Market Outlook | August 6, 2012

“Confusion is a word we have invented for an order which is not yet understood.” (Henry Miller, 1891-1980)

Stalled in transition

Broadly speaking, for those looking to bet on the direction of stock indexes, it is not quite a clear-cut entry point. If you sense others are too fearful, then the contrarian view has some appeal, at least at first glance. In other words, why not buy in a fear-obsessed and not-so-cheerful environment? However, dissecting that thought leads one to simple arithmetic, which shows the S&P 500 index trading closer to the highs of 2007 than the lows of late 2008. Basically, we are not even close to a “collapsing” market, at least in terms of pricing. If you're a fundamental observer, then the corporate earnings growth makes one relatively optimistic. Yet, it has been an impressive trend for a while and this impressive run is bound to stall, from odds makers’ perspectives. Plus, value investors cannot claim things are too cheap for comfort, either. A conundrum, indeed.

Based on day-to-day anxiousness, one can easily state that volatility is very high, but the answer to that intuitive thought is simply: No. Actually, the truth is to the contrary: Perceived turbulence has declined significantly for several months in a calming manner, along with a slowing participation rate. This combination showcases the much-discussed growing disinterest in or temporary pause from risk-taking. However, barometers indicate we are far removed from any extreme panic. Not to mention last week’s trading glitch, which does not boost the confidence of the financial system, especially after the “flash crash” which only lets the commoner conclude that this market is too complex and highly vulnerable. Yet, as we’ve learned, like all crises, a solution follows despite debates and opinions.

Re-grouping

Emerging markets have boasted long-term cycle returns dating back to turn of the last decade. During that period, those runs were rewarding for investors and select countries’ GDP growth. Now, both investment themes have slowed, while cooling the excitement and momentum run. In looking ahead, many observers have asked, when is growth resuming in emerging markets? Some may view that turnaround point as sooner than others. Yet, most point out that the long-term prospects are what keep optimists alive in the short-term. For example, “Leading companies in the developed world earn just 17% of total revenues from emerging markets, even though these markets represent 36% of global GDP.” (McKinsey Quarterly, August 2012). Certainly, the long-term trend in emerging countries cannot be neglected, but timing the nature of the re-acceleration is tricky. Plus, identifying nations beyond the BRIC’s is a puzzle worth pursuing. That’s where patience may be rewarding, while a dose of healthy skepticism in future projections is worth a closer look.

Unanswerable – for now

Questions related to job growth, the success of quantitative easing and stabilization of the Eurozone are too big and difficult to answer for anyone. Time after time, these noisy macro issues engulf the minds of large and small investors. Basically, trying to predict the outcome of these issues may lead to more mistakes than accurate stock or commodity picking. Perhaps, investor frustration deals with the extra work needed to adjust to a new cycle with varying dynamics related to speedy information and increased competition. While it’s certainly not for the casual observer, to claim “buy and hold” is dead would be grossly misleading, as well. After all, since July 2010, the S&P 500 index is up nearly 38% despite the back-and-forth unknowns. Thus, focusing on big-picture answers to determine entry points is not unique and definitely not certain, either.

Article Quotes:

“The most dramatic signs of a US revival are in manufacturing. Even as it was losing out to emerging manufacturing powers in the last decade, the US was reacting much more quickly than other rich nations, by restraining wage growth, boosting the productivity of remaining workers with new technology, allowing a steady fall in the dollar that has made US exports much more competitive, particularly relative to Euro nations, and incorporating inexpensive new foreign sources into its supply chains. The result was that China's rise came largely at Europe's expense. Since 2004 China has gained market share in the export of goods and of manufactured goods, while Europe's share is falling and the US share has held steady. After losing 6 million manufacturing jobs in the last decade, the US gained half a million in the last 18 months while Europe, Canada and Japan lost jobs or saw no change. … Energy is also rapidly emerging as an American competitive advantage. After falling for 25 years, the share of the US energy supply that comes from domestic sources has been rising since 2005, from 69 percent to around 80 percent, due to increasing production of oil and particularly natural gas.” (The Atlantic, August, 3 2012)

“It is not just America’s Treasury that is benefiting from ultra-low borrowing costs. On July 30th Unilever, an Anglo-Dutch consumer-goods group, borrowed $1 billion in the bond markets, in two tranches: 0.45% for three-year money and 0.85% over five years, both record lows for corporate debt. A week earlier IBM had raised ten-year money at a rate of just 1.875%. The Spanish and Italian governments can only dream of funding at such a low cost. Multinational companies have some advantages over governments. Although they can be subject to punitive taxation, they have the potential to move their operations to more welcoming jurisdictions. Their revenues are not dependent on the fortunes of an individual economy. And large companies have been able to strengthen their balance-sheets over the past five years, whereas governments have been forced deep into deficit to prop up their economies.” (The Economist, August 4, 2012)

Levels:

S&P 500 Index [1390.99] – Knocking on the door of 1400 and marching higher from the lows established on June 4, 2012. Trend remains positive despite neutral developing patterns.

Crude [$91.40] – Signs of bottoming visible at $84 as shown in recent weeks, and re-acceleration around $90.

Gold [$1602.00] – Over the last three months, gold has seen plenty of trendless action. For example, the 50-day moving average stands at $1592, illustrating the continued zig-zag and narrow movements around $1600.

DXY – US Dollar Index [82.70] – For over a year, the dollar index has shown signs of strengthening. However, the current strength doesn’t match the peak levels seen in late 2008 (88.46), early 2009 (89.62) and mid 2010 (88.70). Potential pause looming in the near-term.

US 10 Year Treasury Yields [1.54%] – It was last August when yields were closer to 3% before a profound drop. Then, April 2012 marked another defining point, where yields struggled to move above 2%. Now, tiptoeing around all-times lows seems more normal than outrageous.


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