Market Outlook | September 26, 2016

“Success builds character, failure reveals it.” (Dave Checkett)

Discovering Failure

The Central Banks’ ability to stimulate economies has and is continuing to fail miserably. Despite interpretations by financial markets, sugar-coating by Phd economists and confusing messages by central banks, the Central Banks’ inability is enough to make market participants uneasy.  The Bank of Japan’s actions serves as a warning for the US and Eurozone, as growth is illusive and real economy vibrancy continues to struggle in low rate environment. It is only a matter of time before policymakers stop pretending that QE is working. In fact, the Federal Reserve is split on rate-hike policy, and the bond markets do not buy the posturing of a rate-hike. In fact, for a long while bond markets have not bought the story. However, with volatility low and panic mostly contained, the Central Banks can feel they have control of financial markets, albeit in a fragile manner.

Equities: The well-established bullish run continues to trigger new all-time highs in some areas. Participants are not owing stocks because of stellar fundamentals, as taught in schools or practiced in prior years. Instead, desperation for yield, lack of alternatives and return chasing keeps people in the traditional liquid markets and primary stocks. Once again, investors are quite aware that earnings are struggling:

“Companies in the S&P 500 are now expected to report negative earnings growth for the sixth consecutive quarter in the coming weeks, according to analysts polled by FactSet. That slump would be the longest since FactSet began tracking the data in 2008.” (Wall Street Journal, September 25, 2016)

Of course, technology and growth driven shares continue to reaffirm confidence and market leadership.  However, broad indexes have traded in a narrow range for several weeks. And stocks do not offer an ideal entry point for longer-term investors. European banks have showcased notable weaknesses and may stir concerns soon.

A deeply awaited re-acceleration in stocks is what keeps the Bulls confident. Over-reliance on the Federal Reserve and complete abandonment of grass-roots fundamentals heightens the risks, especially for ultra-bulls. Not to mention, the shift in the Fed's status-quo is a long awaited catalyst, but with suppressed volatility concern it is not fully visible. 

Money Managers’ vibes: The overall sentiment in public statements and articles showcase money managers are talking down the market and talking up the risks, ‎which is nothing new. What else is new? Money managers continue to ask “what's the basis for growth?” “What's the favorable policy ahead?” And “is the Fed running out of fuel?” One example of a money manager sharing another warning:

“Laurence D. Fink, who runs the world’s largest asset manager as chief executive officer of BlackRock Inc., said markets may fall 15 percent if governments don’t take aggressive fiscal policy actions and there are aberrant results from referendums in Europe.” (Bloomberg, September 22, 2016)

The Fed's scheme: Posturing and confusing market participants has been the motto and, amazingly, it has worked. Even though
 the Fed losses credibility on one hand, it continues to dominate with its influence as the central bank obsession lives on. Most, of the investors’ obsession is driven by the lack of other options. To bet against a Fed-obsessed market takes a lot of courage and can be the rewarding future trade.  It feels like no escape from the consensus view, but a courageous few seeking big rewards are considering the anti-status-quo bet.

Until, participants abandon faith in the Federal Reserve by rushing into "safer" assets, the Fed's confidence on steering the ship remains high. The inflection point is not about participants confidence as much as the Fed's confidence. A divided Fed combined with investors fleeing the Fed's thesis can cause short-term turbulence while sending a long-term message.

The hunt for yields: ‎ Without a justified rate-hike ahead, the status-quo of low interest rates will continue to persist. In turn, chasing high yield investments in riskier areas will continue to manifest itself. Amazingly, Greek 10-year bonds are trading near 8% and Brazilian 10-year is at 11.82%. Basically, in recent years, the risk perception has rapidly calmed down in Europe. Investor demands for riskier ­assets persists even more, which may benefit Emerging Market assets.  

Dodging all risk means facing zero to negative interests, and savers are irate on this set-up given the changes in the fixed income world. Thus, investors feel anxious and eager to put capital to work to generate yields. The numbing effect of low rates drive investors to be a bit impatient at times. Further complacency continues to resurface in the market as central banks openly encourage risk-taking via low rate policies.

Catalyst search:  Besides the massive attention that surrounds the interest rate discussion, commodities are lingering in the background. On one end, if global demand for oil is very low then that confirms further weakness in the real economy. At the same time, supply is abundant and OPEC nations are desperate to keep prices stable. Thus, a weakening commodities market can put further pressure in other assets, such as equities. In a connected way, weaker commodities and a stronger US Dollar can spark some additional shocks, as well. Interestingly, weaker commodity prices can stir further political risk as oil dependant nations (Saudi, Iran, Russia etc) may act out of desperation. Thus,  declining Crude prices (again) can impact commodities, currencies and geopolitical factors in the months ahead.  

Article Quotes:

Post Brexit discussion:  “The European Central Bank doesn't just determine monetary policy. Today the bank provided a list of 'other decisions' taken by its governing council at its most recent meetings, and while most of it is pretty dull, there was one line that seems to indicate that the bank is moving to make sure the U.K. will no longer have anything to do with manufacturing euro banknotes, should a so-called 'hard Brexit' occur… In the context of Brexit's far-ranging economic implications, the location of a money-printing business is possibly of little consequence, but as debates about London's role in clearing rage on, today's move by the ECB does show European institutions are starting to lay the groundwork for a post-U.K. European Union.” (Bloomberg, September 23, 2016)

“Ms Yellen repeatedly stated that politics was not discussed in her committee, adding that this will be reflected in black and white when transcripts of the Fed’s deliberations are released in five years. Nevertheless, there is ample reason for the Fed to tread carefully given the US is less than two months from one of the most fraught general elections in modern times. So where does this leave the hawks in the Fed? Ms Yellen tried to argue that differences between officials are minor, centring on timing rather than fundamental differences of policy. But there is no doubt that she has a revolt on her hands. Three regional Fed presidents — Loretta Mester, Esther George and Eric Rosengren — voted for an increase. This was the first time three members dissented in the same direction since September 2011, and only the fifth time in 30 years, according to a trawl of Fed records by Goldman Sachs.” (Financial Times, September 22, 2016)

Key Levels: (Prices as of Close: September 23, 2016)

S&P 500 Index [2,139.16] – In the last 50 days, the S&P 500 index has wrestled between 2,160 and 2,180-ish. This showcases a debate between bulls hoping for re-acceleration and bears seeing a topping process. In between, few all-time highs have been reached, but mostly it has been range bound.  August 15^th highs of (2,193.81) and August 23^rd highs of (2,193.42) mark the record highs. 

Crude (Spot) [$44.48] –   Still not on solid footing as the supply/demand debate plays out.   A break above $50 has been challenging, and a drop below $40 could trigger further selling pressure. It remains very sensitive to pending catalysts.

Gold [$1,338.65] – A key inflection point approaches. Staying above $1,350 showcases further strength.  Surpassing July 16^th highs ($1,366) is a critical challenge to restore a bullish bias in this ongoing recovery.

DXY – US Dollar Index [95.47] – Not much movement over the last 15 months. The status-quo approach by central banks has not created a defining moment. Plus, EM currencies and commodities have mostly stabilized. Both factors above lead to an uneventful Dollar story thus far.

US 10 Year Treasury Yields [1.61%] –   More and more, signs show yields remaining low for a while.  March 2016 highs of 1.99% seem so far removed today, both in perception and investor mindset. Yet, Brexit lows of 1.31% remain somewhat of an outlier, until the next shock.  

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