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"Bond Substitutes" Have Fallen Victim to the Now "Ususal Suspects' (Fed Tapering)

We are "re-opening" Soos Global's blog-site using Google's "Blogger" app. For the past few years, Soos Global has been broadcasting its views on SeekingAlpha.com and in published articles on Morningstar.com. Going forward, we expect to centralize all of our market commentary onto the new site and to encourage our readers to participate in making this space a center for thoughtful, interactive discussions on global markets, geopolitical events, corporate news, economic insights and portfolio ideas.

We look forward to lively (often accented with a bit of humor) relevant and meaningful dialogue!

Best,

Ed Leventhal
Founder & Chief Investment Officer
Soos Global Capital Advisors, LLC
Purchase, NY
www.soosglobal.com

While US markets (and the rest of the world too) wait for progress on our Fiscal Cliff negotiations, there are some trends going on in other regions that are worthy of note. As I wrote about in recent weeks, the international equity markets have had a 'stealth' rally since the summer, outpacing the S&P Index. This has been driven largely by a rebound in the Euro ever since Draghi's July speech in which he committed to 'do whatever it takes to save the Euro'. In addition, data coming of out China in the past few weeks have suggested that the pace of their economic slowdown is slowing, and in fact growth may be in a resurgent mode from current 7.7%-ish GDP levels.

I shared the following two charts in a recent email which shows how the int'l equity markets have bested the S&P since last summer, and yet, have only marginally outperformed the S&P on a YTD basis given how poorly the int'l markets did in the first half of this year.

(click to enlarge)

(click to enlarge)

This more optimistic market sentiment related to international equity markets has helped many US stocks that have large businesses in countries around the world. (Btw, that's primarily how I've been positioned for some time, rather than direct ownership). The point of most interest at the moment is whether int'l markets have gotten ahead of themselves with regard to pricing in better times ahead, or whether there's more room to run especially if many European countries can stumble their way out of recession and into slow levels of positive growth. The data, frankly, is very suspect!

Consider the following: The next three charts show various ways of looking at EuroZone (EZ) economic strength, particularly in the manufacturing sector. The PMI (Purchasing Managers Index) data, especially for New Orders, in the Eurozone, has been awful! Furthermore, lots of austerity lies ahead as an outcome of 'bailout' agreements and attempts to get fiscal houses in long-term sustainable order.

(click to enlarge) (Source: Markit)(click to enlarge)(Source: Markit)(click to enlarge)(Source: Markit)

Nonetheless, equity markets are seemingly pricing in relief that a 'crisis' has been avoided, and optimism that recessions can be a thing of the past, and therefore, corporate profitability will grow.

(click to enlarge)

To put things into longer-term perspective, consider this next chart which shows the same ETF over the past few years, which I annotated with highlights of the now all-too-familiar EuroCrisis.

(click to enlarge)

We are currently at equity market levels in Europe that are close to the peaks of mid-2011, just before the Portugal, Greece and overall banking crisis became inflamed. This certainly begs the question as to whether recent moves are overdone, or, alternatively, whether all global events collectively, (namely: China's hopeful resurgent growth, other areas of Asia too, Japan's upcoming election where the expected winner is promising the 'mother of all stimulus programs', the US where some form of Fiscal Cliff deal that would prevent crisis is anticipated) come together to promote economic growth, stronger corporate earnings, and in turn, higher equity valuations. The Fed, and other Central Banks, have certainly done their part to promote the latter view. The fiscal side of the equation, however, around the globe, is equally, if not more so, a headwind in the opposite direction.

How these divergent forces interact in coming months and quarters will be the ultimate defining answer to the question of over- or under-valuation…..the answer also impacted by the geopolitical risks that remain flashing on the radar screen (including Iranian nuclear program, revolution in Syria, protests in Egypt and elsewhere, North Korea's launch this past week of a rocket w/intercontinental range, and tensions in the South China Sea between China and Japan, Vietnam and others over ownership rights).

For now, I'm maintaining my cautiously optimistic view on equities, favoring defensive sectors and preferring indirect ownership of int'l markets. I also, on the heels of the Fed's move earlier this week, lightened up on long-dated USTreasuries…..my view being that by explicitly targeting an unemployment level of 6.5% and an inflation level of 2.5%, the Fed has encouraged market participants to react more aggressively and sooner than they might have when the Fed's plan was less well known and only referred to by long-term calendar metrics. As a result, with long rates so low, the risk of a more immediate sell-off in longer maturities in reaction to any data that suggests that the US is moving closer to either of the Fed's specific metrics, I believe, has gone up considerably. So with more asymmetry in the outlook, meaning, more likelihood that selloffs could be swifter and steeper than any 'flight to quality' rallies, I lightened up on the position.

In equities, a few names are under review, largely because the market has discounted them to levels where the valuations have to questioned relative to the company's medium and long term potential…..some examples include INTC (currently long), BTN (long) and NSC (no position).

(Please note: This article is solely meant to be thought provoking and is not in any way meant to be personal investment advice. Each investor is obligated to opine and decide for themselves as to the appropriateness of anything said in this article to their unique financial profile, risk tolerances and portfolio goals).

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Disclosure: I am long INTC, BTN.

Additional disclosure: Positions may change at any time without notice.