Market Outlook | January 3, 2017

“Status quo, you know, that is Latin for ''the mess we're in.” Ronald Regan (1911-2004)

For 2017, specifically the first quarter, there are three themes that can spark notable movements:  First, the perception of Central Banks and their effectiveness to reignite the real economy. Second, developments in China from economy to foreign policy to commodity consumption. And third, Eurozone changes from Brexit-like events to elections that can shape the political future of the continent and the Euro.  These three global topics are surely on the radar. The nuances serve as a potential catalyst to spark market movements.

Status-quo Wobbling

There is much anticipation and suspense regarding the potential derailing of the current market trend. With so much attention circulating around Trump’s regime and the Brexit fallout, the age-old discussions about interest rates and the power of the Federal Reserve remains a critical topic for risk takers of all kinds. At some point, Yellen will have to confront the truth about the effectiveness of low interest rate policies. The Yellen-Trump relationship, which was reported as hostile pre-election, tamed recently following the December rate hikes.  This relationship requires some clarity, but preserving the status-quo of low interest rates is not easy and seems less welcomed moving ahead.

More than the Yellen-Trump relationship, the limited tools of central banks mixed with the unsustainable, ultra-low rate climate may disrupt the familiar pattern of higher stocks and higher real estate prices. However, with the real economy / global growth not being overly thrilling, predicting sustainable rate hikes is a dangerous game. Not to mention, fiscal spending via infrastructure spending, lower taxes and reduced regulation would provide justified optimism, but a follow-through is desperately awaited. Patience is required before making a huge trend declaration.

Obviously, the low interest rate phenomenon is a global theme that’s beyond Yellen & CO. Central banks have struggled to stimulate economies while raising inflation expectation. To continue would be quite difficult. So far, it has been a big disappointment and desired economic results are still awaited. In fact, this is where the Trump victory, Brexit and more Populism comes in to play since the perception of economic well-being is under severe scrutiny. This expanding populist movement has rattled central banks, who are confronting a reality of anti-establishment sentiment, loss of credibility and lack of creative answers to justify an ultra-low interest rate environment:

“Critics of central bank actions were emboldened by a still sluggish global economy even after years of unprecedented monetary stimulus” (Bloomberg, December 15, 2016).

Near-term Suspense

Investors, recalling last January, are quite nervous going into 2017. Not to mention, a multi-year bullish market mixed with increasing optimism, which logically forces one to think cautiously. “Uncertainty” is discussed from a political level as much as economic, so no surprise. Since mid-year, the remarkable turnaround in US 10 Year Yields tells a critical story. 1.31% to 2.44% may not sound like a big deal, but it is a sharp turn to higher yields. A strong Dollar, higher Treasury yields and weaker Gold prices have defined the last six months. In the first few months of 2017, these macro indicators are worth tracking for clues if last quarter was a prelude of what is to come. However, if last quarter was a bit of an outlier and if the status-quo has not changed, then the suspense is deferred further without clear answers.  

Mysterious China

A concrete trend in China is hard to decipher given government data. Real estate bubbles, overheating economy and slowing growth targets have been well documented. At the same time, the Chinese Stock Market (Based on FXI) is far removed from all-time highs, which tells only part of the story. It’s been over nine years since Chinese stocks hit all-time highs. In this same period, US broad indexes are reaching record highs. In addition, the Trump-China relationship is a wildcard. A few mild spats can trigger concerns, ranging from North Korea to currency manipulation among other antics. The sentiment can shift rapidly.

All that said, the Yuan weakening is a fact that’s visible on many fronts. “The yuan CNY=CFXS, which has reached an 8-1/2 year low, was on course to shed nearly 7 percent against the dollar in 2016” (Reuters, December 30, 2016). Some may be tempted to bet on a recovery, but the fundamental weakness in China is evident.

Also, capital outflow is plaguing the Chinese policymakers. In fact, Bitcoin’s (the digital currency) recent appreciation is attributed to ongoing outflow from China given recent capital controls.  Thus, confidence in China is waning, and policy makers have attempted various stimulus efforts. However, since the perception of “China” is quite vital in the business community as well as commodities, tracking the developments for a potential macro catalyst is vital. In addition, the China vs. US rift is not farfetched, but estimating how and when that plays out is even harder to tell. One thing is certain,  the importance of China in political, economic and military related matters is crucial. This makes the events there much more suspenseful and meaningful in the first quarter.

Eurozone Theatrics

The post-Brexit world has sparked all kinds of emotions, debates and doubt about the future.  The Italian Banks,  the Greek debt crisis and Britain’s negotiation with both are enough for concerns. Yet, since concerns have become the norm, it may have made market participants somewhat numb or unmoved by ongoing shocks. In a strange way, an upside surprise in the Eurozone might materialize since the beaten up themes are known. In other words, the risk-reward may appeal to some daring few seeking a remarkable turnaround.  However, the bureaucratic process for change in the Eurozone will be lengthy and the “breaking up” of the union has too many scenarios to ponder. What’s hard to ignore is the populist trend that’s building (as globalist sentiments continue to crumble from US to UK to France) in Europe with more elections coming up. This is another element that’s brewing to re-shape the European status-quo.

If independence and nationalism are preferred, then the status-quo can get rattled again. Although, the consequence might take time to play out. All that said, the tone, actions and leadership of the European Central Bank (ECB) remains quite intriguing. If the ECB, which has mainly created the non-event status quo move, eventually makes a drastic statement, then a new trend can spark with increased volatility. Like all developed markets, investor’s obsession begins and ends with interest rates.  That surely will reflect in the ongoing weak Euro and contentious attitude between European leaders. Stakes are much higher now and participants are asking shrewder questions, which makes each week and tick critical.

Key Levels: (Prices as of Close: December 23, 2016)

S&P 500 Index [2,238.83] – For 2016, the index was up 9.5% . The last two months were explosive as December 13 marked all-time highs (2,277.53).  Mild pullbacks seem inevitable, at least closer to 2, 200.

Crude (Spot) [$53.72] –  In the last six months, buyers showed confidence around $40 on several occasions. In the near-term, staying above $52 is the critical junction.

Gold [$1145.90] – During the past year, gold fluctuated with July 6 highs of $1,366.25 to December 15 lows of $1, 126.95. In the second half of 2016, gold was down over a 17%.

DXY – US Dollar Index [102.21] – During the last half of 2016, a strong Dollar theme remained in place. Since 2011, when the Dollar bottomed, the trend has been positive. For some perspective, July 2001 highs of 121.02 serve as the milestone to keep in mind.      

US 10 Year Treasury Yields [2.44%] – Along with a stronger dollar in the second half of the year, yields went much higher.  2.50% is a key resistance level to watch as breaking above 3% has been difficult in the last six years.

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 should assume that the editor holds a position in any securities discussed, recommended or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.