Market Outlook | August 17, 2015

“When in doubt, don't.” (Benjamin Franklin 1706-1790)


Summary
‎
• Sideways US stock markets reiterate the fading catalysts for upside moves. The standstill remains as anxiousness builds.

• Interest rate hike chatters resurface, but real economic data is far from justifying real strength from US to Eurozone.

• Actions taken in China further illustrate depth of the global growth crisis and bursting of the Chinese bubble.

• Commodities, currencies, and emerging markets are in terrible shape, reflecting the massive shocks that’s ongoing in the financial system.


Doubt Looming

As more investors buy protection (insurance) in anticipation of enhanced risk, the US key indexes remain in a sideways trend. We're not in a period of blind optimism nor are we in all-out crisis mode, either. What does that lead to? Certainly, a dull trading pattern that lacks any clear direction. At least that’s the overwhelming message from broad based US indexes such as Nasdaq and S&P 500 index, especially last week. It is fair to say that confusion is quite clear in the trading pattern.

So far 2015 has witnessed neutral investor reaction. At the same time, there is a delayed realization of lack of growth in a period of tame volatility. Inflation, rates, and wages remain very low end and mere words from policymakers are not convincing. In the week ahead, FOMC will get some attention, but the soft growth is evident. Until there is an actual rate hike, the Fed’s words carry less weight and meaning, except to calm the nerves of the mostly confused participants.

The Fed rate hike discussion may not be the only top problem considering the ailing growth and need of long-term revival. The glorification of "data- dependent" chatter only makes a mockery of dismal global market conditions. For US market observers there are too many mixed messages. Even the Fed has sent various signals about possible rate hikes, raising doubts about the economy and doubts about Fed’s ability to generate real growth. Perhaps, the Fed would acknowledge that job creation is not in their “job description” and that managing bubbles is supposedly the Fed’s expertise. The bulls strongest point (before and now) is the lack of alternatives, which gives the US a relative edge. That’s been vital recently in which developed markets have held their ground versus emerging markets as the US remains the leader. However, in a global environment, multi-national companies cannot be insulted from multiple, ongoing shocks. Thus, beyond QE, buybacks, and relative strength, the US equity markets await multiple tests of conviction ahead.

Recognition

‎In recent years, the Chinese bubble was discussed—from overheating real estate to less credible GDP numbers to massive rush by retail investors in China. So many pundits warned even before the commodities demise, which of course confirmed the bubble bursting in Emerging Markets especially in China. Last week reflected the dire conditions of the Chinese markets where devaluation measures were a reaffirmation of a weak economy. No surprise here, considering all the interventions and stimulus efforts recently by Chinese lawmakers. Simply, the Chinese central bank is responding to what Financial markets loudly illustrated by the vicious commodities sell-offs and softer economic conditions. Collectively, we knew this last year from the slowdown in global economies from Turkey to Brazil. It was clear that Emerging Market currencies were already in deep trouble at the start of the year. Some called the Yuan devaluation as another chapter of the currency wars. Others see it as a desperate move, but when all said and done there is fragility in the system:

“Over the past several years, borrowers in emerging markets have built up more than $2 trillion in dollar-denominated debt. When the U.S. currency was cheap and the Federal Reserve was holding interest rates close to zero, that debt seemed like a great deal.” (Bloomberg, August 16, 2015)

Coping & Preparing

Some attempts to link Chinese currency actions with possible Fed's rate hike might be misleading or incorrectly interpreted. The answer remains to be discovered, but there is one clear issue – massive uncertainty. The confirmation of desperate economic conditions and slowing emerging markets lead to a vulnerable climate for leaders. This fully impacts foreign policies and domestic attitudes towards businesses which end up influencing polices. The mostly pro-business mindset of prior decades is being questioned now after the persistence of weakness in real economies. As witnessed in the financial crisis in 2008, there is an overreaction on the regulation side that can have further consequences. For market observers these big picture concerns may not be felt in the day-to-day, but surely a shift in sentiment is impactful. Ultimately, the low rate, higher stocks story is unsustainable (even in US) and seems more illusionary than the burning reality. The true economic health conditions need to be flushed out sooner rather than later, and already some truths are boldly revealed in the market.

Article Quotes:

“Disappointing eurozone numbers released on Friday demonstrate the fragility of the region’s recovery despite a cocktail of cheap oil, a weaker euro and mass bond-buying by the European Central Bank. Gross domestic product in the eurozone increased 0.3 per cent, undershooting analysts’ estimates of 0.4 per cent, as France’s economy stagnated and Germany, Italy and the Netherlands grew less than expected. While the currency bloc remains on track for its best year since 2010, the latest figures, released by Eurostat, the commission’s statistics agency, underline how the eurozone is still struggling to recover from the economic crisis. Unemployment is still in double figures and data from Germany indicate that companies in the eurozone’s economic powerhouse remain reluctant to invest, regardless of record low interest rates. The region’s economy remains slightly smaller than in the second quarter of 2008, before the collapse of Lehman Brothers, the US investment bank.” (Financial Times, August 14, 2015)

“Brazilian equities wrapped up their second weekly decline, driving the Ibovespa benchmark closer to a bear market as Latin America’s biggest economy faces its worst recession in a quarter-century. Stocks also slumped amid concern the country will lose its investment-grade credit rating and as a corruption scandal that started at the state oil producer adds to instability. Nationwide protests are planned for Sunday as President Dilma Rousseff fights for her political survival, and a devaluation in China this week is weighing on prospects for exporters including the miner Vale SA. The Ibovespa slid for a fourth straight day, declining 1 percent to 47,508.41 at the close of trading in Sao Paulo. It extended its drop from its 2015 high on May 5 to 18 percent, with a decrease of 20 percent indicating a bear market. Forty-eight of the Ibovespa’s 66 stocks fell Friday as meat exporter JBS SA contributed the most to the decline in the benchmark equity index.” (Bloomberg, August 14, 2015)

Key Levels: (Prices as of Close: August 14, 2015)

S&P 500 Index [2091.54] – Trading within a familiar range between 2080-2120. This mostly tells the story of 2015 as one of neutral action.

Crude (Spot) [$42.50] – Further price deterioration driving oil prices to further lows. August lows of $41.35 are on the radar. Previous lows were in March at around $42. Fragile trading ranges appear at this stage.

Gold [$1,118.25] – In prior months, gold failed to hold above $1,180 on several occasions. Too premature to call a bottom as the risk-reward may attack some speculators at this range.

DXY – US Dollar Index [96.52] – Slight pause. Again, reaching above 100 has been a struggle. Last time the Dollar index stayed above 100 for a sustainable period was in the 2000-2002 period.

US 10 Year Treasury Yields [2.19%] – The summer showcased yields with ability to remain above 2.50%. The 200 day moving average of 2.14% may serve as some near-term barometer. Mainly it has been dancing between 2.20%-2.40% in recent weeks.

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