“Life is a succession of lessons which must be lived
to be understood.” (Helen Keller 1880-1968)
Hopeless Reliance
Just when the markets learned that prior stimulus
efforts by central banks were a failure, more central banks continue to sell
hope via stimulus efforts. As mind-boggling as it seems, investors may be
willing to put further faith on the same central banks that collectively misled
and over promised. Others might say,
it’s quite clear that central banks are limited in their ability to spur
economic growth. Either way, share prices that went through a cleansing process
have not quite served as a severe warning. The European Central Bank (ECB)
announced “encouraging” words about further stimulus; it was strange but
familiar to see a relief rally after massively, bloody trading days. Basically,
the (QE and related) remedy that’s been used again and again by the Federal
Reserve has clearly failed to produce tangible growth. The disconnection between the real economy
and the central bank-led rally was revealed.
Those were the harsh lessons in 2015 and the first two weeks of 2016. Is
anyone learning from previous lessons? That answer remains unclear, but the
debate is alive and well:
“Yet the debate over QE within policy circles is
heating up. Some experts even warn that extreme measures could undermine faith
in the authorities themselves, which would have alarming implications” (The Telegraph, January 22, 2016).
Old Habits
Desperation is beginning to define the narrative of
the global market, as the ECB and Bank of Japan continue to play and encourage
further low rates. Perhaps, that’s one trigger that uplifted the markets last
week after sharp sell-offs. The habit of waiting for stimulus efforts for
higher stock markets has been profitable at times, but illusionary in real
terms. The market is debating and wresting with this as reality is clearly
grimmer than the Central Bank messaging.
Hopelessness explains the market narrative where
desperation has kicked-in. Somehow, desperation does not lead to asset price
destruction, as seen in China and Commodities. Selling Hope by Central Banks
has become a method of propping up prices while deferring an inevitable consequence.
Lack of inflation and growth in the Eurozone should raise more concerns rather
than comfort. However, in a world marred with low growth, investors are seeking
“relative” areas of strength. As long as Emerging Markets struggle, Eurozone
may attract more capital. However, the brewing problems can only be dismissed
in the near-term as debt related and political issues remain a hurdle:
“Because new EU banking rules now require a bank’s
investors—including senior bondholders and uninsured depositors—if a bank is on
the verge of failing, Italy has to work out problems in its financial systems
with much tighter restraints” (Wall Street Journal,
January 24, 2016).
Even if asset prices in Europe continue to rise, the
fundamental concerns will linger. Therefore, risk should not be grossly
underestimated.
Bottoming Search
The dramatics of the Oil market have captured many observers'
attentions. The fallout will remain from Saudi Arabia to Texas. It clearly
impacted the Russian market, forcing their leader to pursue wars and other
foreign policy distractions. That said, regardless of where Crude trades in the
next 3-6 months, the damage to companies and countries will be felt and
revealed. In terms of US stocks,
earnings this time around may cause sensitive responses, unlike the past few
years.
First, the dollar strength impacts corporate earnings.
Secondly, even non-commodity related areas should feel some pain from China and
other consumer related areas. Finally, innovation themes that focus on human
capital (i.e. Technology or Healthcare) may have a broader appeal. However,
specific ideas will be rewarded, and expecting a broad rally might end up being
too ambitious. Therefore, this might be the year for veteran investors who can
dig into specific ideas. The smooth-sailing bullish market with Fed backing may
have run its course, at least in the US. Thus, suspenseful weeks lay ahead, as
the directional path remains unsolved. Those that strive in mysterious markets
might do well based on nuanced grasp and execution on areas of high conviction.
Otherwise, thrilling action ahead for observers.
Article Quotes
“Global investors and companies pulled $735 billion
out of emerging markets in 2015, the worst capital flight in at least 15 years,
the Institute of International Finance said. The amount was almost seven times
bigger than what was recorded in 2014, the Washington-based think tank said in
a report on Wednesday. China was the biggest loser, with $676 billion leaving
its markets. The IIF predicted investors may withdraw $348 billion from
developing countries this year. Emerging-market stocks are trading at the
lowest levels since May 2009 and a gauge of 20 currencies has slumped to a
record. A meltdown in commodity prices and concern over the slowdown in China’s
growth to the weakest since 1990 are spurring investors to dump assets from
China to Russia and Brazil. The 31 biggest developing markets have lost a
combined $2 trillion in equity values since the start of 2016.” (Bloomberg, January
20, 2016)
“Shareholders in China’s rural commercial banks have been offloading their
stakes on Taobao, the biggest online Chinese auction site, in a sign of the
increasingly desperate steps being taken by cash-strapped investors. The stake
sales in the lenders at the bottom of China’s financial system, which are also
appearing on the China Beijing Equity Exchange and an over-the-counter market,
require minimal regulatory approval, if any at all. Until this month, an
official freeze on initial public offerings in Shanghai and Shenzhen has
trapped shareholders from divesting as valuations fall. The backdoor methods
for cashing out of the banks reflects a new urgency among shareholders to leave
the sector amid dwindling returns and mounting bad debt. State-backed Securities
Daily called the marketing of bank shares on the Beijing Equity Exchange a
“clearance sale” of the deposit-taking institutions once carefully regulated by
the state. (Financial Times,
January 24, 2016)
Key Levels: (Prices as of Close: January 22, 2016)
S&P 500 Index [1,906.90] – Going back to August and September, there is some evidence of buyers' appetite
around 1,900. The weeks ahead will measure the conviction of buyers
ahead, as the technical data suggest an oversold rally. However, after topping at 2,100 on several
occasions, buyers in early 2016 require even more conviction (acceptance of
higher risk-reward) than prior buyers in summer 2015.
Crude (Spot) [$29.42] – January 20th lows of $26.19 sets a new radar. Interestingly,
in August and November 2015, the commodity failed to hold above $40. Climbing
back to $40 is not as surprising as staying above $40. The supply-demand mix
does not justify a climb back to $60, yet there are still few factors being
sorted out.
Gold [$1,093.75] – After trading
between $1,100-1,200, the new range is
between $1,050-1,100. There are attempts
to bottom or settle, as upside catalysts are desperately missing.
DXY – US Dollar Index [99.57] – Without a surprise, the Dollar is
maintaining strength. The further demise in EM and further easing policies in
Eurozone justify an elevated Dollar/ at least in the near-term.
US 10 Year Treasury Yields [2.05%] – Back at a very familiar range.
Staying above 2% may prove to be a challenge unless there are massive
upside surprises.
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