Market Outlook | July 6, 2015

“Every calamity is a spur and valuable hint.” (Ralph Waldo Emerson 1803-1882)

Summary
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Hints of risks are hardly foreign to this post 2008 market where many concerns have been raised from slowing real growth to Fed-reliant markets to fragile emerging markets. Despite the Greek/EU debate monopolizing financial headlines, more concerns have been building. Interestingly, the market has been stuck in a trading range and reached an inflection point with massive anticipation of the next move. Perhaps, Greece is the one known macro issue that can quickly turn into a catalyst for emotional investor responses. China’s Emerging Market woes are another volatile matter. Market participants and the Fed are in need of a new narrative especially since volatility has been numb and low rate policies have been the norm, but growth remains weak. Resilience will soon be tested which is only a natural way to gauge investors’ sentiment under duress.

Political Drama

Greece related drama is polluting the airwaves as the debate has just as much to do with political crisis as financial mismanagement. The root of the problem should not be dismissed in this never-ending discussion.

So the public debate and negotiation resume. Meanwhile, the painful reality is here again and no magic can change it. The smearing and finger-pointing between Greece and EU is useless in terms of substance, especially considering "it takes two to dance.” As in, behind every lender there is a borrower and vice versa. The fallout of mismanaged risk and lenders scrambling to get paid is one matter. The ugly resolutions via political based statements by both sides are playing out publicly. The structure of EU is the bigger problem and was witnessed in 2011. The noise at times is much louder than the actual financial troubles according to the risk or volatility measures thus far. However, the next few days will provide some clarity on the mindset of investors and the magnitude of this chaos. Even if this Greece chaos seems fully understood, the element of surprise may find a way to add more suspense.

Beyond Greece

Some look for unexpected shocks or looming dangers, but what about understanding the present concerns from China to Puerto Rico? Even without the Greece /EU circus, there is plenty to digest and plenty risk to assess in a deceivingly low volatile world. There is more turmoil beneath the surface than revealed by the Fed and analysts of multi-national corporations.

Puerto Rico's default may not ‎hit the worrisome scale as Greece did for noisemakers, but China's equities sell-offs are alarming quite a few folks. Mutual funds making bets in what's assumed to be safe yields now find those bets severely back firing.‎ This itself is another reminder for how risk taken in “junkiest” investment turns out to be junky. Unlike Greece negotiations , which is marred with political crisis, the Puerto Rico near default crisis seems to be a business-only matter to be resolved via legal means:

“Municipal bond researchers at Franklin Templeton, whose funds are among the largest owners of Puerto Rico debt, on Wednesday predicted a "long and costly" legal battle as the Caribbean nation tries to restructure more than $70 billion in obligations.” (Reuters, July 1, 2015)

Chinese equity markets felt bubble-like traits for a while. That’s been well documented and the recent sharp selling pressure awoke a wider audience. Considering other BRICS have been in bad shape, many felt that China surely is more stable than other Emerging Markets. Yet, there are plenty of concerns, and, importantly, volatility in the Chinese markets are not quite seen in developed markets:

“China Securities Regulatory Commission (CSRC) unleashed a string of supportive policies, including a 30-percent transaction fee cut and green light to bond issuance among brokerages, on Wednesday evening after the Shanghai gauge plunged 5.2 percent… The amendment, whose draft were scheduled to be on public consultation till July 11, was released on Wednesday evening ‘in haste for special circumstances’, said the securities watchdog on its official microblog weibo.” (China Daily, July 2, 2015)

Does a volatile stock market also reflect a softer economy? Perhaps, that’s the bigger question that awaits an answer more quickly than many may have imagined. Yet, the first signs of “blood” have persisted in recent weeks.


Further Slowdown Hints

1) Commodities are in a downturn from a cyclical point of view. We can gain a lot of perspective into weakening global growth from the downturn of commodities. The first half of 2015 reveals the same weakness with Gold, Copper, Silver and Iron ore falling into the negative by end of June. Crude's moderating prices are not quite convincing of a full recovery either, as the supply-demand imbalance is being discovered.

2) An increasing number of Central Banks continue to lower rates further which showcases a lack of growth— a desperate attempt to induce an unnatural recovery. Asset appreciation is not quite economic growth, and at some point these illusions or untruthful chattering can turn into bitter reality. China's central bank cutting rates for the fourth time since November tells a story itself.

The near-zero interest rate narrative sold as fueling economic growth has shaped the main plot. Yet, the substance behind real growth is slim to none and highly questionable.

3) The Dollar's strength showcases the unstable conditions of Emerging Markets as much as weakness in Gold or the appeal of the most sought after currency. More demand to own dollars is nothing new in last twelve months.

4) US labor numbers suggested much weaker growth than expected. For a while, rate hike discussion has centered around a growing economy and stronger labor. With labor participation at a multi-decade low, it is harder and harder to convince observers the improving labor numbers. Surely, the middle class and business owner can relate to this as much as they can relate to the low inflation data. Thus, celebrating “growth” due to elevated assets again proves to be misleading.

Article Quotes:

“China gets all sorts of credit for managing its economic boom over the past three decades. But promoting an equity market bubble—including vocal cheerleading in state media—was a clear policy mistake. It is a reminder that China’s reputation for omnipotence in economic matters is hardly unassailable. Similar mistakes handling the economy’s deleveraging could prove more devastating. A campaign this year to clean up local government debt turned out to be insufficiently thought through. Beijing had to walk back key elements and supplement the program with a bailout through a central bank bond swap program… The weakness of the euro and the yen means that on trade-weighted, inflation adjusted terms, the yuan has strengthened 13% over the past year, according to the Bank for International Settlements. Against this backdrop, the yuan would probably be falling against the dollar if left to its own devices. While the chances of a currency unraveling are remote, Beijing’s ability to withstand the pain of a strong yuan in the face of a sluggish economy may necessitate a change in tack when investors least expect it.” (Wall Street Journal, July 5, 2015)


“The United States pushed both sides [European creditors and the International Monetary Fund (IMF)] very hard to reach an agreement, and it does still have significant influence with Europe and with the International Monetary Fund. American leaders had a number of fears, starting with concern that a failing state at the south end of the Balkans and not far from the Middle East and North Africa would be seriously problematic. This was compounded by fears of the outside possibility that financial distress emanating from Greece would trigger another, albeit smaller, financial crisis. Not to mention the recognition that Greece has strong cultural affinities with Russia and might become a Russian ally within the European Union. Many European leaders also shared these fears.” (Brookings, June 25, 2015)

Key Levels: (Prices as of Close: July 2, 2015)

S&P 500 Index [2076.78] – On several occasions in 2015, the index has failed to convincingly surpass 2120. This reiterates the neutral state between buyers and sellers. Reinvigorating another upside run has been a struggle recently.

Crude (Spot) [$56.93] – In recent weeks, a defined range between $58-61 has mostly summarized the trading pattern. If Crude stays below $58, then sellers will wonder if a wave of selling pressure awaits ahead. Critical days and weeks are ahead for trend implications.

Gold [$1,168]– The multi-year decline remains intact. Despite the debate of gold being a currency or a commodity, the trading pattern reflects a commodity that’s in a longer-term decline. Clearly, that’s been defined for many months. As long as gold stays above $1,142, buyers will be compelled to sense a potential recovery.

DXY – US Dollar Index [96.11] – Despite a somewhat shaky action in the near-term, the dollar strength remains well established. Staying above 94 suggests continuation of the strong dollar theme.

US 10 Year Treasury Yields [2.38%] – June 11th highs of 2.49% and June 26th highs of 2.48% set the tone in terms of the next upside targets. Meanwhile since January, yields have moved from 1.65% to 2.39%, which reminds us of the slow recovery of an already depressed yields.







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