Market Outlook | October 12, 2015

“When we remember we are all mad, the mysteries disappear and life stands explained.” (Mark Twain 1835-1910)

Mystery vs. Brutal Facts

If there was any mystery to the lack of growth globally, that mystery is actually being revealed quickly. It is actually evident as more data supports the lack of basis for a rate hike. Emerging Market outflow is rampant, which is highlighted by China’s struggles and sell-offs this summer. Commodity prices might recover 10% or 20%, but this is dramatically lower than last cycle’s peak, which reinstates the soft demand and ample supply. Amazingly, these macro factors are slowly being digested since most attention was spent on Greece and Eurozone weaknesses. Massive implications await on how the financial markets will deal with the realization of softer growth. Perhaps, “madness” is one way to explain how harsh realities have been deferred. Even the Fed has reached a point where denying the weak growth data is not believable. In a recent interview, the Federal Reserve vice chairman offered the following:

“Recent employment reports have been somewhat disappointing and, as always, we are closely monitoring developments that could affect our sense of the economic outlook and the risks surrounding that outlook.” (Wall Street Journal, October 11, 2015)

Is there any mystery to the US job numbers? That’s been confirmed by weakness in wage growth and last month’s data that was sourly observed by participants. Inflation expectations are so low that growth revival or job creation via government policy is at near-death levels, and corporate profits are generated by cost-cutting as much as expansion. Being upbeat about the US relative edge seems to be wearing out at times, but unquestionably remains a key driving factor. The preference of investors continues to be to own dollar-based assets that are more liquid than tinkering with further risky assets. The commodity and Emerging Market fallout only strengthened the relative edge of US assets. Thus, the zigzagging broad US market (S&P 500 index and Nasdaq) only reflects how a massive US sell-off is hard to justify. The buyers vs. sellers debate comes down to what are the other alternatives? Again and again, the answer is not very appealing growth, so liquidity and strong currency remain preferred.

The Fed’s Creditability

Fed-dependent analysts are in a painstakingly confusing state. The Fed’s credibility is tarnished and their ability to change the real economy is close to zero, unless they are cheerleading or influencing headlines. Are there still suckers for cheery headlines? Sure, at a time of desperation for good momentum, the masses are suspitable to trickery. Some investors may feel hard-done by the expectations of a rate hike in September. Now it sadly laughable because the “posturing” overtook common sense and that should be unsettling. Even now, the Fed target for a rate-hike is unknown and may not have material impact on corporate earnings or wages.

The biggest risk ahead is if investors feel “betrayed” by the Federal Reserve and other central banks. That’s the worst case set-up for those looking to avoid volatility and turbulence. As Eurozone and Japan continue to apply QE policies, perhaps the reception is less warm than prior years. A shift in attitude towards Central banks is a critical sentiment that’s worth tracking closely. At the end of the day without growth, hiking rates is nearly impossible:

“China’s slowing growth, which could spill over to other emerging market economies, raised risks the dollar might strengthen further, making U.S. exports more expensive in foreign markets and creating an additional drag on the economy.” (Bloomberg, October 8, 2015)

Survival Tactics

Last week, the recovery set off some optimistic results in equity markets. The Dollar’s slight weakness begs the question of a possible trend change. The same can be said about the recent rally that gave the sense of relief from uncertainty following the turbulent summer months. As the narratives on gloomy outcomes has been tiresome to some, shocks were felt in August—mainly in fragile economies such as Brazil, Turkey, and South Africa.

The disappointment with the Fed’s policy should lead to a resounding response, barring few surprises. However, there are no surprises about the mutli-year near-zero interest rates. An election year ahead promotes defensive (or non-decision) actions by the Fed, policy makers, and investors, alike. Without many alternatives, the status quo of low rates, low inflation, lower volatility, and higher ‎stocks remains highly favorable. In fact, that's the “safe” play that's being promoted once again. Even Eurozone investments seem appealing to those cautious of taking a bigger risk/reward in emerging markets and commodities. At some point, value seekers must explore cheaper and more opportunistic assets, even in a tough economic and political climate.

Article Quotes:

“The prevailing expectation is of extraordinarily low real interest rates, which is the difference between interest rates and inflation. Real rates have been on a downward trend for nearly a quarter-century, and the average real rate in the industrialized world over the next 10 years is expected to be zero. Even this presumably reflects some probability that it will be artificially increased by nominal rates at a zero bound — the fact that central banks cannot reduce short-term interest rates below zero — and deflation. In the presence of such low real rates, there can be little chance that economies would overheat.” (Larry Summers, Washington Post, October 7, 2015)

“Following this summer's turmoil in Greece, leaders from France's Francois Hollande, the European Commission's Jean-Claude Juncker, and European Central Bank chief Mario Draghi, have spearheaded the drive to create new supra-national institutions such as a eurozone treasury and parliament. But Mr. Blanchard, who departed the IMF two weeks ago, said radical visions for a full-blown ‘fiscal union’ would not solve fundamental tensions at the heart of the euro.’[Fiscal union] is not a panacea’, Mr. Blanchard told The Telegraph. ‘It should be done, but we should not think once it is done, the euro will work perfectly, and things will be forever fine.’ Although pooling common funds, giving Brussels tax and spending powers, and creating a banking union were ‘essential’ reforms, they would still not make the ‘euro function smoothly even in the best of cases’, said the Frenchman. Any mechanism to transfer funds from strong to weak nations - which has been fiercely resisted by Germany - would only mask the fundamental competitiveness problems that will always plague struggling member states, he said.” (The Telegraph, October 10, 2015)




Key Levels: (Prices as of Close: October 9, 2015)

S&P 500 Index [2,014.89] – Signs of stabilization appear as some attempt of a bottom. Once again buyers’ conviction is tested around the 2,000 level. Since September 29th, lows are near an 8% rally, which begs the question of further stability.

Crude (Spot) [$49.36] – Since the lows in August ($37.75), a recovery over several weeks has occurred. Interestingly, the 200-day moving average is at $50.96. Psychologically, the $50 mark is a new benchmark that gives collective rest in expectations.

Gold [$1,151.55] – Stabilizing around $1,120, as gold attempts to climb back to $1,200, which has been a hurdle following the cycle peak. Very neutral action with some hints of early bottoming possibilities are not quite fully convincing.

DXY – US Dollar Index [94.81] – Failing to stay above 96 in the near-term, the dollar remains strong but relative; the strength is a bit weaker than before.

US 10 Year Treasury Yields [2.08%] – Rates continue to be lower, showcasing lower growth environment mixed with a lack of inflation. The August 24th lows of 1.90% are not too far.









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