Market Outlook | August 4, 2014

“The Siren waits thee, singing song for song.” Walter Savage Landor (1775-1864)

Siren Heard

Last Thursday (July 31), stirred a loud siren of market danger that’s been long awaited. Perhaps, it was a mild nudge to rethink the definition of “risk” or simply a one day plunge at month’s end. Either way there is enough to ponder on pending market correction as participants digest the first signs of a notable sell-off.

Previously silenced skeptics suddenly woke-up just like the volatility index,which stood near death for an extended period. Finally, a day where the broad indexes from Nasdaq to S&P 500 witnessed a drop of more than 1%. A bloody day in the terms of the financial market. Out of panic or curiosity, participants did not quite feel like they did in the autumn of 2008 or the summer of 2011 in which turbulence quickly swept in. However, today, the looming drama appears to be in the early chapters given the early cool off from the multi-year bullish run. Knee-jerk panic is natural, but getting some answers on global growth, interest rate polices and valuable sentiment indicators is vital at this junction. Money managers are forced to consider a move or at least a theme driven thesis to understand how the perception of risk can change.

The wake-up call is not only found in market peaking or in the rise of volatility, but the strength of the U.S. dollar is noteworthy from the macro landscape. Is there a rush for safety? Potential bankruptcy talks from Argentina to Ukraine to Egypt are taking hold despite the vibrant talk of frontier market bond issuance, especially in Africa. Yes the status-quo has encouraged risk-taking and created desperation for the yield seeking investors, but, ongoing investor demands for higher yields comes with risks and at some point the market will acknowledge the hidden risks that have been conveniently omitted. Essentially, layers and layers of risks have been ignored and a gut check waits in August. The songs of reality check are slowly being sung and general inflection points will bring forth unpleasant realities.

Memories Ignited

Portuguese bank problems in July reinforced some of the forgotten memories of the '08 crisis and the volatile conditions of the Euro-zone. In fact, the Portuguese stock market index is down more than 10% for the year; silently the turmoil continues even if the topic is nothing new to European market observers.

Amazingly, calmness was felt for months when viewing the bond yields of Spain or Greece in recent months. One would be surprised to see how low the yields declined following the Euro-zone crisis that consumed markets in recent summers. Basically, the Southern European bonds began to mirror the turbulence index (VIX), suggesting that risk is low and concerns were deemed as over-rated. Yet, how can professionals act surprised? Junk bond issuance and false hope of recovery were quite visible for critical observers. In fact, signs of trend shift in risk is taking place:

“Investors pulled $578.9 million from U.S. junk-bond exchange-traded funds yesterday alone, with BlackRock Inc. (BLK)’s $11.8 billion and ETF (HYG) seeing $362.8 million of withdrawals, according to Bloomberg data. Shares of BlackRock’s iShares iBoxx and High Yield Corporate Bond ETF have plunged 2 percent in the past week to the lowest since October, Bloomberg data show” (Bloomberg, August 1,2014).

Silencing the skeptics will be hard, just as justifying the concept of "low risk" is awfully difficult. From domestic policy matters to foreign policy blunders and movements, maintaining the status-quo is harder than it was during the last two autumns. There is plenty of room for doubt. First, Fed officials scream for a hawkish stance in interest rate policies. Russian capital out flow as result of sanctions and tensions is not to be ignored on financial implications to the Euro-zone. Defending the old Fed script is a daunting task without a bit of near-term eruption or dramatic response that resets the disconnect between reality and perception.

Unconvincing Growth

As if there were not enough reminders of slowing growth, crude price decline reinforces the expansion in supply and weakens global demand. Surely, crude prices have faced selling pressure and reached multi-week lows. Similarly, if key economies were strengthening at a desired pace then interest rates would not be this low. Critical questions were asked before, but now these issues can become mainstream matters ahead of mid-term elections.

Putting parts together, weak commodity demand, unimpressive growth in Western economies, and financial crisis symptoms in Europe are factors that dampen sentiment. Not to mention, foreign policy uncertainties (various regional power struggles), which have risen incrementally giving less “happy times” in those believing in globalization. Challenges ahead and ultimately managing and surviving the turbulence are the rewards for any trader and money manager. Intriguing times and intense days are ahead.

Articles Quotes:

“The annual rate of inflation in the euro zone fell further below the European Central Bank's target in July, and to its lowest level since October 2009.The decline is a setback to the ECB which, in June, launched a series of measures designed to boost growth and start to move the inflation rate back toward its goal of just below 2.0%. It is too soon for those measures to have had an impact, but the further drop in the rate at which consumer prices are increasing underlines the severity of the threat confronting policy makers. Eurostat said consumer prices were just 0.4% higher than in July 2013, as the inflation slowed from 0.5% in June. The inflation rate has now been below 1.0% for 10 straight months…. Low inflation is a particular problem for the euro zone because it makes it more difficult for companies, households and governments in southern Europe to cut their high debts and recover from the currency area's twin banking and fiscal crises.” (Wall Street Journal, July 31, 2014)

“China has acknowledged the existence of a new intercontinental ballistic missile said to be capable of carrying multiple nuclear warheads as far as the United States, state-run media reported Friday (August 1). A government environmental monitoring centre in Shaanxi said on its website that a military facility in the province was developing Dongfeng-41 (DF-41) missiles, the Global Times reported. The DF-41 is designed to have a range of 12,000 kilometres (7,500 miles), according to a report by Jane's Strategic Weapon Systems, putting it among the world's longest-range missiles…..China's military is highly secretive, and the Global Times said it had not previously acknowledged the existence of the DF-41. The original government web post appeared to have been deleted on Friday, but the newspaper posted a screengrab. China's defense ministry in January responded to reports that it had tested a hypersonic missile delivery vehicle by saying that any military experiments were ‘not targeted at any country and at any specific goals’. It made the same response last December when asked about reports that it had tested the DF-41.Tensions between Washington and Beijing have risen in recent months over territorial disputes with US allies in the East and South China Seas, and cyber-hacking. Beijing has boosted its military spending by double digit amounts for several years as it seeks to modernise its armed forces, and now has the world's second biggest military outlays after the US.” (Channel NewsAsia, August 1st, 2014)


Levels: (Prices as of close August 1, 2014)

S&P 500 Index [1,925.15] – For several weeks, the 1980 level appeared to be a key resistance level. Now, last week's sell-off confirms that buyer’s momentum is being exhausted in near-term. Yet, further confirmations are needed as a move below 1850 can reset thoughts on perceived risks.

Crude (Spot) [$97.88] – June’s sell-off was followed by further price weakness in July. For a while, supply expansions have raised questions if further down slide waits, and certainly it has in the near-term.

Gold [$1,285.24] – Trading near its 200 day moving average. Several notable peaks including a top on August 2013 at $1,419, then a stall at $1,385 in late March 2014 and recently another peak on July 11 at $1,340. Basically, the downtrend in Gold prices remains intact over the big picture and moments of resurgence have been short-lived.

DXY – US Dollar Index [81.02] – Strength visible throughout July. In fact, since May 9, 2014 the dollar index has gained momentum and is setting up for a potential macro turning point.

US 10 Year Treasury Yields [2.49%] – Several signs suggest that yields are bottoming somewhere between 2.40-2.50%. The last two years showcase this point when viewing the charts. Yet, surpassing the 2.70% has been a challenge as many wonder about this mixed economic growth combined with demand for safer assets.


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