RCS Investments Market Forecasts (Begn-2012)

Read my latest macro outlook for an in-depth view of how I formulated my market forecast.  My previous financial market forecast can be found here.  Please read the disclaimer to your right.   Hope you enjoy the content.

S&P 500 & Risk Markets:

–Market Situation (Current Backdrop)–:  The investment environment is treacherous.  Mixed signals are omnipresent.  Heck even leading indicators aren’t making sense.

From a bullish standpoint, economic data continues to improve, raising hopes that the U.S. may be decoupling from the global economy.  Consumer discretionary stocks are less than 4% off their all-time highs (chart below).  Investors aren’t worried of a host of macro headwinds facing the consumer.  Furthermore, the bulls scored an important victory in the past week when copper broke out of its consolidating triangle to the upside.  All major U.S. indices are above their 200-day moving averages.  Furthermore, breadth remains strong and the Dow Theory points to further upside.

From a bearish standpoint, Treasury yields (I track the 10-yr) and Chinese equities (Shanghai Composite) have clearly decoupled from the S&P 500.  Other important indices for the global economy (South Korea, Taiwan) are not confirming either.  Eurozone sovereign debt yields (Greece and Italy in particular) remain uncomfortably high.  The wall of worry has disappeared.  Even the Dow Jones U.S. Business Training & Employment Agencies Index isn’t confirming the new found bullishness (disappointing job creation on tap?).

While I remain cautiously bearish, I have taken a more neutral stance in the past month.  You can see my updated portfolio allocations at the end of this post.

–Outlook (Short to Medium-term)–: While I would typically be neutral under the current investment backdrop, a worsening Eurozone crisis, slowing Chinese economy, and relatively bullish sentiment leaves me cautiously bearish.  However, upcoming events will have long-term bullish or bearish ramifications.  Below I illustrate the upcoming macro catalysts and potential secondary effects.

The elevated probability of both extreme scenarios in the first chart stresses the binomial nature of the investment landscape; whether Europe can resolve its issues is of utmost importance to investors worldwide.

Sentiment has become excessively bullish, considering the gravity of the macro uncertainties.  Investors may be buying on the belief that government authorities will do anything to resolve the lingering issues in Europe, or that negative events in the global economy aren’t likely to affect U.S. equity markets or the economy.  Given the difficulty of formulating a market-friendly solution in Europe and persistent troubles in China, it would be foolish to jump into risk with both feet at the current time.  Specifically, earnings from abroad make up 40-50% of the S&P 500.  Further turbulence abroad will negatively affect the index.  Furthermore, most companies have cut costs to the bone and margins are near record highs.  If margins revert back to the mean, revenues better step up.

Overall, risks remain elevated and staying in cash is the safest route until there is more visibility.

In the medium-term, a negative surprise in the global economy would bring a new round of global stimulus.  Sentiment may be extremely bearish, considering that the global recovery could be upended.  A new round of global stimulus would likely catch many off guard.  Note, that this scenario would first see markets drop precipitously for most of the year due to a Eurozone fragmentation and/or Chinese landing.

A positive resolution in the Eurozone would prove bullish for risk markets worldwide.  Business confidence would return, economies would stabilize, and the probability of a Chinese hard landing would decrease.  In this case, investments in hard-assets, such as commodities and precious metals, would prove prudent.  Investments in U.S. multi-nationals would also benefit due to growing Emerging Market economies.

Treasury Market/Interest Rates:

Outlook (Short to Medium-term)—:  Similar to my forecast on the S&P 500, Treasury prices will move according to a resolution in Europe and China in the short run.  A positive resolution in the global economy would have me alert for a possible end to the secular bull run and higher interest rates.  However, for the time being, I remain cautiously bullish given continued uncertainty.

Over the medium and long-term, the outlook is becoming clouded.  Here are both sides of the argument:

On the bearish end, I’m starting to see some love for the asset class; the wall of worry is slowly crumbling.  Moreover, China may need to sell some of its large holdings in U.S. government paper to bailout its banking system.  In the bullish case of a soft-landing and likely Yuan appreciation, government officials in the communist country won’t be buying as much paper as they had done in the past.  Finally, the Fed’s short-sighted strategy of QE may come home to roost once the global restructuring achieves escape velocity.  Growing demand from Emerging Markets and a re-shoring in the U.S. would result in increased demand, economic activity, and consequently inflation.  I covered this dynamic in the “Inflation” section of my macro outlook.

On the bullish end, continued deleveraging by the U.S. consumer and tepid economic growth will temper any increases in inflation.  Furthermore, if we were to have a double-dip recession, a deflationary mindset may dominate the consumer.  Sources of demand for Treasuries will continue to come from retirees, banks, and pension-funds.

—Keeping An Eye Out—:  China China China.  Once China embarks on a sustainable recovery driven by consumption, the secular bull in Treasuries will be done in my view.  On a more granular level, I’ll be looking at consumer inflation expectations as well as the job market and consumption.

Portfolio Adjustments:

Here’s my latest portfolio breakdown:

  • Bullish: 17%
  • Neutral: 52%
  • Bearish: 30%

You can see further detail at the upper right of this page.


This completes my financial markets forecast. My next update will occur around mid-May/early-June.

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