Market Outlook | September 21, 2015

“It pays to be obvious, especially if you have a reputation for subtlety.” (Isaac Asimov 1920-1992)

More Hype Than Substance

The circus around interest rate decisions was merely a sideshow when all is said and done. Amazingly, before the rate decision, the Fed gave mixed signals while acknowledging the slowdown in various US and global data. For the most part, the Fed faced a lose-lose situation in gauging the reaction to a hike or no hike.

So much hype, speculation, and chatter about Fed's decision created some short-term drama for observers. Instead, the collective attention should be channeled to the ‎big picture themes: China, along with Emerging markets, continues to demonstrate a remarkable slowing global economy and fragile EM currencies. Eventually, that’s what it comes down to when assessing to hike or not. The verdict could not have been reached in a week or month. Mounting evidence of unimpressive growth has been persistent for too long and the all-time highs markets were a bit deceptive of real conditions.

Dollar strength for a long while confirmed the demise of some EM currencies and re-confirmed the lack of confidence in non-developed nations. Financial market observers have witnessed a complete collapse of EM from Turkey to Brazil, in a stunning manner. Thus, the Fed had all these visible signals to consider. Substantial weaknesses sounded and some economists did not want to hear. Similarly, US bond markets since June suggested that low rates are here to stay, as exhibited by action in the US 10 year treasuries. Not to mention, the commodities multi-year slowdown turned the decade old boom to a very quick bust from copper to crude.

Can’t Fight Reality

So what did the Fed decide? Despite making promises of "we'll raise soon" and claiming the "economy is improving," the Federal Reserve felt the pain of raising rates without strong support from recent data. Clearly, Yellen & Co lacked a solid justification in an awfully sluggish growth climate. US employment numbers are one misleading piece of data, since the numbers focus on low-wages and non-innovative sectors. Plus, small business has been facing ongoing pressure from regulation mixed with massive competition. The Fed, by not alternating the status-quo, admits their flawed promises, and this is the ultimate capitulation to prior narratives. Again, the reality simply equals no growth and no one wants to hear that for obvious reasons of course.

Misled and naive investors that expected rate hikes must be dejected, but for a long while bond markets have loudly signaled a low interest rate environment. Here is one survey from this summer:

“About 82% of economists surveyed Friday through Tuesday by The Wall Street Journal said the Fed’s first rate increase will come in September, versus 13% who said the central bank will wait until December.” (Wall Street Journal, August 13, 2015)
It is stunning how many economists had high conviction for a September hike while they ignored major financial market hints. Not to mention, the Fed’s wishy-washy approach adds further trickery.

Basically, the big picture vital signals and clues were clear: US 10 year treasury yields are below 2.50%, Crude is below $50, and Emerging Markets are way off their highs. Isn't that clear enough? Surely, interpretations are not highly required when markets themselves hint, confirm, and showcase reality via price movement. Perhaps, the illusion is in thinking the Fed (or other central banks for that matter) can stimulate the real economy. Plus, ‎an election year is looming, which favors doing nothing. At the same time, the usual art of words and trickery by government institutions are to be expected.

Implications

Now uncertainty still persists, especially in equity and currency markets. To be fair, it was brewing even before the Fed's hyped "no decision." Pundits have pointed out that by not raising rate the Fed is benefiting Emerging Markets. Before the announcement, a rate hike was feared to cause further damage to Emerging Markets:

Emerging markets have accumulated $7.5 trillion of external debt and are acutely vulnerable to a rapid rise in US interest rates, regardless of whether they borrowed in dollars or their own currencies, Fitch Ratings has warned. (Telegraph, September 14, 2015)
As for Europe and Japan, the implication of no US interest rate hike signals a different currency challenge. In other words, it is anticipated that ECB will continue with more quantitative easing (QE) to weaken the Euro. Similarly, the Yen is expected to strengthen given the status quo of low US rates. Risk managers will have to access both closely as the implication are significant to financial markets.

As for stocks, the re-test of August lows does not seem far-fetched. Investors must recognize two issues: 1) If the Fed did not raise rates then the economy is much weaker than touted by the consensus. That’s alarming for some, but the weakness is confirmed. 2) The Fed can not save the economy and heavy reliance on the central banks is dangerous. In fact, investors might say – the Fed is unreliable and limited with their perceived “magical” powers. These factors are bound to cause further uncertainty as the bottom has not settled. It is fair to say, the status-quo is unsettled.

Article Quotes:

“ Inflation in the euro area slowed almost to a standstill in August, adding to the challenges for the European Central Bank in its efforts to revive price growth in the region. Consumer prices in the 19-nation currency bloc rose 0.1 percent in August compared to a year earlier, after 0.2 percent in July, the European Union’s statistics office in Luxembourg said on Wednesday. That reading is the lowest in four months, and compares to an initial estimate of 0.2 percent in August… Core inflation, which strips out volatile elements such as energy and food, slowed to 0.9 percent in August from 1 percent in July. Prices in the euro area have been almost stagnant since the ECB started its 1.1 trillion-euro ($1.2 trillion) QE program in March. The inflation rate rose to 0.3 percent in May before slowing again in the following months.” (Bloomberg, September 16, 2015)

“China’s grand vision of an interconnected trade network for South and Central Asia represents the realization of an older U.S. policy initiative. For the last four years, the U.S. State Department has been trying to foster a similar regional trade network through its “New Silk Road Initiative,” a policy unveiled in 2011 to foster economic cooperation, trade liberalization, and better ties across South and Central Asia. The economic initiative had a clear security goal: helping set the conditions for a stable Afghanistan after the withdrawal of U.S. troops, a point outlined by Bob Hormats, who was then the undersecretary of state for economic, agricultural and energy affairs… The crucial element of the initiative was to integrate key pieces of infrastructure in Kazakhstan, Turkmenistan, Pakistan, and Afghanistan, such as telecom networks, railways, and highways.” (Foreign Policy, September 18, 2015)

Key Levels: (Prices as of Close: September 18, 2015)

S&P 500 Index [1,958.03] – Failing to rise above 2,000 after the major sell-off last month, the index chart pattern appears vulnerable as stability remains fragile. Buyers and sellers are fighting for control between 1900-2000.

Crude (Spot) [$44.68] – Weakness that has persisted for months continues to linger. Failure to hold above $50 again confirms not only a soft demand with tons of supply, but a cyclical weakness.

Gold [$1,141.50] – Four years ago, Gold hit the highs of $1,195.00. Since that peak the downside is well known and established. Some bottoming pattern is forming around $1,100, yet a recovery seems to be a drawn out process.

DXY – US Dollar Index [94.86] – Twice this past summer, the dollar index failed to climb above 98. Signs of a relatively waning dollar strength appear; albeit, in the big picture, the dollar strength is resoundingly intact.

US 10 Year Treasury Yields [2.13%] – Since June highs of 2.49%, it is quite clear that yields are on a short-term and multi-decade downturn.








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