Market Outlook | October 1, 2012

“The truest way to be deceived is to think oneself more knowing than others.” François de La Rochefoucauld ((1613-1680)

Seasonal deliberation

The four-year-cycle run in the stock markets mirrors the election season, which stirs up opinions and various thoughts. Interestingly, the fall season, including the month of October, is often feared, as pundits anticipate theatrical events. Certainly, sharp slowdowns have been displayed, most notably during the 2008 credit crisis and 1987 crash – not to mention most historians’ favorite: the 1929 crash resulting in the October panic ahead of the Depression. All sound quite familiar and rehashed in these cautious days and make for a thrilling documentary-like dialogue, but may not tell the full or exact story.

This financial market thus far has encountered various opinions, including some threats of gigantic regulations, or pending global collapse and lack of trust leading to a revisit of recent crises. Certainly, there is plenty that’s unsolved, but knowing where to focus one’s fear is the art that’s rewarding in this faster-paced market. Surely, noise and headline makers are eager for dull or theatrical events. Meanwhile, capital allocators have been punished for lagging broad indexes and simply cannot afford to live by popular or generic ideas. As the schedule has it, this week’s election-related events, along with early releases on labor conditions, combine to spark some talking points. In addition, further central bank and economic growth matters are awaited. Through all various data points, the impact to long-term implications will still remain a mystery to most.

Shaky feelings

This year has been more about accepting the slowing global growth and a collective recognition of various demographic and globalization challenges. At this point, one has to wonder how much ‘bad news’ remains in the tank for a market that has quietly risen while silencing various critics. According to the AAII investor sentiment data, the bearish reading is at a nine-month highs. Thus, it’s fair to assume that bubble-like levels regarding corporate growth are not overly concerning. It’s intriguing that the lack of enthusiasm continues despite the impressive year-to-date stock market returns. Simply, there is no shortage of doubters. Interestingly, other perceived “safe assets” persist in showcasing euphoric investor demand, such as Long US treasury and high-yield bonds.

For now, the appealing trade for broader audiences is to expect commodities to go higher. That's quite evident in speculators of crude that have increased their bets. Similarly, bank analysts have increased gold price estimates and the collective upbeat expert view lives on. Certainly, going against these forces is not easy and not natural to dismiss. Nonetheless, the risk of owning commodities has increased relative to other years, while the upside potential is unclear.

The Macro Reminders

The overly exhausted but never-ending Eurozone discussion may provide some jolt for volatility traders and some ammunition for those heavily entrenched in glooms-day scenarios. The fifth year of the Euro Crisis has rotated its focus between various countries, as Spain seeks a rescue plan. As the Spanish banks hold a $76.3 billion deficit (according to Bloomberg), the uncertainty cannot dissipate overnight as new discoveries unfold. Yet, the shock element is hardly news for a forward-looking market. Distinguishing social and political noise from market behavior remains the ultimate challenge in assessing Eurozone matters.

Finally, in the near-term, the impact of Middle East tension on oil prices and ongoing weaker Chinese growth (low PMI September data) will stimulate various minds to make strategic macro moves. Importantly, the link between oil demand and emerging market growth/slowdown is a puzzle that’s due for unlocking. Similarly, emerging markets are expected to reignite themselves out of the current slump, as demand for growth is desperately needed. Since 2010, the Emerging Market Fund (EEM) has underperformed compared to the S&P 500 index. This reinforces that the US banks, currency and financial system maintain their relative edge despite increased global uncertainty.

Article Quotes:

“The demand side is also dark and threatening for overpriced oil, very threatening. World oil demand, this year, may achieve a scary feat for the oil bulls: two straight years of near perfect stagnation of global demand. The EU27 countries are now in their sixth straight year of oil demand shrinkage, recession aiding, but they are now far from the only countries where oil demand shrinks – and shrinks. …. China's long-term growth rate of oil imports, which hit an average of more than 9 percent a year for 1999-2009 has been slashed in half. Indian oil demand growth, these days, is close to 3.5 percent per year, not the previous 5.5 percent average…. The US is now a large, ever growing net exporter of refined oil products. Domestic refiners are taking crude from wherever available and turning it into diesel, gasoline and other oil products for growing demand from Latin America, Asia, Africa and even Europe, where Europe's outdated, high cost, oversupplied and mismatched refinery output – relative to European refined product demand – creates a growing market for US exports.” (The Market Oracle, Andrew McKillop September 30, 2012)


“Jens Weidmann, president of the Bundesbank, last week said a banking union was a disguised transfer mechanism. On this point, he is right. A banking union would recapitalise Spanish banks at the expense of northern European taxpayers. This is the whole point of having it. It would be dishonest to deny that. A banking union, properly constructed, thus constitutes a fiscal union. This is not something you do before Christmas, or through a directive. I wrote earlier that a banking union is an even bigger deal than a eurozone bond. You can construct a eurozone bond with lots of safeguards. There are even proposals on the table that would turn a eurozone bond into an instrument to deliver austerity – a so-called debt redemption bond. I would rather have a banking union and no eurobonds, than the other way round. I would rather have nothing than a debt redemption bond. Judging from the political debate, Germany is not ready for a fiscal transfer mechanism of any kind. In particular, Germany is not ready for a banking union. Ms. Merkel never made a political case for a banking union in Germany. All she did was play down the implications. I would counsel readers against falling into the trap of thinking that next year’s German elections will miraculously clear all the hurdles. All the various probable outcomes favour a continuation of the present policy.” (Financial Times, Wolfgang Münchau Septmber 30, 2012)

Levels:


S&P 500 Index [1440.67] – Slightly retracing from intra-day highs of 1474.51. Increasing expectation for declines closer to 1400-1350. However, positive momentum remains intact. Since the lows of October 7, 2011, the index has risen by 34%.

Crude [$92.19] –Recent sharp declines are puzzling those expecting price appreciation due to some regional unrest. Interestingly, there is a record number of speculators who continue to bet on higher prices showcasing the already built-up expectations. At the same time, the slight decline below the 50- and 200-day moving averages are compelling to chartists who may make the case for further weakness. Holding above $90 will remain key for sensitive observers in days ahead.

Gold [$1776.00] – Growing suspense on gold’s ability to break above $1800 on the way to record highs will be tested yet again. Recent four-month upward movements have re-ignited confidence for analysts to increase targets while downplaying concerns of “bubbles”. Either way, hardly a fundamental play that’s heavily tilted toward momentum and increased speculation.

DXY – US Dollar Index [79.32] – Amazingly, the 12-month average stands at 79.91 and the four-year average stood at 79.25, which reminds us of the lack of any major changes.

US 10 Year Treasury Yields [1.63%] – In the last two months, struggling to hurdle past 1.80%, while showing resilience around 1.60%. Until there is a movement below or above this trend, the message remains that yields are very close to historic lows.


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