Market Outlook | October 21, 2013

“Delay always breeds danger and to protract a great design is often to ruin it.” Miguel de Cervantes Saavedra (1547-1616)

Exuberance felt

The current reality showcases at least two narratives for those willing to listen beyond headline noise. The first and highly publicized matter shows that the US stock market indexes are making all-time highs. The S&P 500 index is up 22% and the small cap index (Russell 2000) is up more than 31.3% for 2013. As obvious as it gets, this is a noteworthy declaration of a bull market. It was only nine months ago that this felt like a silent bull market. Now it’s louder than ever. A collective glance at the scoreboard leads to further inflow into equities. Interestingly, global stocks continued to see enthusiasm:

“Stock funds worldwide attracted $17.2 billion in new cash during the week, according to the report, which also cited data from fund-tracking firm EPFR Global. The inflows were the biggest in four weeks.” (Reuters October 18, 2013).

Not only are stock prices rising, but capital inflow confirms the ongoing eagerness of participants to seek exposure to this rally. Certainly, cashing returns is a known human trait, as some called it “panic buying.” This positive momentum has been a remarkable force, as rates remain low and the status quo seems more stable than expected.

Delay, defer and deny

The second narrative of the current behavior looks ahead. It deals with the dangers that are not solved in terms of economic revival or general wellbeing of wealth creation. Political pollution diverts attentions, as witnessed most of this month with the mindless shutdown discussions. Interestingly, the debt ceiling discussion is deferred for 2014. The same may apply to decisions regarding Fed tapering. These are two US macro uncertainties that are not going to ruin the rally immediately but remain in the back of the mind of any financial strategist. In fact, last month’s announcement not to taper only surprised the market and enhanced the suspense by buying further time.

Whether this rising market is a declaration of improving investor sentiment or a reflection of a lack of alternative investments remains a debatable question. Yet, earnings season is in full play as clues surface about companies’ quarterly earnings. This week should present additional clarity; therefore, generalizing the earnings result is not a wise approach. So far, there have been mixed reactions with massive moves in both directions when considering stock-specific results. Interestingly, quarterly corporate earnings look like a game of beating expectations; the art of lowering expectations is in full gear. At this point, even the most bullish investors are not quite clear on the market driver’s fundamentals, especially since key indexes are trading at all-time highs.

Tangible guidance

Actual activity in the real economy versus the perception-driven stock market remain unsynchronized. Despite the all-time highs in stocks, the consumer sentiment paints another picture: “Americans in October were the most pessimistic about the nation’s economic prospects in almost two years, as concern mounted that the political gridlock in Washington would hurt the expansion, according to the Bloomberg Consumer Comfort Index of expectations.” (Bloomberg, October 19, 2013). Mysterious to most outside observers are the mechanics of how stock markets work and how sentiment and perception cause reactions and overreactions. Certainly, artful moves are driven by future guesses, past facts and popular (or unpopular) themes. The hunger to decipher the economic wellbeing of US markets must have reached overly anxious levels. In other words, data-starved analysts are waiting for labor numbers this Tuesday, which were delayed due to the government’s partial shutdown. Sure, one data point may not move the needle, but having a barometer for economic growth is vital, especially when growth has slowed globally.

The fragile conditions of emerging markets and Europe stir up the question: Is the US’s relative edge still fully intact? In addition, these questions linger based on pending economic data: Is further risk-taking justified? Is volatility priced correctly at these low levels? Are markets showcasing hubris that will last months? These are very familiar but unanswered questions that need to be asked again.

Article quotes:

“The Fed’s dual mandate, imposed in 1977, requires maximum employment and price stability, but the reality is that there are limits to monetary policy. Printing money cannot increase the wealth of a nation. Moreover, there can be no permanent tradeoff between inflation and unemployment. Market participants learn to adjust to monetary policy. Once workers anticipate inflation, they will demand higher wages and unemployment will revert to its ‘natural’ level consistent with market demand and supply. Increasing real economic growth requires improved technology, capital investment, a better educated workforce, and institutions that are conducive to entrepreneurship and prudent risk taking. Those institutions include a just rule of law that protects persons and property, free trade, sound money, limited government, low marginal tax rates, and market-friendly regulation. … The near zero interest rates on saving accounts since 2008 has harmed conservative investors and significantly lowered their lifetime income. Thus, Fed policy has not led to a net increase in national wealth, merely an arbitrary redistribution to favored groups. If the Fed is too slow to increase rates and shrink its balance sheet, inflation will further redistribute income as creditors are repaid in depreciated dollars. And if the Fed raises rates too fast, the risk of a recession increases. Consequently, Yellen will be faced with difficult options, none of which is cost free. And there will be strong political pressure to fund an already bloated government, provide relief for homeowners, and create jobs – especially when many voters tend to believe those goals can be accomplished by an all-powerful central bank.” (Forbes, James Dorn, October 17, 2013).

“Growth in advanced economies is gaining some speed. The IMF projects these economies will grow 2% next year, up from an expected 1.2% this year. The average unemployment rate in advanced economies is expected to inch down from its peak of 8.3% in 2010 to 8% next year. This is progress, but it is clearly not enough. The state of labour markets remains dismal for a number of reasons. First, even before the crisis, average unemployment rates were high in many countries, and potential output growth too low. For instance, between 1995 and 2004, the average unemployment rate in the Eurozone was 9.5%. Unemployment today is over 11%, but a return to the pre-crisis average would be far from nirvana. Second, the labour market is plagued by a duality of outcomes, which the Great Recession has exacerbated. Workers on temporary contracts have limited employment protection, and have borne the brunt of labour-market adjustment. Low-skilled workers and young people have fared worse than high-skilled and older workers. The long-term unemployed risk being cast away beyond reach of the tides of recovery. Third, some countries in the Eurozone need to boost competitiveness. With devaluation ruled out as an option, the channel to bring this about is through wrenching labour-market adjustments.” (VOX, October 18, 2013)

Levels: (Prices as of close October 18, 2013)

S&P 500 Index [1744.50] – Surpassing previous all-time highs. Last Friday’s close is more than 8% above the 200-day moving average. In the last four months, investors have shown eagerness to buy around, and staying above $1700 for a while has been shaky. The next few trading days will confirm whether this new-wave upside move has legs to it to justify additional buying.

Crude (Spot) [$100.00] – Since peaking on August 28, crude has dropped more than $12 per barrel. It is now back to the $100 range, where buyers’ appetites will be tested. This is due to a combination of weak demand and increased supply.

Gold [$1319.25] – In the last five months, the commodity has traded between $1250-1400. This appears relatively cheap, but the overall long-term trend suggests down or sideways movement.

DXY – US Dollar Index [79.65] – Over the last four months, the dollar has trended downward, showcasing further weakness.

US 10 Year Treasury Yields [2.55%] – Early signs that yields are failing to hold above 2.80%. Further confirmation is awaited as to whether the 200-day moving average (2.23%) is the next critical range.



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