Market Outlook | October 7, 2013

“All truths are easy to understand once they are discovered; the point is to discover them.” Galileo Galilei (1564-1642).

Waiting to understand

The unknown timeframe of the ongoing shutdown and known deadline of the debt ceiling can create enough discomfort even as a simplistic view. Without monthly labor results and without clarity of third-quarter earnings, a suspenseful period awaits the next movement. The market’s attention should not dismiss the traditional market-moving factors other than the Washington theatrical fiasco.

There has been much discussion about prior market behavior during government shutdowns; however, market-moving items revolve around these usual factors:

1. Earnings expectations versus actual results
2. Relative attractiveness of equities versus other assets
3. General cyclical momentum and investor sentiment
4. Discovery and impact of a new “unknown” that turns into short-term fear (i.e., debt ceiling)
5. Macro: Currency and commodity trends

There is some waiting to do before deciphering the points above. Therefore, this will be challenging for the very impatient observers and traders. Last week demonstrated that with a very uneventful movement of -0.07% in the S&P 500 index. The upcoming week may be equally uneventful, but the stage is set for either a relief rally following an end to the suspense or reawakening of panic-like behavior.

Earnings riddle

Even if the current government shutdown event had not occurred, the pending earnings result was already a highly relevant matter to participants. Typically, when markets are dancing around all-time highs as part of a multi-year run, the question of pending sell-offs is normal. Doubting the sustainability is not strange, either. The stakes are relatively high. Earnings concerns are already reflected in general expectations as forecasters attempt to set expectations.
“U.S. companies are warning about third-quarter earnings at a rate lower than last quarter but still at the second highest level since 2001, leaving estimates well below what they were just three months ago. Companies issuing negative outlooks for the quarter outnumber positive ones by 5.2-to-1, the most negative since the 6.3-to-1 ratio in the second quarter.” (Reuters, September 30, 2013)
Interestingly, the financial fund (XLF) has underperformed the broad stock market indexes since late July. Perhaps, that’s a hint of slowing momentum in financial services, but earnings, especially in banks, will verify the actions of recent stock performance.

It is also important to remember that nearly half of S&P500 companies generate revenues from outside the US. Thus, as Europe is showing early sings of recovering along with the US, this might change the landscape for the largest corporations. This makes evaluating corporate health versus US market wellbeing rather difficult and not straightforward.
Risk-taking preferred

The so-called “great rotation” is driving capital from bonds into equities, as heard loudly in prior quarters. The theme of low interest rates forces investors into risking capital in search of returns. Plus, the positive market momentum creates the fear of “missing out.” Thus, capital inflow into stocks both in the US and now into emerging markets begins to carry over. Chasing good performance is not always rewarding, and eagerness can backfire. A breather of a 7-10% pullback might be a “necessary evil” rather than a catastrophic response. However, momentum is too powerful and rational optimism can extend further before turning to irrational moves. This is an interesting period, where risk-taking is being encouraged as headline noise accumulates. Certainly, the bull market has been in place for a while; thus, bargain-hunters may wait longer for correction. At the same time, if expectations are not set back to reality in upcoming weeks, then danger awaits sooner than later.

Article quotes:

“America had already surpassed Russia in natural gas production last year, pulling ahead for the first time since 1982. But this was the first year the US was on pace to surpass Russia in production of both oil and natural gas. … Most of the new oil was coming from the western states. Oil production in Texas has more than doubled since 2010. In North Dakota, it has tripled, and Oklahoma, New Mexico, Wyoming, Colorado and Utah have also shown steep rises in oil production over the same three years, according to EIA data. But the EIA said the new natural gas production was coming from across the eastern United States. Russia is believed to hold one of the world's largest oil-bearing shale formations. But the industry has lagged behind America in its embrace of horizontal drilling and hydraulic fracturing to get at the oil and gas. Meanwhile, energy firms are stepping up production from North Dakota and Texas. Earlier reports from the EIA suggests the trend will continue. The EIA said earlier that US crude oil production rose to an average of 7.6m barrels a day in August, the highest monthly totals since 1989. It forecast total oil production would average 7.5m barrels a day throughout the year, rising to 8.4m barrels a day in 2014.” (The Guardian, October 4, 2013)

“In 2012, textile and apparel exports were $22.7 billion, up 37 percent from just three years earlier. While the size of operations remain behind those of overseas powers like China, the fact that these industries are thriving again after almost being left for dead is indicative of a broader reassessment by American companies about manufacturing in the United States. In 2012, the M.I.T. Forum for Supply Chain Innovation and the publication Supply Chain Digest conducted a joint survey of 340 of their members. The survey found that one-third of American companies with manufacturing overseas said they were considering moving some production to the United States, and about 15 percent of the respondents said they had already decided to do so. … Beyond the cost and time benefits, companies often get a boost with consumers by promoting American-made products, according to a survey conducted in January by The New York Times. The survey found that 68 percent of respondents preferred products made in the United States, even if they cost more, and 63 percent believed they were of higher quality. Retailers from Walmart to Abercrombie & Fitch are starting to respond to those sentiments, creating sections for American-made items and sourcing goods domestically.” (New York Times, September 19, 2013)

Levels: (Prices as of close October 4, 2013)

S&P 500 Index [1690.50] – Since the “no-taper” announcement in September, the index has declined by more than 2%. Staying above 1680 is the next challenge.

Crude (Spot) [$103.84] – Since its August 28 peak of $112.24, crude has dropped by more than 7%, confirming a downtrend. Buyers’ interest above $110 begins to slow, as showcased again in the recent cycle.

Gold [$1316] – Growing evidence of bottoming around $1300. However, the upside that’s visible to chartists is closer to $1360. The pattern is not convincing either way, as the dominant theme is a cycle downturn.

DXY – US Dollar Index [80.53] – For more than three years, it has failed to rise above 84 and typically hovers around 80. The weak dollar theme keeps persisting, with no major alarming changes.

US 10 Year Treasury Yields [2.64%] – During the last two months, yields have jumped from near 2.60% to peaking at 3.0% and now back to the 2.60%-ish range. We are seeing a pause after the explosive run since the spring. Weaker economic numbers and natural pullbacks are causing a breather at current levels.


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