturing or innovation-based sectors. However, a globalized world makes this thought semi-nostalgic, and political constraints make it harder to envision. But it’s a necessity by all accounts to reenergize growth to entice capital activity.
Technology, as a known innovative sector, is showing relative strength despite a cloudy macro outlook. The successful IPOs of Kayak and Palo Alto Networks last week should not go unnoticed. Plus, the Semiconductor index is at the early stages of showing signs of bottoming, along with fundamentals that turned out not as dismal as previously thought (or desired). Surely, picking the right company’s stock is more appropriate in the sector, but requires further digging as entry points remain attractive for months ahead.

Article Quotes

“These events of the past five years have put the aging, close to retirement – or already retired population – in capital preservation modes. After all, who would take care of them in their rainy days – which, with the suddenly longer life expectancy, are expected to have become far more numerous? Better give up consumption now and have something for the invalid years. Youngsters, in contrast, can hope to recoup money when exposing themselves to risk and losses; for people above 60, the chances of recouping after losing are slim. Lower interest rates will not induce older people to take more bets: at best they would buy lotteries occasionally for a few bucks, giving up a few cans of beer. Few are in the position of Federal Reserve chairman Ben Bernanke or other public officials, endowed with generous pensions. In Bernanke's case, he can count upon retirement on generous pensions, and speaking and possibly board fees. Push come to shove, he can even return to lecturing at universities.” (Asian Times, July 21, 2012).

“There are two competing models of successful American cities. One encourages a growing population, fosters a middle-class, family-centered lifestyle, and liberally permits new housing. It used to be the norm nationally, and it still predominates in the South and Southwest. The other favors long-term residents, attracts highly productive, work-driven people, focuses on aesthetic amenities, and makes it difficult to build. It prevails on the West Coast, in the Northeast and in picturesque cities such as Boulder, Colorado and Santa Fe, New Mexico. The first model spurs income convergence, the second spurs economic segregation. Both create cities that people find desirable to live in, but they attract different sorts of residents. This segregation has social and political consequences, as it shapes perceptions – and misperceptions – of one’s fellow citizens and ‘normal’ American life. It also has direct and indirect economic effects. ‘It’s a definite productivity loss,’ Shoag says. ‘If there weren’t restrictions and you could build everywhere, it would be productive for people to move. You do make more as a waiter in LA than you do in Ohio. Preventing people from having that opportunity to move to these high-income places, making it so expensive to live there, is a loss.’ That’s true not only for less-educated workers but for lower earners of all sorts, including the artists and writers who traditionally made places like New York, Los Angeles and Santa Fe cultural centers.” (Bloomberg, July 19, 2012).

Levels

S&P 500 Index [1362.66] – Staying above 1360 has proved to be a near-term struggle on two recent occasions. Yet, buyers don’t appear exhausted (or ready to bail), given some visible buy appetite around 1300. Uptrend intact despite short-term stalls.

Crude [$91.44] – An explosive three-week run where the drivers remain mysterious. For now, curiosity lurks around further price escalation.

Gold [$1595.00] – The zigzag pattern since early May 2012 only leads to frustration for trend-followers on either side of the coin. The plot thickens, with a retest of the 1560 level versus the much-anticipated rally beyond 1620. For now, neutrality remains in force while the bias is building on the upside as gold is labeled (or confused) as the demise instrument.

DXY – US Dollar Index [83.37] – For nearly a year, the dollar has steadily strengthened, painting the picture of high demand for “safety” as well as ongoing decline of other currencies. This stronger dollar theme has not shown any signs of weakness, and remains counterintuitive to the nearly 30-year trend we’ve witnessed.

US 10 Year Treasury Yields [1.45%] – Barely holding above previous historic low of 1.43% reached on June 1, 2012. Now the fragile conditions resurface and are marking a new unchartered territory for participants and leaders alike.


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