Market Outlook | September 16, 2013

“Art is making something out of nothing and selling it.” Frank Zappa (1940-1993)

Fed’s selling points

The central bank gears up to make its selling points as investors wait for the artful messaging. As highly expected by consensus, the Fed is looking to scale back its stimulus efforts of purchasing bonds (treasuries and mortgage-backed securities), which provided cheap money and fueled assets. The timing for this is supported by an “encouraging” economic environment and indicators that a stimulus is less required ahead. Sure: That’s more or less the driver of this much-anticipated taper that’s been long awaited since the revival of this bull market. On the bright side, no one will argue this is a powerful recovery for stockholders and those tracking corporate earnings.

Amazingly, the issue not to be dismissed in this shuffle is the lack of meaningful impact of QE into this real economy that’s created mainly part-time jobs and is expected to grow around 2% GDP. A step back from the jargon and day-to-day psychology begs the question: Is the central bank effective in providing an economic boost, beyond appreciating stock and real estate markets? Complex explanations and crafty language aside, the Federal Reserve should acknowledge that the economy is not as rosy as desired. Importantly, some wonder if the Fed is admitting that the stimulus effort has run its course. Otherwise, the self-promotion of success in reviving the US market might result in a mixed response.

Past and present

Meanwhile, the fifth year anniversary of the Lehman Brothers collapse had a few in a reflective mode this weekend. There is general agreement that the post-crisis management has been successful in providing financial system stability. Thus, we all wait for the explanation this week in what is always a market-moving event – even if baked into forecasters’ estimates. Reactions are hard to predict and this vibrant bull market (year to date: S&P 500 up 18.4% and Nasdaq up 23.3%) continues to test its upside potential. Surely, the stock market is seeking other good news catalysts for the months ahead. Odds suggest that the end-of-stimulus period may lead to the disruption of current trends, and that’s more than reasonable at this junction. Not to mention, ongoing budget discussions in Congress and the guessing game of the next Fed chairman create additional market buzz. Perhaps, these uncertainties are candidates for an eruption in volatility. In some ways, the corporate earnings environment hasn’t fully peaked yet, but concerns are legitimate as ever.

Speculators’ dilemma

An explosive stock market supported by increased capital inflow creates confidence, inviting people to pile on. The decimation of commodities, primarily weakness in metals, reinforces that stocks are a better alternative. Similarly, a sell-off in bonds reiterates the ‘great rotation’ theme that’s been thrown around and realized in practice. “U.S. bond funds saw $30.3 billion in redemptions this month through Aug. 19 – the third-highest on record, according to a report this week from TrimTabs Investment Research.” (Bloomberg, August 23, 2013). As US equities continue to gain traction, the asset is unofficially becoming a safe haven. Yet, as we saw with gold and treasuries, safe havens are not quite “safe” from nasty turnarounds. As the autumn months approach, it’s natural to think about severe declines in the past, as well as irrational behaviors that persist beyond collective expectations. Claiming stocks are safe is overly ambitious and potentially too confident. Perhaps, that’s the mental game that challenges investors, given the lack of alternatives and complacency that follows well-acclaimed rallies.

Article quotes:

“The top 1% of earners also took in a whopping 95% of whatever gains were made in the recovery from the recession, and the top decile took in 50.4% of 2012 income. (Note: The analysis didn't take into account health benefits, unemployment, or Social Security for the rest of the population, but we can probably assume those wouldn't greatly upset the gap between richest and poorest in this country.) [Emanuel Saez, University of California, Berkeley economist] gives us the detailed stats: From 2009 to 2012, average real income per family grew modestly by 6.0% (Table 1). Most of the gains happened in the last year when average incomes grew by 4.6% from 2011 to 2012. However, the gains were very uneven. Top 1% incomes grew by 31.4% while bottom 99% incomes grew only by 0.4% from 2009 to 2012. Hence, the top 1% captured 95% of the income gains in the first three years of the recovery. From 2009 to 2010, top 1% grew fast and then stagnated from 2010 to 2011. Bottom 99% stagnated both from 2009 to 2010 and from 2010 to 2011. In 2012, top 1% incomes increased sharply by 19.6% while bottom 99% incomes grew only by 1.0%. In sum, top 1% incomes are close to full recovery while bottom 99% incomes have hardly started to recover.” (Fast Company, September 12, 2013)


“The inability of credit rating agencies to anticipate sovereign-debt crises and the tendency to overreact once financial difficulties have piled up are well-known phenomena. Ferri et al. (1999) show that the downgrades by Moody’s and S&P exacerbated the Asian crisis in 1997. Examining the Great Depression, Gaillard (2011) and Flandreau et al. (2011) find that major credit rating agencies did not lower sovereign credit ratings until 1931. The ratings assigned by Fitch, Moody’s, and S&P to Eurozone members since 1999 illustrate these chronic shortcomings. For example, no Eurozone country was downgraded by Moody’s during the 1999-2008 period and none was upgraded by this agency between 2009 and mid-2013! More worrying still is that Greece, which was forced to restructure its debt in February 2012, has been the highest-rated defaulting country since sovereign rating rebounded in the mid-1980s. The Hellenic Republic was rated in the single-A category until June 2010 and in the investment-grade category until January 2011 by at least one credit rating agency. Since 2009, credit ratings have persistently lagged behind credit default swaps. Although hardly surprising – given that markets can instantaneously incorporate new economic and financial information – these findings are valuable for policymakers. In particular, they support the view that the credit ratings assigned to Eurozone countries have been more flattering than expected and that credit default swaps may simply be too volatile to be used for regulatory purposes.” (VOX, Norbert Gaillard, September 9, 2013)

Levels: (Prices as of close September 13, 2013)

S&P 500 Index [1687.99] – On two previous occasions this year (May and July), the index struggled to hold above 1680. This time around, the question remains whether surpassing 1680 and holding above 1700 is a sustainable move.

Crude (Spot) [$110.53] – For several weeks, crude has traded between $105-$110. Its momentum seems to be weakening after an explosive run from April to August 2013. Over the past three years, reaching above $110 has proven to be highly challenging for bulls.

Gold [$1328.00] – The $1400 range is proving to be a key resistance level. The recent recovery is pausing, showcasing the ongoing downside established about a year ago.

DXY – US Dollar Index [81.36] – In the last seven trading days, the dollar has reversed its trend. It remains in a neutral zone for intermediate-term trend seekers.

US 10 Year Treasury Yields [2.88%] – In November 2012 and May 2013, investors settled on 1.61% as the low point for long-term rates. On the other hand, in 2009, 2010 and 2011, the high point stood somewhere between 3.50% and 4%.


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