Market Outlook | July 1, 2013

Market Outlook | July 1, 2013

“Tension is the great integrity.” (Richard Buckminster Fuller, 1895-1983).

Truth discovery

The last few weeks have realized some tension, shaken a few status-quo thoughts, conjured up tons of speculation and confirmed some lingering weaknesses that were around us. The puzzle between the need for further stimulus versus economic growth that’s plausible is being worked out. At least, policymakers are working on releasing messages and avoiding panics, while so-called financial experts are scrambling to guess, to rebalance and to simply understand what awaits next.

Moving parts

Risk-taking has been encouraged and heavily promoted for several quarters. The well-documented stimulus efforts shifted from being an obvious policy to an evolving mystery – yet have been rewarding for those who bought into the story. Managers who claim to understand this "Fed" mystery will be tested ahead in financial markets. Meanwhile, others blaming the Federal Reserve need to remember that risk-taking is still a choice. And the Federal Reserve is not quite a financial advisor – a much-needed clarification for some caught up in the recent storm.
Surely, the public relations and messaging by Fed officials add further suspense, but the markets have a mind of their own. Calmness is no guarantee and the next phase of earnings, economic and Fed cycles are converging faster than most would like to admit. An inflection point is either brewing or the boiling point is postponed. Perhaps a chaotic series of events is quietly accumulating.

Hints of change or fear of change from the norm are being contemplated by participants. Three items that stand out, given what is known:

1) The US growth (Real GDP) has been moderate since 2009 but has struggled to accelerate further. This stalling does not demonstrate strong recovery.

2) Emerging markets collectively have slowed down, and that weakness is visible. This only follows a dismantled and fragile European condition, which is bound to get volatile in the fall.

3) General contemplation of rotating out of bonds is sparking further possibilities of near-term turbulence. The threat of rising rates is not a theoretical argument this summer, especially after the recent move in 10-year yields. Thus, migration out of fixed income is a debatable topic that will consume a few people in the weeks ahead.

Digesting and acting

This head-scratching setup waits so that even if one is a risk-taker, the options seem limited. Emerging markets are attempting to bottom as further weakness is resurfacing. Heading into this week, the sluggish condition was further verified in China: “The HSBC/Markit Purchasing Managers' Index (PMI) for June retreated to 48.2, the lowest level since September 2012 and down from May's final reading of 49.2. It was in line with a preliminary reading of 48.3 released on June 20.” (Reuters, June 30, 2013).

Emerging markets’ strong link to commodities (metals) is the big macro driver where both have unraveled. Damaged fund managers who blindly fell in love with last decade’s winners are calibrating to some rude awakenings. Are emerging markets a bargain? Are gold and silver worth a second look at cheaper prices? Are equity markets overvalued despite the relative appeal?

These are a few questions that await additional clues ahead. Clearly, growth is not overly convincing and the success of easing is not overly impressive, either, in the real economy. As confusion builds, it is probably safe to bluntly watch these tensions play out before making strong market assumptions and heavy allocations.

Article quotes:

“The situation in Italy is different from Spain in some important respects. Italy’s banks are not sitting on mountains of bad mortgage debt. Italy has a lower gross external debt position, at 124 per cent of GDP. But the problem in Italy is a vicious circle of a credit crunch, a recession, and a public sector with little fiscal room for manoeuvre to fix an undercapitalised banking system. The new government’s focus on a petty scheme to reduce youth unemployment when its real problem is a liquidity crunch is unbelievably misguided. With the rise in global market interest rates, the country is getting closer to an ESM programme, which would then trigger bond purchases by the European Central Bank. But the ECB cannot recapitalise the Italian banks. Nor can the Italian state. Nor can the ESM. According to Mediobanca, an Italian investment bank, the degree to which Italy can tap private wealth as a source of new funds is limited, since wealth taxes are already relatively high. So even Italy’s sustainability in the eurozone is not assured in the absence of a joint-liability banking union. How could it have come to this? It was my reading of the political situation a year ago that a majority in the European Council was quite serious about a proper banking union to be followed by a fiscal union in the future. Germany had yet to be persuaded. Then came the ECB's celebrated backstop last summer. And that killed it. The politicians no longer saw a need for policies that would be a hard sell back home.” (Financial Times, June 30, 2013)

“In late 2011 many were expecting China's property bubble to burst. It looked as though housing prices had peaked and signs of stress were beginning to appear. But the correction turned out to be quite shallow and in spite of China's government's multiple attempts to arrest housing price appreciation (and partially succeeding) house prices went on rising. With real rates on deposits remaining in negative territory for years, there were few places to turn for wealthy savers. Property became one of the primary vehicles to put away excess cash to escape inflationary pressures. Moreover, municipal governments made large sums of money selling land to developers, while banks ("encouraged" by municipalities) have been happily lending. And in many cases lenders and developers have set up arrangements that are a bit closer than ‘arms length’. Except for ordinary families who got shut out of the housing markets, everyone benefited from this rally. Housing investment as percentage of GDP has been growing unabated, and in recent years started approaching levels that other nations experienced at the height of their property bubbles.” (Sober Look, June 29, 2013)


Levels: (Prices as of close June 28, 2013)

S&P 500 Index [1606.28] – Attempting to hold to the 1600 range, as the next benchmark stands at the 50-day moving average (1621.72).

Crude (Spot) [$96.56] – Three times this year, crude prices have failed to break above $98-100 range. This showcases either a lack of demand or increased inventory.

Gold [$1232.75] – There was a downtrend that began in September 2011, then another peak and deceleration in September 2012. Since then, gold has corrected by nearly 30%. It’s due for some bounce, but the longer-term outlook has been severely impacted.

DXY – US Dollar Index [83.16] – Signs of increased volatility in May and June. The dollar is attempting to resume its strength, as it closed above its 50-day moving average.

US 10 Year Treasury Yields [2.53%] – Since May 1, an explosive run that began from 1.61%. Now a breather is underway.


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