Market Outlook | May 28, 2013

‘It is a bad plan that admits of no modification.’ Publilius Syrus (~100 BC)

Untangling unknowns

There is a commonly touted disconnect between stock markets, economic growth and general socio-political sentiment. At least, when considering all factors, this is puzzling for those attempting to plug in a formula and dissect this matter. It’s discouraging to those seeking a definitive answer. It is also unclear for those predicting a foreseeable future. We see the same old challenge for those managing risk and chasing returns. And this mostly stems beyond politics and government polices. The unconvincing economic growth combined with an explosive stock market is mysterious for experts and outsiders alike. Thus, in that not-so-clear picture, many will attempt to decipher the pending fallouts.

Occasional Clues

The decline in the Japanese stock market sent an early hint of pause in the form of consecutive down days. Granted, the Japanese Index made a strong run already this year, and set up for the inevitable correction, the moves were rather sharp. Interestingly, this negative action is taking place after a collective cheering of a revival in the Japanese economy (‘abenomics’), and flourishing inflow of capital into Japanese funds. Perhaps, the old lesson of going with the popular thought has its dangers. The following was outlined on May 23:
“The latest inflows in the week ending May 22 marked the 27th straight week of cash gains into funds that hold Japanese stocks. The latest demand was for exchange-traded funds, which attracted $1.52 billion, while mutual funds that hold Japanese stocks saw slight outflows of $14.8 million.” (Reuters).

Short-lived or not, other markets wait to see if a similar sell-off pattern is to follow. In the case of Japan drivers of recent sell-offs, they are being discovered and slowly being understood. Some attribute the Japanese sell-off to a weak Chinese PMI (Purchasing Managers Index) data. Money managers cannot deny that the warning sign are here from a fundamental point of view. In fact, there is a strong correlation between weakness in commodity prices and the Chinese stock market. It is worth noting that since May 6, 2011, the CRB (Commodity Index) fell 23% and the fund measuring the Chinese index (FXI) decreased by 20% during the same timeframe.

Basically, the message is quite clear how the commodity and stock market project a similar message of economic weakness. Of course, naturally, the question to ask is: If China is slowing down along with commodities, then why are markets not declining? This is a question to ponder in these summer months ahead.

Fragility

Pressures for downside movement in asset values have been building for a while, considering the lack of impressive global growth and restless responses to familiar ‘easing’ tactics. In fact, lowering interest rates is such a common theme from Japan to Eurozone to other emerging markets. Similarly, the theme of lower growth is also a common theme, which has potential socio-political consequences. Here is one example: “‘The government is showing a much bigger tolerance for slower growth because they understand that China’s potential growth rate is slowing and that concerns about the environment are rising,’ said Bank of America’s Lu. ‘One of the reasons we cut our growth forecast is because protests over environmental issues are leading to the cancellation or delay of a lot of investment projects.’’’ (Bloomberg, May 26, 2013)

With the S&P 500 index up 15% so far this year, a long-awaited breather logically is being discussed and awaited. Volatility is deceivingly calm when viewing the Volatility Index (VIX). Sometimes, calm occurs before potential shocks. There is no question the bullish run is in place, but a fragile stage is silently brewing, at least in the near-term.

Article Quotes:

“Private equity investors are eyeing Africa more intently than ever, with big global firms such as Carlyle Group and KKR & Co. boosting their presence on the continent alongside smaller regional players like Helios Investment Partners and Development Partners International. Deal flow remains far below the peak hit in 2007, though, and well behind the ambitions of most major players. Investors complain of too many buyers chasing too few opportunities, leading to excessive valuations. … The political and economic environment has improved dramatically in many parts of the continent over the past decade. The International Monetary Fund forecasts that 28 of 45 sub-Saharan African countries will post economic growth rates of 5 percent or more this year. There is plenty of money pursuing deals, but only modest amounts are being committed. Helios, an Africa-focused firm founded by former TPG Capital executives, closed its second fund – at $900 million, almost three times the size of its first fund – in June 2011. The firm, which aims to return three times its invested capital, hoped the newer fund would allow it to make larger investments.” (Institutional Investors, May 22, 2013)

“The following editorial appeared in El Pais (Madrid) earlier this month: The consolidation of a fascist party in Greece. The success of Beppe Grillo and Silvio Berlusconi in Italy. The 6.2 million unemployed in Spain, its highest since the year after Franco's death, and the 26.5 million in the EU. The collapse of the French hope for François Hollande. The rise of anti-European parties in Greece, France, Finland, UK, Germany. The dismantling of the welfare state and the return of starvation wages in Southern Europe. … The risk to Europe today is what Fisher said about America under Hoover: ‘If our rulers should still insist of “leaving recovery to nature” and should still refuse to inflate in any way, should vainly try to balance the budget and discharge more government employees, to raise taxes, to float, or try to float, more loans, they will soon have ceased to be our rulers. For we would have insolvency of our national government itself, and probably some form of political revolution.’” (Project Syndicate, May 26, 2013)


Levels: (Prices as of close May 24, 2013)

S&P 500 Index [1649.60] – Slight pullbacks after reaching record highs. Consolidation at this stage seems fitting, with 1600 and 1592 being noteworthy levels. The run since mid-November 2012 showcases the increase demand for equities.

Crude (Spot) [$94.15] – A range forming between $92-96 for several months. No convincing signs of directional movement.

Gold [$1380.5] – The commodity has not changed much since last week. It stands 16% removed from its 200-day moving average, which showcases the magnitude of the recent sell-off, loss of momentum and may convey the message of being cheap for some.

DXY – US Dollar Index [82.12] – Maintaining a four-month strength. However, the near two-year strength is not significant enough to cause major disruptions.

US 10 Year Treasury Yields [2.00%] – Climbed back to 2% after stalling in the first quarter. Questionable sustainability here, given previous patterns.



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