Market Outlook | February 2, 2015

“Narrative is linear, but action has breadth and depth as well as height and is solid.” (Thomas Carlyle 1795-1881)

Narrative Challenged

While a new year is barely being digested, a new calendar month is upon us. The long-lasting narrative of higher stock markets, lower yields, lower volatility, strong dollar and lower commodity prices appears mostly intact. More or less, this seems like a script directed by the central banks. This has become a familiar story, which is mostly understood by observers. It may seem convenient to stick with some of this trend; however, there are other hints and messages to consider in assessing future risks.

Interestingly, three key tradable markets are in agreement about the soft economic conditions on a global basis and the near-term anxiety those conditions may cause. The commodity, currency and bond markets are in-tune with weaker growth. Lack of inflation continues as growth expectations remain tepid. In turn, bond markets suggests that interest rate hikes are (or should not be) not feared. Yields of developed countries keep going lower and lower (even negative) in market government bonds. “Benchmark 10-year yields fell to a 20-month low as an inflation measure plunged in Europe by the most since 2009, amplifying the threat of worldwide deflation” (Bloomberg, January 29, 2015). The strength of the Dollar further emphasizes the rush to safety as profoundly exhibited in 2014. Rotation into the US dollar reflects weakness not only in emerging markets, but the fragility of commodity based economies, too. When closely examined, there is a theme that’s brewing across various markets and equities have yet to follow suit.

Immunity Tested

Meanwhile, the equity markets in the US benefit from the lack of attractive and liquid alternatives for investors. However, the stock market may be delaying the much needed adjustment in future (growth & stock price) expectations along with actual corporate profitability. When viewing the world through other markets, the US equity markets seem immune to crisis like responses so far. However, US stocks benefits from the demise of other investments and that’s the main lesson (or paradox) that many agree with.

There are plenty of observers who continue to ask if the weak commodity demand, stronger dollar and slowing China remain un-reflected in corporate share prices. At the same time, VIX, which measures the volatility of US stocks, has remained calmer than other jittery sentiment barometers. Perhaps, the cheered equity markets, conducted by the Federal Reserve, are slowly pausing after rewarding investors for a long time. Again, a sideways pattern in key stock indexes reflects a brewing near-term debate between buyers and sellers. This tug of war between market forces may explain the trading ranges in the last three months. After all, mild selling pressure was visible in US Equities in last October and December and earlier this year. The magnitude of those corrections was not enough to derail the bull market. Nonetheless, spurts of selling pressure create doubt on the upside movement. Essentially, the Fed’s credibility is on the line.

Last week's US GDP number confirmed slower than expected growth, and further confirmation waits from labor data this week. If the economy fails to justify the elevated equity prices, then this Fed script will be challenged again. As stated above, the bond and commodity markets are very skeptical of current and future growth. With that backdrop in mind, the next few weeks are suspenseful. More volatility can be expected when the perception of rosy stocks meets the reality of a sluggish economy.

Bold Message

Emerging market currencies continue to crumble from Russia to Turkey to Brazil. The foreign exchange markets reflect the damages felt from the slowdown in commodity markets and from the ongoing struggle for emerging market stability. For example, the Turkish Lira making new lows versus the US dollar is one talk that's surfacing. Aggressive risk takers may appreciate the risk-reward here, but collectively the severity of the currency crisis is being understood.

Energy dependent nations are not only Russia, Iran and Saudi Arabia. Recent commodity adjustments, especially in oil, are impacting Canadian and Australian currencies and companies. Here is one example: “The Canadian dollar hit a six-year low Friday after a report showing Canada’s GDP fell 0.2 per cent in November" (CBC News, January 30, 2015). Much of this weakness is driven by an energy dependent economy and the fallout will soon to be revealed by Canadian banks. Therefore, when all is said and done, the impact of commodity weakness reiterates the unstable and uncertain climate in international trade.


Article Quotes:

“Companies are now busily telling the markets about their results for 2014. Investors have paid little attention until the last few days, as instead a succession of central banks have dominated the agenda. But the earnings season for the fourth quarter is usually the most interesting and important of the year, as companies are also publishing full-year results, which tend to be more fully audited and leave less leeway for accounting jiggery-pokery, and providing forecasts for the future… As for revenues, anxiously watched for signs of economic strength, non-oil companies are heading for 4.3 per cent growth in the fourth quarter. This is down from the third quarter and unexciting, but still consistent with some underlying economic growth. Sales are expected to continue ticking on at about this rate during the first two quarters of this year, even as the oil price fall means that the S&P 500 as a whole is slated for an outright fall in revenues.” (Financial Times, January 30, 2015)


“Among the most important of the risks being overlooked is that a Greek exit would send the clearest of messages to the Eurozone public that Euro membership was no longer irrevocable. More importantly, it would send the message to Eurozone bank depositors that they could no longer count on the ECB to always be there to act as a lender of last resort. That realization could provoke a run on the banks in countries like Italy, Portugal, and Ireland where public and private debt levels are now at very much higher levels than they were in 2012 and where these countries now find themselves caught in deflationary traps. Another miscalculation that European policymakers might be making relates to the strength of the financial safety nets that they have put in place. To be sure, the Eurozone now does have a well-funded European Stability Mechanism and an ECB that is committed to buying as many of a member country’s bonds as might be needed. However, these mechanisms can only be activated should the countries being supported commit themselves to IMF-style economic adjustment programs. Considering the anti-austerity political backlash now characterizing these countries, it is far from clear that they would agree to submit themselves to the IMF’s tender mercies.” (The Manhattan Institute, January 25, 2015)


Levels: (Prices as of close: January 30, 2015)

S&P 500 Index [1994.99] – The multiple attempts to surpass 2040 have been unsuccessful. Staying above 2000 this week is an ultimate test since the index has held above 2000 three times before. December 16, 2014 lows of 1972.56 are on the radar for technical sell-offs.

Crude (Spot) [$48.24] – Several trading days in 2015 are hinting a possible bottoming process around $44- 46. Yet, participants are still digesting the new trading ranges after the epic sell-off.

Gold [$1,295.00] – Since mid 2013, Gold trading prices have been well defined between $1,200-$1,400. A bottoming process after the sell-off is linked with the commodity cycle. Importantly, staying above $1,300 in recent months seems to be a struggle, despite spurts of momentum.

DXY – US Dollar Index [94.80] – The multi-month acceleration has partially paused in recent days. However, the explosive strength in the US Dollar remains intact.

US 10 Year Treasury Yields [1.64%] – Last January’s highs of 3.05% seem like a long-time and long ways away. Below 2% has been a norm this year. July 2012 lows of 1.37% are the next critical benchmark.




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