Market Outlook | November 25, 2013

“Whoever is winning at the moment will always seem to be invincible.” George Orwell (1903-1950)

Invincible?

Low US presidential sentiment combined with an all-time low congressional approval rating is not stopping and has not stopped markets from reaching all-time highs. This stresses the lack of correlation between confidence in political leaders and actual asset class appreciation. Unimpressive economic growth is not bothersome to a smooth-sailing rise in stock and home prices.

Numerous expert calls for “bubbles” have not resulted in the market flinching or overreacting. Short-term memories of crisis or panic-like behaviors and contemplation of gloom and doom have yet to bother the volatility index, which loudly points to fearlessness. A sign of calmness, justified or not, is for risk managers to debate. Talks of a new Federal Reserve chairman and over dependence on quantitative easing are not viewed as risky, despite overwhelming chatter. The taper discussion came and went and is to be revisited soon, as conflicting messages from Fed speeches are common.

For market participants, the government shutdown of early autumn was a near non-event for markets then, despite sour sentiment and the usual political bickering. Unmoved, undisturbed, these markets are barley worried. Common as it has been for months, the status quo trend remains a forceful trend that’s influencing markets.

Lack of answers

At this junction of the bullish run: How many latecomers (participants) wait to jump on this bullish ship? This is a pending question that’s fair to ask but murky to grasp as the celebratory sentiment persists. Beyond reason or logic, investors are forced to accept the following:

1) No visible and dramatic symptoms of a macro shift have materialized. Timing is difficult to gauge even with bizarre market dynamics.

2) As long as the majority of participants believe the Fed’s ongoing story, what is believed becomes and remains an ongoing reality.

3) Lack of alternatives in investment areas present further relative strength to US equities versus bonds, commodities or cash.

Catalyst search

Conventional wisdom of identifying trend-changing catalysts has not proved to work thus far. At least, there has not been a major disruption to risk-taking, which leads to less conventional thoughts. For a while, rising interest rates as well as inflation were feared to stir some response. Perhaps, deflation is the issue at hand rather than inflation, and the central banks will have to acknowledge this at some point.

“All of the past week’s data point to heightened deflationary risks. Paltry U.S. consumer price index (CPI) figures, German producer prices undershooting and another bout of weakness in commodity prices, particularly oil, suggest deflation is winning the battle over central bank stimulus. The U.S. inflation rate fell to 1% annualised in October, the lowest figure in almost 50 years, excluding the 2008 financial crisis. …. The German producer price index (PPI) fell 0.2% month-on-month in October, more than expected.” (Financial Sense, November 21, 2013)

Perhaps, deflation is the primary concern that was not overly anticipated. Certainly, declining commodity prices contribute to this threat in developed economics. In months ahead, that’s an issue that awaits, given slowing growth as well. This potentially forces action by the Federal Reserves and changes the market narrative of QE in the US, Europe and Japan and its consequences.

There is a growing chance that the search for a game-changing market catalyst is not a grandiose mystery after all. If the tune of the economy and financial markets march to different beats, then at some point both have to be in sync. In other words, the gap between cheerful corporate profits and economic strength (labor and growth) will be confronted soon enough. It is important to note that corporate profits contribute to stock market strength as much as QE. Corporate profits as a percentage of GDP remain above average. Certainly, this has impacted stock prices, and pending sensitivity to corporate earnings might serve as the clue to minor disruption. Until then, speculators can speculate, doubters can doubt, but the established momentum will determine its own slowdown. For now, the bullish narrative has been made simple and appears invincible. Detecting illusionary market patterns is a risk manager’s valuable asset.

Article quotes:

“Turks are fiercely hoarding foreign currency. The reason? Their own remains weak and could get weaker. The lira has been one of the worst performing emerging markets currencies since May, when investors first took fright at the US Federal Reserve’s plans to start scaling back its vast stimulus. Despite periodic rallies in riskier assets – reflecting changing bets on the timing of tapering – the lira remains 12 per cent down against the dollar since January. Usually, Turks are sanguine about such fluctuations: households tend to sell foreign currency when the lira weakens and build dollar and euro deposits when it snaps back. But since May, households’ foreign currency deposits have risen about 6 per cent to more than $70bn, suggesting savers expect rising inflation and further falls in the lira. International investors share this view, considering Turkey to be one of the countries most vulnerable to a withdrawal of the Fed’s easy money, because it relies on short-term capital inflows to finance a gaping current account deficit. Net outflows from Turkey’s bond market since the end of May jumped to $3.1bn in the second week of November, while net outflows from equity markets over the same period moderated to $154m.” (Financial Times, November 21, 2013)

UK Housing: “Mortgage lending is ‘back with a bang’ with borrowing rocketing 37 per cent in a year as first-time buyers surge into the housing market, according to latest figures. Banks and building societies advanced a total of £17.6billion last month, more than at any time since the financial crisis five years ago, said the Council of Mortgage Lenders. First-time buyers are leading the charge with London agents reporting a near doubling in numbers registering with them this autumn. The latest data came as the Bank of England once again played down fears of a crippling rise in interest rates coming as early as next year. Last month’s total is the first time £17billion has been breached since October 2008 when the British financial system’s ‘near death experience’ condemned the home loans sector to a deep freeze. Loans to buyers with only small deposits are up by 80 per cent. Experts said the revival is set to continue into next year fuelling further house price gains but increasing fears of a dangerous housing ‘bubble.’” (London Evening Standard, November 2013).

Levels: (Prices as of close November 22, 2013)

S&P 500 Index [1804.76] – A few points above last week’s finish led to another all-time high mark last Friday. Since November 2012, the index is up nearly 35%, showcasing a strong run.

Crude (Spot) [$94.84] – Since peaking in late August, prices have declined constantly. A key junction is forming now between a short-term relief rally and notable confirmation of further pricing breakdown.

Gold [$1240.00] – Deceleration continues as felt throughout the year. Annual lows of $1192 are on the radar for some as the bottoming process waits. For now, the unwinding process continues and value seekers may not be overly eager to reenter.

DXY – US Dollar Index [80.70] – Barely moving in the last few weeks. The 15-week moving average is in around 80, which sums up the familiar range.

US 10 Year Treasury Yields [2.74%] – Strong case building for rates to stay above 2.60%. That’s been the case for more than five months. Appears to be stable but overly neutral for trend seekers.

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