Market Outlook | January 17, 2017

“A single event can awaken within us a stranger totally unknown to us. To live is to be slowly born.” (Antoine de Saint-Exupery 1900-1944)

Synchronized Elation

 Higher movements in US stocks, interest rates and oil prices not only materialized in recent months, but the optimism of this trend-continuation remained in place.  The collective expectation of better economic signs, mixed with some tangible data of slight improvement, begs the question: what really is the status of global growth? In the US, is labor data signaling some mild revival? Bank earnings were somewhat healthy, matching the trend of rising interest rates. And fiscal policies are expected to be implemented in a favorable way despite the mind-numbing DC gridlock. Even the Federal Reserve is feeling a bit optimistic about the economy, and relentless buyers continue to accumulate shares. Expectations, like the bullish spirits, remain very uplifted, which sets the bar too high.

The Dow 20,000 obsession is alive and well. Perhaps, that milestone serves more entertainment value for financial pundits than observers of the real economy. Apparently, the rising interest rates have not quite derailed the bullish market; even a mild slowdown in the US Dollar has not stopped the positive momentum. Yet, in grasping the events ahead it helps to identify the “known unknowns” versus the “unknown unknowns”. Turbulence is inevitable, but the critical catalyst is the mysterious element for risk managers.  In most cases, the way the script plays out is driven by surprises and which catalyst will set the tone.

 The KNOWN Unknowns

As Trump looks to enter the White House this Friday, the key US stock indexes are flirting with record highs. Through this headline chatter there are lingering issues that will be highly tracked and discussed.  Here are some of the known concerns that are familiar to participants:

 1. Brexit implementation - Financial markets digested the Brexit decision, but the details of the exit process will shed additional light while triggering more volatility. There is a posturing game between the European Union and UK leadership. The short-term volatility does not mean there won’t be long-term benefits, but predicting the theatrical elements appears genuinely difficult. Of course, the British Pound has felt the pain of Brexit and the turnaround for the currency is unclear. Inevitably,  expect more volatility as the twist and turns continue given pending negotiations. Trading ‎opportunities will present themselves and political agendas will spin the reality, which will create more deception.  In other words, the true impact of Brexit may not be straightforward.    

 2. Trump-GOP relationship - The 2016 election gave republicans the White House and Congress, so new regimes are expected to implement a new path. However, not everyone sees eye to eye on fiscal spending, lower taxes and less regulation. Thus, how the DC political climate shapes up will be essential for investors and business leaders. ‎ As inauguration looms this Friday, now the speculative policy-driven euphoria and financial speculations from supporters and antagonists will be tested a bit. Although, anxiousness can overtake investors and media observers alike, true judgment of policies impact on economic/ financial markets may require patience.

 3. Central Banks influence - In the year ahead, less reliance on the Central Banks (CB) and the continuation of rising rates is highly anticipated. Although Europe seems stuck in a near-zero climate, US rates are rising. Even in China short-term rates are rising, as well.  The link between populism and distaste for CBs might be a bigger theme than currently discussed. In other words, from Emerging Markets to Developed Markets, the doubt is mounting on the success of monetary policies. In fact, CB’s are bound to face collective scrutiny that can force them to be less influential on financial markets. That’s a fundamental shift from the last eight years and noteworthy for all investors.

 If the US economy is perceived to grow and get healthier, then the pace of rate hike and faith in central banks can be more telling. Already, interest rates are rising in the US, as some economic improvements are perceived and mixed optimism is brewing.   Rising rates inversely impacting stocks and real estate remains to be seen. Perhaps, that’s the risk for those that enjoyed the rise of asset prices due to ultra-low rates. If there is a crisis or bursting of a bubble, then a collective rage can point to the CB’s policy failures. Thus, Yellen & Co. must be a bit nervous as their reputation and institutions credibility is on the line.

‎4. China - There are many questions about Chinese growth and the impact of multiple stimulus efforts. But, the China-West relationship is rocky from political, military and trade tensions. ‎ In addition, the Trump-China relationship will be highly watched and publicized, but both sides will need to navigate closely to contain the outbursts. Surely, new trade policies or South China Sea rifts can shake markets a bit. From a fundamental point, how the earnings of global companies are impacted will be more of a direct and immediate interest to investors. So much of the global economy is intertwined into the topics that impact the Chinese market from Commodities to Interest rate policies. The fragility of the Chinese status-quo is surely a mega matter.

5. European Elections - As faith in globalization suffers severe scrutiny, the demand for Nationalism and re-defining sovereign values has grown. That said, Nationalistic parties are in more demand than recent years, which surely can change the completion of the EU as well as business sentiment. Like all topics above, the European election themes are interconnected to Macro factors. Brexit and Trump are reminders of this anti-establishment trend. Some may go that direction; others might go towards a dangerous path. Either way, that’s going to drive the perception of policy risk. No question, 2017 can embark on a new era and shift that might take a while to digest.

Accepting the Unknown

There are many factors that can alter the post-election euphoria and multi-year bull cycle. Surely, sensitivity and suspense have escalated in tandem because the global tension has yet to calm. Despite the posturing from the Federal Reserve, who kept rates and volatility low, there are real economy uncertainties, which will be confronted. The tame volatility that’s been witnessed for a while may provide the earliest hints. But even if volatility inches higher, the question will remain, how will the dust settle after near-term uncertainties? Eventually, noise is bound to resurface, and one or two events can drive the rest of the market narrative. All that said, it seems a bit wise to admit the unknown and not to overly claim it’s quantifiable. Perhaps that’s the healthy approach ahead of an action-packed period.

 Key Levels: (Prices as of Close: January 13, 2017)

S&P 500 Index [2,274.64] –A intra-day high of 2,282.10 was reached on January 6, 2017. This further emphasizes the record-high trading behavior that’s been common in recent years.

Crude (Spot) [$52.37]  –Appears trapped in a range between $50-54.  The commodities ability to stay above $50 appears noteworthy in the weeks ahead. 

Gold [$1,190.35] – Desperately attempts to bottom. The December 15, 2016 low of $1,126.95 is on the radar for both buyers and sellers. The multi-year, sluggish price action lingers especially with a move below $1,200.

DXY – US Dollar Index [101.18] – Strong dollar momentum is waning and slowing a bit. A breather here is be expected after a strong run since May 2016.    

US 10 Year Treasury Yields [2.39%] –   Since July 2016, the turnaround from the low of 1. 31%, has set the tone for a new trend. The re-acceleration from November lows is even more stunning, at least in the near-term.

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