Market Outlook | November 18, 2013

“It is dangerous to be right in matters on which the established authorities are wrong.” (Voltaire 1694-1778)

Swept away

Five years after the 2008 crisis, the volatility level is low, showcasing the lack of anxiety by market participants. In fact, the volatility index is around its lowest level in the post-crisis period. Alarmingly, it feels that the fear of disaster is not quite as powerful as the fear of missing out on the ongoing stock market rally. That’s been the case for months now with ongoing enthusiasm. Additionally, some can proclaim US equity as having a “safe haven” status on a relative basis. Nonetheless, there is no such thing as safe when involved in risk taking, which is obvious when examined in a sober way. For some, being swept away in record highs comes with less visible danger of not knowing the end date to a massive run. As usual, the thrill of momentum is forceful and illusionary unless profit is realized in a very timely fashion. The script is familiar to historians, but the catalysts are mysterious for now.

Deception or not, this bullish market vibe is alive and explosive as skepticism seems to have quickly run out of favor. In fact, recording all-time highs for stock indexes has become a normal event, considering it has happened on several occasions. Perhaps, it’s fair to say that 2013 is the year when this “silent bull market” turned into a grand parade of capital inflow with decorative performances leading into further risk enticement. Amazingly, as year-end approaches, the question arises of what awaits next. On one hand, the capital that stayed on the sidelines in recent years has flowed in. Secondly, the worrisome topics have been dismissed for a while and most likely are being collectively misunderstood. For now, capital is persistently chasing:

“Investors poured some $34.1 billion into all equity mutual funds and exchange-traded funds in the past four weeks that ended November 13, the biggest four-week total since January, according to data from TrimTabs Investment Research.” (Reuters, November 17, 2013)

Weighing danger

Occasional speculation on future Fed actions and policies remains a guessing game that mostly does not disrupt the prevailing theme of quantitative easing. In the financial circles, there is potentially a growing comfort of knowing what to expect in 2014, especially in regards to the playbook and policies of a new Federal Reserve chairman. It is reasonable to wonder if this hubristic multi-year run collides with an overly complacent crowd who may be wrong in “taper” assumptions. For now, the year is nearly winding down and the early part of next year will clarify if the term “bubble” is legitimate.

One item that came and went was the budget debate, which is bound to be revisited soon by policymakers. A contentious political climate hovers around this momentum-driven market that’s been numb to economic slowdown, government shutdown or further labor concerns. The pain-free attitude of the stock market fails to match some real economy patterns, both in the US and Europe. Thus, it’s only wise to look for the sudden shift of sentiment, as the narrative may switch to more practical versus perception-based results. Perhaps, one should not use the stock market as a barometer of the nation’s wellbeing, especially when the approval rating for lawmakers is very low and confidence is even shakier. Thus, the dangers of a recovery are murmured, dissected daily but not quite reflected in the volatility or stock indexes.

Changing tones

The market dynamics around oil prices suggest a different tone than last decade. Primarily, the supply-demand picture is changing, with more supply visible and demand slowing recently. Plus, international events will determine if more supply is due to flood the market. In turn, the pricing pressure on crude is quite visible.

“Last month, for the first time since February 1995, the U.S. produced more crude oil than it imported: 7.7 million barrels per day in October, versus 7.6 million of imports. Domestic output ticked up further to a level just shy of 8 million barrels per day in the week that ended Nov. 8, according to data from the Energy Information Administration.” (Bloomberg, November 14, 2013)

Participants who had estimates clouded by previous decade assumptions are considering adjustments. If crude begins to move below $85, then that might raise some alarms and even be seen as a positive for consumers. The economic implication of oil at this junction is too intriguing and equally impactful, as crude prices failed to reach above $100. For now, six consecutive down weeks in crude prices are catching the attention of market observers.

Meanwhile, the close link between commodities and emerging markets is where the shift has taken place versus last decade. Interestingly, commodities and emerging markets underperforming versus US stocks and other benchmarks begs the question of timely entry points versus further deceleration. In other words, bargain hunters may look to purchase emerging market shares or commodities that have retraced recently.

Yet, slowing global growth makes the upside potential too questionable. At the end of the tactical messaging and perception game, it boils down to global growth and avoiding credit bubbles. Those are the tangible elements that count. Until then, the perception-driven market fragilely impresses (especially US stocks) and draws more risk-takers, but timing as usual is the bigger mystery.

Article quotes:

“According to China’s Foreign Ministry, Medvedev said the following at the meeting: ‘Russia-China relations are comprehensive strategic cooperative partnership both in name and in fact. Russia is ready to further expand the scale of trade and investment with China.’ Trade between China and Russia reached US$88 billion in 2012. While in China, Medvedev said the two sides hope to raise that to US$100 billion by 2015 and US$200 billion by 2020.Given their historically competitive relationship, the booming ties between China and Russia have puzzled many analysts. However, there is growing evidence that Moscow is seeking to balance against China’s influence by expanding its bilateral relationships with China’s neighbors. Over the weekend, for instance, Japan's Foreign Minister Fumio Kishida and Defense Minister Itsunori Onodera held Japan’s first ‘2+2’ meeting with their Russian counterparts, Foreign Minister Sergei Lavrov and Defense Minister Sergei Shoigu.The two sides agreed to hold a joint naval drill aimed at countering terrorism and piracy, and also to hold 2+2 meetings an annual event. Lavrov reportedly told a press conference after the meeting that bilateral cooperation with Tokyo would help resolve security issues on the Korean Peninsula as well as territorial disputes.” (The Diplomat, November 5, 2013).

“There are three reasons why he [Mario Draghi, the ECB president] should now look beyond the conventional. The first is, of course, the economic outlook, and the associated downside risk on inflation. When German commentators such as Hans-Werner Sinn criticise the ECB’s decision to cut rates they never discuss the decision in connection with the inflation target – which should be the primary benchmark. The current inflation rate of 0.7 per cent is below target, and forecasts tell us that it will remain so for at least two years. The second reason is a lack of further policy tools after the next rate cut. The main ECB interest rate is now 0.25 per cent. The deposit rate – the one levied on commercial bank deposits at the ECB – is zero. The central bank could cut its main rate one more time and impose a small negative deposit rate. At that point, the ECB will have run out of policies. That would be an uncomfortable position. The third set of reasons relates to Mr Draghi’s lender-of-last-resort promise – the outright monetary transactions he launched last year. The OMT has no doubt calmed down markets over the past year, but it is not a monetary policy instrument. It is an insurance policy. Its purpose is to reassure investors by reducing the likelihood of a country’s being forced from the eurozone. But it is still only a backstop. Quantitative easing, by contrast, is a monetary policy instrument. Its purpose would not be to bail out countries but to reduce medium to long-term interest rates in specific sectors of the economy.” (Financial Times, November 17, 2013).

Levels: (Prices as of close November 15, 2013)


S&P 500 Index [1798.18] – Making all-time highs yet again this year. More than 30 times, new highs were reached. Nearly 10% above the 200-day moving average.

Crude (Spot) [$93.84] – Sharp drop continues in the last three months, from $110 to below $94. This suggests a notable shift in the supply-demand dynamics supporting lower prices. The next noteworthy point on downside potential is closer to $85.

Gold [$1286.00] – Recent months showcase increasing odds of a bounce at the 1280 rage. If positive momentum is not mustered, then this showcases ongoing negative momentum that has persisted in the last twelve months.

DXY – US Dollar Index [80.71] – Hardly changed. Annual lows stood at 78.99 on October 25. Potentially a turning point of a weak dollar from a very near-term perspective.

US 10 Year Treasury Yields [2.70%] – In the last five months, the low end suggests around 2.50%, while the upside is somewhere between 2.70-3.00%.


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