Market Outlook | November 23, 2015

“There are two ways to live: you can live as if nothing is a miracle; you can live as if everything is a miracle.” (Albert Einstein 1879-1955)

Summary

‎Last week, another run-up in equity markets painted a rosy picture for headline writers. All out attention on the Fed remains the focus to capture audiences, even though various realities and mixed signals resurface about the health of the economy. The status-quo is as firm as it has been for years: lower yields, higher stocks, and gloomier periods for commodity prices. A shock or a stunning eruption in volatility is not overly feared, as the suspense continues into year-end. The Fed's view of the world versus reality will be discovered soon, and any misalignment can be the watershed moment for risk-takers. To start, one must accept the two ways that the world is viewed from economic and financial markets.

Different Worlds

There are two worlds unfolding and that’s been the case for a long while. First, there is the investment world, where investors are looking for opportunities or safety or simply mild adventure to create/preserve wealth. The spirit of growth seekers is to exploit upside potentials or wisely asses relatively appealing investment ideas. After all, this concept is rather simple and straight foreword once fully understood.

Exploiting upside potential, in these days, has dealt a lot with innovation from technology to healthcare, which the Nasdaq demonstrates in the recent successes of several companies. The human ability to invent efficient technology or cure related solutions is still valued greatly by markets; particularly if one wants to test their fortune since risk is never inevitable. But more and more, investors are analyzing the relative appeal of the cards that we're all dealt rather than speculating recklessly. That's the consensus thought process driving the market action.

In other words, in this global landscape investors act and react based on what payoffs will appear in the near-term without taking massive risk-reward?

Is it seeking safety in developed market assets that are yielding closer to zero? Is the answer piling additional capital to an already well established stock market? Is it doubling down exposure in US dollars, given ECB policy, favoring the weaker Euro? Is it appropriate to avoid EM for now and to exploit a recovery later when the climate is less murky? On and on it goes as investment options seem so much less than what's offered by financial experts of all kinds. But, growth seekers must be having more difficult times than those seeking relatively appealing ideas. In a way, it is the lack of growth ideas (outside of few pockets) that are building up the well established "developed" market assets. These behaviors are surely influenced by Central bankers who create the perception, which leads to reactions by investors. ‎Yet, the Fed obsession alone doesn't produce answers. Rather it forms a collective narrative that's simplified for public consumption.
The second world, is the more practical world of government, policies, day to day realities, real economies, and, of course, foreign policy woven into politics, as usual. Sure, US elections are looming, the Middle East is crumbling, and cold war-like symptoms are revisited. ‎So, what's the implication of these issues on markets? A question that's so often asked, but who can answer with clarity after all? At some point, policies do impact corporate profits. Confidence in leadership can translate to some impact on investor sentiment. Sooner or later, the real world and the real economy can't be disregarded by the investment world.

Lack of good policies can impact the next 5-10 years and that lack will essentially be felt at some point or another. In this non-investment world where business operators have to gut it for a profit, the results are not as glorious as the "all-time highs" market. Not to mention, regulatory pressures and costs on business add some hurdles. In addition, enhanced competition from all sides have added challenges, unlike in prior decades. Perhaps, this divergence (two worlds) is mind-boggling for some, puzzling for others, and disregarded even. However, this disconnect can't be a healthy or truthful description. An illusionary prescription by policymakers creates rude surprises later, and the hints typically play-out in financial markets before a mainstream uproar.

Tangible Concepts

Where is this disconnect reflected? First, there is mixed economic data that has the Fed dancing and posturing about rate hikes. Secondly, low rate policies have failed to stimulate sustainable economic growth in developed markets. Debatable as it may be, there are unsolved matters in reviving global growth. Thirdly, the demise of commodities has hurt various economies and businesses as much as it has helped spur consumer growth. All those points considered, the glorious S‎&P 500 index fails to tell the whole story. The puzzle is not for the Fed to solve, but that burden falls on the risk-takers, who chose to speculate on these grand shifts and ideas.


Article Quotes

“To move away from their dependence on oil, then, Arab societies need to develop a new political settlement that forces elites to cede ground to the private sector. That, however, raises a difficult question: if a closed, resource-dependent economy benefits elites, what could possibly persuade those elites to allow for diversification? The answer likely lies in policies that compensate elites for the losses they suffer from a leveling of the economic field. China provides an illustrative example of this process: by incorporating business leaders into the Communist Party structure, Beijing managed to align economic reform with the interests of political elites. Or consider the case of Ethiopia, now among the world’s ten fastest-growing economies, which has set up party-owned enterprises supported by specialized endowments to promote investment in underdeveloped regions. Such models of party capitalism raise tough questions about market competition. But they nonetheless demonstrate that elites tend to favor an expansion of the economic pie when they stand as its lead beneficiaries. Low oil prices offer Gulf states an opportunity for similarly creative institutional reform. Many states in the region have looked to the financial sector as a principal avenue for diversification; so far, however, they have hesitated to implement the legal and regulatory policies that would put that sector onto a sound footing, and regional secondary markets for debt remain underdeveloped.” (Council on Foreign Relations, November 5, 2015)

“U.S. companies are for the first time the biggest borrowers of euro-denominated corporate bonds, issuing a record 87.7 billion euros ($93.49 billion) of debt, according to data compiled by Bloomberg. Companies from Apple Inc. to McDonald’s Corp. have made up a fifth of total new issuance in the market, more than any European country and up from just 1.5 percent five years ago. Draghi’s easy-money policies are making it cheaper than ever for corporate America to cross the Atlantic to issue debt. That’s because the European Central Bank is pledging to boost stimulus just as Federal Reserve policy makers are prepared to raise interest rates for the first time in a decade. The difference between borrowing costs in the U.S. and Europe has widened to the most ever, and few see the gap closing anytime soon.” (Bloomberg, November 18, 2015)

Key Levels: (Prices as of Close: November 20, 2015)

S&P 500 Index [2,089.17] – Approaches annual highs of 2,116.48 (November 3, 2015). The run since mid-October remains strong, suggesting a bullish bias. However, surpassing 2,100 has proven to be difficult several times in the past.

Crude (Spot) [$41.90] – Failed to hold above $45 and $50 after multiple tests. Again, weakness is confirmed as a multi-year demise in Crude prices becomes clearly visible.

Gold [$1,081.50] – Over the last five weeks, a near $100 drop reaffirms the known cyclical downturn. Clearly, Gold trades more like a commodity than a currency. A long awaited bottoming remains unclear at present. Many thought $1,200, but now even $1,100 is not a clear bottom.

DXY – US Dollar Index [99.56] – Since May 2011, the dollar strength has been a stunning and clear-cut macro trend. Its strength is in-tact. March 2015 highs of 100 are not far removed. With Europe applying more QE and Emerging Market's weakness unfolding, the dollar remains strong.

US 10 Year Treasury Yields [2.26%] – Not much has changed week by week. Despite all rate hike chatters, there has been no major shift. We’ve been in a range between 2.0-2.5% for an extended period.


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