Market Outlook | November 16, 2015

“Passion is a positive obsession. Obsession is a negative passion.” (Paul Carvel)

Summary

A collective meltdown across various markets like the one seen this August is potentially looming. At least, the hints are mounting a bit as showcased in last week's trading pattern. Or at least a short-lived correction is mildly underway. The onslaught of commodity prices and sluggish global economy is painful to ignore.

‎Investors are struggling between postponing the inevitable sell-off and confronting the not so pleasant reality. Basically this is playing out in a tug of war between buyers and sellers. This is surely felt in the chart of the S&P 500 index where the action is range bound and lacks directional conviction. The August lows and the May highs serve as the benchmark. However, justifying the elevated share price levels has become harder and harder for the bullish camp. Thus, uncertainly is storming back into the daily market action.

Unhealthy Conditions

If US equity appears overpriced and the global economy continues to slowdown, then a synchronized sinking in asset prices should follow suite. For one, the commodity plunge becomes sharp and sharper for any neutral observer. Not to mention, the Emerging Market debacle is such a mess that each bad news ends up strengthening the dollar. Therefore, the dollar strength stands out once again on a relative basis. Central bank and election chatter cannot improve sentiment overnight. Terrible developments in foreign policy (from Syria, Ukraine, etc) have foreshadowed a lot of the turmoil and slowdown. That said, seeking shelter in an all-time highs stock market is not enough as a long-term solution. At some point, the risk of over piling capital in perceived “safe” assets can shift suddenly. This was tangibly felt in the rise of the volatility index (VIX) in the last two weeks. Nervousness is back.

Demise Revisited

From a global point of view, oil is collapsing due to supply expansion and demand contraction. This is the simple part to grasp. The implication of low oil prices on foreign policy is the complex part, but markets are not dissecting that at this moment. The massive finding on how the commodities are and a clear-cut downturn is alarming to some, but the statement is not quite debatable at this stage:

“Surplus oil inventories are at the highest level in at least a decade because of increased global production, according to the Organization of Petroleum Exporting Countries. Stockpiles in developed economies are 210 million barrels higher than their five-year average, exceeding the glut that accumulated in early 2009 after the financial crisis, the organization said in a report.” (Bloomberg, November 12,2015).

The commodity market has essentially signaled the brutally weak global real economy, where banks, energy companies, and jobs in the energy sector all suffer. The knee-jerk reaction of low oil leading to positive consumer result is a half-truth, which dismisses the full picture. The consequences of weak commodity prices are now being understood and the findings are not thrilling.

The Noisy Mystery

So much attention on the Fed’s next move and so much debate about economic data via flawed and opaque data collection; however, there has not been much debate about the state of key global economies and how it should impact corporate earnings and sentiment. Secondly, the regulatory burden (post 2008 crisis) on companies of all sizes ends up hurting small businesses the most. How can one deny this? Capital seekers and preservers of entrepreneurship have lost confidence in the current landscape.

That said, the symbolic Fed decision appears less relevant despite the headline obsession in business circles. Without pro-growth policies and emerging economies on the brink of collapse, the Fed’s decision is not as massive as it has been made out to be. Certainly, central banks create a lot of noise, but their low rate policies are hardly mysterious. Perhaps, sentiment and attitude towards growth will drive perception as much as the Fed’s policy.

Article Quotes:


“The GDP figure for the eurozone as a whole followed the release earlier on Friday of a mixed set of readings from the currency area’s three largest economies. Growth in the largest economy, Germany, slowed between the second and third quarters on the back of weaker foreign trade, expanding 0.3 per cent — in line with expectations but down from 0.4 per cent in the previous three months. Italy’s economy, the bloc’s third largest, grew 0.2 per cent, down from 0.3 per cent in the second quarter and falling short of forecasts. Istat, the national statistics agency, said stronger domestic demand had compensated for poor export figures. A brighter spot was France where growth took off, moving up to 0.3 per cent after grinding to a halt in the second quarter. The growth, boosted by domestic demand and industrial production, was slightly better than earlier official forecasts. France’s return to growth means it is on course to achieve its target of at least 1 per cent growth this year. That would end three years of stagnation in the eurozone’s second-largest economy. But growth still looks set to fall short of the 1.5 per cent target that economists believe is needed to lower the country’s 10 per cent unemployment rate.” (Financial Times, November 13, 2015)

“The credit boom in emerging markets was in large part a response to the credit bust in the rich world. Fearing a depression in its richest export markets, the authorities in China brought about a massive increase in credit in 2009. Meanwhile a flood of capital escaping the paltry yields on offer in developed economies pushed interest rates lower in developing ones. This search for yield by rich-world investors took them to ever more exotic places. A dollar-denominated government bond issued in 2012 by Zambia, a copper-rich country with an average GDP per person of $1,700 a year, offered just 5.4% interest; even so, it was 24 times oversubscribed as rich-world investors clamoured to buy. The following year a state-backed tuna-fishing venture in Mozambique, a country even poorer than Zambia, was able to raise $850m at an interest rate of 8.5%.In contrast to the credit booms in America and Europe, where households were the main borrowers, three-quarters of the private debt burden in emerging markets is shouldered by businesses: corporate debt has ballooned from less than 50% of GDP in 2008 to almost 75% by 2014. Much of the lending was done in Asia, notably in China. But Turkey, Brazil and Chile also saw substantial increases in the ratio of company debt to GDP (see chart 2). Construction firms (notably in China and Latin America) increased their leverage a great deal. The oil and gas industry was a big player, too, according to the IMF’s latest Global Financial Stability Report.” (The Economist, November 14, 2015).


Key Levels: (Prices as of Close: November 13, 2015)

S&P 500 Index [2,023.04] – Once again the index failed to reach 2,100, showcasing the important technical level where buyers lose momentum. After making a strong run since August 24th lows (1867.01), early signs of fading optimism.

Crude (Spot) [$40.74] – The ferocious sell-off continues as crude drops back to $40. Clearly, the multiple pressures that mounted forced the additional downside move. More supply of oil with less demand is surely playing out in prices.

Gold [$1,081.50] – Very close to August 2015 lows of $1,080.80, as a recent sell-off wiped out any upside momentum. In big picture terms, gold is less eventful as the commodity cycles remain in a multi-year downturn.

DXY – US Dollar Index [98.99] – Dollar strength remains intact and reflects further weakness in other currencies. Certainly, an asset that’s valued more during anuncertain period, which has been illustrated by the actions of the last two weeks.

US 10 Year Treasury Yields [2.26%] – Failed to hold above 2.35%, as the recent rise in yields is being debated. The behavior from the last two weeks needs confirmation that yields are going much lower.





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