Market Outlook | April 1, 2013

“Success depends upon previous preparation, and without such preparation there is sure to be failure.” Confucius (551-479 BC)

Seasonal change

With a seasonal change and a new quarter upon us, perhaps old notes are worth dusting off. One thought to ponder revolves around the relationship between currencies and stock market performance. Since nearly half of S&P 500 companies’ earnings are produced overseas, the strengthening dollar in last six months may appear to impact corporate balance sheets. The impact of currency movements for mutli-national companies should be discovered broadly in this earning season. This is a thought-provoking point hidden behind the ongoing optimism for stock ownership and value. The currency-earnings relationship has been hinted at by some in the past few years but has not been at the center stage of discussions.

Also, from a sentiment point of view, rising earnings expectations in an upward trending market do raise the stakes for the next quarter, as well. Of course, neither sentiment argument is new and both have been previously discussed in summer 2012, but the bullish strength has proven again and again to remain powerful and resilient. Amazingly, in this low-volatility and steady period, it remains equally discomforting for buyers and sellers.

Accumulated curiosity

Beyond the markets flirting with all-time highs, a reflection of low rates is driving US stocks and real estate much higher – not to mention the lack of investment alternatives and the classic "fear of missing out” that revive and propel bull markets. A few questions await: Is headline chatter of all-time highs in US markets very symbolic, as advertised? Or is the soaring stock market mainly a result of low rate/higher asset dynamic? Soon to be discovered …
Now, between an inevitable and long-awaited mild correction and anxious European market lingers as the suspense continues to build. A verdict on the recent European financial system implications is too mysterious, yet many assumed it might serve as the catalyst. However, Eurozone crisis prevention methods or delay may persist. Thus far, there has been no sweeping overreaction regarding Cyprus drama, as the last two weeks hinted. Surely, it sparked a noticeable concern, especially in other vulnerable European markets (i.e. Italy and Spain). Near-term and pending consequence are mostly misunderstood. Many noteworthy Eurozone actions are expected following German elections in September. A barrage of worrisome news can hit randomly, when and if markets need an excuse to sell off. Then, one can adjust accordingly. For now, a tangible reason to panic in this five-year European crisis management has not been found. Eagerly, we collectively and patiently observe.

Humbling results

The last two years, showcase a short-term cycle in which commonly assumed trends did not play out as touted (at least, a surprise to most). What seems obvious today was not too clear back then. These humbling reminders are worthwhile for forecasters.

- Buying gold in September 2011 for accelerated run

Heading into this weekend, the following article demonstrated that:

“Gold fell on Thursday and closed the first three months of 2013 with a quarterly decline of nearly 5 percent as fears about Europe waned, Wall Street surged and strong U.S. economic data cut demand for a safe haven.” (Reuters, March 28, 2013)

- Betting against US stock market after S&P downgrade of US credit

Interestingly, since the downgrade on Friday, August 2, 2011, the S&P 500 index rose 25%. Worrying about the fiscal cliff and other Congress-related issues did not impact the market.

- Assuming continued weakness in US dollar depreciation

Since May 2011, the dollar theme has mildly strengthened. And these days, the euro weakness is picking up pace versus the dollar. Shaky European conditions may even drive further demand for US dollars.

All three macro trends can reverse suddenly, which is not a surprise. Limited ideas in the marketplace are too challenging for passive investors. Yet, the lessons learned from these assumptions are to prepare for trend-shifts, and keeping an open mind is vital.

Constraining realities

Willing fully or not, risk managers had to rotate to equities to participate in the momentum. Also, the rush for safe assets quieted down, although the supply of safe assets is limited, as well. Over the years, buying insurance (hedges for volatility) and deciphering safe assets has consumed most professional time. There are gray areas in terms of earnings sustainability, level of participation and shift in the Fed’s language toward an end game for easing. The week ahead, with Chinese PMI, US labor numbers and digestion of first-quarter returns, should produce some responses to question the known status quo.


Article Quotes:

“Last year marked the most severe and extensive drought in at least 25 years, according to the U.S. Department of Agriculture. It was also the hottest year on record for the United States. Nearly 80 percent of farmland experienced drought in 2012, with more than 2,000 counties designated disaster areas. By September 2012, 50 percent of the crops being harvested were in poor or very poor condition. Last year's damaged harvest is expected to raise food prices by as much as 4 percent in 2013, particularly products like beef, which suffered from a lack of available cattle feed and viable foraging options. Overall, the 2012 drought cost an estimated $150 billion in damage, as well as an estimated 0.5 to 1 percent drop in the U.S. gross domestic product. One industry looking closely, albeit cautiously, at the early-season drought maps is the insurance business. Farmers have filed for a record $14.2 billion in crop insurance so far to cover losses from last year, with the federal government and private companies splitting the bill.” (Inside Climate News, March 28, 2013)

“Oil production in the Lone Star State has more than doubled in only three years, from 1.10 million bpd in January 2010 to 2.26 million bpd in January 2013, which has to be one of the most significant increases in oil output ever recorded in the history of the US over such a short period. The exponential increase in Texas oil output over just the last three years has completely reversed the previous 23-year decline in the state’s oil production that took place from 1986 to 2009. Just a little more than three years ago, Texas was producing less than 20% of America’s domestic oil. The recent gusher of unconventional oil being produced in the Eagle Ford Shale area of Texas, thanks to breakthrough drilling technologies, has pushed the Lone Star State’s share of domestic crude oil above 30% in each of the last ten months, and up to 32.2% in January. Further, Texas oil output in January at an average of 2.26 million bpd was 25.7% greater than the US oil imports that month from all of the Persian Gulf countries (Saudi Arabia, Iraq, Kuwait and Qatar) combined at 1.79 million bpd. In fact, Texas oil output has exceeded Persian Gulf imports in each of the last five months starting in September, and that has never happened before in the history of the monthly EIA data for Persian Gulf imports back to January 1993.” (American Enterprise Institute March 28, 2013)




Levels: (Prices as of close March 31, 2013)

S&P 500 Index [1556.89] – Revisiting the highs of 2007, erasing the post-crisis losses. A jump of 135% since the extreme lows of March 6, 2009 (666.79).

Crude (Spot) [$97.23] – An explosive run in March, leading to a jump from $89 to $97. Interestingly, we’re revisiting a resistance point around $98. Chart observers are eager to see a break above those levels.

Gold [$1613.75] – Neutral/bottoming pattern remains in place. Trading below its 50- and 200-day moving averages, as buyer fatigue appears to resurface.

DXY – US Dollar Index [83.21] – Steady strength, especially in the last two months. The next upside hurdle is above 84, where the dollar peaked in July 2012.

US 10 Year Treasury Yields [1.84%] – Short-term decline in yields continues after peaking above 2%. Most await a break below 1.80% to confirm this trend. For now, 1.80-2% appears to be the normal range.




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