Market Outlook | January 14, 2013

“Without change, something sleeps inside us, and seldom awakens. The sleeper must awaken.” (Frank Herbert, 1920-1986)

Not too silent

The silent bull market that persisted in the last three years is not so silent these days. At least relative to last year, market strength is not quite as easily dismissed as positive expectations increase. Looking around at some estimates, most anticipate markets to replicate the 2012 stock market rally. The broader investment crowd awakens to behold an attractive stock market that has not crumbled but has shown unprecedented returns.

Thus, one is faced with a different market dynamic. On one hand, optimism is less feared than before. Yet, stock prices are not overly cheap enough to take aggressive risks in pursuit of bigger payouts. This is not a comforting junction, as alertness on the next clues (earnings, primarily) will be a demanding exercise for most participants.

Familiarity preferred

Typically, in a period of confusion, the search for safety or the “familiar trade” seems to resurface but that usually has its dangers. Obviously, it’s much easier to get comfortable with risk when markets keep moving higher, volatility remains lower and bad news ends up being mostly “no news.” The last twelve months have not required investor creativity or skills, due to the lack of turbulence. Of course, some courage was needed after the debt ceiling theatrics for those buyers. Similarly, piling into gold and waiting for a “cliff” resolution reaffirms further conventional thought. Investors these days and in the past week remain more skeptical about a potential increase in volatility and appear confident of a continuing smooth-sailing trend. It’s fair to say, what a difference a year makes! Although the optimism has not reached extreme bravado or excess hubris at this point, the recent tone suggests a step closer to collective optimism than previously imagined.

“The weekly poll of bullish sentiment from the American Association of Individual Investors (AAII) rose from 38.71% up to 46.45%. Even though bullish sentiment is at an eleven month high, one would think that with the S&P 500 at a five year high, it would have at least been able to cross the 50% threshold.” (Bespoke Investment Group, January 10, 2013).

Perceived stability

Looking around, stability has been restored both in European and Asian markets, at least temporarily. The fourth quarter of 2012 demonstrated the strength of emerging markets. In particular, the run-up in Chinese-related stocks demonstrates some optimism, while trust remains an investor issue that’s less resolved. Interestingly, capital inflow to emerging markets continues to gain momentum: “Flows into EPFR Global-tracked emerging market equity funds hit a record $7.39 billion during the week ending Jan. 9 as this fund group extended their longest inflow streak since a 29 week run ended in mid-December, 2010.” (Forbes, January 11, 2013).

Meanwhile, European indexes in Spain and Italy turned a positive week after the European Central Bank elected to stick with the status quo in keeping lower rates. The speculative game focuses on European policymakers’ ability to overcome ongoing challenges. The real European economy is far from vibrant, but stocks and interest rates directionally mirror the US markets.

Relevant signs

Perhaps, the improving labor and housing numbers create some comfort on the march toward stability. Yet, with US 10 year Treasury Yields below 2%, the general notion suggests that staying in US equities appears to make sense – until further clarity emerges from earnings growth. In terms of the macro element, treasury yields have not made new lows in a while. In fact, rates have risen from 1.37% to 1.86% in more than six months. This is a very early trend that suggests a bottoming process in rates. Therefore, a follow-through is worth tracking as the potential trend-shifting event.


Article Quotes:

“The United States has long partnered with Europeans on Middle Eastern diplomacy, but Middle East interests are by no means a European preserve. Asian countries importing millions of barrels of oil a day have a keen interest in regional stability and energy security, and they increasingly pursue diplomacy to further those goals. U.S. diplomacy is similarly concerned with stability and energy security. While the United States imports relatively little energy directly from the Middle East, all of its Asian allies import it in growing amounts and use it to manufacture goods that they sell to the United States. In this way, indirect U.S. imports of Middle Eastern oil remain robust. In addition, oil (and to a lesser extent, gas) are globally traded commodities, so a price spike in one place affects prices globally. U.S. production can affect where the specific barrels of U.S. oil consumption come from, but it has much less effect on the price of those barrels. For that reason, the United States cannot turn away from the Middle East. Instead, it will increasingly turn to the Middle East from the other side of the world.” (Center for Strategic & International Studies, January 2013)

“After China’s statistics bureau reported third-quarter GDP in October, Standard Chartered Plc analysts said the 7.4 percent increase was “too good to be true” when compared with the slowdown in electricity production and the readings of a manufacturing index, while London-based Capital Economics Ltd. said its own analysis indicated expansion of about 6.5 percent. The median forecast for December exports in a Bloomberg survey of 40 economists was for a 5 percent gain, with the highest estimate at 9.2 percent, after November’s 2.9 percent growth. Goldman Sachs, ranked by Bloomberg as the most accurate forecaster for the indicator, projected a 7 percent rise. The increase, which was the biggest since May, could indicate exporters’ rush to finish year-end orders and government pressure to report exports before the end of the year to reach the government’s 2012 target of 10 percent growth, Shen Jianguang, Mizuho’s Hong Kong-based chief Asia economist, said in a Jan. 10 note.” (Bloomberg, January 13, 2013).

Levels:

(Prices as of January 11, 2013)

S&P 500 Index [1472.05] – Less than two points removed from 2012 highs reached in September. From a trend perspective, no signs of trend reversal, and the positive trend remains intact. A rally since mid-November showcases the renewed interest in the run-up.

Crude [$93.56] – The multi-month rally continues. A move above $90 shows hints of new trading ranges. The next few weeks can confirm the strength of recent patterns.

Gold [$1657.50] – The much-anticipated bounce-back has yet to materialize significantly. A step back reminds us that there was a potential peak in September 2011 at $1885. Although consensus expects gold to revisit those ranges, the near-term evidence is not visible.

DXY – US Dollar Index [79.56] – Stuck in a multi-month range where there is a lack of movement. The decline since mid-summer 2012 has slowed down as a neutral trend continues.

US 10 Year Treasury Yields [1.86%] – The last few weeks demonstrate rising rates. The move from 1.44% to 1.97% is noteworthy relative to other recent moves. The follow-through is less convincing for most but should not be easily dismissed.


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