Market Outlook | March 31, 2014

“Dreams are today's answers to tomorrow's questions.” Edgar Cayce (1877-1945)

Today’s answers

Stock market appreciation in the recent bull run can be attributed to ongoing stock buybacks, increasing dividend payouts and limited investable options. All contribute to lifting the shares of established and more liquid companies making up the major indexes in particular. In reflecting back, this has been a dream-like period for stockholders in US stock indexes. From tech companies to banks, companies are buying back their own shares and in turn shrinking the supply of available shares for investors. Of course, this strengthens the market perception and the reward appeases existing investors – a critical supply-demand factor for those seeking exposure to US equities. Clearly, rewarding investors appears more critical than growing businesses and earning potential for the next 5-10 years. That’s the central debate, as investors will be asking these “tomorrow’s questions” very soon, with earnings season approaching.

“Last year, the corporations in the Russell 3000, a broad U.S. stock index, repurchased $567.6 billion worth of their own shares—a 21% increase over 2012, calculates Rob Leiphart, an analyst at Birinyi Associates, a research firm in Westport, Conn. That brings total buybacks since the beginning of 2005 to $4.21 trillion—or nearly one-fifth of the total value of all U.S. stocks today.” (Wall Street Journal, March 21, 2014).

As for matters related to labor growth, bank-lending expansion, sustainable earnings and more capital expenditure, this all presents a different story. Perhaps, real economic barometers have been dull and not an overly stellar trend relative to a flamboyant stock market that continued to register all-time highs. There is a severe disconnect between fulfilling shareholders’ desires and those seeking creation of long-term value and economic strength. Perhaps, this is a conflicting reality that always existed but is more pronounced at this junction. So, as the first quarter draws to an end, the run-up in share prices and the pace of economic growth are questioned equally. Are banks now going to lend? Is there more momentum left for further economic growth? Are public policy uncertainties less of an unknown?

Inflection point

At the start of the year, value seekers were viewing beaten up assets that underperformed in 2013 and a full-blown sell-off took place. Among the notable areas that were deeply discounted and mostly disliked were gold and key emerging market areas. Interestingly, gold’s behavior since the Fed’s taper announcement has been telling in the near-term, in which a higher rate and the end of QE makes the gold story less thrilling. Meanwhile, the EM landscape is not only a bargain-hunting exercise, but an area where value investors with limited investment options may continue to bet on a noteworthy recovery. Interestingly, the EM index was up 4% last week, showcasing very early revival from low ranges. The pace of outflow is slowing.

“Funds that specialize in emerging market stocks, meanwhile, posted just $43 million in outflows, marking their smallest outflows in 22 weeks.” (Reuters, March 28, 2014)

Yet, to claim a rotation out of developed markets into EM is premature for now (as there is no concrete evidence yet). But opportunities are opening up for those looking to exploit speculative risk-reward setups.

Cycles viewpoint

Seven years ago, the market was robust and thriving ahead of the 2008 crisis. Some similarities to 2007 are commonly pointed out by pundits, mainly in how risky assets have recovered and recouped last cycle’s losses. Certainly, key indexes demonstrate that point at which housing has climbed back, and volatility has stayed calm as risky assets flourish. One can argue these trends are a restoration of stability. If so, what stage of “stability” are we currently in? The seven-year cycle may have a magic meaning/offer a clue, or simply be a coincidence without substance. At least, it serves as a historical reminder that’s not worth dismissing. Surely, these factors will end up playing a role in mind games of decision making for risk takers. Data points resembling the pre-crisis behavior are worth tracking as we approach this wobbly period. Here is one example:

“For all the warnings from the Federal Reserve over excessive risk-taking as loan growth soars to levels last seen just before the crisis, bankers still have 10 trillion reasons to lend. That’s the dollar amount that banks hold in deposits in the U.S., which exceeded the value of all loans by a record $2.5 trillion last month. Banks are amassing more cash even as lending to U.S. companies this quarter is poised to increase by the most since 2007, according to data compiled by the Fed.” (Bloomberg, March 28, 2014).

Momentum names (social media, biotech, etc.) have showed signs of slowing, but not at a pace to trigger notable sell-offs. The S&P 500 index pattern is stalling at current levels. Surely, the recent week’s actions suggest markets are a bit wobbly where a breather is much needed, like earlier in the year. The bullish bias has been resilient, as the Fed-supported and Fed-guided messaging has led to the joy of shareholders of US companies. Unaddressed economic concerns have accumulated; therefore, triggers of “bad news” are plenty and should not be overly shocking to most in-tune observers. Timing is unpredictable, but cyclical hints are profound and awareness of the current junction is essential in managing risky assets. For now, reexamining the thought that markets are “invincible” is as valuable as speculating on the next macro-driven event.

Article Quotes:

“Like other parts of the US economic recovery — housing, the labour market — capital expenditures by companies have been a letdown recently, even accounting for the weather. The latest example came in Wednesday’s durable goods report, in which the ‘nondefense capital goods orders excluding aircraft’ component fell. (That figure is a proxy and obviously doesn’t capture everything that normally counts as capex, which also includes investment in property and structures, imported capital goods, and certain intangible assets. Capex is often poorly or loosely defined in discussions about it.) But capex has been disappointing for more than a year. The growth rate of investment in both equipment and structures declined last year after a strong 2012, which economists credit partly to a one-off tax incentive that pulled investment forward in time. Equipment spending rebounded quickly after the recession ended in 2009, but its year-on-year growth rate has fallen in every year since 2010. (See page 13 of the revised Q4 GDP release.) The good news here is that it climbed an annualised 10.9 per cent in Q4, the best quarterly growth rate since the third quarter of 2011. Investment in structures has been more volatile, declining much more than equipment spending during the downturn and showing sings of healthy growth only in 2012, before rising just 1.2 per cent last year. The category declined slightly in the fourth quarter.” (Financial Times, March 28, 2014)



“The word dollar didn’t even come up. ‘The volume of transactions that can be carried out in the Chinese currency in international and German financial centers is not commensurate with China’s importance in the global economy,’ the Bundesbank explained in its dry manner on Friday in Berlin, after signing a memorandum of understanding with the People’s Bank of China. President Xi Jinping and Chancellor Angela Merkel were looking on. It was serious business. Everyone knew what this was about. No one had to say it. The agreement spelled out how the two central banks would cooperate on the clearing and settlement of payments denominated in renminbi – to get away from the dollar’s hegemony as payments currency and as reserve currency. This wasn’t an agreement between China and a paper-shuffling financial center like Luxembourg or London, which are working on similar deals, but between two of the world’s largest exporters with a bilateral trade of nearly $200 billion in 2013. German corporations have invested heavily in China over the last 15 years. And recently, Chinese corporations, many of them at least partially state-owned, have started plowing their new money into Germany. This ‘renminbi clearing solution’ – the actual mechanism, clearing bank or clearing house, hasn’t been decided yet – will be an important step for China to internationalize the renminbi and ditch its reliance on the dollar. It will be located in Frankfurt; that the city is ‘home to two central banks,’ Bundesbank Executive Board Member Joachim Nagel pointed out, made it ‘a particularly suitable location.’ As a world payments currency, the renminbi is still minuscule but growing in leaps and bounds: in February, customer initiated and institutional payments, inbound and outbound, denominated in RMB accounted for only 1.42% of all traffic, but it set a new record, according to SWIFT, the NSA-infiltrated, member-owned cooperative that connects over 10,000 banks, corporations, the NSA, and other intelligence agencies around the world.” (Wolf Richter, March 29, 2014)

Levels: (Prices as of close March 28, 2014)

S&P 500 Index [1857.62] – Any movement closer to or below 1850 will trigger noteworthy clues. At this point, buyers’ conviction is being tested with a narrow range of 1845-1875.

Crude (Spot) [$101.67] – Again revisiting the $100-102 level. Increasing hints of bottoming at $98. The 200-day moving average remains at $100. The next key target is the annual high of $105.22 (set on March 3).

Gold [$1296.00] – Sharp decline since March 17, around the time of the Fed’s message regarding rate expectations. Now below 200- and 50-day moving averages, which can trigger some selling pressure. The break below $1320 may have been meaningful in terms of the stalling momentum.

DXY – US Dollar Index [80.10] – For now, the annual lows of March 13 (79.29) appear to be a bottom for the dollar index. Yet this familiar level is hardly a major turning point for now.

US 10 Year Treasury Yields [2.72%] – Surpassing 2.80% has been a challenge in recent attempts. Reaching 3% seems ambitious based on recent behaviors, while breaking below 2.56% would amaze most following the taper/post QE discussion. It is amazing that the 50-day and 200-day moving averages are not far from the current closing price.





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