Weekly Update

2012 is very quietly turning into a very good year for the US equity markets.  With almost three quarters of the year in the books, the SPX index has risen roughly 16% so far this year.  If the index was to finish the year at this level, it would qualify as the 2nd best performance since 2003 and the 3rd best since 1999. If the current pace of gains were to be continued through the 4th quarter, the index would post a gain of around 21%, which would eclipse 1999, but still leave it just behind 2003 and 2009. What is really interesting is most investors don’t believe the markets are up much this year.

Of course nothing is guaranteed in financial markets and it may be that the market has run ahead of itself, only to deliver a painful pullback in the weeks/months ahead.  We definitely believe this is a possibility, but with the open ended QE3 from the Federal Reserve, we do not expect things to play out this way.  If the market does sell off it will likely be short lived, unless there is some sort of external shock.  The market was resilient in the face of significant pressures during the summer and now that governments are continuing to provide significant liquidity, this should provide some support to market prices.

Moreover, it is becoming increasingly clear to the global investor that the US equity market represents leadership at the current time and it is the domestically focused sectors within this market that have generally offered the strongest returns in recent months.  We would expect the quarter end allocation process by institutions to reflect this understanding with the top sectors gaining the most in the final weeks of the quarter.

Our greatest concern regarding QE3 by the Federal Reserve was that it was not only unnecessary, but may in the end prove to be harmful to the long term fixed income marketplace and cause a significant rise in inflation in the not too distant future.

Who Will Win The Election?

With the U.S. election right around the corner and the ongoing debate over whether Greece (or any other country) may leave the Euro, we thought we would talk a bit about prediction markets which track the so called "wisdom of the crowd" theory.

The "wisdom of the crowd" theory is the process of taking into account the collective opinion of a group of individuals rather than a single expert (pundit) to answer a question.  A large group's aggregated answers to questions involving quantity estimation, general world knowledge, and simple reasoning has generally been found to be as good as, and often better than, the answer given by any one of the individuals within the group.  The often-cited explanation for this phenomenon is that there is personal noise associated with each individual judgment, and taking the average over a large number of responses will go some way toward canceling the effect of this noise.

With the information age has come the ability to gather the "wisdom of the crowd" via prediction markets. The most well known of the prediction market websites is Intrade (www.intrade.com).  Intrade is a site that allows users to make predictions on the outcome of hundreds of real-world events.  Stock markets find the price of stocks at any given moment, and futures markets find the price of commodities at any given moment.  Prediction markets, like Intrade, find the probability of something happening - a predefined, uncertain future event.

While not always 100% accurate, the site offers a way to watch the fluctuations of probability for various future events.  Elections are one of the main events on the site and it is interesting to see the fluctuations from week to week.

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