Market Outlook | August 31, 2015

“If every day is an awakening, you will never grow old. You will just keep growing.” (Gail Sheehy)


Summary

• Turbulent action with massive down days are followed by major recoveries.

• The Fed is posturing, yet again sending as many mixed messages regarding rate hikes and the health of the economy.

• The looming fear and uncertainty combusted as volatility surged, but suspense still remains.

• A rush to safety into quality assets is to be expected as confidence restoration is a priority for policymakers.

• The inter-connected and worrisome actions in commodities and Emerging Markets have not quieted down.


Pronounced Moves

Last Monday (August 24th), massive sell-off marked new lows for Crude and other commodities. It also marked new lows for broad equity indexes and US Treasury Yields. A collective and quick shock that’s been in the making. Concerns and worries were felt in a tangible manner as reflective of the state of economic health. A strong and historic sell-off in US stocks occurred during the first hour of trading. but quick recovery took place to lessen some of the blow. Amazingly there was a shift from all-out “panic selling” to “panic buying.” This swing and sharp response mostly defined the trading pattern of last week.

Taking a step or two back, it is fair to say the current wave of uncertainty lingers, regardless of rallies. Narrowed losses and retracement of the VIX (Volatility index) signaled restoration of calm. Yet, the calm is still fragile heading into this week. Amazingly, the markets' multi-year status-quo of low volatility and smooth sailing are now officially rattled. After zigzagging through massive moves in the last two weeks, the stock market finds itself confused in neutrality. Interestingly, before the recent storm, neutrality defined the US equity markets. In other words, buyers and sellers lacked momentum as indexes remained in a sideways pattern. At the same time, the word collapse summarized the behaviors in Emerging markets and commodities. Through all this series of events (China and Crude collapse, etc), it should not be forgotten that the slowing global growth is the ultimate catalyst to this financial turmoil.

Mega rallies after interventions are not uncommon. It was seen in 2008, including the famous short-selling ban to stop the bleeding. Similarly, last week the New York stock exchange took some measures to ease the selling pressure:

“The New York Stock Exchange invoked the little-used Rule 48 to pre-empt panic trading at the stock market open for the third day in a row on Wednesday… The goal of Rule 48 is to ensure orderly trading amid financial market turbulence. It's only used in the event that extremely high market volatility is likely to have a floor-wide impact on the ability of designated market makers (DMMs) to disseminate price indications before the bell.’” (CNBC, August 26, 2015)

Between interventions and rapid policies, the real market level is hard to determine. How these recent reactions cause further damage is unknown.

The Messaging Crisis

From regulators to central banks (primarily concerning the Fed), there is ferocious concern about participants' response. Exchanges made adjustments with trading, China tinkered with various policies including devaluing currency, and Central banks adjusted their language meticulously to palpate the obvious angst. Basically, the art of public relation is a critical aspect of managing investors' expectations and reactions. Clearly, the Fed’s PR efforts have been more noticeable than actual visible signs of growth in real economies. Although inflation has been low, central banks are trying to make the case that inflation is or will increase. Frankly, this is just a battle of words to justify a rate hike, but participants have been fooled by the Fed’s slick words too many times.

At this point, the Federal Reserve is admitting they are limited in their powers. The idolization of the Fed by the financial community has been out of hand, and a reality check awaits. Plus, justification for a rate hike has seemed baseless for a while since the world economy is so slow:

“'The bottom line: we [ The Fed] have been assessing domestic and international financial markets closely in terms of their implications for the U.S. economic outlook and we will continue to do so. From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago,' Dudley [New York Fed President William Dudley] said.” (MarketWatch, Inc August 26, 2015)

This illustrates that the Fed is not keeping their promises yet again, despite not ignoring the anemic global growth. Thus, a lose-lose situation awaits Yellen & Co as fear resurfaces seven years after the epic 2008 crisis and four years after the Eurozone panic. Fuzziness best describes the Fed’s conviction.

Periods of turmoil may be profitable for some media related sources, but remain viciously suspenseful for actual risk managers. Nothing entertaining about daily surprises after such a sober sideways market. Suppressing volatility and intervening with a desperate stimulus policy may trick or please the “hopeful,” but there is enough unease for buyers and sellers at this powerful inflection point.

Digesting the Shocks

There is eagerness and anxiousness by investors. Eagerness to exploit opportunities as any sell-off is viewed as an opportunity—particularly those in good companies or innovative related themes. After all, the market is rewarding non-resource based or companies with limited exposure to Emerging Markets. Therefore the eagerness for bargain hunting by fund managers is to be expected. On the other hand, there is anxiousness, especially after a well established multi-year bull market. Before China, the worries were related to interest rates; before that, concerns mounted about inflation; and before that, the impact of the dollar strength was greatly feared. In short, macro indicators are unsettled and the shock has yet to settle, as well. The magnitude of eagerness to buy and anxiousness to sell is very high, thus turbulence is to be expected. Unlike the smooth-sailing bull market, the current environment is suspenseful hour-to-hour and day-to-day. Yet, denying the very weak global growth is not an option for regulators, companies, investors, or casual observes.

Article Quotes:

“Many other EMs will feel the squeeze when US rates rise. Turkey and South Africa, as well as Brazil, have high foreign capital funding requirements, which will become increasingly expensive. This illustrates the dilemma facing the Fed: if it raises rates as planned, it risks exacerbating an already volatile situation for EMs and beyond. However, while postponement of a rate hike might give some short-term relief, markets could interpret it as a sign things are going wrong with the global economy, states Deutsche Bank in a fixed income research note. This might create panic in its own right, and in times of panic EMs have traditionally been among the first casualties, as investors abandon their careful credit analysis in favour of a ‘sell now, ask questions later’ strategy… If investors are in the mood to be selective, Deutsche argues: ‘Emerging markets facing domestic political problems and/or with high US dollar-denominated debt burdens may be most at risk.’ That would put Russia, another country heavily reliant on commodity exports that suffers from considerable political risk as its economy continues to be strangled by sanctions, squarely in the firing line. Thailand’s political situation will also deter investors in a risk-off environment, as will Brazil’s. The taper tantrum of 2013 will be fresh in the mind for all EM investors. It showed how dramatic the market’s response to Fed diktats can be, and, arguably, how addicted they have become to low US rates.” (Euromoney, August 27, 2015)


“The difference between core and peripheral euro zone countries' exposure to China is clear from trade flows. Around 8 percent of Germany's exports go to China and about 5 percent of both France and Finland's, according to Marc Chandler, head of global currency strategy at Brown Brothers Harriman in New York. Compare that with the periphery: 3 percent of Italy's overseas sales go to China, around 2.5 percent of Spain and Ireland's, and only 2 percent of Portugal's. Of the top 37 European companies' exposed to China in a list drawn up by UBS, only 16 are from the euro zone. Of those, 15 are from core countries Germany, France, Finland and The Netherlands.” (Reuters, August 3, 2015)


Key Levels: (Prices as of Close: August 28, 2015)

S&P 500 Index [1988.87] – An 11% drop from August 10th highs to August 24th lows has occurred. Although the index is off the lows, it is still on shaky grounds since the bottom is not fully convincing.

Crude (Spot) [$45.22] – After hitting new lows last Monday at $37.75, the commodity got back over $45. A desperate bottom awaits even though the supply-demand imbalance continues to suggest weakness.

Gold [$1,135.00] – New lows were briefly established at $1,080.80 in July. That stands out since most commodities saw their lows last week. Staying below $1,200 further confirms the cyclical lows, but a bottoming process has been forming for a while.

DXY – US Dollar Index [96.10] – After pausing in recent weeks, the last few trading days showcased strength in the Dollar. Above 90 is well-defined and reaching above 100 is the next challenge.

US 10 Year Treasury Yields [2.18%] – Attempting to climb back toward 2.20%, which is a familiar range. This is based on historical measure, which are closer to the lows.




Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.