Market Outlook | March 18, 2013

“True genius resides in the capacity for evaluation of uncertain, hazardous, and conflicting information.” (Winston Churchill, 1874-1965)

Optimism confirmed

The relative edge of the US financial system is showcased not only by the vigor of the post-crisis recovery, but also by the never-ending weakness of the European financial system and the ongoing catching up that is required by emerging market economies. Of course, this is not to say the economic or financial strength of today will stay the same in the next 10-15 years. Importantly, in dealing with the present and the known, this theme of America’s comparative edge in this interlinked world is surely playing out in many ways. Also, the potency of the robust US financial system is not to be confused with satisfying or glorious economic (labor, wages etc.) strength for all. Certainly not. Corporate earnings (around all-time highs) should not be confused with labor and housing market performance. Yet, in an overly critical and at times sensational environment of instant opinion sharing and news making, one should try to maintain a clearer picture. Today, the gap between perception and reality is very narrow when evaluating the relative attractiveness of the US financial system. This stretches beyond cliché, as the markets have spoken loudly to back up this quantifiable reality.

To start with the obvious, the US markets have made headlines as the legendary Dow Jones index’s all-time high achievement is often cited for those who still care to listen. Meanwhile, the S&P 500 index flirting within inches of all-time highs is in the mind of practitioners, traders and investors of all kinds. That record, set in October 2007, serves as more of a symbolic rather than tangible reason. Doubters and doomers are less hesitant to fight on the inevitable rally. Of course, confusing the stock market strength with the overall economic status is dangerous, as stated too often. Now in the fourth year of a bull market, participants should welcome reasonable skepticism, and fear is deeply discounted these days, in which a mild reversal would be less surprising to most.

Similarly, the neglected US dollar is back from beaten-up levels, mainly by outperforming other currencies in the last six month. US 10-Year Treasury Yields have fought back to 2% and mild hints of a Federal Reserve change of plans on quantitative easing suggests the US economy has recovered from intensive care. Yet, there is a mystery to the real economic growth and there is fragility to the current confidence buildup. Nonetheless, in this dichotomy, US assets have benefited the most.
Re-awakening

Within the celebratory climate for risk takers in the US, this weekend’s attention quickly shifted toward revisiting the Eurozone crisis via headlines from Cyprus. Initial discussion of a one-time levy on depositors (6.75% or 9. 99%), as in a penalty on all savers for the nation and the Eurozone, sent shockwaves through the financial community. The terms are being negotiated, but the message sends all kind of damaging signals. Perhaps, the real worst-case scenario is for a complete banking collapse, but the thought of a levy alone is not easily palatable Now this deliberation has begun and is likely to result in a suspenseful decision.

This weekend, chatter offered a big-picture reminder that the European crisis repair never evaporated, despite the recent perceived stability in Europe. And “too big to fail” is a concept that’s alive and kicking globally, and playing out in different forms and schemes. In that sense, crisis-like themes are back, despite attempts to ignore the systemic blunders. Bailout (or bail-in) and the consequences of fallouts are not as uncommon as pre-2008. Fairness to stakeholders is another heated debate and is at times lost in the shuffle. The ultimate fear instantly points to a run on banks; therefore, putting out fires is the preferred short-term solution. For now, the final result is unknown, but the speculation is in full gear. Clearly, these dim realizations leave a bad taste that opens up potential rational and irrational fears in market behavior. Eventually, if and when cooler heads prevail, markets will recognize that Cyprus accounts for 0.2% of the Eurozone’s GDP.

Piecing the puzzles

We’re seeing overheating markets on one end, while investor confidence in US equities keeps growing. This may smells like trouble when one is too comfortable, at least for a moderate price correction. Then there is the sensitive and edgy crowd ready to react. The reignited Eurozone crisis can stir chatter and increase demand for “safer assets.” Gold bugs are eager for price appreciation; the flight to safety should benefit US liquid assets, as seen in various past episodes. After all, volatility is at a multi-year low. Plus, one can easily find suppressed negative headlines that are poised to brew. At that point, a slight catalyst can embark into a spring sell-off. Plus, the S&P 500 Index has gained more than 16% since mid-November 2012, in a mostly uninterrupted manner. Chart observers have called for a breather of sorts in broad markets, as winning streaks eventually end. Yet, the words “bubble” or “gloom-doom” are not so easily applicable and fail to fully describe the current dynamics. Thus, dealing with and embracing the conflicting market signals is the practical way to manage risk.






Article Quotes:

“Indian refiners, which are waiting for an order from the oil ministry on whether to stop buying Iranian cargoes, are discussing annual term contracts with Saudi Arabia, Iraq and Kuwait for the year starting April 1, the people said this week, asking not to be identified because the information is confidential. While the volume hasn’t been set, the Indian companies have been told there is enough supply to cover the loss of Iranian crude, the people said. The assurances reduce the risk of disruptions to oil supplies for Asia’s third-largest economy as it seeks to cut fuel subsidies and narrow its budget deficit. They are also evidence of how global penalties against Iran because of its nuclear program are squeezing the nation’s revenues. At current prices, Iran stands to lose about $11.5 billion in sales annually if India stops buying its oil. … Iranian oil shipments advanced 13 percent last month to 1.28 million barrels a day even as the U.S. implemented sanctions that complicate sales from the Persian Gulf country, according to the International Energy Agency. Iranian crude production rose by 70,000 barrels a day to 2.72 million barrels a day in February, with the increased output going to China and India, the Paris-based adviser to 28 oil-consuming nations said in a report today.” (Bloomberg, March 13, 2013)


“With inflation looking like more of a threat to China than unemployment at the moment, China may have no other choice than to revalue CNY upwards vs. USD. China's consumer prices registered a 10-month high in February of 3.2% year-on-year, but more seriously in terms of popular discontent potential, food prices rose 6%. That's partly down to China's New Year festivities. But flows of speculative capital driven by foreign central bank QE programs could see China's inflation levels pushing higher. The magnet for that hot money is partly because CNY has risen in value pulled up by its USD peg. According to the People's Bank of China there was 684 billion CNY ($109 billion) worth of foreign currency exchanged in January, a record for a single month. Large inflows of hot money can spur imbalances in China's economy as it feeds the already significant shadow banking system and speculative activity in real estate and commodities, making them more expensive for industry and households. China could simply try and clamp down on those capital inflows and that's still a possibility. But it has porous capital controls and the authorities want China to become an international finance center and for the CNY to one day become a reserve currency. Enforcing stricter capital controls would be a retrogressive step in terms of achieving those objectives. The downside of allowing CNY to appreciate, especially against USD, is that it will make many of China's exporters uncompetitive and that will create unemployment in the coastal cities. Also, rebalancing toward a consumer driven economy and more value added activity still has a long way to go.” (Futuresmag.com, March 13, 2013)


Levels: (Prices as of close March 15, 2013)

S&P 500 Index [1560.7] – A few points away from the all-time highs of 1576.09 (intra-day highs). Positive momentum lives on in the ongoing bullish run, but mild pullbacks seem more likely in weeks ahead.

Crude (Spot) [$93.45] – Early signs of re-acceleration are developing as the commodity attempts to reach back to the $98 range. Currently, trading is in a neutral area.

Gold [$1586.00] – Buyers have shown recent interest closer to $1550 levels, while sellers’ appetite begins to wane at $1750. Gold is due for a short-term recovery closer to $1650.

DXY – US Dollar Index [82.69] – Holding steady above 80, which showcases further legitimacy to the 15% appreciation since May 6, 2011.

US 10 Year Treasury Yields [1.98%] – Staying above 2% remains a common challenge and again that leap will be tested.








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