Market Outlook | September 8, 2014

“All deception in the course of life is indeed nothing else but a lie reduced to practice, and falsehood passing from words into things.” (Robert Southey 1774-1843)

Simplicity Glorified

Hindsight gives the impression to investors that the market is simple. The current story goes: Invest your money in 2009 in US stocks and the rest is nothing but an upside gains. Eventually lack of turbulence mixed with lax view of risks enables the market conductors to gather additional believers with all-time highs. Wealth creation via stock ownership is expanding from theory to actual dollars and cents. The status quo in the recent years’ serves as powerful evidence of the simplicity of markets and the power of the Fed. Regardless of the various causes, the effect is quite clear and the oversimplification is picking up momentum, and typically that’s when critical details are omitted.

This development begs a few questions besides relying on the known trend. Is it a grave mistake to think the US economy is recovering at the pace of the all-time high stock market? Isn’t it too relaxed to think the Eurozone risk has calmed down? Are corporate profits sustainable? Are ignored macro issues (i.e. Ukraine /Russia) going to spark a market response? In a world where there is no scarcity of opinions plenty has been said. However, the historical data screams of simple maneuvering leading to higher share prices. For years the disconnect between stocks and real economy has been digested; however, this cycle (post 2008) embarks on a new level of day-to-day deception that should trouble even the most profitable of bulls as much as the gloom and doomers whose timing has been off. The concept of low rates and low volatility are creating even more complacency and discouraging the skeptics.

Grasping the Script

Where is the reward in belaboring past results? This is a question haunting investors of all kinds as the autumn season moves in to full gear. There is trickery in perception, and even more data may be deceptive. Important to remember that analysts are only humans pretending to know the future, but are really just hoping for luck. The suspense in markets is trying to grasp the script that’s driving the thought process. Then there is the anticipation to when the script might change, which can leave many mesmerized, humbled or simply amazed by the crowd response. The labor conditions are not so robust and even the Fed has made that point clear. The much discussed data point will center on participation rate:

“The participation rate, which indicates the share of working-age people in the labor force, decreased 0.1 percentage point to 62.8 percent, matching the lowest since 1978.” (Bloomberg, September 5, 2014)

Financial markets stumbled into a new era with advanced technologies impacting trading, further talks of regulations and ongoing evolution of complex products, but the human element of emotions (fear, greed etc.) never goes away. The desire to break new record highs mixed with crowd chasing returns is to be expected. Basically, investing in large brand names (e.g. Dow 30) enables companies to expand profits due to large distribution access, while borrowing at favorable low rates has helped corporate profits. Sure, that’s one version that’s closer to a tangible reality, but the brutal truth is becoming clearer. Politics and other distractions aside, speculators of all kinds must reconsider the difference between wealth creation and a robust economy. For now, the bearish sentiment is at lows that have not been seen in over two decades. It suggests that confidence is growing and that the script has been magical, especially for the S&P 500 index.

Brewing Hints

Emerging markets (EM) have recovered this year, considering the over 23% move since February 3rd lows. Despite the sluggish economy, the EM indexes are roaring which is surely a global theme at this point. Interestingly, recovery in EM has not translated to gains in commodities despite both being correlated in the past.

Meanwhile, the dollar recovery is stunning in some ways, and presently is the most meaningful macro move over the last few months. As the ECB continues to cut rates, the US has contemplated raising rates in turn benefiting the Dollar. Perhaps, there is a rush that awaits to purchase European stocks given the success of US stocks with low rate polices. Central banks have seen the US script working and replicating it seems appealing and convincing. After all, as stated above when simplicity works convincing many are convinced easily and complexities are ignored. In the case of Eurozone, the growth has been sluggish and well documented. Perhaps, the biggest hint of them all is how low rates do not spur growth. Thus, if Europe replicates what has been tried; then it surely feels like desperation, and that they are in need of potential “miracle.” Of course surprises are always possible. This illustrates how the market has succeeded in eliminating skepticism and volatility, but when simplicity fails typically the truth is recognized in an ugly fashion. Timing the inevitable is miraculous as well, but ignoring these danger sings is fully reckless.

Article Quotes:

“The ECB has had years to plan asset purchases (QE Lite), yet Mr. Draghi dodged all questions about the scale. You might conclude that there is still no real agreement on the course of action. Little wonder since Germany’s member of the ECB board – Sabine Lautenschlaeger – said only two months ago that QE is unthinkable except in an “emergency”, and no such emergency exists. By default, the ECB is making the same mistake as the Bank of Japan in its dog days, trying to buy time with half measures, hoping that global recovery will lift Europe off the reefs without anything being done. They may get away with this, but there is a very high risk that Europe will instead remain trapped in mass unemployment, with ever rising debt ratios. The overall policy settings remain contractionary. Monetary policy is still too tight. Fiscal policy is too tight. Bank regulations are too tight. Little is in fact being done to stop a deflationary psychology taking hold across half of Europe. Nobel laureate Joe Stiglitz warns of a depression running through most of this decade. Mr. Draghi said he hopes to ‘significantly stir’ the ECB’s balance sheet back towards the levels of 2012 (€3.1 trillion). That means a €1 trillion boost, and there begins the first big confusion. Much of this will be in the form of cheap loans to banks (TLTROs) in exchange for collateral. As the IMF said earlier this summer, this not remotely akin to QE. The ECB is not taking the risk on its own balance sheet. The monetary mechanism is entirely different, and far less powerful.” (Telegraph, September 5, 2014)

“China’s weak demand for electronics parts and other goods made in Asian countries has economists scratching their heads. U.S. economic growth is picking up, and if history is any guide, this should lead to stronger demand for Chinese-assembled electronics. That in turn should fire demand for electronics parts supplied from across Asia. Something is different this time. South Korea is China’s main source of intermediary goods for computers and other electronics. But Korea’s exports to China declined between May and July. Exports from Taiwan to China also have been subdued. Officials in Seoul worry that China is moving up the value chain, producing its own higher-end electronic parts, and eating Korea’s lunch in the process…. Over time, as China does move up the value chain, HSBC sees risks for Korea and Taiwan. Countries like Thailand, that currently compete with China in lower-end manufacturing of computers, could benefit as China exits some segments.” (Wall Street Journal, September 5, 2014)


Levels: (Prices as of close September 4, 2014)

S&P 500 Index [2,007.71] – About a month ago, S&P made an intra-day low of 1,904. Since then it has not looked back and has gained over 5%. The infatuation with the 2,000 level continues, with September 4th highs (2,011.17) being the next all-time high range for traders.

Crude (Spot) [$93.29] – Downtrend continues. Since the July highs of $107, the commodity has dropped significantly. August lows of around $92 set the benchmark for new lows.

Gold [$1,271.50] – The rally from $1,200 lacks vigor and momentum. The next hurdle remains at $1,300, which has been a struggle for buyers. Since September 9, 2011 Gold has dropped from peaking at $1,895. That downtrend is still intact as short-lived rallies have failed to produce a noteworthy recovery.

DXY – US Dollar Index [83.73] – Explosion continues. After bottoming in May, the last few months have seen a stronger dollar. Critical trends shift as the ECB looks to lower interest rates in turn making the dollar stronger. A game changer of sorts potentially brews, many looking at summer 2013 highs of 84.75 as the next critical level.

US 10 Year Treasury Yields [2.45%] – After testing 2.35% on three occasions recently, rates settled above 2.40%. The last five trading days suggest a new upside move, but a follow through is eagerly awaited.


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