01-09-2012 Market Commentary

By Eddie Katz

Barry Ritholtz - Lots of fund managers come into the new year carrying plenty of cash. They had unceremoniously dumped the losers they were too embarrassed to show on their books at the end of Q4. This sets up the January effect, especially amongst smaller cap names, that can snap back after the December sales. But it also leaves these managers holding excess cash, which they often feel compelled to put to work right away, so as to not fall behind their benchmark (which carries no cash). We like to see Institutional buying. In its purest form, it conveys conviction, implies ongoing purchases over longer periods of time. Generally speaking, it suggests that there is an ongoing flow of money into equities, typically based on expectations for improving earnings and supportive of higher prices. Unfortunately, this New Year’s rally does not seem to have any of those features.

The cash getting put to work can move markets, but it is ephemeral — not typically a lasting trend. I am happy to see markets go higher — I have a decent slug of equity holdings in my portfolios (>50%) — but I am more concerned about the damage of the next leg down than the gains of the present rally. What would increase my enthusiasm stocks? As noted, I prefer conviction driven, not calendar focused moves. I want to see stronger, not lighter volume. And, I prefer to see the leading sectors of the economy lead the market — that means financials, technology, and consumer goods. As we noted Sunday, sentiment has gotten pretty negative. But its not at levels associated with long term rallies. The bottom line is this: These rallies are for traders, not longer term investors. We remain mired in a long term secular bear market — and that means preserving capital and managing risk. Yes, you can be opportunistic, but that is a secondary, not primary objective.

Zero Hedge - The American Association of Individual Investors has just recorded one of the lowest prints for Bearish Investor Sentiment ever. At only 17.16% of respondents bearish, this is second only to the late 2010 (QE2-inspired) trough in bearishness that soon after heralded the top in risk assets for this cycle - as the rumor rally met the news negativity. This level of bearishness is over two standard deviations from long-run norms. Almost 50% of respondents are fully bullish (which explains the retail equity outflows?) which is the highest in 9 months. The ratio of bears to bulls has accelerated to almost record levels as it seems the respondents that AAII is asking are increasingly (over) confident in their nominal returns (perhaps not so much their real returns), or perhaps believe the hype of a fiat print-fest just around the corner and see only upside for USD-numeraire stock prices (even as earnings contract and outlook downgrades persist). So the next time someone tells you that the market will rally because everyone is so negative - not so much.

Gluskin Sheff - The income story may have become front page news, but with only 41% of U.S. companies paying out a dividend to begin with, how can this theme really represent an overbought story, let alone a bubble. Stick with what worked last year: play it safe, but not in 0% yielding cash. Growth is becoming increasingly scarce; stable income is becoming increasingly scarce; the number of safety- valves is becoming increasingly scarce. And what is scarce is what should be populated in a portfolio; just like the abundance of fibre optics should have been avoided in 2000 and the abundance of housing and credit finance avoided in 2007. This is why you are quickly taught the laws of supply and demand in Economics 101:

WSJ - Robert Prince, co-chief investment officer at Bridgewater, and his managers at the world's biggest hedge fund firm are preparing for at least a decade of slow growth and high unemployment for the big developed economies. Mr. Prince describes those economies—the U.S. and Europe, in particular—as "zombies" and says they will remain that way until they work through their mountains of debt. "What you have is a picture of broken economic systems that are operating on life support," Mr. Prince says. "We're in a secular deleveraging that will probably take 15 to 20 years to work through and we're just four years in." In Europe, "the debt crisis is [a] long ways from over," he says. The economic and financial morass will mean interest rates in the U.S. and Europe will essentially be locked at zero for years.

In this bleak environment, Mr. Prince says stocks remain vulnerable to "air pockets" from shocks, such as bad news out of Europe. But for longer-term investors looking out over the next decade, he says, equities may be a good buy. There is even money to be made in U.S. Treasury’s, despite interest rates near record lows, and gold is likely to resume its climb as central banks print money to bolster their economies. Mr. Prince says. Currently, the fund is positioned for higher gold prices, stronger Asian emerging-market currencies and lower yields across high-quality government bond markets, Mr. Prince says.

Morgan Stanley - The unwind of the negative shocks from Japan’s earthquake and the run-up in energy prices earlier in the year are responsible for the recent run of strong data in the US economy, argues our Chief US Economist Vincent Reinhart. Once these tailwinds have played out and a shallow fiscal pothole emerges, growth should slow to around 2% in early 2012. As a result, the Fed will probably mark down its growth and inflation forecasts. The deceleration will likely be enough to convince the FOMC that the downside risks to its dual objectives of maximum employment and stable prices need to be addressed.

However, given the ambiguity in the Federal Reserve Act about how to weigh these objectives against each other, disagreement within the FOMC itself about the relative weights and Bernanke’s efforts to create a more democratic process for decision-making, progress on another QE package is likely to be slow and full of compromise. Eventually though, we believe that a package of Treasury and MBS purchases of US$500-750 billion will arrive some time between March and June. [Editor’s note: This is a slightly complex way of saying they believe QE3 is coming in the spring.]

CitiFX - Gold has held good supports in the $1,550 area [and] is showing signs of strength against the [US Dollar] Index and the equally weighted basket of G10 currencies. Gold looks to now outperform both Bonds (T-Bond) and Stocks (Dow). Unless and until we see a weekly close below $1,535, we believe the uptrend in Gold has resumed and a move to $2,400 throughout the course of this year remains likely.

Conclusion – New year….same game. On Tuesday markets rocketed higher on no real news and yet Friday saw some legitimately positive employment data and stocks sold off. Go figure. We stated at the end of last year that 2012 would be more of the same and we’re sticking with that message. The big factor that must be followed right now is the big “E”. While we aren’t major proponents of P/E ratios since the “E” can be manipulated (we’d prefer Enterprise Value/EBITDA because cash is king…feel free to call us for a further explanation), markets are entering earnings season this week. And since we have continued to see profit margins and earnings continue to hit peak levels, there is now added pressure for companies to show they are growing revenues since they can only cut so many employees to make sure they hit their bottom line targets.

What is interesting is that there have been a number of companies downgrading their earnings estimates of late, which is akin to only submitting your high golf scores. Unfortunately, the market doesn’t care much for sandbaggers and will likely punish those companies that don’t beat a lowered set of expectations. Having said that, if the economy is as strong as some of the recent economic data has purported, then the market could be set up for some outsized gains should a wide swath of S&P 500 companies produce enough earnings “beats”. Our two pennies on the subject is that growth is still not strong enough to sustain recent trends for a period of many quarters. Our conservative approach may prove wrong in the short term (2-3 months), however, trying to predict the “E” and how the market will react to that “E” still seems to us to be a fool’s (i.e. trader’s) game.