Market Outlook | November 19, 2012

“Most quarrels amplify a misunderstanding.” (Andre Gide 1869-1951)

Collective pause

Digesting the market slowdown since autumn stirs mixed reactions and a desperate aim for clarity, as well. The catalysts of global stock market sell-offs range from various triggers such as weakness in corporate earnings, the slowing pace of a three-year bull market and some blurry responses to quantitative easing III. The combination of these factors alone would have been enough to cause a pause way before election results and the over-obsessive focus on “fiscal cliff” matters. Taking a look at the macro picture in the context of the business cycles is the puzzle that faces participants. At the same time, economic recovery, from a pickup in housing to positive signs in the GDP, requires further confirmation.

Gauging moods

Interestingly, a peak in risky assets also accompanies the stock market sell-off. The mid-September period triggered a peak in crude prices, decline in US Treasury yields and a mild strength in the US dollar. Perhaps it’s not a stretch to state that September 14, 2012 marked a vital macroeconomic day around the announcement of open-ended quantitative easing. Surely, beyond the political banter and never-ending European concerns, the Federal Reserve’s stimulus efforts remain controversial. Overall consensus expects this low-rate environment to continue for the next two to four years (according to a recent CFA poll). It remains unclear on the end of the low-rate policy; there is a debate that’s brewing within the Federal Reserve. A myriad of speculations will linger, but the stimulus efforts are viewed with increasing skepticism, especially by larger money managers. Perhaps, the Federal Reserve’s implementation of quantitative easing III may be too early to judge for now.

Growth search

Despite the negative climate generated by the self-fulfilling risk-aversion, the volatility index remains steady thus far. At least, the volatility index has not witnessed a dramatic spike that signals an all-out turmoil. Sure, the consecutive down days in equity markets are known easily to cause an emotional response, but that’s to be expected. Yet, the investor demand for growth themes and/or higher yielding returns remains in place regardless of accumulating noise that surrounds macro flux. The shift away from risky assets has been visible for several weeks, but there is no clarity on its longer-term impact. Interestingly, the less-than-stellar earnings have one positive angle for those desperately seeking good news. According to Bespoke Investment Group: “For the first time in three quarters, more than 60% of companies beat earnings estimates. This season, 60.1% of the 2,158 US companies that reported beat consensus analyst EPS estimates. While not great, at least it's a quarter-over-quarter increase.” (November 16, 2012).

In looking ahead to the first quarter of 2013, investors appear to shift their hopes for an emerging market recovery that can restore collective growth rates to desired levels. After all, the developing market is known to provide relative safety (at lower yields) rather than impressive expected growth rates in developing markets. However, resuming last decade’s trend of extraordinary growth is challenging for China and other nations. Similarly, the relative strength of the US market has been an appealing story for a while given the growing momentum. This creates a quarrel for money managers seeking to deploy capital. For now, global markets remain inter-connected, which in turn enhances the difficulty for money managers.

Article Quotes:

“Most of the weakness in state and local governments’ purchases apart from their spending on construction can be traced to a below-average rebound in tax revenues and the need to balance general-fund budgets, but additional pressure came from below-average growth in federal grants. The American Recovery and Reinvestment Act of 2009 (ARRA) authorized an increase in federal grants to states and localities through 2011; those grants helped support state and local purchases for a while, including in the final months of the recession, by raising the amount of assistance to states and localities above what it would have been otherwise. However, the winding down, beginning in 2011, of payments from that increase in federal grants was most likely a drag on the rate of growth of state and local governments’ purchases last year and in the first half of this year. In contrast, state and local governments’ construction spending was probably held back primarily by general budgetary pressures and by tight credit markets early in the recovery, because federal grants for capital projects in the current recovery have been in line with those during previous recoveries since 1959.” (Congressional Budget Office, November 2012).

“As Beijing is continuously prodded to distinguish its policies and engagements from that of the West in Africa, ‘image’ is of paramount importance. For China, keeping a carefully managed image in Africa will be critical to undercutting the arguments of neo-colonialism that are levied by its critics. The policy of non-interference has always been Beijing’s welcome answer to queries about its self-centered policy and economic gains in Africa. As the initial honeymoon is far spent with multitudes of Chinese businesses descending onto African soil, sections of African populations disagree with the image of China as a non-meddling altruistic partner; hence the display of recent anti-Chinese sentiments in places like Zambia and Sudan, and the increasing deportation of Chinese from countries like Angola, Ghana and Nigeria. To deal with these growing pains in Sino-African relations, and chart a different path from that of the West in Africa, Beijing has an inconceivable task of being both a responsible power that commends and chastises as well as a respectful partner that brandishes the policy of ‘no domestic interference.’ In maintaining this precarious balance, non-interference becomes a mirage since an increase in Chinese economic investments might come with temptations to help shape and sustain the requisite business environment needed for these investments to flourish. Finally, Beijing is currently dealing with a new generation of African leadership that is under pressure to embrace liberal democratic ideals and pragmatic economic agenda. Even though persistently described as a façade by the West, non-interference has variedly won the hearts of some African leaders who perceived it as a much-needed break from the quid pro quo relations with the West.” (The Diplomat, October 25, 2012).

Levels:
S&P 500 Index [1359.88] – Remains in a downtrend. Breaking below $1420, which set off further deceleration.

Crude [$86.07] – Bottoming process developing around $86. After a 16% decline, we will get a better idea of the buyers’ conviction and enthusiasm.

Gold [$1713.50] – The struggle continues to surpass $1800. A very early sign of deceleration is shaping up. However, gold’s behavior relative to other commodities showcases further strength.

DXY – US Dollar Index [81.25] – No major acceleration, but the decline in dollars’ value has stopped and is showing signs of turning the corner.

US 10 Year Treasury Yields [1.58%] – The four-month swing between 1.80-1.55% remains in place. Now the low end of this range showcases recent risk-aversion. Recent patterns suggest high odds of rising yields, as a move below 1.47% can enhance the deceleration.




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