Market Outlook | April 6, 2015

“Behavior is a mirror in which every one displays his own image.” (Johann Wolfgang von Goethe 1749-1832)

Summary

As interest rates seem low and asset prices seem elevated, the market is overly anxious for the next key catalyst. Although, the rate hike discussions have intensified recently, there should be more substance regarding the “recovering” economy. At this stage, robust real economic growth is not convincing month after month. Market participants are forced to re-think the current themes from bonds to commodities. A desperate search awaits for real interpretation of inflation and growth data. As convenient as it is to bash the Fed, the market will have the last and key voice regarding the status-quo trends.

The Build Up

As time passes, many hope to learn new facts about this current interest rate cycle's nuance and mystery. Anxious participants await inflation findings or other surprising or revealing economic indicators. There is a massive scramble for minor clues, but no formula has been revealed thus far. Elevated US asset prices fail to tell the full story. The Fed obsession is brewing, but the questions outweigh the answers, which frankly tests investors' patience.

The low interest rates mixed with (or resulting in) equity bubble-like patterns is a succinct summary of financial conditions. Basically, Fed induced or not, this is the reality of limited investment options and few clear trends. From the UK to the US and now into the Eurozone, the same ol’ game of inflated assets trumps the discussion of slowing down commodity demands. This is the “known” that is producing various interpretations. So the newest and most anticipated discussion looms around potential rate hikes in the US. Yet, the Fed needs data to strengthen the ‎argument for a hike.

Here lies the debate, what's more influential: The few signs of strength in the US economy, mainly in labor numbers in tangible terms, or the overall gloomier picture of the global economy? As stated in last post, the element of “bluff” in the Fed’s tone regarding a rate hike is very hard to ignore. Yet, an ex- Fed chairman claimed in his new blogging role reaffirmed the Fed's intention: “The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed” (Brookings, March 30, 2015).

Tracking Behaviors

The US 10 year yield is below 2% and Crude is struggling to recover, which may suggest ‎that no robust growth, no inflation and no anticipation of near-term rosy recovery looms on the horizon. All noise aside, based on bond and commodity markets there is an argument to be made of lower growth expectations. Surely, energy and emerging markets have corrected enough to showcase a tangible reality check. At least, those so desperate for bargains have something to contemplate:

“The Energy sector alone accounts for nearly half (46%) of the decline in expected earnings for Q1 from December 31 through March 31. The Q1 bottom-up EPS estimate for this sector fell by 50.3% (to $4.16 from $8.38) during the first quarter, which was the largest percentage decline for all 10 sectors.” (Factset, April 2, 2015)

Of course, the status of inflation or desired unemployment level are an unknowns. The Fed’s approach has become more theatrical and managing of expectation than a defined science. For participants expecting a sorted out, well formatted formula, that’s a set-up for disappointment. In fact, anticipating a trend shift on how the Fed chooses to highlight valuable or essential data point is hardly scientific . One indicator that's tracked by Fed watchers is rather decisive:

"The Federal Reserve’s preferred measure of inflation in February fell short of the central bank’s 2% target for the 34th straight month." (Wall Street Journal, March 30, 2015)

It is fair to ask after this, how can one contemplate a rate hike in months ahead?
Meanwhile, for those money managers in the trenches, ability to deal with conflicting data while not being fooled by a “soothing” Fed messaging is the ultimate test and reward. In fact, assuming the Fed knows it all is a bit more dangerous than many so-called professionals would like to admit. ‎So attempting to ride the current wave filled with indexes is at an all-time high.

Interpretations

‎There are two prevailing approaches at this current junction. First, the bulls are celebrating weak job numbers, which signal low odds of rate hikes in the near-term. That, of course, is translated as more upside in equities. The second view is where some optimistic US shareholders are convincing themselves that the job market is growing and economy is as strong as reported. Both fail to offer a simple logical explanations, hence the mystery and "misery" of predicting future events. However, celebrating economic weakness in hopes of further stock market gains is merely artificial and short-term oriented. Amazingly, the Fed appears stuck between desiring to hike and lacking the substance to do it. Thus, the pressure builds on the Fed as much as others. And only time can detect the rest.


Article Quotes:

“In a sign of how China’s cooling demand for steel is affecting ore miners, last month Fortescue, an Australian company, was forced to call off a $2.5 billion bond issue, having days earlier tried to raise the same amount through the loans market. CITIC, China’s largest state-run conglomerate, recently announced that its net profits fell by nearly 18% last year thanks in part to the troubled iron and steel markets. It was forced to take an impairment charge of $2.5 billion on a massive iron-ore project in Australia that has run into delays and cost overruns. Aside from the risk of undermining the rationale for investments such as these, what are the potential knock-on effects of China hitting peak steel? Trade wars, for a start. Unable to peddle all of their output at home, Chinese steel producers have been exporting increasing quantities—to the consternation of producers elsewhere, who accuse them of dumping. MEPS, a consulting firm, estimates that China exported more than 90m tonnes of steel last year, which is greater than the entire output of America’s steel industry and was a rise of over 50% on the previous year. Exports are continuing to surge this year.” (The Economist, April 4, 2015)

“According to the ECB, in February, 12.7 percent of the total liabilities of the euro area's financial corporations, including banks, took the form of debt securities. That's 4.1 trillion euros ($4.5 trillion) worth of debt, a growing part of which is, in regulators' parlance, 'bail-inable.' At the same time, the Financial Stability Board recommends that big banks issue more such securities to create additional capacity for imposing losses on investors if things go wrong. Adhering to the guideline probably will drive up funding costs for banks, as will the growing risk of investing in bank bonds. Almost 53 percent of European financial corporation liabilities, or 17 trillion euros, come from deposits -- also an endangered form of funding because of ultralow interest rates. So, unless banks plan to start shedding assets (which have increased by almost 2 trillion euros since the end of 2013), financial institutions should look elsewhere for long-term and medium-term funding.” (Bloomberg, April 2, 2015)

Levels: (Prices as of Close: April 2, 2015)

S&P 500 Index [2066.96] – Rising above 2100 for a sustainable period has been a challenge. Meanwhile, buyers have shown strength at 2040. Range bound trading action continues, given the multi-year bullish trend.

Crude (Spot) [$49.15] – This year the lows of $44 and highs of $50 appear familiar since the massive sell-off last year. Prices are settling after the major supply-demand adjustment.

Gold [$1,197.00] – The well-established cycle decline since September 2011 is quite visible. Surpassing $1,200 remains a challenge, as has been seen on several occasions.

DXY – US Dollar Index [97.43] – Since March the Dollar strength has retraced a bit. Yet there are no signs that a major currency shift is developing, despite some speculators sensing a trend shift in the Dollar.

US 10 Year Treasury Yields [1.91%] – Another big statement is made with yields failing to hold at or above 2%.




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