4-18-2011 Market Commentary

By Eddie Katz Citi - Latest institutional investor survey uncovers some intriguing signals. Our most recent fund managers' poll, conducted this past week, and encompassing nearly 100 responses, shows meaningful changes from early January's results. In particular, enthusiasm for the dollar has weakened significantly, as average cash holdings dipped and the desire to buy stocks has edged lower. Plus, more than 50% see a bigger chance of the markets sliding 20% than gaining 20%, a sharp reversal from the January 2011 view, when nearly 70% saw a large gain as being more likely. Roughly two-thirds of respondents expect a summer market swoon. New questions within the survey yielded some fascinating insight as 65% of investors think that a typical equity market drop in the summer is probable. This outcome may be consistent with the 89% who do not expect a QE3 program to be introduced by the Fed once QE2 expires at the end of June. There was also only a modest majority of clients who saw meaningfully better employment growth than 225,000 jobs per month for the balance of the year. Slightly more than 70% of investors plan to allocate more funds to equities, down from prior levels. With cash on hand down to about 6.1% of assets under management, on average, clients have almost hit the 6.0% low seen in April 2010, before markets slid. Thus, shifting some of their priorities toward commodities, possibly due to dollar concerns, and from equities is not that surprising to us. Hence, given, the “complacency” readings from our Panic/Euphoria Model, this is somewhat worrisome, especially in light of corporate margin pressures. John Hussman - Our 10-year annual total return projection for the S&P 500 remains in the 3.4% area. Expected returns for shorter horizons are near zero or negative, but are associated with greater potential variability. Commodity prices have been predictably driven higher by the hoarding that results from negative short-term interest rates (if you expect inflation, but interest rates don't compensate, you have an incentive to buy storable goods now, and this process stops when commodity prices are so high that they are actually expected to depreciate relative to a broad basket of goods and services, to the same extent that money is expected to depreciate). In short, the outcome of the present situation need not be rapid inflation, and need not be steep market losses. Rather, the predictable outcome is instability. If you put a brick on a flagpole, and keep raising the flagpole and adding more bricks, you don't have the luxury of predicting when the bricks will fall, or in what direction. What you do know, however, is that the situation is not stable. People may briefly be rewarded for standing directly below, cheering, while branding anyone who keeps their distance as fools or worse. But if you look closely, those cheerleaders are typically hiding enormous welts, scars and gashes from being repeatedly smacked over the head - if you look even closer, you'll find that they have typically thrived no better for it over the long-term. While it's possible to continue without unpleasant events, the Fed has already placed the course of the economy, inflation, and the financial markets beyond a comfortable scope of control should surprises emerge. Gluskin Sheff - Money velocity and the money multiplier have yet to revive. Bank credit is still contracting. Real wages are in decline which means once the food and energy bills are looked after, spending on discretionary items that make up around 40% of consumer spending, is going to fall and with that pricing power in these cyclical areas. Home prices are deflating as well. The inflation story outside of food and energy, is not compelling at all, and keep in mind that if the income pie is stagnant or declining, then what happens is that the surge in these two necessities end up being deflationary forces in the rest of the economy. This is where the term “demand destruction” came from – developments like this. Do not get sucked into the vortex of the commonplace thought process on inflation – deflation is still very much the primary trend. This is why we are concentrating our investment efforts on the fixed-income market as well as on companies in the equity universe that focus on delivering stable cash flows and earnings stability. As far as inflation is concerned, we may as well still focus our attention on the area of the global economy that has pricing power and relatively inelastic supply curves – the market for raw materials. Gluskin Sheff - Gold is hanging in, though, as it is gaining more status as a currency than as a commodity, and ditto for silver which has actually rallied nearly 2% so far today to a new 31 –year high just a snick below $42/oz. So long as these issues surrounding global sovereign debt and the integrity of the international monetary system are alive, rest assured that precious metals, which are the purest hedge against uncertainty, will remain in a full-fledged bull market and should be a core holding of any investment portfolio. Conclusion - We are indifferent if you lean to the “right” or the “left”. We're not here to take sides. What has become apparent is that the media has made the ongoing debates about the budget, debt ceiling and every other political discussion about winning and losing (who really cares about productive policy anyway?). And while we watch these debates rage on, it seems like we are all destined to be losers as each side is placing an “all or nothing” bet. We don't subscribe to the theory that these arguments (in particular about the debt ceiling) will lead to a US default as some true “doom and gloomers” would lead you to believe, however, we can comment that none of the plans presented thus far have given us any hope that this country is back on the path to prosperity. Obviously this commentary has strayed from the political sphere but it is becoming more difficult to ignore as it seems the governments of the world are driving markets more so than the economies themselves (see Ireland, Greece, Portugal, Syria, Egypt, Libya, Bahrain, Yemen, Israel, Iran, etc.). Given the different religious ideologies that exist in each of these nations, we are hopeful and would normally expect that the Easter and Passover holidays will allow for a slow (read: not volatile) week of trading. If only hope were an investment strategy. Regards eddie