Market Outlook | October 31, 2016

“We are limited but we can push back the borders of our limitations.” (Stephen Covey)

Fuzzy Reality

The market has not had a good grasp on the real economy.  Confusing messages from central banks and an unclear economic growth picture makes this rally lack substance. It is irritating for so many to see the massive disconnect, but this has been going on for too long.  Unimpressive real economy US indicators, Chinese slowdown, desperate nations post Crude price correction, multiple wars in the Middle East, weakening Europe and, of course, a central bank (CB) that's losing credibility all lend to observers’ irritation. Despite the elevated asset prices in stocks, real estate and other risky assets (corporate bonds), the average and not so average risk manager is asking questions regarding risk reduction. Even the perception of an “improving” economy hasn’t quite been accepted with warm hands. Despite a recent rise in US 10 year yields, for the most part bond markets are not quite showing an improvement. Interestingly, during the last few weeks, participants have seen a rise in volatility, sell-off in bonds and a strong Dollar.

Meddling Risk

Deciphering pending government intervention is a growing risk that is being understood by more participants.  These interventions are not only limited to CB interest rates policies. In fact, it extends to fines as witnessed at Wells Fargo and Deutshe Banks. Similarly, more and changing regulations as recently seen in the LIBOR movement have occurred due to new rules. In fact, that has elevated LIBOR prices, changing the status-quo a bit:

“The three-month U.S. dollar London interbank offered rate extended its climb Wednesday, reaching the highest since May 2009. According to strategists at Citigroup Inc. and JPMorgan Chase & Co., it will keep rising for the rest of 2016, potentially eclipsing 1 percent by year-end.” (Bloomberg, October 27,2016)

Other perceived government related risks are clearly visible in elections, which are not only suspenseful in the US but in other key countries, as well. At some point, further government involvement combined with limited small business growth (more on this be below) can bring an accelerated symptom of more socialism to capital markets. That’s a bigger risk still being digested, but it is hardly quantifiable.

Stimulus Failure

Frankly, the Central Bank obsession has made government officials become more of a variable in market movements versus basic fundamental matters. For several years, the Central Banks have been able to dictate the message to participants from Europe to Japan to the UK to the USA.  Bodies of government imposing more regulation, which is a burden to small businesses, has failed to uplift the economy the same way QE trickery has failed to move the needle for the real economy.

Corporate profits have dropped for several quarters sending a signal of lackluster results:

“Profits have fallen for five straight quarters, the longest skid since the last recession, according to the Bureau of Economic Analysis.”  (Bloomberg, October 21, 2016)

The rage in the real economy is felt with Nationalist political candidates gaining some traction. Loss of faith in globalization is another hint of slowdown.  Yet, Central Banks continue to posture of raising rates, but interest rates policies are not quite enough. The endless rate-hike posturing is insulting is some ways. At some point, a collective realization awaits for reorganization, Fed failure or a possible limitation in CB’s policies. Thus, a new era waits in which a shift occurs from CB obsession into a realization of chronic real economy concern. Perhaps, the message here is that rates will stay low for a while, unless policy driven leadership breaks the trend of the current status-quo.    

Article Quotes:

“According to The Heritage Foundation’s research, the Environmental Protection Agency has been the most enthusiastic regulatory agency in the past several years, imposing a staggering $54 billion in new regulations since 2009. But the EPA is not the only culprit. Overall, federal agencies have implemented 229 new major rules (rules expected to cost businesses and individuals over $100 million) since 2009. That adds up to a $107.7 billion increase in regulatory costs in just seven years. The NFIB found the biggest small business complaints included not just the actual costs of compliance, but also the time spent doing paperwork and figuring out new requirements. As NFIB explains, “Wasting entrepreneurs’ time is a serious growth impediment.” With so much money and time tied up in regulatory procedures, small businesses are left with little opportunity or desire to grow.” (The Daily Signal, October 27, 2016)

“Demography is the only thing that matters in the very long run…Because these demographic forces are unlikely to reverse direction very rapidly, the conclusion is that equilibrium and actual interest rates will stay lower for longer than the Fed has previously recognised. Of course, the market has already reached this conclusion, but it is important that the Fed is no longer fighting the market to anything like the same extent as it did in 2014-15. This considerably reduces the risk of a sudden hawkish shift in Fed policy settings in coming years. Furthermore, greater recognition of the permanent effects of demography on the equilibrium real interest rate has important implications for inflation targets, the fiscal stance and supply side economic policy. These considerations are now entering the centre of the debate about macro-economic policy. The relationship between demography, growth and interest rates has been studied by economists ever since the days of Malthus, but it has played relatively little role in mainstream macro-economic discussion in the last few decades.” (Financial Times, October 23, 2016)

Key Levels: (Prices as of Close: October 28, 2016)

S&P 500 Index [2,126.41] –   Approaching a critical support level around 2,120. In the last 2 months, the index has stayed above 2,120; however, another test awaits. Interestingly, the recent failure to stay above a 50-day moving average creates further worrisome technical responses.   

Crude (Spot) [$48.70] –   The recent attempt to surpass $50 remains quite a challenge.  Yet, since August, Crude prices have stabilized and elevated. Upside momentum appears to be waning in the near-term.

Gold [$1,273.00] –   Since August, Gold price has declined on a consistent basis. Some wonder if $1,260 is a bottom again, as seen in June. However, a convincing catalyst is unclear.

DXY – US Dollar Index [98.34] – October reiterated the strength of the Dollar. From September 22 lows of 95.04 to October 28 highs of 99.11, the macro theme of a strong Dollar remains intact.

US 10 Year Treasury Yields [1.84%] – Yields have risen in a noteworthy manner. Since the lows of 1.53% on September 30, 2016, yields have climbed up along with the dollar.

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