Market Outlook | April 29, 2013

“To repeat what others have said, requires education; to challenge it, requires brains.” (Mary Pettibone Poole)

The back-and-forth uproar

A short-term driven rally in gold and commodities awoke the previously deflated gold bugs, while enticing action by the bargain-hunting investors, who seized the trading opportunity. Similarly, sellers of commodities dried up and took some profit after a multi-month decline. Gold closed the week up 3.31%, which has the investment community asking: Now what? Again, for calm and prudent observers, evidence continues to suggest that gold and silver are more of a trading vehicle than an investment. The sudden 10% drop in gold two weeks ago went beyond fundamentals; thus, we shouldn't act puzzled by the gold recovery in the past week.Central bank buying does not translate to increased price, either.

“Central banks are the biggest losers, with about $560 billion of value erased since gold reached a record $1,921.15 an ounce in September 2011. The metal was already in the eighth year of its longest bull market since the end of World War I when reserves started expanding again in 2008. They were also buying in 1980 when bullion peaked at the equivalent of $2,400 in today’s money, and selling in 1999 as prices slumped to a 20-year low.” (Bloomberg, April 25, 2013)

The econ puzzle

There is a disconnect between markets and the economy, which is worth noting. First, labor numbers for March and the first-quarter GDP confirmed that the consensus analyst estimate is much higher than reality. Yet, the markets (bonds and stocks) are more concerned about Quantitative Easing (QE) implications. Secondly, QE has proven not to be quite the “mega” job creator, nor the driver of a GDP boost. Of course, slowing government spending (defense spending -11.5%) fails to boost the real economy. Plus, business investments fell last quarter, contributing to a softer GDP. Both reveal that a robust economy cannot only rely on consumer spending. Although the level of growth is debatable, the trend is not clear enough to make a judgment. After all, there is upside left in this US recovery, and therefore, not showing negative growth is a reason to remain upbeat.

By now, those benefiting from QE are asset holders of equities or some homebuyers given the ability to borrow cheaply. How does QE help the real economy with confidence restoration? This is a legitimate question that’s continuously asked. The answer thus far is not appeasing. Interestingly, the labor numbers for last month come out at the end of this week and will confirm if labor (economic) weakness is slowing.

The convergence of the real economy and stock markets comes into to play when the Fed begins to message its outlook and interest rate plan. Of course, in those discussions to raise or lower rates, the justification lies in economic conditions. However, some can argue the typical period of disconnect between markets and the economy is more of an art than substance. The dent in the US 10 year treasuries from 2.00% to 1.66%, merely showcases that there are expectations of further easing, as the economy has recently disappointed. Similarly, growth expectations are not as cheerful as before.

Not quite simple

One undertone these days is to dislike the stock market and seek shelter in gold. This is a sentiment that’s heard often in conversations, writings and even some thought-out investment plans. Perhaps, being desperate for yield makes investing not quite easy, as some choose to blame the Federal Reserve's policies. For a few years, piling into the stock market was the easy next move or preferred choice for asset managers. Yet, the shift into stocks is at times proclaimed as an "artificial" run. The stock market still functions by rewarding good companies and punishing poorly managed ones. Lose or win money, one needs to grasp too many moving parts and risks in this pure game of speculation. Tons of conspiracy-driven thoughts float out there as part of the noise. Having a defeatist response to the speculative environment is not quite logical and is misleading. In other words, the fundamental dynamic has not vanished, even if folks keep thinking markets “shoot to the moon”; due to Fed policy, some stocks still get punished.

When the S&P 500 index is near all-time highs, and earning uncertainty resurfaces, then it is normal to have jittery thoughts. Somehow, volatility is still calm, and Fed/government policies remain intact. Eurozone growth does not exist, but its demise was not as bad as expected. The status quo has barely changed as the next turbulence is desperately awaited.

Article Quotes:

“There are no calls for celebration, no desire to relax in the corridors of Brussels but some officials believe the euro zone has turned a corner, sharpening the focus on longer-term reforms and structures. Despite a messy bailout of Cyprus, markets are calm, Ireland's rescue program is on track and Greece and Portugal, while still in recession, hope for a slow recovery next year. Slovenia's banks are a concern, but one that policymakers are confident they can deal with. And although Malta's banking system is vast compared with its economy, it is not structured in the same way as in Cyprus. The same goes for Luxembourg. … Borrowing costs in Ireland, where yields on the government's 10-year bonds shot above 8 percent before the country was bailed out in November 2011, are now down to 3.8 percent. Benchmark yields in Italy and Spain are also far below their peaks, indicating a much lower level of perceived risk by investors, despite the continued political uncertainty in Italy and the possibility that Spain may need further support. Another sign of confidence is that banks in southern Europe rely less on the ECB for funding, according to central bank data. That trend continued after the Cyprus bailout, signaling that they are finding it easier to raise funding normally.” (Reuters April 26, 2013).

“Military expenditures reflect states' threat perceptions, and reveal how they are planning for both immediate and long-term contingencies. In times of external threat, military priorities take precedence over domestic ones, like social and economic services; in times of relative peace, countries devote a greater share of their economy to domestic priorities. The best way to measure military expenditures is as a percentage of total GDP, because this reflects how much a country could potentially spend. In 1988, as the Cold War was winding down, the six major Southeast Asian states spent an average of almost 3.5 percent of GDP on military expenditures. (All data comes from the Stockholm International Peace Research Institute, the most dependable source for worldwide military data, which began publishing its global military figures in 1988.) By 2012, that number had dropped to less than 2 percent of GDP. Vietnam, despite current tensions with China over maritime issues, has reduced its military expenditures most dramatically, to 2.4 percent in 2012, down from 7.1 percent of GDP in 1988. Back then, an impoverished China was actively involved with insurgencies in Burma and Thailand; and U.S.-Soviet competition threatened the stability of the entire region. Singapore, Indonesia, and Malaysia had only recently settled border disputes, while Vietnam was still recovering from wars it fought against the United States and China. Now, only North Korea and Taiwan fear for their survival -- almost every other state is more stable and prosperous than it has ever been. (Taiwan's military spending dropped from 5.3 of GDP in 1988 to 2.3 percent in 2012; there are no good statistics on North Korean military spending.)” (Foreign Policy, April 25, 2013).

Levels: (Prices as of close April 26, 2013)

S&P 500 Index [1582.24] – Pausing between 1540-1580, opening up the debate between bulls and bears.

Crude (Spot) [$93.0] – Staying above $96 has proved difficult, showing a lack of buy demand. After a 12% drop from April 1 to April 18, crude is stabilizing near the 50-day moving average. It remains in a fragile state.

Gold [$1393.75] – Despite the near-term recovery, gold is removed from its 50-day moving average of $1642.66. To put it in perspective, the decline from October 2012 to this April’s lows was nearly 23%. Only early signs of recouping the severe loss.

DXY – US Dollar Index [82.71] – Up nearly 16% since the lows of May 2011. There are signs of stability for a currency that’s been depreciating for more than three decades.

US 10 Year Treasury Yields [1.66%] – Since March 2013, interest rates have fallen at a fast pace. The fall below 1.70% marks a new concern of further decline in yields, given talks of further easing.



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