Market Outlook | February 17, 2015

“Illusion is the first of the pleasures.” Voltaire (1694-1778)

Summary

The equity markets reminded us yet again that brewing crisis in foreign policy, escalating religious and regional conflicts, or dampening economic climate are not factors in impacting collective share prices of key indexes. For now, perception based realities are preferred over confronting future realities. Central Banks remain the dominate force in financial markets and continue to shape and influence this multi-year, well known narrative. Hence, stocks (via participants’ actions) are de-emphasizing the alarming responses from currencies and commodities as participants are primarily reacting to the low interest rate climate.

Illusionary Realities

The reality remains that the bullish market is in place and turbulence is nearly off the radar. Interestingly, DAX (German index) was trading around or at all-time highs even before the ECB stimulus decision. Before the ECB’s QE launch, developed market assets were appreciating for a several years, with US assets being the biggest beneficiaries of capital inflow. However, a rising stock market in the US or Germany may not necessarily project a better economic growth ahead or an increase in labor productivity. For now, economic nuances are not the decisive factor as long as crisis is averted and GDP is not negative. Until then the trend lives on.

Similarly, liquid assets that are in stable footing are in high demand; it makes sense that the DAX and US broad indexes are in favor. When all is said and done let’s not forget: The S&P 500 index has risen over 33% since the peak in October 2007. Basically, if one solely relies on stock indexes, then the financial trauma of 2008 would seem long forgotten. (As if the crisis then was illusionary). Worrying has not paid as much as accepting the consensuses of the Fed’s action. This all-time high may seem illusionary to others, but that’s essentially the reality of the “scoreboard.”

The conflict between the rewarding stock market and mixed economic data are not highly debated at the forefront. In a way, there is a numbness to bad results that have given unimpressive economic results from Greece to Italy to Japan. Sure, Emerging Market woes have been felt and those woes left a massive dent last year. Yet, it feels that markets appear less sensitive to matters related to weak GDP, labor numbers, or other government related policies. Amazingly, if slightly positive news comes out regarding retail sales or consumer trends, then markets are sensitive to the upside. That suggests that the various bad news have been heard, incorporated, and certainly not feared. The same applies to the energy sector and commodity related nations where the negative shock has been somewhat flushed out. The perception driven financial inter-workings may easily confuse someone since all-time high indexes are not tangible.

Safety Redefined

For most part, fund managers are not making philosophical or bold macro statements in their trading decisions. Simply, it remains convenient to ride the upside wave and not fight the established trend. Surely, this is the popular and so called “safe” approach. This investment behavior plays into the Fed’s script. After all, in the post 2008 era, it is hard to dispute the fact that those central banks have masterminded this rally. Induced by low interest rates and desperate measures to restore confidence, the Fed’s game plan has work as crisis is not a near-term threat.

Capital allocators were not dwelling on Eurozone crisis. Even now there is not much of a collective worry regarding the Greek talks. The Greek Exit is an unsolved headline matter and has not reshaped broader sentiment at this point. In addition, a break-out in volatility is not quite feared these days. Similarly, the Ukraine-Russia discussion is not much of an event, despite Russia's economic and currency collapse—highlighted by massive oil correction. Instead, the near-term mindset is about riding the trend, seeking bargain opportunities in energy, and obeying the commands of the Federal Reserve (until told otherwise). For good or for bad, betting on volatility is not as safe is it once seemed. However, predicting the confluence of negative events is a daunting challenge. Perhaps, most have realized that and not bothered dwelling on the gloomy outcome. The “safe” approach is shaped by recent patterns, which is understandable from a human behavior point of view.

Dullness

This ongoing meme of lower rates and lower volatility that results in higher stock markets has overly-simplified the art and the science of financial markets. If risk is taken out of the equation then it is hard to know what is real and what is not. Perception alone is too powerful. Is the middle class doing well? Are small businesses being created? Is there new innovation across traditional sectors? Underneath the surface there is plenty brewing for keen observers, but it has not translated into actionable results. Decimated Emerging Market currencies, Oil price impact on Middle East, occasional negative bond yields, attitudes towards Eurozone, and other political factors are heating up. However, the markets cannot pinpoint on the nuanced base-daily movements. Instead, attention is nearly all Fed-centric, which makes it easier for some to track and tricky for others to trade.

Article Quotes:

“With rapidly falling world oil prices, disinflation pressures are unlikely to abate any time soon. According to the latest World Economic Outlook forecasts (IMF 2015) and our estimates, headline inflation is expected to stay low through 2015 in euro peggers and remain below targets in Hungary, Poland, and Sweden. In fact, the sharp decline in oil prices since June 2014 will drag inflation lower, as the commodity price drop filters through to domestic prices. Is this good or bad for the economy? A 2009 Vox column by Robert Ophèleon the Eurozone’s previous disinflationary episode in the wake of the Global Crisis remains a reliable guide in thinking through this issue. The prospect of lower cost-of-living and production costs is undoubtedly a positive development in the short run:
• Lower energy prices boost the purchasing power of households and businesses. Given the still negative output gaps throughout the region, a pick-up in demand would be a boon for domestic producers.
• The lower consumer and firm outlays on goods and services would also ease the liquidity strains of debt service for heavily indebted firms and households, reducing the risk of default and the related negative effect on consumption and investment.” (VOXEU.org, February 16, 2015)

“After pulling more than $16 billion last year, investors have poured $4.97 billion into U.S. high-yield mutual funds and exchange-traded funds since December, according to Lipper. BlackRock Inc.’s junk-bond ETF, the largest of its kind, has seen inflows during each of the last 13 days, the longest streak of deposits in more than two years. Junk bonds are benefiting from demand for higher-yielding assets as the European Central Bank’s new round of bond purchases pushes yields on more than $1.7 trillion of debt worldwide below zero. The resurgence is sending down borrowing costs for speculative-grade borrowers.” (Bloomberg, February 10, 2015)


Levels: (Prices as of Close: February 13, 2015)

S&P 500 Index [2,096.99] – Another all-time high revisited, again. Previously surpassing 2,050 was a challenge. Now, the index is slightly above the previous all-time highs from December 29, 2014.

Crude (Spot) [$50.02] – The two week rally is pausing. Investors regain confidence after of a new bottom around $45. Further catalysts are needed to stimulate an extended upside move.

Gold [$1,222.50] – In the past twelve months, buyers’ appetite kept fading at the $1,300 range. A long drawn out bottoming process that’s kept up the intrigue, but demand is not picking up.

DXY – US Dollar Index [94.20] – In the last three weeks, the dollar has stabilized while maintaining its positive trend. It is in a mild pause after the explosive strength last year.

US 10 Year Treasury Yields [2.05%] – This month has showcased a mild uptick in yields above 2%. Recently, the move suggests that 1.70% appears like a new bottom for yields for now. However, this move above 2% is still not overly convincing.




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