Market Outlook | June 9, 2014

“Truth is more of a stranger than fiction.” Mark Twain (1835-1910)

Understandably strange

This is a market that never ceases to amaze, as the run-up in stocks continues. But these days it feels like surprises are rare when speculating on the direction of interest rates, stock markets or volatility. What has been stunning is how the share price run-up continues without significant or major hiccups. Fending off various macro risks, the bull market has entered a phase where seasoned money managers so often caution publicly, but still fear missing out on the run. These mixed messages between talk and action are rather ambivalent. The fear of missing out on risk-taking (reward-seeking) opportunities is a bigger fear these days than the fear of a massive collapse.

It is rather strange that the increase in stock value does not necessarily suggest a robust increase in the economy or earnings. Sure, the job numbers are viewed as positive, but wage growth remains questionable or mysterious on a broader level. Similarly, the GDP numbers have puzzled but not shocked forward-looking participants. Near-term worries of finding sustained returns surpass any longer-term analyses of consequences. Frankly, the long term seems too far for market participants, and the Fed-dictated markets lives on.

The ongoing market mantra continues to suggest:

a) Worry less, as showcased by the collapse in volatility.

b) More and more people are feeling that “bubbles” have not expanded enough to burst.

In other words, a recovery may be the tagline for promoters of all kinds, but certainly markets cannot overheat when organically, the recovery is not actually “hot” enough. From data to data, these points continue to linger.

Subtle trends

What is not making all-time highs is equally interesting to track for trend followers. For example, the biotech index is not quite at all-time highs and has regressed from late February 2014 highs. Neither have the shares of banks (Goldman or Morgan Stanley) risen to record highs. They have struggled to replenish enough momentum for an upside move. Even the so-called homebuilders fund (XHB) has not mustered the strength to restore its annual highs. These signs of a lack of new record highs is not a suggestion of an overall top; however, they beg the question of whether this is a hint of downside, or whether these sectors will catch up to the rest of the major indexes. Certainly, emerging markets are far removed from the glory days and will attract value buyers. Perhaps, a rotation from developed markets to EM is the logical sequence of capital flow.

To be sorted

ECB’s decision about low rates hardly shocked economists, as negative rates made several headlines. This is a global phenomenon that has been witnessed in the US, UK, Japan and now the Eurozone. Dynamics that drive decisions are focused around the abnormal yield patterns, which happen to remain at the forefront of macro discussions. Importantly, can the low rate environment lead to economic growth, such as increased lending activity, and produce meaningful results in Europe? This is a question so familiar to US observers, where the Fed policies’ ability to impact the real economy is debatable. Thus, the recent yield demand and lack of it needs a regrouping or correction – a breather of sorts to redefine the meaning of risk-reward. Obviously, the risk-taking has extended to African bonds and asset-backed securities. The volatility index (VIX) closing at levels seen in 2007 reinstates the calm and boldness that are encouraged in this trading climate.

Traditionally, markets know how to humble hubris. When trading seems relatively “easy,” the danger does arise. Even if claims of caution have been exhausted, risk never evaporates. Instead, the narrative is where the catalysts form. By now, a synchronized global thinking that suggests comfort over worries has rewarded those who’ve ridden the wave. Brilliance or luck aside, we’ve learned that was the right move. However, an honest approach begs the following: How much upside news is not factored into the market? Unknown. Thus, the sequence of strange developments is identifiable, but how it will sort out is the mystery that requires risk management.

Article Quotes:

“Widespread anti-EU protest votes in last month's European Parliament elections will make it harder for many governments to pursue deficit-cutting and structural economic reforms or to deepen the integration of the 18-nation euro area. Public resistance in Germany, Europe's biggest economy, may make it impossible for the European Central Bank to go beyond last week's monetary easing measures to more radical U.S.-style asset purchases if low inflation persists or worsens. Berlin is balking at using its own healthy fiscal position to invest more in infrastructure or spur domestic demand with tax cuts that could help balance Europe's economic adjustment. European Union leaders and the ECB have done enough to restore market confidence for now by equipping the euro zone with a financial rescue fund, stricter fiscal discipline, a single banking supervisor and a de facto lender of last resort. But the political will to complete economic and monetary union looks ever weaker, especially if it requires winning public approval for changes to the EU's governing treaties. In a book published before the elections French economist Jean Pisani-Ferry argued that Europe's leaders were reluctant to give any more power to Brussels and sought to avoid controversy over further European integration.” (Reuters, June 8, 2014)


“Vietnam and other Southeast Asian countries are spooked these days by China's aggressive behavior. But the real threat to Vietnam's future may come from a different communist neighbor.Ambitious plans for hydroelectric development in the region, especially by Laos, pose a real danger to the food supply of Vietnam and Cambodia. Upstream dams will imperil the fish stocks that provide the vast majority of Cambodia's protein and could also denude the Mekong River of the silt Vietnam needs for its rice basket. Laos's drive to become the ‘battery of Southeast Asia’ is producing plenty of sparks, but not the right kind. Diplomatic tension over the dams – as well as their effect on fisheries and agriculture in a river basin that is home to more than 60 million people – threatens to drive Southeast Asian countries apart right as they are trying to present a common face toward China's increasingly brazen behavior in claiming parts of the South China Sea for itself. The whole region is caught in a hydropower frenzy, thanks in part to China's plans to build multiple big dams far upstream. Laos is building several of its own on the Mekong to generate electricity – for export. That includes the Don Sahong project, right near the Laos-Cambodia border, and the much bigger Xayaburi dam further upstream. The country of slightly more than 6 million people doesn't need more power, but it does need hard currency.” (Foreign Policy, June 6, 2014)

Levels: (Prices as of close June 6, 2014)

S&P 500 Index [1949.44] – Another record-high finish, 12% higher than February 5th lows. A melt-up from 1880, another explosive move re-confirming strength.

Crude (Spot) [$102.71] – No major change week over week. Quite a familiar place, with the 200-day moving average at $100. The wrestling match between buyers and sellers continues.

Gold [$1252.50] – Some signs of a bottom, although no strong evidence around or above the $1240 levels. Intermediate-term correction and pause is in full effect.

DXY – US Dollar Index [80.36] – Since May 8th, the dollar has confirmed stability and shown slight signs of gains.

US 10 Year Treasury Yields [2.58%] – July 2012 lows of 1.37% seem distant in time and percentage points. However, the January highs of 3.05% are on the radar, and it’s unclear when they can be achieved.





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