Market Outlook | January 27, 2014

“Security is mostly a superstition. It does not exist in nature...Life is either a daring adventure or nothing.” Helen Keller (1880 - 1968)

Collective awakening

Chants and praise of all-time highs in US markets were becoming a tiresome topic for several weeks. Equally, the claims of a crash or massive breakdown and murmurs of a collapse have been nearly as annoying in the last five years, despite occasional legitimate points from some of the skeptical crowd. Balanced skepticism is healthy, and although market participants in the past few years have not appreciated it, being a critical investor might be even more rewarding this year. Admission of slowing to flat global growth has been mildly hinted at in the past but not quite heavily emphasized. QE’s magical powers became an even more powerful narrative and found a way to elevate asset prices and reduce the fear factor. There has been a bandwagon effect of inviting many to risk-taking exercise. Yet the search for a market-moving catalyst has been long awaited and at times misdirected, misunderstood or simply mistimed.

Now an eye-catching catalyst is here when considering the emerging market (EM) fallout of currencies and stocks last week. From Argentina to Turkey to Chile, there was a panic-like mode with an ongoing trend of weekly outflows. In addition, earnings season is here to provide a fundamental gut check of key companies as the verdict awaits. Similarly, a sentiment shift is brewing and geared to pause the uptrend in developed markets, to reignite worries of fragile emerging markets and create acceptance of more unknowns to cause a stir. In an interconnected and interwoven world, any capital market concern may be contagious, or at least may lead to a collective awakening. Now, analysts have to decipher the various tiers of concerns, from developing markets to Eurozone buying opportunities to pending results of developed and QE-driven economies.

Skeptics had many gloomy points, but last year's weakness in emerging markets tells the story of the changing and delicate perception of risky assets. Plus, moments where wobbly markets are visible find a way to re-awaken the nearly half-dead volatility that's been barely visible. Amazingly, for a while, talks of turbulence seemed erased from market action, forecasters and casual onlookers. Even with pending correction potentially looming, with the S&P 500 index going from 1850 to 1790, most participants appear to be interested in when to reenter, rather than exiting fully. The bullish bias prevails for now, but convictions are set to be tested.

Risk resurfacing

Amazingly, the status-quo supporters and adamant doubters share one thing in common: They both long and humbly awaited a catalyst of sorts to shake up this stubborn Fed-induced rally. Not that risk ever vanished, but now the true meaning of risk is confronted Risky assets were truly encouraged, but now doubts are setting in as to future plans.

Lenders to EM and those betting on appreciating EM currency and a declining dollar are deeply and in a worrisome manner asking if these assumptions have merits. The low interest rate policies encouraged and partially forced investors to chase high yield. Of course, when desperately chasing yields, the reward might be overstated, like any status-quo idea that initially assumes and attracts easy money. However, when it fails, it sees that money flow out at a rapid pace.

Memories of 2007 are echoed by those seeing a rapid rise in asset prices in a synchronized fashion. 1998 comes to mind when thinking of a currency crisis, and 2008 comes to mind when an illusion turns into a gut-wrenching reality check. For now, fear is examined at its early stages, since too many analysts cried wolf earlier. Plenty of false alarms were sounded about market "tops" and now, the decisions have to be made by risk allocators and managers. The smooth sailing and numbing bull market is at a junction that begs for answers to overwhelming question that have long been asked. What’s the impact of the taper moving forward? What are the consequences of the transition of the new Fed Chairwoman? How weak is global growth? There are plenty of unanswered questions, but regardless of the answers, the unsettling feeling will persist.

Bracing

It’s natural to expect fund managers to begin the search for safety when economic slowdown and political instability begin to kick in various economies. In the past few years, gold, US Treasury, US dollar and US large cap stocks have been known as places to hide. It’s unclear whether the rotation into perceived safety will prevail over an all-out synchronized sinking of multiple assets. The level of sell off is to be discovered in the near-term in days and weeks ahead. Importantly, last Friday showcased high demand for protection against declining markets.

“January call options – contracts betting on the rise of the underlying security – on the VIX this week rose to a record 8.4 million contracts at the Chicago Board Options Exchange (CBOE.O) while the index itself jumped nearly 30 percent on Friday and about 44 percent for the week.” (Reuters, January 24, 2014)

In terms of bracing ahead for future opportunities, European stocks are talked about by analysts on their upside potential, as casual participants are accustomed to hearing the woes and struggles in the last five years. Again, weak economic overhang has not stopped European equities from rising to new highs. Certainly, forecasters feel the need to raise estimates, and that’s a common and influential theme these days across the financial circle.

“The World Bank raised its global-growth forecasts, predicting the economy will expand 3.2 percent this year. That is higher than its June projection of 3 percent. The Washington-based lender raised the estimate for growth in the richest nations to 2.2 percent from 2 percent. Part of the increase reflects improvement in the 18-country euro area.” (Bloomberg, January 17, 2014)

Perhaps, risk-takers looking beyond US companies and assets may seek European stocks as the next area of interest. Certainly, finding growth stories with a promising decade outlook is scarce and less predictable. At some point, if bargain hunters sense that emerging markets are cheap, then maybe that’s a consideration to wait for, as well. Maybe this is worth examining after the near-term turbulence goes through its natural phase.


Article quotes:

“In the past two years or so, you have seen more hedge funds dabbling in tech investing. As one venture investor put it in 2011, ‘They are the antichrist of patient, supportive early-stage investing.’ But increasingly, hedge funds are scoring some of the deals you would expect traditional VCs to get. Case in point — Snapchat. Over the past few weeks, I spoke to a dozen or so public and private market investors around this trend, why it is taking place, and what it means for founders. Coatue isn’t the first ‘cross-over’ fund (an investment fund that crosses over to the private from the public markets) to emerge in technology investing. Integral Capital Partners, co-founded by Roger McNamee and John Powell, was one of the first to start doing this in the nineties. Hedge fund Tiger Global has been doing it more recently, with a venture arm that has backed Warby Parker, Nextdoor, Redfin, Eventbrite and Pure Storage, among many others. This wasn’t Coatue’s first mid-stage private tech backing. Last year, the firm established a $300 million growth fund for this purpose, as reported by Pando’s Sarah Lacy. The fund recently led mobile travel startup Hotel Tonight’s $45 million round in September. Coatue also participated in Box’s funding round in 2012. And Coatue and Tiger Global aren’t the only hedge funds to jump into the private markets tech-investing game of late. Altimeter has been backing private tech companies for the past few years. Valiant Capital Partners has backed Dropbox, Evernote, and Pinterest in the past two years. Maverick Capital has participated in a few seed deals, including Zenefits in 2013. And the fund isn’t just going after growth-stage funding. In December, the firm participated in a seed round in Estimote, which develops beacons.” (TechCrunch, January 18, 2014).

Regarding China: “In 2014 rising borrowing costs will mean repercussions for the real economy: industries that used to rely on cheap capital, especially those in overcapacity, such as steel, cement, glass, and even rail, face strong headwinds in financing. As mentioned above, the just-concluded national railway network conference (a senior-level central affair for this ‘strategic’ sector) announced that the fixed asset investment goal for rail in 2014 was 630 billion RMB, 30 billion RMB less than what was spent last year. Targeting lower growth in 2014 was well beneath market expectations, given how important rail investment was in anchoring Chinese growth targets over the past five years. With falling rail FAI and steel sector consolidation, rising export surpluses thanks to a strong US will not be enough to get China to the rumored 2014 7.5% growth target (we still bet that high a target will not be announced). In response to the financial crisis huge industrial and property investment kept China sailing relatively smoothly, underwritten by largely unregulated shadow bank lending. Off-balance sheet activity and over-investment in China are two sides of the same coin, and if Beijing is determined to tackle either of them then the either side will be affected too. The most productive real economy firms in China – the ones that have to pay the bills and create the sustainable jobs going forward – are completely tangled up in this legacy. Cutting through this in 2014 is going to be messy. Ultimately, this year, we see no alternative for Beijing other than letting capable, productive private businesses off their leash so they can help pull the economy out of the ditch.” (Rhodium Group, January 22, 2014)

Levels: (Prices as of close January 24, 2014)

S&P 500 Index [1790.29] – It appears that 1850 was a sign of a top, as the struggle to climb above 1840 showcased a start of a consolidation phase. Many observers wait to see a break below 1780 to make a noteworthy point about sell-off potentials.

Crude (Spot) [$96.64] –After weakness in December 2013, the commodity has recovered at a quick pace. Still questionable if surpassing $100 is a possibility.

Gold [$1263.00] – At this point, $1300 is on the radar of buyers, but envisioning a run above $1400 requires further momentum acceleration.

DXY – US Dollar Index [80.45] – Since May 2011, the dollar index has shown signs of stabilizing and not going down further.

US 10 Year Treasury Yields [2.71%] – Sudden turn from annual highs of 3.05%. November lows of 2.65% might be the next critical point, as yields sentiment has shifted.



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