Market Outlook | February 24, 2014

“The only alternative to co-existence is co-destruction.” Jawaharlal Nehru (1889 - 1964)

Coexisting views

In a period where US stock market indexes are showing cheerful signs, there is also growing fear and anxiety developing underneath the surface. As spotted many times last year, there is the paradoxical relationship of higher markets, which also attract worrisome behaviors and growing groans. Perhaps, it’s not overly surprising to see investors and traders focus on the “cheapness” of volatility in recent months. In fact, the lack of turbulence is not a new story. It has persisted for a long while, where the unpredictable elements were debated.. Collective acknowledgement of low volatility in US markets has been credited to the Federal Reserve policies and messaging. Surely, a shift in policies can stir some uncertainty, yet most of it has been short-lived. Thus, betting on fear is common for traders, but some here and there await an overly dramatic act of full-blown panic . Plus, given various instruments these days, more and more participants are inclined to think that a severe correction may be looming. That is known to drum up some reaction and trading activity:

“Investors traded 4.4 million Vix futures contracts in January, a 52% increase from the same period a year earlier and 38% higher than December, a rise largely attributable to a January spike in volatility and the continued popularity of exchange-traded products (ETPs) tracking short-term futures, according to … (the) Chicago Board Options Exchange (CBOE), which calculates the index.” (Risk.net, February 21, 2014)

Of course, rising markets with strong momentum also build confidence for those already owning shares and even drive up additional flow for those seeking to test their luck further. Since 2009, it has been a strong cyclical run where optimism is preferred and appears to justify current price ranges. Finally, there are those who see the danger of elevated markets and slowing global growth, but sense a relative advantage in US equities. Similarly, the more practical view suggests there are less attractive alternatives to seek at this junction. Certainly, that’s been recognized by most money managers who attempt to navigate through this tricky junction as capital continues rotation into equities.

“The inflows into stock funds in the week were the biggest in 12 weeks, according to the report, which also cited data from fund-tracker EPFR Global. Investors pulled $45 billion out of money market funds, meanwhile, marking their biggest outflows since last October. The inflows marked the third straight week of new demand for stock funds. Funds that specialize in U.S. stocks attracted $8.3 billion of the net inflows into stock funds.” (Reuters, February 21, 2014).

Surely, emerging market worries and some earnings underperformance can trigger questionable responses on a stock or company-specific basis. Yet, the S&P 500 Index is not too far off from all-time highs – a barometer that may not tell the full story, but explains the existing sentiment. Plus, worrisome headline matters have not left a lasting impression of danger and extended sell-offs.

Preparation

Plenty of suspense waits with the repositioning of major ideas and capital. A multi-year cycle run typically suggests a step closer to the inevitable ugly finish. At least that’s the mindset of risk-takers in this generation; market tops are not an archaic thought, given the 2008 and 2000 fall-outs. For all the comparison to and debates about the 1929-style crash, one cannot ignore the last decade, when two bubbles left a lasting effect but the broad indexes rose from the grave quickly, as well. Bubble-bursting thoughts have formed even before the actual formation of a bubble; thus, plenty of false singles have come and gone. In the common bubble talks, there are references to the disconnect of the economy versus stock prices. To bring down the markets, more than one catalyst is needed and participants need to believe that those catalysts are legitimate. Thus far, worrisome issues have been shrugged off despite the bearish experts’ attempts to map out and indentify specific risks that have persisted and in some cases have been misunderstood (i.e., QE, the currency crisis or fundamental concerns).

Psychological impact

So far in 2014, there has been a puzzling up-and-down occurrence that’s still being digested. Mid-January sell-offs dues to emerging market currency worries and natural pullbacks have now been recouped. “Taper” worries that partially triggered a response are now not overly a concern. The economic slowdown, which seems to be mixed with recent disappointments, has not materialized into bigger falls. Even the underperformance of companies’ revenues due to slowing emerging markets has not stirred a larger panic-like behavior, either. The psychological impact of QE might have created a remarkable sense of confidence, beyond the practical point of low interest rates, which encourages risk-taking. Perhaps, the market is not convincing people that the end of the QE era is in full gear. After all, inflation and high interest rates are not on the headline concern list.

Sentiment is proving to be as powerful as reality, and that’s the puzzling part that keeps reoccurring and leaving the average mind stunned. The mystery of markets at some point is mostly discovered, but the rest is psychological. Discovering the mystery is as challenging as understanding the prevailing psychology for a specific theme and trend. At this tricky junction, more mysteries will be discovered on a daily basis, and sorting out the relevant catalysts from the less relevant ones is where the reward lies.

Article Quotes:

“QE can alter long-term interest rates which can influence private investment and the creditworthiness of the private sector. QE has a powerful psychological impact on both asset prices and the economy and can alter expectations of future economic outcomes. Some economists call this the ‘expectations channel’ or forward guidance effect. QE involves a portfolio rebalancing effect where the Fed’s intervention in the outstanding private sector assets can alter the asset options for private portfolio composition. Some economists refer to this as the ‘wealth effect.’ QE alters the composition of the private sector’s assets by changing the “moneyness” of the private sector’s assets. Some might call this ‘monetization,’ but it’s important to frame this correctly so as to avoid concluding that the Fed is ‘printing money.’ While technically true, the Fed is also ‘unprinting’ a T-bond. Depending on how the policy is implemented QE could potentially drive down the value of the dollar relative to other currencies which could alter foreign trade balances.” (Orcam Financial Group, Cullen Roche, February 10, 2014)

“The conventional wisdom is that, when confronted by a bear, you should lie motionless until it loses interest (or assumes that you are dead) and leaves you alone. But there are different species of bear, with some more likely to be deterred by bold, purposeful action. The question is how to determine the right approach when terror incarnate is staring you in the face. This scenario is helpful for thinking about the eurozone as it attempts to survive its next round of trials – beginning with the European Parliament election in May. Can it continue simply to ‘lie still,’ hoping that no new shocks arise that diminish its economic health, if not threaten its survival? Some take the sanguine view that the current ‘lie still’ approach is adequate to ensure that the eurozone economy does more than avoid decline. From their perspective, Germany’s decision over the last three years to permit actual and prospective transfers just large enough to prevent financial meltdown will somehow be enough to enable the eurozone finally to begin to recover from a half-decade of recession and stagnation. But the fact is that these transfers – that is, European Stability Mechanism-financed bailout programs and the European Central Bank’s prospective ‘outright monetary transactions’ (OMT) bond-buying scheme – can do little more than fend off collapse. They cannot boost economic output, because they are conditional upon recipient countries’ continued pursuit of internal devaluation (lowering domestic wages and prices).” (Project-Syndicate, February 21, 2014)

Levels: (Prices as of close February 21, 2014)

S&P 500 Index [1836.63] – Attempting to elevate near and past all-time highs set on January 15, 2014 (1850.84). However, last week, that target was not achieved. The index is in an intriguing trading range, given that last month, investors chose to sell at these levels. There’s a retest of previous patterns ahead.

Crude (Spot) [$102.20] – From January 9 to February 19,there has been a quick and strong move by crude, revisiting and eclipsing the $100-per-barrel price. Yet, the sustainability of this run has a few doubters. The next few weeks are set to confirm the recent momentum.

Gold [$1316.25] – After climbing out of recent lows, the 50-day moving average stands at $1341.07. Observers wait to see a follow-through in the near-term.

DXY – US Dollar Index [80.23] – In the last 15 days, the index has mostly seen a downward decline. A glimpse of recovery waits, based on the pattern of the last six months.

US 10 Year Treasury Yields [2.73%] – Holding steady around a familiar range. The 20-day moving average is 2.70%, which is around last week’s finish.





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