Market Outlook | April 28, 2014

“Vision is the art of seeing things invisible.” Jonathan Swift (1667-1745)

Clarity awaits (yet again)

As April draws to a close, eager participants seeking hints on Fed policy, labor conditions, GDP status and some guidance on housing growth await several data points. Surely, waiting and reacting to data has not always proven to be instrumental in altering the existing bullish stock market. Whether corporate earnings or economic recovery, the catalysts for price declines are a mystery. As much as pundits want to rave about one or two factors, it takes a lot to bring down this market. Surely, signs of slowing in momentum-driven stocks have been quite visible in the last few weeks, considering biotech, as well as some high-growth tech names. On a company-specific basis, those weaknesses are identifiable but have not been enough to trigger broader, meaningful corrections.

At the same time, the pace of the housing slowdown and interest rate policies require clarification. With the US 10 year yields at 2.66% (a relatively low range), the market is not suggesting that the economic strength is vibrant. In turn, any doubt about US economic growth is reasonable. Plus, the dollar has not shown any strength. Therefore, investors need to be convinced that economic “strength” is a supportable trend, rather than a stalling trend. The questions will be asked, especially regarding the “taper,” and suspense will linger despite volatility hovering at familiar calm/low levels.

Search for sense

Does supply-demand make sense when markets are tinkered with and simple logic goes out the window? Gold owners have been learning that in the last few years, with prices declining. Is there real demand? Is supply understood? Similar logic (or lack thereof) applies in the patterns of oil prices. In terms of oil prices, one would think price decline is highly possible with US supply expansion and a not-so-vibrant global economy recently. Yet again, the logic of supply-demand is not enough to be a speculator, and certainly, grasping more of the inefficient dynamics is vital. Perhaps, this is a telling point for various markets, from stocks and commodities to interest rates. The irrational nature of markets is normal, and sometimes the prevailing theme or momentum can drive the direction of prices. Thus, logical explanations are not always available in this tricky market.

Rotational game

Any wobbly pattern in US stock markets may trigger interest (or the consideration of shelter) in emerging markets which have shown signs of revival since early February 2014 lows. Certainly, investors have slowly trickled money back into EM funds in recent weeks. Some may argue that short-term recovery from 2013’s underperformance is not quite convincing, but long-term participants continue to favor EM upside potential. The relative-basis argument here simply suggests any pullback in US markets will require rotation into developing markets, and the recent cycle supports that. Equally, some European markets that have underperformed may appeal to those bargain hunters.

Macro puzzle

More than the general emerging market climate, the status of the Chinese economy is a puzzle within itself. On one end, large US corporations view the Chinese market as a great contributor to earnings:

“China has proven to be a strong engine for Apple (AAPL), with its new partner China Mobile (CHL) helping push fiscal Q2 iPhone sales to more than 43 million, far more than expected. The $9.2 billion that China added to Apple's coffers comprised nearly 25% of the company's total quarterly revenue, up 13% from a year earlier. … Starbucks (SBUX) saw net revenues in its China/Asia-Pacific region grow 24% year over year to $265.3 million during its fiscal Q2, driven in part by nearly 700 stores opening over the past year. Comparable store sales were up 7%.” (Investors Business Daily, April 26, 2014)

On the other hand, China’s domestic growth and currency management remains a suspenseful international story. The growth rate of last decade is hard to replicate, and investors are coming to terms with that. Meanwhile, the Yuan continues to weaken. The currency markets are seeing speculation on drivers and partially discovered facts. This Yuan devaluation is hitting new multi-month lows, which will force corporations to hedge currency exposure. Other participants will interpret these as weak economic signs. Surely, this can stir political talk of “currency wars” and intervention, which certainly can stir up a bigger macro debate. Frankly, lesser-known currency-related news might result in a sensitive market reaction.


Article Quotes:

“To be sure, Beijing's willingness to inject itself into the South Sudanese crisis is driven by the simple fact that China buys almost 80 percent of South Sudanese oil exports and has watched with alarm as the current fighting has crippled the country's ability to produce and export oil to customers in Asia. Oil production in both Sudans has dropped from a peak of about 480,000 barrels a day in 2010 to about 160,000 barrels today, and even that last bit is under pressure from rebels in South Sudan, who have ordered international oil companies to pack up and leave as part of a strategy to cut off the main economic lifeline of the South Sudanese government. China may also not have much of a choice. The cease-fire in South Sudan brokered in early 2014 imploded in the last week, with rebels advancing on key cities in oil-producing regions and slaughtering civilians as they went. The political nature of the fighting – which pits Salva Kiir's South Sudanese government forces against rebels led by Riek Machar – has by some accounts descended into an ethnic bloodletting. China has been caught in the middle; a pair of its oil workers were abducted by Machar's forces last week and Chinese oil firms have been told to leave the country. … China's traditional interests in both Sudan and South Sudan, and its newfound interest as a mediator, were on full display in the wake of the attacks. China's foreign ministry on Wednesday ‘strongly condemned’ the killings in Bentiu and called on ‘relevant parties in South Sudan to resolve their issues by pushing forward political dialogue and achieve reconciliation.’ But the ministry also called on South Sudan's government to better protect Chinese oil firms and workers there after the two workers were abducted last week.” (Foreign Policy, April 24, 2014)

“Major organizations that carry out banking activities, but are not banks, may become so important to the financial system that they need to be regulated like traditional banks, a European Central Bank governing council member said on Saturday. Financial regulators are seeking to shine a light on so-called ‘shadow banking,’ a 24-trillion-euro ($33 trillion) industry in Europe – half the world's total – that comprises money market funds, some hedge funds, and firms involved in securities lending and repurchase markets. Such groups borrow and lend like banks, but because they are not banks they often fall outside the remit of regulators. Speaking at the Finnish Social Forum, Erkki Liikanen said there was a risk that tighter banking regulation in the aftermath of the global financial crisis could lead to growth in unregulated shadow banking. If markets then began to expect that shadow banks would have to be bailed out with public funds to prevent a financial sector collapse, the problem would not have not been solved, Liikanen said, adding that authorities were following developments.” (Reuters, April 26, 2014)

Levels: (Prices as of close April 25, 2014)

S&P 500 Index [1863.40] – Numerous hints of stalling; surpassing 1900 has proven to be challenging. Interestingly, the index peaked closer to 1850 to start the year. Although currently above the 50-day moving average, further tests await. Staying above 1880 would restore further confidence.

Crude (Spot) [$100.60] – Buyers’ demand above $105 appears to lose momentum. As usual in recent times, trading is around $100. Early hints suggest that without a noteworthy catalyst, downside pressure is a near-term possibility.

Gold [$1291.50] – The 1280 range is setting the tone as a bottom for optimists of gold prices. Realists are wondering if 1360 is the next critical range.

DXY – US Dollar Index [79.74] – For now, the April 10 lows (79.33) are the benchmark to measure potential future weakness. Trend-shifting moves have not transpired in the last three months.

US 10 Year Treasury Yields [2.66%] – The common range these days is between 2.60-2.80%. The 3% level has proved to be a tough place to reach throughout all of 2014. Interestingly, the 50-day moving average is almost at Friday’s close.






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