Market Outlook | March 28, 2016

“The best thinking has been done in solitude. The worst has been done in turmoil.” (Thomas Alva Edison 1847-1931)

Still Rattled

Officials publicly declaring that the Central Banks have run out of ammunition may cause an all-out panic. Ironically, the truth is more devastating than the cosmetic day-to-day trading action, as seen in the last two years. There is simply no place to hide from the painful lack of global growth, sluggish demand for commodities and overly exhausted low interest rate policies. At the same time, the uncertain status of the European Union, the sour impact of oil-rich nations, the unclear growth picture in China and the shaky stabilization in commodities add on to a list of unknowns. The status-quo or range-bound trading action appears dull and unsustainable.

Fragility Confronted

Risk-taking, these days, is taking on a whole meaning from traditional measures. The Fed-led narrative itself appears more and more like a theoretical exercise rather than a fact-based assessment of financial markets. Basically, confidence is deflating in the concept of “globalization,” as a new generation is questioning the fruitfulness of capitalism.  Seriously, this a new risk measure that was not quite pondered in the textbooks or trading books of the 1990’s. The wild card of all wild cards should worry investors more than the known, general fundamental-based risks.

Globalization being at risk is only a factor when the slowdown is significant, as witnessed in China. Plus, nationalism is a new trend. As a response, the documented slowdown in global growth appears as much as immigration concerns. Effectively, the weakness in China has unraveled the prior faith of recovery, and lack of wage growth in the US has stirred outrage, especially among voters. Perhaps, both factors are clearly out of the hands of the Central Banks, yet investors continue to glorify the powers of the Central Banks—primarily out of desperation. As American voters wrestle with a “socialist” and nationalist candidates, the state owned companies in China, under the influence of communism, are dealing with the current crisis. The Chinese are attempting to explore privatization along with stimulus efforts (more under article quotes).  The ultimate verdict on the magnitude of the Chinese slowdown is still being digested by consumers, investors and corporate leaders. Perhaps, that’s another wild card to ponder. Meanwhile, the relationship between China and the Western world is another factor that can reshape the outlook of globalization.

Grappling with Priorities

While key money managers struggled to make money last year, investors are now more convinced of the difficulty of dealing with the current market environment. On one hand, finding deeply undervalued assets in energy or emerging markets seems relatively appealing. On the other hand, riding the status-quo is a bit unsettling, despite some signs of stabilization. The major challenges involve everything from trying to predict government agencies moves from the Central Banks to “Brexit” to various elections. In terms of sole reliance on corporate profits or company specific trends, this may not be enough in a macro-centric climate. Therefore, identifying priorities is puzzling, but critical. Is it the macro picture that’s important or company (industry) specific trends that will drive the sentiment? The big picture themes are too interconnected and markets have shown strong correlation, particularly between commodities and stocks.  The wait and see game requires patience, but vision is needed to dodge some bullets. Clearly, there is unease that’s occasionally suppressed, but uncharted territories invite further trepidation.  That’s not overly shocking, but it is certainly hard to accept. 

Article Quotes:

“Beijing's main tool for reducing excess industrial capacity is the reform of China's giant state-owned enterprises (SOEs), something it has been trying to do since the late 1970s. In the 1980s, Beijing sought to make individual state-owned factories responsible for their financial performance by, for example, moving their accounts out of the state budget and onto separate income statements. In the 1990s, Chinese officials attempted to turn legacy communist production units into modern corporations. And in the first decade of this century, Beijing consolidated its oversight of SOEs by creating so-called state asset management committees, with the State-owned Assets Supervision and Administration Commission at the top of the pyramid. Throughout the course of these reforms, the Chinese state, and the Communist Party in particular, has kept a firm grip on the top management of SOEs. The government uses SOEs to support official policy, even appointing government bureaucrats as company executives (usually with massive increases in pay relative to their previous government salaries). But recently, as SOEs in many sectors have suffered big losses, such control has been less rewarding. In the past, Beijing has sought to address this problem by privatizing or shuttering smaller SOEs and maintaining control over the country's larger, more profitable ones—a practice that the government of Chinese President Jiang Zemin introduced in the 1990s under the slogan of ‘grasping the large and letting go of the small’. Today, Beijing is considering relaxing government control through further privatizations, at least in loss-making sectors such as mining, manufacturing, and other heavy industries.” (Council on Foreign Relations, March 24, 2016)

“The average euro area interest rate on new loans to households for house purchase was 2.27% in January 2016 – close to the 2.20% record low observed in May 2015 and less than half the 5.51% record high of October 2008. Interest rate levels have steadily decreased since the end of 2011 when rates were close to 4%, accompanying the decrease in the ECB main refinancing operations rate. At the same time, monthly volumes of new loans for house purchase have been increasing since the beginning of 2012. In 2015 the monthly average volume of new housing loans was €68.5 billion, the second highest peak of the decade, representing an increase of about 45% compared with the averages for the previous five years. In January 2016 new volumes fell by 15% compared with the 2015 average, a phenomenon that has been consistently observed at the beginning of each calendar year since the launch of these statistics in 2003. Interest rates on new bank loans to corporations have followed a broadly similar path to new loans to households for house purchase, reaching the low level of 1.82% in January 2016. Interest rates on corporate loans, like those on new household loans, have steadily decreased following a local peak of 3.48% in December 2011.” (Euro Area Statistics, March 24, 2016)

Key Levels: (Prices as of Close: March 24, 2016)

S&P 500 Index [2,049.58] –   Early signs of resistance appear around the 2,040-2,050 range. After a more than 10% run since February lows now the index is stalling a bit. Given the four day holiday week with low volume, one should wait to conclude before declaring a near-term top.  Failing to break 2,100 again will reconfirm the range-bound action in equity markets.

Crude (Spot) [$39.44] – Unchanged week over week. This suggests that stabilization is forming near $40 for now. An unsettled picture in the demand/supply dynamics might keep prices stable, as well. 

Gold [$1,252.10] – A lengthy bottoming process continues, considering for over two years the commodity has attempted to hold above $1,200. An upside momentum has not fully set-up.

DXY – US Dollar Index [96.14] – Once again, there is a strong bottoming formation around 95. This illustrates the established strength in the dollar, which is a dominant force in currency markets.

US 10 Year Treasury Yields [1.90%] – The last few trading days suggest positive momentum building above 1.80%. However, in the big picture, these trading ranges do not have a big impact.

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