Market Outlook | September 22, 2014

“For me the greatest beauty always lies in the greatest clarity” (Gotthold Ephraim, 1729-1781).

Some Clarity

For a while now, on a daily or weekly basis, the questions surrounding the Federal Reserve’s polices examine the impact on interest rates and stock market directions. Surely, there is a mixture of some mystery and suspense. All-time highs along with rate-hike chatter create enough commotion to entice plenty into the risk-taking business. It is a guessing game of sorts that invites intense punditry and speculations.

At this stage plenty of explanations have been presented (i.e. stock buybacks, lack of alternatives, risk taking encouraged, IPO boom etc.), but the market gets to have the last laugh as timing a catalytic move is more difficult to predict. As attention zooms into stocks and rates, other areas such as currencies and commodities are reflecting some reality and changing perceptions that are valuable for the months ahead. Surely, risk-taking is not a defined science, but recognizing trends and identifying potential catalysts are two ways to increase odds.

The decline in commodities is visible in gold, crude, copper and natural gas. This is less debatable as the direction is defined. In fact, the CRB (Commodity Index) peaked in May 2011; in hindsight this turned out to be a prelude to the demise of gold and crude prices. Similarly, Emerging Markets (EM) have sold-off since September 5, 2014; and, not to mention, the ongoing underperformance versus US stock indexes. Finally, the decline in commodities and EM are inversely linked with a strong dollar. Interestingly, the dollar index’s empathic run for the last several weeks sums up current global conditions. Therefore, the relationship between Commodities—EM—Dollar is vitally interconnected. What this says about US stocks and volatility has yet to be deciphered.

Visibly Sluggish

Decline in commodities and sluggish emerging markets beg other questions: Is there a slowdown in the global economy? Or are there changes to last decade’s trends? One can argue that a slowdown in EM contributes to a slowing of demand in commodities. That has been visible and correlated enough to make a convincing statement to investors. For months, talk of the Eurozone slowdown mixed with sluggish China data has lingered. Both contributors to global growth are seeking stimulus measures as an attempt to reawaken the economy.

“The People’s Bank of China is injecting 500 billion yuan ($81 billion) into the nation’s largest banks, according to a government official familiar with the matter, signaling the deepest concern yet with an economic slowdown” (Bloomberg, September 17, 2014).

Fair to say, it’s widely recognized that the global economy is slowing down. For a long while many wondered why yields are so low if key economies are growing. If these real economy woes are going to be reflected in stocks or volatility is the ultimate pressing question. Challenges for ECB to stimulate the economy will be debated and political factors will get in the way. The collective price of low rates to stimulate economies is a trick that’s been tried and certainly is not magical. A sense of desperation can be felt in Europe as QE is up for consideration. Beyond the clever technical words and hopes of economic tactical moves, the woes continue and somehow the stock markets do not reflect the pending turmoil that’s cooking slowly in the desperate “kitchen.”

Current Theme

For now US bulls are arguing that rates will remain low, volatility will stay calm and stocks run-up will have room to go. This has been heard for several years. No credible methodology has been discovered to figure out the timing or end to this. Thus, the trend lives on. Last week’s Fed message dominated financial markets, but the end result led to the same status-quo of all-time high stocks. The sideshow of hyped IPO mixed with the urgency to chase market rally distracts from macro concerns stated above, as well as foreign policy developments that are brewing. Current scripts and investor habits appear oversimplified in their promotion of risk. “Fear is not to be feared” is the ultimate and dangerous takeaway of this. However, for staunch bull participants to ignore the various signals of macro realities from larger economies and other assets is a reckless approach. Even if the day of crisis is unknown, it helps to know the few symptoms that are silently moving.

Article Quotes:

“G-20 economies have submitted individual plans to boost gross domestic product by an additional 2 percent over five years, a goal the group committed to in February. The group will say in their statement that measures proposed so far will boost GDP by 1.8 percent. Members will commit to additional action to meet their target ahead of a summit of G-20 leaders in Brisbane, Australia, in November, the official said. Even as the group discusses longer-term measures to lift economic output, officials in the U.S. and Canada are pressing for more immediate steps to boost demand… G-20 finance chiefs are considering asking investors in the communique to be vigilant against taking excessive risks, according to another official from a G-20 economy, who asked not to be identified because the talks are private. Some emerging markets argued against including the warning in the statement due to concern it could cause reactions in the financial markets, the official said. German Finance Minister Wolfgang Schaeuble told the G-20 meeting yesterday that expansive fiscal and monetary policies could risk creating a bubble in equity and property markets, according to a German delegation official, who briefed reporters on condition of anonymity in line with policy.” (Bloomberg, September 20, 2014)

“Short-sellers who profit from stock price declines have resumed targeting Chinese companies after a three-year lull, but many of the researchers who instigate the strategy are now cloaked in anonymity, shielding themselves from angry companies and Beijing's counter-investigations. Three reports published this month separately accused three Chinese companies - Tianhe Chemicals, 21Vianet and Shenguan Holdings - of business or accounting fraud. All three companies said the allegations were baseless but their shares were hit by a wave of short-selling by clients of the research firms and then by other investors as the reports were made public. The reports were written by research firms that did not publicly disclose names of research analysts or even a phone number. In the last wave of short-selling that peaked in 2011 and wiped more than $21 billion off the market value of Chinese companies listed in the United States, the researchers advocating short-selling were mostly public. Carson Block of Muddy Waters, one of the most prominent short sellers, openly accused several Chinese companies of accounting fraud. Block said in 2012, according to several media reports, that he moved to California from Hong Kong because he had received death threats.” (Reuters, September 22, 2014)

Levels: (Prices as of close September 19, 2014)

S&P 500 Index [2,010.40] – A short-lived stay below 2,000. Another run-up last week to new record highs. Interestingly, the recent move from 2,011 (Sep 4) to 1,978 (Sep 15) did not stir enough of a reaction, this did not result in a selling pressure. Instead, the bullish bias resumed based on last weeks’ finish.

Crude (Spot) [$92.41] – In the last twelve months, crude has lost its momentum and in the past 3 months, the deceleration has been pronounced. The next critical level is closer to $90 while technical observers await for a lively bounce at current levels. Two vital takeaways from early 2012 and mid2013 suggests that $100 is where buyers have been exhausted. Perhaps, it is a hint to ongoing decline below $100.

Gold [$1,220.50] – A near $500 drop from September 2012 highs has marked a beginning of a cyclical bear market for Gold. The inability to entice buyers above $1,400 has triggered even less belief in the previous bullish story. July 5th lows of $1,192 are desperately awaited by some buyers as much as sellers. Revisiting 2012 highs for now seems ambitious.

DXY – US Dollar Index [84.73] – An explosive run in recent months. The index is up more than 6% from the lows in July 2014. Investors are awakening to the dollar strength story. The sharp rise may lead to suspicion about the sustainability; however, it is hard to deny the massive shift in the index from cycle/pattern observers.

US 10 Year Treasury Yields [2.57 %] – 2014 was mostly defined by the trend that saw yields decline from 3.04% (January 2nd) to 2.30% (August 15th). Remarkable declaration of ongoing lower yields. However, Since August 15th the downtrend has been slightly broken with a move above 2.50%. It begs the question if this trend reversal is a fundamental change or a short-lived rise in yields.