Market Outlook | February 10, 2014

“When it is not necessary to make a decision, it is necessary not to make a decision.” – Lord Falkland (1610-1643)

Slow digestion

The markets have reached a sideways pattern as investors contemplate whether all-time highs are justified or further correction is needed. In some ways, new data is being processed, from labor to GDP growth. Similarly, potential new catalysts are silently brewing, but dramatic surprises have yet to faze observers. Shocks and overreactions have not seeped through the collective mindset of US equities, but the signs are there for those looking closely.

Technical and momentum observers await responses from buyers who may look to re-enter after recent pullbacks. Is there enthusiasm left, as witnessed last year? Guidance from central banks and taper plans are watched day to day, but a clear-cut answer is hardly available. And it might not be for longer than pundits claim. Labor numbers are leading to mixed responses after falling below expectations, but more supporting data is clearly needed. Sentiment trackers debate whether the recent wave of mild panic has enough fuel to trigger additional selling. Looking at emerging market (EM) indexes, those who need to sell appear to have already sold at a rampant pace based on massive outflow. A well-documented slowdown and outflow has created enough headlines to grab money managers’ attention. In fact, the focus may turn to where value seekers are now examining specific EM opportunities. After all, the growth rates of China and India last year remained higher than more mature markets. As for achieving expectations, that’s another matter that’s unknown. For now, prices in EMs may be cheap by some estimates as the downtrend cycle continues to play out. Certainly, the overall macro backdrop of BRIC and other EMs is sluggish and not overly comforting:

“HSBC's composite emerging markets index of manufacturing and services purchasing managers' surveys slipped for the second month running to 51.4 in January. It stayed under the 2013 average of 51.7 and well below the score of 64.1 posted last January.” (The Reuters, February 9, 2014)

Meanwhile, in the US, fundamental observers, on average, are not overly disappointed as companies continue to exceed analyst expectations. In fact, according to S&P CapIQ earnings:

“The current beat rate for Q4 now stands at almost 66%, slightly higher than the historical average of 65%.” (February 7, 2014).

Subdued responses

Even though the last few weeks witnessed a rise in volatility, there seems to be calm in turbulence. The VIX index is a common barometer for extreme reactions of fear for US stocks. December 2008 was the watershed point for fear, when the index reached 89 and quickly came down as stability resurfaced. In the last two and a half years, the index has not surpassed the level of 20 for a significant period, suggesting that worrisome, collapse-like panic selling is not quite visible. A contingent crowd is claiming complacency, which has some valid points, especially when the S&P 500 index climbed to new all-time highs.

Spring 2010 and summer 2011 witnessed bigger moves related to big-picture concerns (VIX tested over 40 ranges) but calm eventually prevailed. What were the drivers? US equities were relatively attractive and the Fed’s QE plan was in rhythm, not shocking or surprising the investor base that continued to see improving corporate earnings, unimpressive commodity promises and importantly low interest rates. Therefore, the relative argument has much more meaning for influential capital flow and market reaction. Plus, US equities were favored even though many multinational companies have notable revenue exposure from overseas companies. As 2014 begins, is there a concern like 2010 and 2011, about the budget and growth-related policies that should cause some nervous responses? Or is it external concerns of EM weakness that can stir a new wave of sell-offs? Curiosity looms on this answer, as Eurozone and developing markets will confront pending data points to make solid conclusions.

Strategizing

From a risk-reward point of view, betting on EM recovery appeals to some, while others may prefer to stay away from this theme. Equally, declining US stocks may at first glance appear attractive, but there are plenty of naysayers. In other words, the shock and awe factor is not quite glaring. The risk-aversion seekers will continue to pile into Treasuries and the US dollar, as witnessed in other crisis periods. Yet, bunkering up is a theme that’s not quite foreign in recent years. Macro observers are seeing commodities attempt to bottom, with crude surging and gold stabilizing, but last decade’s expectations of all-time highs are not quite on the radar. In a world where relative attractiveness is valued more than absolute data, changing the status-quo trend is not quite rapid. Surviving within this theme of low interest is the primary focus while exploring insignificant and significant catalysts. For now, decisions are not as important as digesting the moving parts of economic conditions, perception related to sentiment and pending market-moving policies.

Article Quotes:

“Although China has shown signs of an economic slowdown, foreign institutional investors are still betting on its cheap equity market with potential for big returns. Qualified Foreign Institutional Investors (QFIIs) opened 45 new A-share accounts in China last December, a monthly record for 2013, the China Security Depository and Clearing Co., Ltd. said in January. This marked the 24th consecutive month in which QFIIs have opened accounts in China's A-share markets and brings the total number of accounts to 612. Foreign investors have to be licensed as QFII or Renminbi QFII, two schemes created in 2002 and 2011 respectively, allowing qualified investors to trade a limited quota in China's largely isolated capital market. The State Administration of Foreign Exchange, China's foreign exchange regulator, granted 51.4 billion U.S. dollars of investment quotas to 235 QFIIs, and 167.8 billion yuan to 57 RQFIIs as of Jan. 27, 2014. … Nearly 60 percent of 1,734 listed enterprises that have released their preliminary annual reports are optimistic about how they performed last year, with 398 firms estimating that their profits surged by over 100 percent.” (People’s Daily, February 8, 2014)

“Starkman argues, three factors contributed to the disappearance of investigative journalism. Years of financial deregulation made the legal documentation that reporters relied upon to conduct their investigations – indictments, testimony, settlements – less available. The ‘stampede of the middle class into the stock market,’ Starkman writes, fueled demand for insider business intelligence and investor-oriented news, and coincided with the rise of CNBC and its ascendant strain of access reporting. And the explosion of search engines and e-commerce decimated the news industry’s traditional business model, shrinking budgets for investigative projects and making publishers more wary of upsetting advertisers. Accountability journalism, of course, is both expensive and antagonistic to corporate brands. Just as dubious subprime practices seeped into Wall Street culture, newsrooms became least equipped to examine them. Even in the early aughts, when articles in the business press questioned the rise of housing prices and mortgage loans, they typically did so for audiences of investors: these were financial products to be avoided rather than evidence of systemic corruption. Likewise, pre-crash critiques of Lehman Brothers, Citigroup, and Washington Mutual focused on their growth strategies and stock performance.” (The New Yorker, February 5, 2014)

Levels: (Prices as of close February 7, 2014)

S&P 500 Index [1797.02] – From January 15 highs of 1850 to February 5 lows of 1737.92, the index witnessed a more than 6% swing. It is now seeking to stabilize closer to 1800. Late December and early January suggested that buyers’ appetites began to fade around 1840.

Crude (Spot) [$99.88] – Inching closer to $100, last reached on December 27, 2013. An inflection point waits again at this junction. Multi-week highs achieved while the supply is expanding and demand is questionable. Therefore, the fundamentals challenge the current momentum in weeks ahead.

Gold [$1256.50] – Since July 2013, gold prices have hinted at bottoming and showed signs of regaining positive flow. Optimists envision upside moves closer to $100

DXY – US Dollar Index [80.69] – Since the lows of last October, the index has not appreciated much and remains stable. The dollar strength is not quite a dominant trend as of now.

US 10 Year Treasury Yields [2.68%] – After a sudden drop earlier this year, questions linger as to whether yields can stay near or above 3%. For now, the February 3 lows of 2.56% serve as a key benchmark.


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