Market Outlook | August 20, 2012

"By law of periodical repetition, everything which has happened once must happen again and again – and not capriciously, but at regular periods, and each thing in its own period, not another's and each obeying its own law." (Mark Twain, 1835-1910)

Calmness prevails

The trend of dwindling trading volume continues to match a very low volatility period in the late summer months. However, it is not slowing the overall positive market response so far in 2012. Beyond elections, the pending outcome of stimulus and interest rate policies sounds hopeful for some participants and vital for policy makers. Through this un-shuffling of sorts, the US dollar remains the most attractive currency by far, for now. Yet, economic growth is not a simple reading in this new era and is certainly open to interpretation, given opaque methodologies. Despite the salesman efforts by pundits and political advisors in key topics such as economic growth, the “fiscal cliff” and corporate earnings, growth generally fails to present a clear direction with any certainty. So if investors avoid being overly greedy while ignoring most of the fear mongering, then their odds of being lucky increase.

Repetition

The four-year cycle is intriguing to watch for market observers. After the technology bubble of the late 1990s, the S&P 500 index finally began to stand on solid ground in the spring of 2003. Back then, the index bottomed at 788 in March 2003, then began a smooth upside trend up all the way up to 1576 (all-time high) in October 2007. It was an impressive run between 2003-2007, in which the S&P 500 gained 99.78% right ahead of the credit meltdown. Similarly, we’re in another four-year cycle that sparked after the credit crisis of 2008. After the dismal and highly documented collapse, in the spring of 2009 a new revival re-emerged. One can easily notice a similar upside pattern. This time, there has been around a 100% appreciation for the S&P 500 index when measuring between 2003-August 2012. This showcases that cycles find a way to provoke similarities despite a rapidly changing world.

The mirroring pattern in both recent four-year cycles is noteworthy for observers but market facts are clouded by political views given the heavy focus on pending election results. As we approach October, this trend is rather suspenseful and the outcomes remain mysterious, even to the brave making daring directional bets.


Disconnect clarified

The broad market as measured by the share performances of 500 companies, tells a story that may not be fully descriptive of the world that’s visible to all. First, nearly half of the companies in the S&P 500 index earn their revenue from non-US markets. Secondly, the average results are tilted toward larger companies while not describing the story for smaller firms and regular small businesses, especially when it comes to access to cheaper capital. Thirdly, the stock market movement should not be confused with the general economy at all times, as that remains a tricky relationship. This is a lesson that keeps repeating for those willing to sift through noise and read through misleading presentations. Thus, developing a genuine opinion is becoming much harder, and pinpointing themes and ideas requires a demanding workload – not to mention the added risk, which is not quite well received in this risk-averse mainstream world.

Article Quotes:

“Mr. Goodhart used monetary history to test these competing theories. He examined the overthrow of Rome and a period in the tenth century when the Japanese government stopped minting coins. If the origin of money were purely private, these shocks should have had no monetary effects. But after Rome’s collapse, traders resorted to barter; in Japan they started to use rice instead of coins. There is a clear link between fiscal power and money. The evidence suggests that only ‘informal’ monies can spring up purely privately. But informal money can exist on the grandest scale. The dollar’s position as the world’s reserve currency is not mandated by any government, for example. Its pre-eminence outside America rests on it being the best option for international transactions. Once a competitor currency becomes preferable, firms and other governments will move on. The good news for the dollar is that the Chinese yuan is not yet widely accepted and suffers from higher inflation, reducing its usefulness. But a shift in the world’s reserve currency could be swifter than many assume. The dollar’s other competitor, the euro, has deeper problems. Its origins were not private. Nor is it a proper Cartalist money, backed by a nation state. This means it lacks a foundation in the power of either the market or the state.” (The Economist, August 18, 2012)

“So some may find it surprising that in a year when Europe's troubles have thrown the global economy into fits, gold has been a loser's bet. The price per ounce of everyone's favorite rock is down about 7 percent for the year and is off 15 percent from its September peak. According to a report released yesterday by the World Gold Council, total demand for gold fell 7 percent in the second quarter of 2012 compared to the year before. Let this be a reminder that, no matter how long it's been around, gold just isn't that special. It's a commodity that responds to the laws of supply and demand. Unlike commodities such as wheat or oil, which you can at least eat or burn for fuel, gold pretty much lacks any inherent value beyond what the market assigns to it. And in the past decade, much of the new demand that set gold off on a wild tear from around $300-an-ounce at the turn of the century to almost $1,900-an-ounce last year has come from two places: India and China. Combined, they account for 45 percent of the world's demand for gold jewelry and bars.” (The Atlantic, August 17, 2012)

Levels:

S&P 500 Index [1418.16] – Approaching annual highs from April (1422), a continued sign of strength in place. Although odds for a pullback are heavily discussed, the trend showcases a positive upward swing.

Crude [$96.01] – Attempting to climb back to $100. Interestingly, the much-followed 200-day average stands at $96.69; that can get a few chart observers to rethink their views.

Gold [$1618.50] – The ongoing and slow bottoming process continues to drag on. The 50-day moving average tells the story at $1597.00.

DXY – US Dollar Index [82.59] –Although mostly trendless, it is fair to say dollar weakness has not been visible in the last year or recent days. However, the multi-month strength continues to lack meaningful follow-through.

US 10 Year Treasury Yields [1.81%] – After making all-time lows last month, yields are somewhat recovering, but climbing back to 2% remains challenging.

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