Market Outlook | April 18, 2016

“Greatness is a road leading towards the unknown.” (Charles de Gaulle 1890-1970)

Hardly Settled

An ongoing wave of calmness resonates in the markets in which US stock volatility is still low, yields on European debt are relatively moderate and an all-out panic in the day-to-day is not quite felt. After all, the S&P 500 index is attempting to revisit all-time highs and Crude is not quite at the desperate lows it witnessed early in the year. A breather of sorts, after a turbulent January, is creating mixed reactions. 

Meanwhile, a the quasi-settled turbulence of the financial market  fails to tell the full story.  There are plenty of unsettled nerves in the intermediate-term, as the global political climate is perceived overly turbulent from Britain to Brazil to Russia to China. Western leadership is being questioned, since the global economy is failing to drive more confidence in the globalized and well-established system. Nationalism is in demand, as witnessed in European elections; and, deciphering the consequences of this trend is the ultimate challenge for money managers. The short-term gains from status-quo preservation via stabilization in financial markets are not answering the long-term concerns. 

Important to note, most of these concerns are not new. Significant capital is seeking risk exposure and desperate for returns. Therefore, the sentiment in stock markets is not quite the same sentiment as ground level discussions. Perhaps, all the unsettling issues do not automatically deter many from deploying capital. That’s the critical factor that may explain the ongoing disconnect between the real economy and financial markets.

Sectors' Duress

Financial services are being attacked from multiple angles, as pressure mounts for operators and investors alike. Hedge Funds have under performed recently, energy loans on banks’ balance sheets are troubling, negative interest rates by central banks are troubling, increasing banks' regulatory pressure is impacting margins, populists' vicious attacks on wall street are accelerating and revenue making opportunities for banks seem rather bleak  in 2016.  These are some of the well-known and documented matters. Mounting pressure on financial services can quickly translate to less faith in capitalism and diminishing global growth. That’s a danger to Western civilization and less appreciated in generic discussions. Ultimately that’s the long-term concern and the great unknown. This is the big picture concern that’s awfully difficult to quantify and remains in the back of the heads of most investors.  Unwarranted blames for political gains aside, the financial sector is facing a challenging period in both practical and ideological debates.    

Lively Movements

Emerging Markets (EM) have shown some recovery at least in terms of stock and currency movement. After an abysmal recent run in commodities and EM, the first quarter reminded us that stability is mildly possible:

“The best rally in emerging-market stocks and bonds in seven years is sending bears back into hibernation…Traders added more than $1 billion to U.S.-traded emerging-market stock and bond ETFs this month through April 15.” (Bloomberg, April 17, 2016)

Yet, skepticism is plenty, especially since the fallout in China is not understood. From stimulus efforts in China to tensions in the pacific to demand for Nationalism in the West that can lead to adverse trade relations, misunderstandings abound. Nonetheless, the rift between China and the West is not to be downplayed and the impact is mostly unknown. China is strengthening her ties with EM, especially Russia. At the same time, political tensions with Japan will continue to linger, and, at some point, that can convert into a financial risk.  Western leaders haven’t found a stable answer for China and corporations are realizing new challenges to navigate in China, as well.  Despite the short-term rally in EM, the long-term picture is murky. However, investors are not bothering about the long-term and are willing to live only in the present, for now.

Article Quotes:

“Speaking to the FT during a trip to Beijing, Alexei Moiseev said Russia expected to sign a deal this year that would link China’s national electronic payment network into its own soon-to-be-launched credit card system as part of measures aimed at reducing reliance on the west. ….Amid several rounds of negotiations over financial integration, many see Russia’s primary aim as access to China’s debt markets. Western sanctions mean many of Russia’s largest banks and corporations are unable to raise finance in dollars. Historically low oil prices have also hurt Russia’s economy and led to an increase in financing needs. Meanwhile, China is easing international access to its onshore bond market, estimated at some $6tr — the third largest in the world. Several western banks and corporates, including HSBC and Daimler, as well as South Korea, have over the past year issued so-called 'panda bonds'.” (Financial Times, April 17, 2016)

“For equity investors across the developed world, large chunks of the past year and a half have been miserable. But for different reasons. The International Monetary Fund, in an analysis, looked at the stock-price declines in Europe, the U.S. and Japan from the beginning of 2015 to the market bottom in mid-February of this year. (The U.S. and Europe have since recovered.) For Europe, the analysis tells a particularly dismal story: Corporate earnings play a bigger role in stock slumps in Europe than elsewhere–and corporate profits don’t look good. The IMF breaks the change in prices down into three parts: the risk -free rate of interest, the equity risk premium and the change in current and expected earnings…. The bottom line is that the decline in earnings explains a much bigger share of the decline in stock prices in Europe than it does in Japan or the U.S, and the outlook on that front is considerably more miserable.” (Wall Street Journal, April 15, 2016)

Key Levels: (Prices as of Close: April 15, 2016)

S&P 500 Index [2,080.73] – There has been a major upside move since February 11^th lows. Nearly a 15% increase since then. The ever so familiar range between 1,900-2,100 is being revisited. The May 2015 high of 2,134.72 is the next critical point.

Crude (Spot) [$40.36] –From $26.05 to above $40 showcased a sharp recovery that coincided with the equity markets in recent weeks. Now, there is an attempted stabilization around $40.

Gold [$1,227.10] – March 4^th  highs of $1,277.50 remain a key level in the near-term. Breaking above $1,250 has been a challenge last year and early this year.

DXY – US Dollar Index [94.69] – The Dollar weakness remains a big theme thus far in 2016.  The pullback from 100 to 94 in the near-term defines the current trend.

US 10 Year Treasury Yields [1.75%] – Yields remain closer to annual lows of 1.68%. It further confirms the weakness in the economy as it is perceived by bond markets. Climbing back to 2% seems possible in the near-term.

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