Market Outlook | August 11, 2014

“Fatigue makes cowards of us all.” Vince Lombardi (1913-1970)

Mistakenly Fatigued

Another week that sparked massive global events for historians, political pundits and foreign policy makers. However, accumulating troublesome signs of globalization failed to create a bone rattling drama of sorts in highly followed and tracked US market indexes.

Russia made several headlines. Certainly that’s not new this year as participants have not shown big worries concerning implications from sanctions. Fundamentalism threatens in several regions and Iraq attacks are back making headlines, yet this seems like a fatigued story (especially for Americans) even though the dangers to globalized markets might be greater than last decade. Danger is hard to ignore even for the half-hearted onlooker. Then there is Italy, where economic weakness has been highlighted for a while, as the country entered another recession. In all three headline events, the consequences are not understood. More clarity is needed to grasp the impact on corporate balance sheets. For now, the impact on earnings and corporate profits as it relates to macro concerns does not appear as a concern issue for market participants.

Risk Conductors

Eurozone struggles and eerie long-term outlooks are not viewed as new or primary concerns for now. Perhaps, like most issues, it feels like “bad news is exhausted” as a wave of multi-day panic is not quite visible. Portugal and Greece carry prior symptoms of crisis, which still linger. Italy and Spain were on the radar of danger for a long while, too. Nonetheless, investors have chosen to trust the ECB as the provider of solution. Thus, again trusting the Fed or ECB is reflected in the very low global bond yields. This suggests investors heavily discounting risk as out of desperation for higher returns. Central banks, acting as the conductor of broad risk perception, have orchestrated a powerful inter-connected message to not fear risk or crisis. Participants blindly or wisely have followed this and those that bet against central bank policies have been ridiculed severely. Whether bullying tactics or a cherry picked script, central banks still possess and command the strength to move markets.

Similarly, the US stock market moves on regardless of macro risks. An occasional brief hiccup within the bullish run is followed by the “same ol’ movement” that’s been the script for weeks since March 2009. Being fatigued of the ever-so-growing religious fundamentalism, political unrest to vital regions and unrecoverable economic woes are tragic in some ways, but the rewarding Fed-driven stock market can blind even the sharpest minds. However, money managers are not paid for making foreign policy decisions or identifying dangers; they are basically measured by index benchmarks and against their peers. Deeply enveloped in the financial markets world, fund managers are balancing the noise from reality, but again it all comes back to the nucleus: Central Banks. The Fed-led engineering of low rates, higher markets, increasing buy-backs and lack of alternatives is powerful enough to lift shares as observers have fully discovered. The question remains if this perception of reduced risk matches the real economy data points which have been fragile.

“The sluggish pace of recovery for both discretionary and non-discretionary services expenditures suggests that the fundamentals for consumer spending remain soft. In particular, it appears that households remain—almost five years after the end of the recession—wary about their future income growth and employment prospects.” (Federal Reserve of New York, August 6, 2014)

Hints Galore

Unlike prior periods, this market has witnessed movements of up and down 1% in recent weeks while piling on to endless excuses for sell-offs. A few sirens went off; some heard the light warnings. For example, Southern European stock indexes since late June have sold-off sharply. Same goes for the Russian index. Similarly, July 3rd marked a turning point for a reawaking of volatility index (VIX). The dollar strengthening in the month of July is not to be taken lightly, either. In terms of fundamentals, the valuation of the small cap has been questioned as they reached elevated ranges earlier this year. “Small cap stocks in the S&P 600 are down an average of 19.0% from their 52-week highs” (Bespoke, August 7, 2014).

However, collectively major hints are waiting to suggest an all-out panic. Thus, the daring have a chance to make big moves (regarding risk positioning), while the causal trend-follower waits another day or week for an obvious declaration from markets. Nothing daring about betting on higher US markets and lower volatility at this junction. Is it strange to blindly to trust the Fed or stranger to bet against the status quo? The mind numbing question enhances the suspense. Many have opinions, but market action will ultimately tell the real, hidden story.

Articles Quotes:

“There was some surprise in the market when holders of senior bonds escaped a bail-in in the rescue of Banco Espirito Santo, but perhaps there shouldn’t have been given that the European Central Bank was a major creditor of the Portuguese bank. Forcing a contribution from seniors in addition to subordinated bondholders would have posed a dilemma about what to do with the ECB’s claims, which amounted to a net €7.4bn at the end of June. Imposing losses on ECB claims would, in effect, have meant Eurozone taxpayers helping to pay for the recapitalisation, something that bank regulators and politicians have pledged to avoid under new bank resolution legislation shortly to take effect across Europe….. The new pan-European rules must be applied by the end of 2015. That will create a strict hierarchy of creditor seniority that must be followed to decide which claims should be bailed in to recapitalise financial institutions in trouble.That situation may place the ECB in peril, since it is a major creditor of many Eurozone banks. It could also leave it wide open to accusations that it has a conflict of interest when it takes direct control of bank supervision across Europe from this November.” (IFR, August 5, 2014)

“This combination of rising labor costs and low value added is clearly unsustainable. If China is to transform itself from a large trading country into a powerful one, it must raise its productivity, with the manufacturing sector adding more value to exports (and, increasingly, to goods for domestic consumption). To be sure, China’s enduring comparative advantage in processing and assembling industrial products has enabled it to retain its status as the world’s largest exporter. As massive quantities of labor-intensive processing and assembly work have been transferred to China from Japan, South Korea, Singapore, Taiwan, and Hong Kong, so have these economies’ trade surpluses. Moreover, this has contributed to large – and widely criticized – trade imbalances with the US and the European Union, the primary end markets for Chinese-processed industrial products. But, again, the data may not be what they seem. Consider China’s growing re-import trade, whereby goods that have been exported to nearby countries, particularly Hong Kong, return to the mainland. China’s re-imports have increased more than 12-fold since 2000, and now dwarf those of other re-importing leaders as a share of total trade.” (Project Syndicate, August 8, 2014)


Levels: (Prices as of close August 8, 2014)

S&P 500 Index [1,931.59] – From March 2009 lows to summer 2014 highs, the index is up nearly 200% reflecting the long-term bull market. Meanwhile, since the July 14th peak to the August 7th low point, the index dropped over 4%. A pullback is generally expected and mildly hinted, yet more pressure is needed to convince sellers.

Crude (Spot) [$97.88] – Over a 10% drop in prices since late June suggests a selling pressure in the commodity. Supply expansion is a fundamental driver that’s been long awaited. Macro events have generated less of an impact versus supply-demand dynamics. Charts suggest the next critical point is closer to $94 if a short-term bounce fails to gain momentum.

Gold [$1,305.25] – Once again back around $1,300, which has been so familiar since last summer. In fact, the 50 day moving average is $1,293 and the 15 day moving average stood at $1,299. Basically, since the massive sell-offs in early 2013, Gold has struggled to find a catalyst for an upside move.

DXY – US Dollar Index [81.02] – Since mid-May, the dollar has found a renewed momentum for an upside move. Strong signs of bottoming at current levels, July highs of 84 deemed as the next critical point, if the strength continues.

US 10 Year Treasury Yields [2.42%] – Since January, there has been a one-sided trend in which yields have relentlessly dropped from 3.05%. Interestingly, last Friday marked an intra-day low for the year at 2.34%. There is a clear message of low yields in which the 2.50% point has been breached for the third time. This raises the question if trend change is in sight.





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