Turmoil in the Arab world triggered a market correction that was overdue. We are still in a bull market and opportunities to re-enter will soon materialize.

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http://www.pcgwm.com/
The magnificent 7 and equity markets - Review 9
I have not written about the magnificent 7 for a couple of months and it is rather
appropriate to review them following the strong performance displayed by equity markets
around the world since then.
In September I wrote: “I have not changed my view of no double dip and the FED QE2
(USD 1 trillion dollar additional liquidity) if confirmed will fuel asset prices. […]The
S&P500 … has yet to pass the 1200 mark again which I expect to be done by the end of the
year”. Since September, the S&P 500 went up 20% (including last week correction). Late
October the market started to accelerate and became overextended; events in the Arab
world have triggered an overdue correction.
Economic news from the US continue to point towards a continued GDP growth and a
(slowly) improving situation in unemployment; Commercial and Industrial Loans at
All Commercial Banks in the US have definitely passed the trough and now seems to be
well entrenched in an upward move: it shows that banks are again net lenders to the
economy (+ USD 13.7 billion in two months – for other economic indicators please refer
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http://www.pcgwm.com/
to http://marketsandbeyond.blogspot.com/2011/02/us-economy-outlook.html). In
Europe Germany is almost exclusively the only growth engine with a rapidly improving
economy on the back of strong exports and an improving domestic consumption. Fast
growing economies in the rest of the world continue to forge ahead whilst inflation is
becoming a real issue and will put pressure on Central Banks/Governments to act sooner
rather than later; this is reflecting in stock markets (+/- 10% down).
S&P 500 Banks index: the index has traded range bound for 18 months and has
yet to decisively to breach the 165 level; there is no sign this happening any time soon and,
conversely, there is no sign of a deterioration either. In my opinion, the level comes from a
continuing reappraisal of the future profitability of banks (less leverage more controls)
versus their ability to pass on additional costs to customers. Positive.
Global 1200 financial index: Since July 2009, the world financial is trapped
within a 20% range, 800 representing a solid floor and 1000 a ceiling difficult to
decisively pass. Reasons for this are equivalent to the US: new domestic/regional rules and
new BIS capital ratios. However, in Asia, banks are slightly under pressure due to
persisting questions about the magnitude of non-performing loans in China in a booming
economic environment which is spurring inflation, whilst in Europe fears about the health
of Eurozone banks regularly comes back to the forefront together with problems with PIGS
countries. The index continues trading around its 200 days moving average. Positive.
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TED spread (LIBOR USD 3 mth - US 3 mth T-bills): the spread continues to stand
well below its 20 years average (the OIS displays the same pattern whilst has started
to pick up since December reflecting persistent question marks about the quality of
European banks’ assets) . The interbank market shows no stress. Positive
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USD bank BBB 10 yr - US 10 yr yield: After posing for a coupe of months, the
spread started to march downwards again in November. Positive.
OEX volatility: OEX volatility continued to regress to break the 20% level, recently
checked by events in North Africa and the Middle East. Neutral.
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S&P Case Shiller house price index: The latest data for US home values (December)
published 22nd February have continued to go down for the 5th consecutive month,
only two cities showing positive numbers.
The unadjusted data are negative (-4% since July, the recent high) - adjusted data post the
same pattern:
Composite-10: Dec 2010: m/m -0.85%; y/y -1.20%
Composite-20: July 2010: m/m -0.96%; y/y -2.38%
As the report comments:
“We ended 2010 with a weak report. The National Index is down 4.1% from the fourth
quarter of 2009 and 18 of 20 cities are down over the last 12 months. Both monthly
Composites and the National Index are moving closer to their 2009 troughs.”
The slow recovery faltered. Negative.
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Oil price: The oil prices broke through $ 90/b to trade at $ 112 for the Brent
and $98 WTI. The situation in the Arab world compounded already rising oil prices.
Events in Libya (1.6 million b/day production, now shut down) escalated fears in the
market even if there is no penury expectation due to spare capacity within OPEC that
would come on-stream if needed (+/-3 million b/day). However, continued unrest in the
region and a real possibility of this spreading to Gulf producing states, including Saudi
Arabia, will continue to maintain high prices: this will act as a tax on growth; for the past
40 years, all recessions had oil prices spiking beforehand. In the US natural gas prices
traded well below $4/btu until Friday when prices passed the $4 mark; still, they remain
at depressed levels thanks to shale gas. Uranium jumped 50% to $65 since our last review
late September. Half-way has been walked to the June 2007 at $138: Negative.
Conclusion: The indicators on the banking situation remain significantly positive, the
rest definitely turned down. Equity markets are correcting (overdue since the divergence
with the 200 days MA was getting overstretched); the risk is that this correction gathers
pace due to higher oil prices and inflationary pressure already significant in fast growing
economies (and starting to appear in the Western world) leading to monetary tightening.
The magnificent 7 are telling us that it is time to reduce exposure to equity markets in fast
growing economies and high beta stocks elsewhere.
Continue investing in high yielding equities / net cash companies with a
strong franchise. Opportunities will soon come up in emerging markets.
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Sources:
S&P/Case-Shiller Home Price Indices
http://www.standardandpoors.com/indices/sp-case-shiller-home-price-
indices/en/eu/?indexId=spusa-cashpidff--p-us----
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