“Courage is the capacity to
confront what can be imagined.” (Leo Rosten 1908-1997)
Truth Unravels Quickly
The US relative edge has been a
common theme for several years. Tech and Biotech, which seemed insulated from
any weakness, are now feeling the all-out onslaught by investors. So much
attention has focused on the Central Banks and at times created an illusionary
description of reality. Now, the real economy that has been hurting in most
nations is translating into share price drops. Basically, the truth of
corporate earnings and economic health cannot be concealed for too long. Now,
the market unraveling is beyond China, Energy, and Emerging Markets. There is no escaping of this sluggish growth
atmosphere. Unlike other markets, the US markets had mostly evaded
major painful sell-offs and capital outflow. Of course, there were a few
corrections in August and October, but now the optimism is fading quickly as
the US 10 year yields are below 1.90%, where the rush for “safer” assets is
becoming popular.
Collective Pain
From
financials to retail to technology, the company results are screaming of a panic-like
environment. The Fed’s credibility has been questioned again and again. Fair to
say, Central Banks have officially lost their “trustworthy” status (more on
this below). However, these days old
tricks such as stock buybacks or relative appeal may not be enough to maintain
the strength of US stocks. Banks are facing regulatory scrutiny and legal
battles where revenue is absolutely hurting. Public technology companies that
were either over-valued or viewed as invincible are facing harsher reality
check. Retailers with old business models have faced a difficult run with the ever-so
growing focus on online commerce. However, e-commerce alone does not always
produce desired results. Perhaps, a
double whammy of concerns for retailers:
“The
reality at Michael Kors undercuts the conventional wisdom among retailers
that e-commerce would prove to be more profitable than in-store
sales because it doesn't come with the overhead expenses of operating
locations, hiring clerks and cashiers, etc. Instead, the reality
is that online shopping isn't yet the saving grace
retailers were counting on when they started plunging billions of dollars into
new websites and shipping facilities.” (Bloomberg,
February 2, 2016)
What Next?
The penultimate question is now
being asked viciously and pragmatically. If US assets were in sheer demand and
fruitful in recent years, then how do investors deal with the slowing growth
that's turning sour these days? Given the signs of breaking down of indexes,
specific shares, and key sectors, then follow-up question is: Where does one
rotate to? A question that may have sounded silly 12 months or 24 months ago
since the US relative edge in the financial markets was blatantly clear.
However, now the realized
weakness is real, and worrisome questions are being asked widely for US
companies earnings. On one hand, the Fed-led narrative is overly tiresome and
lacks backing from real economy data. On the other hand, with global assets so
cheap after a very traitorous period in EM (led by China), the risk-reward
profiles are shifting. That's the drastic shift re-setting investors’ mindset. However, there is one critical element. If a
synchronized sinking (collapse across key assets) is in the making at this
junction of the cycle, then the rush to safety may persist even further.
Underneath the crisis has been brewing across various sectors as investors are
getting acclimated.
As Central Banks continue to lose
credibility, it should force investors (and voters in US and Europe) to
pressure actions by policymakers. At some point, beyond shareholders
confronting reality, elected leaders will have to seek solutions to revive
economies. Low to negative interest rates are surely not the answer to boost
demand. Perhaps, that debate about the success of quantitative easing has been
settled, despite ambitious and misleading narratives. In some ways, the gap
between the real economy and stock markets is closing and that is the real gut
check for everyone. But with the shifting narrative comes further volatility
and ugly moves. Thus, bracing for further surprises seems prudent as much
as practical.
Article Quotes
“The pressures on these central
banks aren’t likely to ease. Over the past two years, a net of more than
$846 billion has exited emerging markets and an additional $450 billion could
flow out of developing countries this year, according to an estimate from the
Institute of International Finance. Between 2010 and 2014, an average
of $1.2 trillion worth of foreign private capital flowed into emerging markets
each year, according to the IIF. Last year, these countries collectively saw
their first net cash outflows since 1988. In many emerging countries,
government revenue from earnings on exports has also fallen—especially for
economies reliant on commodities—while deposit growth in banking systems has
waned. Broad money growth, a proxy for liquidity in financial systems in
emerging Asia and Latin America, dropped by 3.8 percentage points and 3.4
percentage points over the past year, according to Oxford Economics.” (Wall Street
Journal, February 7, 2016)
“First, rising commodity prices were responsible for
driving inflation above target from 2008 to 2012 and falling commodity prices
brought it back below target from 2013 on. Since this was externally-generated
inflation, you could argue that is outside the Bank’s remit. However, the Bank
is targeting CPI which includes this externally-generated element. And its
forecasts were consistently wrong. It keeps expecting inflation to return to
target at the 18 month-two year horizon. It has to do this, by definition; if
it thought inflation would be a lot higher or lower than target, then its
policy should change. Still, all the highly-trained economists at the
Bank failed to predict the commodity cycle.” (The Economist, February
5, 2016)
Key Levels: (Prices as of Close:
February 5, 2016)
S&P 500 Index [1,880.05]
– The Index struggles to hold on to the 1,900 range. A critical
inflection point given the current range, which held both in August and
October. Perhaps, now is the ultimate test for buyers as technical pressure mounts.
Crude (Spot) [$30.89] – Suspense grows
as investors await the sustainability of the new range $30-35. Demand still seems mostly soft globally, and
supply is abundant. A series of events is needed to spur a rise; otherwise, the
downside trend remains in place.
Gold [$1,150.35] – The commodity
is up nearly 10% since December 17, 2015 lows.
Some revival appears in a period of sharp equity sell-offs and distrust
of central banks. However, it is premature to declare a massive turnaround. A
move past $1,200 can stimulate further buying.
DXY – US Dollar Index [97.03] – There are early signs of retracement of
dollar strength. Obviously, in the last 12 months the dollar's relative
strength was quite stunning and visible. A mild breather for now seems
reasonable, but additional follow-through can be a game-changer.
US 10 Year Treasury Yields
[1.83%] – Fails to climb back to 2%. Clearly, the bond market does not sense an
economic recovery on one end. Plus, investors are reducing exposure to riskier
assets. A critical barometer of current conditions is the lowering Treasury
yields. A downtrend is evident.
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