Market Outlook | May 18, 2015

“There is no conversation more boring than the one where everybody agrees.” (Michel de Montaigne 1533-1592)


Summary

The market narrative appears “boring" and, on relative basis, more and more predictable rather than suspenseful. Low rates, higher equities and contained turbulence—all too common for participants. Of course, using the term "predictable" is dangerous and misleading at any cycle or junction. If it was so predictable then ‎the mystery and puzzle associated with risk would be non-existent. But that's not the case, even if it feels like the risk has been systematically extracted from the system. Even calm (or sideways) market price movements can suddenly become riskier than imagined, but recent behaviors continue to discount (or nearly ignore) worries. With key US indexes revisiting all-time highs, the bullish trend is resoundingly confirmed. In this process, assessing tangible versus theoretical risk is awfully deceptive and greatly challenging.

Uneventful Climate

Similar to the polarizing political environment these days, the market opinions also have formed two main but varying crowds: The hopeful crowd, who point out the signs of improvement from the gloomy days of 2008/2009 and the skeptics who doubt the Fed’s ability to reenergize the real economy. The truth lies somewhere in between and the status-quo for liquid markets has hardly changed. The near-death of volatility mixed with less dramatic reactions regarding real economy matters make this market dull, especially for volatility seekers. Interestingly, the volatility index (VIX) for US equities is trading closer to 2015 lows:

“Instead, as the S&P 500 ground to fresh record highs, the index hasn’t had a single move, up or down, of 2% this year, compared with three such swings by this time in 2014 and two in 2013.” (Wall Street Journal, May 13, 2015)

The combination of unglamorous corporate earnings results and weak GDP and wage numbers failed to rattle the confidence of investors. Again, the Fed’s game plan is highly trusted and skepticism is not quite reflected in day-to-day action. If volatility is too calm with markets appreciating, then it hints of a collective agreement. As in, sellers are holding off and buyers are not changing their sentiment.


Identifying Catalysts

In addition to the less eventful price action, the catalysts of major trend shifts are becoming tiresome, as well. What are viewed as potential catalysts are well known by now, such as pending interest rate hikes, ECB rate cut impact, resolution to Greek debate, economic mixed data, and disparity between large corporations and small businesses. All discussed so often, but not quite impactful for risk takers seeking actionable moves.

The rate hike guessing games live on without much clarity. At the same time, central banks continue to lower interest rates in a synchronized manner—a theme that’s loudly visible in 2015. Experts of all kinds are scrambling to decipher the next unknown major move or surprise that may derail the status-quo. Last year the Dollar strength and commodity collapse told a powerful story about weak global economy and softer emerging markets. This year, investors continue to settle into the concept of seeking US assets and currencies. The collective mindset is not quite geared to change despite the ground level pain that’s been felt in developed nations. Interestingly, those that feared inflation realized that picking the wrong catalyst is costly. Instead, now deflation is the buzz word from the US to the Eurozone.

Perhaps the takeaway from several years of observation is to seek catalysts that are not necessarily making daily headline noise, since the known catalysts have been less impactful and quickly numbing. Thus, the reward of risk taking begins with identifying the right and meaningful catalysts as much as timing the actual event.

Rude Awakening

Amazingly, in a period where markets are hitting all-time highs, key high profile fund managers have warned about either the elevated stock market valuations or the consequences of the Fed’s polices. However, the warning signs have been stated even if skeptics have nothing to show for it on the financial scoreboards. From yield chasing to revival of leverage to ambitious IPO valuations (more under article quotes), defending solid fundamentals in a genuine manner remains questionable. Yet, the reward is not in the warning of gloomy outcomes, as many have learned the hard way. The desperation for growth stories leads to irrational behaviors and some are taking place. Amazingly, a rude awakening is how markets typically react when previously feared and ignored items take center stage. Thus, that epic moment naturally takes its own pace, but decision makers have a choice in managing expectations.



Article Quotes:

“The sudden reversal in bond markets in the middle of April, coming immediately after the financial markets were said by some commentators to be “running out of bonds to buy” has been one of the sharpest sell-offs seen in fixed income since 2008. It is a salutary reminder of the much bigger shock that might occur when the central banks finally abandon their zero interest rate policies, though this still does not seem imminent. What explains the recent “bund tantrum”? Its causes can be traced back to the summer of 2014, when oil prices suddenly collapsed. With headline inflation rates plummeting, fears of “bad deflation” spread like wildfire, especially in the eurozone. Eventually, the ECB adopted a major regime change, culminating in the announcement of a €1tn programme of sovereign bond purchases on 22 January.The initial response of financial markets to these events seemed well justified. Led by the eurozone, government bond yields trended sharply downwards, and the euro and dollar exchange rates adjusted appropriately. By the end of January, markets had adjusted to ECB quantitative easing very much in line with the playbook established in previous QE episodes in the US, UK and Japan.”(Financial Times, May 10, 2015)


“HUNTING unicorns used to involve entrapment by a virgin. Now it requires merely the writing of large cheques. Hardly a week passes without a promising tech startup earning a valuation of more than $1 billion from venture capitalists, so becoming a “unicorn” in tech parlance. There are now more than 100 such firms. But doubts about such valuations are growing, even in Silicon Valley. It is easy to see why promising startups (and their backers) want to become a member of the unicorn club. It helps entrepreneurs gain credibility—their greatest hurdle—with future investors, business partners and, most importantly, their most talented staff. Even mid-ability app developers have lots of choice in the job market today. Research shows that they are more likely to opt for, or stay at, a firm that is worth more than $1 billion. And unicorn investors, often big hedge funds, help startups postpone their initial public offering (IPOs) and avoid demands from public investors for instant profits. Yet high valuations come at a price, says Fenwick & West, a law firm. It has analysed 37 unicorn deals and found that all included terms to protect investors against losing money—in particular, putting them first in line to get their money back if the company is sold. Such “liquidation preferences” are not nefarious, nor new. But they mean that unicorn valuations are not directly comparable to public-company valuations.” (The Economist, May 13, 2015)


Key Levels: (Prices as of Close: May 15, 2015)

S&P 500 Index [2122.73] – The index is only a few points removed from previous intra-day highs of 2125.92. Again, this is another confirmation of established strength, but the new upside wave is not fully defined.

Crude (Spot) [$59.39] – Recent weeks has showcased some mild recovery. Questions remain if the commodity can rise above $60.

Gold [$1,225.00] – After bottoming around $1,160, another recovery attempt for gold awaits. The next key hurdle for bulls is for gold to break above $1,280, which has remained difficult.

DXY – US Dollar Index [93.13] – March and April signified a slowdown on the powerful dollar's momentum. After peaking on March 13th at 100, the dollar index has retraced over 7%. It's too early to draw conclusions on the Dollar and overall currency implications.

US 10 Year Treasury Yields [2.14%] – As witnessed earlier this year, 10 year yields held above 1.80%. However, there was plenty of skepticism until the notable upside move. Interestingly, for another week yields remain above 2%.




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