Market Outlook | October 26, 2015

“A lesson that is never learned can never be too often taught.” (Seneca)

Recurring Themes

The major themes from the financial market in 2014 continue to resurface again in a vicious form. Last year, the US dollar strength was quite visible, especially with the collapse of Emerging Market currencies. EM risk has not declined and weak growth numbers suggest the level of risk is being discovered. In fact, the risk to emerging markets is openly addressed by various policymakers:


“ ‘What worries me about the global economy right now is that we see the consequences of some of the policies that were used in response to the crisis, specifically big build-ups of debt,’ he [Mark Carney, Bank of England’s governor] told an audience in Lima, Peru. ‘A lot of it comes from outside the formal banking sector in a number of countries and emerging market economies. That debt and the policy response to that debt is going to be key.’” (The Telegraph, October 8, 2015)

As a result of concerns in developing markets, investors rushed (and continue to rush) into safe assets as capital rotates into US dollars. When said and done, investment options are very limited in a less-thrilling growth environment where yields are closer to zero. That’s the recurring message felt by investors and policymakers alike.

Limited Options

Although, stocks are not exactly at all time highs, the lack of investment options have lead to a rotation into US equities. This, in turn, minimizes the selling pressure of US stocks, which are deemed positive from a relative perspective. The mild scare from last August regarding Chinese markets came and went. The spikes in volatility are short-lived or isolated to regions or specific countries. A broad based panic that forces a dramatic selling for months has not arrived, yet.

In fact, the multi- year bullish run appears intact, despite the wobbly nature of US stock markets. Recent recovery in broad indexes from S&P 500 to Nasdaq confirm how the optimists have not bailed out of their stock holdings. Similarly, even the bears are noticing the resiliency of liquid markets. Meanwhile, participants seem to have a numb response to known “bad news,” which is hardly surprising these days.

More stimulus efforts via Quantitative Easing (QE) become a never-ending theme as exhibited by the European Central bank last week. At the same time, no rate hikes from the Federal Reserve tells the story:

1) Lack of economic growth is not overly bothersome to financial markets—as learned before, many times in recent years.

2) More QE has become an accepted justification to keep share prices higher for larger companies. This is already witnessed in the US, and the Eurozone is seeing the same pattern.

3) Commodities' weakness persists, reflecting soft demand. A quick turnaround seems difficult; it surely takes time as cyclical downturn is lengthy.


Discoveries & Questions

Truth discovery is the first part of navigating markets. Understanding the real catalyst beyond headlines or Central bank trickery is essential. Then implementing the discovered truth is a massive challenge for investors, but very important. In late 2015, there are not many surprising discoveries, instead the same lessons keep repeating again and again.

Truth discovery in the following topics serves as critical market understanding:

1) Are stimulus efforts re-energizing the real economy?

2) Is the real economy growing globally?

3) Have central banks run out of ideas and in a desperate mode?

The test for investors has been to avoid the temptations of thinking that weakness in economic themes leads to lower stock markets. Figuring out the mixed data and reaching a conclusion is challenging, as well. Clearly, economic trends haven’t changed as desired, inflation is low along with rates, and sustainable growth is hard to come by. If actions speak louder than words, then the Fed would’ve raised rates if the economy was in good shape. At this stage, outside of posturing by the Fed and selective data points, it becomes fair to say that there are not many pieces of tangible evidence that show improvement in the economy. However, the disconnect between the economic conditions and stock prices are not that shocking to close market observers. Considering the fact that investors flock to what’s safe (i.e. liquid assets) and capital follows momentum, the resurgence of US broad indexes is understandable. However, the status-quo should not be overly celebrated as a sign of elimination of risk or clear-cut signs of robust growth. Instead, the recent action should be recognized as a sign that policymakers and investors are running out of ideas with few exceptions. Plus, commodities and Emerging Markets have not fully showcased a healthy and reliable recovery.

Article Quotes:

“China has never said the economy must grow seven percent this year, Premier Li Keqiang said in comments reported by the government ahead of a key meeting this week that will set economic and social targets for the next five years. Li's comments coincide with remarks by a top central bank official, who said on Saturday that China would be able to keep annual economic growth at around 6-7 percent over that period. The statements come at a time of growing concern in global financial markets over China's once mighty economic juggernaut. China cut interest rates for the sixth time in less than a year on Friday. Monetary policy easing in the world's second-largest economy is at its most aggressive since the 2008/09 financial crisis, as growth looks set to slip to a 25-year-low this year of under 7 percent. China's economy grew 6.9 percent in the July-to-September quarter from a year earlier, data showed last week.‎” (Reuters, October 25, 2015)

"Some companies including GMK Norilsk Nickel PJSC, Russia’s biggest mining company, and Turkey’s largest mobile operator, known as Turkcell, have returned to the debt market this month after weakness in the dollar helped lower emerging-market borrowing costs from a four-year high. In Brazil, the redemptions are contributing to capital outflows. At least three small and medium-sized Brazilian banks, including Banco do Estado do Rio Grande do Sul SA and Banco BMG SA, have offered to buy back their overseas bonds in the past month amid a selloff in developing-market assets. The Institute of International Finance forecast on Oct. 1 that about $540 billion will leave emerging markets this year, the first net capital outflow since 1988. The unwinding of dollar borrowings is more than a fleeting phenomenon, which will contribute to the weakening of emerging-market currencies against the U.S. currency, according to Pierre Lapointe, the Montreal-based head of global strategy and research at Pavilion Global Markets Ltd. The Fed’s broad measure of the dollar against major U.S. trading partners has rallied 16 percent since the middle of 2014 and reached a 12-year high.” (Bloomberg, October 16, 2015)


Key Levels: (Prices as of Close: October 23, 2015)

S&P 500 Index [2,075.15] – An upside run continues from August lows and is approaching a critical 2,100 range. The recent break of the 200-day moving average (2,060.11) showcases revived momentum.

Crude (Spot) [$44.66] – Once again, Crude fails to stay above $48. This confirms the slowing momentum closer to $50. Again, the supply-demand set-up suggests lower prices than prior projections.

Gold [$1,161.25] – Attempts to climb to $1,200, but not quite convincing to observers. Gold remains range-bound at this time. Surpassing $1,200 is a near-term challenge, yet again.

DXY – US Dollar Index [97.12] – Dollar strength regained its momentum. A sharp turnaround since October 15, 2015 has reiterated the dollar strength—a dominate theme for over a year.

US 10 Year Treasury Yields [2.08%] – Yields are closer to 2% and confirm the weak economy, though bond markets are not convinced yet. Interestingly, a move below 2% shouldn’t be overly shocking, even at this stage.









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