Market Outlook | December 21, 2015

“A smooth sea never made a skilled mariner.” (English Proverb)

Cosmetic vs. Pragmatic

The cosmetic world is the more verbose and intellectually misleading world, where the central banks make public statements for massive investment crowds. The practical world is where credit investments and commodity-linked companies go bankrupt and confidence is shattered. They did it, Yellen & Co raised interest rates, at last. The symbolic rate hike move, the actual event came after much hype, and went into the sunset as year-end approaches. Basically, through the crafty technique of gauging the market reactions and attempting to minimizing any surprises, the Fed accomplished its public relations and diplomatic efforts. Massive questions remain in the practical world as to what this means. To hike or not to hike is an endless debate that’s been going on for a while, but the true state of affairs is not necessarily overly rosy.

A negative year is more than possible with S&P 500 index down nearly 3% and the Dow Jones average losing almost 4% for 2015. Certainly, energy related shares are weighing down on broad US indexes, as stock markets feel the commodity cycle impact. The Nasdaq being up 5% this year showcases how innovative themes in Technology and Healthcare maintain an edge, which has been the case in recent years. The relative appeal is generally felt. Nonetheless, there are plenty of “innovative” themes that have struggled and this theme of “innovation” will be in question for years ahead.

Relative Appeal

Japan and Germany are having a “good” year when measuring the relative performances of their stock market indexes. Both nations, so far, are posting an 8% gain on their indexes (Nikkei and DAX). This displays some relative appeal versus the Emerging Markets, which have been crushed by weakness in commodities. Interestingly, Japan and Germany (along with other European nations) are still in low rate mode. Any theme that avoided exposure to commodity related economies, currencies or companies is getting rewarded. That’s the strong message from Nasdaq, Nikkei and DAX. Or there is another way of viewing it: There is a lack of alternatives in terms of investment, which make even mediocre ideas seem more appealing than usual.
Meanwhile, with Crude now closer to $30 rather than $50, an all-out collapse is playing out, as was hinted for several months and quarters. Nations tied to commodities are seeing accelerated pain from Brazil to Australia to China. The same applies to currencies tied to commodities, and this crisis mode has yet to settle:

“One must wonder how Crude in the $30’s range resets global business and consumer expectations. The stunning issue is if global demand will remain weak especially in emerging markets. Failure of economic revival can lead to more tensions from the Middle East to the Pacific. Therefore, pick up in EM demand is not only an economic issue, but a critical political matter that can shape behaviors ahead.” (Bloomberg, December 17, 2015)

Digestion Continues

The Fed’s actions begs so many questions. The first step was taken, but many unanswered questions remain ahead in an election year. We are entering a period of not only uncertainly, but also a period where the universal application of low interest rates is changing. Now, the Bank of England is next on the radar for pending rate hikes, while the ECB is maintaining low rates. The intense questions are about the real economy, though. The theatrics of the central banks are reaching a point of limitation. Some issues to ponder: How are corporate earnings? How is the job creation market? What is the attitude towards global growth? What about the tense foreign affairs from Syria to Western elections? There are too many questions and not many convincing resolutions for a revival in real economies. Yet, for directional risk takers numerous opportunities await from volatility to deeply under-valued investments. Anyone that thought the Fed answered or guided investors on the conditions of the global economy are gravely mistaken.

Article Quotes

“In a world of largely floating exchange rates, most central banks, particularly those in developed economies, can consider the decision calmly without any immediate need to move. Indeed, the central banks managing the world’s second- and third-most widely traded currencies, the European Central Bank and the Bank of Japan, may find the Fed’s rate rise helpful. Both, facing weak economies and dangerously low inflation, have engaged on programmes of quantitative easing. A widening of interest rate differentials with the US, increasing the chance of further currency depreciation, is likely at the margin to make their task easier. True, the eurozone and Japanese economies are not particularly open to trade, and hence the exchange rate is one of the lesser channels for monetary policy. But nonetheless, with the leadership of both central banks keen to show results for their monetary experiment, the Fed taking off in a different direction is likely to help. The impact is more ambiguous for the Bank of England. Having embarked on its own QE programme earlier than the ECB or BoJ and been rewarded with steady growth, the BoE finds itself in a position closer to the Fed’s, debating the timing of its first rise rather than whether to extend easing.” (December 18, 2015)

“Historically, interest-rate increases from the Federal Reserve have been buy signals for emerging-market assets. This time looks different, even after a selloff that has pushed currencies to record lows and equities down to levels not seen since 2009.Developing-nation stocks advanced 38 percent on average and currencies jumped 11 percent during the two previous Fed tightening cycles starting in 1999 and 2004. Firms including UBS AG and Citigroup Inc. say more pain is in store after the first U.S. interest rate increase in almost a decade because emerging markets haven’t fallen enough to reflect subdued growth. In the past, developing nations benefited from stronger U.S. growth. Now, stagnating global trade, a slowdown in China and a collapse in global commodity prices continue to take their toll. While stock valuations are similar to 2004, earnings have gone from growing 29 percent to falling 21 percent, and debt levels have reached a record high. Adjusted for inflation, 17 of 21 emerging-market currencies are more expensive than they were 11 years ago on a trade-weighted basis.” (Bloomberg, December 17, 2015)

Key Levels: (Prices as of Close: December 18, 2015)

S&P 500 Index [2,012.37] – The last few months showcased turbulence, but when all is said and done the 2,000 level remains familiar. Clearly, strong evidence suggests the index failed to climb above 2,100.

Crude (Spot) [$34.74] – Sits at multi-year lows after a massive sell-off during the last few months. A desperate bottoming process is attempting to form, but there is no evidence of stability at this stage.

Gold [$1,081.50] – A four year cycle downturn remains in place. The recent breakdown at $1,200 suggests another wave of selling pressure. There has been over a 40% decline since the peak in 2011, which tells most of the story.

DXY – US Dollar Index [98.70] – For most of 2015, the index has stayed above 94, while topping around 100. During the last five years, the dollar has bottomed and strengthened; the positive momentum remains intact.

US 10 Year Treasury Yields [2.20%] – Closed at a familiar range. Again, yields have been closer to 2.20% all year long. The last several weeks have showcased a narrow band between 2.30% and 2.15%.


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