“Life does not proceed by the association and addition
of elements, but by dissociation and division.” (Henri Bergson
1859-1941)
The Rampant Disconnect
On one end, the volatility index for US stocks is
signaling calmness, as the turbulence and fear have eased a bit. That’s for
folks that actually believe that financial markets are telling the truth about
the real economy. However, the real economy is not so robust by several
measures. How could US 10 year yields remain this low? How can anger drive the
election cycle? How can small business feel embittered if there was real
growth? Basic questions. To preserve
capital, difficult questions must be asked and beyond the illusionary headlines
a reality check is constantly needed.
Amazingly, early in 2016 the Turkish and Brazilian
stock markets appear relatively attractive, as the indexes are up 16% and 15%,
respectively. Of course, both stock indexes are rising from deeply discounted
levels after taking major nosedives. Appealing to the average investor's eyes
at first glance, but a deeper look ignites a deeper discussion. Here is the
disconnect in which the stock market fails to tell the real story. Both
nations are facing the ongoing risks of weakening economic climate, a bitter
voter class, lack of investor confidence and sheer political instability. Yet,
stocks, which tend to look ahead, tell a message that ground level observers
cannot imagine. Thus, the massive disconnects between reality and
financial markets are not limited to these two emerging economies. It is a
phenomenon of our modern time, and these disconnects prolong harsh truth
discoveries.
Misleading Optimism
Perhaps, the example above fits the bigger picture
where Central Bank-led markets have projected optimism beyond what is
justified. That’s the criticism of the Fed in US markets and has been the case
for a while. US financial markets have served as a shelter for those escaping
the collapse of Emerging Markets and commodities. Sure, rotating capital into
US assets is a relative argument, which
justifies some of the asset appreciation in the US (not only stocks but real
estate in key markets) over recent years. Figuring out the justification for
optimism in Brazil and Turkey only signals that investors are desperate to
place capital in distressed areas. On an absolute basis, global growth is slow
and sometimes it is as simple as that.
We’ve reaching a point where the stock market as a
measure of sentiment is completely out of whack. That’s felt primarily in low
interest rates, which do not signal strength but rather desperation. Basically,
elevated stock markets are covering up the painful real economy. Even the
leader of “optimism”, aka the Federal Reserve, is confronting this disconnect
after years and years. Last week the following was re-discovered:
“The minutes showed committee members considered a
number of distinct risks, with a softening outlook for global growth and the
ensuing volatility in financial markets chief among them.” (Bloomberg, April 6,
2016)
In the next 3-6 months, shocks seem inevitable and not
overly surprising. Yet, mapping out the script and timing seems overly
rewarding at this stage.
Reality Confronted
Japan exemplifies an advanced market that has seen
constant low rate policies. The capital flow in recent years was positive, but
now the narrative is changing:
“Overseas investors, which account for about 70
percent of the value traded in Tokyo shares, bought a net 18.5 trillion yen
between 2012 and 2015. Global fund managers, which were negative on Japanese
shares for almost all of the five years before Abe came to power, have been
overweight every month since, according to a Bank of America Corp. Merrill
Lynch survey… Now that bullishness is dissipating… They’ve [Investors] sold a net 5 trillion yen since the
second week of January, the longest stretch since 16 weeks.” (Bloomberg, April 10,
2016)
Is the recent reaction in Japan a prelude to US and
European markets? Again, Central Bank fueled stock market rallies had a
short-term fix. Basically, it aroused positive sentiment and created an interesting
investment opportunity, but the disconnect is laughable at this point.
Perhaps, the Japanese capital outflow and negative returns this year confirms
the shaky status of the Central Bank narrative. At some point, the optimistic
storytelling is merely deception that can create further consequences. Credit
to the Federal Reserve attempts to lower expectations. Yet, the rate hike from
December 2015 lacks basis.
The puzzle that lays ahead for investors is to
decipher what reality is untold. What’s the disconnect that’s not recognized?
Perhaps, confronting the (political, economic and social factors) truth enables one to pinpoint the required
correction to adjust to reasonable ranges. For now, the sideways markets are
confused. Buyers and sellers are not showcasing conviction and capital is
desperately seeking a “growth” idea. A messy climate, indeed. Patience might be
the most valuable asset when evaluating assets.
Article Quotes:
“Six countries lay overlapping claims to the East and
South China Seas, an area that is rich in hydrocarbons and natural gas and
through which trillions of dollars of global trade flow. As it seeks to expand
its maritime presence, China has been met by growing assertiveness from
regional claimants like Japan, Vietnam, and the Philippines. The increasingly
frequent standoffs span from the Diaoyu/Senkaku Islands, on China’s eastern flank,
to the long stretch of archipelagos in the South China Sea that comprise
hundreds of islets. The U.S. pivot to Asia, involving renewed diplomatic
activity and military redeployment, could signal Washington’s heightened role
in the disputes, which, if not managed wisely, could turn part of Asia’s
maritime regions from thriving trade channels into arenas of conflict….
Thousands of
vessels, from fishing boats to coastal patrols and naval ships, ply the East
and South China Sea waters. Increased use of the contested waters by
China and its neighbors heighten the risk that miscalculations by sea captains
or political leaders could trigger an armed conflict, which the United States
could be drawn into through its military commitments to allies Japan and the Philippines.
Policy experts believe that a crisis management system for the region is
crucial.” (Council of Foreign Relations, April 2016)
“The first question
is which outcome Europeans would and should prefer. Some have already written
off the United Kingdom, claiming that a partner that would consider leaving is
not the kind of partner they want, anyway. Whether or not one shares this
opinion, the point is worth studying. Indeed, it would be naive not to ask
whether retaining a member that is challenging the very principle of European
integration would really be in the EU’s best interests. The reality is that the
British public debate on sovereignty will not end when the votes are counted.
After all, even if the majority says “yes” to the EU, a share of the population
– a substantial one, according to the polls – will remain convinced that Brexit would have been much better for the UK. Given this, debates and negotiations involving the UK and its European
partners will continue to feature deep disagreements over the restrictions and
conditions that accompany membership in the EU. For years to come, the British
will demand a constant drumbeat of reaffirmation that they made the right
choice. This is an
important consideration that should not be dismissed out of hand. But it should not lead the rest of Europe to favor Brexit. Indeed,
if the majority of British voters decided to abandon the EU, everyone would
suffer the consequences.” (Project Syndicate,
March 21, 2016)
Key Levels: (Prices as of Close:
April 8, 2016)
S&P 500 Index [2,047.60] – In recent months,
the 2,050-2,100 range has proven to be a challenging range for bulls to
reinvigorate more momentum within. In the near-term, surpassing 2,050 will be
critical.
Crude (Spot) [$39.72] – The growing
evidence of support around $36 confirms additional buyers' interest. The stabilization
continues.
Gold [$1,213.60] – Very sluggish and lengthy
bottoming process continues. It is mostly centered around $1,200, as finding
additional momentum has been a struggle.
DXY – US Dollar Index [94.23] – Slightly down week after
week. For several months, the dollar strength theme has slowed down, but 94
still seems like a reasonable bottom.
US 10 Year Treasury Yields [1.71%] – Yields have failed
to stay above 2%. February lows of 1.52% are a crucial near-term benchmark. This
is further confirmation of bond markets not being convinced of the economic
data.
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
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believed to be reliable, its accuracy or completeness cannot be guaranteed, nor
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