Over the past few years, the global economic turmoil and European debt crisis led investors to a "flight to safety” in the bond market, inflating bond prices in several developed countries and mainly the U.S. However, a shift into equities and other risk-sensitive assets might finally be at hand.

Fed Boosts Equities

The Federal Reserve attempts to suppress treasury yields and stimulate the economy and the housing market after 2008 crisis succeeded in channeling capital into equities, triggering a rally that extends to nowadays, as professional investors search for yield in a global zero-interest rate environment despite the higher risk it accompanies in an uncertain global climate.

Still, the post-crisis rally in equities failed to attract the normal retail investor and many other skeptical investors, who remained on the sidelines in anticipation for more clarity over Europe and global growth prospects which kept huge amount of cash on the sidelines. This idea was well supported by the noticeably lower-than-average volume levels during this period.

The steady downtrend in volume levels indicated less contribution in equities, which made many analysts skeptical over the sustainability of the bullish trend, however, markets continued to grind higher, forcing a reconsideration or redefinition of earlier assumptions on the relationship between volume levels and security prices.

Improved Global Outlook, Sentiment

Two main tail risks for the global economy have diminished. First, the euro zone break looks less and less likely, as effort exerted by the European Central Bank (ECB) and European governments succeeded in stamping in their determination to end the crisis.

The ECB has had a major role in lowering bond yields on peripheral countries by implementing three main programs.

1) Long term refinancing operations (LTRO) which provided extra liquidity to banks through cheap loans.

2) Open Market Operations which promised to conditionally intervene in bond markets in order to suppress yields on troubled countries.

3) Boosting ESM to give countries extra liquidity if needed and reduce the default risk.

The second risk is a global recession; this has been reduced although it remains a possibility. However, Improvement in United States economic outlook, as signs of recovery in the housing market, improvement in the services sector activities and durable goods orders, ultimately resulted in better-than-expected economic growth in the fourth quarter of 2012.

Nevertheless, the recovery remains gradual, in-line with the expected trend within the recent range, and it is not expected to swiftly accelerate in the near term. This would keep the FED on hold and will compel it to continue injecting money through QE, especially when the government embarks on fiscal tightening over the years ahead as it strives to cut deficit.

China is back on track, the fourth quarter GDP jumped to 7.9 percent, up from 7.4 percent in the third quarter of 2012, fixed asset investments, industrial production and retail sales have been recovering since September, while the new government may start to widen the base of domestic consumption through economic reforms.

Currency Wars

While U.S., Japan, and to a certain extent, the United Kingdom enter the battlefield of currency devaluation in attempts to boost growth and exports, the European Central Bank seems to be heading in the opposite direction, or at least looks rather unconcerned about the currency in the meantime. The European central bank has a priority of bringing back confidence to the zone.

On the other hand, the U.S. and Japan adopted an aggressive approach of flooding money into the system, as a weaker currency is mandatory to the health of their economy.

Possible Effect on Asset Classes

Equities : Given the above assumptions, and if the trend would persist, investors will maintain moving money back into equities, where the latest reports suggested Equity inflows surged to multi-year high. Equities could be the ultimate destination for capital and volume levels to start picking up and moving higher again extending the rally and indices could see new all-time highs over the next medium term.

Although I am constructive on equities, what concerns me is the major euphoria over the current trend in stock prices, as sentiment turned extremely bullish, which makes a downside correction possible in the near term, a correction of 5 percent could provide a good opportunity to re-enter.

Technical   - DOW:  The index is hovering below the 13912 key resistance and 1.271 Fibonacci extension of the latest bearish wave, 350 points away from the all-time high recorded in 2007 at 14266. 13912-resistance coincides with the main ascending resistance shown on the weekly chart above, and that’s makes a technical correction likely from current levels towards 13500. However, whether we get a correction or not, the technical picture requires a break above 13912 for the bullish wave to continue; towards the next upside target at 14266. Above 14266, the index will find new key levels within an uncharted territory, possibly 14760, and 15000. 

The medium term bullish trend will remain intact so long as 12775 level is holding back corrections.

Gold : If the economy continues to improve in line with the expected trend, the FED will come at a step closer to withdrawing money back from the system. And while the government applies fiscal reforms and relative tightening, gold will probably lose grounds to other risky assets as money flows into higher returns.  Nevertheless, on the longer run, gold will be the ultimate hedge against inflation when the quantitative easing influence on inflation levels kicks in, triggered by economic recovery.  

Technical : Gold has been moving sideways since recording September 2011 record high at 1920.00,  the technical picture suggest a continuation of the current bearish wave at least towards the bottom of the range at 1525.00 area, as price is trading within a clear descending channel, only a break above the channel and 1700.00 resistance would suggest another leg higher probably towards the top of the range at 1800.00, however doesn’t negate the sideways bias. Only a break above 1800.00 could point to another run towards 1920.00. On the other hand, a break below 1525.00 will signal a serious selloff.