Market Outlook | April 27, 2015

“Our fatigue is often caused not by work, but by worry, frustration and resentment" (Dale Carnegie, 1888-1955)

Summary

This headline of US stocks reaching all-time highs is a symbol of strength that's becoming old news to casual observers. For others, ‎buyers' convictions will be reexamined and tested yet again this spring (just like other times before). The fatigue of "all-time" highs is here and the upside surprise factor is not as shocking. The Fed’s script has worked again and again and now the Nasdaq strength can be attributed to innovative areas that have rewarded investors. The markets have not zoned onto one worrisome matter to cause a sour turn of events. For now, worrisome big picture issues (from Eurozone to China slowdown to wages etc.) are only contemplated and are piling up. However, dissecting and digesting worrisome issues is not a collective priority for participants.


Searching Variables

It feels like the fatigue of the “all-time highs” chatter is becoming less authentic than before. Instead, it is more like the norm that’s being accepted. Stories of “improving the economy” are also tiresome to hear, especially when the tangible evidence is not easily visible. As is plenty of mixed data in the US. On the other hand, in the global economy, strength has not been easy to find; it is more selective than in the past. Meanwhile, discussions of a Fed rate appear numbing, since we've heard it before but no one has a good read on timing. It behaves more like a theoretical exercise as much as an actionable, tradable event. As witnessed before, the status-quo is too dominant and investors seem out of ideas and desperately seek Fed guidance. Interestingly, the Fed is not full of ideas either, as lofty expectations for digestible assets continue to loom.

Yet, if the economy is not “growing” as robustly (by some measures) and investors are not tangibly convinced, then why should stocks continue to go higher? Again, on the broad level, a classic argument to buy stocks is primarily driven by the low rates and lack of alternatives. Sure, limited options are understandable and quite clear, but chasing yields for the sake of "chasing" does not seem sound, either. Or fair to say, there is risk that’s misunderstood and not quantifiable. Bears must at least acknowledge one point: this bubble is not quite like 2000 or 2008. Each peak has its own nuances, such as the tech bubble or credit crisis, but here the interconnection of central banks plays a vital and, for most, an unprecedented role. All that said, volatility is hardly feared, Eurozone slowdown is not a shock, Fed rate hike is unknown, and the rest seems like business as usual. In this set-up any economic data beyond “mixed data” is instrumental to provide further guidance. The week ahead presents some clarity on wage growth. However, in the past few months any excitement for a grand discovery via economic data has disappointed investors. Basically, the status-quo is well defined and magical clues are nearly nonexistent. It is disappointing for those searching for a game-changing data point.

Message from Earnings

The common theme for this earning season revolves around the strength of the dollar and its impact on US corporations. Surely, the crafty company press releases find clever explanations for weakness of any sorts. We’ve heard excuses in the past and now the dollar strength is a reoccurring complaint or explanation for some under-performance. Here is an insightful explanation regarding the dollars’ impact:

“On average, revisions have been negative irrespective of foreign revenue exposure but companies with more than 60% Foreign Revenue have been hit particularly hard with respect to earnings expectations. On the other hand, earnings expectations for companies with between 20% and 60% Foreign Revenue have not been revised nearly as sharply even though revenue expectations for this group have seen meaningful negative revisions. Also of note is that the 125 companies, which do not report geographic segment data, do not appear to have significant foreign exposure on average, at least as reflected by consensus estimates for 2015.” (S&P Capital IQ, April 2015)

Meanwhile, savvy investors will continue to ask and to dig at the impact of the global economy on large corporations. Some answers are not as gloom and doom, and others have not been quite discovered. Thus, are markets more biased by the Fed’s (general) bias towards higher stocks? Or are markets focusing on basic fundamentals and future growth potential? Both questions linger at all-time highs with a collective participation. As stated above, what are the catalysts to drive markets even higher at this junction? Certainly in the innovative tech world, companies like Google, Amazon and Microsoft continue to showcase their value in making money, and investors are thrilled. Perhaps, the Nasdaq leaders are making a splash to justify the current levels. Other sectors may not be as rosy as tech has been in this bullish cycle.

Connecting the Dots

Forces that justify a bull market seem plentiful. Momentum is biased towards the upside: large tech public companies are making money, which justifies the current hype, and rates are low via coordinate central bank efforts with no signs of going much higher. This is puzzling set-up for most, since fighting the Fed has been punished severely; yet, finding common sense in all this is no easy task. Hints of a breakdown are not readily available, strength in the economy is not widely felt and thus some of the market action seems illusionary. In other words, all-time high stocks only reflect a very narrow perspective of trading markets. Thus the mind games are challenging for risk-takers who find it so convenient to ride the wave, as they had for several years, but common sense suggests thinking twice. This begs the question, in the next 2-3 years can markets create enough wealth without Fed interference? This question is not fully confronted because the short-term nature of liquid markets ends up being distracting.



Article Quotes:

“The explosive moves in equities really started in July 2014, with the Shanghai Composite and the CSI 300 rallying 110 percent and 114 percent respectively since then. The explosive moves have become much more pronounced since March and it's interesting to see just that over 7.4 million new A-share accounts have been opened in that time. What's more, many of these new investors are young enough that they won't have been too negatively affected by the 72 percent crash in the Shanghai Composite between 2007 and 2008. What we are seeing right now is a household portfolio re-balancing, with what seems like a fear of missing out and a growing view that equities are going higher. The authorities have even allowed individuals to have 20 separate A-share accounts, providing greater flexibility to investors on where they trade. The number of accounts being opened also suggests there is a wall of capital that has not yet fully been invested in the market (rumor has it that nearly $20 billion currently sits in Chinese bank accounts)... Some investors have also looked at using margin financing, in which an investor borrows money to buy securities. Margin financing really started in March 2010, but has grown in popularity recently. Purchases of stock using margin financing as a percentage of turnover has pushed up to around 16 percent, which is at a historically elevated level and helped by some innovations from brokers, who have designed various products to help high-net worth individuals achieve greater leverage ratios.”(China Daily, April 24, 2015)

“JPMorgan broke out returns for foreign investors into four components: dividends, change in earnings per share (in local currency) over the past 12 months, change over 12 months in the ratio of price to earnings, and the exchange rate. Dividends, naturally, where paid are always positive. In a few cases — China, India, the Philippines and South Africa — the change in both EPS and P/E ratios was positive. In many others, P/E ratios rose even as earnings per share fell, as investors decided the damage had been done and company performance would pick up from now on. But in many countries where investors took a positive view on local market performance, the gains for foreign investors were wiped out by the currency. Investors can take some heart from the turnaround so far this year. But the other thing the two charts make graphically clear is the importance of differentiation. For emerging market equities as a whole, foreign investors have made 10 per cent so far this year, compared with 7 per cent over the past 12 months. So things have picked up, but not by much. Those who got their choices and timing right did much better. Those who got them wrong, much worse.” (Financial Times, April 24, 2015)

Key Levels: (Prices as of Close: April 24, 2015)

S&P 500 Index [2117.69] – The previous high of 2119.59 from February was revisited last week with the index peaking at 2120.92. Interestingly, this sets the stage for buyers to contemplate if buying now makes more sense than it did in February. It is fair to say that this is yet another critical inflection point.

Crude (Spot) [$57.15] – A strong run since March 18, 2015 confirms stabilization from cyclical demise. Sustaining this recent move is the real question for trend followers.

Gold [$1,185.75] – Failed to hold $1,280 earlier this year, leading to more weakness. A new range has formed between $1,160-1,240. The commodity cycle dictates the current slowdown.

DXY – US Dollar Index [96.92] – Surely, the strong dollar was a vital and noticeable theme last year. Now, a slight breather is taking place. Since March 13, 2015 the pause is in effect; although, it is unclear if there is a major fundamental shift in currency market is a bit pre-mature.

US 10 Year Treasury Yields [1.90%] – A familiar sight again with 10 year below 2% and above 1.80%. Fixed income sentiment has not changed dramatically and remains at a standstill.



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