“Confusion now hath made his masterpiece!” William Shakespeare
(1564-1616)
Early Digestion
The post-Brexit market reactions turned into perceived
“overreaction”, as global equity markets rebounded and volatility calmed down dramatically.
As the second half of 2016 begins, there is this feeling that “all is
manageable” by the Central Banks, and the ongoing thesis of low rates, higher
markets will continue in a smooth sailing manner. Perhaps, that’s a
desired outcome of those deeply entrusting the Central Banks' narratives and
their PR efforts. Many institutions and investors are typically taking commands
from the Central Banks and might be gravely mislead. Sure, markets did rebound and the “panic”
mode transferred quickly into business as usual, as calmness resumed to the
good ol’ status quo. However, it is not quite convincing that the
status-quo thinking is reliable when
moving forward.
Further Questions Piling
That said, is a zigzagging market a reflection of stability
or a collection of clueless participants? Is there any confrontation in
concluding that Brexit effects are understood? Isn’t nervousness warranted, as
more Italian Banks are in crisis mode, Brexit negotiation are still
misunderstood and the Eurozone is weaker than before? Isn’t a market rally
disconnected with real economy hardships and frustrations? Aren’t low rates
signaling potential fear, lack of growth and loss of central bank Credibility? More questions to ponder.
Perhaps, the massive sell-off and the “resilient”
recovery illustrate one thing: confusion. If last week’s action is
viewed as market confidence rather than confusion then that can pave the way
for another negative shock.
1)
Bond markets do not buy
into strength in the real economy = Lower interest rates.
This applies not only in US
markets but across developed markets where yields are either very low or
negative. There is over $11.7 trillion of negative yielding government bonds in
the world led by Japan and Europe. This is phenomenal from a historical point
of view, and entering uncharted territory. Certainly, negative yields are not a
one-time skew, rather a well-established trend.
Central banks are waging a
war against those realists and skeptics who are dumbfounded by the monetary
policy. The Fed is not conceding easily regarding prior mistakes, and are shamelessly
willing to move from rate hikes to possible rate cuts in the UK and US. The long drawn out weakness showcases the
fragile Western economies, which has been ignored.
2)
Commodities viewed as a
bargain as well as a relative “shelter” = Price recovery.
The CRB Index bottomed on
January 22, 2016, starting a recovery. Of course, commodities were butchered
for about 5 years or so (2011-2015). Certainly, Gold has received a lot of
attention, climbing out of the so familiar $1,200 range. Importantly, the less
trust investors have in central banks, then the more likely that Gold becomes
the “go to” asset through customary practice. There is still a debate if Gold
acts likes currency or a commodity. Gold tracks closely with commodities when
examining the last boom and bust behaviors. Yet, the accelerating uncertainty
in currencies and central bank actions is mounting.
At the same time, copper is
reviving itself and, for some, it is a leading indicator of global growth.
Unlike Gold, which is relished as a defense position, copper is viewed as
a barometer of economic strength and used by some analysts as a leading
indicator. The strength in
copper might be a barometer for global growth or further reflection of a commodities
uptick. Deciphering this will be critical in the near-term. However,
commodities at this cycle are not near the “top” and are attracting few
bottom-pickers.
3)
Shift in perceived Emerging
Markets = Buying opportunities.
The weakness in Europe and the
rampant demand for nationalism is making developed world appear not as stable
as a year or so ago. If another element of uncertainly is circulating in
the Western world (economic, political and /or military) then the additional
risk of Emerging Markets does not seem overly “scary”. Surely, EM is
recovering after an abysmal period of slow growth, FX damages and an inevitable
cycle peak that materialized few years ago. That said, as the BRICS attempt to
dig out of a hole and commodity reliant nations seek to stabilize, there is
some risk-reward opportunities that participants will consider, especially when
desperate for yields.
Mismatching Story
Central Banks are clashing with the day to day
realities, as the bond markets are not buying it. As Yellen claims, recession possibilities are
“very low”, the 10 Year Treasury is below 1.50% (hitting annual intra-day lows
last Friday at 1.37%). The Fed is massively struggling to convince participants
about their stale and usual narrative. In other words, the Fed’s story is not
matching the economic data, business climate and unfolding political dynamics. The
obsession with stocks in the US may cloud the vision of average observers in
terms of economic health. However,
with populism and nationalism becoming a theme in the Western world, a
wake-up call is quite visible at this stage.
Perhaps, the S&P 500 index is hinting another
signal, where buyer’s momentum is stalling around 2,100. Maybe, the stock
biased observers need to see a correction; even though, the bond markets
flat-out are declaring soft economic growth. In addition, the quick rise and
fall of the volatility index showcases further a long bias that’s deeply ingrained
in this market. There are cracks in the Fed’s messaging and theories, but
they are not collectively appreciated. Perhaps, the harsh reality check
of “confusion” by the Fed can create a
quicker migration into safer or non-developed world assets.
Article Quotes:
“Europe and America have economies of a similar
size, but the aggregate market value of the top 500 European firms is half that
of the top 500 American firms. Aggregate profits are 50-65% smaller, depending
on the measure used. Of these firms, the median American company is
worth $18 billion, with net income of $746m in the past year. The median
European firm is worth $8 billion and earned only $440m. It wasn’t meant to
turn out like this. In the 1980s corporate Europe was held back by a patchwork of
national boundaries, the heavy hand of the state and cross-shareholdings with
banks and insurance companies. Starting in the late 1980s new ideas emerged to
reinvigorate European business. There was a trend towards privatizing
industries and making them answerable to investors. There was a push to create
pan-European firms that would compete across the EU’s single market using, in
most countries, a single currency. And there was a drive to take European firms
global, exploiting the historical links of their home countries around the
world.” (The
Economist June 30, 2016)
“Italian banks never recovered from the last crisis.
Larded with bad loans, several depend on support from the Italian
government-organised private investment fund Atlas, as well as the ECB’s
liquidity facilities. Still more capital is required. Buyers could be found for
non-performing loans if they were marked down far enough. But those markdowns would
make official the well-known holes in the banks’ balance sheets. This in turn
would require the banks to raise more equity — for which there are no buyers
apart from Atlas, which is just about out of money. The worst case scenario
would be if depositors, many of them the small- and medium-sized enterprises at
the core of Italy’s economy, moved their cash to banks that are perceived as
less risky, causing a liquidity squeeze. More immediately, banking wobbles
could create political trouble for Matteo Renzi, the prime minister, who is
facing opposition from Italy’s populist Five Star Movement and worries about
losing a constitutional referendum he called for October.” (Financial Times, June 30,
2016)
Key Levels: (Prices as of Close: July 1, 2016)
S&P 500 Index [2,102.95] – Once again, 2,100 is
proving to be a critical point. In the past, buyers' momentum faded near this
range. However, at the same time, sellers' momentum stalls at the 2,050 range.
Thus, the bullish bias remains
intact while sideways action sums up the recent moves.
Crude (Spot) [$48.99] – Further signs of
stabilization appear between $45-50. The February 12, 2o16 lows of $26.o5 seems
like a while ago. Since then there has been stabilization.
Gold [$1,340.00] – Positive momentum since the start of the year. A positive
trend accelerated above $1,300; August 2013 highs of $1419.00 will be the next
target.
DXY – US Dollar Index [95.64] – For over three months,
the dollar index stabilized around 94. Unlike in 2014 and 2015, the dollar
strength is not surging at the same pace. Fair to say, a relatively strong
dollar is still in place.
US 10 Year Treasury Yields [1.44%] – Since peaking on December 4, 2015 at 2.35%,
yields have resoundingly declined below 1.50%. Again, the bond markets are not
seeing a vibrant growth in the real economy.
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