The Overnight Report: Small Gains, Low Volumes

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By Rudi Filapek-Vandyck

The Dow Jones Industrial Average booked a gain of 45.33 points, or 0.4%, to 11868.81. The Standard & Poor's 500-stock index added 3.94 points, or 0.3%, to 1215.76, and the Nasdaq Composite advanced 1.7 points, or 0.1%, to 2541.01. The defensive utilities, health-care and consumer-staples sectors posted the strongest gains.

There was a rumour going around global financial markets last night that one of the world's largest financial institutions (no name attached as yet) had been pumping extra-liquidity in to FX markets to defend its position, worth hundreds of millions of dollars, at 1.29 between euro and USD. Given the euro and global risk appetite have been so closely aligned this year, should we now assume the fate of global equities and commodities lies with said institution's ability to prevent EUR/USD from sinking below that pivotal level?

Thus far, the strong defence has held and EUR/USD has recovered back above 1.30.

There were other factors in play as well. Economic data in the US continue to surprise market expectations and last night delivered more of the same, with the Labor Department reporting weekly initial jobless printed 366,000, well below forecasts and well below the 400,000 mark that simply couldn't be crossed earlier in the year. Note the number of new jobless claims (for the week ending Dec 10) is the lowest since Lehman went bust – more than three years ago. In addition, both the Philly Fed survey as the Empire manufacturing survey came out better than expected.

Industrial production for November disappointed, however, falling 0.2% from the previous month, against a consensus estimate for growth of 0.1%. November's minor retreat followed a relatively strong 0.7% rise in the previous month, plus economists suspect a follow-on effect from the floods in Thailand.

Whatever was hidden in the details last night, the tone was set for a positive opening on Wall Street after three straight days of losses and that's exactly what transpired. The Dow opened triple digits higher, the S&P500 surged to 1226 and the Nasdaq jumped from the open as well, but… a lack of serious conviction soon kicked in and indices merely drifted towards lower gains as the session matured.

It didn't help that IMF head Christine Lagarde painted a very worrisome outlook for the global economy next year, suggesting Europe would not be able to solve its problems without the rest of the world chipping in too.

Note that while Europe remains on everybody's radar, there's also still a painful gridlock on Capitol Hill, Washington where negotiations over how to extend a payroll tax holiday, considered necessary to support growth next year, remain fruitless. Federal workers have been put on alert for a possible shut-down if the negotiations don’t make a breakthrough by year-end.

Ah, politicians…

Investors also took heart from the fact that yesterday's Spanish bond auction went well, with investors chipping in E6.03bn, which was well above the E3.5bn target set by the Treasury. The sale of E2.5bn of 5-year bonds yielded 4.0%, well down on the 5.3% rate for the 5-year auction in November. European PMI releases were negative, but better than expected.

That proved enough for European bourses to book some gains, which provided a positive platform for US equities to open the day on a positive note too. The not so good news is that all gains were booked on paper thin volumes.

In FX markets, the euro bounced back above 1.30 and has managed to stay above that pivotal level. The Aussie dollar thus managed to rise from lows around US98.60c to US99.85c. The AUD was near US99.20c in late US trade. Commodities recovered after yesterday's carnage, but showed no appetite, nor conviction. Crude oil is going through its own pains at the moment. Nymex crude oil fell by US$1.08 to US$93.87 a barrel, but London Brent crude rose US17c to US$105.19 a barrel.

Gold remains the talk of town and yesterday, as the USD finally stopped strengthening, gold managed a mini-bounce. Chartists still expect the price to drop below US$1500/oz as the market psychology has received a few bruises this week. No immediate prospects for QE and no inflation problems on the immediate horizon are proving too much to bear for gold at the moment.

It goes without saying, but in an environment of shorter cycles, such as what we have been experiencing since 2008, timing becomes of critical importance, even for those investors taking a longer term view. The better the entry point, the higher the success rate and the returns, no matter what the investment horizon looks like.

The fact was again pulled into the limelight as UBS retreated from its earlier positive view on commodities last night. As reported by FNArena at the time, UBS decided to switch to a positive view on commodities a few weeks ago, after having been negative since late last year. Others such as BA-Merrill Lynch and JP Morgan remained cautious towards the sector, but UBS thought the correction was almost over, and thus a more accommodative stance seemed warranted.

All that has now changed and the title of the UBS commodities switcheroo report says it all: "Pain Before Gain". Capital flows are deserting Emerging Markets in favour of the US, surmise the analysts, plus better-than-expected economic data in the US (see also above) are keeping the Fed at bay regarding QE. Thus expect no respite for commodities in the short term.

I never imagined I would actually write the following sentence, but global commodities will suffer because of unexpected economic strength in the US. This really, really is a crazy world. Read that previous sentence again, just for fun!

More pain before gain is a theme that can also be found in various strategy reports issued by equities experts for calendar 2012. US strategists at Citi have been flagging it for a while: things are likely to get worse first, before we can start thinking sustainable upswing for equities again. Citi's team notes all kinds of indicators, including the in-house proprietary Euphoria/Panic model, are pointing towards a better year ahead, but the current short term trend is suggesting otherwise.

What we are likely going to see is more weakness in the first half of 2012, before a strong relief rally pushes equities into the black next year, predicts Citi. On this basis the strategists believe 2012 will be a mildly positive year overall for equity markets and other risk assets. Get your timing right, however, and it could be more than that.

Citi's team of quant analysts in Australia, led by Nick Morton, pointed out yesterday that many solid, defensive stocks are now trading near all-time high valuation premia vis-a-vis the beaten down growth stocks. This suggests a lower risk approach in favour of those growth stocks as -at the very least- this valuation gap is unlikely to remain as wide as it is.

I have been making the same observations since October, as many of the stocks I had been mentioning since early in the calendar year, including Monadelphous ((MND)), Campbell Bros ((CPB)), Domino's Pizza ((DMP)) and Coca-Cola Amatil ((CCL)), are all trading at or above consensus price targets. There's only so much these stocks can rise based on their earnings growth forecasts.

Note also that stocks such as Amcor ((AMC)) and Ansell ((ANN) are receiving recommendation downgrades this month, for that very same reason.

Which is another reminder for investors that whoever is going defensive right now is well behind the curve. Timing counts and it does as much on the way in as on the way out. The world has en masse sought refuge in safety and on the sidelines, which makes all the rest the only logical place to look at. But maybe not as yet? (see UBS earlier)

Morton's team of quant analysts state the obvious: 2012 will to a large extent be a year for stock pickers and the winners will not be the winners of this year because of the wide valuation gap between defensives and growth stocks. The team has picked nine prime targets for the year ahead, which I'd like to keep for FNArena subscribers. Look out for a story in Treasure Chest on Monday.

Lastly, as I have been quoting from domestic and international experts views in this week's Overnight Reports, it's probably appropriate I also include the local "King of Spin" Charlie Aitken, iconic market commentator from the insto desk at Bell Potter (used to be Southern Cross Equities). Aitken regularly and proudly recalls he turned bearish on the market in late April. What he never adds is that a small army of other market experts had already done so at the time, well ahead of him.

Recently, Aitken was convinced we would see a November-December rally, and he is definitely not the only one who's still waiting for that one to occur. At times he does provide interesting market insights, which he gains through his contacts in the industry. Such as that funds managers and hedge funds are worried about liquidity and have thus chosen to play equities via futures, ETFs, options and the like, instead of directly via equities.

What these strategies have created is an environment wherein correlations between sectors and assets have become increasingly tight. Above all, it suggests there's a lot of top down buying and selling going on, which suggests there must be a lot of mispricing on an individual basis, says Aitken. Sounds logical.

Aitken is on the same song sheet as my observations in October and with Nick Morton and his team at Citi in that safety and defensive have become too dear, so the logical conclusion is that outperformance next year will come from the losers and the laggards of 2011. There's nothing wrong with such a conclusion, it's just that Aitken always delivers the news as if he just re-invented the wheel, while instead, he's a master in spinning it.

Aitken is correct in that shares in companies that will deliver strong growth in the years ahead and that are cheaply priced today will, when the time is right, rally hard to compensate for the mispricing. Maybe that's one message investors on the sidelines today should take on board?

Today, the central bank in India is not expected to announce any changes and in the US the November CPI number will be released.

March 2012 SPI futures contracts are indicating a positive opening today, rising 15 points or 0.4% to 4131.

 

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