Market Outlook | October 19, 2015

"No degree of dullness can safeguard a work against the determination of critics to find it fascinating.” (Harold Rosenberg)

Dullness & Anxiety

The status-quo pattern has resurfaced again: no rate hikes, lower growth and low inflation. This leads the investor crowd to fall-back to the usual and common narrative. There is a sense of dullness that’s mixed with occasional anxiety when attempting to paint the current investor sentiment.

Dullness represents the endless QE policies (low rates) applied across multiple continents as the theme is repetitive while failing to produce desired and tangible growth. A major shift in the prices of macro indicators has yet to occur given: US 10 year Treasury yields around 2%, Crude is dancing around or below $50 and the S&P 500 index is hovering above 2000. This symbolizes the very common and familiar ranges at this point. Meanwhile, anxiety has come in waves from one crisis to the next. First, heightened anxiety was felt in the Eurozone with major attention focused on Greece. Then it was the Chinese’s meltdown in the summer, in which mild panic came and went. Then sudden spikes in volatility proved to be short-lived just like some investors memory.

Last year’s anxiety in commodities and Emerging Markets (EM) is less eventful these days as the dust has mostly settled in for now. In other words, the "shock factor" has declined in how investors view the shock of oversupply and weak demand. Yet, even if the shocks appear short-term in nature, each blow (caused by softer global demand) has a lasting long-term impact in which the consequences remain mysterious. The investor who has to plan for the next 3-5 years faces many uncertainties as the previous five years seem like outliers. Maybe investing time to understand prior crisis is one step to discovering the roots of volatility ahead. Yet, the mystery of timing the next burst in anxiety is illusive even to so called financial wizards. The magic of timing is nonexistent!

Pain Realized

A minor rally in the near-term re-energized avid market observers as they seek further upside moves. Yet, the year-to-date performance (S&P 500 index and Dow Jones is negative in 2015) numbers are not overly enticing for momentum chasers. Mounting selling pressure has subsided a bit since August despite brewing concern and very sluggish growth. Ongoing stalemate between buyers and sellers continues to require more patience in US equities. Meanwhile, seeing sharp moves in the Russian rubel or Turkish Lira is not earth shattering anymore for observers who are accustomed to emerging market volatility. Both nations are facing grave economic concerns as they resort to military actions instead of focusing on wealth creation. That’s evident in both countries military involvement in Syria as investors lose confidence with increased capital outflow. Here is the status in Russia:

“Cash fled the country [Russia] in 2014. Last year, net purchases of foreign financial assets by Russian banks and companies reached $122.4 billion, driving total capital outflow to a staggering $153 billion.” (Bloomberg, October 14, 2015)

At the same time, there is wide recognition of vulnerable currencies and struggling economies like Brazil, which have confirmed weakness on multiple fronts. Not to mention, the many nations/economies that are closely tied to China as they felt the effects of lower growth rates especially Latin America. Perhaps, there is numbness to the slowdown in EM, as investors further decipher the magnitude of recent “collapse”. We are nearing a stage where investors may look to “reset” expectations while seeking relatively appealing investments.

Search for Guidance

The key conductors of financial markets are certainly the central banks when measuring by collective perception. Their credibility is (and has been) on the line, yet again. Simply, the act of pundits praising high stock market is one angle in appreciating wealth creation. However, on the ground level, there is brewing tension from struggling middle classes in developed markets to lack of favorable policies that can actually create growth. Beyond savers frustration with low interest rates (not earning enough yield), there is a well-known major disconnect between the stock market and economies. That disconnect has been bothersome and tricky for observers throughout the recent bull market. Yet, an investor calling for an all out collapse must consider the art of financial markets where truth discovery takes up time. Until Emerging Markets can restore confidence, capital will prefer developed market assets as witnessed recently. Amazingly, stability in EM would add a twist to the current dynamic. Yet, what’s the next big surprise? Weakness in Developed Markets via corporate earnings? Or undiscovered turmoil in China and other Emerging Markets? In today’s landscape figuring out these two questions potentially presents an attractive reward ahead. The critical thinker that sees beyond the known dullness and occasional anxiety, one can only ask for the fortune of being on the right side of the pending surprise.

Article Quotes:

“What went wrong in Latin America? The short answer is China’s slowdown, which has punctured commodity prices and, with them, exports from and investment in South America. In some cases the woes are mainly self-inflicted. Brazil and Venezuela kept spending even after the commodity boom began to subside. Both are now suffering deep recessions. Exclude these two and Latin American countries will grow by 2.6% this year on average, according to the IMF. From the Panama Canal north, the region’s economies are tied much more closely to the United States than to China. Mexico, Central America and the Caribbean are net commodity importers. Growth there is steady, if mostly unspectacular. Well-managed economies in South America, such as Peru, Chile and Colombia, are adjusting gradually to a harsher world. They are still growing, albeit at only 2-3%, because they have been able to apply a modest amount of monetary and fiscal stimulus. Currency depreciations should eventually pave the way for recovery. But in the short term they have stirred inflation. The central banks of both Peru and Colombia raised their interest rates last month; Chile may follow.” (The Economist, October 10, 2015).

“Without anyone quite noticing, Europe’s internal balance of power has been shifting. Germany’s dominant position, which has seemed absolute since the 2008 financial crisis, is gradually weakening – with far-reaching implications for the European Union. Of course, from a soft-power perspective, the mere fact that people believe Germany is strong bolsters the country’s status and strategic position. But it will not be long before people begin to notice that the main driver of that perception – that Germany’s economy continued to grow, while most other eurozone economies experienced a prolonged recession – represents an exceptional circumstance, one that will soon disappear. In 12 of the last 20 years, Germany’s growth rate been lower than the average of the other three large eurozone countries (France, Italy, and Spain). Although German growth surged ahead during the post-crisis period, as the graph shows, the International Monetary Fund predicts that it will fall back below that three-country average – and far below the eurozone average, which includes the smaller high-growth countries of Central and Eastern Europe – within five years.” (Project-Syndicate, October 15, 2015)



Key Levels: (Prices as of Close: October 16, 2015)

S&P 500 Index [2,033.11] – A near 9% rally since the August and September lows showcasing some recovery from prior sell-offs. Easing of the selling pressure is reflected in the declining volatility. Climbing back up to 2100 is the next critical mark for observers.

Crude (Spot) [$47.26] – Some stabilization in prices in last few weeks. Clearly, the $50 range is the near-term level for gauging momentum.

Gold [$1,180.85] – Long drawn out bottoming attempt around $1,200. The lack of catalysts for upside move is visible. Yet, the heavy selling multi-year cycle pressure has eased.

DXY – US Dollar Index [94.81] – Following a major surge in late 2014 and early 2015, the dollar is calmer now. The dollar strength is not overwhelming like before but still much stronger than other currencies on relative basis.

US 10 Year Treasury Yields [2.03%] – Once again, closer to 2% rather than 2.50%. Not surprising when considering the low inflation and low growth forces.



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