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Correlations breaks for 2011

The stock market rally has entered a key phase, as the SP 500 has risen above the "golden cross" in weekly data, a resolutely bullish signal.This is the point where the 50- and 200-week moving averages cross.Although this is an indicator of a long-lasting bull trend, this signal does not necessarily imply stability.Nevertheless, it is likely to give rise to fresh inflows.In this respect, the latest ICI data suggest that this upsurge could encourage portfolio arbitrages among mutual funds in favour of equities.
As is well known, the various measures of investor sentiment are contrarian indicators.They have currently reached their most extreme levels in several months - which are signs of a potential fall .Nonetheless, supportive factors exist, first and foremost M&As and - above all - valuations.

Risk/volatility regimes rank the factors that influence the course of the stock market
.During periods of extreme risk, returns on equities are largely influenced by the macroeconomic news flow.Conversely, which is the case currently with the VIX close to its historical average, valuations confirm the trend in stock market indices during periods of confidence.
By using expected PERs drawn from the S&P, a calculation made on the basis of prices at the beginning of the year gives the following potential upside:EPS for 2011 at USD 95 (+13%).With a forward PER of 14.5, a target of 1,375 by the end of the year seems totally reasonable.The crucial question for asset allocation will be the simultaneous trend in other asset classes.
1. Will the dollar (DXY index) be adversely affected by this rise in stock market indices?The correlation between the dollar and the SP500 has been significantly and permanently negative for several years.A quick look at the chart below shows that this has not always been the case.A dollar boosted (or, at the very least, kept stable) by the comparative advantage of growth should therefore not necessarily be incompatible with a double-digit rise in stock market indices.This is one of my bets for 2010.

2. Until oil became a fully-fledged asset class, a rise in oil prices was supposed to have a negative impact on indices (rise in the input price and monetary policy tightening). Our commodity analysts are resolutely negative on oil in 2010, which at first sight does not bode well for equities.But it does not seem that a continuous rise in prices (oil and soft commodities), the resulting inflation and the associated monetary policy tightening in emerging countries would be any more positive for stock markets.Watch out for trend breaks!