Market Outlook | August 10, 2015

“It is hard to free fools from the chains they revere.” (Voltaire 1694-1778)

Summary
‎
• US stock market indexes appear directionless while awaiting catalysts to confirm or negate the growing doubts.
• US bond and developed markets yields suggest a lack of global growth.
• Commodities and Emerging Markets remain in a cyclical downturn. Now, the impact of these moves should impact currencies, company’s earnings, and foreign policies.
• Although the massive panic has been mostly contained, the central banks cheerleading tactics appear misleading rather than convincing.


Overly Revered

‎The reverence of the Federal Reserve is a powerful matter. In fact, talk to veterans and observers of financial markets and one saying is heard across multiple cycles: “Don’t fight the Fed.” A reference that has been used too many times to suggest that if you bet against the Fed then financial pain/loss awaits. A saying that illustrates the Fed sets the tone, the script, and expectations which remain highly revered if not feared. Since 2008, it was no different when the near zero interest rate policies lifted equity markets and investors were rewarded by sticking to the script. Perhaps not challenging or questioning the Fed became too profitable (or dangerous) and left others too intimidated. Of course, when one is rewarded with the rising stock market over six years or so, being skeptical against the main conductor is a tough task. Yes – gloom and doomers were proved wrong, and, surely, the task of an investor is not to impose one's own views, but rather seek fortunes. For now, fortune seekers view the Fed and the Fed’s policies as the “truth” barometer – at least in the scope of financial markets.

Amazingly in recent years, the Federal Reserve has become a character of its own. Holding press conferences, giving highly anticipated speeches, and leaking to writers about market conditions all make for a Hollywood-style of management rather than a dull risk manager seeking no attention. The idolization of the Federal Reserve is dangerous and an illusionary picture at times. How many times can investors believe the Fed will raise rates soon enough? How many times can one trust the Fed’s claim of a strong recovery?

In today’s climate, Central banks are following these low interest rates in which are becoming the focal point for desperately needed catalysts. From the UK to Europe to China, central banks are highly coordinated and appear to mimic each other. Yet, all their messages seem to be more or less similar:

“QE -- a monetary policy tool first deployed in modern times by Japan a decade and a half ago and since adopted by the U.S. and Europe -- is being echoed in China as Premier Li Keqiang seeks to cushion a slowdown without full-blooded monetary easing that would risk spurring yet another debt surge. While the official line is a firm “no” to Federal Reserve-style QE, the PBOC is using its balance sheet as a backstop rather than a checkbook in efforts to target stimulus toward the real economy” (Bloomberg, August 9, 2015).

Terms like “data-dependent” make a mockery of the Fed and its followers. Since when are markets not data depending? (Always are). Since when are investments decisions data-dependent? There is a humbling development in all this; perhaps the Fed seems as clueless as its audience about the next move. And being “clueless” about the next move is normal and closer to the less-than-pretty truth. Yet, the challenge for the Fed is justifying a growing economy in a period of low inflation, low yields, and lackluster growth. Maybe the truth seekers need to have a mindset that says “don’t fear the Fed!.” Perhaps, that’s too courageous for some risk-managers, but sooner or later the truth will be revealed. Many have been fooled again and again that a rate hike is coming “soon.”

Markets Responded

Regardless of Central bank messaging or interpretations, other markets illustrate a different picture. The currency and commodities markets provide a view of crumbling emerging markets that were too resource dependent. Surely, the commodities bubble has started to burst a while ago as new lows are the dominate these days. As crude crumbles with massive supply and lack of demand – there has been an awakening of sorts. Similarly, emerging market currencies are feeling the pain tied to nations that are overly tied to resource-based nations.

Bond yields of developed nations still remain low. The drama with Greece came and went, but yields are much lower. Despite cheerful responses of European equities and actions led by the ECB, weakness persists in economic data:

“Surprisingly soft German industrial output and exports data also supported lower yields in Europe. Industrial output fell by 1.4 percent in June, falling short of economists' mid-range forecast in a Reuters poll for a rise of 0.3 percent” (Reuters, August 7, 2015).

In the US or Eurozone, the bond markets are not buying the improving economy story. Skepticism persists. And the volatility of currency and commodity markets further illustrates the damages being felt by companies and nations.

Tracking Tangibles

The big picture themes that have been lingering need some resolution. To start, equity markets are stuck and desperately seeking the next move. Beyond the Fed rate-hike anticipation, finding upside catalysts is severely challenging after six years of strength. Meanwhile, share buybacks which have been favorable to a bullish trend are slowing down. Dollar strength has been a result of slowing commodities and emerging markets, but the impact on corporate earnings is slowly being felt. Finally, GDP or labor numbers are not overly promising either. If results turnout to be in-line, that’s not good enough given the building pressure for a clear-cut answer. Yet, there are too many gray areas and too much spin. One must acknowledge that the Fed remains in a lose-lose situation: A rate hike without a strong economy or no hike that keeps the near zero interest rate policy intact. Thus, the volatility of equity markets will have a major say in weeks and months ahead. Basically, US stocks have not feared any miscalculation of risk in the current policies. Thus, cautiously we collectively watch.

Article Quotes:

“China's fledgling municipal bond market is showing increasing signs of stress after a provincial bond market auction went undersubscribed for the first time in four years. One auction of 10-year bonds by the northeastern province of Liaoning failed to sell out on Friday and yields on other auctions by the province rose by between 20 and 29 basis points from an auction by the Xinjiang ethnic autonomous region on Thursday. Beijing revamped its bond market in 2014, allowing local governments to issue such bonds directly. It followed up by launching a massive local debt swap that exchanged high-yielding local government financing vehicle (LGFV) debt for the new municipal bonds. Average muni bond yields have been rising since May. The average yield for seven-year municipal bonds, which in May were trading only 20 basis points above the sovereign rate, had by end-July opened up a 50 basis point gap above treasuries and were trading in line with policy bank debt. Analysts have flagged China's recent move to further open the domestic bond market to international capital as a response in part to lukewarm demand, especially from non-bank clients, for new municipal debt, whose issuance could reach more than 2 trillion yuan ($322 billion) this year.” (Reuters, August 7, 2015)

“The economic logic says that there are two different problems. Greece needs debt relief and the eurozone does not work. That requires two instruments. If the IMF is true to its word, then it should forgive Greek debt—not least to be accountable for its serial mistakes in the conduct of the Greek program and for delaying by six precious months a transparent discussion of a necessary debt relief. This would force the European authorities to contribute their share of further debt relief and may even induce them to repay the Fund on Greece’s behalf. The solution to the eurozone’s more fundamental problem requires deeper reflection. French President François Hollande has invoked the vision of Delors to move Europe closer to a political union, a theme that has been reiterated by Italian Minister of Economy and Finances Pier Carlos Padoan. Schäuble, in contrast, has made it politically legitimate to discuss the breakup of the euro area. The German Council of Economic Experts has now added its voice to that idea, suggesting that exit from the euro area now become integral to the way the euro area works (paragraph 8 of the Executive Summary). But if a euro break up is now open to discussion, some would argue the least disruptive way to do so is by Germany exiting from the eurozone. That will open up many possibilities for a new configuration. Of course, the most likely outcome is that Greece will continue to borrow new money from the creditors to pay its old debts to those creditors. As it undertakes more austerity, Greek output and prices will fall, making its debt burden greater. That will be blamed on Greek intransigence. More weekends of high drama will lead to driblets of debt relief. The Greek tragedy and euro area fragility seem destined to continue.” (Bruegel, August 6, 2015)

Key Levels: (Prices as of Close: August 7, 2015)

S&P 500 Index [2077.57] – Barely moved since last week and has been wobbling between 2080-2120. Increasing evidence of lack of conviction by both buyers and sellers. This matches the theme for 2015 of neutral behavior and great anticipation for catalysts.

Crude (Spot) [$43.87] – December 19, 2008 lows of $32.40 remain a benchmark on the minds of long-term observers. Meanwhile, in the near-term, March 20,2015 lows of $42.03 stand out as a barometer. More supply expansion worries remain over further pricing pressure.

Gold [$1,093.50] – A break below $1,200 sets the tone for another wave of downside moves. July lows of $1,080.80 are on the near-term radar. Cyclical decline remains in place.

DXY – US Dollar Index [97.56] – The strength remains. Although below annual highs of 100.39, being above 90 suggests the relative appeal of the greenback as a currency.

US 10 Year Treasury Yields [2.16%] – Recent breakdown below 2.30% hints of lack of faith about the story of the improving economy. Certainly, far removed from annual lows of 1.63%, but 3% is looking further away, yet again.

Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.