Market Outlook | May 5, 2014

“Doubt can only be removed by action.” Johann Wolfgang von Goethe (1749-1832)

Doubts deferred

No matter how many times this market is doubted, the broad indexes continue to trade near or at record highs. Despite various pundits loudly proclaiming skepticism and illustrating justifiable reasons for pullbacks, the six-year bull market lives on. Political disarray, economic weakness, brewing macro concerns, earnings slowdowns and changes in the regulatory framework all fail to take down the collective shares of US-based companies. Whether absurd, illusionary or simply a normal cycle, this end result has participants wondering about the mechanics, risks and the magic to pursue fortune. Regardless of experience, know-how or directional biases, this market is designed to puzzle participants, since the future is full of surprises.

Despite the doubts of all kinds in the past and gloomy forecasts by some, both failed to impact a market that marches to its own beat. After all, the reflection of the top 500 companies’ shares is not always a measurement of small business health across the US. Not to mention, when the supply of stock shares available for trading has shrunk, supply-demand would support a rise in prices (of shares).
“Companies hard-pressed to grow their businesses organically are paying dividends and reducing share count in order to maintain 5 percent to 7 percent cash-on-cash returns for investors.” (Bloomberg, May 2, 2014).

Numerous times, history teaches us to distinguish between current economic conditions and future expectations of shares. What about the classic relative argument? Yields overall remain low, the world is less stable than usual and there are limited liquid and “trustworthy” options outside of US equities. Maybe that partially explains the capital inflow and increased investor demand for stocks. Is this an issue of desperation from a lack of ideas, or rather the eagerness that urges one to chase returns? The puzzle requires further deciphering to answer questions such as: Is there rotation from developed markets to emerging markets?

Forced messaging

The Federal Reserve had a plan, a vision and a story to paint a picture of recovery following stimulus efforts. A great deal of cleverness and trickery has resulted in rising markets and increased risk appetite as the final chapters of the Fed script are played out. The ending to this master plan (QE / taper) appears to suggest a strong labor market, rising stock market and perceived economic growth. Perhaps, it is up to the participants to be believers in the Central Banks. Regardless of adjustments or potential spins, the 0.1% headline GDP result is hardly something to be proud of as a conductor of financial markets. In fact, the action of US 10 year Treasury Yields below 3% showcases a disbelief in strong economic recovery. Clearly, making the case that QE had the ability to stimulate the real economy drove the “taper” plan. Skeptics questioned this several times, and now doubt the results of QE, which is quite reasonable. The unfathomable disconnect between the economic strength measures and ground-level reality is huge. Yet, one cannot dismiss that from the dark moments of early 2009 until today, there was stability and some uptick to restore economic and investor confidence. For now, the Fed’s messaging is forcing people to have confidence in its ability, and fighting the Fed is a discouraged trait in financial circles.

Refining market view

Identifying the catalysts that would punish stocks for a poor economy is a daunting task. It’s fair to say that no formula or magic exists to figure out the ultimate top. A lesson that mega-bears had to learn recently is that even global tension or talks of a government shutdown do not simply affect the trading of shares. However, Fed or corporate tactics that have worked in recent years may face further resistance and change in tone. At this stage, another 50-100% upside in stock prices may end up being rather ambitious, even for the most optimistic participant. In fact, the NASDAQ has slowed down since March 6, 2014, as high-growth stocks began to stall. Similarly, the S&P 500 index has stalled and in search of a catalyst for price re-acceleration. Yet, more and more, many have documented cautionary messages. From the credit bubble to China peaking, there are gloom-and-doom habits (and talk) that have yet to evaporate. Thus, investors are forced to ponder what’s the more surprising move in the near term: a 20% upside move or 20% downside move? For now, the real fear is tilted toward missing a further upside run. It is also less comforting for bulls to give up their thesis, at least based on the low-volatility indicators. Until fear is reflected in actual trading indicators, calm is part of the status quo. However, if further signs of a lack of trust in economic recovery continue to persist, then that may move the needle in fear gauges.



Article Quotes:

“If Europe were politically unified, the issue would dominate the run-up to next month’s European Parliament election as well. One camp would call for massive north-to-south fiscal transfers. Another would emphasize the need for structural adjustment as a precondition for investment and job creation. A third would propose that governments, rather than hoping that jobs move to people, should accept that people will have to move to jobs. There would be enough sound and fury to interest the voters and lure them into voting. Instead, such ideas – reminiscent of the debate in the United States in the 1930’s about how to respond to the Great Depression – are barely discussed in Europe. Rather, mainstream European parties have cautiously avoided proposals that could prove divisive. Their manifestos and campaign materials do not convey the sense of urgency that the current situation demands. This caution benefits fringe parties that advocate radical solutions. They hope to profit from the voters’ anger against whomever can be held responsible for the current situation. But the fringe parties are not united. In the north, they object to the risks entailed by financial assistance provided to the south. In the south, they protest against the austerity imposed by the north. This hardly forms the basis for a common message, let alone a unified policy.” (Project-Syndicate, April 29, 2014)


“China’s exchange rate policy has, of course, always been a controversial matter. After a decade of deliberate undervaluation, intended to promote export led growth, China finally succumbed to international pressure in 2005, and allowed the real value of the renminbi (RMB) to start rising. Since then, it has risen by about 30 per cent, with only one interruption in the aftermath of the great financial crash. The new prices data suggest that the renminbi is now approximately fairly valued. Arvind Subramanian and Martin Kessler have already crunched the numbers, and have concluded that the average level of prices in China is almost exactly where it should be compared to the US, allowing for the economy’s relative level of development. Other methods produce slightly different results, but the conclusion that the currency is no longer substantially undervalued seems robust. In this respect, China has been a good global citizen in recent years, no doubt in part because a rising exchange rate helped with its domestic objectives by boosting consumption. The rising RMB has helped to reduce the huge trade imbalance between the US and China, and taken some of the pressure off other emerging economies whose competitiveness was under threat. The inexorable rise in the RMB has also led to burgeoning ‘carry trades,’ involving a surge in short term capital flows into the onshore market in mainland China. This has been a two-edged sword. It has provided a source of funding for the financial system, at a time when more credit was needed to disguise the stresses in the highly indebted local government and corporate sectors. But it also extended the internal credit bubble even further into unsustainable territory, and forced China to intervene even more heavily in the foreign exchange markets to keep the currency down.” (Financial Times, May 4, 2014)

Levels: (Prices as of close May 2, 2014)

S&P 500 Index [1881.14] – A few points removed from all-time highs of 1897.28 set on April 4. For several weeks, the market has shown a familiar range from 1840-1880. Breaking out of this range has been a challenge awaited with suspense.

Crude (Spot) [$99.76] – In many ways, the $100 mark is not only a psychological level, but also where the current 50 and 15-day moving averages currently stand. Basically, supply shortage is not a massive issue to spark a catalyst; instead, supply-demand is perceived to be contained.

Gold [$1291.50] – The last six months have showcased that prices fade around $1360, and late December 2013 lows of $1195.25 are again talked about.

DXY – US Dollar Index [79.51] – At a fragile state here, as the dollar weakness is on the verge of making new lows. Yet again, another mild inflection point within the weak dollar trend.

US 10 Year Treasury Yields [2.66%] – For the fifth time in 2014, Treasury Yields are being tested. Can yields stay above 2.60%? This has been asked before, as the convincing answer has not been defined yet.




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