“There is nothing as mysterious as something clearly
seen.” (Robert Frost, 1874-1963)
Early Perspective
It has not even a month since the Federal Reserve
mildly or symbolically hiked US interest rates.
It has not been six month since Crude has traded in the $30’s range. It
has not been a year since the escalated feud between Russia and Turkey in
Syria. Not quite a week has passed since
the grand tension between Iran and Saudi Arabia. Time will tell as the list of uncertainties
build.
Years have passed since the low interest rate policies
became the norm from the US to Japan to Europe. It has been several years
since commodities along with Emerging Markets began to decline on a consistent
basis. Several months have passed since the massive China scare in August 2015,
and the ripple effects have yet to fully
materialize.
The S&P 500 index and Dow Jones index both closed
negative last year (first time since 2008 – more on this below), reminding us
on average it was a tough year to invest, speculate, or even observe financial
markets. The US dollar roared again as a symbol of strength and shelter from the
ugliness that persisted everywhere. With
all that brewing, a new calendar year starts; however, importantly focusing on
the first quarter is more logical and relatively digestible for investors
seeking a road map.
Near-Term Considerations
1.
Crude below $20 in Q1 2016? Iran entering the
crude oil market leads to further expansion of the already over-supplied
market. Combined with China’s soft (and
softer) demand puts additional pressure on prices; not to mention the recent US
entry to the Oil market, which certainly rattled supply, as well. Here is another supply expansion
example: “Russia’s oil output
is poised to reach a post-Soviet record of 10.86 million barrels a day this
week as the nation’s producers continue to withstand the slump
in prices, according to Energy Ministry data” (Bloomberg, December 31,2015).
This has been a
textbook supply-demand set up at a grand level, where the recent prices are
fully justified. Thus from $100 to $3o, the change in crude prices is
understandable for analysts or causal observers. However, the implication of
very cheap crude prices is the big unknown. Fallout of this drives energy
investments to go sour, from companies to fixed income impacting overall global
growth. How does it impact employment, economies, financial services,
wealth creation, and, of course, “distressed” opportunities? The first
quarter may settle some nerves, but emotions are seeping back in the market.
From credit funds and energy investments that already collapsed there will be
more to follow. Perhaps, the energy crisis may remind us of the credit crisis
from 2008.
2. Non-commodity themes, such as German and Japanese equities
along with NASDAQ, were attractive versus other ideas. Israel and India are in
the mix given the innovation based industries, which are less reliant on
commodities. Saudi Arabia and Russia appear in trouble economically and soon
maybe even militarily. Harsh lessons are discovered about non-diversified
economies from South Africa to Nigeria to Venezuela. Hence, more diversified
economies, such as US and Germany, look much more appealing.
One can feel this in the
escalation of tensions in foreign policy: from the heated battle between Iran
and Saudi Arabia to Syria divided into four as it crumbles over proxy wars. All
these are factors, not only for Oil, but for immigration, weapons sales, and
next wave of military risks. Certainly, all these issues hit at the heart of
international trade as investors are realizing the great impact of commodities,
which was underestimated by average analysts. Cash flowing out of these
commodity heavy nations is a harsh reality.
Similarly, Brazil is set to be a bigger mess after the Olympics. just
like it was a mess after world cup:
“Since its peak
growth in 2010, the Brazilian economy has done nothing but decelerate, entering
negative territory in 2014. Growth was -2.6% in the second quarter of 2015, while there are
no signs of improvement.” (Bruegel, November 6, 2015)
3. Bureaucratic influences: Election year apathy in Washington
means less willingness than usual for bold moves (with very few exceptions).
From Fed supported market to uglier real economy realities, key policy
responses ahead are greatly awaited. On a whole, as a global growth is not
impressive and Fed hike remains questionable, even the relatively appealing US
market cannot rely only on relative appeal. Some substance is needed to propel
tangible growth. In an election year,
the truth should be revealed quickly as some decisions remain in a standstill.
Similarly, in Europe the “Brexit” and victory from the far-right stir a debate
between national interests and the union. After the 2011 Greece crisis, this
debate and vulnerability of the union has been exposed. Further angst or at
least harsh verbal responses can cause some market reactions. Lingering issues
that are unsolved can annoy or worry investors, which may translate to
sentimental response.
Seeing It Through
So many pundits expect more volatility or extended
equity markets and further crumbling EM/Commodities. That said, if the
sluggish growth and choppy trading action persists, then how does one respond
when expected events actually materialize? It is easier to call market
tops or identify concerns, but the fruitful reward comes from executing ideas
that were thought-out well before the panic-like madness. Essentially, there is
a three step process to consider before entering ideas:
1.
Identify the riskiest
segment of the market.
2.
Opine on possible
time-frame and catalysts.
3.
Pinpoint the specific
investment to match the thought.
To get all three right is what makes a story. To reach
this point every quarter or year is not truly possible given nature of markets
(with very few exceptions).
Financial markets are overly competitive for those
seeking gains, since too much capital is chasing limited ideas. From efficient trading to widespread information to computer generated
ideas and execution, the industry has elevated its tools very sharply. At the
end, like Crude and Emerging Markets proved, defining for logic for too long is
impossible. Eventually, valuations and risk are reassessed and investors do reset
their expectations.
A 7 Year Reflection
Since December 31, 2008, the S&P 500 index
increased by 126%, Crude declined by 17%, and the Dollar index increased by
21%. When all is said and done, in the last seven years, placing once capital
into US equities via US dollar exposure proved to be a net winner. Yes, that was also the vividly clear case during
the last few years. Interestingly, since the last major crisis, these
results reflect the strength of the dollar and ongoing positive influences (i.e
buybacks, demise of EM and Eurozone etc)
that contributed to stronger equity markets. The S&P 500
index is not overly rational at times, but the boost from the Fed plays a
critical part, as well. Therefore, if
the low rate “crutch” (or boost) nears an end while the energy establishment
unravels, then a new cycle is bound to reset. A vicious reset awaits,
perhaps. The unraveling is ugly, the
emotional sparks cause further damage, and calling the bottom is a risky
exercise. Thus, not only a start to a year, but an end of a presidential,
economic, and credit cycle.
Article Quotes
“Central banks and finance ministries in emerging
markets have few options once their currencies start plummeting, and often must
intervene in exchange markets in what is usually a futile effort to stabilize
the rate. Countries such as Argentina, Brazil, Indonesia, Russia, and
Thailand depleted their foreign reserves to prop up their currencies and
ultimately turned to the IMF to stem the losses. Tapping the fund comes with
conditions, and countries must agree to introduce structural changes to their
fiscal policies and financial system. The IMF has received much criticism for
proposing stringent conditions, known as the "Washington Consensus,"
on Asian borrowers in 1997–98, which stipulated austerity measures and the
removal of capital controls. The IMF has altered its approach over the years
and is now more flexible on government budget cuts, but its stabilization
policies still spur popular discontent… The policy dilemma that faces
central bankers and governments in emerging markets with current account
deficits is that supporting currencies by raising interest rates, thus making
domestic financial assets more attractive to foreign investors, can also slow
the economy.” (Council on Foreign Relations,
October 28, 2015)
“Lending to companies and households across the euro
zone picked up again in November, recording year-on-year growth of 0.9 percent
and 1.4 percent respectively, the European Central Bank said on Wednesday. The development is positive news for the euro zone's economy, which has
long struggled with slack credit, and indicates some success for the ECB's
money-printing scheme to buy chiefly government bonds.
The ECB also said, however, that the annual growth
rate of the M3 measure of money circulating in the euro zone, which is often an
indicator of future economic activity, had lost pace. Growth in M3, which
includes items such as deposits with a longer maturity, holdings in money
market funds and some debt securities, was 5.1 percent in November. This result
compares unfavourably with 5.3 percent growth in October and is also lower than
analysts polled by Reuters had expected.” (Reuters, December
30, 2015)
Key Levels: (Prices as of Close: December 31, 2015)
S&P 500 Index [2,043.94] – For several weeks, the index traded between 2,100 and 2,050. Now it stands at
a fragile range where a break below 2,000 can stir further scare. Yet, the
neutral state of the index is becoming very common.
Crude (Spot) [$37.04] – Crude traded below $40 for nearly all of December 2015. Gauging a bottoming
process is rather difficult and unclear. What is certain is the multi-year
deteriorating trend.
Gold [$1,068.25] – The search for
bottoms has resulted in ongoing new lows. A break below $1,000 would not be
overly surprising, but would mark a new wave of downturns. $1,180 seems like
the first range needed to mark a meaningful bottom.
DXY – US Dollar Index [97.98] – The dollar is strong and poised to get stronger. The multi-decade data combined with easing
policies by other central banks continues to make the case. During the second
half of 2015, the index comfortably stayed above 96, confirming the strength.
US 10 Year Treasury Yields [2.24%] – The last several weeks witnessed a tight range (2.20-2.30%). The next
direction lacks major conviction. Yet, the lack of upside movement in yields
ahead of the Fed confirms one or all of the following: 1) The Fed will raise rates moderately, 2)
global growth will continue to be slow, and/or 3) the US Treasuries will still
be deemed as safe and appealing.
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,
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believed to be reliable, its accuracy or completeness cannot be guaranteed, nor
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investment performance of any securities or strategies discussed.
