Market Outlook | March 16, 2015

“When a symbol unmoors itself from what it symbolizes, it loses meaning. It becomes ineffective.” (Arundhati Roy)

Summary

No shortage of discouraging headlines these days as it relates to variables impacting future growth. Concerns are accumulating as key markets slowly digest the harsher realities of growth conditions. Commodities confirm a slowing demand in China and emerging economies. Eurozone showcases the political nightmare created by the economic woes of post 2008. US assets, including the Dollar, march on higher with an enviable position against other markets. More pressure is building for financial markets to readjust the risk perception and justifiable valuations despite QE efforts to re-boost Eurozone. Bulls appear more nervy than in prior quarters, as this bullish cycle’s resilience is tested—again.

Misleading Symbolism

For a while the stock market in the US has symbolized economic well-being, while also serving as a barometer for wealth creation and even perceived by some as the nation’s key sentiment indicator. Of course, the financial markets remain a tool for wealth creation regardless of varying perceptions. In the last six years though, the wealth creation of S&P 500 or Nasdaq index disguised as well-being incorrectly describes the sentiment of the average citizens' well-being. To add insult to injury, small business and middle class day-to-day matter are not at the forefront because of this glorified and overly-celebrated bullish run. Finally, in a period where the Eurozone and China are slowing and severely fragile, US assets are enjoying a relative advantage that’s so great that the absolute concerns have been ignored. Typically, the political discourse is overly focused on the stock market as somewhat of a gauge. Meanwhile, the low interest rates, low inflation, lower commodity pricing and less business friendly policies tell a much grimmer story for the vast majority.

Desperate Bargain Hunting

The dollar strength has reminded many of the woes not only in Europe but mainly in Emerging Markets, with very few exceptions. As investors are optimistic about India, other nations like Brazil, Turkey and Venezuela are scrambling to deal with the turmoil. In fact, the interconnected economic and political crisis is not only reflected in financial markets, but also in social unrests. A classic example is Brazil where currency is collapsing and outrage is expanding:

“Rousseff’s government is raising taxes and cutting spending as a means to shrink the budget deficit and avert a downgrade to its sovereign credit rating after years of ballooning spending and subsidized lending.” (Bloomberg, March 15, 2015)
Interestingly, opportunistic capital is seeking investments in Emerging Markets these days, but the growth potential seems mysterious. On one hand, bargain hunters these days have to look at EM, especially as the US becomes saturated and a bit expensive. Here is one example:

“China’s $653 billion sovereign-wealth fund is looking to invest more in emerging markets, according to an infrastructure investing official at China Investment Corp…. CIC is reconsidering its approach to investing in infrastructure because assets in developed markets have become too expensive, with 'inflated pricing' at auctions.” (Wall Street Journal, March 11, 2015)

As 2014 illustrated, the capital outflow from EM and commodities was felt with massive selling. Now those planning ahead for 2-3 years are asking the questions regarding the piling on the NASDAQ (US tech and biotech), which is hardly cheap, versus EM infrastructure or commodity related investments.

As EM and commodities continue to decline in value then bargain seekers are eager to take further risks, but the bottoming process will require further patience. As oil and gold speculators learned in last few weeks, the commodity cycle unwinding takes a while.

Mysterious Catalysts

As the Nasdaq trades near its all-time highs, nostalgic memories of the tech bubble naturally resurfaces. Of course, when the S&P 500 index reached all-time highs in 2007, the Nasdaq was not quite at historic highs. A few years since the 2007 peak, in a synchronized manner, US assets have climbed higher—mainly during a period where innovative themes are rewarded and low interest rates boost equities. Not to mention, when commodities are out favor the innovative segments, such as tech and biotech, naturally attract further capital. Speculators may seek a rotation, but the evidence is not quite clear.

Meanwhile, the ECB actions of low rates and higher equities will be tested further. For now, most of the stimulus damage is realized in the declining Euro. So much noise persists on what the Eurozone's next moves will be, but the reality is still grim for those looking beyond recent European equities appreciation. Yet, the known catalysts (i.e. Fed or earnings) in the past have let down those seeking or expecting a correction. The chatter of the Fed raising rates has picked up tons of momentum but with inflation, wages and commodities remaining low it is not quite convincing that rates would rise. Perhaps, the catalysts are not only the Fed’s action or anticipated action, instead it is culminating issues that have been ignored. At some point, a boiling point for list-worries can inflame a further spike in volatility. The catalyst that can tilt sentiment in a vibrant manner remains mysterious for now. However, the pressure is clear from all angles and regions.

Article Quotes:

“These are some of the reforms that countries like Italy and Greece, but also France and Germany, need to implement. The ECB’s QE buys political leaders time, but it remains to be seen whether they are prepared to use it — and a bit of political capital — to create consensus around the need for reforms. And even if they did, it’s hard to say if reform proposals could make their way through parliaments and, finally, to implementation. Indeed, the incentives to go through a painful process of change are not there, surely not in the short term. What the ECB seems to have done with QE is to provide a large carpet under which to sweep issues that require complex, long-term solutions that do not necessarily advance the political agenda of their proponents and might undermine their political ambitions. Indeed, by buying more time for the euro in the short term, Draghi may have pushed any long-term solution further away. Fostering complacency is the implicit risk in the decision to extend the ECB’s safety net and to support economic growth in the eurozone, as opposed to just keeping prices in line with the agreed inflation target. Complacency has never been in Draghi’s frank and forceful vocabulary. But in reality, even if it correctly addresses the issue of medium-term growth, the ECB’s move limits the incentive to focus on what will happen to Europe’s single currency, the euro, in the longer term if member states are unable or unwilling to modernize their economies, make them more productive, and adapt to the constraints posed by the euro.” (Foreign Policy, March 13, 2015)


“Despite appearances, China’s political system is badly broken, and nobody knows it better than the Communist Party itself. China’s strongman leader, Xi Jinping, is hoping that a crackdown on dissent and corruption will shore up the party’s rule. He is determined to avoid becoming the Mikhail Gorbachev of China, presiding over the party’s collapse. But instead of being the antithesis of Mr. Gorbachev, Mr. Xi may well wind up having the same effect. His despotism is severely stressing China’s system and society—and bringing it closer to a breaking point. Predicting the demise of authoritarian regimes is a risky business. Few Western experts forecast the collapse of the Soviet Union before it occurred in 1991; the CIA missed it entirely. The downfall of Eastern Europe’s communist states two years earlier was similarly scorned as the wishful thinking of anticommunists — until it happened. The post-Soviet 'color revolutions' in Georgia, Ukraine and Kyrgyzstan from 2003 to 2005, as well as the 2011 Arab Spring uprisings, all burst forth unanticipated. China-watchers have been on high alert for telltale signs of regime decay and decline ever since the regime’s near-death experience in Tiananmen Square in 1989. Since then, several seasoned Sinologists have risked their professional reputations by asserting that the collapse of CCP rule was inevitable. Others were more cautious—myself included. But times change in China, and so must our analyses.” (Wall Street Journal, March 6, 2015)


Levels: (Prices as of Close: March 13, 2015)

S&P 500 Index [2053.40] – The near-term test for this bullish trend is ability to hold above 2040. Since November 2014 buyers have debated between the 2000-2080 range.

Crude (Spot) [$44.84] – A few points removed from the January 29, 2015 lows of $43.58. Clearly, the boom and bust nature of commodities takes a while to settle in. The break above $50 ended up being short-lived.

Gold [$1,152.00] – Over a 10% drop since late January peak. Again, further confirmation that Gold trades more like a commodity and remains out of favor.

DXY – US Dollar Index [100.33] – The explosive run continues as a new landmark is reached (over 100). With every strength the dollar exhibits the further the weakness of Emerging Market currencies and the Euro goes. The highs from September 2001 remain the next major landmark point. Rather a profound macro trend.

US 10 Year Treasury Yields [2.24%] – A new range formed between 2-2.20% and stabilized around 2%, but further upside momentum in rates remains unconvincing.



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