Market Outlook | June 2, 2014

Market Outlook | June 2, 2014

“It is no use trying to sum people up. One must follow hints, not exactly what is said, nor yet entirely what is done.” John Greenleaf Whittier (1807-1892)

Continuation

Just when optimism appears to have reached a new plateau, amazingly, the broad indexes find a way to redefine the meaning of record highs. Other historic highs last week restated the strength of this bullish run and reemphasized the power of the central bank’s script, regardless of real economy-based worries. For speculators and investors alike, the search for massive macro-driven hints and catalysts remains a desperate priority. For some naysayers, capitulation seems to be a desired path as volatility keeps drifting lower. Others attempt to maintain a healthy skepticism despite the unshakeable status quo form.

A “safer” risk taking

Interestingly, within the euphoric response, the shift toward safer assets is still visible. It’s not easy to picture a rush to safety in a period where risk is deemed safer with low volatility, as plenty are chasing attractive returns, given what has transpired in the last few years of this bullish run. Yet, there is evidence of rotation into more reliable, liquid and Fed-supported assets.

First, the flow into US Treasuries illustrates the search for safety in terms of a liquid, reliable investment that yields around 2.50%. On an absolute level, 2.48% does not seems too enticing, but when other developed markets such as Japan (0.57%), France (1.77%) and Germany (1.36%) offer lesser yields, then the US 10-year bonds seem attractive after all. The relative game at the end of the day is what drives market behaviors. Overwhelmingly, investors expect the status quo to continue, as the consensus expects the ECB to continue this trend of lower rates.

Secondly, the success in share prices of larger companies’ shares versus small cap demonstrates a shift toward safer, recognizable firms. Cost cutting and share buybacks surely play a role in rising share prices as much as organic growth in business. Meanwhile, small cap companies’ shares have struggled this year; at times of turbulence, this has been revealed. In fact, the Russell 2000 Index is not making new record highs, but is instead 6% removed from annual highs reached on March 4, 2014.

Finally, the same point about quality can be stated about high-end real estate from London to New York. Equally, the same concept in larger and safer investments is applicable to hedge funds:

“Many investors who were burned by the volatile markets of the financial crisis have turned to big hedge funds for the more stable returns and safety of size – scale, solid infrastructure and operational security. Credit Suisse's 2014 hedge fund investor survey showed only a third of respondents would invest in a fund under $50 million, while just over half could invest in one between $50 million and $100 million and three-quarters could do so in one over $100 million.” (Reuters, June 1 2014).

Bottom line: This bullish market is not quite a fair barometer of collective participation in the real economy. Instead, even though at a glance, risk taking seems appealing and robust, for the most part this so-called recovery benefits select areas of the investment segments in which quality is still in favor. A collective recovery is still mysterious.

Limited ideas

Shifts into more liquid, reliable assets may suggest either a shortage of investable assets or lack of confidence in alternatives such as gold and emerging markets. Fed’s policy of low rates limits ones option and there is a disregard for absolute struggle of economic and fundamental recovery. If 2009 is the benchmark, then the economy and markets have come a long way toward stabilizing. Yet, the weak GDP numbers in Europe and the US are constantly ignored. Markets are hardly panicking about these less-than-stellar numbers as the consensus expects a better-growth second half.

Meanwhile, those who perceived gold to be a safe asset learned in 2013 that it is a speculative instrument that is a non-yielding asset. In an environment where yield is so scarce and in high demand, gold prices are losing their luster after a massive outflow. Not to mention, the debate between gold being a commodity or currency has been mostly settled, as gold was not immune from the commodity cool down. Plus, a speculative asset is typically viewed as risky, but in gold’s case, a multi-year run has corrected, and is now pausing and attempting to stabilize to a new era. The slowdown in emerging markets also played a role on the demand side.

Another puzzle to limited ideas is seen in increased issuance of African bonds as a new frontier market.Certainly, the yield search into Africa makes sense, considering Southern European yields have also come down notably, as noted recently by the Greek bond issuance. Subprime memories persist when thinking about the lack of investment options to meet a ferocious appetite for risk taking. Surely, the low volatility levels remind many of 2007, yet it is only human nature to find new segments of exciting opportunities. However, repeating similar mistakes of risk taking should not surprise us, especially when there is desperation to make good returns in a world where bigger capital is focused on familiar, limited options.
Article Quotes:

“After spending the past decade and more than $200 billion acquiring mines and oilfields from Australia to Argentina, China’s attention is turning to food. The world’s most populous nation is confronting a harsh reality: For every additional bushel of wheat or pound of beef the world produces, China will need almost half of that to keep its citizens fed. And in a recognition that it can’t produce enough crops and meat domestically, mainland Chinese and Hong Kong-listed firms spent $12.3 billion abroad on takeovers and investments in food, drink or agriculture last year, the most in at least a decade, data compiled by Bloomberg show. Those purchases included the largest Chinese takeover of a U.S. company when Shuanghui International Holdings Ltd. bought Smithfield Foods Inc. for $7 billion including debt. They are likely to be followed by overseas forays into beef, sheep meat and grain assets, according to the National Australia Bank Ltd.” (Bloomberg, May 30, 2014)

“First quarter Spanish GDP was tweaked lower in its latest revision. But even this modest rate of growth was only eked out thanks to still substantial government deficit spending and falling inflation. Which suggests Spain’s economy will struggle to hit escape velocity. Indeed, there are worrying signs the first quarter represented a high point – however underwhelming in the first place – for the euro zone more generally. Recent data point to a further softening. And a need for a European Central Bank policy response. Spain’s economy expanded 0.5% on the year in the first quarter, revised down from a previously reported 0.6% rise. But Edward Hugh, a Spain-based economist and respected blogger, pointed out that there’s even less growth here than meets the eye. For one thing, in money terms, the economy is stagnating. Much of what apparent growth there is comes thanks to inflation adjustment, Mr. Hugh noted. That’s because Spain was effectively in deflation during the first quarter, and a negative GDP deflator (the component in GDP data that creates the inflation adjusted figure generally referred to when talking about economic growth) is thus boosting – subtracting a negative creates a positive – reported growth.” (Wall Street Journal, May 29, 2014)

Levels: (Prices as of close May 30, 2014)

S&P 500 Index [1923.57] – Eclipsing prior record highs and setting a strong monthly finish. Since April 11 lows, the index has gained more than 6%.

Crude (Spot) [$102.71] – Over the last few months, a back-and-forth movement between the $98-102 range. No clear signs of an established new trend, and the supply-demand dynamics remain mysterious rather than clear for participants.

Gold [$1255.00] – The oversold rally from December lows ($1195.25) to March highs ($1385) proved to be short lived, as $1400 was elusive and $1200 became a quite familiar place. A multi-week low with no signs of bottoming at this junction.

DXY – US Dollar Index [80.36] – Since May 8, 2014, slight hints of a rising dollar, but mostly a sign of a stabilizing dollar.

US 10 Year Treasury Yields [2.47%] – Annual highs of 3.05% in the second day of this year actually triggered a downside move, as the annual lows of 2.40% were set last week.



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