The Show Must Go On:

“Modern capitalism has no purpose except to keep the show going” – Joan Robinson

Few people are brave enough to predict the market we are in right now over the medium term. There are too many contradictions and doubts about the fundamentals that govern markets, and it comes down to herd mentality in such situations. Equity markets have not sold off, and this makes for a truly enlightening study on investor psychology. Nothing seems to matter but interest rates. All the other news flow is superfluous, even if it is related to revolutions and nuclear meltdowns.

The current situation in Japan is still not under control. The Fukushima nuclear plant continues to emit waves of nuclear radiation, as the market capitalization of TEPCO has fallen bellow $1 trillion. There are definitely some unaddressed supply concerns that the developed world will have to take note of as a result of the productivity slowdown in the aftermath of the Japan disaster. Meanwhile, the situation in the Middle East also remains far from solved, and yet investors seem confident that the crisis is on its last legs. Oil prices have stabilized just above $100 for now, an indication that investors perceive less risk to oil supply in the coming weeks. All this confidence is coming amidst Obama announcing that he is not ruling out arming the Libyan rebels. Seems a little bit like what America did to Afghanistan when Russia was in control? There is no end game in sight if one looks at the middle-east situation based on historical perspective

The S&P 500 closed on Tuesday near one of its favourite levels of resistance at 1320. This upward surge from 1279 (after the initial post-Japan sell off) has been driven by no fundamental news. The housing slide in America continues to be worrisome- with the Case-Shiller 20-City Home Price Index falling 3.1% from year ago levels. There are supply concerns faced by auto manufacturers as a result of the Japan disaster, and unemployment has not witnessed any great slowdown. Likewise in the case of the Eur/Dollar, the risk on trade for the dollar continues through to this week with the currency pair trading above the pivotal 1.4 level.

Meanwhile, the Euro-zone continues to battle credit downgrades and risk aversion in the bond markets, even as equity markets remain calm. The Dax is nearing its key 7000 mark, and the FTSE is near 6000. Both these levels are important in assessing how much optimism is priced into the markets, and as they are crossed, the risk on trade is definitely on. Predictably, following from the pattern of equity markets in America and Japan (Nikkei comfortably above 9000), the European equity markets are not bothered by socio-economic fundamentals.

The yields on the 10 year German bonds (bunds) are within 3 basis points of the most in 14 months. This makes sense since there is clearly going to be an ECB rate hike in the very near future (next meeting is on April 7^th). The other concerns in the Euro zone are of course the credit ratings of Portugal and Greece which were downgraded once again by S&P to BBB- and BB- respectively. Now Portugal’s rating is one notch above junk status. Does not seem like thrilling news for equities at the outset does it! Furthermore, there are also political concerns in the Euro zone , with the governments in France and Germany facing political uncertainty. Merkel and Sarkozy have both lost in regional elections held recently in their countries. There seems to be a resurgence of socialist political power in the Euro zone and perhaps befittingly so given that austerity is being promoted by the right wingers.

So what does one do in a situation, where we remain in a bear market in the sense that with every jolt to the economic structure of the world, there is a knee-jerk reactionary sell off, and commodities remain expensive? Equities seem destined to remain in a sideways trend for some time to come, and as I have been pointing out all through this year, June is the key month for the markets. Given that low interest rates are probably the sole drivers of the equity markets as of today, QE3 is looking all the more probable.