Market Outlook | July 27, 2015

“Tricks and treachery are merely proofs of lack of skill.” (François de la Rochefoucauld 1613-1680)

Summary
‎
• Mounting evidence of a rate hike is not justified given soft current economic conditions and lower commodity prices.

• No major, convincing reason gives cause to abandon US assets or US dollar relative to Emerging markets, which continue to struggle.

• Policymakers in US, Eurozone, and China have over-relied on the art of intervention and deferral of problems.

• US Investors are realizing that poor earnings cannot be ignored any longer and share buyback trends are unsustainable.


The Inter-Connected Narrative

For those only tracking US equities in the last few years, the investment climate seems rather calm. Especially when a roaring bull market is quite established, even with a shaky geopolitical set-up elsewhere. If one steps away from the elevated Nasdaq index and from the depressed US stock volatility (VIX) measures another reality awaits. A reality that's not been addressed by a majority of investors who have been blinded or convinced by the Fed's assurance. However, the Fed, like investors, cannot dismiss the forces that impact economic well-being for too long.

First, no one can ignore the commodity price debacle that has ranged from Gold to Crude. Multi-year lows were reached for commodities last week and highlighted by financial journals. As a result of this, one can celebrate cheaper oil prices and buy airline or retail stocks—the common knee jerk reaction. However, declining commodities reflect not only an end of a commodity boom cycle but also signals a period of a significant global growth, especially in Emerging markets. Even in the US the energy boom is impacted from labor numbers to poor investments, and those seep through the real economy:



“There seem to be broader signs of concern about the global economy which the commodity price decline seems to reinforce. Composite purchasing managers' indices for the manufacturing sector in the emerging market countries have dipped slightly below 50, indicating a decline in output. Figures show that unemployment in emerging markets has risen from 5.2% to 5.7% since the start of the year. The IMF cut its global growth forecast for this year to 3.3% from 3.5%, largely on American first half weakness.” (The Economist, July 21, 2015)

Secondly, the China story has many twists and turns. The last decade rush into this theme is now back firing and being viewed as a "bubble" that's severely close to popping. Yes, the Chinese economy is large and China does invest globally from US to Africa, but ‎confidence is mixed. As learned in last few weeks, desperate government interventions are needed to stabilize the market. Perhaps, policymakers globally have come to terms with intervention as the last resort to fight off natural worries and sell-offs. Meanwhile, the bubble-like climate of retail investors naively piling on and state media controlling the messaging should be worrisome enough. At the end of the day, waning confidence raises more uncertainty in China. Eventually, this can lead to changes in the foreign policies alliance with Russia and trouble with Western supported neighbors like Japan. These developments should not be dismissed by economic observers, since crisis typically leads to radical shifts in policies.

Thirdly, western leadership, especially in the Eurozone, has made a questionable series of decisions ‎and the crafty deferral of problems remain part of the desperate strategy. The Greece saga only affirmed the weak position of all those in the European Union. Demonizing and humiliating the Greeks as the sole trouble maker of the continents is not only misleading, but shows the less-than-honorable leadership that's struggling severely. In fact, it's laughable (or sad) that the market rallied after the Greece saga this summer, which solved nothing but further exposed EZ problems. A cheerful bunch only realized the short-term market lift, but long-term planners are reassessing the further waves of concerns. Beyond deferring problems and markets reacting to instantly gratifying news, inter-woven issues are infesting the Eurozone economies.

Europe remains so desperate to find growth, and Asia is slowing down. Perhaps the Iran deal was that attempt to stimulate business opportunity for European companies in a new market. European leaders are desperate—lacking the class or a moral compass in figuring out the future and by not confronting past mistakes. Yet, developed market bond yields still remain low and fail to tell the real story, while the calmness keeps investors comforted and the low rate stimulus formula has proven to be a good enough distraction from crisis mode: “As the Greek debt crisis has calmed, the ECB's €1.1tn quantitative easing programme has resumed its steady hammering down of bond yields.” (Financial Times, July 24, 2015)

‎Finally, when coming back to US markets, the broad indexes (i.e S&P 500 and Nasdaq) cannot hide the real economy worries for long. Plus, corporate earnings weakness is slowly revealed, especially in this earnings season. Bond yields are not rising, rate hikes are not convincing, and poor/disappointed earnings continue to resurface. The strength of the US dollar is bound to impact earnings. Obviously, when the world is in turmoil the dollar is preferred, but the shift in currencies affect companies revenues. Now, the global concerns are becoming real to some observers. The few technology new school giants, such as Amazon and Google, ‎cannot carry the whole index or the economy, for that matter. No question, share buybacks and low interest rates have rewarded stocks. Over-reliance on both factors seems riskier than risk indicators project.



Article Quotes:

“Germany’s immense current-account surplus – the excess savings generated by suppressing wages to subsidize exports – has been both a cause of the eurozone crisis and an obstacle to resolving it. Before the crisis, it fueled German banks’ bad lending to southern Europe and Ireland. Now that Germany’s annual surplus – which has grown to €233 billion ($255 billion), approaching 8% of GDP– is no longer being recycled in southern Europe, the country’s depressed domestic demand is exporting deflation, deepening the eurozone’s debt woes. Germany’s external surplus clearly falls afoul of eurozone rules on dangerous imbalances. But, by leaning on the European Commission, Merkel’s government has obtained a free pass. This makes a mockery of its claim to champion the eurozone as a rules-based club. In fact, Germany breaks rules with impunity, changes them to suit its needs, or even invents them at will. Indeed, even as it pushes others to reform, Germany has ignored the Commission’s recommendations. As a condition of the new eurozone loan program, Germany is forcing Greece to raise its pension age – while it lowers its own. It is insisting that Greek shops open on Sundays, even though German ones do not. Corporatism, it seems, is to be stamped out elsewhere, but protected at home.” (Project Syndicate, July 23, 2015)


“The government has launched several plans to reform its exchanges, but these have been dwarfed by its efforts to stop the decline in stock prices. Apart from pouring state money into the market, it is also believed to have been behind announcements by China’s brokers association of a new target—4,500—for the Shanghai Stock Exchange Composite Index. (It peaked above 5,000 in mid-June before plunging to 3,500 in early July; it’s recovered to about 4,000.) Beijing halted initial public offerings, recruited state banks to funnel at least $200 billion to brokerages to help buy shares, and used official speeches and commentary to assure citizens the market will stabilize. According to a leaked document posted by China Digital Times, the government also instructed state media to reduce coverage of the market… Some analysts have noted that China’s slumping stock market hasn’t yet caused a significant slowdown in economic growth and that Beijing’s handling of equities might have minimal impact on the government’s management of China’s macroeconomics. But the response to the crisis sets a tone for the broader economy. Xi had promoted financial reforms, including changes in the equity market, as part of the overall agenda of economic liberalization. Market forces would be allowed to play a 'decisive' role in determining the direction of the economy, Chinese leaders announced in a major communiqué in November 2013, after a meeting of the party’s Central Committee.” (Bloomberg, July 23, 2014)

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

S&P 500 Index [2079.65] – On five occasions this year, the index failed to climb above 2120. The index has been defined by a sideways action recently, and there is a sense of uncertainty visible in the chart pattern.

Crude (Spot) [$48.14] – A dramatic and sharp sell-off since June 24, where at one point the commodity dropped from $61 to $47.72. Amazingly last July, Crude traded mostly above $100.

Gold [$1,080.80] – After failing to hold at $1,180 for a while, a building selling pressure materialized for gold, leading to a break below $1,100. Psychologically damaging, but this is continuation of a slowdown where the bottom remains unknown.

DXY – US Dollar Index [97.24] – Strength remains steady. Given the weakness in commodities and currencies of most emerging markets, no major influences have yet to alter the established dollar strength.

US 10 Year Treasury Yields [2.26%] – In the last two months, yields have struggled to climb above 2.45% on four occasions. This stalling raises further questions about bond markets confidence of a resurging US economy.






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