Market Outlook | March 17, 2014

“Time crumbles things; everything grows old under the power of Time and is forgotten through the lapse of Time.” Aristotle (384 BC-322 BC)

Silently crumbling?

Turbulence is reawakening a bit within the existing positive momentum that has formed a stable US financial market. Of course, hints of a trend shift are brewing more and more as perceived risk is being evaluated in developed markets. From the pending FOMC meeting to several EM nations increasing interest rates, the landscape is mildly changing. Similarly, pending responses to technical indicators as well as reshuffling of capital into new themes can trigger new thoughts. Plus, ongoing data will continue to seep through the investor mindset. How to perceive risk will be revealed further and the bulls’ confidence level will be tested – yet again. The status-quo approach is overly comfortable for those betting on rising stocks and low rates. However, the danger of being flatfooted ahead of turbulence begs the question of how to prepare for the next move.

The volatility index has not and is not signaling absolute panic, and previously, false signals have prematurely called for short-lived sell-offs. Thus, naysayers to this bullish run have had shaken confidence in recent trading action, where “bad news” has been deferred or deemed a non-forceful catalyst. Uncertainty of macro and micro concerns is calmly digested, and a collective rush to exit is not quite justified by mainstream investors. One part of the puzzle is deciphering the pace of economic and corporate growth, which offers plenty of tricks and data points to ponder. Perhaps, the market has a mind of its own, living and moving at its own pace.

Meanwhile, deflation and disinflation concerns are brewing in developed markets. In fact, the deflation debate has reached beyond speculation, but rather has become a reality that’s come to the forefront in Europe:

“Europe's headline price data understate the full deflation risk. Eurostat's HICP index ‘at constant taxes’ – stripping out the one-off effects of austerity – shows that 23 of the EU's 28 countries have seen a fall in prices over the past seven months.” (The Telegraph, March 12, 2014).

Big-picture parts

The macro-climate is awakening to the realization that post-crisis matters have stability, but long-term issues persist with a slowing global climate. In the recovery mode, optimism was restored and volatility significantly reduced, and soon, coping with unknown risk measurement was the ultimate test for portfolio managers. As usual, risk aversion, leading into more established currencies and commodities, is worth tracking. Thus far, hard assets have risen in 2014 and there are early signs of rotation into safe/established assets, given ongoing emerging market political and financial turmoil.

Meanwhile, China’s slowing growth is a topic that’s been murmured about, but its impact on the developed market is still being understood. Plus, the recent announcement of a wider trading band for the Yuan over the weekend, although anticipated, suggests more fluctuation in currency markets. The reaction is causing some suspense as to how traders would react in the near-term toward weaker Chinese currency and impact on global stocks. Surely, policy changes like this can be historic and transitions can cause some mild disruptions. Nonetheless, this is a new dynamic to the currency market and the impact on Chinese stocks is yet to be determined. The Chinese index (FXI) has remained cheap relative to US markets, and now the currency policy may serve as a catalyst to spark a response.

New cycle

The instrumental factor that’s driven market appreciation is low interest rate policies, and certainly that has impacted how investors demanded higher-yielding assets.

“Our results show that, in emerging markets, issuance would have been significantly lower without QE since 2009. A counterfactual analysis shows that issuance without QE would have been broadly half of the actual issuance since 2009, with the gap increasing in late 2012. In advanced economies, the impact of QE was less strong and concentrated in early 2009, mainly as a reflection of the MBS rather than Treasury purchases.” (ECB, Global Corporate Bond Issuance, March 2014).

The taper era remains a wildcard from a period where risk-taking has been encouraged and rewarded. How this will change has been asked but not answered. Again, the US 10 year Treasury yield is below 3%, the stock market is near all-time highs and EMs are less stable; these are the known themes. We are in more or less a vulnerable stage of this cycle, as assets are not valued cheaply. How will this shape up in the next 1-2 years? Which moves first: Either rates up and stocks down or otherwise? Mapping out a plan on interest rates and asset prices is challenging risk managers. Clearly, the disconnect between the real economy and the stock market is dangerous (despite crafty explanations) and the warning has been felt but not always heard. The messaging of the Fed or the response to the Fed’s message is clearly a vital sign where an inflection point can be felt. Already, the S&P 500 index showed signs of cracking in January. Thus, a repeat of price retreat is not far fetched. Catalysts are plenty for bigger moves, especially in the early stages of the taper era. The question is timing, and with limited ideas, risky assets serve a purpose and eager investors desire risk. Balancing the need for returns versus unmasked realities is the art for money managers.




Article Quotes:

“Major US banks are running away from lending to highly leveraged buyouts, industry statistics show. Bank of America, JPMorgan Chase, Wells Fargo and Citigroup have all fallen far down the list of top LBO lenders in 2014 after regulators pressed changes that would have made such loans more expensive. Stepping away from such business will surely crimp profits and is one example of how new regulations are forcing changes to the banking sector. BofA earned roughly $140 million in 2013 from financing new LBOs, sources said. The banks, which were all among the top 11 LBO lenders in 2011 to 2013, could do no better than No. 18 in 2014, according to Thomson Reuters LPC statistics shared exclusively with The Post. The change comes after the Office of the Comptroller of the Currency (OCC) stepped up a campaign last year against such highly leveraged buyout financing. The OCC and the Federal Reserve in the fall told the major banks if they funded new LBOs that had greater than six times debt-to-earnings before interest, taxes, depreciation and amortization (Ebitda) ratios, they would have to consider them non-conforming loans and hold more cash against them, sources said.” (New York Post, March 13, 2014)

“Skilled immigration is of great importance to the US, representing 16% of US workers with a bachelor’s degree, and 29% of the growth of this labour force over the period 1995-2008. Presently, proponents for increased skilled immigration argue that it supports economic growth, and some have gone so far as to say that the alternative would be paramount to ‘national suicide.’ Opponents believe skilled immigration is already too high and hurts the outcomes of citizen workers. In particular, Bill Gates has stated that Microsoft hires four additional employees to support each skilled worker brought into the US through the H-1B visa program. Matloff (2003) instead argues that US companies use skilled immigrants to displace older citizen workers that have higher salaries. Our research proposes a more subtle relationship than that suggested in the public discourse on immigration or from more aggregate models of international worker flows. We study the way in which the hiring of skilled immigrants affects the employment structures of US firms using employer-employee data from the US. While OLS and IV specifications find increases in total skilled employment by the firm with increases in skilled immigrant employment, we find evidence that employment expansion is greater for younger natives than their older counterparts.” (VOX, March 16, 2014)




Levels: (Prices as of close March 14, 2014)

S&P 500 Index [1841.13] – Very optimistic observers are wondering if 1900 wasn’t reached due to a momentum slowdown. Yet, for the upcoming week, holding above 1840 can trigger restoration of the ongoing bullish run. Notably, the January 15 highs of 1850.84 might have suggested a vital hint during the early sell-off this year.

Crude (Spot) [$98.89] – March 3 highs of $105.22 marked a peak in the recent run. The 200-day moving average sits at the all-too-familiar $100 range. Therefore, staying above $100 will be retested; if not, negative momentum might continue to build for months ahead.

Gold [$1368.75] – Since late December, the commodity is up nearly 15%, which suggests a recovery run after a weak 2013 performance. The next noteworthy target is $1400 (or $1419.50), which was a key resistance point in September 2013.

DXY – US Dollar Index [79.44] – The downtrend is intact, as new lows have been achieved consecutively in recent weeks. The next noteworthy low is not far removed. It stands at 78.91, which was set in February of last year.

US 10 Year Treasury Yields [2.65%] – Annual lows of 2.56% were reached on February 3, 2014. Yet, surpassing 2.80% remains a challenge, suggesting a weak growth environment. Annual highs of 3.05% appear further away now, given analysts’ expectations of rising yields. Interestingly, the 200-day moving average stands at 2.67%, which is in line with Friday’s close.


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