Market Outlook | June 23, 2014

“Never ignore a gut feeling, but never believe that it's enough.” (Robert Heller 1826–1878)

Trend reinforced

The near death of volatility combined with record-high stocks are numbing by now. This is nothing new, if you’re only watching the scoreboard of known index performances. Still, it never ceases to amaze as an ongoing theme of recent years, where the Fed’s messaging is the powerful force. Equally, some money managers have been talking down the market, given unimpressive economic growth rates, and macro unrest is brewing despite being ignored for a long while. Various sour or risky realities from all angles are barely impacting sentiment, which also is rather remarkable. Thus, the daily news flow and implication analysis of risk managers do not match the Fed-led rally that loudly proclaims the death of risk and the appreciation of share prices in a calm process.

There are some concerns from oil markets regarding Iraq, barely highlighting the macro concerns in the Middle East. Surely, the impact is first felt in commodities, as resource-based concerns linger. The consensus view anticipates crude will accelerate, as it has in prior tension-filled periods. Yet impacting the rest of the equity and bond markets remains a suspenseful question. For now, even bond markets are not viewing the Iraq concerns as a worry. So far, not much turbulence has been witnessed, even with weaker earnings, which are not at the forefront of investor discussion. Perhaps, domestic worries in the US, Eurozone and China are replacing foreign policy-related worries. Not to mention, mid-term election implications and less certainty by voters in the US are in the back of the minds of some managers. Accumulating factors build up for those looking to think a step or two ahead, but presently, those thoughts do not carry much weight in day-to-day trading.

Old questions

The paradox of a one-sided market: The vocal bearish skeptics have struggled to wrestle down bulls, who are actually gaining more momentum despite the lack of many days of 1% or higher moves in broad indexes. Yellen's support of this status quo welcomes yet another quarter where risk allocation is revisited closely. How much deploying of new capital to equities awaits? What's the peak potential given record highs? Perhaps, the Fed provided some hints of pausing.

Few calls for bubbles, demand for sell-offs and worries of over-valuations point to a lack of substance in the eyes of market influencers. Sure, warning signs are common and have been heard before. In fact, many argue valuations (compared with historical norms by some measures) are not stretched and the economy is not overheating; thus, worrying is overrated. And that’s the vibe that’s felt in the market. Not asking critical questions is not an option.

Stock markets’ disconnect with a tangible reality suggests that one or two major events outside of the Fed's scripts hardly bother investors to alter tactics. Against this backdrop, the “globalization” or “free-market” story is being reevaluated. Yet, frontier markets appear like today's version of yesterday's BRICs, with increasing bond issuance and soaring stock markets.

“Individual countries have posted some significant returns, too. Since the start of 2013, Bulgaria’s market has soared 91%, Pakistan’s has jumped 88%, and Nigeria’s has risen 47%. The strong performance is helping frontier markets – usually defined as countries that have a stock exchange but don’t meet the size and liquidity requirements to be in the emerging-markets index – to gain more acceptance in the investment community.” (Wall Street Journal, June 1st, 2014).

Limited hints

Gut feelings may not have a place in the savvy analytical work of risk managers and market participants, yet they might have value at some junction. Charts of asset prices may not be enough to look ahead when they only tell of past actions. Comfort is a common theme for risk-takers, as low risk is perceived as not wishful thinking, but a description of present action; thus, the mystery of timing lives on. Expert advice is losing voice, and even pessimists are forced to take on a positive stance these days to play catch-up or chase returns. As absurd as it is to see the majority of markets in agreement with bulls, for some it seems even sillier to fight against a market that has been rewarding for years. For now, the unanimous bullish market may breed new waves of overconfidence, which is the trait worth tracking for those looking to readjust capital deployment.

Article Quotes:

“The theme of Federal Reserve Chair Janet Yellen’s press conference this week was ‘uncertainty’ – uncertainty about what’s going to happen to interest rates, about how fast the economy will grow, about inflation. Just how uncertain is Yellen? Well, we counted: She used the word eight times in her hour-long Q&A with reporters. (‘Certain’ didn’t occur at all, according to the Fed transcript.) In her first press conference, back in March, she used the u-word only once. Nothing about the economic outlook is ever certain. So why this sudden burst of ‘uncertainty’ from the Fed chair? It’s a message to buoyant financial markets: A little caution would be welcome. ‘To the extent that low levels of volatility may induce risk-taking behavior that for example entails excessive buildup in leverage or maturity extension, things that can pose risks to financial stability later on, that is a concern to me,’ she said, choosing her words with extreme care. (Translation: We know that low interest rates can lead yield-hungry investors to do dumb things and take big risks that can hurt them – and the rest of us.)” (The Brookings Institution, June 19, 2014)


“The growing bloodshed in Iraq and Syria is being watched as keenly in China as anywhere else in the world. Indeed, the greater Middle East is becoming an ever greater focus of Chinese foreign policy. At the just-concluded sixth ministerial conference of the China-Arab States Cooperation Forum, held in Beijing, Chinese President Xi Jinping called upon his Arab counterparts to upgrade their strategic relationships with China, by deepening bilateral cooperation in areas ranging from finance and energy to space technology. This reflects China’s broader goal – established partly in response to America’s ‘pivot’ toward Asia – of rebalancing its strategic focus westward, with an emphasis on the Arab world. Of course, economic ties between China and Arab countries have been growing stronger for more than a decade, with the trade volume increasing from $25.5 billion in 2004 to $238.9 billion in 2013. China is now the Arab world’s second-largest trading partner, and the largest trading partner for nine Arab countries. Within ten years, the volume of China-Arab trade is expected to reach $600 billion. Engineering contracts and investment have also enhanced ties. From 2004 to 2013, China’s crude oil imports from Arab countries grew by more than 12% annually, on average, reaching 133 million tons per year. And China’s ‘march west’ strategy furthers its goal of safeguarding access to these resources. As the director of the State Council’s Development Research Center, Li Wei, pointed out in February, at the current rate, China will be consuming 800 million tons of oil annually, and importing 75% of its petroleum, by 2030.” (Minghao Zhao Project Syndicate, June 18, 2014)

Levels: (Prices as of close June 20, 2014)

S&P 500 Index [1962.87] – Another record high leading to a more than 8% run since the April 11, 2014 lows. Previous highs were 1955.55, not far from Friday’s close.

Crude (Spot) [$106.91] – The breakout above $104 in the last two weeks sets the stage for a period of nervous response to Iraq and other unsettling factors. Yet, one should recall that crude has gathered momentum since early May, and this is a continuation of what’s building.

Gold [$1293.00] – After bottoming around $1200 last December, there are signs of a new stage in recovery of surpassing the $1300 range. Although bulls are somewhat reenergized, more evidence is needed in a commodity that’s fighting an intermediate-term bearish bias.

DXY – US Dollar Index [80.36] – At the low end of trading over the last 15 days. Early hints of a weak dollar will resume, but convincing price action is not available.

US 10 Year Treasury Yields [2.60%] – The 2.60-2.70% range is too familiar in the past year, while below 2.50% has become a rare event. Therefore, the status-quo trend is not quite disturbed. Seven years ago, yields stood at 5.32%, the highest point, which seems so far away in this downtrend.



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