Market Outlook | September 3, 2013

“What convinces is conviction.” Lyndon B. Johnson (1908-1973)

Shakiness felt

One notices that skepticism never quite left the financial circles, even during the rising US stock market and some success in the confidence restoration projects both in the US and Europe. In fact, more time is spent on known concerns than unknown consequences, which explains the inevitable suspense. The one known worrisome issue is the lack of economic growth that stretches from China to the US to European nations. Collectively, the intellectual discussions of interest rate policy or currency management are left for prolonged dialogue. However, the weakening economic climate is visible even for the most casual observer, thus denting the confidence that’s been built since 2008. The painted picture of optimism, led by central banks, now needs validation and a further confidence boost, but that easing argument is losing its luster and anxiousness is building from different angles.

Emerging markets continue to witness sharp sell-0ffs, eroding confidence and causing unpleasant responses to risk-taking. Surely, this uncertainty in so-called emerging markets is not at the early stages, but the accumulating outcomes are difficult to ignore and clearly outlined in headlines.

“Investors worldwide pulled $2 billion out of emerging market debt funds in the latest week, the 14th straight week of outflows and the biggest withdrawals since June, a Bank of America Merrill Lynch Global Research report said on Friday.” (Reuters, August 30, 2013).
As a start, global economic growth is not visible (perhaps a global theme); thus, naturally, it creates all types of questions and knee-jerk responses. Notably, emerging market currencies have witnessed increased volatility, particularly in India, Brazil, Indonesia and Turkey. Entering a new season, the following is generally expected:

“The growth slowdown is a much greater concern than the recent asset-price volatility, even if the latter grabs more headlines. Equity and bond markets in the developing world remain relatively illiquid, even after the long boom. Thus, even modest portfolio shifts can still lead to big price swings, perhaps even more so when traders are off on their August vacations.” (Kenneth Rogoff, Project Syndicate September 2, 2013)

Thinking ahead

If skepticism is widespread and if the concerns are well known, then why not be a contrarian? Perhaps, seeking value in a disliked story is what should motivate risk-takers moving ahead. Already, a wave of fund managers has looked into Europe for bargains. There are signs of life in the Eurozone, although minor improvements:

“The recovery in the Eurozone manufacturing sector entered its second month during August. At 51.4, up from a flash reading of 51.3, the seasonally adjusted Markit Eurozone Manufacturing PMI rose for the fourth successive month to reach its highest level since June 2011.“ ((Markit, September 2, 2013)

Similarly, in due time, emerging market recovery may not be a far-fetched idea either. The list of uncertainties is building, which stretches from “taper” speculation to the pending debt ceiling debate and results of the upcoming German elections. More often than not, these pending events are the basis for a lack of conviction for buyers. As a quick reminder, EEM (Emerging Market Index) is 32% below its all-time highs reached in October 2007. It’s hard to claim that emerging markets are deeply overvalued for the growing crowd that’s afraid of further meltdown.

Managing suspense

Recent economics numbers and earnings result in the US have not created enough comfort for those judging on an absolute basis. Certainly on a relative basis, the US markets have shown strength versus other markets since the last crisis. Interestingly, until recent months, the inflow to US equity was picking up a tremendous pace. However, the ETF and equity fund outflow has picked up to multi-year highs in recent weeks. “U.S. ETFs saw $16.1 billion in redemptions through Thursday [August 29], representing the biggest outflow in one month since $17.1 billion exited in January 2010. The largest ETF was the main driver, as the SPDR S&P 500.” (MarketWatch, August 30, 2013).

The cautious approach is in full effect as gold has rallied from annual lows. This matches the declining investor sentiment as well, given the desperate search for good news. Capital is seeking shelter while fund managers are forced to put capital to work. To be overly bearish is not an overly unique view these days, as most known fears are already factored in. Being a daring bull might be less fashionable today than before. This is a deadlocked market that’s not overly cheap or overly euphoric, which puts one in no man’s land. For now, not overreacting is an asset when approaching an unsettling period ahead.

Article quotes:

“Canadian interest rates usually follow the interest rates of the U.S.…). So if U.S. interest rates continue to rise, it is very likely that Canadian housing prices will drop and defaults will go up. But two thirds of Canadian mortgages are insured by the Canadian Mortgage and Housing Corp. (CMHC), the Canadian version of Fannie Mae. CMHC is owned and guaranteed by the government. Thus the government will be on the hook, not Canadian banks. Canadians have therefore skipped a step: If (or, should we say, when) their housing crisis happens, there won't be any argument in the media about "too big to fail"; the government will take care of it. Jim Chanos of Kynikos Associates (who is not short Canadian banks), made an interesting point after Brian's talk. He is more worried about problems in Canada from incomes declining once the China-induced commodities supercycle ends — after all, Canada has benefited tremendously from it. To Jim's point, Canada reminds me of Australia, another beneficiary of the Chinese commodities party: Low-skilled people who used to work at McDonald's restaurants in Sydney or Canberra began moving to the west coast and getting jobs driving trucks at iron ore mines, instantly making more than $100,000 a year.” (Institutional Investor, August 8, 2013)

“Even with Wall Street’s help, Mexico is struggling to lure investors to its local-currency bonds as speculation the Federal Reserve will curb stimulus sparks an exodus from emerging markets. Mexico’s sale of 25 billion pesos ($1.9 billion) of five-year notes last week attracted the weakest demand since the government started using a group of banks in 2010 to help handle sales of new benchmark bonds. The bid-to-cover ratio, a measure of investor demand, was 1.02 times for the offering, which included participation by firms including Grupo Financiero BBVA Bancomer SA, Deutsche Bank AG and Barclays Plc (BARC), according to two people with direct knowledge of the transaction who asked not to be identified because they aren’t authorized to speak publicly. Investors have yanked $44 billion from emerging-market bond and stock funds since the end of May, according to data provider EPFR Global, on concern the Fed will reduce its $85 billion of monthly bond purchases as soon as this month. Yields on Mexican notes jumped 0.1 percentage point last week, five times the average in emerging markets, data compiled by Bank of America Corp. show.” (Bloomberg, September 2, 2013)

Levels: (Prices as of close August 30, 2013)

S&P 500 Index [1632.97] – Back to familiar levels from late spring/early summer after peaking on August 2nd (1709.67). In the near-term, a buyer’s appetite around 1640 can showcase the willingness for risk-taking.

Crude (Spot) [$106.42] – For more than two months, the commodity has traded closer to the $104 range, which is in line with the 50-day moving average. The long-term picture reminds us that crude is up more than 30% since November 2012. Perhaps, investors await a natural pause from the explosive run until the next catalyst.

Gold [$1407.75] – Clawing back to and around $1400. The inevitable bounce has taken place but the doubt lingers on the enthusiasm back to $1700. The perception of gold as a volatility hedge is also unclear in this run versus prior years. The 200-day moving average of $1468.71 is the next key target.

DXY – US Dollar Index [82.08] – Between summer 2012 and today, the index has traded within a tight range. Yet the swings have been too common recently, suggesting increased volatility in currency markets.

US 10 Year Treasury Yields [2.78%] – Attempting to surpass the 3% mark. The jump from 1.61% to 2.93% in a few months is noteworthy but questionably sustainable, given debatable signals of an improving economy.

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