Market Outlook | April 7, 2014

“It is the eye of ignorance that assigns a fixed and unchangeable color to every object; beware of this stumbling block.” (Paul Gauguin, 1848-1903)

Some stumbling

Chatter, debate and uproar about market mechanics dominated last week’s financial discussion points. More will follow on this trading maze, and there will be worthwhile debate where more guidance is needed. However, markets of all kinds are trying to examine whether share prices are justified at this junction between all-time highs in US market and the mixed and less-stable emerging market world. Nickel-and-diming strategies on high volume are eventually a regulatory challenge rather than a cyclical or psychological matter. Regardless of how the day-to-day mechanics (some abstract) have transpired, this is and has been a bull market. It has been for a while, with the revival of economic conditions and growth in select industries. Refocusing the attention on bigger issues is in the minds of risk-takers and it has been for weeks. Certainly, inflow to US equity markets has not stopped either, and the expectations for better-than-prior-year returns still persist.

Finding perspective

As a start, the S&P 500 index didn’t reach all-time highs overnight, and the Fed’s message is not reexamined daily. Neither are the labor conditions that have been brewing. In the last few weeks, the market had moments of silent stumbling as highlighted by trading action last Friday. Yet, the current bull market is easily painted as stable, well-established, Fed-driven magic that turned into reality. Of course, that’s one version, and the view of this market run-up depends on the perspective. Investors gaining from appreciation are not too worried about the ifs and whys. Corporate leaders who have averted showcasing real growth might get a bit nervous playing the share buyback and layoff game as a short-term fix for higher share prices. The post-2008 recovery has been fruitful for shareholders, and the buzz felt from the ease of 2013 may linger more than desired by rational seekers. Critical thinking is now required in risk allocation. Against this backdrop, memories of 2000 and 2007 peaks are in the minds of cycle observers who know that bull markets build slowly and sell-0ffs are explosive to take away gains, especially for the latecomers. Yet, many ponder this again and again: Can we have a bubble with not-so-glorious economic recovery, but a roaring stock market?

Near-term dynamics

If the volatility index provides any worthwhile hints, then for now, it mirrors 2013 trends. Basically, calm is the dominant force, despite mild, occasionally worrisome periods. In terms of the “taper,” the decision by the European Central Bank and the pace of an emerging market slowdown, the market is comfortable that issues are known and surprise hasn’t overly crept up. Perhaps, the potential for a meaningful correction lies in the possibility that these “known” or “expected” matters end up being underestimated. Basically, a Fed-driven market is reliant on messaging and the Fed’s leadership, from an unemployment target to inflation status to the definition of “economic growth.” Yet, NASDAQ’s recent action symbolizing momentum and innovative companies tells a story of minor pullbacks as early signs. Since March 7th, the tech and biotech-heavy index is down more than 5%. The question ahead is if buyers are seeing a discounted entry point or declining momentum. The same applies to the Russell 2000 index, which is led by growth-driven companies and, like the NASDAQ, another area with wobbling signs. At least bubble seekers can focus here to see the level of breakdown.

Interestingly, with US momentum names slightly slowing, the EM themes have shown signs of liveliness. It’s unclear if this is a new trend or a short-term rotation. Nonetheless, momentum areas in US markets, especially in tech and biotech, may set the tone for the rest of the sectors. At some point, the health of business fundamentals may re-shift the focus from the interest rate policies that have mesmerized and captured participants’ thinking.

Article Quotes:

“Buybacks are such a common feature of corporate life and the stock markets that it’s easy to forget that they were essentially illegal not too long ago. They are used to manipulate share prices and earnings per share, all in the name of ‘maximizing shareholder value.’ The result has been an explosion of wealth among executives who are typically loaded with stock-based pay and who enjoy the luxury of determining the amounts of the buybacks as well as their timing. As buybacks increased in frequency and value, so did the share of executive pay in the form of stock options and stock awards. The result was a positive feedback loop that enriched all executives and handed a few unimaginable wealth. A new research paper written by William Lazonick of the University of Massachusetts Lowell, which will be presented at the conference of the Institute of New Economic Thinking in Toronto on April 10 to 12, noted that in 2012, the 500 highest-paid executives in the United States received an average pay of $24.4-million (U.S.) – 52 per cent from stock options and 26 per cent from stock awards. ‘The more one delves into the reasons for the huge increase in open-market [share] repurchase since the mid-1980s, the clearer it becomes that the only plausible reason for this mode of resource allocation is that the very executives who make the buyback decisions have much to gain personally through their stock-based pay,’ Mr. Lazonick said. As executive pay soared, workers’ wages stagnated when measured against productivity gains. Between 1948 and 1983, when regulations severely limited the size of buybacks, real compensation per hour and gains in productivity per hour closely tracked one other. That’s no longer the case. In the early 1980s, a significant gap between productivity and wages emerged and kept getting wider. By 2012, the 100-per-cent rise in productivity (partly due to corporate ‘downsizing’) from its level in 1963 was met with a mere 60-per-cent increase in real wages.” (The Globe and Mail, April 4, 2014).

“More than Sino-European relations, though, the unstoppable river may be the flow of Chinese goods around the world. A recent paper for Bruegel, a think-tank, co-written by Jim O’Neill, a former Goldman Sachs economist who coined the term ‘BRIC’ (for the fast-rising economies of Brazil, Russia, India and China), predicts some striking changes. China has already overtaken America as the biggest single trader and will match the EU by 2020. By then, China’s share of global GDP (measured at purchasing-power parity) will also probably surpass the EU’s. Some European countries will lose their share of global trade faster than others. On current trends, by 2020 China will become the biggest single destination for German exports (overtaking France) and the second-biggest for France (displacing Belgium, but still behind Germany). Italy and Germany will export more to emerging and developing markets than to their euro-zone partners (unlike France, Spain, Belgium and the Netherlands). All this raises some big questions. Internationally, it will be ever harder for Europeans to justify their disproportionate seats and voting weights in the IMF and World Bank. That may push some to reconsider the idea of a single seat for the EU or perhaps the euro zone. At home, the implications may be harder still. If European countries trade more with the outside world than with each other, the commitment to a single currency may weaken. Yet diverging trade patterns may also mean that euro-zone countries have to become more integrated to be better prepared to resist asymmetric shocks from external partners.” (The Economist, April 5, 2014).



Levels: (Prices as of close April 4, 2014)

S&P 500 Index [1865] – Another sign of momentum stalling around 1880. Overall, the bullish cycle remains in play as some pullbacks are awaited.

Crude (Spot) [$101.14] – During the last few weeks, a narrow trading range between $98-102. Appears steady at current levels without major directional shift.

Gold [$1284.00] – Since peaking on March 17, 2014, the commodity has dropped more than 7% after making a 15% run since late December 2013. Fair to say, gold is seeking and reaching a normalizing level.

DXY – US Dollar Index [80.42] – March 13 bottom of 79.26 may signal the beginning of new strength in the dollar. Yet, a major move is not quite visible, as witnessed for years.

US 10 Year Treasury Yields [2.72%] – Patterns suggest again that surpassing the 2.80% mark is challenging in the near-term, as the 3% target is long awaited.


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