Market Outlook | February 9, 2015

“Reason is the slow and torturous method by which those who do not know the truth discover it.” (Blaise Pascal 1623-1662)

Synopsis

For months, investors have heard plenty about slowing Eurozone and Chinese economies. Both have been on investors’ radars and seem to lack clear or definitive answers as it relates to stopping the “bleeding” or redefining a new hopeful cycle. For now, a slow demise in the Eurozone and gradual deceleration in the Chinese economy remain in place despite some optimistic chatter in financial markets. The recent stimulus measures in both regions most likely signal an act of desperation rather than a clear-cut solution. Meanwhile, US stocks have maintained their relative appeal as buyers and sellers debate the next directional move.

The Slow Demise

When are these slowdowns going to be felt in a profound manner? At what point is it a shock? For now, data keeps reminding us of the fragile state of the global economy with seldom signs of revival. On a weekly basis, the weak conditions of European economies are revealed. Perhaps, that’s explained by the desperately needed stimulus (QE) earlier this year. This lack of growth is further visible by the very low yields (where negative yields are common these days). Then there is the political crisis, which is a front page issue. This is brewing further with the Greek exit from the Eurozone, which drives the suspenseful twist in this saga. The angst from the well-established crisis has dragged on—it is tangibly felt and politically has created unease for market stability.

“Even after two bailout packages, it is unrealistic to expect Greek taxpayers to start making large repayments anytime soon – not with unemployment at 25% (and above 50% for young people). Germany and other hawkish northern Europeans are right to insist that Greece adhere to its commitments on structural reform, so that economic convergence with the rest of the eurozone can occur one day. But they ought to be making even deeper concessions on debt repayments, where the overhang still creates considerable policy uncertainty for investors.” (Project Syndicate February 2, 2015)

There are plenty of unsettled worries. Beyond Greece—what if others leave the Eurozone? How is this settling for investors? Can we accept this slow demise? Regardless of spurts of optimism, the dire European conditions are too difficult to ignore for markets of all kinds.


The Gradual Deceleration

In terms of China, most of the discussion revolves around the slowing growth rate. It is quite evident that the slowing demand in commodities is closely tied to weakness in China. Clearly, this correlation between commodities and China (as well as Emerging Markets) is being realized by participants. Again, this result is not going to cause an overreaction these days.

“Coal imports dropped nearly 40 percent to 16.78 million tonnes, down from December's 27.22 million tonnes, and China also appeared to cut back on its strategic stocking of crude oil imports, which slid by 7.9 percent in volume terms.” (Reuters, February 8, 2015)

As these data points pile-up, the question remains: When does this turn to panic or loss of confidence? On one hand, the Chinese fund (FXI) is quite removed from its peak in 2007. The share prices of Chinese stocks in the last four years have stayed in a narrow range as positive news remains scarce. This may suggests that the disconnect between real economy and share prices is not overly misaligned unlike other markets.

On the other hand, a 2008 like crisis has not been felt, yet, which would express a lack of faith and confidence. Interestingly, FXI is up nearly 20% since early October as stimulus hopes to find a way to raise asset prices. Nonetheless, the Yuan is not quite close to Dollar or Euro status in terms of popularity. For now, tangible data confirms the struggle for a revival on the ground level economy. Massive dependence on stimulus efforts may create near-term optimism, but it is less likely to solve longer-term fundamentals.

“Weighed down by a property slump and overcapacity, China saw the biggest outflow of capital since at least 1998 last quarter. With money headed out of the country, the reserve-ratio cut is aimed at preserving the liquidity status quo.” (Bloomberg, February 4, 2015)

If capital is flowing out of China and into US assets then it is safe to say that wealth is not as comfortable staying in China as it did a decade ago.


The Standstill

Signs of mild instability have been brewing under the surface recently. A stock market shock or spike in stock volatility has not materialized, but some mild and indirect clues are building. The last sixty days reveal the uneasy responses and anxiousness about broad US indexes. The price swings illustrate the debate between believers of ongoing bullish rally versus doubters seeking a mild breather. The S&P 500 index has struggled to make new all-time highs in 2015 thus far. A very mild pause in the two year momentum may begin to invite tougher questions from investors. Similarly, VIX (Volatility index for US stocks) has gone back and forth between 16 and 24, with above 20 illustrating heightened investor anxiousness.

In addition, the positive labor data reinforces the consensus view of a possible rate hike in mid-year. However, the bond markets need to confirm if the economic strength presented in government data is plausible. Plenty of cynicism surrounds the guidance from the Fed, especially with low inflation and unimpressive wage growth that may not justify a rate-hike.

As seen in other markets, the commodity sell-offs (primarily in Crude) hurt corporations as much as they help consumers. The strong dollar impact on US companies has led to not-overly-thrilling results that hurt earnings. This impact of a strong dollar is to be discovered in upcoming quarters. As usual, if the Eurozone and China fail to offer a promising outlook, then the US benefits from the “safe haven” perception. This is a powerful edge that keeps assets higher, even if on an absolute level weakness is brewing.


Article Quotes:

“The central-bank stimulus spree of 2015 has the look of a global currency war. In quick succession, countries representing about a third of the world’s economic output—from the eurozone to China, Australia and Canada—have taken steps that have driven down the value of their currencies. But if it’s a war, it’s a gentle one so far. Half the central banks representing the Group of 20 developed and large emerging economies, whose top monetary and finance officials meet to discuss the global economy this week in Istanbul, have taken easing steps so far this year. The moves—mainly in the form of interest-rate cuts but also asset purchases—have ricocheted through foreign-exchange markets, driving the currencies of some countries down and those of others, primarily the U.S., up. That helps the economies of countries that are easing while complicating life for some central banks, such as the Federal Reserve, and creating challenges for exporters, from the U.S. to Switzerland and Denmark… Mention of currency war evokes images of countries deliberately trying to force their currencies down to boost exports and curb imports at their neighbors’ expense. By definition, it’s a zero-sum game… Unlike past easy-money campaigns, these latest efforts—from economies totaling about $36 trillion in annual output—aren’t aimed at addressing financial crises, as with the U.S.-led global effort six years ago. Rather, central banks are taking aim at the risks of too-low inflation and weak economic growth.” (WSJ, February 8, 2015)


“It is only ‘a matter of time’ before Greece is forced out of the eurozone, the former US Federal Reserve chairman Alan Greenspan forecast. The prediction came as the UK chancellor, George Osborne, said Britain was ‘stepping up’ contingency planning for dealing with any escalation of the crisis. The former US central bank chairman said it was hard to see any other final outcome of attempts by the new leftwing Syriza government in Athens to renegotiate the terms of the country’s €240bn (£179bn) international bailout.‘I don’t see that it helps them to be in the euro, and I certainly don’t see that it helps the rest of the eurozone, and I think it is just a matter of time before everyone recognises that parting is the best strategy,’ Greenspan told BBC Radio 4’s The World This Weekend. Osborne, who held talks in Downing Street last week with anti-austerity finance minister Yanis Varoufakis, will join fellow G20 finance ministers at a summit in Turkey on Monday where the situation in Greece will “dominate discussions.” He warned that a Greek exit – also known as Grexit – would cause “real ructions” and “real instability in financial markets in Europe.” (The Guardian, February 8, 2015)

Levels: (Prices as of Close: February 7, 2015)

S&P 500 Index [2055.47] – Back and forth swings between the 2000-2060 ranges have occurred for several weeks. Buyers and sellers are battling out the next critical move. Within the recent trading range the lowest point of 1972.56 (December 16, 2014) and the highest point 2093.55 (December 31, 2014) are key points.

Crude (Spot) [$51.69] – After attempting to find a bottom during most of January, Crude prices held above $50 this month. Sustainability remains questionable despite some easing of the selling pressure.

Gold [$1,259.25] – Stuck in a narrow trading range between $1200-1300. It is struggling to find a noteworthy upside catalysts.

DXY – US Dollar Index [94.80] – The last two weeks have had a mild pause on the well-defined trend of a strong dollar. It is way too premature to state whether or not the Dollar strength is being challenged.

US 10 Year Treasury Yields [1.95%] – A pronounced jump in yields in recent trading days has occurred. From the lows of 1.63% (January 30, 2015) to a close of 1.95% shows some early signs of stabilization in yields. Certainly, a convincing follow-through is needed.

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