Market Outlook | July 20, 2015

“The greatest intelligence is precisely the one that suffers most from its own limitations.” (Andre Gide 1869-1951)

Summary
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With weakness in commodities, worries in Emerging markets, and ongoing fuzziness in Europe the US markets have regained upside momentum. Particularly, this is evident by the strength of the US dollar during the last three months, as other currencies seem riskier. Interestingly, shareholders of innovation driven themes, such as technology, continue to benefit, and resource based themes are struggling and out of favor. The ongoing stock market rally highlights the overwhelming participants' responses to larger tech driven companies. However, the real economy and smaller companies are struggling to fathom how a near all-time high stock market reflects the sluggish day-to-day economic activities. This conundrum is now a nightmare for the Federal Reserve, which has to create some hype/sense to explain the lack of convincing substance for interest rate polices.

Innovation Desired

There is strong momentum for select large cap technology, as exhibited by Google shares last week. Unlike, commodities (e.g. Crude) affected by the supply-demand imbalance or emerging markets that are cooling and failing to generate growth stories, the US tech giants are in a world of their own. The Nasdaq, a symbol of Technology and Biotech, is roaring again in an explosive manner. An over 6% jump for the Nasdaq index since July 8th tells the story of a further buying or reaffirmation of an ongoing trend. However, the mega-tech companies with a dominate market share do not insinuate the well-being of US or global economies. That’s the tricky part in making an investment versus analyzing the well-being of a broader economy. In the near-term, investors are chasing returns, while being comfortable with the recent trends for US equities. After all, the well defined status-quo is in place as the feeling of “risk” seems to evaporate. At least, that’s the feeling in developed markets, where volatility is contained and bond yields are not quite spiking.

The positive movement in innovation stocks summarizes the story of our current times. Obsolete business models have either lost out due to this globalized world or simply cannot compete due to more efficient-based technologies entering the scene. That applies across wide sectors from retail to financial services, and the impact is being felt. Surely, this is obvious in all facets of life and investing is no different. In fact, the labor markets are slumping due to vast shifts in industries, and newer companies are more efficient or technical. In short, the labor market needs to adjust. Value managers must be having a hard time finding old school companies with growth potentials, especially those that are mid- to smaller sized. Massive changes in the marketplace continue and newer business models are desperately needed.

Deciphering Messages

As US stocks rally along with the Dollar, the international community still grapples with developments in Greece, China, and Iran. Greece reflects a political crisis in the Eurozone, which is akin to an ongoing public divorce. Yet, when all said and done, the Greek exit chatter is way too premature (at least for now) and the Eurozone goes on (despite murmurs). China is a debate about bubble-like patterns versus unconvincing GDP numbers published by the government. And the Iran deal raises not only discussion about crude supply but the changing (moral) values of Western leadership in years ahead. In fact, if troubled by all three uncertain events then a rotation to the US dollar surely makes sense, and that’s what the markets have showcased.

In addition, Brazil and Russia are on shakier ground than imagined during a period when investors have piled tons of capital into BRICS. Both remind us of a not-so-robust global growth. The struggles in Brazil continue and are quite visible in the data again and again:


“Another day, another disastrous data point from Brazil. The national statistics office revealed on Tuesday that retail sales fell a seasonally adjusted 0.9 per cent in May from April and by (an unadjusted) 4.5 per cent year on year… The broad retail index — which captures these items as well as construction materials, another beneficiary of the boom years — reflects the extent to which Brazilians have pulled in their spending. It was down 10.4 per cent year on year in May.” (Financial Times, July 15, 2015)

The same can be said about China, where the slow global growth is being felt:

“The world's largest auto market saw auto sales tumble 2.3 percent in June year-over-year, according to China's Association of Automobile Manufacturers. It's the first year-over-year decline in monthly auto sales in more than two years.” (CNBC, July 19, 2015)


The Rate Saga

Corporate earnings, labor market health, and business growth are all essential for determining the status of the real economy. Surely, the FOMC meetings, in their intellectual and gentle approach, dissect this matter. Yet, beyond the endless articles and casual chatters regarding rate hikes, justifying an interest rate increase has been difficult to muster. Surely, the US political climate plays a role in rate hike factors, as well— especially heading into an election year. Yet, the standstill in the no-interest decision has helped the status-quo prevail higher asset prices without panic-like bursts. The narrative goes on, Congress, along with market participants, exhibited skepticism, but the market has not been shaken dramatically. It has come down to this: Does the market trust the Fed or do participants realize the Fed is in a lose-lose situation? This question has been deferred for too long:

“Federal Reserve Chair Janet Yellen told lawmakers that waiting too long to raise interest rates holds risks for the U.S. economy, along with tightening too quickly. ‘There are risks on both sides,’ she [Janet Yellen] told the Senate Banking Committee on Thursday in her second day of congressional testimony.” (Bloomberg, July 16, 2015)

It is fair to say that the Fed somewhat acknowledges the lose-lose situation it faces at this junction. At some point, the markets may get tired of the status-quo and these words might actually have some value. By then, managing risk maybe more difficult than desired.


Article Quotes:

“But while questions remain over how much more oil Iran will be able to export, and by when they’ll be able to do it, OPEC still has to start preparing for another one of its members to increase production in a bear market, as Reuters reports. The cartel is hoping that demand, which has been tepid this last year on weak growth in Asia and Europe, will tick upwards again and help to absorb new Iranian supplies. Time will tell if that bet pays off. While historically OPEC has cut production in times of oversupply as a way to keep prices high, this time around it’s chosen to sit tight and try to squeeze out non-OPEC producers for market share. But shale’s resilience is throwing a wrench in that plan, and a flood of new Iranian crude looms ominously on the horizon. Saudi Arabia is the only realistic candidate capable of cutting production to make room for Iran, but it’s hard to imagine Riyadh willingly doing that for its regional rival. What we’re left with are some strong long-term forces acting to keep the global oil supply booming, likely ensuring cheap prices for the foreseeable future. For producers like OPEC’s petrostates or American fracking firms, that could be a big problem. For everyone else, well, it’s a buyer’s market.” (The American Interest, July 15, 2015)

“According to Nassim Nicholas Taleb and Gregory F. Treverton, appearances can be deceiving, especially when it comes to the stability of a nation. In their essay in Foreign Affairs, ‘The Calm Before the Storm,’ Taleb and Treverton argue that what you see is not what you get when it comes to the apparent ‘stability’ of the political system of a given country. They argue that countries with relatively decentralized governments and a wide variety of political expression such as Italy or the U.S. are actually quite strong politically despite the perception of conflict and lack of national cohesion. The corollary to this is that a strong central government and the lack of political diversity you see in countries such as Saudi Arabia, North Korea, Venezuela and China actually makes these countries more fragile… They start by asserting that China’s more than a decade run of strong economic growth makes it difficult to assess the future of the country. China has recovered surprisingly well from the huge shocks of the Maoist period over the last 35 plus years. That is, however, a long time ago and therefore less likely to protect the country against future shocks. On the negative side of the slate they highlight that China’s political system is among the most centralized in the world, its economy is somewhat diverse, depends on exports to the West, and its government has been taking on hundreds of billions in debt lately, leaving it more vulnerable to slowdowns in both domestic and foreign growth.” (Valuewalk, July 19, 2015)



Key Levels: (Prices as of Close: July 17, 2015)

S&P 500 Index [2126.64] – In the last 90 days, the index has traded in a range between 2060 and 2120. After peaking in May (2134.72) and June (2129.87), the index is close again to revisiting and testing prior highs.

Crude (Spot) [$50.89] – Crude failed to hold above $60. The deceleration of a long-term cyclical decline continues. Weaker demand and expanding supply explain the dramatic fall over the last 12 months. There are no signs of stability around $50, yet.

Gold [$1,132.80] – For a long while the signs of calmness appeared around $1,180-1,200. Recent selling pressure confirms the commodity cycle slowdown. A break below $1,150 signals more weakness rather than a bottoming process.

DXY – US Dollar Index [97.86] – Regaining strength after a pause in prior months and with the recent Emerging market and European worries, the Dollar remains a strong currency that’s heavily sought after.

US 10 Year Treasury Yields [2.34%] – The last 30 days showcase a very narrow range between 2.20-2.45%. Perhaps, the rate hike discussion is more confusing rather than convincing as yields remain in somewhat of a neutral range.






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