Market Outlook | March 17, 2014

“Time crumbles things; everything grows old under the power of Time and is forgotten through the lapse of Time.” Aristotle (384 BC-322 BC)

Silently crumbling?

Turbulence is reawakening a bit within the existing positive momentum that has formed a stable US financial market. Of course, hints of a trend shift are brewing more and more as perceived risk is being evaluated in developed markets. From the pending FOMC meeting to several EM nations increasing interest rates, the landscape is mildly changing. Similarly, pending responses to technical indicators as well as reshuffling of capital into new themes can trigger new thoughts. Plus, ongoing data will continue to seep through the investor mindset. How to perceive risk will be revealed further and the bulls’ confidence level will be tested – yet again. The status-quo approach is overly comfortable for those betting on rising stocks and low rates. However, the danger of being flatfooted ahead of turbulence begs the question of how to prepare for the next move.

The volatility index has not and is not signaling absolute panic, and previously, false signals have prematurely called for short-lived sell-offs. Thus, naysayers to this bullish run have had shaken confidence in recent trading action, where “bad news” has been deferred or deemed a non-forceful catalyst. Uncertainty of macro and micro concerns is calmly digested, and a collective rush to exit is not quite justified by mainstream investors. One part of the puzzle is deciphering the pace of economic and corporate growth, which offers plenty of tricks and data points to ponder. Perhaps, the market has a mind of its own, living and moving at its own pace.

Meanwhile, deflation and disinflation concerns are brewing in developed markets. In fact, the deflation debate has reached beyond speculation, but rather has become a reality that’s come to the forefront in Europe:

“Europe's headline price data understate the full deflation risk. Eurostat's HICP index ‘at constant taxes’ – stripping out the one-off effects of austerity – shows that 23 of the EU's 28 countries have seen a fall in prices over the past seven months.” (The Telegraph, March 12, 2014).

Big-picture parts

The macro-climate is awakening to the realization that post-crisis matters have stability, but long-term issues persist with a slowing global climate. In the recovery mode, optimism was restored and volatility significantly reduced, and soon, coping with unknown risk measurement was the ultimate test for portfolio managers. As usual, risk aversion, leading into more established currencies and commodities, is worth tracking. Thus far, hard assets have risen in 2014 and there are early signs of rotation into safe/established assets, given ongoing emerging market political and financial turmoil.

Meanwhile, China’s slowing growth is a topic that’s been murmured about, but its impact on the developed market is still being understood. Plus, the recent announcement of a wider trading band for the Yuan over the weekend, although anticipated, suggests more fluctuation in currency markets. The reaction is causing some suspense as to how traders would react in the near-term toward weaker Chinese currency and impact on global stocks. Surely, policy changes like this can be historic and transitions can cause some mild disruptions. Nonetheless, this is a new dynamic to the currency market and the impact on Chinese stocks is yet to be determined. The Chinese index (FXI) has remained cheap relative to US markets, and now the currency policy may serve as a catalyst to spark a response.

New cycle

The instrumental factor that’s driven market appreciation is low interest rate policies, and certainly that has impacted how investors demanded higher-yielding assets.

“Our results show that, in emerging markets, issuance would have been significantly lower without QE since 2009. A counterfactual analysis shows that issuance without QE would have been broadly half of the actual issuance since 2009, with the gap increasing in late 2012. In advanced economies, the impact of QE was less strong and concentrated in early 2009, mainly as a reflection of the MBS rather than Treasury purchases.” (ECB, Global Corporate Bond Issuance, March 2014).

The taper era remains a wildcard from a period where risk-taking has been encouraged and rewarded. How this will change has been asked but not answered. Again, the US 10 year Treasury yield is below 3%, the stock market is near all-time highs and EMs are less stable; these are the known themes. We are in more or less a vulnerable stage of this cycle, as assets are not valued cheaply. How will this shape up in the next 1-2 years? Which moves first: Either rates up and stocks down or otherwise? Mapping out a plan on interest rates and asset prices is challenging risk managers. Clearly, the disconnect between the real economy and the stock market is dangerous (despite crafty explanations) and the warning has been felt but not always heard. The messaging of the Fed or the response to the Fed’s message is clearly a vital sign where an inflection point can be felt. Already, the S&P 500 index showed signs of cracking in January. Thus, a repeat of price retreat is not far fetched. Catalysts are plenty for bigger moves, especially in the early stages of the taper era. The question is timing, and with limited ideas, risky assets serve a purpose and eager investors desire risk. Balancing the need for returns versus unmasked realities is the art for money managers.




Article Quotes:

“Major US banks are running away from lending to highly leveraged buyouts, industry statistics show. Bank of America, JPMorgan Chase, Wells Fargo and Citigroup have all fallen far down the list of top LBO lenders in 2014 after regulators pressed changes that would have made such loans more expensive. Stepping away from such business will surely crimp profits and is one example of how new regulations are forcing changes to the banking sector. BofA earned roughly $140 million in 2013 from financing new LBOs, sources said. The banks, which were all among the top 11 LBO lenders in 2011 to 2013, could do no better than No. 18 in 2014, according to Thomson Reuters LPC statistics shared exclusively with The Post. The change comes after the Office of the Comptroller of the Currency (OCC) stepped up a campaign last year against such highly leveraged buyout financing. The OCC and the Federal Reserve in the fall told the major banks if they funded new LBOs that had greater than six times debt-to-earnings before interest, taxes, depreciation and amortization (Ebitda) ratios, they would have to consider them non-conforming loans and hold more cash against them, sources said.” (New York Post, March 13, 2014)

“Skilled immigration is of great importance to the US, representing 16% of US workers with a bachelor’s degree, and 29% of the growth of this labour force over the period 1995-2008. Presently, proponents for increased skilled immigration argue that it supports economic growth, and some have gone so far as to say that the alternative would be paramount to ‘national suicide.’ Opponents believe skilled immigration is already too high and hurts the outcomes of citizen workers. In particular, Bill Gates has stated that Microsoft hires four additional employees to support each skilled worker brought into the US through the H-1B visa program. Matloff (2003) instead argues that US companies use skilled immigrants to displace older citizen workers that have higher salaries. Our research proposes a more subtle relationship than that suggested in the public discourse on immigration or from more aggregate models of international worker flows. We study the way in which the hiring of skilled immigrants affects the employment structures of US firms using employer-employee data from the US. While OLS and IV specifications find increases in total skilled employment by the firm with increases in skilled immigrant employment, we find evidence that employment expansion is greater for younger natives than their older counterparts.” (VOX, March 16, 2014)




Levels: (Prices as of close March 14, 2014)

S&P 500 Index [1841.13] – Very optimistic observers are wondering if 1900 wasn’t reached due to a momentum slowdown. Yet, for the upcoming week, holding above 1840 can trigger restoration of the ongoing bullish run. Notably, the January 15 highs of 1850.84 might have suggested a vital hint during the early sell-off this year.

Crude (Spot) [$98.89] – March 3 highs of $105.22 marked a peak in the recent run. The 200-day moving average sits at the all-too-familiar $100 range. Therefore, staying above $100 will be retested; if not, negative momentum might continue to build for months ahead.

Gold [$1368.75] – Since late December, the commodity is up nearly 15%, which suggests a recovery run after a weak 2013 performance. The next noteworthy target is $1400 (or $1419.50), which was a key resistance point in September 2013.

DXY – US Dollar Index [79.44] – The downtrend is intact, as new lows have been achieved consecutively in recent weeks. The next noteworthy low is not far removed. It stands at 78.91, which was set in February of last year.

US 10 Year Treasury Yields [2.65%] – Annual lows of 2.56% were reached on February 3, 2014. Yet, surpassing 2.80% remains a challenge, suggesting a weak growth environment. Annual highs of 3.05% appear further away now, given analysts’ expectations of rising yields. Interestingly, the 200-day moving average stands at 2.67%, which is in line with Friday’s close.


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.

Market Outlook | March 10, 2014

“Do not quench your inspiration and your imagination; do not become the slave of your model.” Vincent van Gogh (1853-1890)

Strength established

Analysts these days are torn between pointing out worrying factors for the next market movement versus praising the already known powerful bull market. Typically, when indexes reach all-time highs, the technical/chart observers will point out that the bullish run faces no resistance ahead. Junctions like this invite the common thought of “unlimited” upside potential and reawaken the sideline capital that’s been overly skeptical. Capital inflow into US markets is quite evident:

“The inflows into stock funds in the week ended March 5 marked the fourth straight week of new cash into the funds. Funds that specialize in U.S. stocks attracted $8.9 billion of the net inflows, marking their biggest inflows since late December.” (Reuters. March 6, 2014)

Equally, this sentiment comforts those adding on to further risk and participating in the upside momentum of this five-year bullish run. Importantly, in 2013, the S&P 500 index registered all-time highs on numerous occasions. Therefore, the mention of record highs at this point is hardly news or alarming for observers. This is dangerous in some ways, when price appreciation has a numbing effect as markets again march to their own rhythm. Even the Eurozone is viewed as recovering or calming down, yet the banks’ exposure to debt is worth tracking:

“Banks in the region [Eurozone] now hold about €1.75trn in government debt, equivalent to 5.7% of their assets and the highest relative exposure since 2006, according to European Central Bank data. In Italy and Spain, roughly one in every 10 euros in the entire banking system is now on loan to governments.” now on loan to governments.” (IFR, March 8, 2014).

Surely, bargain hunters in undervalued European assets might seek select investments, but overall, the crisis concerns have not fully evaporated. At least, risk reduction is not an overnight exercise as risk-takers test their luck.

Since September 2010, developed markets have performed very well versus emerging markets, and this has been highly discussed in recent periods. A massive investor exit from emerging markets is more profound given multiple weeks of consecutive capital outflow. Forward-thinking observers are facing a dilemma, asking: Does one buy emerging markets that are out of favor and relatively cheap? Or does one chase the momentum of what’s been proving to work – US equities? Both are equally challenging to answer, but it’s fair to say that EM is more of a bargain these days, and the risk-reward appropriately reflects that.

Misaligned perspectives

The dollar is now reaching a five-month low, which is a noteworthy macro theme. A weak dollar has helped US exporters further, as seen in prior years. Ongoing cost-cutting methods by corporations have led to some adjustments, which in turn leads to softening economic growth. The interest of shareholders (maximizing stockholders’ value) is naturally not always quite aligned with those seeking economic growth. Thus, the further demise of the real economy is not a topic that’s endearing to capital allocators and risk managers.

Unemployment data has its own trickery, interest rate policy comes with its own self-serving messaging purpose and the stock market reflects shareholders’ perceived value. Thus, finding the truth amidst conflicting events and trends is mind numbing to those not looking to deeply speculate on unfolding events. Settling for the simple and clear explanation of low rates and higher risk tolerance continues to convince plenty.

Basics examined

Investors continue to examine: a) Are prices relatively cheap enough? b) Does the upside offer promising returns? Investors in equities in the US contemplate this as we head into another week. As basic as this sounds, answers to these questions remain the fundamental driver in a market that is rational. In other words, if one is seeking value at bargain prices, then not too many ideas are available outside of stock-specific investments. Similarly, if one is looking for distressed assets, then the best bet appears to be waiting for the next crisis (or heavy price adjustment). Patience is required here, as assets have collectively risen in the post-2008 period. Surely, there is scarcity of ideas, especially for investors looking to deploy large capital. Equally, as the markets have long realized, there are limited safe and liquid assets that can produce yields. A game of limited options for big capital forces creates a point where capital is invested based on relative options rather than stellar fundamentals. That being said, shocks have been averted, as “safer” assets are being redefined. Importantly, signs of irrational behaviors are seeping through and markets are creating their own realities. At some point, the basic questions will be asked, but for now, some realities are conveniently deferred.

Article Quotes:

“This year Western firms’ giant bet on the emerging world will come under more scrutiny. Most multinationals are far more profitable in emerging markets than Vodafone. American firms made a 12% return on equity in 2012, roughly in line with their global average. But having grown fast, profits are now falling in dollar terms. There has been a long bout of share-price underperformance as investors have lost their euphoria. An index run by Stoxx, a data firm, of Western firms with high emerging-market exposures has lagged the broader S&P 500 index by about 40% over three years. And the recovery in the rich world will mean there will be more competition for resources within firms. All this will bring strategic questions into sharp relief. Divisional chiefs from Brazil or Asia will no longer get a blank cheque from their boards. Although the average company has prospered, there have been disasters; plenty of firms and some whole industries need a rethink. The emerging-market rush may end up like a giant version of the first internet boom 15 years ago. The broad thrust was right but some big mistakes were made. The companies suffering a slowdown in profits come in three buckets. Consumer firms including Coca-Cola, Nestlé, Unilever and Procter & Gamble have suffered a gentle weakening in demand and a currency drag.” (The Economist, March 8, 2014)

“On March 5, during an annual meeting of its legislature, Beijing announced that it is increasing its military budget by 12.2 percent, to a total of $131.6 billion in 2014. While still less than a third of the $496 billion that Defense Secretary Chuck Hagel proposed in February for the U.S. military in 2015, it still represents a significant expansion, even after two decades of double-digit growth in the PLA's [People’s Liberation Army] official budget. But few doubt that the grand total allocated to China's military is yet higher, and many in the U.S. government wish they had more insight into the method to the darkness surrounding the PLA. There is general consensus that China, like many nations, spends more on its military than it reports: In February, the U.S. Defense Intelligence Agency said that China's military budget reached $240 billion in 2013, according to Bloomberg. As the most salient data point of China's military, Beijing's official budget gets a lot of attention. And that's largely because there's little other information that comes with it. ‘The single number, without any accompanying detail, represents the sum total of public transparency by the world's second-largest defence spender and the fastest rising military power, pored over by intelligence agencies and military experts from around the world in an effort to glean any clues about China's future strategic intentions,’ reported the Financial Times.” (Foreign Policy, March 7, 2014)

Levels: (Prices as of close March 7, 2014)

S&P 500 Index [1878.04] – Reached all-time intra-day highs of 1883.47, which will serve as a very near-term barometer. The bullish run has been confirmed, especially in the recent move above 1840.

Crude (Spot) [$102.58] – Barely moved relative to prior week. Prices seem stuck in the $100-105 range. Buyers and sellers are reconsidering the recent moves and reassessing whether prices are justified, given supply output in recent months.

Gold [$1345.25] –Nearly a 13% rise since the lows late last year. The first wave of a recovery bounce is materializing. The second wave of recovery is being questioned in terms of further momentum to get near or past $1400.

DXY – US Dollar Index [79.69] – Most of February witnessed a decline in the dollar. This is a common trend, but a move below 80 triggers some questions about a pending trend in the near-term.

US 10 Year Treasury Yields [2.78%] – Impressive move back to the 50-day moving average (2.78%). Showcases signs of recovery in economic data. Reaching 3% is the ultimate test that can set the tone for the first half of 2014.



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.

Market Outlook | March 3, 2014

“Thoughts are forces.” Ralph Waldo Trine (1866-1958)

Forces behind resilience

Throughout the last 12 months or so, moments of edginess have persisted but failed to materialize into an actual major sell-off. In fact, hindsight shows that the momentum of markets is a force that marches to its own rhythm in digesting the importance of key events. As long as participants have a “thought” that the prevailing theme supports risk-taking, then stock market rallies remain, like a self-fulfilling prophecy. Of course, improving signals of economic strength or corporate earnings are needed to fuel a rally. In some cases, glimpses of improvement have been hinted at in the last five years when tracking government data at face value. Certainly, the low point of 2008 and early 2009 still serves as a benchmark and a worst-case scenario. At this stage, one has to wonder about whether the numerous occasions may have signaled looming troubles but been misleading, too. Amazingly, a few concerns have come and gone as stock markets approach new highs:

1) Disconnect between the pace of real economic growth and stock market appreciation
2) Geopolitical events and socio-economic-driven tensions across various established and emerging nations
3) Emerging market growth slowdown, capital outflows and a few currency crises
4) Uncertainty around taper discussions and QE plan changes
5) Questionable sustainability of high corporate profits
6) US government dysfunction, including a period of shutdown
7) Regulatory risk associated with banks and increased regulatory cost for various industries
8) Shifting sentiment toward business leaders and excessive skepticism of past business models

Drumming to its own beat

Despite all these day-to-day issues related to the topics above, the US broad indexes live in their own reality and at their own pace of creating value for shareholders. Also, everyone has his or her own perception and interpretation of what transpires. Perhaps, the wise have agreed that limited investment options and a limited number of shares in larger companies end up contributing to the ongoing run of record highs. Not many markets, currencies or ideas are deemed as safe or relatively attractive as the US markets. Sure, that’s been true for a long while. Capital outflow from developing nations and into US assets further illustrates investors’ perception. Political and international antics aside, the markets know how to puzzle participants, or maybe broad indexes are unfazed by unfolding events, surprising observers plenty. Driven by illusion or not, the basis for market movements so far has been diffused or misunderstood. In some cases, expectations are so low that outperforming (i.e. earnings) has become a justifiable “reality.”

Surely, retirement accounts and pension funds have recouped pre-crisis losses, and the optimism has become a force that’s a bit beyond reason but in line for experts. Toppling this bullish run has been categorized as a dangerous activity, and fighting the Fed is seen as an intimidating act against the status quo. Yet, a new month is here, and the tiresome argument of invincibility is not enough to deflect and ignore all the pressures to this cyclical run. Risk managers are not in a position to rewrite the definition of risk, but rather confront the risky conditions of a market that has promoted and rewarded risky assets. Amazingly, the doubters of turbulence are now armed with historical performance as their biggest evidence, and that in itself is known to spark trouble ahead.

Brewing catalysts

Unfolding events in the Ukraine saga will impact energy prices, specifically in crude and natural gas. Clearly, gas has big implications for EU, and Russian gas supply and markets will begin to track this, at least in commodities. Plus, international oil companies that have signed deals in Ukraine might feel some impact on revenues. Whether this will serve as a catalyst for risk-aversion broadly is questionable for now, as the political jabbing continues to make noise. As stated above, a lot of crisis events have come and gone unnoticed or without being harmful to this lively script favoring US equities. However, the looming and accumulating factors in the recent saga over energy and strategic global powers can stir some sense of unease. Of course, lack of stability hurts both EU and Russia, where sensitivity is high in this inter-connected world. Not to mention, capital outflow from BRIC nations has been a sensitive theme itself, especially in 2013. Even this year, the trend continues:

“Withdrawals from U.S.-based ETFs investing in emerging-market equities and bonds totaled $11.3 billion this year, already surpassing the redemption of $8.8 billion for the whole of 2013, according to data compiled by Bloomberg.” (Bloomberg, February 27, 2014).

Equally, Chinese bubble talks are brewing on the side as well, given low PMI manufacturing data. Therefore, the slow economic growth environment can stir agitating responses and reactions. A complacent market may not be ready to grasp the overnight panic-like responses. The tricky part is not relying on the history of the last five years as indicative of the next five months.

In terms of US markets, a few innovative areas such as technology and biotech have witnessed massive runs, especially in smaller and growth-driven companies. The run-ups here have been explosive, based on charts and technical observations. If a pullback awaits, these high-performing areas appear vulnerable where the money can exit quickly, as seen in a few emerging market countries (i.e. Turkey). Perhaps, the catalysts are adding up, a breather is needed and a reality check like earlier in the year awaits. March historically has produced periods of sell-off, and last week’s GDP numbers did not excite the optimists. Thus, the reasons for a sell-off were never scarce before, but now genuine optimism seems harder to find for seekers. Even bargain hunters may decide to wait before deploying capital to new ideas.

Article Quotes:

“The recent volatility in the offshore renminbi exchange rate has turned the spotlight on to a little-followed corner of the derivatives market that may have attracted the attention of China’s central bank. A persistent weakening of the PBOC’s onshore reference rate has been amplified in the offshore market, where the spot rate for renminbi, or CNH, slid on Wednesday afternoon to 6.113 against the US dollar, a 1.29% drop in just six trading days from 6.034 on February 18. It is the largest fall in the spot CNH rate since it was first quoted in mid-2011. Analysts believe the apparent intervention of the Chinese central bank in the currency market was designed to show that the currency could go down as well as up, but it has had the biggest impact on investors holding unhedged currency derivatives as a leveraged bet on future appreciation. Speculators piled into the trade as the CNH spot rate gained 4% against the dollar on an annualised basis in the fourth quarter last year. Deutsche Bank estimates the total of offshore renminbi structured forwards traded so far this year is already close to US$100bn, about 40% of the US$250bn traded in the whole of last year. Market observers believe the PBOC has deliberately introduced volatility to the currency market as part of larger plan to increase the market’s role in setting prices.” (IFR, March 1, 2014)

“Eurozone policymakers are struggling simultaneously to strengthen the balance sheets of banks and governments, but each is dragging down the other: banks facing large loan losses are increasing their already outsize exposure to eurozone sovereign debt, which falls in value as fears rise that the governments will be called on to bail them out. Each is therefore weakened by financial exposure to the other. One of the chief economic challenges facing the eurozone is that action taken by the ECB to stimulate lending to the private sector is being rendered ineffective by the weak condition of the banking sector. Cheaper ECB borrowing rates for banks have encouraged them to lend more to their governments, but not to businesses and consumers. Particularly in Italy, Spain, Portugal, and Greece, the ECB is now largely powerless to lower the interest rates that matter most to economic growth. European banks have been trying to repair their balance sheets by raising capital, but uncertainty over the quality of the assets they hold makes such capital expensive. Many eurozone bank stocks trade at less than book value, which means that investors believe the banks are overstating the value of their assets. Rather than raise capital, therefore, banks have resorted to cutting back on their lending. This further weakens the eurozone economy by reducing the supply of credit available to the private sector.” (Council of Foreign Relation, March 3, 2014)


Levels: (Prices as of close February 28, 2014)

S&P 500 Index [1859.45] – Continuing to make a bullish run. Showing signs of holding above 1800, but the sustainability of this momentum is showcasing resilience.

Crude (Spot) [$102.59] – In the last eight months, prices have swung from the $110 to $92 range. Yet the recent rise in crude prices since early January has been explosive.

Gold [$1332.25] – The recent bounce-back has prices reaching near the 50-day moving average. The near-term test is surpassing the $1350 point to re-accelerate further. Whether the buyers’ momentum is
intact will be tested in upcoming weeks.

DXY – US Dollar Index [79.69] – A move below 80 is the lowest close in several months. Signs of weakness in the dollar, although it’s too premature to declare based on this index.

US 10 Year Treasury Yields [2.64%] – Recent pullbacks have driven yields closer to the 200-day moving average (2.63%). Yet, the 50-day moving average sits at 2.80%.




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.

Market Outlook | February 24, 2014

“The only alternative to co-existence is co-destruction.” Jawaharlal Nehru (1889 - 1964)

Coexisting views

In a period where US stock market indexes are showing cheerful signs, there is also growing fear and anxiety developing underneath the surface. As spotted many times last year, there is the paradoxical relationship of higher markets, which also attract worrisome behaviors and growing groans. Perhaps, it’s not overly surprising to see investors and traders focus on the “cheapness” of volatility in recent months. In fact, the lack of turbulence is not a new story. It has persisted for a long while, where the unpredictable elements were debated.. Collective acknowledgement of low volatility in US markets has been credited to the Federal Reserve policies and messaging. Surely, a shift in policies can stir some uncertainty, yet most of it has been short-lived. Thus, betting on fear is common for traders, but some here and there await an overly dramatic act of full-blown panic . Plus, given various instruments these days, more and more participants are inclined to think that a severe correction may be looming. That is known to drum up some reaction and trading activity:

“Investors traded 4.4 million Vix futures contracts in January, a 52% increase from the same period a year earlier and 38% higher than December, a rise largely attributable to a January spike in volatility and the continued popularity of exchange-traded products (ETPs) tracking short-term futures, according to … (the) Chicago Board Options Exchange (CBOE), which calculates the index.” (Risk.net, February 21, 2014)

Of course, rising markets with strong momentum also build confidence for those already owning shares and even drive up additional flow for those seeking to test their luck further. Since 2009, it has been a strong cyclical run where optimism is preferred and appears to justify current price ranges. Finally, there are those who see the danger of elevated markets and slowing global growth, but sense a relative advantage in US equities. Similarly, the more practical view suggests there are less attractive alternatives to seek at this junction. Certainly, that’s been recognized by most money managers who attempt to navigate through this tricky junction as capital continues rotation into equities.

“The inflows into stock funds in the week were the biggest in 12 weeks, according to the report, which also cited data from fund-tracker EPFR Global. Investors pulled $45 billion out of money market funds, meanwhile, marking their biggest outflows since last October. The inflows marked the third straight week of new demand for stock funds. Funds that specialize in U.S. stocks attracted $8.3 billion of the net inflows into stock funds.” (Reuters, February 21, 2014).

Surely, emerging market worries and some earnings underperformance can trigger questionable responses on a stock or company-specific basis. Yet, the S&P 500 Index is not too far off from all-time highs – a barometer that may not tell the full story, but explains the existing sentiment. Plus, worrisome headline matters have not left a lasting impression of danger and extended sell-offs.

Preparation

Plenty of suspense waits with the repositioning of major ideas and capital. A multi-year cycle run typically suggests a step closer to the inevitable ugly finish. At least that’s the mindset of risk-takers in this generation; market tops are not an archaic thought, given the 2008 and 2000 fall-outs. For all the comparison to and debates about the 1929-style crash, one cannot ignore the last decade, when two bubbles left a lasting effect but the broad indexes rose from the grave quickly, as well. Bubble-bursting thoughts have formed even before the actual formation of a bubble; thus, plenty of false singles have come and gone. In the common bubble talks, there are references to the disconnect of the economy versus stock prices. To bring down the markets, more than one catalyst is needed and participants need to believe that those catalysts are legitimate. Thus far, worrisome issues have been shrugged off despite the bearish experts’ attempts to map out and indentify specific risks that have persisted and in some cases have been misunderstood (i.e., QE, the currency crisis or fundamental concerns).

Psychological impact

So far in 2014, there has been a puzzling up-and-down occurrence that’s still being digested. Mid-January sell-offs dues to emerging market currency worries and natural pullbacks have now been recouped. “Taper” worries that partially triggered a response are now not overly a concern. The economic slowdown, which seems to be mixed with recent disappointments, has not materialized into bigger falls. Even the underperformance of companies’ revenues due to slowing emerging markets has not stirred a larger panic-like behavior, either. The psychological impact of QE might have created a remarkable sense of confidence, beyond the practical point of low interest rates, which encourages risk-taking. Perhaps, the market is not convincing people that the end of the QE era is in full gear. After all, inflation and high interest rates are not on the headline concern list.

Sentiment is proving to be as powerful as reality, and that’s the puzzling part that keeps reoccurring and leaving the average mind stunned. The mystery of markets at some point is mostly discovered, but the rest is psychological. Discovering the mystery is as challenging as understanding the prevailing psychology for a specific theme and trend. At this tricky junction, more mysteries will be discovered on a daily basis, and sorting out the relevant catalysts from the less relevant ones is where the reward lies.

Article Quotes:

“QE can alter long-term interest rates which can influence private investment and the creditworthiness of the private sector. QE has a powerful psychological impact on both asset prices and the economy and can alter expectations of future economic outcomes. Some economists call this the ‘expectations channel’ or forward guidance effect. QE involves a portfolio rebalancing effect where the Fed’s intervention in the outstanding private sector assets can alter the asset options for private portfolio composition. Some economists refer to this as the ‘wealth effect.’ QE alters the composition of the private sector’s assets by changing the “moneyness” of the private sector’s assets. Some might call this ‘monetization,’ but it’s important to frame this correctly so as to avoid concluding that the Fed is ‘printing money.’ While technically true, the Fed is also ‘unprinting’ a T-bond. Depending on how the policy is implemented QE could potentially drive down the value of the dollar relative to other currencies which could alter foreign trade balances.” (Orcam Financial Group, Cullen Roche, February 10, 2014)

“The conventional wisdom is that, when confronted by a bear, you should lie motionless until it loses interest (or assumes that you are dead) and leaves you alone. But there are different species of bear, with some more likely to be deterred by bold, purposeful action. The question is how to determine the right approach when terror incarnate is staring you in the face. This scenario is helpful for thinking about the eurozone as it attempts to survive its next round of trials – beginning with the European Parliament election in May. Can it continue simply to ‘lie still,’ hoping that no new shocks arise that diminish its economic health, if not threaten its survival? Some take the sanguine view that the current ‘lie still’ approach is adequate to ensure that the eurozone economy does more than avoid decline. From their perspective, Germany’s decision over the last three years to permit actual and prospective transfers just large enough to prevent financial meltdown will somehow be enough to enable the eurozone finally to begin to recover from a half-decade of recession and stagnation. But the fact is that these transfers – that is, European Stability Mechanism-financed bailout programs and the European Central Bank’s prospective ‘outright monetary transactions’ (OMT) bond-buying scheme – can do little more than fend off collapse. They cannot boost economic output, because they are conditional upon recipient countries’ continued pursuit of internal devaluation (lowering domestic wages and prices).” (Project-Syndicate, February 21, 2014)

Levels: (Prices as of close February 21, 2014)

S&P 500 Index [1836.63] – Attempting to elevate near and past all-time highs set on January 15, 2014 (1850.84). However, last week, that target was not achieved. The index is in an intriguing trading range, given that last month, investors chose to sell at these levels. There’s a retest of previous patterns ahead.

Crude (Spot) [$102.20] – From January 9 to February 19,there has been a quick and strong move by crude, revisiting and eclipsing the $100-per-barrel price. Yet, the sustainability of this run has a few doubters. The next few weeks are set to confirm the recent momentum.

Gold [$1316.25] – After climbing out of recent lows, the 50-day moving average stands at $1341.07. Observers wait to see a follow-through in the near-term.

DXY – US Dollar Index [80.23] – In the last 15 days, the index has mostly seen a downward decline. A glimpse of recovery waits, based on the pattern of the last six months.

US 10 Year Treasury Yields [2.73%] – Holding steady around a familiar range. The 20-day moving average is 2.70%, which is around last week’s finish.





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.

Market Outlook | February 17, 2014

“Better be wise by the misfortunes of others than by your own.” Aesop (620 BC - 560 BC)


Demise turned bargain

In some ways, value seekers are fascinated by the bargains available in commodities and emerging markets (EM) early this year, after both themes underperformed last year. Certainly, these were two areas that were disliked and let many investors down in 2013. Recent signs of revival are not overly surprising, given that investors are known to naturally revisit neglected ideas, especially when there are signs of being cheap. In addition, investors who made good fortune in these areas in the past decade share a nostalgic feeling and play into the investor’s mindset, as well. In other words, commodity and EM bulls have promoted the fundamental case for years (and were backed by the surging prices), and now it is only a matter of participants observing that prices are relatively low. Surely, the fundamentals will not improve overnight, and crisis mode has not been cleansed. Thus, it’s fair to say the risk-reward remains colorful, from gold to BRIC nations. The risk of being a short-lived rally is a matter to consider as the rush for risk-taking continues to persist.

From the contrarian point of view, entering now seems attractive; however, the driving force behind recent resurgence is mostly about bargain hunting and a lack of investable ideas rather than the absolute attractiveness of emerging markets and commodities. Not to mention that, with US equities flirting with all-time highs, there is skepticism and a search for new rotational ideas, as well. Interestingly, it’s critical that money managers of all kinds are looking to reengineer their capital allocation process. Of course, the argument of cheapness alone is not enough and has been heard before in prior months – even in late 2013. Certainly, price drives the early wave of buyers, and whether this momentum is short lived, perception driven or legitimate remains to be seen. After all, it is a game of relative attractiveness, and January 2014 already demonstrated that these markets are wobbly; thus, the second-best option is to buy cheaply. It is not only gold and crude that are attracting investor interest; soft commodities are displaying similar patterns:

“The net-long position in arabica coffee surged 97 percent to 15,728 contracts, the highest since September 2011. Futures in New York gained 29 percent this year, the most among the 24 commodities tracked by the GSCI. In Brazil, the top producer of coffee, sugar and oranges, the driest January since 1954 drained dams and seared plants. Investors held a net-long wager in corn of 34,340 contracts. That’s the first bullish position since June and compares with a net-short of 5,314 a week earlier.” (Bloomberg, February 16, 2014).

Hints and confusions

Increased volatility was a short-term threat that came and went. After a turbulent January, a sudden reversal to a sense of normalcy has taken place. From December 26, 2013 to February 3, 2014, the volatility index rose from 11.69 to 21.48. This marked a sudden rise in expected turbulence, with ongoing concerns of emerging market currency woes. However, since the peak on February 3, 2014 (21.48), the turbulence indicator for US markets has retreated to 13.57 – a sudden drop in volatility. This brought on a sense of calm and a collective signal that market concerns are subsiding at a rapid pace. At least, that’s the hint. Similarly, the US 10 year Treasury yields peaked at 3.05% the first day of trading in January this year. Then, with ongoing turbulence and concerns about US economic growth, the shift toward safe assets drove yields below 2.60% at the start of February. Now, signs of recovery in yields are visibly matched with a decline in volatility, which continues to support a rise in stocks, as witnessed for months. It is important to state that volatility has really declined since 2008; therefore, calm seems too normal, especially in the last 3-5 years.

Amazingly, the S&P 500 index is just a few points away (less than 1%) from recouping the losses from mid-January and making record highs. The up-and-down session witnessed recently may persist in coming weeks. However, this post-2008 recovery is marching on with strength, despite changes in Fed leadership, mild currency turbulence and a never-ending appetite for equities over most assets. Now the question is, if the S&P 500 and US broad indexes are set to make new highs, what happens to the buying appetite? Is there more demand for equities? Did the volatility fears vanish quickly yet again? In a matter of 30 days, how could fortunes turn from massive nervousness to promising? Has the market settled on the acceptable theme? Is there rotation from US markets to emerging or European markets? These are all intriguing questions that desperately require answers in the weeks ahead.

The growth mystery

Clearly, there are prolonged moments of disconnect between forward-looking stocks and actual economic data – hence, the long mystery that tricks/challenges speculators and simple observers who dismiss the paradoxes and complex nature of markets. The strength of the economy is marketed by some (conveniently to make a point) and questioned by others, but the financial market responses showcase a mixed reaction. Certainly, panic is not at the forefront of deliberations.

With that being said, much attention has been dedicated to the Federal Reserve’s plans and diagnosis of current economic strength. For a while, the narrative shifted to improving economic growth and justified taper plans. That’s still the case for now. The economic strength is not clear-cut enough to make a unanimous statement. Corporate earnings in some instances showcase the pain from the emerging market slowdown, which is being felt in companies’ earnings. Plus, elevated expectations are set to disappoint at some point. GDP numbers in Japan turned out below expectations, the Eurozone is not overly convincing despite fourth-quarter growth, BRIC nations are not overly impressive and the US economy is talked up, but positive momentum needs more follow-through.




Article Quotes:

“The risk of the euro zone sliding into an economically and financially damaging spiral of deflation similar to Japan's 20-year experience from the mid-1990s is rising, according to a growing number of leading economists. This counters the prevailing consensus among policymakers, who insist there is no threat of deflation, and financial markets, which are not pricing in or positioning for such an eventuality. In its widely read annual ‘Equity Gilt Study’, Barclays drew parallels between Japan and the euro zone, concluding that the risks of a prolonged period of falling prices in the 18-nation bloc was significant. Economists at JP Morgan are more sanguine, but they wrote in a research note on Thursday that given Japan's experience, ‘no one should be surprised if it happens’. Inflation across the euro zone is falling fast, and was last measured at an annual rate of just 0.7 percent, well below the European Central Bank's target of ‘below, but close to’ 2 percent, the lowest in the developed world, and down from 3 percent barely two years ago. Deflation tempts consumers to postpone spending and businesses to delay investment because they expect prices to be lower in the future. This slows growth and puts upward pressure on unemployment. It also increases the real debt burden of debtors, from consumers to companies to governments. … The euro zone is at the very early stages of its fight to ward off deflation, while Japan took 20 years to defeat it. Consumer prices in Japan are now rising twice as fast as those in the euro zone.” (Reuters, February 13, 2014)

“Ever since the Communist Party came to power, high employment has been a priority for China’s leaders. Hu Jintao, China’s previous president, famously confided to his U.S. counterpart George W. Bush that employment was the issue, above any other, that kept him awake at night. More recently Li Keqiang, China’s premier, stated ‘Employment is the biggest thing for well-being. For us, stable growth is mainly for the sake of maintaining employment.’ In the days of the planned economy, achieving full employment was relatively easy. Rural workers were collectivized on state-managed farms and urban workers were assigned to city work units. Following reform and opening up, China’s leaders maintained high employment through annual double-digit GDP growth that became an engine for massive job creation. Such was the effectiveness of this jobs engine that in the late 1990s, when China restructured its vast network of state-owned enterprises (SOEs), making tens of millions of workers redundant, the labor market only briefly flinched before the booming economic quickly picked up the slack. However, the economic restructuring the current generation of leaders is embarking on is unlikely to offer the same luxury. There are several important reasons for this. First, the reforms will result in a prolonged period of much slower growth. Speaking last year, Chinese President Xi Jinping said, ‘China must undergo structural reforms even though it will sacrifice faster growth.’ Growth is already half the rate achieved at the height of the mid-2000s boom, with further moderations expected as the adjustment cost of reform becomes increasingly evident.” (The Diplomat, February 12, 2014)



Levels: (Prices as of close February 14, 2014)

S&P 500 Index [1838.63] – A more than 2% gain last week, propelling the index to revisit prior all-time highs. Momentum is positive, but this short-term rally needs confirmation to ensure a new wave of buying momentum.

Crude (Spot) [$100.30] – In an impressive manner, after reaching the $91 range in early January, the index has made a ferocious rally back to the commonly noted $100 range. Psychologically, this range triggers reactions, given the key psychological level. However, surpassing this $100 range proved to be difficult in late December.

Gold [$1318.60] – Signs of bottoming being confirmed. In looking ahead, $1360 can be a bigger hurdle to restore the gold bugs’ growing optimism of a further surge in prices.

DXY – US Dollar Index [80.13] – Since January 31, 2014, the index has declined mildly back to its multi-year average. It remains between September 2012 lows of $78.60 and July 2013 highs of $84.75.

US 10 Year Treasury Yields [2.74%] – Early signs that yields have bottomed after declining from 3% to 2.56% within a month. However, the 50-day moving average stands at 2.83%, a hurdle that’s closely watched.






**

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.

Market Outlook | February 10, 2014

“When it is not necessary to make a decision, it is necessary not to make a decision.” – Lord Falkland (1610-1643)

Slow digestion

The markets have reached a sideways pattern as investors contemplate whether all-time highs are justified or further correction is needed. In some ways, new data is being processed, from labor to GDP growth. Similarly, potential new catalysts are silently brewing, but dramatic surprises have yet to faze observers. Shocks and overreactions have not seeped through the collective mindset of US equities, but the signs are there for those looking closely.

Technical and momentum observers await responses from buyers who may look to re-enter after recent pullbacks. Is there enthusiasm left, as witnessed last year? Guidance from central banks and taper plans are watched day to day, but a clear-cut answer is hardly available. And it might not be for longer than pundits claim. Labor numbers are leading to mixed responses after falling below expectations, but more supporting data is clearly needed. Sentiment trackers debate whether the recent wave of mild panic has enough fuel to trigger additional selling. Looking at emerging market (EM) indexes, those who need to sell appear to have already sold at a rampant pace based on massive outflow. A well-documented slowdown and outflow has created enough headlines to grab money managers’ attention. In fact, the focus may turn to where value seekers are now examining specific EM opportunities. After all, the growth rates of China and India last year remained higher than more mature markets. As for achieving expectations, that’s another matter that’s unknown. For now, prices in EMs may be cheap by some estimates as the downtrend cycle continues to play out. Certainly, the overall macro backdrop of BRIC and other EMs is sluggish and not overly comforting:

“HSBC's composite emerging markets index of manufacturing and services purchasing managers' surveys slipped for the second month running to 51.4 in January. It stayed under the 2013 average of 51.7 and well below the score of 64.1 posted last January.” (The Reuters, February 9, 2014)

Meanwhile, in the US, fundamental observers, on average, are not overly disappointed as companies continue to exceed analyst expectations. In fact, according to S&P CapIQ earnings:

“The current beat rate for Q4 now stands at almost 66%, slightly higher than the historical average of 65%.” (February 7, 2014).

Subdued responses

Even though the last few weeks witnessed a rise in volatility, there seems to be calm in turbulence. The VIX index is a common barometer for extreme reactions of fear for US stocks. December 2008 was the watershed point for fear, when the index reached 89 and quickly came down as stability resurfaced. In the last two and a half years, the index has not surpassed the level of 20 for a significant period, suggesting that worrisome, collapse-like panic selling is not quite visible. A contingent crowd is claiming complacency, which has some valid points, especially when the S&P 500 index climbed to new all-time highs.

Spring 2010 and summer 2011 witnessed bigger moves related to big-picture concerns (VIX tested over 40 ranges) but calm eventually prevailed. What were the drivers? US equities were relatively attractive and the Fed’s QE plan was in rhythm, not shocking or surprising the investor base that continued to see improving corporate earnings, unimpressive commodity promises and importantly low interest rates. Therefore, the relative argument has much more meaning for influential capital flow and market reaction. Plus, US equities were favored even though many multinational companies have notable revenue exposure from overseas companies. As 2014 begins, is there a concern like 2010 and 2011, about the budget and growth-related policies that should cause some nervous responses? Or is it external concerns of EM weakness that can stir a new wave of sell-offs? Curiosity looms on this answer, as Eurozone and developing markets will confront pending data points to make solid conclusions.

Strategizing

From a risk-reward point of view, betting on EM recovery appeals to some, while others may prefer to stay away from this theme. Equally, declining US stocks may at first glance appear attractive, but there are plenty of naysayers. In other words, the shock and awe factor is not quite glaring. The risk-aversion seekers will continue to pile into Treasuries and the US dollar, as witnessed in other crisis periods. Yet, bunkering up is a theme that’s not quite foreign in recent years. Macro observers are seeing commodities attempt to bottom, with crude surging and gold stabilizing, but last decade’s expectations of all-time highs are not quite on the radar. In a world where relative attractiveness is valued more than absolute data, changing the status-quo trend is not quite rapid. Surviving within this theme of low interest is the primary focus while exploring insignificant and significant catalysts. For now, decisions are not as important as digesting the moving parts of economic conditions, perception related to sentiment and pending market-moving policies.

Article Quotes:

“Although China has shown signs of an economic slowdown, foreign institutional investors are still betting on its cheap equity market with potential for big returns. Qualified Foreign Institutional Investors (QFIIs) opened 45 new A-share accounts in China last December, a monthly record for 2013, the China Security Depository and Clearing Co., Ltd. said in January. This marked the 24th consecutive month in which QFIIs have opened accounts in China's A-share markets and brings the total number of accounts to 612. Foreign investors have to be licensed as QFII or Renminbi QFII, two schemes created in 2002 and 2011 respectively, allowing qualified investors to trade a limited quota in China's largely isolated capital market. The State Administration of Foreign Exchange, China's foreign exchange regulator, granted 51.4 billion U.S. dollars of investment quotas to 235 QFIIs, and 167.8 billion yuan to 57 RQFIIs as of Jan. 27, 2014. … Nearly 60 percent of 1,734 listed enterprises that have released their preliminary annual reports are optimistic about how they performed last year, with 398 firms estimating that their profits surged by over 100 percent.” (People’s Daily, February 8, 2014)

“Starkman argues, three factors contributed to the disappearance of investigative journalism. Years of financial deregulation made the legal documentation that reporters relied upon to conduct their investigations – indictments, testimony, settlements – less available. The ‘stampede of the middle class into the stock market,’ Starkman writes, fueled demand for insider business intelligence and investor-oriented news, and coincided with the rise of CNBC and its ascendant strain of access reporting. And the explosion of search engines and e-commerce decimated the news industry’s traditional business model, shrinking budgets for investigative projects and making publishers more wary of upsetting advertisers. Accountability journalism, of course, is both expensive and antagonistic to corporate brands. Just as dubious subprime practices seeped into Wall Street culture, newsrooms became least equipped to examine them. Even in the early aughts, when articles in the business press questioned the rise of housing prices and mortgage loans, they typically did so for audiences of investors: these were financial products to be avoided rather than evidence of systemic corruption. Likewise, pre-crash critiques of Lehman Brothers, Citigroup, and Washington Mutual focused on their growth strategies and stock performance.” (The New Yorker, February 5, 2014)

Levels: (Prices as of close February 7, 2014)

S&P 500 Index [1797.02] – From January 15 highs of 1850 to February 5 lows of 1737.92, the index witnessed a more than 6% swing. It is now seeking to stabilize closer to 1800. Late December and early January suggested that buyers’ appetites began to fade around 1840.

Crude (Spot) [$99.88] – Inching closer to $100, last reached on December 27, 2013. An inflection point waits again at this junction. Multi-week highs achieved while the supply is expanding and demand is questionable. Therefore, the fundamentals challenge the current momentum in weeks ahead.

Gold [$1256.50] – Since July 2013, gold prices have hinted at bottoming and showed signs of regaining positive flow. Optimists envision upside moves closer to $100

DXY – US Dollar Index [80.69] – Since the lows of last October, the index has not appreciated much and remains stable. The dollar strength is not quite a dominant trend as of now.

US 10 Year Treasury Yields [2.68%] – After a sudden drop earlier this year, questions linger as to whether yields can stay near or above 3%. For now, the February 3 lows of 2.56% serve as a key benchmark.


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.

Market Outlook | February 3, 2014

“Turbulence is life force. It is opportunity. Let's love turbulence and use it for change.” Ramsay Clark (1927-present)

Turbulence lurking

Volatility has for a long while been tame, until the recent awakening from emerging market woes and outflows. Interestingly, the volatility index reached its lowest point both in March and December 2013. This illustrated that US equity markets were not overly bothered by risk-related items and stocks were highly favored. As many experts pointed out, this reflects the overhanging complacency that has been brewing for a while.

The end of the 2008 crisis until the end of 2013 marked a period of calmness led by the Fed’s plans, which are credited for navigating out of the crisis. Brilliant or not, Bernanke is now no longer the captain of the ship. This Fed succession plan is marketed as smooth, but investors will have the last say. In fact, in the last five years or so, it appears that confidence has been restored and the relative US edge is apparent despite recent wobbly behavior. However, the relative edge is being questioned and doubts are resurfacing, especially if economic and earnings strength cannot justify these elevated market levels. More suspense now awaits on inflation/deflation, taper implications domestic and abroad and sustainability of corporate earnings. Several forces are building up at once; thus, the pressure is adding up.

Adjustment period

As one Fed leader departs, observers wonder if the low volatility and favorable climate for risky assets are also in danger of leaving. Similarly, a new month is here where the tone on earnings and stability is more shaken than in previous months. Currencies are unraveling, few central banks are hiking and global growth remains sluggish. The dawn of the taper era is in full gear and its implications are still being felt. Yet, a pending correction in developed markets versus ongoing sell-offs in emerging markets shouldn’t be evaluated equally. On one hand, emerging markets have fallen along with commodities in the last 12-18 months. The mass exodus by investors has been evident for a while and is now playing out viciously.

“Almost $9 billion was pulled out of ETFs that track developing markets in 2013, the first annual outflow since the securities were created.” (Bloomberg, January 30, 2014).

The struggle in performance with the BRIC nations is well documented. The China growth slowdown triggered many investors to prepare for potentially disappointing news. At this stage, it will not be a major surprise if China and other major economies begin to showcase bubble-like traits. Instead, the missing piece is grasping the magnitude of concerns that are in the minds of risk-takers beyond BRIC nations such as Turkey, Argentina and South Africa. Lack of stability in the currency markets is already factored in, but how this ends will be discovered in the upcoming weeks.

“Emerging markets are now half the global economy, so we are in uncharted waters. Roughly $4 trillion of foreign funds swept into emerging markets after the Lehman crisis, much of it by then ‘momentum money’ late to the party. The IMF says $470bn is directly linked to money printing by the Fed.” (Telegraph, January 29, 2014).

In terms of developed markets, the US has stood out despite ongoing concerns. It was a few days ago, on January 15, 2014, when the S&P 500 index made all-time highs. Since then, the sudden drop is a wake-up call for a long-awaited correction. Surely, some pullback is to be expected and other macro concerns are brewing to serve as a downside catalyst. It has been a while since a correction (10% decline) has materialized, and some wonder if that’s been deferred for too long.

For portfolio managers, these two points are worth considering when thinking about the broad markets:

1) If further sell-off, then how and where to reduce risk exposures
2) If the sell-off continues, then it’s worth looking into themes (both in developed and emerging markets) that can offer cheap entry points

Preparing and positioning for the next moves is worthwhile, especially early in the year, when uncertainties have to be unraveled, discovered and eventually understood by participants. The unexpected is common, but preparing and refining an investment thesis might be best suited in this first quarter.

Gauging catalysts

There is a constant shift between the search for growth and the shift toward shelter. The growth phase has been in play when considering low interest rates. Similarly, last decade’s growth was mainly driven by the commodities boom, which has slowed down since late 2012. The last period of noticeable nervousness was seen in summer 2011 with the US downgrade. Now in 2014, choppiness in the market pattern is expected, even if major catalysts fail to overtake the collective mindset. Commodities have been out of favor, emerging markets are deemed even riskier and risky loans are back in the US. Long-term trend seekers are forced to explore frontier markets or go safe, but the familiar and liquid instruments such as Treasuries, Dollars and established larger stocks will attract some attention For a while, panic has been suppressed; thus, the rush to safety may appeal to most in the near-term. In an inter-connected world, minor catalysts can be part of a bigger catalyst that’s damaging. Thus, having an open and flexible mind is required to navigate a reflective period when a reality check is a necessary cyclical occurrence.



Article quotes:

“The emerging markets currencies sell-off intensified last week but not every asset class is in a doom-and-gloom scenario. In the emerging bond markets at least, investors are taking a more nuanced and discriminating view. The primary market remains open, although issuance opportunities are rare. (See EM section.) In the secondary market, corporate credits in particular are holding steady. JP Morgan’s CEMBI index, which measures the performance of US dollar-denominated corporate bonds, is actually showing a positive return of 0.50% for the year to January 28, although on a spread basis it is 18bp wider. The best credits from Turkey and South Africa are also performing relatively well, despite the fact that both countries are at the centre of the storm in the FX and rates markets. Turkish bottling company Coca-Cola Icecek, for example, has seen its 2018 bonds fall by just 35 cents in cash terms since mid-January, with the note trading up 1/2 a point for the year up to January 30. In spread terms, the bond is trading 65bp tighter than where it priced last April. South African miner AngloGold Ashanti is another credit bearing up well. A rally in the gold price over the past month has helped tighten the yield on its 2020 bond to 7.40% mid-market from 7.75% at the beginning of the year. By contrast, South Africa has seen the yield on its benchmark 2025 note jump to 5.55% from 5.30% over the same period.” (International Financial Review February 1, 2014)

“Top banking regulators in the U.S. are being urged to reconsider risk-retention rules for collateralized loan obligations on concern they would increase financing costs for speculative-grade borrowers. BlueMountain Capital Management LLC, Invesco Ltd. and Blackstone Group LP-controlled SeaWorld Entertainment Inc. are among the more than 30 firms that wrote to the Federal Reserve, the Federal Deposit Insurance Corp. and the Securities and Exchange Commission, and asked them not to enact the rules, according to letters posted on websites of the regulators and the U.S. central bank. CLO issuance in the U.S. surged last year by 49 percent to $82 billion. The CLO market had its most active year since 2007 in 2013, mirrored by record volume for the high-yield, high-risk loans these funds invest in, with $349.3 billion of new debt issued. The borrowings have been used to finance some of the biggest buyouts in history including the purchase of Energy Future Holdings Corp. Implementation of risk-retention rules may raise annual interest expenses faced by junk-rated companies by as much as $3.2 billion, according to a study sponsored by the Loan Syndications and Trading Association, the loan market’s main trade group.” (Bloomberg, January 13, 2014)



Levels: (Prices as of close February 3, 2014)

S&P 500 Index [1741.89] – After nearly hitting 1850 on January 15, the index has pulled back moderately. A move below or around 1650 may suggest a meaningful pressure.

Crude (Spot) [$96.67] – Traders question whether crude can surpass the $98 level at this junction after failing to do so in December 2013. Again, the supply continues to expand, but that factors is not fully realized.

Gold [$1257.30] – Early signs suggest that $1260 was a resistance point where buyers’ momentum faded. Summer lows of $1192.00 remain the noteworthy price for those expecting further decline. For now, the 50-day moving average stands at $1236.77.

DXY – US Dollar Index [81.01] – In the last 30 days, the dollar has gained versus other currencies. Perhaps, a new wave of strong dollar is shaping up. Yet, the recent move is too mild to make a strong case for a sustainable run.

US 10 Year Treasury Yields [2.57%] – Since the January 2nd highs of 3.05%, yields have continued to come down. The yields-down trend matches the weakening economic conditions.



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.

Market Outlook | January 27, 2014

“Security is mostly a superstition. It does not exist in nature...Life is either a daring adventure or nothing.” Helen Keller (1880 - 1968)

Collective awakening

Chants and praise of all-time highs in US markets were becoming a tiresome topic for several weeks. Equally, the claims of a crash or massive breakdown and murmurs of a collapse have been nearly as annoying in the last five years, despite occasional legitimate points from some of the skeptical crowd. Balanced skepticism is healthy, and although market participants in the past few years have not appreciated it, being a critical investor might be even more rewarding this year. Admission of slowing to flat global growth has been mildly hinted at in the past but not quite heavily emphasized. QE’s magical powers became an even more powerful narrative and found a way to elevate asset prices and reduce the fear factor. There has been a bandwagon effect of inviting many to risk-taking exercise. Yet the search for a market-moving catalyst has been long awaited and at times misdirected, misunderstood or simply mistimed.

Now an eye-catching catalyst is here when considering the emerging market (EM) fallout of currencies and stocks last week. From Argentina to Turkey to Chile, there was a panic-like mode with an ongoing trend of weekly outflows. In addition, earnings season is here to provide a fundamental gut check of key companies as the verdict awaits. Similarly, a sentiment shift is brewing and geared to pause the uptrend in developed markets, to reignite worries of fragile emerging markets and create acceptance of more unknowns to cause a stir. In an interconnected and interwoven world, any capital market concern may be contagious, or at least may lead to a collective awakening. Now, analysts have to decipher the various tiers of concerns, from developing markets to Eurozone buying opportunities to pending results of developed and QE-driven economies.

Skeptics had many gloomy points, but last year's weakness in emerging markets tells the story of the changing and delicate perception of risky assets. Plus, moments where wobbly markets are visible find a way to re-awaken the nearly half-dead volatility that's been barely visible. Amazingly, for a while, talks of turbulence seemed erased from market action, forecasters and casual onlookers. Even with pending correction potentially looming, with the S&P 500 index going from 1850 to 1790, most participants appear to be interested in when to reenter, rather than exiting fully. The bullish bias prevails for now, but convictions are set to be tested.

Risk resurfacing

Amazingly, the status-quo supporters and adamant doubters share one thing in common: They both long and humbly awaited a catalyst of sorts to shake up this stubborn Fed-induced rally. Not that risk ever vanished, but now the true meaning of risk is confronted Risky assets were truly encouraged, but now doubts are setting in as to future plans.

Lenders to EM and those betting on appreciating EM currency and a declining dollar are deeply and in a worrisome manner asking if these assumptions have merits. The low interest rate policies encouraged and partially forced investors to chase high yield. Of course, when desperately chasing yields, the reward might be overstated, like any status-quo idea that initially assumes and attracts easy money. However, when it fails, it sees that money flow out at a rapid pace.

Memories of 2007 are echoed by those seeing a rapid rise in asset prices in a synchronized fashion. 1998 comes to mind when thinking of a currency crisis, and 2008 comes to mind when an illusion turns into a gut-wrenching reality check. For now, fear is examined at its early stages, since too many analysts cried wolf earlier. Plenty of false alarms were sounded about market "tops" and now, the decisions have to be made by risk allocators and managers. The smooth sailing and numbing bull market is at a junction that begs for answers to overwhelming question that have long been asked. What’s the impact of the taper moving forward? What are the consequences of the transition of the new Fed Chairwoman? How weak is global growth? There are plenty of unanswered questions, but regardless of the answers, the unsettling feeling will persist.

Bracing

It’s natural to expect fund managers to begin the search for safety when economic slowdown and political instability begin to kick in various economies. In the past few years, gold, US Treasury, US dollar and US large cap stocks have been known as places to hide. It’s unclear whether the rotation into perceived safety will prevail over an all-out synchronized sinking of multiple assets. The level of sell off is to be discovered in the near-term in days and weeks ahead. Importantly, last Friday showcased high demand for protection against declining markets.

“January call options – contracts betting on the rise of the underlying security – on the VIX this week rose to a record 8.4 million contracts at the Chicago Board Options Exchange (CBOE.O) while the index itself jumped nearly 30 percent on Friday and about 44 percent for the week.” (Reuters, January 24, 2014)

In terms of bracing ahead for future opportunities, European stocks are talked about by analysts on their upside potential, as casual participants are accustomed to hearing the woes and struggles in the last five years. Again, weak economic overhang has not stopped European equities from rising to new highs. Certainly, forecasters feel the need to raise estimates, and that’s a common and influential theme these days across the financial circle.

“The World Bank raised its global-growth forecasts, predicting the economy will expand 3.2 percent this year. That is higher than its June projection of 3 percent. The Washington-based lender raised the estimate for growth in the richest nations to 2.2 percent from 2 percent. Part of the increase reflects improvement in the 18-country euro area.” (Bloomberg, January 17, 2014)

Perhaps, risk-takers looking beyond US companies and assets may seek European stocks as the next area of interest. Certainly, finding growth stories with a promising decade outlook is scarce and less predictable. At some point, if bargain hunters sense that emerging markets are cheap, then maybe that’s a consideration to wait for, as well. Maybe this is worth examining after the near-term turbulence goes through its natural phase.


Article quotes:

“In the past two years or so, you have seen more hedge funds dabbling in tech investing. As one venture investor put it in 2011, ‘They are the antichrist of patient, supportive early-stage investing.’ But increasingly, hedge funds are scoring some of the deals you would expect traditional VCs to get. Case in point — Snapchat. Over the past few weeks, I spoke to a dozen or so public and private market investors around this trend, why it is taking place, and what it means for founders. Coatue isn’t the first ‘cross-over’ fund (an investment fund that crosses over to the private from the public markets) to emerge in technology investing. Integral Capital Partners, co-founded by Roger McNamee and John Powell, was one of the first to start doing this in the nineties. Hedge fund Tiger Global has been doing it more recently, with a venture arm that has backed Warby Parker, Nextdoor, Redfin, Eventbrite and Pure Storage, among many others. This wasn’t Coatue’s first mid-stage private tech backing. Last year, the firm established a $300 million growth fund for this purpose, as reported by Pando’s Sarah Lacy. The fund recently led mobile travel startup Hotel Tonight’s $45 million round in September. Coatue also participated in Box’s funding round in 2012. And Coatue and Tiger Global aren’t the only hedge funds to jump into the private markets tech-investing game of late. Altimeter has been backing private tech companies for the past few years. Valiant Capital Partners has backed Dropbox, Evernote, and Pinterest in the past two years. Maverick Capital has participated in a few seed deals, including Zenefits in 2013. And the fund isn’t just going after growth-stage funding. In December, the firm participated in a seed round in Estimote, which develops beacons.” (TechCrunch, January 18, 2014).

Regarding China: “In 2014 rising borrowing costs will mean repercussions for the real economy: industries that used to rely on cheap capital, especially those in overcapacity, such as steel, cement, glass, and even rail, face strong headwinds in financing. As mentioned above, the just-concluded national railway network conference (a senior-level central affair for this ‘strategic’ sector) announced that the fixed asset investment goal for rail in 2014 was 630 billion RMB, 30 billion RMB less than what was spent last year. Targeting lower growth in 2014 was well beneath market expectations, given how important rail investment was in anchoring Chinese growth targets over the past five years. With falling rail FAI and steel sector consolidation, rising export surpluses thanks to a strong US will not be enough to get China to the rumored 2014 7.5% growth target (we still bet that high a target will not be announced). In response to the financial crisis huge industrial and property investment kept China sailing relatively smoothly, underwritten by largely unregulated shadow bank lending. Off-balance sheet activity and over-investment in China are two sides of the same coin, and if Beijing is determined to tackle either of them then the either side will be affected too. The most productive real economy firms in China – the ones that have to pay the bills and create the sustainable jobs going forward – are completely tangled up in this legacy. Cutting through this in 2014 is going to be messy. Ultimately, this year, we see no alternative for Beijing other than letting capable, productive private businesses off their leash so they can help pull the economy out of the ditch.” (Rhodium Group, January 22, 2014)

Levels: (Prices as of close January 24, 2014)

S&P 500 Index [1790.29] – It appears that 1850 was a sign of a top, as the struggle to climb above 1840 showcased a start of a consolidation phase. Many observers wait to see a break below 1780 to make a noteworthy point about sell-off potentials.

Crude (Spot) [$96.64] –After weakness in December 2013, the commodity has recovered at a quick pace. Still questionable if surpassing $100 is a possibility.

Gold [$1263.00] – At this point, $1300 is on the radar of buyers, but envisioning a run above $1400 requires further momentum acceleration.

DXY – US Dollar Index [80.45] – Since May 2011, the dollar index has shown signs of stabilizing and not going down further.

US 10 Year Treasury Yields [2.71%] – Sudden turn from annual highs of 3.05%. November lows of 2.65% might be the next critical point, as yields sentiment has shifted.



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.

Market Outlook | January 13, 2014

“Magic becomes art when it has nothing to hide.” (Ben Okri, 1959-present)

Art or magic?

The Federal Reserve is credited with having engineered an appreciating stock market while cooling volatility and reviving investor optimism. Certainly, based on the last few years, there is some truth to actual index return numbers. Asset appreciation and improving fundamentals are not quite highly correlated. It is a tenuous relationship that requires daily examination. Plenty of questions about the real economy are being asked, and frankly, markets are deciphering answers to driving forces for global growth. What’s the end goal for central banks to inflate assets, revive confidence or claim to have (or not to have) magical powers? And does investor confidence translate to a vibrant economy? Are these disconnects simply noise or distraction, or artistic presentation for mainstream followers?

Surely, being an investor in up-and-down markets (specifically stock) is one matter. Tracking the social trends of economic activity is another, but the thrill of risk-taking is a powerful force. Thus, analysts are consumed with “taper” discussions, which at times seem like a magic-like trickery or artful messaging. Either way, there is no one magical catalyst, and clues have been mounting for those curious enough to look beyond this status-quo-driven explosive rally.

Interconnected

The low interest rate period by developed markets fueled the stock market indexes and has also been credited with appreciating the currencies of emerging markets in recent years. Clearly, low-yield policies force US investors to seek higher yields in riskier assets, both domestically and abroad. The stimulus efforts were beneficial in lifting EM currencies, and recent expectations of changing policies and slowing global demand (especially in China) led to the near-term demise of emerging market currencies. Basically, further taper announcements and an appreciating US dollar are suspected to have a negative impact on EM currencies. Therefore, the interconnectedness of markets is on full display, where the US economy and currency play a major role for investors of all kinds. While emerging markets remain relatively small:

“The role of EM currencies as an internationally traded asset class is still remarkably limited compared with the increasing weight of their base economies in the global economic mix; of the $5 trillion or so daily FX volume reported in the Bank for International Settlements’ 2013 triennial survey the top-three EM currencies totalled less than 7%, with the Mexican peso at 2.5% (compared with 1.3% in 2010), the Chinese renminbi at 2.2% (0.9% in 2010), and the Russian rouble at 1.6% (0.9% in 2010).” (EuroMoney, January 9, 2014).



Unease accumulating

Several uncertainties have lingered for a long while amidst the current upbeat market – a reminder for those sidetracked in recent established trends. Certainly, economic strength has been up for debate beyond the headline results. Last month’s labor numbers were slightly puzzling and somewhat concerning if not a seasonal matter. Secondly, the taper announcement did not shock the market last time. The outgoing Fed chairman should typically create some unease, but the pending policies are not fully clear. However, a general belief circulates that the transition is going to be smooth, without disruption to financial markets.

In the near-term, watching treasury yields is essential as bond investors debate the strength of the economy and potential upside GDP potential. There is lots of chatter in this area. Thirdly, oil prices continue to decline and growth demands are slowing, as well. Thus, major macro shifts continue to brew with volatility being so low and compliancy running high. Finally, the inflation feared in prior years has not been visible recently, but it’s unclear if deflation is the near-term concern. A series of surprises in the inflation or deflation debate adds to the ongoing list of unknowns, where experts are merely speculating. Putting together all these pending catalysts, one is well served to grasp the nuances of each before doubling down on tempting risky assets. Interestingly, pension funds began reducing risk from stocks into bonds:

“U.S. pensions, which control $16 trillion, shifted out of equities and into bonds in the third quarter [2013] at the fastest rate since 2008, latest data compiled by the Federal Reserve show. The plans were more willing to own stocks after the Fed dropped interest rates close to zero and pushed down yields to record lows with its bond buying to support the U.S. economy crippled by the financial crisis.” (Bloomberg, January 12, 2014).

“Surprises”

Thus, the risk-reward of past returns is known and remains influential in shaping collective minds, but the months ahead are set to surprise. Perhaps, risk takers who are open for surprises might find what’s ahead suspenseful and thrilling in some ways. As an example, 2013 witnessed a not-so-intuitive result in a sector that many thought were near dead. “In a booming year for the stock market, newspaper stocks actually more than doubled the return of the S&P 500 in 2013. Newspaper stocks rose by 79% in a year when the S&P 500 rose by just under 30%, a whopping performance few would have predicted.” (StreetFight, January 7, 2014). Maybe this is a reminder to throw out the consensus expectations when thinking about the events ahead. Betting on surprise is a risk just as much betting on what is supposedly “known.”

Article quotes:

“Prior to the crisis, inflation rates in the periphery were well above 2 percent, while the German inflation rate was below 2 percent. The EU experience in this respect was different from the US experience. Easy monetary conditions with negative real interest rates generated bubble-driven growth in the periphery and pretty high peripheral inflation rates. As part of the ongoing adjustment process, inflation rates had to fall in order to regain competitiveness relative to the euro-area core. But in this process, the ECB failed to achieve its mandate, the stabilisation of euro-area inflation at close but below 2 percent. Some in Germany fear that higher German inflation would devalue German savings. But in a monetary union, the value of money is defined at the union level. The ECB should therefore act to fulfill its mandate and restore inflation to close to 2 percent, accepting higher inflation rates in Germany. But will the ECB action be enough to prevent further disinflation in the euro area? Will it be enough to generate enough demand to end the recessionary tendency, which is still plaguing the euro area? The ECB’s current rate reduction will mostly support the banks in the euro-area periphery while relatively little new lending will reach corporations and households. In the core of the euro area, the rate cut will basically go unnoticed.” (Bruegel, January 10, 2014)

“The 2011 Anholt-Gfk Roper Nations Brands Index, which annually measures the image of 50 nations, ranked China an impressive third for its ‘culture/heritage’ brand. Countries with long histories and rich cultural resources tend to do well in terms of this branding attribute, with France and Italy perennially topping the rankings. China’s cultural pull is nowhere more evident than in its meteoric rise as an international tourist destination....In relation to other attributes, however, Brand China’s performance is largely disappointing. Of the 50 countries listed in the Reputation Institute’s 2012 global RepTrak overall rankings, which surveys respondents in G8 countries, China ranked 43rd, below Egypt (39th) and Ukraine (42nd) and just above Colombia (44th) and Nigeria (47th), placing China in the bottom 15 percent. The 2012 FutureBrand country brand index, which surveys opinion leaders in 18 countries, ranked China well back in the field at 66th out of 110. The Anholt-Gfk Roper Nations Brands Index lists China’s poorest performing brand attribute as ‘governance,’ followed by ‘exports.’ One may find any one of the nation brand ranking methodologies to be unconvincing or unrepresentative given that many tend to draw respondents from the world’s richer countries. Yet each tells a similar story: brand China’s major strength is culture, and its major weakness is in governance and the political sphere.” (The Diplomat, January 11, 2014)

Levels: (Prices as of close January 10, 2014)

S&P 500 Index [1842.37] – A few points away from December 31, 2013 highs of 1849.44. The positive trend is in place until a break below $1800 (50-day moving average); not much of a major discussion regarding pullbacks.

Crude (Spot) [$92.72] – The last time crude reached around or below $92 was in late November 2013 ($91.77). Meanwhile, last year’s lows of $85.61 stand out as the next critical level. The combination of slowing Chinese demand and expanding US supply continues to play out in the oil market.

Gold [$1226.00] – Slight signs of a recovery, as bottoming is taking place at $1200. Elevating above $1300 may entice new buying, but the vast majority of participants have decided to bail out of gold holdings.

DXY – US Dollar Index [80.65]– Remains in the steady range bound between March 2012 lows (78.09) and July 2013 highs (84.75). This level of calmness mirrors the low volatility that’s resurfaced.

US 10 Year Treasury Yields [2.85%] – There was a short-lived move above 3% earlier this year, and now a pullback to familiar territory of being above 2.50%.



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.

Market Outlook | January 6, 2014

“Americans detest all lies except lies spoken in public or printed lies.” Edgar Watson Howe (1853 - 1937)

Cheerful expectations

Mixed emotions have surfaced and continue to resurface in this global market. Cheerfulness can describe some developed markets that have witnessed price appreciations. Sourness defines some emerging market trends, and unanswered and uncertain describes the rest of the investment and economic climate. Optimism is widely felt by financial market participants, but the real economy on a global scale is concerning, and remains fuzzy. Plenty of distractions resurface in headlines, but generating global growth is a puzzle that’s being deferred and the harsh consequences have yet to be critically addressed.

Cheerfulness and hopefulness are awfully common when entering a New Year, and the consensus market outlook is no different. When reflecting back to 2013, cheerfulness – as in risk taking in financial markets – was the appropriate and rewarding choice. Gauging the sentiment of economic weakness from Brazil to Turkey the US markets maintained their relative attractiveness. From global growth cooling to emerging market currencies struggling, it became quite clear that the investable options were limited.

When tracking only shares of large multi-national corporations (that make up the Dow Jones and most of the S&P 500 index), being cheerful is appropriate in view of last year. Regulatory and tax uncertainty has been overly discussed, but that uncertainty hasn’t trickled into day-to-day market activity. Neither interest rates being low nor corporate earnings being not quite amazing budged the volatility index. “Taper” fears and even the decision to “taper” did not faze the faithful risk-takers either. Thus, fear has vanished just like memories of 2008 in some ways. The chapter of investing for 2013 basically simplified and glorified risk-taking while laughing at the concept of risk and fear. This is a classic prelude to hubris, and now all that bravado needs some substance. But being cheerful is king for now – this is the loud message for money managers of all kinds.

Adding up disconnects

Much talk has persisted about the disconnect between stock markets and the real economy for a while. The perception may change if economic strength justifies stock market appreciation, which will satisfy naysayers and logic seekers. Surely, there will be more puzzles to untangle in upcoming months. There is a disconnect between mutli-national companies’ earnings and most small businesses. There is a disconnect between developed and emerging markets, which has played out for the last few years. Equally, a disconnect exists between political leadership and people’s sentiment toward government in the US, which is very low. Congress and presidential ratings are at a low, while key US broad indexes are at all-time highs. That in itself should set the tone for 2014, a mid-term election year where politics are deemed hopeless, stock markets attract the hopeful and the skeptic has plenty to chew on and tons to ponder. But suspense is the feasible reality.

Themes for 2014

Crude prices – The changing landscape of the supply/demand setup suggests lower prices, as was hinted at in the late part of 2013. Supply is expanding in the US and begs the question of whether crude prices will get closer to $85 rather than $100. Plus, the sluggish global growth has played a role in oil demand, as well.

“Shipments of foreign crude fell 1.1 percent to 7.41 million barrels a day, the fewest since January 1998, based on the four-week average through Dec. 27, according to data released today by the EIA, the Energy Department’s statistical arm. U.S. crude output surged to a 25-year high on rising production from shale formations.” (Bloomberg, January 3, 2014).

The impact of crude prices is bound to influence companies and consumers alike. That shift in behavior can impact earnings of select industries and policies of select nations, as the flow of capital may change. Therefore, preparing for shifting in crude prices might change the macro dynamics significantly.

Emerging markets – The highly tracked BRIC nations have cooled, with plenty of emphasis on China. Value seekers will make arguments that there are bargains worth exploring. Surely, the risk-reward is attractive for those daring bunches and surprise seekers. Last year, the vulnerability of emerging market currency was a theme in itself, which is one macro threat to volatility levels. One noticeable example is that the Turkish market in recent weeks has hinted that some developing markets are too fragile. Political risk is one matter, but when economic growth unravels, volatility persists and domino-like effects continue to send panic waves, with investors seeking a rapid exit. In fact, the market observers have zoned in on a few countries by coining the term “fragile five”:

“Those worried about an EM sell-off will be cheered by Société Générale’s outlook for the coming year. The bank reckons the currencies of the so-called fragile five EMs – Brazil, India, Indonesia, Turkey and South Africa – could drop from now until March, when the Fed is expected to start tapering. But not to worry: they should appreciate in the following three quarters as the Fed pursues a dovish policy.” (Financial Times, December 2, 2013)

Trust in central banks – This is probably the most obvious catalyst that’s talked about. The multi-year appreciation of US stocks and housing has restored confidence in the Federal Reserve. Similarly, the Federal Reserve has more confidence that its messaging is followed, and goals are easier to achieve with a compliant consensus base. Any change in the Fed-investor relationship is clearly the vulnerable catalyst to stir a massive dent in financial markets. Perhaps, the thrilling part for speculators is to guess when the status-quo mindset is set to change. That’s a lot to ask of a forecaster, and speculating on timing of this can be deemed reckless by some measures. The discussion of inflation vs. deflation has been ferociously debated in the same manner as folks argue about whether the economy is growing or weakening. Thus, the Fed’s creditability is on the line, especially with a new Chairperson needing to answer several disconnects in the marketplace. That itself should create unease if the messaging continues to derail from tangible, observable realities. Plus, if risk-taking participants who are pouring money into elevated markets begin to lose capital, then early outrage may emerge. Typically, when consensus begins to lose money on Fed-supported bets, then market paths are reset to new perceptions.

Article quotes:

“Pay is dropping too. At Goldman Sachs and JPMorgan Chase average pay slipped by about 5% in the first nine months of last year, a figure that is probably representative of the wider industry. Over the longer run, average pay at the world’s biggest investment banks has barely changed which means it has fallen slightly after inflation. The pace of pay cuts is likely to accelerate, senior bankers say. The biggest reason for the cutbacks is that after decades of growth in revenues (punctuated by brief declines), the investment-banking industry is facing a structural downturn. Regulators in America have banned banks from trading securities for their own profit. Higher capital standards everywhere are forcing investment banks to shrink their balance-sheets and regulations are making banks move much of their derivatives trading from opaque and profitable ‘over-the-counter’ transactions onto exchanges and into central clearing-houses, where fees are likely to fall. In fact, the industry’s revenues and profitability have fallen far more sharply than pay and employment. McKinsey, a consultant, reckons that for the 13 biggest investment banks revenues have fallen by 10% a year since 2009, while costs have dropped by just 1% a year. The main reason for this mismatch is the relentless optimism of those who work in the industry. Most big banks hired energetically after the financial crisis, hoping to gain a greater share of the market as rivals cut back.” (The Economist, January 4, 2014)

“Consumer inflation expectations turn out to be above the central bank’s inflation target in all three countries. In the United Kingdom, inflation has been running above target for a while now, which may explain some of the gap. But that is not the case in the United States and especially Japan, where inflation expectations do not appear to have responded fully to relatively long-lasting shifts in the inflation rate. Above-target consumer expectations are ironic since the Fed and the Bank of Japan have been worrying, to different degrees, about deflation. The data also show that consumer inflation expectations are extremely sensitive to oil prices. Somewhat alarmingly, those expectations seem to be related to the level of oil prices, not the rate of change as economic theory would suggest. These two characteristics of consumer inflation expectations may be related and could arise from the way consumers form expectations. Rational inattention theory, which emphasizes the costs of processing information, suggests that households may not spend a lot of time and effort rethinking their estimate of the prevailing inflation rate (see Sims 2010). These information processing costs tend to make consumers update their inflation expectations infrequently, especially during periods when inflation is relatively stable. Moreover, instead of using sophisticated models to predict inflation, consumers are more likely to rely on a few simple rules of thumb. Because oil prices are highly volatile, one such rule of thumb could be linked to the price of oil. The apparent importance of the level of oil prices may be related to this casual way of forming expectations. Consumers may well have been feeling the pinch of rising oil prices over the past few years. In an era of stagnant incomes, they could be equating high oil prices with high inflation, an association that presumably will weaken over time.” (Federal Reserve of San Fransisco, November 25, 2013).

Levels: (Prices as of close January 3, 2014)

S&P 500 Index [1831.37] – 2013 highs of 1849.44 (set in December 2013) also mark all-times highs, which is the benchmark. Clearly, the bullish trend is intact, without signs of cracks.

Crude (Spot) [$93.96] – There has been a massive selloff in the last few trading sessions, from $100 to below $94. The supply-demand dynamics support the recent move and suggest further possibilities of a downturn.

Gold [$1225.00] – Digging out of the bottom. December’s lows of $1195.25 and July’s low of $1192.00 make a strong statement about a potential floor. Gold optimists view the next key target as $1400, as the long climb awaits.

DXY – US Dollar Index [80.79]– Hardly showcasing any movement for the last two years. Interestingly, on January 3, 2013, the index stood at 80.38.

US 10 Year Treasury Yields [2.99%] – Signs of strengthening yields since July 2012. Breaking above and staying above 3% is the challenge in months ahead.





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.