Market Outlook | September 23, 2013

“Considering how dangerous everything is, nothing is really very frightening.” Gertrude Stein (1874-1946)

Dangerously comfortable

The story of rising markets is easier to tell when day by day, a roaring bull market picks up momentum. Certainly, any novice, or expert, for that matter, can identify a positive market and proclaim its previous undeniable success while boldly claiming higher conviction. Similarly, policymakers like the Central Bank prefer to proclaim their instrumental role in championing rising asset prices. Collectively, it seems participants are programmed to simply think that higher market levels produce an intangible but psychologically powerful list of reasons for risk-taking. Perhaps, those cashing out from the current run feel the tangible impact of stimulus-led results. Meanwhile, others deploying new capital with renewed greed might lose sight of where we've come since the crisis. Now in the fall of 2013, it shouldn't take much to get collective angst or pure genuine confusion about the sustained status quo driven market. Plenty of items are candidates for next ‘big catalyst,’ but usually, the build-up tends to be overdone, mistimed and blown out of proportion. However, entering a fragile period, one should be aware of controllable market-moving elements.

Policymaking pressures

Fearing the worst is not a rewarding investment thesis thus far, as skepticism is not scarce and US markets have shown resilience. Yet, somehow this time around the stakes appear higher, considering the unknowns. First, the Fed is not the almighty fortuneteller or mighty fighter for ‘the people’ who participate in the real economy. This is not as obvious as it may be. Confused and overly pressured by stakeholders of all kinds, experts following the Central Bank will remind us that the Fed is running out of tools. Last week's delay to do anything with taper guidance not only illustrates the disheartening motto of ‘kicking the can down the road,’ but it also shows admission of having exhausted relevant options. Perhaps, some would say, the Fed is not going to admit its weak points or lack of ability to navigate the economy to a promising landscape. It’s politics as usual for a non-political entity that's been labeled a ‘hedge fund’ by a key investor. Not only is the Fed’s role being questioned, but the Fed’s new chairman is a daily guessing game that only raises the stakes to historic levels.

Adding to this mix is the discussion of the US budget in a contentious political climate. Memories of 2011 remind us that market participants are not big fans of debt ceiling debates. Yet, the sensitive Fed discussions can be dangerously mixed in with budget talks to create some inflection point. The current set-up of all-time highs in stock market indexes and soft economic growth creates a divergence that in turn creates uneasy sentiment and irrational behaviors.

Rotation game

During the first half of 2013, the demise of emerging markets eventually turned into a late-summer bargain-hunting project for those betting on recovery. Now the appetite to re-enter risky emerging markets is picking up, as China’s manufacturing is re-stabilizing and emerging market currencies are stabilizing from recent volatility. Short-lived or not, rotation to emerging markets is quite noticeable: “[EPFR] said it found that $1.65 billion had flowed to emerging equity funds in the week to September 18.” (Reuters, September 20, 2013. Clearly, the taper decision and relative appearance versus developed markets will impact the timing and direction of pending moves.

The common Eurozone post-crisis dilemma shifted to renewed interest for value-driven managers in desperate need of optimistic purchases. The highly anticipated German elections are behind us, which takes away one uncertain factor. In fact, Angela Merkel’s victory preserves the status quo, but whether that’s beneficial or not is a debate. As the risk-reward is unclear, it only invites courageous speculators to express views of the near future in a complex region.

Meanwhile, US housing as a key driver of consumer mood painted a positive picture at one end, while stock price appreciation produced a sense of wealth creation. The hype of QE has merits when tracking known indexes and housing data, but fails to provide a nuanced explanation for the fundamental improvements. In a game of perception, reality is understated and the bluffing game takes center stage. Thus, each economic data from now until the next ‘taper’ discussion is bound to be micro-analyzed. Amazingly, as these market-moving dynamics play out, the ‘safe’ thing to do is perceived as taking on more risk in already risky assets that are not cheap. As history reminds us, truth discovery is either a lengthy process or a shock; thus, staying nimble is the autumn theme for financial markets.

Article quotes:

“China’s one-child policy, which since 1979 has limited most Chinese couples to a single child, is notorious for having accelerated the rate of China’s aging. It’s also created a glut of young men who can’t find Chinese wives; by 2020, bachelor ranks will swell to between 30 million and 35 million—equal to the population of Canada. But lovelorn suitors aren’t the only fallout from China’s draconian population controls, says Zhang Xiaobo, a Peking University economist. ‘I just returned to Beijing [from Washington, DC], and housing prices are three times that of DC,’ Zhang said. ‘If you look at all the indicators there’s a housing bubble. But despite the very low economic returns, people [keep buying].’ The reason? Intensified marriage market competition, says Zhang. ‘The reason is that people have to buy a house in order to get married,’ he says, explaining that the mothers of most brides will accept only grooms who can provide a home for their daughter. This, says Zhang, is what has made home prices so unaffordable (a small Beijing two-bedroom is about $330,614—what an average Beijinger earns in 32 years). And, ironically, the one-child policy will eventually reverse this trend, knocking the floor out of the market. China’s gender imbalance contributed 30 percent to 48 percent of the rise in real home prices in 35 major cities from 2003 to 2009, according to research Zhang and two colleagues conducted. Home values rose more sharply in cities with many more young men than young women.” (The Atlantic, September 13, 2013)

“The new European structure seems to be missing something. The current paralysis of the financial markets is due to transactions conducted over the past year by the European Central Bank (ECB), notably the Outright Monetary Transactions (OMT) programme by which treasury bonds are acquired in secondary, sovereign bond markets to boost countries under pressure. Two hedge funds, however, Brevan Howard in London and Bridgewater in the United States, believe that the German elections will become a turning point in the crisis – for the worse. For Brevan Howard, a Merkel victory may slow down the reform process in the Eurozone. This is an understandable fear given the snail's pace at which reforms were carried out in the past two years. The blame lies with the Bundesrat or Federal Council, which must approve each of Germany's administrative expenses, including each contribution to the bailout funds for member states, to the European Financial Stability Facility and to the European Stability Mechanism (ESM). Many issues remain unresolved. The first is the banking union. Or better yet, a system that would put EU banks under the supervision of the ECB. The aim is to avoid jolts linked to opaque positions, partially protected by national financial authorities. As indispensable as it is slow to implement, a banking union must overcome two hurdles: the reluctance of German banks to submit to the control of the ECB and Berlin's multiple doubts regarding the European deposit insurance fund. These are precisely the two points that could soon become major differences between Germany and the other members of the Eurozone.” (Fabrizio Goria, Press Europ, August, 28, 2013).

Levels: (Prices as of close September 20, 2013)

S&P 500 Index [1709.91] – After making all-time highs of 1729.86, there is a wave of optimism reflected in the charts. However, staying above 1700 created a few doubts earlier this summer. Buyers might be vulnerable for short-term pullbacks within this multi-year run.

Crude (Spot) [$110.53] – Climbing above the $108-110 range has proven to be difficult over the last 50 days. This marks a resistance level and showcases a slowdown in momentum as the three-month range-bound trade resumes.

Gold [$1328.00] – Following a sharp first-half decline, a bottoming process might surface around $1279-1300. Gold is showcasing some revival in an oversold asset that’s underperformed for more than a year. Upside potential is mysterious, but upcoming weeks will provide vital clues.

DXY – US Dollar Index [81.36] – A three-month decline in the dollar index has awakened the multi-decade common theme of the weak dollar. Suspense builds as to whether the DXY will go below its annual lows of 78.91 from February 2013.

US 10 Year Treasury Yields [2.88%] – The next noticeable yield move is either a break above 2.90% or breaking below 2.70% (around the 50-day moving average). For now, this narrow band suggests investors are waiting for clarity on rate-moving factors.



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