Market Outlook | December 14, 2015

"All enterprises that are entered into with indiscreet zeal may be pursued with great vigor at first, but are sure to collapse in the end." (Tacitus)

Inter-Connected Demise

Finally, there is mainstream realization that the commodities slow-down is highly tied to slowing emerging markets, including China. Also, impossible to dismiss, that the slow global demand only portrays one-side of the equation. So, the BRICS and commodities are in absolute turmoil - nothing new for avid and close market observers. Instead, this is an ongoing commodity down-cycle that has played out for few years, but new lows do spark further attention and boldly reawaken volatility.

However, there is another element to this madness. The very highly regarded Fed decision on interest rates mixed with the powers of central banks, which have dominated countless hours in the financial media, will resurface again this week. Suspenseful decision has obsessed waiting observers and now the chess-game just got more adventurous. More and more, the Fed is running out of excuses and the truth is being quickly revealed in financial markets already. From Brazil to Turkey to Russia, finding upbeat data points seems nearly impossible even for the most optimistic. In fact, risk is mounting in riskier assets (and riskier nations):

"The yield on South Africa's 10-year government bond has rocketed 65 basis points (0.65 percentage points) today to a seven-year high of 9.46 per cent. The yield hasn't been that high since the peak of the financial crisis in 2008, writes Joel Lewin." (Financial Times, December 10, 2015)

In the background, burning EM, complete collapse of commodity prices, and a credit market crisis are all brewing. The Fed lacks the basis to support a rate hike, beyond the clearly relative advantage of the US versus other nations. But on an absolute basis, the labor or business growth numbers are not overly impressive. Not to mention, inflation is much lower than expected. It is simply difficult to claim the real economy is growing-A point that's been mentioned, since Quantitative Easing has failed to revive small businesses and profit margins. The macro picture is looking bleaker and bleaker even as the Fed attempts to convince the audience that there is legitimate job creation and decent growth. The idolized central banks are running out of ideas and the truth is uglier than expected for global markets. Although, the "truth" has many false interpretations, for the first time in a while perception and reality might be singing the same exact tune. If that's the case, then danger is confronted and perception is re-set.

The Overdue Awakening

Emphatically, those that doubted the global growth are getting an alarming reminder of global slowdown. Massive sell-offs in energy related areas are just a single chapter in the big commodity breakdown. But the commodity breakdown is not an isolated matter, it is a reflection of soft demand globally mixed with the "endless" glut of supply. The soft demand is highly concentrated from the absolute weakness in EM's highlighted by China. If this is a difficult year for hedge funds and various money managers. If one goes back to the summer sell-off in August, that period stirred the status-quo and panic like wave served as a gut check.

Now the junk bond demise is in-line within this context of slow growth and low interest rate environments, leading to irrational yield chasing by investment managers. Over the last few years, those desperate to find returns went out and took on additional risk in obscure areas. Reckless or not, the risk of a Central bank led low rate environment was the risk of yield chasing. Many over-reached into less known areas and the fallout is being discovered now. Each investor must take responsibility of course, but it would be naive to dismiss the Fed's role in this behavior.

Symptoms of Crisis

From all angles, it feels like 2008 all over again. Crude prices hitting lows since the last crisis, funds blowing up, and major downside market movements all seem too familiar. Synchronized sinking across various sectors is the real feeling of a crisis. Commodities, Credit, and China are causing feeling so sour that nationalism is being geared to be a popular distraction to ongoing economic woes. The conflict between Russia and Turkey illustrates two countries that were clobbered in economic terms, and both are sensing they have less to lose. The same cannot be said about the US, which is appealing to those looking to preserve wealth. Though further shift to "safer assets" is not a new trend, a near-term rush into safer assets is to be expected. At the same time, the outflow of capital from riskier assets should accelerate.

Article Quotes

"At the 6th Forum on China-Africa Cooperation last Friday in Johannesburg, a new relationship between the world's second-largest economy and its fastest rising continent was on display. The forum is the main platform for official high-level political and economic dialogue between Africa and China, held once every three years. China made headlines at the event by announcing a $60 billion package of loans, aid, investment, and other financial support to Africa. Yet for all the fanfare, the relationship between China and Africa is under strain. That is why Beijing must now rethink its engagement with the continent, focusing less on the size and number of commitments it offers and more on sustainability, with an approach that goes beyond government-to-government initiatives." (Foreing Affairs, December 7, 2015)

"The sharp drop in currencies in Brazil and Russia appears set to claim an unlikely victim: appliance sales. Market researcher Euromonitor expects this year's consumer appliance sales globally will grow only around 2 percent in retail volume terms, largely driven by sharp slumps in Brazil and Russia. That's down from 3.8 percent growth in 2014 and would mark the lowest level since 2009, during the Global Financial Crisis. Major appliance sales in Russia and Brazil are expected to drop 28 percent and 6 percent respectively this year, Euromonitor said. Those two countries have seen their currencies drop sharply over the past year, hurt by declining prices for their commodity exports and fund outflows from most emerging markets amid expectations the U.S. Federal Reserve will soon hike interest rates for the first time in nine years. Russia has also been hit by international sanctions over its annexation of Crimea in March 2014 and its role in the pro-Russian uprising in Ukraine. The dollar has gained 18 percent against the ruble and soared 43.4 percent against the real so far this year." (CNBC, December 11, 2015)



Key Levels: (Prices as of Close: December 11, 2015)

S&P 500 Index [2,012.37] - Numerous occasions in 2015 confirmed heavy selling pressure around 2,100. This was felt again as the index topped at 2,104 (on December 2nd). Clearly, this is a meaningful range where buyers' momentum dries up.

Crude (Spot) [$41.71] - Unlike the spring rally from $44 to $62 and unlike the summer stabilization around $44, the selling pressure is now gushing. Buyers are not viewing mid $40's price level as a bottoming process, as the fallout has reached a new low.

Gold [$1,081.50] - Bottom-pickers have seen Gold prices fail to bottom on numerous occasions. First, in 2011-2013, many felt $1,600 was a possible bottom. It wasn't as selling mounted. Recently, $1,200 had magical appeal based on charts and trends, yet again new lows shattered.

DXY - US Dollar Index [100.51] - As a dominant theme, the dollar remains very strong and comfortable at its current level. Since last December, the demise of other currencies has boosted the Dollar's relative edge. Outside of major macro events, this trend does not seem easily shakable.

US 10 Year Treasury Yields [2.12%] - The mighty anticipation of interest rate policy does not alter the well know behavior in yields. Recently, hovering around 2.20% is a familiar sight. June highs of 2.49% seem rather far away, but not as far as the annual lows of 1.63%. A wide range of actions (i.e surprises) need to develop to break out of the current range.


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