Market Outlook | March 4, 2013

“All empty souls tend toward extreme opinions.” William Butler Yeats (1865-1939)

Unanimous and familiar

Characterizing the stock market behaviors in last few years has led to various expressions. About a year ago, there was the "silent bull market," which was followed by “bad news exhausted.” Today, that's grown into a widely accepted and visible bullish market. The Fed's near-promise of maintaining low interest rates continues to set the tone while numbing occasional thoughts of escalating volatility or undesired disruption.

The status quo view, shaped by low interest rates and a contained inflation period, continues to suggest taking bets in risky assets. Perhaps, memories of the 2008 crisis fade more quickly than imagined. Amazingly, American International Group (AIG) is the most favored stock among hedge funds. Clearly, this is a symbolic reality showcasing the fact that old wounds heal and optimism is welcomed even by simplistic observations. To hammer the point home, Chairman Bernanke proclaimed, "I don’t think the economy is overheating” – therefore the sudden downtrend shift may take a while to materialize. Or simply, panic-like responses are likely to be postponed down the road, even though credit markets and use of leverage are clearly back in the system.

The pursuit

Of course, another driver of the current “chase” for higher returns is partially caused by the fear of missing out. In other words, the three-year bullish run has become somewhat of an advertisement to attract/entice the gloomy bystanders from a year or two ago. Thus, as investors begin to scramble for returns, the cycle’s endpoint will be harder to determine. Traders may face near-term swings, but having a dose of skepticism is healthy, especially in managing directional patterns. In fact, within the Federal Reserve, there is a split of opinions regarding further quantitative easing. For asset managers, there is a balance act between fighting the Fed and blindingly riding a wave, which is reckless. The saga continues.

At the same time, measures of US economic recovery point to growing investor sentiment when measuring housing and manufacturing data. However, the improvements are minor, yet effective enough to project a recovery. Also, the US 10 Year Treasury Yields jumped in January of this year but failed to maintain above 2% last month. Now, the struggle to reach beyond 2%, restates same old perception rather than drastic changes. Yet, if stocks continue to be in high demand, a bond sell-off might seem logical – a point argued by some experts. However, in practice, this view may play out at a less predictable pace.

Relative strength

In big-picture financial terms, the relative advantage of US markets remains in place when considering global factors. The Eurozone crisis management gets plenty of headlines for some while causing plenty of headaches for others. Downgrades here and there are common, as signs of resilience appear short lived. In fact, the recent UK downgrade does not take away the strength of UK versus Eurozone (not to mention US versus Europe):

“Yet there are also key differences which set the British version of austerity, such as it is, apart from the sort of self-defeating fiscal consolidation we are seeing in the Eurozone. This is now unambiguously apparent in the data. Revisions to UK GDP published on Wednesday show that last year the UK economy grew 0.3pc [versus Eurozone -0.6pc] and actually quite a bit more if you ignore disruptions to production of North Sea oil. It now appears that onshore Britain never had a double-dip recession. Unemployment is also falling, with substantial private sector job creation.” (The Telegraph, February 27, 2013)

As the debate lingers in Europe, there is a suspenseful discussion of China that persists beyond economic scopes. The recent Chinese announcement of property tax and mortgage rules is poised to elicit a mixed reaction. “Property investment, which includes real-estate development, property management and intermediary services, accounted for 18 percent of China’s gross domestic product last year.” (Bloomberg News, March 2,2013). Talks of calming the real-estate bubble-like pattern in China have their consequences, and the full effect has not been felt. Any slowdown in growth is most likely to cause sensitive reactions to an already edgy climate.

Any uncertainty in Europe or emerging markets finds a way to further benefit US liquid securities and the US real estate market. The relative edge is tested at times and discussions of “falling empires” might be overstated. Nonetheless, this US growth prospect, as fragile as it may be, fares well against other economies for now.

Article Quotes:

“Merkel surely understands this, and she is determined to avoid a catastrophic euro crisis just before her own election in Germany on Sept. 22. She is therefore almost certain to heed Italian voters' refusal to accept further tax hikes, budget cuts or labor reforms. From now on, the European Central Bank will have to offer its support to Italy without any tough pre-conditions. In fact, Italy can realistically be expected to make only one economic promise: to maintain the existing taxes and reform laws already legislated under Monti. That promise should be easy enough to keep, since Italy's new parliament will be no more able to muster a majority for repealing old laws than for introducing new ones. The European Commission, meanwhile, can move the fiscal goalposts in Italy's favor. Once that precedent is set for Italy, similar flexibility should spread across the euro zone – and at that point the ECB would be able to offer effectively unconditional guarantees of financial support for all members of the euro zone, while Merkel and German voters turn a blind eye. Once investors work all this out, European financial markets can be expected to calm down and Italian politicians to return to what they know and love: plotting, backstabbing and Machiavellian intrigue.” (Reuters, February 28, 2013)

“Deferrals and forbearance also mask the true delinquency rates on student loans. Overall, about 17 percent of borrowers are at least ninety days past due on their educational debt, but when we remove the estimated 44 percent of all borrowers for whom no payment is due or the payment is too small to offset the accrued interest, the delinquency rate rises to over 30 percent. These student loan delinquencies and overall large student debt burdens could limit borrowers’ access to (and demand for) other credit, such as mortgages and auto loans. In fact, our data show that the growth in student loan balances and delinquencies was accompanied by a sharp reduction in mortgage and auto loan borrowing and other debt accumulation among younger age groups, with the decline being greater for student loan borrowers and especially so for those with larger student loan balances. In addition, we find delinquent student borrowers much more likely to be late on other debts.” (Federal Reserve of New York, February 28, 2013)

Levels: (Prices as of close March 1, 2013)

S&P 500 Index [1518.20] – Wider intra-day swings developing in the last two weeks. 1500-1520 is the current range of interest while the intermediate-term strength remains intact.

Crude (Spot) [$90.68] – Downtrend continues. Crude has declined more than 8% since peaking on January 30. It is barely above the 200-day moving average, which will attract onlookers who may change sentiment on the commodity’s behavior.

Gold [$1582.25] – When gold prices broke below $1660, that marked another vital point in the existing downtrend. Interestingly, the 200-day moving average sits at $1662 as gold believers continue to have faith in the recovery of the metal. There have been several hints of ongoing deceleration, despite any pending bounces.

DXY – US Dollar Index [81.48] – The dollar is up more than 4% since the February 1, 2013 lows. Inverse correlation to commodities is closely tracked and materializing in recent weeks.

US 10 Year Treasury Yields [1.84%] – For several months, surpassing the 1.80% mark was a daunting task. Yet, we’ve seen a tale of two months so far in 2013 where rates jumped and cooled before surpassing 2%.


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