Market Outlook | October 14, 2013

“Have no fear of perfection – you'll never reach it.” Salvador Dalí (1904-1989)

Perfection desired

Anyone worried about a peaking market or with a skeptical view continues to feel puzzled by the relentless positive momentum. Whether due to legitimate upside forces the mood remains cheerful rather than overly subdued, as the S&P 500 index is hovering near all-time high levels. Since the last debt ceiling debate in 2011, this smooth-sailing upside move seems all too perfect at times. Of course, ongoing signs of market strength and asset value appreciation in turn stir up renewed skepticism, which forces investors to buy downside insurance (or bet on volatility) as pundits loudly express a wide range of political outcomes.

“VIX (Volatility Index) option trading set a record volume day this past week, surpassing the old record by almost 400,000 contracts. 400,000 is the total volume on some light days, so that really is a significant beat on volume. Basically the volatility market went from ‘what me worry?’ to ‘worry!’ to ‘what me worry?’ again.” (CBOE, Options Hub, October 12, 2013)

Yet, are markets too numb to dissect unpleasant news? Or are investors pleasantly deferring bad news for 2014? Both questions are a daily debate for newsmakers or risk takers.

For now, risk-taking remains in style. Future conductors of financial markets are expected to keep a similar easing policy. Last week’s announcement of a Fed Chairman replacement removed one uncertainty. But other macro factors remain unknown. Clearly, status-quo preservation through QE has been a crowd favorite, as “addicts” are infatuated with relief rather than grappling with side effects. Whether we are seeing a justified rally or an overly jumpy news-driven rally, the stock market optimists are further encouraged by recent resilience to maintain a bullish perspective.
Yet, no market gain is safe or perfect, no policy is overly comforting and shifts can occur suddenly. Perhaps, this upcoming week is vital for capital preservation or aggressive speculators. Frankly, the stakes are too high in terms of witnessing a meaningful move, a contrast to the casual and steady nature of this not-so-quiet bull market. In fact, early signs of confusion are reappearing.

Bubble-like memories

To get nervous about a pending bubble versus identifying overly extreme conditions are two different matters. Rational minds could not ignore government uncertainties blended with earnings and potentially an exhausted multi-year run. Certainly, this autumn marks the fifth-year anniversary of the nerve racking “end of times”-like banking crisis. Memories might fade, but “bubble”-like thoughts resurface when dysfunction or distrust floods the airwaves. Somehow, veterans remind us that investor complacency has its dangers, but timing is still everything – hence the escalating drama and thrill that’s felt by traders, investors and observers alike. The unknown entices excitement, increases risks and forces digestion of nuances that can translate into market-moving factors. To claim we are at an extreme is not as clear. Thus, bubble symptoms can be spotted here and there, but overall we’re in a no man’s territory that makes it rather more edgy and confusing than opportunistic.

“It is not too often that you see a week where both bearish and bullish sentiment rise by three or more percentage points in the same week. In fact, the last time it happened was back in May 2009 just as we were coming out of the bear market. However, when you have a market where prices move on headlines or even rumors of meetings, you can't blame investors for being confused.” (Bespoke Investors, October 10, 2013).

Sluggish reality

Real economy hints continue to suggest a slowdown, which even the most optimistic observer cannot blindly ignore. Sure, markets are forward looking, but in reality, indexes are a measure of sentiment by participants with stake. Unlike voters who vote, shareholders who own shares express approval/disapproval via buying and selling. These days, selling has not been visible. In fact, global markets have shown liveliness in recent weeks. Yet, perception alone cannot erase nervousness felt by investors, business owners and policymakers. At some point, if the disconnect between the stock market and economic indicators grows wider, then the engineers of financial markets might lose additional credibility. For now, facing reality might be more vital than ignoring potential pain that’s felt by stakeholders in the global economy. The reality begins when the stock market reflects the not-so-rosy global growth picture. Then a collective regrouping can take place and new entry points can reemerge. A breather to reflect on current conditions is a reality that is inevitable.

Article quotes:

“Beyond the fact that spurring growth has a multiplicity of benefits, of which reduced federal debt is only one, there is the further aspect that growth-enhancing policies have more widely felt benefits than measures that raise taxes or cut spending. Spurring growth is also an area where neither side of the political spectrum has a monopoly on good ideas. We need more public infrastructure investment but we also need to reduce regulatory barriers that hold back private infrastructure. We need more investment in education but also increases in accountability for those who provide it. We need more investment in the basic science behind renewable energy technologies, but in the medium term we need to take advantage of the remarkable natural gas resources that have recently become available to the US. We need to assure that government has the tools to work effectively in the information age but also to assure that public policy promotes entrepreneurship. If even half the energy that has been devoted over the past five years to “budget deals” were devoted instead to “growth strategies” we could enjoy sounder government finances and a restoration of the power of the American example. At a time when the majority of the US thinks that it is moving in the wrong direction, and family incomes have been stagnant, a reduction in political fighting is not enough – we have to start focusing on the issues that are actually most important.” (Financial Times, Lawrence Summers, October 13, 2013)

“Euro zone countries will consider on Monday how to pay for the repair of their broken banks after health checks next year that are expected to uncover problems that have festered since the financial crisis. Nobody knows the true scale of potential losses at Europe's banks, but the International Monetary Fund hinted at the enormity of the problem this month, saying that Spanish and Italian banks face 230 billion euros ($310 billion) of losses alone on credit to companies in the next two years. Yet five years after the United States demanded its big banks take on new capital to reassure investors, Europe is still struggling to impose order on its financial system, having given emergency aid to five countries. Finance ministers from the 17-nation currency area meeting in Luxembourg will tackle the issue of plugging holes expected to be revealed by the European Central Bank's health checks next year. … During the region's debt turmoil, the European Union conducted two bank stress tests, considered flops for blunders such as giving a clean bill of health to Irish banks months before they pushed the country to the brink of bankruptcy. The ECB's new checks are seen as the last chance to come clean for the euro zone as the bloc tries to set up a single banking framework, known as banking union. The debate opens amid ebbing political enthusiasm for banking union – originally planned as a three-stage process involving ECB bank supervision, alongside an agency to shut failing banks and a system of deposit guarantees. It would be the boldest step in European integration since the crisis.” (Reuters, October 13, 2013).

Levels: (Prices as of close October 11, 2013)

S&P 500 Index [1703.20] – Up less than 1% week over week. Revisiting the 1700 level, which proved to be a top in early August when the index peaked at 1709.67. At the same time, optimists are eyeing the all-time highs from September 19 of 1729.86. In both cases, buyers have showcased interest at or below 1660, yet volume is needed to confirm the up days.

Crude (Spot) [$102.02] – The downtrend continues, as the commodity has dropped by nearly $10 per barrel since August 28. Investors debate between a pending bottom at $100 versus an ongoing breakdown. Demand slowing and supply expanding are the takeaways in the recent cycle, which can make the case for a move around $95.00

Gold [$1268.20] – A fragile and early sign of recovery at these oversold levels. Intermediate-term momentum remains negative. Speculators await a near-term recovery, which has struggled as the index dropped more than 3% last week.

DXY – US Dollar Index [80.53] – Since July, the dollar has decelerated and is a few points above annual lows (78.91 – February 2013).

US 10 Year Treasury Yields [2.68%] – Charts suggest an early attempt to re-accelerate and bottom around 2.60%. This case can be supported further with real economic strength. 3% remains the key upside target.


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