Rudi On Thursday

At least in previous years there was always some sort of general consensus from which investors could take guidance from, either as a contrarian or as someone looking for support and confirmation. The first observation to make, of course, is that general consensus in both the two previous years has been proven painfully wrong on both occasions.

By the end of 2007 the general consensus seemed that we would head into a tougher environment, but there would still be gains ahead for equity markets. Instead what followed was one of the most savage bear markets ever witnessed. And this time around last year everything just seemed doom and gloom and the world was simply giving up on the prospect of a quick solution to all the problems that were keeping banks, economies and consumer spirits down.

Consensus only proved correct for about ten weeks into the new calendar year. After that it was up, up, up and away.

If there is any sort of consensus this year, which frankly I doubt there is, it is, maybe, that a majority would be “cautiously optimistic” about markets’ prospects for next year. But let’s be frank on this: “cautiously optimistic” is in essence a poetic way to state: don’t know, but there’s always hope.

This is, believe it or not, nothing unusual given where we have come from (deep trough) and where we are right now: in recovery, but still awaiting formal confirmation.

Some readers have been trying to seek some sort of philosophical debate with me recently. About whether anyone really knows what is going to happen next year? Whether anyone can genuinely know what is going to happen?

Of course not. Markets have rallied on “hope” -the expectation that sooner or later all the efforts put in place will give birth to stronger economies- and many indications are pointing to the direction of gradual, but preliminary and fragile results being booked. But many questions remain, not to mention the wide variety of market views that live in and around the markets.

According to some, markets are topping and ultimately on their way back to the March lows and potentially to even lower levels. According to others, a new multi-year bull market has commenced and we are currently simply climbing the wall of worry. Most experts and commentators are somewhere in between, but even in the middle there is no consensus.

Some believe the first quarter will see global growth peaking and then gradually falling back to weaker levels as next year progresses. Others believe Q1 will see a momentary relapse, after which a gradual strengthening will occur. How about a turning point mid-year?

I could go on and on, but I am sure you all get the idea by now. Some stockbrokers I talk to admit they have no idea what’s going to happen. Given the key characteristic of their profession, however, they are inclined to take a positive view – “cautiously optimistic”, see above.

I’d be inclined to take a positive view too, in the longer run. I believe we will come out of this, but it will happen via pitfalls, bumps and winding roads. As such I am still inclined to see value on FY11 metrics. Shorter term, however, there are many clouds in the sky, and they are hanging low.

I cannot help but admire how some commentators continue to hold on to their forecast of a Santa rally this year. Call it whatever you want, but even if share markets manage to put in some last minute gains between now and early January, this is hardly an environment that deserves a positive label. Markets are limping towards year-end. There is uncertainty and confusion all around.

That too is a transformational thing. So far, for most in 2009, many positive factors had fallen in line, all pointing into the same direction. That is no longer the case, and thus 2010 will by default present investors with a different type of environment. Make no mistake, there is a genuine possibility, I believe, that what is likely to turn out an economic U-recovery might still go hand in hand with a V-type of recovery in corporate profits.

Confirmation of present forecasts for 2010 and 2011 will be a positive factor, but will there still be enough positive surprises?

Bob Doll, Vice Chairman and Chief Investment Officer, Equities at Blackrock formulated all of the above as follows this week:

“We are growing more concerned about the near-term outlook,.., a number of indicators warrant increased caution. Mixed economic data, lingering deflation risks, the pause in the equity rally over the past couple of months, a lack of clear leadership in the markets, the slowing of volume and some other technical indicators lead us to believe that stocks may experience some sort of consolidation or corrective action.

“Over the longer term, however, our outlook is that the economic recovery is for real, policymakers remain committed to promoting a pro-growth environment and stocks should continue to move higher, although in a volatile manner. As such, we think it makes sense to ride out any downturns. We acknowledge that there are serious risks to overcome, but we believe the cyclical bull market that began in March remains intact and would venture to say that we have yet to see the cyclical highs for the current market.”

In other words: long term positive, short term cloudy and uncertain.

Nowhere is this scenario as perfectly illustrated as in the chart I put on top of this week’s editorial. FNArena has, through myself and through colleague Greg’s Overnight Reports warned for months that investors should watch out for a potential come back of the US dollar.
It’s not that we are big fans of Uncle Sam’s financial or economic policy, but experience has taught us that if a certain trend becomes so engrained that everybody stops questioning it, and then a reversal happens – these things do not happen without causing mayhem and pain.

This is exactly what the US dollar is causing right now. I bet we all know at least one person who has been stopped out in either gold, oil or stocks that are leveraged to both commodities over the past days. There will be more, I am sure.

As a quick aside: what I find fascinating is that the USD index has now managed to break through technical support levels – something considered plainly impossible by a whole army of chartists and FX experts until it simply happened this week. This is always something that should be paid attention to.
As can be seen on the chart above, it doesn’t happen that often that the USD index moves in or out the so-called Ichimoku cloud. The last time it happened was in April, eight months ago. Every time it happens a new trend seems to be in the making, with the USD index initially spending some time inside the cloud.

If history repeats, the USD index is now on its way to higher levels, at least for the time being. This should not bode well for assets that have abundantly benefited from USD weakness this year, including gold, crude oil and equities in general.

Most experts are holding on to the mantra that the trend remains intact for ongoing US dollar weakness. So too Giles Keating, Head of Global Research for Credit Suisse Private Banking and Asset Management. But Keating doesn’t see a repeat of the relatively smooth one-way bet that applied for most of 2009. The USD will still weaken throughout 2010, he believes, but there will be big gyrations along the way, causing corrections and increased volatility elsewhere.

As a result, it won’t be as easy as this year to make returns from oil, gold, commodity currencies and equities. Keating still believes that all these investment strategies, and some others, that have served investors well in 2009 will equally serve them well in 2010. But the overall environment will be tougher: lower returns, more corrections and volatility, with an underlying trend that remains positive.

This transformation has in essence already started.

According to Nariman Behravesh, chief economist at IHS Global Insight, the top ten factors to consider for next year are:

1. A slow recovery for the US

2. Europe and Japan will recover even slower than the US

3. Emerging markets will outperform developed economies

4. Interest rates in G-8 countries will remain low

5. Fiscal stimuli across the globe will begin to ease

6. Commodity prices will largely move sideways

7. Inflation will not be a problem

8. Post initial improvements, global imbalances will worsen again

9. The USD might strengthen at times, but its trend remains down

10. The risk of a “hard W” remains uncomfortably high

Meanwhile, economists at Macquarie argued on Wednesday, predictions for the new year are always based on what is most likely to happen, whereas unlikely events that do happen at times tend to have a much greater impact on markets and asset prices. Macquarie has therefore lined up seven factors deemed as “unthinkable” – but if and when these happen, expect turmoil and carnage!

1. Turns out higher interest rates in Australia flatten overall consumption and the RBA is forced to start cutting again

2. Against all odds, the US consumer bounces back with a vengeance

3. The Federal Reserve starts tightening much sooner and more aggressively than most people expect

4. House prices across the globe start booming again

5. Governments introduce “Tobin Taxes” on financial transactions (extra revenues plus an extra tool in the fight against asset bubbles)

6. How about increased geopolitical issues? A positive regime change in Iran anyone?

7. Central bankers give up their independence under political pressures

Conclude the economists: “While fortune may not always favour the brave, it is always worthwhile questioning the conventional wisdom currently priced into markets. While we don’t expect any of these developments to occur in the year ahead, we do think that they are possible. And given the fragility of investor confidence following the seismic shifts in markets in the last couple of years, markets are likely to react strongly if one of these surprises comes to fruition.”

One last snippet from the insto desk at GSJB Were (has been predicting a Santa rally for weeks): next week starts the “best” sweet spot for equities in each calendar year with odds at 83% that shares will advance between then and December 31st. The insto desk believes it will happen on light volume and the S&P200 should work its way back to 4800, if not 5000.

The index closed at 4637.90 today (3.4% below 4800).

Funny that is, a few months ago I calculated that fair value for the Australian share market would be around 4800. UBS strategists later came to the same conclusion. Don’t let anyone tell you the share market is “expensive”. This is only the case if the economic recovery turns out a mirage.

This is my last editorial for 2009. In five days I will leave Australia by plane. I’ll be back in time to join most of the crew from the second week of January onwards.

Best Wishes to you all. I hope you enjoyed our efforts this year and that you will continue doing so for many years to come.

See our December stockmarket predicting contest below.

Till next year!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab Team at FNArena)

P.S. I – FNArena has secured four copies of a book, published in the US: The Supply and Demand Paradox – A Treatise on Economics. Author: Byron Fisher. For more info: thesupplyanddemandparadox.com

To allocate these four copies, we hereby open up a stock market predicting contest. Only paying subscribers are eligible to participate. Task: predict at what level the S&P/ASX200 index will close this Friday, December 11. Be quick, this contest closes on Thursday, December 10, at exactly 5pm.

To participate: send an email to info@fnarena.com with Supply and Demand Paradox in the subject field. Put in your prediction for the index, together with your subscription details, in the body of the email.

The four copies will be sent to those participants whose predictions turn out closest.