Market Outlook | August 25, 2014

“Making the simple complicated is commonplace; making the complicated simple, awesomely simple, that's creativity.”(Charles Mingus, 1922-1979)

Narrative Reflected

When larger corporations have low borrowing cost, low tax structures, low wages, low supply of shares (via buybacks), low volatility and massive scale global distribution, then what did investors expect? Surely, this set-up leads to multiple record highs in the share prices of large companies. Basically, it explains the favorable stock market momentum from various angles. Of course, it is easier to see the key drivers today versus a few years ago in a one-sided bull market. In hindsight, analysts or money managers that have narrowed their thesis in this manner were absolutely right in betting on a bullish stock market. And here we are in summer 2014, and yet again the US stocks are at near all-time highs despite endless macro and foreign policy concerns that loom for next decade. However, markets react profoundly to relevant indicators while being in the habit of ignoring other worrisome parts.

Certainly, directional index guesses are one matter for risk-takers, but identifying the big driving forces such as interest rates, desirable tax treatment and internationally diversified corporate revenue stream is vital.

Two Worlds

Imagine all the perceived market moving factors and noise between 2009 and today. Frankly, it seems to boils down to a few items that are a bit more influential than the nitty-gritty fundamentals. Albeit, the key forces listed above do end up impacting corporate profits enough to keep the ongoing capital inflow in to US equities. Of course, this favorable set up for share prices does not quite apply in same manner for mid-to-small companies that impact most of the real economy on daily basis. For example here is one perspective:

“Across the U.S., small-business lending has been stuck in a slow, grinding recovery behind most other types of business and consumer loans. At the end of the first quarter, banks held $585 billion in loans to small businesses, up 1% from last September but still 18% less than the peak of $711 billion in 2008, according to the Federal Deposit Insurance Corp” (Wall Street Journal, August 17, 2014).

Perhaps, the much belabored “disconnect” between street level economy and the financial market is becoming tangible for causal participants. The Federal Reserve could not even pull off a magical approach to the struggles in the labor market as outlined last Friday. An artful presentation of reality from the Fed has its limits, even if timing is unknown. Simply ignoring the wounds of this recovery via technically maneuvered stock market appreciation is an insult to most experts. After the bailouts, the financial markets were under scrutiny, but the reward of owning S&P 500 companies has evaporated those prior concerns. Even if mid-to-small business concerns arose in the background, the rising market has found a way to sooth some of the pain while rewarding shareholders. In turn, this has boosted confidence for Fed believers; whether this is for good or for bad will be discovered soon.

Catalyst Search

As summer is winding down, the low borrowing costs are stirring up again to new heights. As the attention is obsessively focused on interest rates, other factors are set to change too. For example, if share buybacks reduce, then there is enough to muster critical questions for this bull market. Perhaps, pending changes are forming:

“Companies in the S&P 500 bought back $120bn of shares in the quarter to June 30, down from $159bn in the first quarter, which was the second-largest amount ever, according to preliminary data from S&P Dow Jones Indices.” (Financial Times, August 24, 2014)

For a while, deferring concerns have been the fashionable approach of policymakers. Perhaps, the deference is to prevent an all-out panic in response to an unsolvable problem. August has also been a roller-coaster, a reflection of the nature of the recent market examination. Early in the month, volatility spiked after a few danger signs. Nonetheless, that was short-lived and led to a quick return back to the status-quo of explosive markets and a decline in worries. Notably, the last two months the dollar has strengthened and a follow-through is eagerly awaited as a key catalyst. Collapse in crude prices all summer and slowing momentum in Gold reinforce that a commodity spike is not worrisome either.

The narrative may appear set to change, unlike the past few years, but collective comfort in status-quo also delays shifts in sentiment. Forecasting a top has been close to a “miracle work” and feels like a nearly impossible task. Equally, betting against Central Banks requires courage, but lacks evidence of success in recent years. Importantly, real economy woes are hard to ignore, but expressing a directional view (via bet) in the market is an artful task by itself .

Article Quotes:

“The trade and investment figures are hard to verify, too. According to one source used by Mr. [Howard] French, “China’s Export-Import Bank extended $62.7 billion in loans to African countries between 2001-2010, or $12.5 billion more than the World Bank.” Other figures go even higher. What is clear, at any rate, is that Chinese people and money have flooded into Africa in the past decade, chiefly to buy raw materials to fuel China’s roaring economy. What is tantalizingly unclear is whether the Chinese economic onslaught is the result of a methodical policy fashioned in Beijing as part of an imperialist venture to promote “Chinese values” and dominate the continent as Europeans did a century ago, or whether it has become a self-generating process fired up by individual Chinese who are simply keen to enrich themselves without the slightest intention of kowtowing to the authorities back home. The conversations recorded by Mr. French in a dozen of sub-Saharan Africa’s 48 countries leave an impression that strongly supports the second thesis. Indeed, many of the Chinese in Africa excoriate the Communist Party back home and have dared to start new lives far away precisely to breathe fresher air—much as pioneers from Europe did when heading to the new world or to the dark continent. Many cite the Chinese ruling party’s corruption as a spur for seeking a freer climate elsewhere and even say that Africa is a lot less corrupt by comparison.” (The Economist, August 23, 2014)

“Switzerland’s two largest closely held banks are poised to publish their earnings after two centuries of secrecy. Cie. Lombard, Odier SCA, the Geneva-based bank established in 1796, is due to publish its financial statement on Aug. 28th, according to a company official who asked not to be named in line with the bank’s policy. Pictet & Cie. Group SCA, the third-biggest Swiss wealth and asset manager after UBS AG (UBSN) and Credit Suisse Group AG (CSGN), is also poised to report this month. Under pressure from regulators overseas, the two companies dropped their centuries-old partnership structures in January, bringing with it the requirement to report earnings publicly. They’re doing so as Switzerland’s private banking industry and traditional secrecy comes under unprecedented scrutiny from tax authorities in the U.S. and Europe… While Pictet and Lombard Odier haven’t disclosed which figures they will publish in the earnings, they are set to produce a trove of information for industry analysts, investors in publicly traded asset managers and the banks’ own customers regarding their performance. The banks, traditionally used by the world’s richest families to protect their fortunes, oversee about $630 billion for private and institutional clients, according to the companies.”(Bloomberg, August 22, 2014)


Levels: (Prices as of close August 22, 2014)

S&P 500 Index [1,988] – On three occasions in July, the index did not stay above 1,980 for a sustainable period. Perhaps, that suggests waning buyer's momentum. In a recent rally, the new all-time intra-day highs were set last week at 1,994. Fair to say it is an inflection point between selling pressure versus acceleration.

Crude (Spot) [$93.65] – Has dropped nearly 15% since July 20th highs showcasing that the downtrend remains intact. The January 10th lows of $91.24 are the next key target to see if the “bleeding can stop.” Supply-demand dynamics in Crude from the last two years explain most of this current move with expanding supply mixed with weakening demand.

Gold [$1,275.25] – Several pieces of evidence showcase that the $1,320 range has been a challenging hurdle for buyers. Meanwhile, the next critical point is a move below $1,240, which may delay the odds of pullbacks.

DXY – US Dollar Index [82.33] – Like July’s strong move, August is playing out as another month of strengthening the Dollar. No signs of change in momentum as macro observers watch closely.

US 10 Year Treasury Yields [2.40%] – Potential bottoming around 2.35% based on last week’s action. Further evidence is needed to confirm that there is a change in rate directions.





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