Markets Open the Year on a Note of Optimism, Stocks Rise Around the World

On the first trading day of 2011, markets were showing an optimistic performance, with stocks around the world ending the day higher, the dollar gaining against most of its peers, while gold rises once again above the 1410 level. Gold has been testing these levels for almost two months now, and a breakout to either direction should easily bring sustained momentum. We cannot disregard the possibility of a solid correction if the Chinese authorities signal too much pessimism about the performance of the economy, or if the Eurozone sovereign debt worries return without finding a decisive commitment from the Germans. But on the whole, the trends are being determined by the Federal Reserve and its anticipated bond purchases, which creates optimism about the global economy, boosts commodities, and of course gold too, which has its own additional reasons. For as long as the current mild atmosphere continues, we think that the present state of affairs in the markets will be maintained, and gold will continue to appreciate.

On Friday we will have the NFP release, so market focus will be on the numbers, but this piece of data is clearly not as dominant or powerful in the minds of traders as it used to be for much of the past decade. Instead, what everyone seems to be focusing on is clearly the Fed`s stance, partly because it is understood that the private sector is not in a position to create the necessary momentum in the jobs market, and partly because stock prices are nowadays driven almost entirely by inflation and risk expectations. That is not to say that growth will not pick up as well, but there is a difference between building a car factory for the middle class and building an empty city of skyscrapers in the middle of an empty desert (of which the greatest experts live in China). Both are recorded as growth, but whether they are the same kind of growth is a matter of debate. As such, NFP does not have the kind of relevance that it had when everyone believed that data and economic activity drive stock prices. The Fed is easing, and easing is good for U.S. stocks, so they appreciate.

In any case, the U.S. is performing better, having been smashed earlier in the crisis on the implosion of the real estate bubble, and the cleanup process is naturally less painful than the contraction that precedes it. Reflecting this, Bloomberg reports that investors are demanding a smaller premium to own U.S. corporate bonds than global company debt at 166 bps vs. 169 bps. for the latter. We think that this trend will continue for another reason apart from the better U.S. outlook. We believe that in the coming years home bias among speculators will increase, as the international political environment becomes difficult and cloudy, protectionism becomes the new fashion, and capital controls are introduced or tightened around the world. This is only a natural, corrective reaction to the liberalism of 1990-2008, and it probably does not signify a permanent reversal, but clearly, from a speculative point of view, it does imply that U.S. stocks will do better as the U.S. transforms itself, painfully, to a more balanced growth model with a heavier emphasis on exports.