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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Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | December 17, 2012

“Where there is an open mind there will always be a frontier.” (Charles F. Kettering, 1876-1958)

Grasping the landscape

Moderate optimism is being felt, and rightfully so, after a three-year re-awakening of a bull market. Anticipation of improvement in housing and less panic about Europe fueled price movement of risky assets. Central banks stuck to their grand plan of maintaining a low rate policy as an ongoing stimulus effort. Importantly, minimizing the elements for downside surprises was essential in taming volatility.

As stated in many ways and forms, betting on low volatility and strong European market performance would not have been viewed as a winning strategy (to put it politely) by most last year. The frenzied thoughts and chatter from more than a year ago were not overly influential as US markets stabilized. Now, it is back to square one in reevaluating gains and assessing whether piling onto this rally is still warranted. Gloom-and-doomers have not evaporated in making noise and believers have quietly increased their stake, so gauging consensus is more of an enigma today than a few years back. Confidence rebuilding is a tricky process to measure. Yet, fund managers do not have that luxury to hide from performance. After all, the financial scoreboard has the final say and with that in mind, we are entering the reflection mode in mapping out valuable trends.

The scramble to grasp why global markets are up has been overly discussed as usual at year-end. Meanwhile, pondering reasons for possible decline in asset prices is worth observing while selectively extracting meaningful themes. And keeping an open mind for surprises typically is rewarding even in this short-term-oriented marketplace.

Revisiting: The known worrisome topics

Concerns looming around a potential peak or correction in US markets circle around the following:

1) Difficult to sustain corporate earnings which have reached historic highs in recent years.

2) Expiration and replacement of Operation Twist. Consequences of Federal Reserve’s stimulus efforts as time passes.

3) Markets reaching extended or exhausted levels, given the broad-base rally over the past three years.

4) Government deliberation: policy makers’ perceived mismanagement, leading to additional uncertainty in Europe and US.

5) Volatility rising from relatively low levels driven by shifts in sentiments favoring "risk-aversion."

6) Sell-offs in key commodities following a multi-year run, causing a drag in other risky assets.

First, crude inventories continue to rise, causing a negative impact on pricing. "U.S. average daily output will climb 14 percent this year, the most in six decades, according to the Energy Department, as Anadarko Petroleum Corp. and Chesapeake Energy Corp. exploit new deposits from North Dakota to Texas.” (Bloomberg, December 13, 2012)

Secondly, gold prices have not surpassed all-time highs and appear to have lost some luster versus pervious years. Goldbugs overall may not be too pleased with actual results, given the lofty expectations.

Continuing the run

Despite the points above, there are forces to support the ongoing bull market. Similarly, the natural worries do not translate into fear-like behavior overnight and to claim a bubble-like collapse is due loses merit unless there are drastic fundamental changes. Of course, during a tense period after a bank crisis and flash crash, there is a growing audience that has a wide appetite for calamity.

Favorable points supporting the current upside run include:

1. Speculators expressing a negative market view remain elevated via "short interest" in the S&P 500 index. The indicator is near summer highs, suggesting sentiment is not quite overly positive. Therefore, worries of a sudden sharp sell-off should not feared like 2000 and 2008.

2. Economic recovery persists related to housing and labor as trends build on positive results. A business cycle that’s bottoming and geared to convince doubters on sustainability.

3. Limited investment options in a low-yield environment leaves room for further upside in select liquid assets. Unless there are major shifts in currencies and interest rates, the lack of alternatives theme remains in force.

4. The interconnected global marketplace is gearing for another run for a synchronized upside movement from recovering China and other emerging markets. This theme has persisted over the last few weeks, in which the Emerging Market Index (EEM) is up 9% in the last four weeks.

Between now and year-end, capturing new developing themes may not be highly visible. Plus, the worrisome items do not disappear and will be pondered for most of 2013, as well. Anticipation for a trend shift grows daily, but the existing trend is not broken easily. Thus, the challenge for trades is to balance both views selectively. This is a daunting task indeed.

Article Quotes:

“Apartment prices in Manhattan have increased substantially relative to rents over the past seventeen years, raising concern about the sustainability of current prices. Although they have retreated somewhat since 2008, price-rent ratios in the borough are more than twice as high as they were in the mid-1990s. Part of this increase can be explained by lower mortgage rates, which tend to lift sales prices relative to rents by reducing financing costs, and by lower property taxes. Moreover, price-rent ratios appear to have been unusually low in the mid-1990s. Still, current rent levels, mortgage rates, and property tax rates make it difficult to account for the high prices of Manhattan co-ops and condominiums in 2011 without assuming an expected future price appreciation of at least 4 percent per year. That figure could be even higher if transaction costs and risk premiums are included. While the analysis here covers the period through 2011, reports of accelerating rents but stable apartment prices in 2012 suggest that people may have tempered their expectations for price appreciation.” (The Federal Reserve Bank of New York, November 9, 2012).

“During a difficult summer, the leadership’s understated response to China’s economic woes looked like an under-reaction. But the economy has gathered momentum in recent months. Industrial production grew by over 10% in the 12 months to November, its first double-digit growth since March. … The recovery is also visible in electricity output (up by 7.9% in the same period). This had failed to grow in the 12 months to June, inspiring fears that the economy was much weaker than the official growth figures suggest. But two related problems still weigh on China’s manufacturers. The first is excess capacity in industries such as steel, cement and carmaking. The second is excess inventory. In the first half of the year unsold goods piled up as firms failed to find customers for their wares. Since then they have slowed production and reduced their stockpiles..” (The Economist, December 15, 2012).

Levels:

S&P 500 Index [1413.58] – Closed right near the 50-day moving average. Once again, this suggests the strength remains intact, despite growing odds of a near-term pause.

Crude [$85.93] – Since mid-October, crude has failed to surpass $90. Many of the price swings continue to occur between $85-95. Interestingly, the annual highs of $110 seem too far and revisiting July lows of $77.28 would require a major shift. Understandably, followers of crude prices are on edge for the next directional movement.

Gold [$1696.25] – For more than 15 months, gold has failed to surpass $1900 on three occasions. Interestingly, in the last three months, gold has also not significantly declined below $1700. The much-discussed hype and enthusiasm may not match price actions.

DXY – US Dollar Index [80.15] – The last three months showcase some signs of a strengthening dollar. This reinforces the bottoming process that began in May 2011.

US 10 Year Treasury Yields [1.70%] – Digging out of historic lows for several months and beginning to show moderately rising yields. Breaking above 1.85% could spark a noteworthy trend.

Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | December 10, 2012

“Ninety-nine percent of the failures come from people who have the habit of making excuses.” George Washington Carver (1864-1943)

Mixed labor results combined with a slightly convincing housing recovery linger in this recovery process. Another week has passed where US labor numbers can be interpreted as not so ugly. Others might conclude the economic health results were not that amazing, either, with the truth residing somewhere in between. Meanwhile, the discussion of market meltdown or complete collapse appears less viable despite occasional fear-driven moments, while the positively trending market is slightly more visible and the bullish stock market run is now more acknowledged than denied by casual observers. Those who made excuses for not participating in the stock market are now realizing the S&P 500 Index is up more than 12% in 2012.

Like several months before, the investor’s search for clarity centers around the following:

1. Assessing trends and hints from economic data
2. Grasping impact of low interest rates
3. Speculating on big-picture sentiment and catalysts

 Economic recovery

The trick of digesting data creates a danger for those who lump various data points into one headline story. Even the nature of stimulus impact on housing and labor is mysterious, for the most part. As the end of Operation Twist looms around year-end, there are brewing questions on Federal Reserve policy. Whether Quantitative Easing 3 was “overkill” or much needed is to be determined – a macro call of high significance. In fact, the extension of stimulus efforts from the Federal Reserve is not off the table, either. All that said, long-term investors who are looking to deploy capital for three to five years face a quandary given the shaky grasp of the current business cycle.

Digging out of lows

Global interest rates remain around historic lows. The pattern of trading at or around all-time lows has become a norm in this era. In fact, the contemplation of negative yields is not a bizarre thought these days, as hinted by the European Central Bank. Plus, the same story is evident in 30-year mortgages, which remained near all-time lows last week by dropping below 3.40%. Interestingly, many have attempted to call the rates in the past few years and have not been accurate. Thus, this mega global coordinated effort is not bound to change in one quarter, but any clue will be overly dissected.

Forecasting sentiment

Favoring gold against owning other instruments, including cash, has its appeal mainly for those seeking diversification. Yet, there is more risk to gold that’s loudly publicized besides the directional debates. Perhaps, this historical reference is worth noting for commodity risk assessors: “In 1933 President Roosevelt issued Executive Order 6102, prohibiting the private holding of gold and requiring U.S. citizens to turn over their gold bullion or face a $10,000 fine (equivalent around $170,000 today) or 10 years imprisonment. In response, opportunistic coin dealers encourage investors to buy expensive “numismatic” or “collectible” coins, taking advantage of an exemption in the 1933 order which protected these assets from government seizure.” (Naked Capitalism, Satyajit Das, December 6, 2012).

Collectively, soft and hard commodities have showcased underperformance for more than a year. Specifically, the CRB – or commodity index – has declined by nearly 20% since peaking in early May 2011. The commodity optimist sees further price increases as part of the ongoing decade-long run, while others suggest that further easing from risk-aversion may make the gold story less appealing. Right now, both views are deadlocked without any trend shift to make a splash.

Speculators may find it worthwhile to guess investors’ response toward risk in upcoming months. The script of risk-aversion is typically associated with increasing US dollar demand, less trust in Federal Reserve policy and ongoing credit downgrades in European nations. This bearish script is wearing down, along with upside expectations that are coming down. However, unknown risks associated with tax implications and pending regulatory changes continue to cause a natural pause. Not to mention overly sensationalized fiscal worries that are lumped into many forward-looking dialogue.

The desperate search for growth is a common theme that stretches from the GDP to corporate earnings and emerging markets growth. Revival of the Chinese market in recent weeks is fulfilling the demand of risky asset investors. Other developing countries like Turkey and Mexico offer renewed momentum for those searching for a sustainable but profitable run. Similarly, in recent weeks, the Chinese recovery is showing positive signs despite skepticism. This is demonstrated by a 20% run in the Chinese index since September 5, 2012. Perhaps, the investor’s dilemma of lack of growth combined with limited options will force more risk-taking than imagined.

Article Quotes:

“As evidenced by the tire case, China often does retaliate (China also recently initiated investigations on US polysilicon in retaliation for the punitive US duties on Chinese solar cells). In fact, the US may stand to lose more in such tit-for-tat exchanges because most of China's exports have little added value. For example, Chinese inputs account for less than 2% of the value of each iPhone imported to the US from China, while Apple's profits amount to 60% of that value. Sadly, the misguided US effort to ‘get tough on China’ does not stop with trade but extends to investment. Countries with a substantial trade surplus like China tend to invest heavily overseas, and such investments create jobs in other countries. However, the US government has been cool towards Chinese investment. Unlike companies from most other countries, Chinese companies wishing to invest in the US are often singled out for a heightened national security review by the federal inter-agency Committee on Foreign Investment in the United States (CFIUS). The extent of US hostility towards China in trade and investment is puzzling given the co-dependence of the two economies. The benefit to the US from its economic relationship with China is real – and contrary to what many claim, such benefit does not come at the cost of US jobs. Chinese investment has an even greater potential for creating US jobs. A cash-flush China would be happy to invest in the United States if it is allowed to do so, and many Chinese companies would be happy to comply with whatever security requirements the US government has in store (if it tells them what these are).” (Asian Times, December 8, 2012)


“Private equity firms and hedge funds have stepped into the morass that is the US housing market by scooping up single-family homes at discounted prices and renting them out to disenfranchised masses. Their goal is to generate returns from a combination of rental income and appreciation in housing prices. Silver Bay Realty Trust, a joint venture of RMBS specialist Two Harbors Investment with private-capital management firms Pine River Capital Management and Provident Real Estate Advisors, is seeking to put a public face on the booming trend through its forthcoming initial public offering. Credit Suisse, Bank of America Merrill Lynch and JP Morgan plan to price 13.25m shares at an indicative price of US$18–$20 each on December 13. The vehicle, which is seeking to be structured as a REIT, is initially targeting a net annual yield of 6%–8% after factoring in vacancies and operating costs. Higher returns are expected in future years as occupancies rise and the value of owned homes appreciates. Silver Bay gets its revenue from an underlying portfolio of 3,100 homes. The vehicle is structured as an up-REIT, whereby the joint-venture partners will control a 64% equity stake and public shareholders the remainder.” (International Financing Review, December 8, 2012)

Levels:

S&P 500 Index [1418.07] – New challenges facing the current momentum as the index nears 1420.

Crude [$85.93] – Ongoing pause continues following a peak since $100 in mid September. So far, resilience is witnessed at $85. At same time, buyers’ appetite above $90 is less visible.

Gold [$1701.50] – For the second time in a month, attempting to climb above $1700. Enthusiasm of the commodity anticipates a rally, while recent history shows that Quantitative Easing 3 has yet to have a big influence on pricing.

DXY – US Dollar Index [80.15] – No major decline since the fall. Yet, the catalyst for a noteworthy upside move remains a mystery at this point.

US 10 Year Treasury Yields [1.61%] – Stability in place between 1.55-1.82% which is a theme that continues to repeat. A step back reinforces an era of historic lows that continues to resurface.

Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | December 3, 2012

“Blame is safer than praise” Ralph Waldo Emerson (1803-1882)

Familiar banter

It wasn't long ago that the phrase “manufactured news” was used by some during the debt ceiling crisis. Now, the much and overly discussed “fiscal cliff” is reaching a tiresome level of over-hyped discussion. It’s debatable whether the actual substance is overblown or the fear-mongering produces political posturing and indirect market confusion. Nonetheless, unlike the summer of 2011, when a lack of government cooperation led to increased volatility and market turmoil, this time around there is a sea of calm in participants’ reactions. Interestingly, panic-like mode is not easily generated and spikes in volatility have yet to materialize. At the same time, there is no comforting sign of safety in an already low-rate environment with limited investment themes. In the near-term, the political debate may heat up on the surface, but the US’s relative edge cannot be easily dismissed from an investor’s perspective.

Clarity search

There is a rising equity market climate as the S&P 500 index maintains its strength above 1400. Ongoing bullish residues from the recent recovery are visible for chart observers and a few economic trend followers. Finding tangible reasons for further bullish stability is harder after the year-over-year appreciations. In addition, sustaining attractive earnings is an uphill climb and the quantitative-easing-as-stimulus tactic is wearing down as a long-term solution. So the puzzled crowd awaits the next substantive matter, especially in housing strength, GDP growth and key corporate fundamentals, particularly those related to consumer trends.

Last week, US GDP numbers for the third quarter were revised higher. However, the headline and one-line summary does not tell the full story: The latest GDI [Gross Domestic Income] data tell a sobering story. In the three months through September, GDI grew at an annualized, inflation-adjusted rate of only 1.7 percent, compared with 2.7 percent for GDP. Historically, when we've seen divergences like this, it has been more common for the GDP estimate to be revised toward the GDI estimate. So future revisions are likely to show that GDP growth was a bit weaker than the current optimistic headlines suggest. (Bloomberg, November 29, 2012). There are signs of improvement, yet the pace of economic strength is sluggish enough to welcome debates and differing interpretations. A fragile consumer environment combined with weak macro backdrop requires time to accelerate investor sentiment. Thus, the labor numbers remain vital along with housing improvement in months ahead. Perhaps, any disappointment in those areas can spark further sensitivity.

Abandoning last decade’s themes remains difficult. Too early to claim the gold run has peaked. Similarly, it’s too premature to conclude that Chinese investments are not attractive at these levels.  Clues on emerging market slowdown have persisted throughout the year. Recent rejuvenation of the Chinese recovery is gaining some traction but is met with a dose of skepticism. Equally, the slowdown in the BRIC nations is too evident across various indicators: “The $1.69 billion initial public offering for Moscow-based wireless telecommunications provider, MegaFon, brings the volume of IPOs from BRIC issuers to $21.5 billion, a 60% decline compared to last year at this time and the slowest year-to-date period for BRIC IPOs since 2003.” (Reuters, Deals intelligence, November 29, 2012).

Conflicting thoughts

The recovery process since 2009 has produced a move away from financial collapse and major recession and reemphasized relative US strength. This has created a dilemma for those taking a directional view. Fund managers are forced to take risks in emerging markets and revisit the Chinese economic strength, appealing trends in Mexico or cheap assets in most of Europe. US investors are diving deeper into mortgage-related and higher-risk assets, given the low-rate environment. At the same time, issuance of corporate bonds escalates and enthusiasm in equity markets wanes, but both trends can suddenly shift. The inherent conflicts in major trends are not easy and bound to challenge forecasters.

Article Quotes:

“Today’s modern household appliances are not only cheaper than ever before, they are the most energy-efficient appliances in history, resulting in additional savings for consumers through lower operating costs. The average dishwasher today is not only more than twice as energy-efficient as a comparable 1981 model, but its cost today is only about 1/3 the price of the 1981 dishwasher, measured in what is ultimately most important: our time. Put those two factors together, and the average American’s dishwasher today is about six times better than the dishwasher of thirty years ago. Stated differently, if dishwashers hadn’t fallen in price by a factor of three since 1981, and if they hadn’t improved in energy efficiency by a factor of more than two, Americans today might be paying more than $1,000 for a basic dishwasher instead of $300, and it would take more than twice as much energy to operate. Likewise, we would expect comparable large decreases in the amount of work time required to buy the other four appliances, along with significant reductions in operating costs due to their increased energy efficiency. … Today’s affordable and energy-efficient household appliances are part of the ‘miracle of manufacturing,’ which continues to deliver cheaper and better goods to American consumers year after year, which translates into a higher standard of living for all Americans, especially for lower and middle-income households.” (The American Enterprise Institute, December 1, 2012)

“The physical environment is in pretty good shape. It is cleaner in developed countries than it was in those same countries when they were developing, and the same potential exists in countries that are still developing today. While some resources have been depleted so that the easiest-to-obtain supplies are gone and what remains is costly and difficult to obtain (oil being the most prominent example), that very cost makes the discovery and development of substitutes possible, necessary, and likely. We have barely breached the surface of nuclear, solar, geothermal, wind, and tidal power. Recent fossil fuel discoveries have been a pleasant and unforeseen surprise (though we’d be foolish to rely on more such good fortune). People have been finding cheaper substitutes for existing resources since the beginning of human history, and there is no sign that we will stop any time soon. We have heard concerns about the permanent slowing or stopping of global growth after every depression or severe recession. In the 1890s, the idea was circulated that everything worth inventing had already been invented. In the 1930s, it was popular to say that capitalism had created the mechanism of its own destruction. In the 1970s, concerns focused on foreign competition and resource constraints, and some people forecast mass starvation. Today’s concerns are no different in principle, and they are no more realistic.” (Advisors Perspective, Laurence B. Siegel, November 27, 2012)

Levels:

S&P 500 Index [1416.18] – Trading between the 50- and 200-day moving averages. Buyers’ interest around 1380 showcases ongoing investor willingness for US equity exposure.

Crude [$88.91] – Calmness remains, as wide price swings are not visible. The range between $85-90 is becoming too familiar.

Gold [$1726.00] – Soaring above $1750 or decreasing below $1700 creates equal suspense. There is a lack of trend clarity for now, despite overall buyers’ demand.

DXY – US Dollar Index [80.15] – The 200- and 50-day moving averages stand at 80. This reinforces the lack of movement in several months.

US 10 Year Treasury Yields [1.61%] – A drop below 1.60% has been very short-lived. The most noticeable period of very low rates took place this summer. No evidence of trend reversal from this multi-year rate drop.

Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | November 26, 2012

“The wisest mind has something yet to learn.” (George Santayana 1863 - 1952)

Familiar unease

For about three years, common macro-related fears persisted in various financial market conversations. Those worrisome topics stretched from slowing corporate earnings, to a complex cleanup of the European crisis, to decelerating emerging markets. Today, no clarity or certainly exits on these big-picture topics; thus, participants are left to balance their views between collapse and, hopefully, rally. Finding the middle ground is less thrilling, more nuance-oriented and most likely closer to the truth than a simple statistical summary. Plus, the interconnected themes, which are worth tracking for observers and participants, can easily shape and form a consensus perception. Yet, the fears of fundamental and macro concerns are exhausted and dramatic shifts are short-lived.

The last two months demonstrated the suspense of all key macro events and a breather among risk-takers. Yet, risk-takers do not sit on the sidelines long enough, as that would go against human nature. Eventually, money has to be invested somewhere. Betting on upside surprises is still more intriguing than betting on the collapse of known macro issues. As a start, GDP is expected to be revised higher in the US, supporting the building argument of an improving economy. Eurozone concerns may me overstated in some cases, as the German economy is showing signs of recovery and is not as bad as advertised. After all, the German DAX Index is up nearly 24% this year as the leading European economy. Certainly, the thought of Eurozone collapse may linger in headlines, but actual results are not clear-cut. Finally, overall market volatility remains tamed as the low interest rate policy remains in place. This suggests that markets may turn out more stable than the many conventional stories told.

Revisiting old ideas

Five years ago, the themes of housing and emerging markets were favored among fund managers. In both cases the bubble was forming before its eventual burst in 2008. Now, the questions of lessons learned are deliberated by historians, but forward-thinking observers are noticing that history is digested faster than imagined. While most concluded that risk in housing is not fruitful or plausible, the recent trends suggest otherwise on a broad level. The housing recovery in this new era (post-2008) makes a tangible and strong argument for revival. The Federal Reserve Chairman addressed the following point:
“Recently, the housing market has shown some clear signs of improvement, as home sales, prices, and construction have all moved up since early this year. These developments are encouraging, and it seems likely that, on net, residential investment will be a source of economic growth and new jobs over the next couple of years.” (Ben Bernanke, New York Economic Club, November 20, 2012). Of course, sustaining this housing recovery is an uphill battle, which is addressed by economists and analysts alike, especially since the bounce was somewhat inevitable from depressed levels. Nonetheless, momentum is powerful, especially in a world with limited ideas with a compelling growth story. Investors in homebuilders (XHB – Homebuilders Index) have realized more than a 100% gain in the past year. The recent stock market pause enables investors to re-assess conviction levels in housing-related strength.

The second controversial theme from last decade relates to China. This is a tricky theme that has seen explosive development, but for all the growth talk, the Chinese index (FXI) peaked in 2007, way before the noticeable economic pause that’s been debated for the majority of 2012. For a while, the hard landing was greatly feared and over-discussed. Recent data points to a softer landing and increasing investor demand. “They [Investors] have pumped nearly $4 billion into Chinese equity funds in the past two months alone, trying to get in early on what they hope will be a sustained rally.” (Reuters, November 25, 2012). Increasing investor demand makes sense since the Chinese markets are relatively cheap and the momentum from last decade has yet to evaporate. Nonetheless, popularity is no guarantee of price appreciation – a point for speculators to reassess.

Down the stretch

The S&P 500 index is up 12% on the year, showcasing that despite outflow in equity markets, finding returns is attractive. Fragile conditions in the credit and banking sectors persist, and the system at times feels clogged. In recent months, investors have realized the attractive risk-reward in US financial services even beyond housing. According to Factset: “two of the stocks that received the most interest [from the largest 50 hedge funds] during the quarter included AIG and Capital One Financial Corp.” (November 19, 2012). There is momentum that favors a continuation of a collective rise in key asset prices for now. Of course, companies are lowering earning guidance and sustaining the recent run is not an easy task when skepticism keeps building. Nonetheless, the months ahead will provide more clues while potential short-lived shocks can provide evidence on investors’ resilience.

Article Quotes:

“According to projections by HSBC, in six years’ time the United States will be more dependent on imports from Mexico than from any other country. Soon ‘Hecho en México’ will become more familiar to Americans than “Made in China.”… Mexican businesses have been fighting with one hand tied behind their backs, thanks to a chronic credit drought. Lending is equivalent to 26% of GDP, compared with 61% in Brazil and 71% in Chile. The drought started with the “tequila crisis” of 1994, when a currency devaluation triggered the collapse of the country’s loosely regulated banking system. Banks spent the best part of a decade dealing with their dodgy legacy assets and were nervous about making new loans. Mexico has been one of the world’s ten biggest oil producers. The revenues of Pemex, the state-run oil and gas monopoly, provide about a third of the government’s income.” (The Economist, November 24, 2012)

“Britain's biggest pension funds have delivered deplorable performance over the past decade. New research, seen exclusively by The Telegraph, shows that 14 of the 20 biggest actively managed pension funds delivered below-average returns over this period. In total more than £62bn of retirement savings is invested in these funds. Just three of the UK's largest funds (managed by Standard Life, Zurich and Windsor Life) delivered a decent return for investors, while another three – which have a further £21.5bn invested in them – beat the average fund in their sector only by a whisker. The underperforming pensions are managed by some of Britain's largest insurers and banks, including Aviva, Scottish Widows, Lloyds, Scottish Equitable, Friends Life and Barclays. … Philippa Gee, who runs her own advisory firm, said many people pointed out that passive tracker funds were "guaranteed to underperform" because they simply returned what the market did, minus charges. Philppa stated:  ‘Fund managers have no encouragement to outperform as this would involve taking a high risk, which may not fit comfortably with the investment style of the fund in question, and they have no push from investors to perform, as the money will stay there whatever the return delivered.’ This is because the banks, salesmen and advisers who sold these pensions in the first place are, on the whole, no longer reviewing them – although some will still be collecting an annual commission payment on the back of the sale.” (The Telegraph, November 25, 2012).

Levels:

S&P 500 Index [1409.15] – Climbing back above its 200-day moving average. Attempting to stabilize around 1400.

Crude [$88.28] – Narrow range forming between $85-89 in recent trading days. Like most risky assets, crude is overcoming a multi-week decline that began in mid-September 2012.

Gold [$1734.50] – Heavy resistance at $1800 points to a noteworthy trend that catches the eyes of gold aficionados.

DXY – US Dollar Index [80.19] – Another short-lived upside move. A shift back to risky assets is most likely to cause further dollar weakness.

US 10 Year Treasury Yields [1.68%] – Since the announcement of QE3, yields are trading between 1.60-1.80% – nearly in line with their 50-day moving average of 1.70%.

http://markettakers.blogspot.com

Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | November 19, 2012

“Most quarrels amplify a misunderstanding.” (Andre Gide 1869-1951)

Collective pause

Digesting the market slowdown since autumn stirs mixed reactions and a desperate aim for clarity, as well. The catalysts of global stock market sell-offs range from various triggers such as weakness in corporate earnings, the slowing pace of a three-year bull market and some blurry responses to quantitative easing III. The combination of these factors alone would have been enough to cause a pause way before election results and the over-obsessive focus on “fiscal cliff” matters. Taking a look at the macro picture in the context of the business cycles is the puzzle that faces participants. At the same time, economic recovery, from a pickup in housing to positive signs in the GDP, requires further confirmation.

Gauging moods

Interestingly, a peak in risky assets also accompanies the stock market sell-off. The mid-September period triggered a peak in crude prices, decline in US Treasury yields and a mild strength in the US dollar. Perhaps it’s not a stretch to state that September 14, 2012 marked a vital macroeconomic day around the announcement of open-ended quantitative easing. Surely, beyond the political banter and never-ending European concerns, the Federal Reserve’s stimulus efforts remain controversial. Overall consensus expects this low-rate environment to continue for the next two to four years (according to a recent CFA poll). It remains unclear on the end of the low-rate policy; there is a debate that’s brewing within the Federal Reserve. A myriad of speculations will linger, but the stimulus efforts are viewed with increasing skepticism, especially by larger money managers. Perhaps, the Federal Reserve’s implementation of quantitative easing III may be too early to judge for now.

Growth search

Despite the negative climate generated by the self-fulfilling risk-aversion, the volatility index remains steady thus far. At least, the volatility index has not witnessed a dramatic spike that signals an all-out turmoil. Sure, the consecutive down days in equity markets are known easily to cause an emotional response, but that’s to be expected. Yet, the investor demand for growth themes and/or higher yielding returns remains in place regardless of accumulating noise that surrounds macro flux. The shift away from risky assets has been visible for several weeks, but there is no clarity on its longer-term impact. Interestingly, the less-than-stellar earnings have one positive angle for those desperately seeking good news. According to Bespoke Investment Group: “For the first time in three quarters, more than 60% of companies beat earnings estimates. This season, 60.1% of the 2,158 US companies that reported beat consensus analyst EPS estimates. While not great, at least it's a quarter-over-quarter increase.” (November 16, 2012).

In looking ahead to the first quarter of 2013, investors appear to shift their hopes for an emerging market recovery that can restore collective growth rates to desired levels. After all, the developing market is known to provide relative safety (at lower yields) rather than impressive expected growth rates in developing markets. However, resuming last decade’s trend of extraordinary growth is challenging for China and other nations. Similarly, the relative strength of the US market has been an appealing story for a while given the growing momentum. This creates a quarrel for money managers seeking to deploy capital. For now, global markets remain inter-connected, which in turn enhances the difficulty for money managers.

Article Quotes:

“Most of the weakness in state and local governments’ purchases apart from their spending on construction can be traced to a below-average rebound in tax revenues and the need to balance general-fund budgets, but additional pressure came from below-average growth in federal grants. The American Recovery and Reinvestment Act of 2009 (ARRA) authorized an increase in federal grants to states and localities through 2011; those grants helped support state and local purchases for a while, including in the final months of the recession, by raising the amount of assistance to states and localities above what it would have been otherwise. However, the winding down, beginning in 2011, of payments from that increase in federal grants was most likely a drag on the rate of growth of state and local governments’ purchases last year and in the first half of this year. In contrast, state and local governments’ construction spending was probably held back primarily by general budgetary pressures and by tight credit markets early in the recovery, because federal grants for capital projects in the current recovery have been in line with those during previous recoveries since 1959.” (Congressional Budget Office, November 2012).

“As Beijing is continuously prodded to distinguish its policies and engagements from that of the West in Africa, ‘image’ is of paramount importance. For China, keeping a carefully managed image in Africa will be critical to undercutting the arguments of neo-colonialism that are levied by its critics. The policy of non-interference has always been Beijing’s welcome answer to queries about its self-centered policy and economic gains in Africa. As the initial honeymoon is far spent with multitudes of Chinese businesses descending onto African soil, sections of African populations disagree with the image of China as a non-meddling altruistic partner; hence the display of recent anti-Chinese sentiments in places like Zambia and Sudan, and the increasing deportation of Chinese from countries like Angola, Ghana and Nigeria. To deal with these growing pains in Sino-African relations, and chart a different path from that of the West in Africa, Beijing has an inconceivable task of being both a responsible power that commends and chastises as well as a respectful partner that brandishes the policy of ‘no domestic interference.’ In maintaining this precarious balance, non-interference becomes a mirage since an increase in Chinese economic investments might come with temptations to help shape and sustain the requisite business environment needed for these investments to flourish. Finally, Beijing is currently dealing with a new generation of African leadership that is under pressure to embrace liberal democratic ideals and pragmatic economic agenda. Even though persistently described as a façade by the West, non-interference has variedly won the hearts of some African leaders who perceived it as a much-needed break from the quid pro quo relations with the West.” (The Diplomat, October 25, 2012).

Levels:
S&P 500 Index [1359.88] – Remains in a downtrend. Breaking below $1420, which set off further deceleration.

Crude [$86.07] – Bottoming process developing around $86. After a 16% decline, we will get a better idea of the buyers’ conviction and enthusiasm.

Gold [$1713.50] – The struggle continues to surpass $1800. A very early sign of deceleration is shaping up. However, gold’s behavior relative to other commodities showcases further strength.

DXY – US Dollar Index [81.25] – No major acceleration, but the decline in dollars’ value has stopped and is showing signs of turning the corner.

US 10 Year Treasury Yields [1.58%] – The four-month swing between 1.80-1.55% remains in place. Now the low end of this range showcases recent risk-aversion. Recent patterns suggest high odds of rising yields, as a move below 1.47% can enhance the deceleration.




http://markettakers.blogspot.com


Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | November 12, 2012

‘Man maintains his balance, poise, and sense of security only as he is moving forward.’ Maxwell Maltz (1927-2003)

Rebuilding

Elections marked a close to one big picture suspense while policymakers’ decision is being mildly confronted. Surely, tax implication and sustainability of the current recovery creates a speculative and potential edginess for those assessing risk. In terms of sentiment, excessive worries remains contained for a while since last summer and emotional responses are inevitable. We are entering a stretch that requires patience for investors in Europe and other emerging markets as well. The possibility of a collective recovery for an inter-connected markets is setting up as myriads of clues surface between now and year-end. This weekend observers noted that Chinese export surged by 11.6% reflecting a pick up in global trade. Perhaps, an early sign of positive movement in larger economies.

The U.S. economic recovery is slowly recognized while few have contemplated the odds of further recession ahead. Current pace of recovery showcases a visible strength in housing.

‘Construction spending in September climbed to a nearly three-year high at an annualized rate of $852 billion, as increased spending on houses, apartments and private nonresidential projects outweighed a continuing downturn in public construction.’ (Associated General Contractors of America, November 1, 2012).

Next year pundits will reassess the impact of housing while the Federal Reserve guidance on mortgages will be attentively watched. Improving labor numbers are needed to support housing and overall growth. Thus far, recent month’s labor results have reshaped gloom and doomers to re-think the ugliest scenario.

Digesting retracements

Since mid-September US stock prices, as measured by broad indexes, have declined. A two month pause triggered around the announcement of QE3 and the decelerated price action as a result of slowing corporate earnings. Adjustment to new earnings expectations presents challenges for shareholders seeking to add further risk exposure. According to Factset: ‘only 40% of companies have reported sales above estimates. This percentage is well below the average of 55% recorded over the past four quarters.’ (Factset Insights, November 9, 2012). Interestingly, the resurgence in Europe and Emerging markets remains vital since larger U.S. companies rely in overseas markets for earnings growth.

Room for surprises

Thus far, any sings of domestic hope has yet to impress analysts such to produce cheerful projections. Instead common expert thought calls for a weaker outlook:

‘Economists expect the economy to grow at an annual rate of 1.8 percent in the current quarter, down from the previous estimate of 2.2 percent growth, according to the Philadelphia Federal Reserve's fourth-quarter survey of 39 forecasters.’ (Reuters, November 9, 2012).

This collective expectations presents some upside surprise in GDP numbers given analysts lowering their expectations. Perhaps, the fist half of 2013 is the next suspenseful period to assess the speed of current expansion.

The bullish argument today, in some ways is not as appealing (since stocks have rose significantly ) as March 2009 dismal lows. Yet, the hurdle of averting suspected sovereign risk both in U.S. and Europe can trigger further, but substantial optimism. Simultaneously, the economic recovery in the U.S. needs to pick up the pace in a favorable direction. Recent Midwest drought and Northeast storm will play a role in economic numbers for near-term observers. Nonetheless, the business cycle favors an economic recovery when isolating noise within the business cycles. Not to mention, recent pullbacks in S&P 500 Index were needed and relatively healthy to have a breather. In due time, investors will have the choice to revisit entry points in riskier assets.

Article Quotes:

‘ If past-year food price information is relevant for inflation expectations, then we expect respondents who, prior to receiving the selected information, are less informed about it to find the information more valuable and to be more responsive to it. Therefore, to gauge respondents’ familiarity with the selected information, we ask: ‘Over the last twelve months, by how much do you think the average prices of food and beverages in the U.S. have changed?’ The respondents who were randomly assigned to receive the selected information (the information group) were then informed that food/beverage price inflation in the U.S. had been 1.39 percent over the last twelve months, based on data from the Bureau of Labor Statistics. Respondents in the control group did not receive this information. We measure respondents’ ‘Perception Gap’ as the difference between the objective information value (1.39 percent) and respondents’ prior beliefs; a negative perception gap corresponds to overestimation of past food/beverage price inflation. We find that respondents have inaccurate perceptions of past changes in food and beverage prices. The average perception gap in our sample is -4.92 percentage points (meaning respondents report past food/beverage price inflation, on average, to be 6.31 percent). We find that nearly 40 percent of our respondents believe past-year food and beverage price inflation was 7 percent or more, when, in fact, the published measure has not risen as high as 7 percent since 1981.’ (Federal Reserve of New York, Nudging Inflation Expectations: An Experiment, November 5, 2012).

‘In recent weeks asset managers within Japan have scrapped plans to launch funds that had aimed to raise a combined Y67bn ($840m) to invest in shares in Shanghai, according to analysts at Lipper. In the latest monthly survey of individual investors by Nomura, Japan’s largest brokerage, the renminbi fell to an all-time low rating as investors were asked to select one currency as an ‘appealing’ investment target over a three-month timeframe. Since Tokyo nationalised a disputed chain of islands in the East China Sea in mid-September, Japanese businesses such as Shiseido, the cosmetics company, and watchmaker Citizen, have experienced steep falls in sales in China, as consumers in China steer clear of obviously Japanese branded goods. Now households in Japan are responding in kind, say analysts, by checking flows of investment into Chinese stocks, bonds and bank accounts…. The dispute ‘has cast a pall’ over Japan-based funds investing in China, said Yoshihiro Hamada, head of product development at Diam Asset Management in Tokyo, which has struggled since October to find Japanese banks and securities companies willing to market its Rmb94m ($15m) bond fund.” (Financial Times, November 11, 2012)

Levels:

S&P 500 Index [1379.85] – The downtrend since mid-September is in place. The index is slightly below 200 day moving average which catches the attention of technical observer.

Crude [$86.07] – Back to familiar range around $85-86, a level that has triggered upside moves twice in 2011 (February and October) and earlier this year.

Gold [$1738.25] – The near-term question lingers on the commodities ability to revisit and surpass $1800. A growing possibility given last weeks action.

DXY – US Dollar Index [81.05] – Since mid October, the dollar index is strengthening modestly. A reflection of slight risk adjustment, but not quite a big move to cause a trend shift.

US 10 Year Treasury Yields [1.60%] – Ongoing zig-zag between 1.80-1.60% continues. Now at the low end of the 3 month trend reinforcing the low rate theme.

http://markettakers.blogspot.com


Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | November 5, 2012

“Suspense is worse than disappointment.” (Robert Burns 1759-1896)

Improvement acknowledged

The political suspense lurks in the background for financial markets that are in equal limbo. The anticipated election results can easily stir short-term movements in macro indicators. Yet, guessing the potential priorities of policymakers is a daunting task that will keep many speculating and re-adjusting for months ahead. Nonetheless, the analysis of the current conditions presents more encouraging signs than highlighted in the day-to-day chatter. Perhaps, the early indicators like the silent bull market are now being vividly felt in the real economy.

Meanwhile, the improving economic data points match the bottoming business cycle. Stability in housing and turnaround in labor numbers paint a favorable picture in the post-meltdown era. The S&P homebuilders index (XHB) is up more than 238% from its lows of March 2009, showcasing the revival in housing – or at least, investors’ conviction on further recovery when taking account of the current trends and influence of policy makers. On a similar point, the Federal Reserve of Cleveland reminds us of the following:

“A direct link between housing markets and employment is found in the construction of new homes. When home prices are rising, more households will find new homes to be a viable alternative to existing homes. Starts of single-family homes have increased 27 percent over the previous year, and multifamily housing starts are up 35 percent.” (Stephan Whitaker, October 30, 2012).

Breathers and adjustments

For more than three years, the bullish stock market run looked ahead to a recovery. In that period, shareholders were rewarded for betting heavily on continued earning growth. Now broad indexes are pausing, as the S&P 500 index cooled by 4% from its annual highs (the index is up 12.5% in 2012). Collectively, we are entering a deliberation period in which participants are balancing the earnings growth slowdown versus the lack of alternatives in other liquid investments. Importantly, there are vital periods where there is a disconnect between the pace of economic recovery and stock market movement.

The relative edge of US markets remains noteworthy, while emerging markets attempt to play catch-up. In this setup, seeking investment ideas in emerging markets is appealing in areas that are undervalued or neglected. Encouraging signs of Chinese recovery enhance the near-term curiosity for risk-takers. The recent expansion in Chinese manufacturing serves as an ongoing hint of a new phase of a recovery, but confirmation is long awaited as skepticism grows.

The interconnected nature of markets is biased for a collectively working financial system. Currently, there is increased demand for corporate debt in Europe, and emerging markets demonstrate desperation for yields among global investors. The element of additional surprises in Eurozone resolutions is poised to trigger further enthusiasm away from trepidation that has escalated in recent years. Already, early risk takers are cashing in, as illustrated in this example:

“London-based hedge fund Adelante Asset Management has made a 70 percent gain on a sale of Greek bonds, showing the potential for big profits from betting on a recovery in the fortunes of a country effectively off-limits to investors a few months ago.” (Ekathimerini.com, November 2, 2012).

Big-picture calmness

The contentious discussion of quantitative easing in the US remains a heated debate at times but is generally accepted by the market. For now, the short story suggests: Inflation expectations remain low and economic recovery is not overheating; therefore, low interest rates remain in place for an extended period. Meanwhile, the CRB index reminds us that commodity prices (as a collective unit) are down for the year, and the overall message is that escalating prices are not to be feared.. In addition, volatility has remained low and “fear-mongering” messages are not sparking sensitive reactions. Perhaps, there is a macro stability brewing when considering low rates, contained commodity pricing and relatively low volatility. The suspense may turn to fear when these macro factors adjust more than expected.

Article Quotes:

“For all my value investor friends’ faith in physical assets and commodities producers, those are much more open to confiscatory taxation or seizure than shares in companies that have shown an ability to retain long-term franchise value. If you own a gold mine in South Africa or an oil concession in Argentina, you have a target painted on your money’s back. There are always politically compelling arguments for your having obtained a mineral concession through an unfair or even illegal process. You can’t move the mine or the oil well, and they get to take it back when they want. Sovereigns can take a long time to pay partial compensation. From an equity owner or corporate bondholder’s point of view, the best long-term source of income is a durable international brand, or a corporate design or technology team that has shown an ability to replicate itself over generations. Think Hermes, or Volkswagen, or Schneider Electric. None of them sell what they did in 1960, but they have shown the ability to develop and expand their product lines over time. They’re not based on confiscatable oil wells or gold mines, and the international debt they support isn’t documented by reversible Presidential decrees. The credit investor is always living in fear of inflation and devaluation. Better to own the debt of someone who has to worry about their access to markets, and who has been forced to meet customers’ needs over time.” (Financial Times, John Dizard, November 4, 2012).

“The fact that China watchers, as well as influential political insiders, still cannot say with certainty which leaders – or even how many – will comprise the new lineup is a testament to how opaque and anachronistic the selection process is for the rulers of a rapidly modernizing nation playing an increasingly important role in the global marketplace. In that sense, no matter who walks out onto the rostrum at the Great Hall of the People when the next Politburo Standing Committee (PBSC) is introduced to the world, attention will quickly shift from the identity of the new leaders to whether they can successfully manage the many challenges facing the regime. How severe are those challenges, and what is the likelihood that the new leadership will see bold action on reform as the best – and perhaps the only – means for addressing them? A first step in answering these questions is to put the issues confronting the CCP, as well as the ferment over how best to address them, in their proper context. Chinese elites, and especially the intelligentsia, have a storied tradition of trying to shape the thinking of an incoming administration. Against this backdrop, the effervescence of the debate in recent weeks over reform and the CCP’s future is consistent with the atmosphere that always precedes a leadership turnover.” (Center for Strategic & International Studies, November 1, 2012)

Levels:

S&P 500 Index [1414.20] – Staying above 1400 for a sustainable period is a tough feat considering the peaks in 2000 and 2007. Yet, the momentum remains positive for now, despite increasing odds for pullbacks.

Crude [$84.86] – After a 30% drop from March-June 2012, oil prices are attempting to stabilize around the $85 range.

Gold [$1685.00] – For the fourth time since last September, gold has not demonstrated the ability to stay above or reach $1800. Recent declines make a case for a trading range closer to $1600.

DXY – US Dollar Index [80.59] – In line with the 200-day moving average, while slightly above annual lows.

US 10 Year Treasury Yields [1.71%] – Eclipsing 1.80% will surprise most, while staying below 2% for months ahead appears to match the consensus view.


Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed

Market Outlook | October 29, 2012

“Our dilemma is that we hate change and love it at the same time; what we really want is for things to remain the same but get better.” (Sydney Harris, 1917-1986).

Quandary confronted

If the earning slowdown was not a concern in previous months, it has now certainly awakened those who inquired about the sustainability of corporate earning growth. The actual versus expected quarterly announcements can find a way to “beat” estimates, but confidence in solid growth for two quarters ahead is not that high.
“Only 36% of companies have reported sales above estimates. This percentage is well below the average of 55% recorded over the past four quarters. If 36% is the final percentage, it will tie the Q1 2009 quarter (36%) as the quarter with the lowest percentage of companies reporting sales above estimates in the past four years.” (Factset Insights, October 26, 2012).

In addition, expecting further fuel from an already explosive stock market may be asking too much. Some chartists and others traders are loudly proclaiming the increased odds for pullbacks that have persisted over a few days. A more rational perspective would expect a 5-10% pullback, but that’s not quite dramatic enough to label it a prelude to a doomsday setup.

Yet, the struggle for money managers resides in distinguishing rapid micro noise from sustainable macro trends. Silently, in the background, two surprise elements may await: 1) A recovering emerging market led by China 2) a Eurozone solution better than the worst-case scenario. Both factors are poised to either lessen the pending sell-offs or fuel a renewed acceleration. Either way, the surprise element serves as a wildcard in influencing investors’ mindsets.

Grasping constraints

In taking a breath or two, one quickly realizes the intriguing dynamics of the fixed income market. First, money managers are demanding higher yields given the low treasury returns. Secondly, there is a lack of high-quality fixed-income products that can produce attractive yields without enhanced risk. Thus, owning “safe assets” sounds appealing in turbulent periods, but an obsession with safety comes with opportunity costs, as well. Perhaps this is frustrating for analysts who were accustomed to expecting reliable returns in previous decades. Similarly, this is frightening to those who cannot overcome or ignore the 2008 debacle and other equity market glitches, which led most participants to flee the risk exposure of US stocks. These patterns are well documented, but the money management world is forced to think sharply, to work harder and enhance one’s ability to deliver a balanced and accurate view of risk. The adjustment to slower growth and the higher price for safety changes market dynamics beyond the textbook definition of risk management.

Balancing mix

Conflicting forces of sluggish corporate fundamentals ahead are somewhat offset by the lack of trustworthy alternatives to liquid investments – not to mention the fact that the lack of evidence of a major “bubble” in this current run makes it difficult to envision more than a 15% drop in broad stock indexes. At the same time, improvements in economic numbers hint of a much-needed turnaround for confidence restoration. Yet, layers of puzzles create unease, which simply makes risk takers rather edgy. That unease is felt by moderates and expected rise in volatility. On that note, the upcoming week will provide further hints and data points to ponder. Pending announcements range from various job reports to construction spending to updates on the Chinese Purchasing Manager Index (PMI). Surely, digesting these points in the context of the big-picture concerns can spark noticeable reactions and overreactions.

Article Quotes:

“The [Chinese] economy’s strong performance at the end of the third quarter was in fact fuelled by a jump in investment, illustrating that consumption is still far from strong enough to power growth on its own. Retail sales, the best indicator of overall consumption, have been resilient, rising 14.2 per cent year-on-year in September. However, that has not made up for a deep slump in housing construction. Fearing that growth was on the verge of slowing too much, the government did what it does best: it cranked up investment. The approach has been two-pronged. The National Development and Reform Commission, a powerful planning agency, has approved a series of large infrastructure projects since May. Meanwhile, the central bank has loosened monetary policy by cutting interest rates twice and injecting liquidity in money markets to ensure that these projects could obtain financing. The fruits of these efforts began to be harvested in September. Investment in railways surged 78 per cent year-on-year and investment on roads climbed 38 per cent. This mini-boom in investment, not the resilience of consumption, was the reason that so many analysts concluded that China might be at the end of its nearly two-year-long downturn. If infrastructure spending continues to surge, it is entirely possible that the healthy trend of the first three quarters will reverse in the final three months of the year, and investment could once again overtake consumption as the biggest contributor to Chinese growth.” (Financial Times, October 18, 2012).

“From an economic growth perspective, it appears that fiscal policy has already been tightened too much and has been a vital factor behind the sub-par recovery. The bottom line make-up of GDP over in the three years of recovery shows that private sector demand is expanding at a reasonable pace, no doubt aided by the record low level of interest rates. The problem for bottom line GDP growth has been, quite extraordinarily, the fact that government demand has cut GDP for eight of the last 10 quarters. Attempts to cut the budget deficit at the federal level and balance the budget at the state level is hurting economic growth and constraining job creation. Ed Dolan from EconoMonitor points out that the September quarter GDP outcome was a rare example in recent times where government demand contributed to GDP growth. Indeed, government demand contributed a hefty 0.7 percentage points of the 2.0 per cent GDP growth rate, but at Dolan notes, that boost to GDP “turns out to be almost entirely due to a big jump in federal national defence consumption expenditures … the contribution to GDP growth from state and local government was a pathetic 0.01 per cent of GDP.” (Business Spectator, October 29, 2012).

Levels:

S&P 500 Index [1411.94] – Several signs of selling pressure at 1460. Buyers’ conviction will be examined at 1400 following a multi-week breather.

Crude [$86.28] – Recent downtrend in place after peaking at $100. No early sings of bottoming around $85 range at this point.

Gold [$1737.00] – Further evidence of sellers’ momentum at $1750, showcasing the run-up is pausing. However, the multi-year uptrend is not affected.

DXY – US Dollar Index [80.04] – Remains in a trading range over a two-month period. A long-awaited bottoming process may take place, but movements remain limited.

US 10 Year Treasury Yields [1.74%] – Trading closer to three-month highs of 1.82%. In mid-August and September, yields couldn’t surpass 1.90%. Increasing odds of that trend repeating this month, as well.

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