“We are all in the gutter, but some of us are looking
at the stars.” (Oscar
Wilde)
Euphoria Digested
As headlines loudly proclaim US stocks moving higher
to record highs, we should not forget the well-established bull market that has
been in place for a while. The post Trump market euphoria is not quite a
turnaround from the deeply depressed price levels in stocks, but rather a
further exclamation point to the current bull market in US stocks.
Similarly, the rise in US 10 year
Treasury Yields, inflation expectations and a stronger Dollar beg a similar
question of if this is an acceleration of what’s established or a new game
changing trend?
The Dollar has been stronger, as exemplified by a
noticeable strength versus most currencies in 2014. That said, investors of all
kinds are facing the question of whether to chase the returns or to stay
lightly positioned into 2017. For a couple
of years, the feeling of “don’t want to miss out” has infiltrated the mindset of
stock investors. Yet, the interest rate picture is where a new trend may
follow, as suspenseful observers await. Bond markets are where the volatility is
brewing, and now investors are forced to shift their mindsets. The sell-off in bond markets seems abrupt for
now, but continued selling in bonds can be a dramatic shift that some participants
have long awaited. Now, Italy’s referendum
vote is adding further anxiety and more votes await in Europe.
Shifting Dynamics
The QE era that fueled stocks maybe nearing an end,
not only because of a new White House regime but because of a Central Bank
model under severe scrutiny. On one
hand, equity buyers who have benefited greatly from QE should not complain or bemoan policies that benefited
financial markets more than the real economy. However, on the other hand,
the Trump victory (like Brexit) symbolizes the failure of the real economy,
where job and wage growth aren’t as rosy as painted by economist and political
pundits. Thus, the conundrum has fully struck. Maybe the recent “melt-up”
in stocks was a mere continuation of the bullish theme in financial markets. Betting on new trends with conviction is too
challenging since the Trump-Yellen, Trump-Congress and Trump-Financial Markets
relationships are yet to be fully discovered. The grand plans of lower
regulation and lower taxes need to materialize a bit.
Two years ago…
The collapse of commodities in recent years has weakened
BRICs and other Emerging Markets (EM). In 2014, the Dollar strength and EM
weakness were critical themes that
played out across equities, currencies and commodities. Perhaps, the effects of
that remain in place and, again, are being revisited. This serves as a reminder to all that the
Emerging Market fund (EEM) peaked on September 5, 2014 and has been in a
downtrend ever since. Even before protectionist policies were anticipated, this
was the market’s response. Now, policies tied to Nationalism are not only fueled
by a Trump-led US, but are also vibrant theme in upcoming European elections. Again,
in the election shuffle and media hype, it is easy to get lost with convenient
narratives. However, the Dollar, since 2008, has stopped its perennial weakness;
and, in the last few years, the EM fragility has brought the greenback at the forefront
of strong currencies.
Continuing on the theme that relates to 2014, it was
the January of that month when US 10 year yields peaked at 3.05%. Since then, a
constant decline in Treasury Yields has mirrored the low rate policies, which
are deeply ingrained in observers’ minds. The upcoming months will determine if
either the new post QE/Central Bank era of dictating a low rate environment or
a period where suppressed inflation and roaring rates can shift the dynamics dramatically.
Now, if bond markets have finally
accepted that inflation is rising and that government spending will stimulate
the economy, then revisiting the 3.0% on the 10 year yield does not seem
farfetched. However, the Central Bank’s lethargic status-quo is still hanging
in the backdrop.
Article Quotes:
“A new paper from Hyun Song Shin of the Bank for
International Settlements suggests that a stronger dollar may have significant
financial, as well as trade, effects in emerging markets. Many companies
have borrowed in dollars, so the cost of repaying their debt rises when the
greenback gains ground against their domestic currencies. Much of this
borrowing is conducted through the banking system, leaving the banks exposed to
the risk of a rising dollar. Accordingly Mr Shin finds that “dollar
appreciation is associated with a slowing of cross-border dollar lending”—in
other words, a tightening of credit conditions in emerging markets. The dollar
may be a better indicator of risk appetite than the VIX index of equity
volatility, the paper argues. But investors are also worried that the election
of Mr Trump signals a turning-point in globalisation. On the campaign trail, he
pledged to renegotiate the North American Free-Trade Agreement, NAFTA, to
declare China a currency manipulator and to impose protectionist tariffs.”(Economist, November 19, 2016)
“First, there is the prospect of divergence in growth
and central-bank interest rates: the market thinks both are heading higher in
the U.S. but remaining muted in Europe. Expectations of short-dated Eurozone
interest rates have fallen back, even as market-based measures of medium-term
inflation expectations have risen, ING notes. Secondly, and more worryingly,
German bonds are benefiting because southern European government bonds have
been hit. The 10-year spread between Italy and Germany has reached its
widest point since May 2014, despite European Central Bank bond purchases.
France has come under pressure too. Political and credit risk are coming to the
fore again in Europe, encouraging investors to seek safety. The divergence
could be here to stay, with Europe facing a packed election calendar in 2017.
Bond investors need to get used to a world where markets are no longer in sync.”
(Wall Street Journal, November 22, 2016)
Key Levels: (Prices as of Close: November 25, 2016)
S&P 500 Index [2,213.35] – Another all-time high. After
spending the last several months trading between 2080-2180, this recent move up
is a re-acceleration of an already existing bullish trend.
Crude (Spot) [$46.06] – Held
above $44 recently. Surely, the OPEC meeting is the near-term catalyst. Importantly, since May 2016, the commodity
has traded between $42-50. Now, breaking
above $50 is the upcoming challenge.
Gold [$1,187] – The recent break below $1,220 suggests
extended weakness. Some will view this as deeply oversold and an opportunity to
purchase. If there is a rate hike in December, it’ll be interesting to see how Gold
responds.
DXY – US Dollar Index [101.49] – Strength remains. A break above 100 can trigger a new wave of
Dollar strength that inversely impacts other currencies. In terms of a next key
level, the July 2001 high of 121.02 is somewhat on the radar. Amazingly, from
2001-2008, the Dollar weakness was a consistent and glaring trend. Some
reversal has been brewing.
US 10 Year Treasury Yields [2.35%] – Above the 200 day moving average (2.20%) and
confirming a near-term uptrend. The spike from 1.80% to 2.41% this month is
rather stunning, but needs lasting substance.
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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