Market Outlook | December 31, 2012

“Any occurrence requiring undivided attention will be accompanied by a compelling distraction.” (Robert Bloch, 1917-1994)

Balancing distractions

Heading into 2012, sentiment was overly depressed and fearful around the debt ceiling debacle and much-hyped downgrade. Eventually, betting against fear paid well, and investing in risky assets, mainly US stocks, rewarded the daring bunch then. Particularly, underestimating the financial sector resulted in leaving profits on the table for shareholders. That’s showcased in housing, where the homebuilder index re-ignited silently and is now praised loudly, given year-to-date numbers. Similarly, banks confirmed stability and rapid acceleration for shareholders. Overall, stability has been restored and investors’ appetite for risk is slowly normalizing, yet nagging skepticism is abundantly visible.

As we encounter a new year, analysts are becoming more bullish. It feels like the gloom-and-doomers have awakened to positive momentum, and sentiment is net positive and quietly building. Analysts are either playing catch-up or, convinced by momentum, are suggesting a stronger 2013 for stocks. Repeating the returns of this year in US markets may not be as easy as one expects. Of course, the evidence of a bubble is not quite convincing either, at least for stocks.

All of a sudden in a short period, we've shifted from “bad news exhausted” to seeing optimism resurfacing, but not quite to bubble-like levels as witnessed twice in last decade. This leaves the crowd with plenty to ponder: How many upside surprises are left? Of course, any "cliff" resolution can re-spark enthusiasm for the short term, while other issues loom further ahead.

Connected puzzles

Recent consecutive down days slightly altered the established positive tone as year-end shuffling resumed. Perhaps, regardless of an unclear tax picture and extended earnings growth, there is no lay-up in any market. Tamed volatility has been a surprising story to most in 2012, but assuming extreme lows remain in place. One overriding issue revolves around the low interest rate policy that's been outlined by the Federal Reserve. Taking away the potential fear of rate hikes and guiding without month-to-month prognosis shifts has been comforting for markets. Is quantitative easing comforting enough for fundamentals and economic indicators? That’s a major question to be answered in a nerve-wracking first quarter. As the Federal Reserve Bank of Cleveland reminds us:

“Arguably the improvement in labor market conditions might be because of QE3 and the market’s anticipation that it is probably not going to end imminently. It remains to be seen how much more improvement is necessary before the Committee ends QE3.” (December 28, 2012).

Economic improvements led by labor and housing segments are expected to continue; at least, consensus is moving toward those expectations. The ever-so-overly awaited collective "growth" may serve as the last and only hope. As usual, the Federal Reserve’s quantitative easing policies appear to have run out of “magic” to some, while the merits of those actions will be naturally debated by practitioners and historians alike. For now, it’s too early to conclude.


Safety questioned

The way in which gold is set to end the year may not please its buyers. Surely, a 6.5x jump in gold prices since 1999 reinforces that being a gold bull is not necessarily a creative or innovative idea. Certainly, this is not a beginning of a run, while the current pattern is too fuzzy to call an end. Those waiting for the gold explosion have had their patience tested this year on numerous occasions. Clue after clue suggest a hurdle above $1800 per ounce. The lack of catalysts or changing landscape between retail speculators and those hedging are tricky for observers to surmise. In terms of the recent trend: “Speculators are becoming less positive, reducing their net-long position to 112,421 futures and options in the week to Dec. 18, the least since August, U.S. Commodity Futures Trading Commission data show. Hedge funds’ bets on a rally this year were on average 28 percent lower than in 2011.” (Bloomberg, December 28, 2012).

A central bank buying gold to hedge its own books is not a guarantee of rising prices. Importantly, if global economic strength persists, then the appetite for gold may alter a bit. For now, we may see a technical bounce is in the cards for odds makers in gold prices, but restlessness among participants might persist if prices fail to appreciate or barely move. The consensus view on gold is favorable – in fact, it appears too favorable when glancing at surveys and reports. Optimism in gold will have to determine if ongoing popularity soothes or misleads from a risk-reward perspective.

Article Quotes:

“Many homes are paid for in cash in China, so buying a car with cash is considered no big deal. The idea of paying by credit is catching on among the younger generation, though older Chinese still abhor the notion. As recently as five years ago the percentage of buyers using credit to buy a car was tiny. But that is changing, say auto analysts. Eva Chan, who is buying a new car, says she could afford to pay cash but has decided to use credit because a local bank is offering an interest-free loan as part of a dealer promotion. She ends up with a Rmb200,000 ($32,000) car, bought with Rmb120,000 of credit. … South Korea’s Hyundai Motor this year set up a car financing joint venture   with Beijing Automotive Industry Corporation. Lee Kyo Chang, chief executive of Beijing Hyundai Auto Finance, says that while only 15 per cent of buyers use credit, 30 per cent say they would be willing to. Commercial banks, Mr. Lee says, approve only half of applications, so car financing companies, which have less conservative approval policies, can step into the breach.” (Financial Times, December 27, 2012).


”In September 2012, the average hedge fund still charged 1.6 percent annually in management fees and collected 18.7 percent of any gains, according to data provider Preqin. Through November of that year, the average global hedge fund investor earned just 2.6 percent, according to the HFRX global index maintained by Hedge Fund Research. In 2011, investors lost nearly 9 percent. The average annual return from 2009 to 2012, supposedly recovery years following the losses of more than 20 percent in 2008, was a measly 3 percent. … The other wing of the industry consists of hedge funds that have essentially gone back in time to something closer to the original concept – impressive returns in all market conditions, with fees to match as long as the returns are forthcoming. In the 1960s, Warren E. Buffett ran a fund charging no management fee but taking 25 percent of investment gains above a 6 percent threshold return.” (New York Times, December 28, 2012)

Levels:

S&P 500 Index [1402] – Attempting to hold above 1400. Entering a fragile territory between 1380-1400.

Crude [$85.93] – Recent resurgence showcasing a strong move since December 8,which saw lows of $85.21. Yet, skeptics question its ability for momentum to extend above $98. A potential trend shift forming.

Gold [$1657.50] – Steady decline since the start of the fourth quarter. From its peak of $1791, gold has declined by nearly 8%. Until there is a break below $1600, long-term investors are not quite geared to bail out on this multi-year trend. Nonetheless, those seeking price appreciation may not be pleased with the new, slower pace in the past two years.

DXY – US Dollar Index [79.67] – Strengthening dollar possibilities seem short-lived and unconvincing for now. Meanwhile, the lack of surprises and significant changes explain the narrow trading range between 79-81.

US 10 Year Treasury Yields [1.70%] – For the fourth time in six months, yields have failed to reach above 1.80%. Climbing to 2% would re-catch the attention of macro observers. For now, there is a lack of strong, compelling reasons to claim a trend shift, but it’s fair to say stability has been established since the summer lows of 1.37%.


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