Market Outlook | September 15, 2014

“It is no use trying to sum people up. One must follow hints, not exactly what is said, nor yet entirely what is done.” John Greenleaf Whittier (1807-1892)

Summer Shifts

The summer presented two massive trends: Strengthening of the Dollar and ongoing decline in Crude prices. For a long while the weakening dollar combined with the stable rise of Crude prices has been regarded as a “normal” macro occurrence. Basically, the status-quo that’s been ingrained in many analysts’ expectations may change their tune. Pundits in the past few days have addressed the Dollar’s multi-week run as well as its best run in 17 years. Part of the strength in the greenback is driven by further ECB rate cuts and stimulus. Perhaps, the recent ECB decision has stirred further changes in currency markets:

“Many central banks have simply given up the pretense of independent monetary policy, and the ECB's move will lead them further down that path. That, in turn, creates challenges for currency traders, who have long relied on differentiation in interest-rate outlooks to determine which currencies to buy or sell. It makes it difficult to pick standalone winners, even if traders have lately done well betting on broad-based losses for nearly all currencies against the dollar.” (Wall Street Journal, September 14, 2014)

The strengthening Dollar trend awaits the Fed for clarity this week, of course, especially as attention shifts to interest rates, which remain a top priority for observers. The slow awakening to changing Dollar dynamics can impact the big picture script. Analysts will have to dissect the Dollar’s impact on corporate balance sheets and how those perceptions may play out. For now, the multi-week run is slowly digested and speculators debate the sustainability.

Meanwhile, the commodities sell-off of 2013 is now brightly reflected in Crude prices as well. Therefore, it raises questions about a weak global demand or the expanding supply, especially in the US. It is fair to say both are market moving factors. The slowdown in the global economy is playing its part suggests further hint to the sluggish economic factors, not just in Europe, but in emerging markets as well. This is primarily led in China where the slowdown is accumulating.


Turning Points?

So many inflection points in the past twelve months have come and gone. Several macro shifts were talked about (e.g. rates, euro zone struggles, etc.) have also come and gone. Surely, interest rates are on top of the list as usual. It remains suspenseful and mostly guess work. Meanwhile, it was a year ago that “Septaper” dominated headlines. Surely, that coined term came and went as well. At the same time, US 10-year yields consensus rates were expected around and above 3%, but never quite got there either. Meanwhile, few minor sell-offs of around 4-5% in S&P 500 index did not lead to a massive sell-off, but rather a rush by participants to buy on weakness. Essentially this has led to more days of stock indexes reaching record highs with evaporating volatility and hardly any major “earth shattering moves.” Certainly, complacency has been visible for too long.

Thus, here we are in another autumn, six years removed from 2008, a period when all out panic defined the financial climate. A reset of sorts has redefined the perception of risk. Yet now, at a multi-year bull cycle, the destiny of stocks embarks to new levels, and justifying the run is a classic question that has reappeared. The hints from dollar and crude movements is one matter, but the reversal in volatility and interest rates may have a bigger say than the former on stock performance. Psychologically, there are two factors in play: 1) Unlike other times in the past two years, skeptics appear very cautious to challenge the status quo 2) The combination of upcoming mid-term elections and worsening foreign affairs can spark sudden change in sentiment. For now, the obvious answer is not presented, but the hints accumulate from various markets and directions.

Near-Term Hints

The challenge in deciphering hints is sorting the noise from the substance. The anticipated Fed meeting should provide guidance on interest rate policies. For some observers and speculators, volatility (VIX) bottomed around 11.24 on August 25, 2014. Similarly, US 10-year yields marked their lows on August 15, 2014 at 2.30%. Finally, the S&P 500 fell below 2000, a self-proclaimed psychological range that’s created some buzz. All suggest vital hints that may potentially alter the status quo of low rates, low turbulence and higher markets. It is too early for many given the prior false signals, but there are enough hints to build on. Basically, the tide is shifting even if it is not convincing on a mass level. Regardless of pending events or comments/words from policymakers, the market has silently spoken for those willing to listen. From dollar to crude and from rates to volatility, there is unease mixed with newer trends that are mildly tangible but surely visible.

Article Quotes:

“China's factory output grew at the weakest pace in nearly six years in August while growth in other key sectors also cooled, raising fears the world's second-largest economy may be at risk of a sharp slowdown unless Beijing takes fresh stimulus measures. The output data, combined with weaker readings in retail sales, investment and imports, pointed to a further loss of momentum as the cooling housing market increasingly drags on other sectors from cement to steel and saps consumer confidence. Industrial output rose 6.9 percent in August from a year earlier - the lowest since 2008 when the economy was buffeted by the global financial crisis - compared with expectations for 8.8 percent and slowing sharply from 9.0 percent in July…. China's economy got off to a weak start this year as first-quarter growth cooled to an 18-month low of 7.4 percent. Beijing responded with a flurry of stimulus measures that pushed the pace up slightly to 7.5 percent in the second quarter, but soft July and August data suggest the boost from those steps is rapidly waning.” (Reuters, September 13, 2014)

Eurozone: “The key problem is that in most countries it is impossible to generate a credible commitment to reduce spending in the future, let alone by the staggering amounts required by a tax cut of 5% of GDP. Take the two biggest and most celebrated consolidation plans Europe has seen – Finland and Sweden in the 1990s. Over the period 1992–1996, Finland’s primary deficit should have been reduced by 11.4% of GDP, of which 12.1% in spending cuts; the corresponding figures for Sweden over the 1993–1997 period were 10.6% and 6.8% of GDP, respectively. The IMF took these enormous figures at face value in its recent database on discretionary changes in fiscal consolidations. However, in my own research I have shown that these cuts are based on the announced plans by the incoming governments. The reality turned out to be very different – at the end of the period, Finland cut its primary spending by a mere 0.4% of GDP, and Sweden by 3.6%. But one need not go so far back into the past. In almost one whole year of work, the spending review initiated by the Italian government in 2013 – without a doubt the most thorough and serious such attempt so far in Italy – has identified at most €10 billion (about 0.6% of GDP) of spending cuts, most of which are still highly controversial and subject to political approval. As of now, nobody knows what fraction will be effectively implemented, or when.” (VOX EU, September 13, 2014)


Levels: (Prices as of close September 12, 2014)

S&P 500 Index [1985.54] – The glorified 2000 landmark point created some hype for bulls and observers, but sustaining those gains is questionable. Buyer’s momentum seems wobbly based on last week’s pattern.

Crude (Spot) [$92.27] – The downtrend continues and confirms the massive shift in trends since late June. Trading around $92, which was last seen around January 2014. Signs of a minor selling relief are apparent despite the well-defined cycle weakness.

Gold [$1,241.25] – Broke below June lows of $1,242. A few months ago this range triggered a buy point; however, this time around perhaps buyers are reexamining the revealing decline in commodities. The next critical level was $1,192, which was reached in July 2013. The commodity sell-off theme has become convincing.

DXY – US Dollar Index [83.73] – The last 90 days showcased a powerful run in the dollar. In July 2013, the index peaked at 84.75 which is few points away from Friday’s close. Chartists are wondering if this run is set to pause around 84 after this explosive surge.

US 10 Year Treasury Yields [2.61 %] – The recent move from 2.32% to above 2.60% triggers questions of whether or not this run can keep up. Perhaps, a few more weeks are needed as the 3% benchmark serves as the more meaningful range.





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