Market Outlook | June 29, 2015

“It has yet to be proven that intelligence has any survival value.” Arthur C. Clarke

Summary

The Nasdaq index made all-time highs earlier this month. Climbing back to all-time highs took 15 years, which puts several market moving elements in perspective. First, shares of innovative ideas primarily in technology and biotech remain much more attractive these days than resource or commodity based ideas as seen in last decade. Second, but importantly, US equities, (and US dollar based assets) as an investment, remain in high demand as growth driven liquid themes are rewarded by investors. Third, it takes a long-time to revisit “all-time” highs which stresses the importance of grasping and tracking market cycles. Finally, the Greek sideshow is distracting day-to-day news, but other macro events might turn out to be more critical. A synchronized volatility can stir reactions which are hard to guess since “survival” mode investor decisions are unpredictable.


Turbulence Isolated

The currency markets along with commodities sparked a wave of turbulence last year. That awoke participants to take actions by reducing exposure in EM currencies and limit bets in low growth EM areas. Then the bond market volatility in the first half of 2015 re-emphasized that other key markets are not as smooth as US equities. With Greece back in the forefront, the volatility in bond markets is back. In the last 12-18 months volatility is visible commodities, currencies, and bonds. On the other hand, US Equities continue to escape from spikes in volatility as worrisome trading patterns and price adjustments are not visible. Therefore, equity volatility (VIX) remains insulated from the rest of the financial markets as the established bull market marches on:

“The Standard & Poor’s 500 Index hasn’t posted a gain or loss of 2 percent or more for 126 days, the longest streak since one ending in February 2007, according to data compiled by Bloomberg and Deutsche Bank AG. The last time the gauge went without a 2 percent move in the first half of the year was in 2005.” (Bloomberg, June 23, 2015)


Connecting the Pieces
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Investors emphasizing survival as a theme have piled on to US dollar based assets, as exhibited by the demand for US equities. Recent unfolding events of the EM currency debacle, commodity sell-offs, Russia's political crisis, and Greeks never-ending chatter all served as "marketing" promotion to own US stocks. The same lesson has echoed again in 2015. When Chinese stocks drop over 7% in one day, while US stocks barely move over 2% for many days (as stated above), then it serves as another reason for wealth preserves to shift into US assets. Even with Nasdaq around its all-time highs, the markets behavior is less focused on "stretched" valuations; however, the collective investors decision turns their attention to liquidity and stability.

In the near-term, there seems to be more uncertainty underneath the surface (as usual), but markets with relative stability become a much more appealing story. Nothing is really "stable" but a multi-year bull market suddenly appears like an "insurance" for those looking for both growth and liquidity. The questions boil down to one critical matter: When does “safety” turn into misery? That's the unknown and those assessing risk have calculated all possibilities except narrowing the time-frame. Timing seems near impossible as markets harshly teach investors. The Greek episode has been heard before ad nausea, and that is hardly a shock for participants. Timing is not answered by the Fed, either. Instead, the long search for catalysts reverts discussion back to Central bank actions or less expected shocks. As month-end trading and the first half of the year draw to a close in the near-term, the big picture narrative has hardly changed.

Fed’s Messaging

For some, the Fed messaging seems a mixture of comical smooth talk rather than substance driven. As usual, central banks appear like a PR machine in their approach to calm nerves, to provide some albeit very limited guidance, and to influence the ‎narrative (market chatter):

"The U.S. hasn’t reached 3% annual growth in gross domestic product since 2005 and few economists, inside or outside the Fed, believe the good old days are coming back anytime soon. Most believe the upper speed limit for the U.S. economy is now significantly lower: 2% to 2.5% vs. a historic growth rate of 3.3%."‎ (Marketwatch, June 21, 2015)


The Fed has succeeded in helping guide the equity market higher and in calming nerves from crisis mode. However, the substance that follows the near all-time highs in the market is highly questionable and will soon be confronted by overly anxious risk-takers and believers of the Fed. The rate-hike guessing-game lives on as speculation without basis.


Emerging Risk Reassessed

EM equities tell a different story, though. The shaky behavior in commodities and currencies was directly linked with EM stocks. Plus, slowing global growth brutally impacted EM markets as their prior decade-long favorable run became questionable. The collapse in Crude and Gold reaffirmed the slowing global economy and waning demand. Risk-takers of EM investments are now assessing if there is value opportunity in finding new ideas in less favorable regions. For now, the more established US stocks do not offer the same risk-reward as EM. Those patient, value-seeking investors may revisit EM, which has been dull for a while.

Unlike the Nasdaq or S&P 500 index , the MSCI Emerging market index is far removed from its 2007 all-time highs. Clearly, the BRICS are struggling despite China’s recent explosion and recent sharp collapse. BRICS are attempting to rediscover any fundamental strength that’s long been missing from Russia to Brazil. Lower rates were not enough to spark a noteworthy recovery in EM, but if the risk is better understood then patient investors might step in aggressively. In terms of China, which has roared at a rapid pace, some reality is setting in with massive correction:

“A 20 percent fall in Chinese stocks over the past two weeks, mainly blamed on a flood of initial public offerings, highlights the risks that regulators face as they try to use the stock market to support the slowing economy….. The stock market, which has seen indexes gain as much as 150 percent since November, has been one of China's few bright spots as economic growth has flagged and property prices have slid, and regulators have tried to take advantage of it to support the wider economy.” (Reuters, June 28, 2015)

Article Quotes


“In the past year, volatility in global financial markets began to rise from the unusually low levels that prevailed in mid-2014,spiking a few times. The spikes, which followed years of generally declining volatility, often reflected concerns about the diverging global economic outlook, uncertainty about the monetary policy stance and fluctuations in oil prices. Investors also began to demand higher compensation for volatility risk. In particular, after narrowing until mid-2014, the gap between implied volatility and expectations of realised volatility ("volatility risk premium") in the US equity market started to widen. As risky assets such as equities and high-yield bonds were hit during these bouts of volatility, investors flocked to safe government bonds, sending their yields to new lows. The easing actions of central banks helped to quickly quell such spikes. Nevertheless, nervousness in financial markets seemed to return with increasing frequency, underscoring the fragility of otherwise buoyant markets. A normalisation in volatility from exceptionally low levels is generally welcome. To some extent, it is a sign that investors' risk perceptions and attitudes are becoming more balanced. That said, volatility spikes induced by little new information about economic developments highlight the impact of changing financial market characteristics and market liquidity.” (Bank For International Settlements, June 28, 2015)

“China quadrupled the number of countries to which it was the biggest export market in the decade to 2014, the UBS analysts wrote. In the same period, the U.S. almost halved the number of countries for which it held the same title. In terms of exports as a share of GDP, nearly all countries UBS covers saw their China exposure rise; some doubled -- Japan, South Korea, U.S., Brazil, Canada, Chile -- while some tripled -- Germany, the EU -- and some even quadrupled, like Australia. For commodity exporters including South Africa, Australia, Indonesia and Brazil, the impact of a slowing China has been predictably negative. Re-exporting countries -- those most dependent on China's electronics demand such as Taiwan, Korea, the Philippines and Vietnam -- fared better. Vietnam and the Philippines did this by increasing their market share and the value of their electronics and textiles exports to China. Taiwan and Korea, meanwhile, increased supplies destined for China's final consumers.
The UBS economists note that the role of processing in China's export story has shrunk since the global financial crisis. Due to weaker developed-market demand and eroding competitiveness in lower end and labor-intensive sectors, China is moving up the value chain. That could mean less Chinese demand for developed exporters and more competition, too.” (Bloomberg, June 23, 2015)


Key Levels: (Prices as of Close: June 19, 2015)

S&P 500 Index [2101.49] – Since mid-April, the index is stuck in a narrow trading range with very contained to minimal volatility. Either buyers and sellers both lack conviction or this is a natural stalling phase within a bull market. Directionless describes most of the market action in recent weeks.

Crude (Spot) [$59.61] – In the last two months, Crude has hovered around $60 with swings that are within $57-61 levels. This appears as an ongoing breather after a sharp spring recovery from last year's demise.

Gold [$1,172.65] – On multiple occasions in the last four months, the commodity has failed to climb above $1,200 in a meaningful way. This further illustrates the lack of momentum and limited catalysts at this junction.

DXY – US Dollar Index [95.47] – Returns back to familiar above 94 range. March highs of 100 have not been reached in recent weeks. Despite the multi-month pause, the Dollar strength remains intact.

US 10 Year Treasury Yields [2.47%] – The June 11, 2015 high of 2.49% remains a critical hurdle rate as last week’s run appears to re-test these highs. A critical junction is reached as traders await the month-end behavior.




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