Market Story I: Sunday, January 16, 2011

Happy New Year, may all your wishes come true this year, after all, the next financial nightmare is just around the corner...

Equity Markets started the new year on a mixed note, with a bumper in the first week of trading, followed by a strong rebound in the past 5 trading days. Tracking the US Presidential cycle, market analysts have a strong consensus for positive equity returns in 2011, with expectations running between 15 % 20 % for the US markets. In fact, the 3rd Presidential year in the US has given an average return of 23 %, making the remarkable bullishness more understandable.

My own view is that markets could be up 10 - 15 % in 2011, but it will also be down at least 10 % once this year. I expect volatility to return to the markets and 2011 to be a transition year, with the secular bear trend continuing it´s course latest beginning 2012. None of the problems that have caused the last crisis have been addressed or solved. Basel III looks like a joke in the face of the last banking crisis and the government´s response to the world wide debt problem with more debt is jus the frosting on the cake. With central banks starting to manipulate bond markets, like the FED, who now owns more Treasury Bonds than China, and the ECB, who starts to buy totally overvalued Eurobonds to protect it´s own worthless currency, are just two bright examples how we witness the biggest manipulation of financial markets in history. That this is going to end very badly is for sure, but the question is how and when.

As we look back on past financial crisis since the stock-market crash in 1987, after which the incredible path of market intervention´s by Central Banks world wide started to intensify, we witness a clear and simple 4 year crisis cycle all fueled by a manipulated and over leveraged "financial system": 1987: Stock-market crash; first Wall-Street self made credit crunch. 1991: Savings & Loan scandal & LBO crisis; Wall Street going wacko. 1994: Mexico Tequila crisis: Bond markets going wacko. 1998: LTCM-crisis; Emerging Markets getting slamed. 2001: definite implosion of the dotcon bubble, probably one of the greatest Wall-Street scams. 2003: Enron, Worldcom etc... scandal; balance-sheet implosion on Wall-Street. 2007: subprime loan crisis. Indeed, the 4 year crisis cycle started to shorten a little but it´s difficult to say for some crisis, when it really started. None of the just mentioned crisis have brought us better rules ore better regulations. Instead, we are just printing money.

Looking ahead, as you can see in the Charts below, we are living in a divided world. Not only wealth distribution is getting out of control, with the top 20 % of the US population owing 93 % of the country´s assets, but also on a global basis, in equity markets right now. Where as especially the US stock-market is breaking every resistance since the FED has announced QE2. BRIC Nations on the other hand are rather fighting with support than resistance. This comes probably from the fact that in China and India, inflation is running out of control. Of course, the Government does not confirm that. Now the crucial question for the industrialized world is how emerging markets will handle the current inflation problem. Quote Felix Zulauf:

The emerging world has experienced high levels of growth, but it is entering a period of rising inflation. How emerging economies handle that inflation will be the decisive factor for the industrialized world. If they decide to fight inflation with really restrictive monetary policies, we're in trouble. If they hike interest rates only a little to restrain growth, the cycle can be extended. But that means later on, perhaps in a year or two, they will have much higher inflation and will have to crunch it. The choice is between more growth in the short term and then a crunch, or a more serious bear market now.

Rather sooner than later, we are going to be in trouble again. With the S&P500 trading almost at 1300 and the Dow Jones Industrial just below the 12´000 barrier, I don´t see a good risk reward for equity markets at this point in time. There are some individual names that are looking extremely interesting, but for now, I would rather buy the dips, than chase the rallies. I expect a correction in Q1 of about 10 %, followed by a rally, that could take us higher, but it will be the start of distribution phase, marking the next big top in the current secular bear market. For a trader it should be a good year. For an investor, I see it rather difficult.

SPY: another low volume break-out, 127.4 support, momentum weak.