Market Outlook | April 8, 2013

“Everything has been said before, but since nobody listens we have to keep going back and beginning all over again.” (Andre Gide, 1869-1951)

Hunt for a catalyst

Generally, over the last few weeks, there has been a search for negative news to drive markets lower. First it was the Cyprus dilemma, then it shifted to US employment numbers. Other catalysts (or a combination of the first two) await in these spring months. The resilient market is not “giving in” easily to day-to-day worrisome news – which is tiresome for the simple minded, challenging for the thoughtful planner and artful for the removed observer.
Digesting labor data

For a while, the doubts have lingered around this rising market, which caused many to await some breather or price correction. March’s labor numbers sent a unanimous sign of disappointment on Friday, since the employment result was significantly below analysts’ expectations. Of course, matching collective expectations is one issue, and judging absolute numbers (i.e., non-farm payroll) is another matter. Yet, it’s fair to say that job growth, which is a sample measure for the real economy, did not send a sign of noteworthy strength but rather a one-month reality check for all participants. Frankly, there is one trend that is not a fluke or a one-time event. That is the workforce participation rate, which fell to 63.3% – the lowest in 24 years. Although this is much discussed, the roots of this are vital in order to grasp the US trends. Here is one well-balanced explanation of the current status:

“There are three big explanations for why so few Americans are in the labor force: 1) The country is aging. 2) Men have been leaving the labor force consistently for 60 years. 3) More people are in school.” (Motley Fool, April 5, 2013).

The impact of the labor numbers, as usual, is an attempt to decipher the pace of recovery, the perception of economic strength, the potential influence required by the Federal Reserve and speculations on how one clue can impact future financial market behavior. As economists regroup to understand the nuance of the labor status, the markets are eager to express a view on interest rates and equity risk. For now, the economy is not quite collapsing, the job recovery is not close to overheating and the demographic trends of baby boomers are highly influential.

Commodities – trading vs. investing:

Since May 6, 2011, the multi-year run-up in commodities (CRB Index) has begun to weaken. A 22% drop in commodities in nearly two years hints at a new era, when buying and holding commodities for the long term makes less sense than last decade. In fact, gold investors are restless and impatient about the lack of movement and unconvincing status as a safe haven. Similarly, crude has not held its strength, especially when inventories are estimated to reach the high ranges. Copper has dropped for three consecutive weeks, emphasizing the lack of demand versus the available supply. The same applies for corn, where oversupply is contributing to lower prices. “The U.S.D.A. said in its quarterly grains report that corn stocks totaled 5.4 billion bushels as of the beginning of March, and that farmers intend to plant the most corn in nearly 80 years. Corn closed at $7.33 a bushel March 27, the day before the report came out.” (Associated Press, April 4, 2013).

Thus, the investment community is contemplating how to implement the risk of commodities into greater portfolios. This paradigm is shifting as the commodities optimism slowly fades. Also, the speculative nature of gold and crude is too much noise to manage on a day-to-day basis – especially when the returns are not steady and are below prior years’ expectations. Similarly, emerging markets (EEM) also peaked on May 6, 2011 and are down 16% since then. Surely, there was a strong connection between expanding emerging markets and increasing demand for commodities. Now the inverse may hold true in the emerging market-commodity relationship, in which both remain fragile despite this explosive US bull market that is near all-time highs.

Observing

The deep search for catalysts and new ideas persists as anxiety continues to build. Are markets extended? Is the labor recovery slumping? Is Europe overdue for collapse now? Are commodities worth abandoning? And what about other fiscal crises and governance risk? All these questions are circulating in the minds of many. To be fair, all these questions are nothing new. Thus, a self-fulfilling panic-like move may resurface, but building a logical argument in a not-so-rational market is challenging for all. That being said, patience and closer observation in the weeks ahead may be as rewarding as acting and reacting.

Article Quotes:

“The truth is that the responsibility for the euro-crisis is shared. For every reckless debt or there was a reckless creditor… The northern countries were all too ready to provide loans to southerners so as to be able to accumulate export surpluses. The northern countries’ banks involved in these lending operations managed to shift the loan losses to their respective governments. None was subjected to the bail-ins that will now be imposed on the debtor countries. The recognition that responsibilities for this crisis are shared would go a long way to making it acceptable for the costs of the adjustment to be shared among taxpayers in the north and south of the eurozone. The failure to recognize shared responsibility has led to the imposition of a bail-in template that increases the risk of banking crises and economic depression in the eurozone. When a banking crisis erupts, authorities have to weigh up two risks. One is the moral hazard risk that will emerge in the future when the banks are bailed out. The other is the immediate risk of an implosion of the banking system when bail-ins are implemented.” (CEPS, April 4, 2013).

“In China – and in Russia (and partly in Brazil and India) – state capitalism has become more entrenched, which does not bode well for growth. Overall, these four countries (the BRICs) have been over-hyped, and other emerging economies may do better in the next decade: Malaysia, the Philippines, and Indonesia in Asia; Chile, Colombia, and Peru in Latin America; and Kazakhstan, Azerbaijan, and Poland in Eastern Europe and Central Asia. Farther East, Japan is trying a new economic experiment to stop deflation, boost economic growth, and restore business and consumer confidence. ‘Abenomics’ has several components: aggressive monetary stimulus by the Bank of Japan; a fiscal stimulus this year to jump start demand, followed by fiscal austerity in 2014 to rein in deficits and debt; a push to increase nominal wages to boost domestic demand; structural reforms to deregulate the economy; and new free-trade agreements – starting with the Trans-Pacific Partnership – to boost trade and productivity. But the challenges are daunting. It is not clear if deflation can be beaten with monetary policy; excessive fiscal stimulus and deferred austerity may make the debt unsustainable; and the structural-reform components of Abenomics are vague. Moreover, tensions with China over territorial claims in the East China Sea may adversely affect trade and foreign direct investment.” (EconoMonitor, April 1, 2013).

Levels: (Prices as of close April 5, 2013)

S&P 500 Index [1553.28] – A four-year bull market run that’s back to 2007 levels now wrestles to keep up the momentum. After a nearly 6% run since February 26, 2013, a near-term pullback would hardly be surprising.

Crude (Spot) [$92.70] – After a very explosive run last month, crude affirmed its base is closer to $92 than $98. Buyers’ momentum continues to fade at $96, which has been witnessed on several occasions.

Gold [$1546.50] – Since December 17, 2012, gold is down nearly 9%. The adored commodity has re-established a new downtrend.

DXY – US Dollar Index [83.21] – Showcasing stability in the past few weeks. No major changes as the intermediate-term trend signals dollar strength.

US 10 Year Treasury Yields [1.84%] –After climbing above 2%, the yield has backtracked closer to 2012 year-end levels. The back-and-forth swings create a fuzzy trend. In the near-term, staying above 1.60% will determine the nature of activity and sentiment.




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