Market Outlook | July 15, 2013

“Creativity is the power to connect the seemingly unconnected.” (William Plomer 1903-1973)

Emphatic gains

A seven-day winning streak for the S&P 500 index has reinforced the already known and existing bull market. Flirting with all-time highs demonstrates strength with unknown upside. This current trend reaffirms the rotation out of fixed income and emerging markets while showcasing the pent-up and ongoing demand for stocks. According to EPFR Global, $11.8 billion flowed into equity funds last week. Interestingly, this was the largest inflow into equities since September 2011. The S&P 500 is up nearly 18% for the year. Certainly, this is a landscape that awakens performance chasers, as the fear of missing out remains a powerful motivator. The financial sector is breaking out to new highs and this is a powerful force heading into earnings. Advisors and managers of all kinds are gaining confidence in participating in this wave while risk tolerance continues to expand.

Victory by default

Naturally, when reaching all-time highs, along with euphoric responses there are equal doubts that resurface. One issue relates to earnings sustainability. Secondly, many ask: What’s the upside from this point on? Is this too easy to invest, with low volatility and constant upside moves? Discussions of the end of QE can trigger short-lived concerns, but asset prices have risen to previous record highs as the Fed has successfully pleased homeowners and stockholders. Yet the real selling point for US equities (in addition to QE and strong currency) is the lack of alternatives and the dismal conditions of emerging markets. Surely, both China and Brazil have seen major sell-offs in their respective stock markets. For example, the Brazilian Index is down more than 50% since peaking in November 2010.
As investors continue to exit developing markets, perhaps the daring investors are seeing value at current levels and can dig in. Perhaps, the neglected emerging market theme offers the best risk-reward, but at this point that contrarian trade is not overly popular. However, at this point the ever-so-popular investment in US equities is gaining followers. As noted by observers and foreign investors, the US market stands to continue to benefit from capital inflow as disappointed emerging market investors seek shelter. The safer exposure versus the daring bet is clearly defined by recent behaviors, and investors are left to choose.

Mind games

Comparisons to 2007-‘08 may resurface here and there, but as usual, history repeats in a different form. Also, unlike the 2000 stock market bubble, the retail participation and innovation craze is not quite at the same pace. In an environment where most commodities have declined and interest rates appear to be rising, the macro challenges affecting future stock market behavior are equally mysterious. Even though the bullish momentum can continue beyond what’s imagined, the hints of a stronger dollar and real economic growth are not eagerly convincing. Calming words from Central Banks have been magical in re-fueling the market. But is this substance from the real economy or hype from financial instruments? Balancing the two challenges practical observers. Amazingly, perception forces that are more like artwork than science drive markets. The artful managers with a full grasp of connecting macro dots are in a better position at this tricky junction.

Article quotes:

“In 1966, Mao launched the Cultural Revolution to prevent China from ‘taking the capitalist road,’ yet ironically his efforts ended up having precisely the opposite effect. ‘A common verdict is, “no Cultural Revolution, no economic reform,”’ declare Roderick MacFarquhar and Michael Schoenhals, leading historians of the period, in their 2008 book Mao's Last Revolution. ‘The Cultural Revolution was so great a disaster that it provoked an even more profound cultural revolution, precisely the one that Mao intended to forestall.’ By force-marching Chinese society away from its old ways of doing things, Mao presented Deng with a vast construction site on which the demolition of old structures and strictures had been mostly completed, making it shovel-ready for Deng's bold new policy of reform and opening up. Mao's epic destructiveness, which was supposed to prepare China for his version of utopian socialism, instead paved the way for China's transformation into exactly the kind of capitalist economy that he most reviled during his lifetime, but also a nation that Mao, like every modern Chinese reformer before him, dreamed of fashioning: a strong and prosperous one. The question for Chinese leaders now is what exactly they intend to do with their newfound and hard-fought wealth and power – and the challenge for the United States, is how to best help shape the answer in ways beneficial for both nations' people.” (Foreign Policy, July 12, 2013).

“If unlimited Quantitative Easing was Bernanke’s policy of successfully convincing the market that he is a madman, just like Henry Kissinger’s nuclear policy with Russia during the Nixon administration, then laying out a roadmap to tapering actually pulls away the curtain and reveals the Fed as being sane and rational. While -2% real yields might be accepted under a ‘mad’ Fed regime, a reasonable Fed will certainly not be able to push real yields to such extremes – particularly when a slowly recovering economy makes alternative investments more attractive than locking in negative real rates of return. Given financial markets’ dislike of uncertainty, this change in directive by the Fed also comes at a precarious time for the Committee, as Bernanke’s term as Chairman ends in January and given President Obama’s recent remarks, he will not be returning. While Janet Yellen is favored to be appointed after Bernanke and keep Fed policy largely status quo, the departure of Bernanke will still result in the Committee losing a powerful dovish voter at a time when policy decisions and communications have become increasingly democratized. As a result, we have likely seen the beginning of a regime shift towards higher rate volatility.” (EconoMonitor, July 12, 2013).




Levels: (Prices as of close July 12, 2013)

S&P 500 Index [1680.19] – A few points removed from intra-day highs of May 22 (1687.18). Nearly an 8% explosion since the June 24 lows.

Crude (Spot) [$105.95] –Reaching a key range between $105-110 last seen in spring 2012. A relentless run since December 2012 lows with a noticeable re-acceleration since breaking above $98.

Gold [$1285.00] – Near 8% run since the lows of July 1 ($1192.00). Yet, the longer-term downtrend is intact, as the 50-day moving average stands at $1359.83.

DXY – US Dollar Index [82.98] – Retracing after making multi-year highs on July 9, 2013. Overall, since Spring 2011, the strengthening dollar is a noticeable theme.

US 10 Year Treasury Yields [2.58%] – Taking a short-term breather after an explosive two-month rise. A new trend is stabilizing between 2.40-2.60%.



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