Market Outlook | September 9, 2013

“Good judgment comes from experience, and often experience comes from bad judgment.” Rita Mae Brown (1944-Present)

Anxiety building

When the phrase ‘Septaper,’ the anticipation of a stimulus taper in September, begins to circulate in the financial circles, then one notices the obsession that’s reaching a new frenzy level. All guesses aside, this long-anticipated twist in the stimulus efforts has been on the minds of many, but for now, the timing remains only a popular guess. Interestingly, these days there is not much suspense in evaluating the success of quantitative easing. The stimulus efforts have not overly impressed many in creating plenty of full-time jobs to propel a robust economy. Escaping the post-2008 crisis and climbing back to some stability showcases some belief in central banker guidance.

Nonetheless, the expectations of QE as an organic growth-generating tool are questionable and surely awaken the skeptics. Plus, recent economic reports, including last month’s labor numbers, do not suggest an overheating economy, but are rather categorized as somewhat fragile and barely stable conditions. Thus, how can the Fed taper if the economy is not strong enough? In fact, another question might be better: If QE has not been successful in fueling a recovery in the real economy, then why should the end of QE cause suspense?

The timing of the taper is not the only concern. Amazingly, the reaction of a mostly expected event draws the suspense. This QE debate, combined with the next Fed chairman discussion and pending Syria, offers plenty of distractions from a known fundamental weakness. Nonetheless, one should not forget the inflection point that’s facing financial services that have stabilized mildly. Growth is scarce globally and government/political mismanagement is a potential risk. Both combinations are legitimate enough to cause concern, but it’s unclear if these concerns could spark a 2008-like panic.

Realization

Clearly now, there is the realization or long-awaited acknowledgement of the disconnect between the real economy and stock and home price appreciation. The acknowledgement of QE’s limitations is not only in participants’ minds, but also felt by the central bank conductors. The S&P 500 index is up nearly 16% in 2013, which showcases a bull market that’s still clinging and alive. Yet, the forecast for further positive corporate earnings is doubtful today versus last year. A wave of uncertainty looms, especially following this multi-year run. It’s not surprising that there is ongoing rotation into European stocks for now in anticipation of an over-valued US stock market. There is a potential shift that’s taking hold as investors seek bargains while looking ahead:

“Despite the risks, the fact European stocks remain cheap is encouraging more US funds to put money into the market, say strategists and investment managers. HSBC’s cyclically adjusted price earnings multiples are running at 11.4 times compared with an historical average of 14.8 times.” (Financial Times, September 8, 2013).

Comprehending fear

As we head toward the final stretch of this year, investors so far witnessed a collapse of commodities, sell-offs in emerging markets, increased volatility in developing countries’ currencies and, recently, a developing trend of bonds declining. Strangely, around the spring, US equities appeared like the temporary “safe haven,” as risk-taking was encouraged and key index performances enticed more global inflow. Now, if the status quo shifts too quickly, then a notable shift can take place. Whether emerging markets or commodities are the answer remains to be seen. The themes that suffered the most in 2013 might at first glance present the best risk-reward potential versus the established US equities. This answer is not determined. Yet, this synchronized global marketplace does not offer an insulated investment product. Therefore, expecting the unexpected should not be that strange during a fear-driven cycle.

Article quotes:

“Austerity in Europe has had a profound impact on the eurozone’s current account, which has swung from a deficit of almost $100 billion in 2008 to a surplus of almost $300 billion this year. This was a consequence of the sudden stop of capital flows to the eurozone’s southern members, which forced these countries to turn their current accounts from a combined deficit of $300 billion five years ago to a small surplus today. Because the external-surplus countries of the eurozone’s north, Germany and Netherlands, did not expand their demand, the eurozone overall is now running the world’s largest current-account surplus – exceeding even that of China, which has long been accused of engaging in competitive currency manipulation. This extraordinary swing of almost $400 billion in the eurozone’s current-account balance did not result from a ‘competitive devaluation’; the euro has remained strong. So the real reason for the eurozone’s large external surplus today is that internal demand has been so weak that imports have been practically stagnant over the last five years (the average annual growth rate was a paltry 0.25%). The cause of this state of affairs, in one word, is austerity. Weak demand in Europe is the real reason why emerging markets’ current accounts deteriorated (and, with the exception of China, swung into deficit). Thus, if anything, emerging-market leaders should have complained about European austerity, not about US quantitative easing. Fed Chairman Ben Bernanke’s talk of ‘tapering’ quantitative easing might have triggered the current bout of instability; but emerging markets’ underlying vulnerability was made in Europe.” (Daniel Gros, Project Syndicate, September 6, 2013)

“Chinese refiners will buy 28 percent less West African crude this month than a year earlier, the least in data starting in August 2011, according to loading plans and a Bloomberg News survey of eight traders. Shares of Frontline, which operates 32 very large crude carriers, will drop 38 percent in 12 months, the average of 14 analyst estimates compiled by Bloomberg shows. Those of Euronav SA, with 13 supertankers in its fleet, will retreat 24 percent, the forecasts show. Tanker owners are enduring a fifth year of declining rates as fleet growth outpaces demand. China’s preference for cheaper Middle East oil over West African supplies shortens voyages by 42 percent, effectively increasing the capacity of the fleet, says ICAP Shipping International Ltd., a shipbroker in London. That’s adding to changes in trade flows as the U.S., the only country that buys more oil than China, meets the highest proportion of its energy needs since 1986. ‘Falling shipments point to potentially one more bad month of earnings, which tanker owners could really do without,’ Simon Newman, the London-based head of tanker research at ICAP Shipping, said by telephone on Aug. 28. ‘To avoid an even weaker market, owners will need significant support from shipments out of other areas.’” (Bloomberg, September 3, 2013)

Levels: (Prices as of close September 6, 2013)

S&P 500 Index [1655.17] – Eclipsing the 50-day moving average and revisiting annual highs of 1709.67 remains a challenge. The last few trading days have produced a tight range between 1630-1665.

Crude (Spot) [$110.53] – Like in May 2011 and March 2012, crude oil is back up over $105. The last two years remind us of crude’s inability to hold above $110 for a sustainable period. For the third consecutive year, the question is asked again if crude can explode significantly above $110. Perhaps the unsettled Middle East is the wildcard, but the chart pattern suggests heavy resistance ahead.

Gold [$1385.00] – The last time gold made a run from $1200 to the $1400 range goes back to August-November 2010. The difference being that this time around, the recent move represented a recovery bounce following a severe drop from a cycle peak. Surpassing $1400 might be as hard as exploding to $1600. Unsettling markets may serve as a catalyst, but the natural bullish flow remains in flux.

DXY – US Dollar Index [81.36] – Since September 2012, DXY has not fallen below $79 but has not surpassed $84.75. Frankly, this is a tight range, suggesting that despite the recent currency volatility, the overall swings are not overly dramatic based on this index.

US 10 Year Treasury Yields [2.93%] – The jump from 1.61% (May 1, 2013) to nearly 3.00% today remains the key macro indicator thus far. Staying above 3% is mysterious for now, as participants wonder if the next range is around 3.00%-3.50%. Last time yields stayed in this range was in first half of 2011 before debt ceiling volatility.


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