Market Outlook | August 24, 2015

“The truth is incontrovertible, malice may attack it, ignorance may deride it, but in the end; there it is.” (Winston Churchill 1874-1965)

Summary
‎
• All-out panic and massive selling pressure has persisted in Emerging Markets for many months and now the damage is being realized globally.
• The status-quo that was so calming is unraveling as the truth of real economic conditions is being revealed.
• The Fed’s posturing and multiple bluffs of rate hikes were misleading, as bond markets signaled a lack of growth and lower yields.
• Chinese policymakers intervened in stocks, currencies, and regulatory measures, which showcases the massive crisis.
• Global growth has been clearly weak and expectations continue to adjust, but without growth upside catalysts are very slim.
• The strength of the Dollar has emphatically demonstrated the demise of EM currencies and accelerated a rush to safety.
• Underestimating minor hints has proven costly and listing to the Fed’s messaging without skepticism is equally as costly.


Hints of Calamity

‎Last week's bruising action did not happen overnight and what occurred will not vanish overnight, either. Piercing volatility in Currencies, Commodities, and Emerging Markets (EM) were brewing for a while. In these areas volatility spiked and concerns mounted as the selling pressure accelerated, as noted many times. For over 12 months, markets clearly reflected demise in the Brazilian, Russian, and Chinese economies. The panic in Chinese policymakers has been so evident this summer and is surely a prelude for crisis. Major policy changes by Chinese policymakers were witnessed in prior attempts to the market up to recent currency adjustments. Massive decline in global demand is well known by now and China, the face of global trade, is feeling the pain. Plus, it is symbolic that the “new age” leader is struggling and this translates into near-term psychological concerns heading into the autumn.

Mainstream discussions spent so much time Greece and tons of talks about a eurozone break-up that China's economic impact has been neglected. However, as a few observers pointed out few weeks ago, the Chinese debacle was exponentially critical in tilting the semi-calmness into notable crisis. The Chinese economy that has been lauded and praised from investments in US to Africa, now finds itself at the desperate hour.

To think that Crude was over $100 not long ago, but now is at $40 is massive readjustment. This is not quite understood and the stakes are much higher than anticipated. Corporations, fund managers, countries budgets and sentiment have not fully realized the magnitude of recent moves. Yes, a commodity secular decline has been in place for few years, but the ripple effects of commodities on EM and developed markets are a mystery that lingers. From Asia to Latin America, growth has been scarce and the numbers are staggering:

“Corruption scandals from Brazil to Mexico, a collapse in commodities and a plunge in Latin American currencies have wiped out $800 billion in market value since 2010 -- equivalent to the economy of Turkey. The region now accounts for just 2.1 percent of global market capitalization, down from 5 percent five years ago.” (Bloomberg, August 18, 2015)

Status-Quo Shaken

The US markets hinted few signals that the upside momentum was fading, despite being the favored and relatively appealing global investment. Neutrality and sideways patterns defined the stock market most of the year. Meanwhile, the bond markets reflected slow growth via low yields. Regardless of the Fed’s messaging, the bond investors did not buy the ‘growth” story. Justifying a rate hike seemed baseless even before last week, and the disconnect between real economy and stock markets has been misaligned too long.

The US stock volatility has been tame, but finally awoke a little. It is now inevitable to suppress the uncertainly that’s plaguing investors. For a long while, US assets, particularly Nasdaq related company shares, remained insulated from global crisis that persisted left and right. Last Friday presented a massive wake-up call. Not terribly shocking considering the last major cycle reset was in 2008 and upside catalysts were barely convincing. A bull market has persisted for many years and now questions must be asked. A near 7% loss in one week for the Nasdaq sends a mild panic in the system, especially since Nasdaq was slowly becoming viewed as a “safe haven.” Perhaps that is why when so called “quality”, innovative related shares began to show weakness then an all-out selling pressure persisted during last Friday. Corporate earnings are slowly feeling the pain from EM and commodities. It might have taken a while, but corporate earnings are slowly acknowledging the soft economic numbers that have been somewhat dismissed (or ignored).


Realizations & Actions

Navigators of risk-reward now have an action-pact set up. The Fed is losing credibility even faster than imagined. In a inter-linked world, soft commodities and soft demand have major consequences. The recent, very mild US recovery that’s marketed by political forces dismisses the struggles of small businesses and the middle class. Isolating market risk to EM or commodities is reckless in many respects since markets do sink in a synchronized manner when all-out panic sets in. Lessons from 2008 remind us that when the truth is discovered, a collective emotional response is inevitable. Many anticipate intervention in developed markets like the one seen in China, if markets continue with sharp drops. However, it is an understatement to claim that the recent corrections are enough. There is no magic in timing the market, but regulators/policymakers are struggling to defer the truth further out. Central Banks have used tons of ammunition, but now must admit their limitations. The idolization of Central Banks is what glued the markets higher with a tame volatility. Yet, investors are realizing the Fed’s lack of power, which leads to unsettling results.

Many interpretations persist during panicky times like this, but, simply, this correction was long overdue. Fear is not the answer, but discovering the truth is the sane and only approach. BRICS have collapsed (hurt by commodities mainly), the Dollar is by far the best currency and interest rates are not set to go higher. These three themes were known before the start of the year and remain intact even amidst the current “crisis.”

Article Quotes:

“ The purchasing managers' index for the currency area, compiled by data company Markit, edged up from 53.9 in July to 54.1 in August — a figure well above the crucial 50 level that marks an expansion in activity and one of the highest over the past four years. The PMIs are watched closely by the region’s policymakers and the uptick will come as a relief after disappointing news on growth last week. The picture was less optimistic in the US where data also compiled by Markit, suggested manufacturing growth in August slowed to its weakest pace since October 2013. Businesses cited the strength of the dollar crimping exports sales together with weaker global demand, Markit said. The data could provide further pause for thought for the US Federal Reserve ahead of a decision next month whether to start raising interest rates. In the eurozone, preliminary GDP figures for the second quarter, published last Friday, suggested the region’s recovery lost momentum over the spring despite a cocktail of low oil prices, a weaker euro and aggressive monetary easing by the European Central Bank. The official figures put growth at 0.3 per cent, against 0.4 per cent for the opening three months of the year.” (Financial Times, August 21, 2015)

“Central banks are increasingly using communication as an integral element of monetary policy. While initially financial markets were the main audience, in recent years there has been increasing attention paid to communicating with the general public. The reason is that the effects of monetary policy largely operate through expectations, and that the set of relevant actors also includes the household sector. For instance, expectations about the economic outlook can be an important determinant of the consumption and investment decisions that households make on a daily basis (Blinder et al 2008)… Turning to building people’s knowledge of monetary policy, we find clear evidence that the media channel is important. In the survey, we ask people to indicate whether they use sources such as newspapers, television or the Internet to acquire information on the ECB. We use this information in various ways to study the effects on knowledge. For instance, following Blinder and Krueger (2004), we compute a measure for the intensity of information and a measure for the diversity of information. The first measure is the fraction of sources through which the person often hears about monetary policy, while the second measure is the fraction of media sources through which the person never gets information about the ECB. We use these two measures in a set of regressions that seek to explain variation in knowledge across respondents.” (VOX, August 23, 2015)


Key Levels: (Prices as of Close: August 21, 2015)

S&P 500 Index [1970.89] – The very sharp drop revisits levels from February 2015. In May, June, and July, markets hinted of a top around 2120 with buyers' interest fading.

Crude (Spot) [$40.45] – Prior attempts to bottom at $50 failed. The attempt to surpass $60 ended up being rejected due to seller’s pressure. Two years ago in August, Crude stood at $112 to put things in perspective. The bottom has not formed yet.

Gold [$1,118.25] – Selling pressure eased around $1,200 on multiple occasions. Yet, the recent break below $1,100 was short lived. In the near-term a climb back to $1,200 is not surprising, but the cyclical weakness remains.

DXY – US Dollar Index [96.52] – Since March the dollar strength has paused. However, that occurred after the major surge from the second half of 2014. In the near-term trading pattern appears range bound.

US 10 Year Treasury Yields [2.03%] – The peak on June 11, 2015 at 2.49% suggests the realization of slow growth. Since then yields have declined, showcasing a lack of growth and, in turn, a lack of rate hike potentials.




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