Market Outlook | October 10, 2016

‘The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.” (Winston Churchill 1874-1965)

‎Beyond Risks

When one compiles recent developments in financial markets, one realizes that the risk of volatility and high warnings regarding a ‘crash’ are visibly discussed. In fact, the potential death of capitalism or near ‘death’ of public markets is worrisome, and this rapid change is being digested too slowly as other distractions are mounting. Perhaps, a gigantic pivot towards ‘socialism’ should be at the forefront of potential concerns for participants and advocates of free markets. The concealed news items seem to have a more powerful impact than the daily noise of the status-quo that's polluting the market. Money managers have a risk that's concealed and too big to calculate, but an ideological shift is taking place.

Of course, lower yields, saturated markets and suppressed volatility are plenty to chew for investors. But, if there is a glaring fundamental shift on the mechanics, drivers and conductors of financial markets, then is it not bit silly to disregard the real, big picture?  Market participants are too consumed on Fed obsession and the misleading interpretation of risk. Perhaps, wealth creation via financial markets as we once knew is an archaic chapter that's been replaced by unbearable government intervention. ‎More defaults, frauds and calls for bailouts only strengthen the points of those looking to destroy (intentional and unintentionally) capital markets. The demise of the Deutsche Bank is one example currently playing out as the Eurozone contemplates bailing-out, and this theme seems like deje vu to financial market observers.

New Indigestible Era

The Bank of Japan buying equity ETFs, the Fed contemplating stock purchases and painstaking obsession with Central Banks is creating ‎ bigger ideological concerns. It is insane in some ways to think that Bank of Japan is the largest shareholders of many private companies in Japan. Still, this central bank scheme did not help revive growth; however, the action of central banks buying equity ETFs is surely a game-changing paradigm. This has some people numb and others deeply worried without comprehension of what's to follow with government actions:

“Already a top-five owner of 81 companies in Japan’s Nikkei 225 Stock Average, the BOJ is on course to become the No. 1 shareholder in 55 of those firms by the end of next year, according to estimates compiled by Bloomberg from the central bank’s exchange-traded fund holdings. BOJ Governor Haruhiko Kuroda almost doubled his annual ETF buying target last month, adding to an unprecedented campaign to revitalize Japan’s stagnant economy.”  (Bloomberg, August 14, 2016)

Similarly, the post bank bail-out days already have empowered federal government while shredding the public sentiment and trust in banks.  Without trust in capitalism and free-flowing markets, a generation is being swept away with ideas of ‘socialism’ and more turn faithless in the concept of wealth creation. Politicians exploiting this post-crisis dynamics without real economy solutions are utterly dangerous in the intermediate-term.

Stunningly, not only are Central Banks controlling the market narrative, there is early discussion of the Fed potentially buying stocks, which was merely unfathomable last decade. Once example of stunning development:

“Former U.S. Treasury Secretary Lawrence Summers floated the idea of continuous purchases of stocks as a potential ingredient in a recipe for the developed world to strengthen economies struggling with subdued growth and inflation. Among the proposals that deserve ‘serious reflection’ is the purchase of a ‘wider range of assets on a sustained and continuing basis,’ Summers said in a lecture at a Bank of Japan conference in Tokyo Friday. ‘I’m not prepared to make a policy recommendation at this point,’ he told reporters later.” (September 30, 2016)

Bureaucratic Suffocation

Regulators can scrutinize prior behaviors and settle with financial operators, but the net result is lack of job creation, as well as lack of future wealth creation for the middle class. Frankly, without respect and effort for promoting prosperity or rewarding innovation, the US is at risk of losing its glamour as a leader of innovation and small business growth. Damages from the crisis eight years ago have left a very toxic residue in business sentiment and shifted the structural and psychological set-up.

To judge fairly, one would need to admit the reckless promotion of risk by government and accept the reckless participation by banks. Again, those debates still lack closure from congress to courts to the essential attitude of investors. No matter what politicians and agenda-driven folks tell us, government's heavy cooperation with the private sector fails to move the needle in GDP or other critical real economy measures. Socialist countries have failed miserably and the envy of the world was America's ability to promote upward mobility with less bureaucracy. ‎In fact, the same bureaucracy that suffocates growth in Europe should serve as a massive example of what not to do. Wasn't Brexit a reminder of that? Regardless of Brexit concerns for future implications, the European Union’s ability to correct past failures and map a bright future is being heavily doubted. Skepticism is skyrocketing across all angles from government leadership to corporations’ growing influence. Through this chaotic wave of distrust, Nationalism, which seemed like a lost art, is easily gearing to spread like wildfire (as seen in Europe) given the grave condition of wealth creation and crippling status of real economy growth.

Looking Ahead

In the near-term, many election and government decisions will swings the markets. From Brexit to trade policies to Central Bank coordination, the reliance on political leaders is greater than desired.  For money managers, these are risks that are hard to quantify and are not part of the traditional money management analysis. Thus, with looming uncertainties re-occurring constantly, many hedge fund managers and investors are forced to navigate in a suspenseful period. Yet, for the market fundamentals, the disconnect between financial markets (i.e. stock indexes) and real economy must converge at some point. That itself is a mystery to all. Thus, risk perception might be low until a major re-set materializes naturally. This suspense is more like a day-to-day anxiousness for most. That said, this is more like the norm and accelerating faster than imagined.

Article Quotes:

“Nobel Prize-winning economist Joseph Stiglitz predicted in a interview out on Wednesday that Italy and other countries would leave the euro zone in coming years, and he blamed the euro and German austerity policies for Europe's economic problems. Europe lacks the decisiveness to undertake needed reforms such as the creation of a banking union involving joint bank deposit guarantees, and also lacks solidarity across national boundaries, Stiglitz was quoted as saying by Die Welt newspaper. ‘There will still be a euro zone in 10 years, but the question is, what will it look like? It's very unlikely that it will still have 19 members. It's difficult to say who will still belong,’ the paper quoted Stiglitz as saying.’  ‘The people in Italy are increasingly disappointed in the euro,’ Stiglitz was quoted as saying. ‘Italians are starting to realize that Italy doesn't work in the euro,’ he added. He said Germany had already accepted that Greece would leave the euro zone, noting that he had advised both Greece and Portugal in the past to exit the single currency.” (Reuters, October 5, 2016)

“Central banks are embarking on the largest quarterly purchase of assets since quantitative easing was introduced following the financial crisis, as policymakers double down on monetary policy despite growing concern it has reached its limits.

“In the final three months of the year, the UK, Japan and Europe are expected to spend a combined $506bn on assets — the largest quarterly sum created While the US concluded its QE operations in 2014, the BoJ, BoE and ECB are still expanding, pushing the collective balance sheets of G4 central banks to more than $13tn.Citi estimates that the collective balance sheets of central banks is now equal to about 40 per cent of global GDP, a move that is shrinking the universe of securities available for investment, according to credit strategist Hans Lorenzen the early days of the US Federal Reserve’s QE programme in 2009....‎While the US concluded its QE operations in 2014, the BoJ, BoE and ECB are still expanding, pushing the collective balance sheets of G4 central banks to more than $13tn.Citi estimates that the collective balance sheets of central banks is now equal to about 40 per cent of global GDP, a move that is shrinking the universe of securities available for investment, according to credit strategist Hans Lorenzen.” (Financial Times, October 4, 2016)

Key Levels: (Prices as of Close: October 7, 2016)

S&P 500 Index [2,153.74] – After reaching all-time highs on August 15 (2193.81), the index continues to decline. Early signs of peaking have appeared, but they are too mild to be notable.  

Crude (Spot) [$49.81] – Nearly set to re-visit June 9 highs of $51.67. The August and September rallies lifted Crude above $40. 

Gold [$1,258.75] – Signs of a major slowdown in momentum after reaching $1,360. The sharp sell-off, recently, reconfirms slowing buyers’ demand.  Interestingly, the 200 day moving average stands at $1,255 – just a few points removed.

DXY – US Dollar Index [96.63] – Since May, the dollar has bottomed and risen mildly which simply suggests it is maintaining its strength. Annual highs remain at 99.82 reached in January.

US 10 Year Treasury Yields [1.71%] – Mostly trendless. Recently, yields spent a lot of time trading between 1.50% and 1.70%. Certainly, the status-quo remains in place and a catalysts is desperately needed.

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.