As I've intimated a few times over the course of the past two months, Fundamentally Technical has not been terminated, but merely on a temporary leave of absence. Since leaving my previous employer, Briaud Financial Advisors, in late December, my focus has been on finding another position that would fill the void that caused my departure from the firm. Because of that, I was simply in no place, mentally, to provide any coherent analysis of the markets. But with this process now complete (I have accepted a Senior Financial Analyst position with Suddenlink Communications’ CAO group to do merger and acquisition due diligence and strategic asset valuation.), I am pleased to report that things are getting back to normal and, therefore, FT will once again publish the daily commentary and insight that you have come to expect. My sincerest thanks to all of you for your patience during this trying time. I’m excited about this new opportunity and look forward to working with a great group of people. And along with this change in position, I am excited to have FT back in focus. I know the coming months will see some of my best work come to fruition and I’m excited to have you along for the ride.
Now on to the meat and potatoes…….
Without delving too deeply into all that has transpired since my last post, suffice it to say that the euphoria of December 2010 has followed through in an unabated manner into the new year. So far this year, the S&P 500 is up nearly 6.0% as corporate earnings and domestic economic indicators continue to improve. But just as I suggested prior to my hiatus (and a couple of months leading up till then), valuations are suggesting that the equity prices are getting ahead of themselves. According to Standard and Poors, the S&P 500 earned $76.97/share during 2010. This translates to a trailing twelve month price to earnings ratio of 17.24. With a historical average closer to the 12 -15 range, it is clear that the current market environment is not conducive to adding equity exposure. This is not to say that prices can’t move higher, of course. If the past three months have shown nothing else, it’s that momentum is a real phenomenon in the marketplace, which makes reconciling fundamental issues with market prices all the more difficult and frustrating.
That said, my negativity on equity at this point is largely driven by valuations rather than economic concerns, though there are issues in the intermediate-term outlook. GDP, PMI, manufacturing activity, and a host of other economic reports continue to paint a picture of a domestic economy that is continuing to heal itself, albeit with a great deal of help from the Federal Reserve. The bigger question, of course, is whether or not this economic recovery will be able to continue apace as federal interventions begin to wind down and the economy is forced to stand on its own two feet. With QE2 slated to expire in June, the liquidity beer keg that has intoxicated the financial markets for the past three years will finally begin float. And just like a party goer that’s had a little too much fun, the question isn’t whether or not there’s going to an economic hangover, but rather how much will it hurt. If economic growth has truly been organic and self-sustaining during this time, the effects of a draw in liquidity should be relatively minor. Unfortunately, though, I’m concerned that we’re going to need more than a couple of aspirin to stave off the headache since any conversation with your neighbors is likely to include commentary on a friend/family member who has lost a job or been unable to find a job. Such anecdotal evidence is highly suggestive of an economy that still has fundamental issues to work through. And even if such stories are more rooted in perception rather than reality, the fact is that the very presence of such concerns among a majority of Americans will have lingering negative effects on economic performance.
Further clouding the economic forecast has been the recent run up in commodity prices, especially in the energy and agricultural sectors. Clearly, uncontrolled inflation is a concern for both policy makers as well as individuals. And while overall inflation remains under control (though creeping up), a sustained rise in energy and agricultural prices will inevitably constrict the U.S. economy’s performance. So how likely are the recent moves to remain in place? With respect to crude oil prices, there’s not a lot of fundamental support for $100/barrel prices since inventories are fairly high. However, optimism over global economic growth and instability in the Middle East has added about $15 to $20/barrel to prices. I don’t see this premium as sustainable unless things really get out of control on the geopolitical front. It’s a possibility, but not very probable in my opinion.
Agricultural commodities, especially cotton, corn, and wheat, have seen their prices move in historic scale over the past six months. As with crude oil, concerns about dwindling supplies due to improving global economic performance are underpinning much of the recent of spike. Adding additional fuel to the fire is the momentum effect. Investors are clamoring to buy up commodities in an attempt to capture some of the impressive gains that have been seen of late. This has brought a wave of capital that is disproportionately large to the markets they are buying into. Whether they are ETFs, managed future funds, or hedge funds, this crush of new money into the agricultural markets has been largely focused on the buy-side of the ledger, thereby giving each market an inherently upward bias. As such, prices are simply disconnected from fundamentals. In many ways, this is the same phenomenon that we saw in crude oil a few years ago. And just like crude prices dropped sharply after their historic run, so too will this be the case with the ags. I have no idea when this reversal will take hold, but it’s clear to me that there’s a lot more danger associated with owning agricultural commodities than there is staying away from them. Aggressive folks, of course, could play this from the short side, but momentum is a tricky beast and very adept at running shorts from their positions.
Since I’ve talked a lot about what I don’t like, here’s one market I do like: gold. After being negative on the yellow metal for so long, I finally came around to the bull camp in mid-January. Having held numerous technical levels, gold’s price action has been nothing short of impressive and, as the last few weeks have shown, it is still among the markets that investors turn to when things get dicey. Considering the growing threat of inflation within this uncertain environment, gold is primed for another round of investor euphoria. In months/years past, it is possible that U.S. Treasury securities could have garnered a significant portion of the ‘flight to quality’ trade, but with the general direction of interests rates looking up and QE2 efforts winding down, it seems likely to me that investors will opt for gold rather than Treasuries, thereby adding additional fuel to the bullish fire. I like using a security like GLD or IAU for gold exposure since they are directly tied to bullion prices and, therefore, little tracking error. Some would suggest that buying shares of gold miners would be the preferred way to gain exposure, but, in my experience, these shares often trade more in-step with the general equity market rather than with bullion prices. As such, there’s a level of risk that’s not worth taking on by owning the miners.
And with that FT is back. It’s been too long since I last said……
Until tomorrow……
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