It’s Back to the Future for the markets. Last week, both the Dow and the S&P traded at five year highs with the Indices hitting 14,000 and 1500 respectively. Every time the US market trades at a multiyear high, fears of a pullback descend. Keep in mind however that back in 2007, the US unemployment rate was 4.7%, the 10 year US Treasury yield was 4.68%; both indicators (as we now know) of an overheated economy at the top of the economic cycle. Today, the 10y US Treasury yields 1.98% and the unemployment rate is at 7.9%, both far from a cycle top. Downside risk also remains supported in the medium term by an extraordinary mix of central bank actions and fiscal policies we have seen thus far and they are set to continue. So what could go wrong? The lifeblood of this rally can be traced back to Europe and ECB President Mario Draghi’s actions and July 2012 speech, it is therefore imperative for Europe to resolve the upcoming macros issues favorably – the Italian elections, the future of Cyprus in the Eurozone, Spain’s budget, and the negotiation of Ireland’s existing bailout package. We may have to contend with a volatile February as US budget sequestration and Italian elections loom, but the risk remains to the upside.
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