Market Outlook | July 13, 2015

“Waiting is painful. Forgetting is painful. But not knowing which to do is the worse kind of suffering.” (Paulo Coelho)

Summary
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Looking beyond the Greece/EU talks is essential at this point, especially for data and other surprising market-sentiment related events. Sooner or later, the Greece debacle and obsession will be behind observers’ minds. Then markets will start to re-focus into less political and more fundamental matters. For now, commodities are in a cyclical decline, dollar strength is intact, and equity markets and bonds are on pause. A major waiting game is in full gear, as the established bullish stock market continues to hold on. Justifying a rate hike in a slowing global economy is a major challenge for policymakers.

Conviction Reexamined

‎Believers of the Fed and believers of this multi-year bull market await another test of conviction. Whether markets operate under an illusionary narrative or by a simple formula via the guidance of central banks remains a debate in itself. However, claiming that “liquid markets reflect the real economy” is a dangerously misleading statement. From the US to Europe to China, the stimulus efforts of policy makers and their respective messaging does not tell the full truth. Even when markets appear overly “stable,” it fails to tell the story of the uncertain, shaky climate.

In fact, the markets reflect a narrow perception that is generated by a few market-moving influencers and the rest of the observers ride the wave. Operators in risk-taking or opportunity-seeking segments must be in state of confusion from recent days. This is rightfully so considering the confluence of some negative events and the other usual “non-events .”

Are investors going to continue trusting Central Bankers? Are investors going to stay relatively calm? Both questions have been asked so many times in recent weeks, but they are worth asking again since multiple events are piling up. Ultimately, buyers and owners of risky assets will have a major say in how risk should be digested.

Unphased

Surely, the sideways pattern of the S&P 500 index reflects confusion and an ongoing waiting game. In fact, the index of larger US companies is not even up 1% in 2015. To be exact, the index is up 0.86% so far this year, which showcases the combination of stalling bull market and the uncertain and suspenseful market that’s data hungry. Volatility (VIX) for equities still remains quite; however, roaring volatility in currencies, bonds, and commodities are a good reminder of turbulent realities. Of course, technical factors, such as share buybacks and dividends, attract many to own stocks. However, envisioning fruitful returns in the next 1-2 years is becoming more challenging. Tough questions have been deferred and the US bull cycle has been untested for a long while. It's fair to say, complacency is alive and well, given the relative appeal.

The Global Dilemma

The political crisis and public humiliation of Greece have gone beyond worries related to financial matters. The concept of the European Union is being re-evaluated and politicized, of course. Hardly a shock where we are, given the financial troubles from 2008 and summer 2011 have already signaled all-types of warnings in reshaping the European landscape. Amazingly, it is worth noting that the Eurozone did recover from 2011 with some revival. Perhaps, the low bond yields in Germany and other developed markets reflect that, unlike 2011, there is a belief that this is more contained. Now the recent talks filled with deadlines and angst continue, but the long-term economic picture is still fuzzy. For longer-term investors these times are even more suspenseful than for a shorter-term trader.

As Europe tries to resolve various issues, the Chinese markets are bleeding despite recent sharp recovery. When viewing the slowdown in commodities demand along with inflated Chinese valuations, one cannot help but expect more turbulence. The decade ahead seems even more mysterious, but the near-term appears even more nerve-racking:

“While the IMF expects global growth to pick up again next year, the bouts of turmoil underscore the fragility in the world’s economy, where anemic output in one region risks dragging down others across the globe. Policy makers have fewer options left to respond to downside surprises, the IMF said. Governments have pushed debt to dangerously high levels and central banks are constrained by the lower limits of rate reductions.” (Wall Street Journal, July 9, 2015)

Regardless of government interventions, the signs of slowdown are too real to ignore. At some point, the coordinated easing policies from the UK to Japan to the US to Europe may not be the only medicine for wealth creation. Perhaps, the uniform actions, plus political tensions, and alliances such as Russia, China, Iran will have an impact on corporate actions. Right now, those longer-term questions are not overly contemplated because the day to day noise pollutes the airwaves. Yet, evaluating long-term implication and making the right bets might be fruitful for those looking ahead.


Article Quotes:

“While meeting at a two-day summit of the Shanghai Cooperation Organization in Ufa, Russia, Russian President Vladimir Putin and Chinese President Xi Jinping are reportedly discussing a framework that would merge China’s multi-billion dollar network of roads, railways, and pipelines through Central Asia with the Eurasian Union, the post-Soviet economic bloc that includes Armenia, Belarus, Kazakhstan, Kyrgyzstan, and Russia. The two projects would be combined under the auspices of the Shanghai Cooperation Organization, and if the proposal is completed, it would make the opaque organization the preeminent economic body from Shanghai to St. Petersburg… State media in both countries are already trumpeting the cooperation proposal and the SCO, with the Chinese state news agency Xinhua calling it a blueprint for 'cooperation and prosperity of the whole Eurasian continent.' That marks quite a departure from Moscow and Beijing’s previous tug of war over influence in Central Asia.” (Foreign Policy, July 10, 2015)

“Eleven of the 15 non-financial U.S. companies that spent the most on buybacks last year base part of CEO pay on earnings per share or total shareholder return, or both, according to data compiled by Bloomberg. These metrics get a boost when businesses return cash to investors, giving companies like International Business Machines Corp. and Cisco Systems Inc. added incentive to dole out cash to stockholders. Linking compensation to buybacks and dividends can encourage managers to sacrifice funds that could be used for long-term investments, economist William Lazonick said. It also raises the prospect that executives are being paid for short-term returns rather than running a business well… IBM drew criticism from analysts and investors last year for what they considered excessive share repurchases. The company returned more than $13 billion, the fourth-largest amount in the U.S., while it was struggling to reinvent itself to a provider of cloud services. In 12 straight quarters of year-over-year declines in sales, IBM boosted operating EPS in nine quarters -- with the help of buybacks.” (Bloomberg, July 7, 2015)

Key Levels: (Prices as of Close: July 10, 2015)

S&P 500 Index [2076.78] – During the last six months, the index has traded within a tight range of 2040-2120. Once again, buyers’ convictions are being tested.

Crude (Spot) [$52.74] – Already in an established bear cycle from a long-term picture, the recent deceleration and inability to hold at $60 confirms the low demand and expanding supply.

Gold [$1,159.39] – Once again, Gold is trading like a commodity rather than a “currency”. The weakness in the commodity cycle remains. The next critical level is at annual lows of $1,147.25 which were reached during March 2015.

DXY – US Dollar Index [96.02] – Staying above 94 is proving a test in the near-term. However, current levels seem to be stable, and this reemphasizes the dollar strength as one of the more dominant themes.

US 10 Year Treasury Yields [2.39%] – No major change since the prior week. In the last 30 days, trading has ranged from 2.20%-2.45. The next trend is not clearly established.





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