Market Outlook | June 27, 2016

“Surprises are foolish things. The pleasure is not enhanced, and the inconvenience is often considerable.” (Jane Austen 1775-1817)

Digesting Surprises

To the surprise of many, Brexit materialized and markets reacted. In short, results were historic. The element of surprise is not pretty, especially when the stakes are much higher. Hence, Friday’s (June 24) swings and demonstrative reactions across key markets.

“The $2.08 trillion wiped off global equity markets on Friday after Britain voted to leave the European Union was the biggest daily loss ever, trumping the Lehman Brothers bankruptcy during the 2008 financial crisis and the Black Monday stock market crash of 1987, according to Standard & Poor's Dow Jones Indices.” (Reuters, June 26, 2016)

Brexit is not the cause of a multi-year decline in global growth. Rather the effect of a weak European Union, frustration over lack of real economy vibrancy, reflection of poor Western pool leadership (on local and global basis) and a reality check for overly-inflated markets. What has inflated select markets can be attributed to the "disconnect" that's been persistently in developed equity markets ‎and select real estate investments.

Several basic questions need to be asked about the formation of the European Union in 1993. If European countries were in a position of strength in the first place, why form a union? If the Economy was strong then, why would “Brexit” be such a big deal? If the Union was so great, why did Brexit materialize?  In answering all these questions, one must grasp the biases and agendas of this storytellers. All that said, there is no denying that the union is weak, just like the Eurozone economies.

Early Conclusions

The last four years have showcased three grand themes:

• The US and other nations failed to stimulate real and vibrant growth that sustains the middle class and small-mid size businesses.
• The loss of Central Bank’s creditability, who have kept rates low while failing to admit the minimal impact on stimulating economies. Now with more desperation, Central Banks will look to provide liquidity while orchestrating “crisis management”     
• The lack of future faith in globalization since the flow of goods, capital and people has not translated to wealth creation across local economies.

One critical perspective to keep in mind: The interest rate hike discussion in the US is looking more and more off the table, regardless of Brexit. Perhaps, now Yellen may have found an excuse or an "out" to claim that a rate-hike is not feasible due to the current uncertainly. However, prior rate hikes were unjustified, the Fed’s narrative was misleading (albeit not fully recognized), and the economic reality in being confronted in a harsh manner has set in. Central Banks from Japan to England to ECB are forced to adjust to current conditions, but most of this is caused by self-inflicted wounds. The complete dismissal of the truth by financial leaders has postponed the inevitable correction, which is way overdue.   

Days Ahead

As reactions and over-reactions are being understood and executed, the broader question relates to market behavior over the next six months. Digesting the news quickly is more vital than being consumed with the theatrics of volatility and media obsession.

Exploring the Next 6 Months:

1)     A US Interest Rate hike is very unlikely in 2016.

In a world already consumed with negative rates, that theme is not bound to change. US 10 Year Yields already hinted at further decline months before, and bond markets are unimpressed with US economic data. Thus, unless there is a miraculous real economy revival, further economic weakness may trigger discussions of rate cuts rather than rate hikes. Perhaps, that’s the surprise of all surprises ahead.

2)     Volatility in public markets to continue.    

                                           

      Turbulence is a function of two issues. First, the surprise element leads to shock-like responses, which turn into violent short-term moves. Basically, emotion-driven responses. Second, the unknown will be even more mysterious than usual. Thus, timing the end of the turbulence is extremely difficult, which makes more investors seek “safer” assets for shelter.

3)    Brexit can trigger new themes and opportunities.

In the last five years, both commodities and Emerging Markets (assets and currencies) witnessed massive price corrections. Gold is attracting new momentum, while other commodities still appear cheap relative to last decade prices. Meanwhile, EM themes that were in desperate conditions may look relatively appealing as the Eurozone mess is exposed once again. Plus, in a world of low interest rates, further risk taking may be welcomed in less overvalued areas. From Argentina to China, bargain hunters may seek ideas as developed markets wrestle with ongoing volatility.

Bottom-line: In the weeks ahead, the market is gearing to rotate from digesting a surprise to grasping the new landscape. However, this rotation may materialize much faster than the consensus expects. Capitalizing on quick changes early might be where the big reward lies. 

Article Quotes:

“China responded to a surge in the dollar by weakening its currency fixing by the most since the aftermath of August’s devaluation. The People’s Bank of China set the reference rate 0.9 percent weaker at 6.6375 a dollar. A gauge of the greenback’s strength climbed 1.8 percent on Friday, the most since 2011 as the U.K.’s vote to exit the European Union ignited turmoil in global financial markets. The victory for Brexit pummeled the pound and high-yielding assets as more than $2.5 trillion was wiped from global equity values. China shared $598 billion in trade with the EU last year, second only to the U.S., and slowing growth and capital outflows make the nation vulnerable to the effects of the Brexit vote, according to Bloomberg Intelligence economists Fielding Chen and Tom Orlik. If Brexit does trigger a significant adverse impact on European demand and global investor sentiment, China could be among the Asian economies least well-placed to respond, they say.” (Bloomberg, June 16, 2016)

“The UK makes up just 1.6 per cent of world oil demand, so crude should not be too affected by a Brexit vote, many traders think. But some analysts think the market is being blasé. The oil market, while primarily driven long term by supply and demand, can be heavily influenced in the short term by currency moves and traders’ risk appetite. In the event of a Brexit the US dollar is expected to strengthen sharply, weighing across dollar-denominated commodities as they become more expensive for holders of other currencies. There may also be a flight to safety — in such a sell-off oil tends to get dumped by the fast-money in favour of assets like gold. The Greece crisis in 2012 helped trigger a near 30 per cent drop in the oil price, albeit from a level well above its current price of $50 a barrel. Demand is also not entirely removed from the equation. While the UK’s 64m people consume only 1.6m barrels a day — compared to 19.6m b/d in the US, the world’s largest oil consumer — the total EU bloc covers more than 500m people and accounts for almost 15 per cent of global oil demand (12.5m b/d). A Brexit is expected to be followed by greater uncertainty across the EU, probably hampering growth in an area where oil demand was already declining for much of the past decade.” (Financial Times, June 23, 2016)

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

S&P 500 Index [2,037.41] – Failed at 2,100 in April and again in June. In the near-term stabilization around 2,050 will be watched closely. However, based on the recent moves in the 2+ years, a move to $1,900 appears like the next target.  

  

Crude (Spot) [$47.64] – The commodity is trading within a set range of $46-50 at a  50-day moving average of $46.79, which will be tracked closely by technical observers.

Gold [$1,315.50] – A break above $1,280 marks a new, positive momentum. Staying above $1,300 seems feasible if the shift toward safe assets continues to emerge. Even before Brexit, stabilization was forming.   

DXY – US Dollar Index [95.44] – A massive one-day move. Before the Brexit commotion, the currency index was slightly dull in a range bound trade.

US 10 Year Treasury Yields [1.60%] –   The break below 1.80% earlier this month showcased the weak global economy and lower chances of a rate-hike. Meanwhile, the post-Brexit response was very pronounced, hitting the extreme range of 1.40% at one point during Friday.

Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.