Market Outlook | January 19, 2015

“All genius is a conquering of chaos and mystery.” Otto Weininger (1880-1903)

The Scramble

The start of the year opened all kinds of worries on matters that influence financial markets. To be fair, some of the headline worries were "known” for a while—even 2-3 years ago. Other concerns were “less known” a few quarters ago. Those who put all their faith in Central banks are realizing that surprises are part of risk-taking. Risk is unavoidable and volatility can erupt at anytime. The sole reliance on the message of policymakers and central banks is awfully dangerous at times, particularly during this chaotic junction. If one struggles to "dance with the unknowns" then the current market conditions maybe more treacherous, especially after a period of complacency.

Some of the “known” worries have been on the radar especially in recent months. Examples of this include: pending interest rate policies by central banks (i.e. anticipated rate cuts by ECB), impact of the strong dollar on companies' balance sheets and the lack of growth in the real economy globally. This is in addition to the lower global yields and inflation.

Meanwhile, less expected matters that require further digestion are now on the radar of average and casual money managers. At the forefront of investor curiosity is the massive oil sell-off and its impact on oil rich nations. Sure, this is part of the commodity cycle peak, but the crude price reset has reshaped the status-quo thinking of many analysts. In weeks and quarters ahead, the impact of energy fallout on US banks' balance sheets will be discovered and certainly pondered. In addition, damaging results from natural resources stir further questions of possible political unrest from Russia to other Eastern European nations.

Dealing with the Expected

The so called “known worries” is highlighted by the slow global growth environment, which is not only highly documented but is now presented in generic headlines. From the Eurozone to China to other Emerging Markets, finding growth is a massive struggle as confidence remains scarce by some measures. The evidence of frail economic conditions is piling on, especially in the Eurozone:

“The eurozone is struggling to avert a third recession since the financial crisis as the currency union grapples with high debt and a lack of international competitiveness. The [World] bank cut its outlook for growth in the region by 0.7 percentage point to 1.1% this year” (Wall Street Journal, January 13, 2015).

Clearly, Eurozone leaders are scrambling from dealing with an economic crisis that has quickly turned into a political mess. Of course, the very low yields in Europe illustrate the lack of growth along with the lack of inflation. Perhaps, this simply explains the desperate search for stimulus or reform.

Surely, the ECB talks of lower rates spark massive speculation as the currency markets continue to react. In fact, for months, the Dollar has been getting stronger, the Euro is weaker and further interest rate cuts in Europe are widely expected. Therefore, the Swiss announcement to unpeg the Franc is hardly a surprise when considered within this context. Importantly, the takeaway of Swiss disassociation from the Eurozone itself hints of ugliness to follow.


Colliding Forces

In this anxious period, it helps to reflect back to the sequence of events to enhance ones perspective. Before the markets were swept away with the rattling actions of the Swiss Franc, there were other factors to ponder in the currency and commodity world. Before Oil prices collapsed, the commodity indexes signaled an ongoing cooling cycle for Oil, copper and other hard commodities. Not to mention, weak global demands were also a prelude to Crude demise. Before the spike in volatility in early 2015, the unsettling actions during last October and December served as vital clues to the wobbly inter-connected markets. The dramatic shifts following the September hints are visible in various macro indicators:

On September 19th 2014, US 10 year treasury yields stood at 2.65%, VIX (Volatility index) was hovering around 11 and Crude prices closed at $92.41. What a difference few months make. US 10 year yields now trade at 1.83%, VIX spiked to 20 and Crude sits a little above $48.

Similarly, before Oil price's dramatic drop, the US dollar already began to strengthen—making it the story of 2014. Before the Swiss franc announcement, it was vastly expected that the Euro was set to go lower, especially with ECB expected to cut rates. So, what’s the new discovery? What’s the new surprise? Perhaps, the status-quo of low volatility, and the unshakable trust in Central Banks are not as stable as some imagined. The narrative of the financial markets is changing regardless of the foreseeable or unforeseeable events that have transpired. Crude below $50 and developed market yields near zero and the dollar at multi-year highs illustrates ultimate change. Stale models and expectations are forced to adjust, but before an adjustment some emotional responses are inevitable. Change is chaotic and expecting no change in the market narrative might be even more deadly than imagined.

Article Quotes:

“The Soviet war in Afghanistan was followed by a long-term decline in oil prices. The recent price slide – to $50-60 per barrel, halving the value of Russia’s oil production – suggests that history is about to repeat itself. And oil prices are not Russia’s only problem. Western sanctions, which seemed to constitute only a pinprick a few months ago, appear to have inflicted serious damage, with the ruble having lost nearly half its value against the US dollar last year. Though financial markets will calm down when the ruble’s exchange rate settles into its new equilibrium, Russia’s economy will remain weak, forcing the country’s leaders to make tough choices. Against this background, a stalemate in the Donbas seems more likely than an outright offensive aimed at occupying the remainder of the region and establishing a land corridor to Crimea – the outcome that many in the West initially feared. President Vladimir Putin’s new Novorossya project simply cannot progress with oil prices at their current level. To be sure, Russia will continue to challenge Europe. But no amount of posturing can offset the disintegration of the economy’s material base caused by the new equilibrium in the oil market. In this sense, the US has come to Europe’s rescue in a different way: Its production of shale oil and gas is likely to play a greater role in keeping Russia at bay than NATO troops on Europe’s eastern borders.’’ (Daniel Gros, Project Syndicate January 14, 2015)


“National central banks in the eurozone, with the notable exception of the Bundesbank, are not really worthy of the name; they are glorified think-tanks. It is the ECB that effectively “prints” the money that will be used to make the asset purchase necessary for quantitative easing (although how exactly this will happen remains unclear). While the credit risk of those bonds might sit on the books of the national central banks, that distinction would quickly be rendered irrelevant in the event of a disorderly default.To understand why, consider what would happen if a central bank lost money on its sovereign debt investments. The country’s treasury would have two options: It could exclude the central bank from the restructuring (in which case the other investors in the debt would demand a premium to hold the paper in the first place – the precise opposite of what quantitative easing should achieve) or it could demand that the central bank take the losses (a “haircut”, in the financial jargon).How would the central bank make good that loss? It could ask the country’s treasury to issue more debt. But, remember, it’s just defaulted, so that’s going to be tricky. Or, as it would effectively now owe euros to the wider eurozone, it could ask for the debt to be forgiven. If the rest of the club didn’t forgive the debt, the forlorn country would be forced to leave the eurozone; if they did, then – sorry, Germany – it would rather suggest that, despite appearances, the risk was actually being shared all along. So, the purchase of government bonds by national central banks will either drive up sovereign debt yields in the market (which somewhat neuters the quantitative easing programme) or the default risk must ultimately be shared among all the different eurozone countries (which is exactly what it was designed to avoid).” (The Telegraph, January 18, 2015)


Levels: (Prices as of close: January 16, 2015)

S&P 500 Index [2019.42] – Attempting to hold between 2000-2050. A wobbly pattern develops as the uptrend pauses. A break below 1950 may trigger a sell-0ff.

Crude (Spot) [$48.36] – In September 2008, Crude peaked at $147 and then bottomed at $32 in December that year. Of course, that transpired very quickly during a period of financial crisis, which resulted in a bottoming process around $32-40. Now, the bottom is mysterious as the intra-day lows of $44.20 are closely watched and on the radar.

Gold [$1,259.00] – In the last two and a half years, Gold has bottomed or attempted to bottom around $1,200. Surely, technical and non-technical observers have noticed this even before this current mild run. A break above $1,400 may send a strong message to observers of a noteworthy trend shift.

DXY – US Dollar Index [91.08] – Since July 1st 2014, the index has appreciated over 16%. Amazingly, in this 6+ month period showcased a steady uptrend. Strong signs of confirmation of a strengthening dollar are appearing.

US 10 Year Treasury Yields [1.83%] – Unlike during October and December 2014, treasury yields were not able to stay above 2%. This downtrend remains as the search for safety continues by investors. A notable point would be the 1.37% lows from July 2012 which serve as a key downside target.


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 12, 2015

“Something unpleasant is coming when men are anxious to tell the truth.” (Benjamin Disraeli 1804-1881)

Murmurs of Anxiousness

The last three months of trading have produced mixed emotions ranging from moments of edginess to reaffirmation of all-time highs. At times the volatility index has awakened from a deep sleep, especially as witnessed in October and December last year. But in most cases, the status-quo of higher stocks, lower volatility resumes in a customary and familiar manner. Of course, the commodity index tells the loudest story beyond oil’s recent price demise. The pricing of natural resources is adjusting as global investors re-think prior demand assumptions. Basically, global demand for commodities is slowing and that’s not breaking news. In fact, the summer of 2014 confirmed the collective collapse of commodities as exhibited by the CRB Index—a barometer for various commodities. Stability in commodity prices is desperately needed.

In a similar manner, the global yields that continue to dip lower in developed markets emphasize the lack of tangible growth and dropping inflation expectations. The US 10 year Treasury yields are now below 2%, and it may not be a short-lived stay considering other developed market yields. Spurring growth in an inter-connected world is a daunting task for governments and corporations these days. It’s evident in the struggles of Emerging Markets that capital is flowing into the US dollar at a faster pace. That said, tensions define most of the set-up that has formulated in recent weeks.

The Rate Challenge

The “rate hike” chatter is obsessive in financial circles, but justifying a strong economy in classic terms is rather difficult. The Fed’s narrative is hazy in many ways. To hike rates there needs to be growth, while keeping rates near zero is unnaturally risky. To explain, the economic numbers (i.e GDP, unemployment data), if taken at face value (without skeptical analysis), may lead one to conclude that there is a strong economic improvement. Yet, wage growth was not overly convincing, increasing healthcare costs led to the creation of more part-time jobs, and consumers’ financial health were not as vibrant as some painted.

“Wage growth is currently so low the Fed can afford to wait to see it actually pick up. Indeed, to be consistent with the Fed’s 2% inflation target, wages would need to be increasing by 3% to 4%.” (WSJ, January 9, 2014)

Thus, the Fed faces a known challenge between justifying and pleading that there is strength in real economy. At the same time, low inflation expectations and lower yields in financial markets do not support the glossy theory of low rates leading to more growth. Regardless of stock markets record high-like behavior, to claim a victory on the success of QE is misleading. Amazingly, in 2009 and 2010, many skeptics claimed that the zero interest rate policy is unhealthy and unsustainable. Now, a soaring stock market fails to reflect the angst in the consumer market. Therefore, for the Fed to blatantly ignore the behavioral responses of the financial market does not seem reasonable. The mystery of how the Federal Reserve responds draws a lot of opinions, but no hike approach should not be as surprising as some pundits think. In the same way that inflation did not end up being a major issue, there is a chance that higher US interest rates do not materialize as forecasted.

Bargain Search

Opportunist participants will seek bargains in oil prices as well as in Emerging Markets. Certainly, the drop in oil prices is still being understood. The speculation of a bottom in crude prices remains a big and unknown debate. Similarly, the impact of oil prices on the US junk bond markets remains suspenseful, which raise questions about both the risk and reward ahead. The Russian and Brazilian markets also seem appealing given the recent plunge. In the case of Russia, overcoming the big blow from the energy crisis surely is one of the highest risk-rewards lurking in the current market. The stimulus for an upside EM move is not fully understood as commodity based economics and currencies limp and attempt to recover. If investors feel that the US stock market is overvalued then a migration to EM’s is a possibility. However on an absolute basis, grasping the upside potential of developing markets seems much more difficult to decipher. Perhaps, the mystery is what attracts the risk-takers that seek to catch a new trend.


Article Quotes:

“The announced merger last week between China’s two train makers will enhance the country’s ability to penetrate foreign markets and expand transport infrastructure into the periphery. State owned CSR Corp and China CNR are already the world’s leading manufacturers of rolling stock with annual revenues of $16 billion each and combined capitalization of $26 billion, FT reported. Their main customers are China Railway Group (CRG) and China Railway Construction Corporation (CRCC), the nation’s builders of railways and other infrastructure. These companies are also refocusing their attention overseas. CSR and CCNR were split off from the same parent in 2000 to promote domestic competition. As China’s business increasingly looks abroad for projects, the combined company will rip benefits from economies of scale and compete more effectively with foreign companies such as Germany’s Siemens, France’s Alstom, Canada’s Bombardier, and Japan’s Kawasaki. This move gains from the nation’s favorable political course. In November 2013, China’s leader Xi Jinping proposed to build the “Silk Road Economic Belt,” envisioning the development of transport networks from the Pacific Ocean to the Baltic Sea. Towards this goal, China is willing to invest the initial sum of $40 billion for building ports, roads and rail links. Undoubtedly, the combined CSR-CCNR company is determined to play a key role in the revival of the Silk Road transport corridor.” (Silk Road Reporters, January 9, 2015)

“A more interesting perspective on Brazil’s lack of trade openness can be obtained by looking at the number and characteristics of exporting firms. The first result is that very few Brazilian firms export (see World Bank 2014). The share of exporters among all formal-sector firms is less than 0.5%. Indeed, the absolute number of exporters in Brazil – less than 20,000 – is roughly the same as that of Norway, a country of just over five million people compared to Brazil’s 200 million. This means that, while in Norway there is one exporting firm for about every 250 Norwegians, the ratio in Brazil is one for every 10,000 Brazilians. Of course, Norway and Brazil are vastly different countries. Norway is one of the richest countries in the world; its GDP per capita is almost ten times that of Brazil. Norway’s total GDP is about a quarter of Brazil’s, indicating that Norway can be more aptly described as a small open economy… Out of all Brazilian exporters, a much smaller number of firms make up the overwhelming share of exports – the top 1% of exporting firms generates 59% of total exports, while the top 25% of firms account for 98% of exports (Exporter dynamics database). We also observe little dynamism among Brazilian exporters. Even given the small number of exporters, Brazil has a very low entry rate – very few firms become new exporters. On the flipside, Brazilian exporters have a very high survival rate, meaning that the few firms that export are likely to continue doing so.” (VOX, January 11, 2015)

Levels: (Prices as of close: January 9, 2015)

S&P 500 Index [2044.81] – Early signs of slowing momentum. A break below 2250 is noteworthy for technical observers. Plus, a break below the 200-day moving average can spark additional selling. For now, a sideways range between 2000-2080 is forming in this wobbly set-up.

Crude (Spot) [$48.36] – Struggling to settle at a bottom. A few weeks ago the $54-58 range appeared to be the bottom. Now, the January 7, 2015 lows of $46.83 stand out as a potential low, but the chaotic sell-off is still unsettled.

Gold [$1,206.00] – Over last two months, Gold prices continue to indicate the bottoming process at around $1,200. After surpassing the 50-day moving average ($1,191), signs of very mild momentum appear. At least a pause in the selling pressure is visible.

DXY – US Dollar Index [91.08] – Multi-year highs continue as the momentum is heating up further. The unsettled global markets prefer the dollar over other currencies. Cyclically a recovery in the DXY appeared long over-due and is not materializing.

US 10 Year Treasury Yields [1.94%] – Below 2% mark an alarming new level. Last time, in October 2014, yields reached 1.86% and quickly bounced above 2%. After peaking at 3.05% in January 2014, yields have been on a constant decline reaffirming the bond rally.

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 5, 2015

“We must never neglect the patient's own use of his symptoms.” Alfred Adler (1870-1937)

Symptoms Reawakening

In summer 2011, the Eurozone (EZ) crisis mesmerized the financial markets by making “never-ending” headlines. Of course, those realizations shocked various markets, forcing European bond yields to go much higher. Doubts were raised about the Southern European market as bailouts averted disastrous conditions. Fascinatingly, those were only temporary solutions.

As some pundits have pointed out, the EZ economic crisis converted into a political crisis. The structural set-up for policy making is inefficient and helped drag out this unsolved matter even longer. That’s the core issue brewing today, as political leaders use this crisis as the basis for talk rather than plans for economic revival. Basically, it’s challenging to solve problems when various nations have diverse interests. The mainstream media has documented the conundrum that continues to plague Europe. This conundrum has provided a relative edge for the US financial and political system, which became a major market theme from 2011-2014.

Since then the EZ debt crisis symptoms were not eliminated from the banking system; even though bailouts via bond-buying calmed markets. But the political debate lives on. Surely, economic revival is hardly visible, which increases the tensions on the street level. In the last two years, bond yields in Europe are quiet and calm, and in Germany 10 year bond yields are near 0%.

“German five-year yields dropped below zero for the first time ever, touching -0.007pc on the first day of new year trading, implying that investors are willing to pay the German government to store their money for the rest of this decade.” (The Telegraph January 2, 2014).

Risk and volatility have been priced low recently, which has been part of the on-going global theme. Additionally, inflation remains way below prior expectations in developed markets. This mirrors the decline in commodity pricing and some wonder if too little inflation is an even a bigger problem. That said, it is difficult to visualize organic growth in the real economy, even in periods where financial markets' turbulence was held in check. This begs the question if markets are pricing risks in an accurate manner.


Revisiting Old Notes

As 2015 approaches, revisiting the notes from the volatile European summer of 2011 is a worthwhile start. This is better suited than the calm 2014, where ECB promised stimulus and most EZ concerns seemed under control. There will be future trading days where the EZ will dominate global market action. In the days ahead many anticipate volatility spikes driven by talks of Greek bonds or Greek exit from the Euro area. Other times, false signals (or rumors) will emerge due to bluffs by political actors. This may lead to irrational financial market spooks and chatter. The narrative of economic concern, mixed with politics, is set to create substantial discussions or worries. As for tangible growth or solutions, plenty of issues remain uncertain.

Realizations

In the last few years a few lessons have become clearer:

1. When bond yields continue to reach extreme lows, one concludes that growth is less visible.

2. Similarly, when Crude prices drop dramatically, then it is fair to say emerging market (mainly China) growth slows. This at least serves as a confirmation for doubters.

3. When the US dollar makes multi-year highs, it reflects the trouble of other currencies including weakness in Euro.

These three points are being digested by the market. They even give US stocks further reason to seem attractive—better returns than government bonds and less riskier than commodities or Emerging Markets. Obviously, these conclusions can lead to investors chasing returns and an “oversimplification” of risk. The danger in weeks and quarters ahead is the understanding of the risks rather than understanding what’s transpired during the last 5-6 years.

Thus, quantitative easing is the crux of policy discussion. If low rates fail to fuel a substantial economic stimulus (at least a meaningful one), then shouldn’t markets respond? Many wonder if the time for outrage in markets is long overdue. Beyond the outrage, analysts are trying to figure out if low oil prices boost consumers' spending and if a weaker Euro helps the German economy. Maybe there are new trends to exploit as realizations are digested.

However, what’s the cost of betting on the status-quo (high stocks, low volatility and low yields) staying the same? A suspenseful question with no convincing alternative answer thus far. If something seems without risk for too long, then some would presume it is likely dangerous. Yet danger has not affected the markets for a sustainable period. Perhaps, this first quarter could provide clues as to what markets call or view as “danger.” Until then, the status-quo remains the easy choice, but it is unknown if that’s the right choice for this year.

Article Quotes:

“But the ECB is not wholly responsible for the Eurozone disaster - after all, it has been forced to act as fiscal enforcer because of the absence of a unifying fiscal authority. The truth is that the Eurozone is in an unstable equilibrium. Inexorable forces are forcing it towards either consolidation or breakup. Consolidation means creation of a supranational fiscal authority with tax-raising and bond-issuing powers of its own. Breakup...Well, we all know what that means. QE will do nothing to fix this. Indeed nothing the ECB can do will deal with the fundamental problem of an incomplete and unstable monetary union. There is no political will for consolidation, and the growth of nationalistic political movements makes the disorderly exit of one or more Euro member states increasingly likely. This is the "black hole" theory of the Eurozone. Inexorable gravitational forces draw the countries of the Eurozone ever closer together. To start with, only the smaller and weaker countries experience the severe economic dislocation that is an inevitable consequence of the pull towards consolidation. But as they approach consolidation - the "singularity" - the economic depression of the periphery spirals out to core countries, including the most powerful. Even the mighty Germany is slowing...” (Pieria, Frances Coppola, January 2, 2015)

“Russian Arctic offshore energy efforts are in a period of unwelcome pause, and the flight of Western companies in the face of sanctions imposed by their home countries has left the future of these efforts up in the air. But this state is unlikely to last for long. Western firms have left incredible opportunity in their wake, and China is in the perfect position to benefit. Over the past 10-15 years, the People’s Republic of China (PRC) has systematically increased its activity in the high north through various avenues. Russia’s current relations with the West are likely to substantially boost this enterprise, which should concern the international community given the importance that the Arctic will play in the years to come. The region’s massive resource reserves, China’s growing presence, Chinese challenges to regional Arctic governance, and the current standoff between Russia and the West are a potentially potent combination. This situation should be recognized and efforts should be made to mitigate possible negative consequences. These efforts, however, should not be directed at preventing Chinese Arctic activity. China’s wealth and capital make it an important partner for Arctic nations in developing the high north, and it holds legitimate interests in the region. Rather, China’s entry into the Arctic must be managed responsibly through international channels to mitigate or prevent any harmful effects. Doing so may also create a rare avenue through which the West can seek common ground and understanding with Russia that can be built upon.” (The Diplomat, January 3, 2015)

Levels: (Prices as of close: January 2, 2015)

S&P 500 Index [2058.77] – After few days of trading above 2080, the index has retraced a bit. Of course, given light trading volumes of late December, jumping to a conclusion is pre-mature. All-time highs were set December 29th at 2093.55.

Crude (Spot) [$52.69] – Struggling to find a bottom after the bloody sell-off. Early signs of a bottom remain difficult to call as Friday’s lows near $52 are on the radar for keen observers.

Gold [$1,206.00] – More evidence of a bottoming process around the $1,200 price range. Interestingly, the 50 day average stands at $1,195.

DXY – US Dollar Index [91.08] –Another multi-year high put an exclamation point to the Dollar’s strength in 2014. From a long-term point of view, this strength appears set to continue as positive momentum continues to develop.

US 10 Year Treasury Yields [2.11%] – A drop below 2% would not be surprising at this junction. An October 15th low of 1.86% is in the realm of possibilities.



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 | December 29, 2014

“I am not afraid of tomorrow, for I have seen yesterday and I love today.” (William Allen White 1868-1944)

Many predictions for next year have been made in the recent past. The season for reflection is in full gear as forecasts continue to be made publicly by many experts. The following quote comes to mind when reading predictions in general, “When in doubt, predict that the present trend will continue” (Merkins Maxim). Interestingly, betting on the status-quo, as in going with the consensus (i.e Fed’s script), has proven to be a winner at least in this roaring bull market. Perhaps, this showcases that doubts are always there and sometimes too complex to deal with until an ultimate all-out crisis. Amazingly, doubts only matter when general perception turns sour; otherwise, it can be like a background noise that lacks attention. So doubts are plenty, but knowing when and how they'll impact the markets is the mystery and “the gamble” that keeps observers intrigued.

In looking ahead, the much talked about QE/Fed/interest rates, Russia’s fate and stock market valuations dominate financial discussions and annual predictions. However, beyond the usual headlines, having a road-map of interconnected themes might shed some light into the suspenseful year ahead. Here are few themes and trends to ponder.

Seven Themes for 2015:

1. Status of Emerging Market Currencies

The dollar strength is a profound theme in 2014. It also reflects the weakness in emerging market currencies’, while mildly hinting at the growing geopolitical risk. The “troubled” world has yet again resoundingly chosen the dollar as the preferred currency. The dollar remains the dominant currency despite the noise from goldbugs (a.k.a Gold aficionados) and a minor digital currency hype (i.e. Bitcoin) that came and went.

Interestingly, the dollar strength emerged way before the massive oil price collapse. Certainly the collapse of commodity prices has affected the economies of commodity-dependent nations. Both oil-rich nations and economies that heavily depend on natural resources have witnesses decline in their currencies. Recent examples include, the Brazilian Real, Indonesia’s Rupiah and the South African Rand—all demonstrating weakness versus the Dollar.

Bargain hunters seeking notable surprises may want to believe: 1) China’s economy turns out better than expected 2) Eurozone avoids another crisis 3) further commodity price decline is less likely. That’s the wishful list for the more daring risk-takers. Yet, the historical data for the last two years suggest deterioration of commodities and lackluster global growth as more of a reality than just a worry. If this continues, then a further mess in geopolitical conditions and rotation to the dollar is hardly surprising. If there is a massive turnaround in EM and Commodities growth, it will inevitably lead to stability in EM FX (a very big “if” of course). Surely, the optimists here might be dancing with the highest risk-reward trade for 2015 in terms of surprises. That said, the EM FX behavior and trends will serve as a vital barometer for global markets, as well as the Dollars’ ongoing momentum.

2. Tangible Revelation About China's Economic Weakness

Is the slowdown in Chinese growth real? Worse than imagined results pose some knee-jerk reactions. This could potentially impact global Western corporations. China serves as a symbol of the emerging world and the leader of the new frontier. China has become the lifeline of global trade in a period of inter-connected economies. For many years, pundits have written about the bubble-like traits from housing to shadow-banking to manufacturing. Some data points have merits as growth appears to cool down, even if finding trustworthy data remains a challenge.

“Chinese industrial profits dropped 4.2 percent in November to 676.12 billion yuan ($108.85 billion), official data showed on Saturday, the biggest annual decline since August 2012 as the economy hit major unexpected headwinds in the second half.” (Reuters, December 27, 2014).

Meanwhile, foreign policy strategists remind us the important role of China as a nation in the chess game for leadership. Here is one example:

“Beijing's move to bail out Russia, on top of its recent aid for Venezuela and Argentina, signals the death of the post-war Bretton Woods world. It’s also marks the beginning of the end for America's linchpin role in the global economy and Japan's influence in Asia…. Beijing's move to bail out Russia, on top of its recent aid for Venezuela and Argentina, signals the death of the post-war Bretton Woods world. It’s also marks the beginning of the end for America's linchpin role in the global economy and Japan's influence in Asia.” (Bloomberg, December 25, 2014)

With every geopolitical concern (i.e. Russia’s turmoil or the drop in oil prices) there is one persistent and common question: Where does China stand on this? This question illustrates the importance of China on the international stage regardless of day-to-day financial market behaviors. Thus financial speculators debate the direction of a recovery versus prior expectations. At the same time, political strategists look to sort out the rhetoric versus the actions of Chinese leaders as they relate to global policies.

The Chinese –Western relationship is not as rosy as the mid-2000’s. Slowdowns or rifts on an international level can stir mild volatility and impact Western corporate interests (i.e. protectionist policies). Essentially, this is one critical market moving items to follow in China for long and short term investors.

In looking ahead, three key items await regarding China: 1) GDP numbers and economic trends 2) Recovery (or lack of recovery) of demand for commodities and 3) Policies regarding western companies' abilities to conduct profitable businesses. If Chinese domestic concerns mount, then a negative response (result of ripple effects) to Western companies' investments is not quite a far-fetched idea.

3. Commodities Cycle Adjusting to a New Paradigm

Supply-demand adjustments are shaping new realities in commodities, as exhibited in Oil prices this year and Gold prices last year. As mentioned in point 1 and 2 above, the commodity cycle directly impacted (impacts) currencies and key EM economies. Fair to say the 2000-2008 paradigm of booming Emerging Markets and overly optimistic demand expectations for commodities has run its course. A new cycle is here and expectations have been greeted by reality and the markets have loudly responded.

For cycle observers, the commodity cycle bust or adjustment period is in full gear. Amazingly, the CRB index (which includes soft and hard commodities) peaked on July 2008. Since that point, the index has lost over half its value and dropped from 473 to 234. Amazingly, that same July in 2008, is when Crude peaked at $147.27. Of course, that price now looks so much more expensive and simply unimaginable in retrospect. Gold peaked on September 2011 at $1,895 confirming the multi-years cycle slowdown for hard commodities. What’s the point of these trading ranges? This confirms the boom and bust cycle of commodities and surely the “bust” is explosive and it takes time to bottom.

Where 2015 stands in this commodity cycle slowdown is a great unknown. It is safe to assume that stabilization from the selling pressure might be one angle to consider. The most optimistic investor may feel that these distressed or deeply discounted levels present an attractive entry point. Surely, the last six months clearly confirm commodities as the out of favor market. Speculators will take a stab at this versus other areas that are perceived to be overvalued (i.e. US Stocks). Yet, finding justification for rising commodities must be related to changes in the supply-demand perceptions. In addition, unfolding macro events can spark intermediate-term reactions.

4. Non-Market Tensions as an Indicator for Real Economic Weakness

When discussing the Dow surpassing 18,000 and record highs, we often disregard the social outbursts and expressions that may serve as a secondary sentiment indicator for the real economy. From Hong Kong to Brazil to Western countries, protests have been a common theme. Sure, the subjects vary from economic policy in Europe to immigration related issues or civil liberties in the US. So, do lack of wage increases, troubling student loan stats and rising cost of living contribute further to the outbursts? A period where “hope” seems dark for opportunity-seeking middle class and small business owners lends to frustrations being expressed. There is a disconnect between financial market asset appreciation and the well-being of citizens. Buybacks and corporate cost-cutting can elevate share prices, but the post-2008 recovery has mixed emotions.

At some point are protests stirred by frustration of wages and rise in cost of living? If so, then paying attention to this unorthodox market sentiment can help us gauge the real economy. The QE policies and sophisticated Washington tactics can boast about the impressive growth from near-death levels in 2009. However, the Fed’s or financial market script may need to pay attention to the general issues and outbursts. These events could provide a non-traditional indicator that may come handy to measure the pulse from ground level sentiment.

5. The Role of Federal Spending in US GDP

The negative first quarter GDP suddenly saw a boost and that abysmal (weather related) result is long forgotten. The 5% GDP number in the 3rd quarter of 2014 sparked various reactions. On one hand, simple headline readers can quickly celebrate and justify the positive sentiment. On the other hand, these numbers find a way to jump around from quarter to quarter. Defense and healthcare spending by the government attributed to growth in GDP. Notably, the 5% GDP quarter related to an increase in government spending. A 16% increase in defense spending (to combat ISIS) stood out to many analysts in last quarter’s result. The sustainability of this spending remains to be seen. Interestingly, recent policy for defense spending might continue to suggest that GDP growth is heavily reliant on government spending:

“The U.S. Congress approved an annual defense policy bill on Friday [December 12] that authorizes American training for Iraqi and Syrian forces fighting Islamic State rebels and sets overall defense spending at $577 billion, including $64 billion for wars abroad.” (Reuters, December 12, 2014)

The defense spending trend is vital to track, especially to see if it plays an influential role in headline GDP results. Meanwhile, healthcare expenditures remain the main driver of GDP after revision.

“In fact, the U.S. spends two-and-a-half times more than the average of the 34 countries in the Organization for Economic Co-operation and Development. No other country comes close to spending almost 18 percent of gross domestic product (GDP) on health care.” (The Center for Public Integrity, December 22, 2014)

The question remains if this trend leads to a broad based growth by smaller private companies. Surely, the government spending benefits earnings for larger corporations (in defense and healthcare), but it begs the question about the well-being of the real economy. Especially for areas/industries that do not rely on federal spending. The impact of these expenditures into wages and consumption are vital to see beyond political banter. Otherwise, select companies in the S&P 500 index might reap the rewards while the real economy remains stuck in a sluggish form. Surely, that disconnect between real economy and share prices/stocks has been visible. Essentially, the government spending trends will either widen or narrow this highly documented disconnect.

6. Perception of Corporate Cost-Cutting

The health of corporate profits is well documented. Surely, the share buyback trends mixed with cost-cutting have contributed to the elevation of key companies’ share prices. This trend falls under the more established status-quo theme. However, recent developments at Coca-Cola and McDonalds, for example, begin to raise some doubts about sustainability. This headline sheds some light into the developing trends relating to cost-cutting:

“Atlanta-based Coke plans to ax at least 1,000 to 2,000 jobs globally in the coming weeks, the biggest thinning of its ranks in 15 years. It is also introducing stricter budgeting, telling executives to swap limousines for taxis, and dropped its lavish Christmas party for Wall Street analysts.” (Wall Street Journal, December 23, 2014)

Of course, the corporate model of cost-cutting has led to share price appreciations. At what point will investors not accept cost-cutting as a positive long-term strategy? That’s when the stock selling pressure may mount, but for now investors choose to live in the present. As soon as investors stop rewarding companies that are too short-term oriented, then a sentiment shift is very likely.

7. Dissecting Recent Clues in US Volatility

The VIX (Volatility Index) reached 31 on October 15th and it touched 25 on December 16th this year. On both occasions, the short-lived spikes in volatility ended up quickly brushing off concerns and going back to euphoric responses. Ultimately, that led to new stock market highs. In the last 90 days or so, the spikes in volatility beg some questions that may understate brewing concerns. The anxiousness that persisted in October and December 2014 may turn out as an indicator for valuable clues for 2015. There is value in understanding the slight panics that took place.

Turbulence has been mostly absent in this low interest rate climate. The overarching theme of US relative edge has been clear and proven by market behaviors. This fourth quarter has already witnessed some macro shocks given oil price correction. Nonetheless, US stocks seem heavily unaffected. One would think that the crumbling of EM, uncertainty in Russia, slowdown in China and Eurozone mess are all enough to raise volatility. Yet, the resilience in US markets has been appreciated by investors and the perception of “safety” is building conviction. There is a danger of hubris that’s been dismissed because markets have not punished the bulls, yet. For now, the market observer’s obsession is heavily focused on interest rate polices, which is the most dominate issue that’s constantly discussed and debated. However, the subdued volatility index has quietly signaled unease and unrest. The magnitude of pending doubts may not be as calm as in the past few years. If and when the investors decide to look beyond the Fed, there might be a collective realization that the world has been burning underneath. Perhaps then these slight dangers could convert into rude responses.


Levels: (Prices as of close: December 26, 2014)

S&P 500 Index [2088.77] – Another record was set for the fifty second time in 2014 during last week's holiday-shortened week. The index closed over 6% above its 50 day moving average.

Crude (Spot) [$54.73] – Not far removed from December 16th lows of $53.60. There are pre-mature signs of bottoming around $54. Investor's anxiousness builds in search for a new bottom.

Gold [$1,195.25] – On several occasions, the technical charts suggest a bottom at $1,200. This has brought about mixed feelings from investors. Nonetheless, a follow-through above $1,200 has not been visible.

DXY – US Dollar Index [90.03] – In March 2008 DXY stood at 80, which was a very familiar place. Now surpassing the 90 level marks a new era. This reflects the ongoing decline in other currencies and a decline in commodities. However, momentum remains positive.

US 10 Year Treasury Yields [2.24%] – Interestingly, December 16th lows yields of 2% may have set some near-term lows. Similarly, the last few trading sessions suggest 2.15% as a possible low point as well. Observers await to see if recent stability is a prelude to a bottoming process.

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 | December 22, 2014

“Unreasonable haste is the direct road to error." Moliere (1622-1673)

Hasty Bounce

The recent run-up in stocks seems so sudden when considering the prior weeks’ big sell-offs and heightened volatility. Sure, for US stock indexes all-time highs are a few points removed. Another record high would hardly be surprising at this stage given the pattern in 2013 or 2014. As investors digested the hard commodity decline (led by oil) of recent weeks, a bounce back in US stocks was not surprising, but a roaring broad index recovery presents some challenges for bargain hunters. The Fed’s crafty or practical script (keeping interest rates low) has yet to create panic. Instead, a stimulating equity markets further reflects the US relative attractiveness. At what point is slow growth an issue for corporate earnings? At what point is the US less attractive than other markets? What’s more attractive than US equities? Answering or guessing at these questions might present fruitful future ideas (if any).

Amazingly, the volatility index that soared above 20 this month quickly descended back to 16. Turbulence came and went in mid-October and could again in mid-December. Worries of unstable Crude prices and less vibrant Emerging Markets (EM) are at the forefront of investors' minds. For now, flocking into “safer” themes has been the great escape for those judging by the scoreboard. For example, the strength of the Dollar the second half of this year reflects further instability in Eurozone and EM. This recent hasty market bounce back can not quite eliminate the mystery of the unexpected events, related to currency and commodity markets in months ahead.

At the same time, any thoughts of higher interest rates remain damp as signs of higher yields are a rarity in developed markets. Even the so called risky markets in Europe, such as Spain and Italy, are seeing extreme low yields. Both nations' 10 year government yields were trading below 2% at the end of last week. Yes, growth is not visible in the Eurozone, but the panic of default has calmed down as well. This creates a state of confusion regarding perception of risk. This set-up encourages plenty of investors to stick with the established trend.

Mind Games

A series of short-term market responses have led to an up and down fourth quarter. The rush to buy cheaply valued oil and gold company stocks is one wave of looming interest for some. Similarly, bargain hunting in “discounted” EM is in the minds of classic value investors. The rush back to all-time highs appeals to the hopeful, who await new record highs. Ultimately, the rapid bounce reflects the well-known status quo (higher stocks, lower rates) and at times felt like it was never-ending. Of course, that’s a repetitive pattern that’s putting some investors in a state of complacency. Last week's Fed announcement found a way to lift stocks higher from a mild fragility. Yet, thinly traded volume ahead of the holidays begs some questions about reading too much into the day-to-day action. Perhaps, the sharp corrections from this October and December presented mild hints that are still being understood. Not overreacting to one or two moves is a mental test for risk-takers at this period.

The Relative Search

Hindsight is deceptive because it makes situations appears simpler than they were in real-time. Assuming low interest rates, lower commodities and higher stock markets from a few years ago were not as easily evident as historical data presents today. Equally, expecting a trend-shift/reversal turned out to be inaccurate because timing is a guessing game and risk is always part of the equation. Being skeptical is healthy at times, but perception drives reality more than one can imagine. Depressed wage growth compared with stock market record highs exposes a massive disconnect. Yet, an illusionary perception can trick not only the irrelevant investor, but the so called experts, too. A lesson that’s timeless and clearly exhibited in 2014.

The interconnected markets have been shown to respond quickly and the “relatively attractive” theme eventually gets rewarded. When EM currencies declined, investors flocked to the US Dollar. When Gold and Crude sold-off heavily, more capital inflow went into Equities. When junk bonds failed to hide their risky nature, more capital is bound to flow into Treasuries or lower risk bonds.

When markets are confused about what’s really relatively attractive, then increase in volatility is only natural. Such common patterns and relationships influence behaviors in a meaningful way.


Article Quotes:

“Energy junk bonds now account for a phenomenal 15.7% of the $1.3 trillion junk-bond market. Alas, last week, JPMorgan warned that up to 40% of these energy junk bonds could default over the next few years if oil stays below $65 a barrel. Bond expert Marty Fridson, CIO at LLF Advisors, figured that of the 180 ‘distressed’ bonds in the BofA Merrill Lynch high-yield index, 52 were issued by energy companies. And Bloomberg reported that the yield spread between energy junk bonds and Treasuries has more than doubled since September to 942 basis points (9.42 percentage points)… Oil and gas are inseparable from Wall Street. Over the years, as companies took advantage of the Fed's policies and issued this enormous amount of risky debt at a super-low cost, and as they raised money by spinning off subsidiaries into over-priced IPOs that flew off the shelf in one of the most inflated markets in history, and as they spun off other assets into white-hot MLPs, and as banks put now iffy bridge loans together, and as mergers and acquisitions were funded, at each step along the way, Wall Street extracted its fees. Now the boom is turning into a bust, and the contagion is spreading from the oil patch to Wall Street. Energy companies are cutting back. BP, Chevron, Goodrich... They're not cutting back production by turning a valve. They'll keep the oil and gas flowing to generate cash to stay alive, and it will contribute to the glut.” (Econintersect LLC, December 21, 2014)

“At U.S. debt auctions in 2014, investors submitted bids for $6.3 trillion of interest-bearing Treasuries, or 3 times the amount sold. Since 1994, the bid-to-cover ratio this year has been exceeded only twice—in 2011 and 2012. Before the financial crisis, the high was 2.65 times... Investors bought a record 58 percent of Treasuries at auctions this year, while dealers purchased less than any other year since the government began releasing the data in 2003. Average daily trading has fallen to 4.1 percent of the total outstanding, from 13.1 percent a decade ago, according to Fed and Treasury data compiled by Bloomberg. ‘It’s gotten to the point where the market depth, the liquidity that dealers can provide has been reduced, even for Treasuries,’ Michael Lorizio, a senior trader at Manulife Asset Management, said by telephone from Boston on Dec. 18. The amount of bonds sold at auction to fund U.S. spending is decreasing as faster economic growth boosts tax receipts and shrinks the deficit, which is set to narrow further in 2015. The Congressional Budget Office estimates the shortfall will decrease to $469 billion in the year ending Sept. 30 from $483 billion last fiscal year. That would be the smallest funding gap in seven years. The deficit has declined in four of the past five years since peaking at $1.4 trillion in 2009.” (Bloomberg, December 21, 2014)

Levels: (Prices as of close: December 19, 2014)

S&P 500 Index [2070.65] – Despite hitting a low point in mid-October (1820.66) and mid-December (1972.56), the index is a few points removed from all-time highs (December. 5th reached 2079). The last two months have showcased the sharp-sell offs followed by stronger bounces.

Crude (Spot) [$57.81] – Following the massive sell-off, there has been some attempt of stabilization between $54-$58. It is amazing to think that Crude stood at $107.73 on June 20, 2014.

Gold [$1,199] – In several occasions the technical charts suggest a bottom at $1,200. This has brought about mixed feelings from investors. Nonetheless, a follow-through above $1,200 has not been visible.

DXY – US Dollar Index [89.59] – The demise of Emerging Market currencies has played a key role in the dollar maintaining its strength. The well-defined uptrend since July tells a revealing story.

US 10 Year Treasury Yields [2.16%] – The prior attempt to hold above 2.15% earlier this month did not work out. The 2% lows of December 16th are on the radar of those tracking yields closely. For several weeks, yields have stayed below 2.40%, setting the tone for the current cycle.


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 | December 15, 2014

“Uncertainty and mystery are energies of life. Don't let them scare you unduly, for they keep boredom at bay and spark creativity.” (R. I. Fitzhenry)

Current Landscape

On one end, opportunistic traders are tempted to buy the "cheaply valued" oil related investments. Meanwhile, macro observers are baffled by the pace of oil deceleration, dollar acceleration and uncertain ripple effects on oil-rich nations. Stock markets are debating and digesting oil impact on indexes, while the Central bank chatter remains top priority. Headline writers are hammering the dramatic oil decline and market sell-off fear lingers. For others, the sell-off from mid-October is still mysterious and leaves them waiting for clues. Equally, the emerging markets (EM) woes of 2013 and the Eurozone 2011 crisis are being revisited. Interestingly, the current market narrative includes prior dangers that were short-lived in the recent past. Nonetheless, the fundamental concerns (i.e. supply-demand dynamics) find a way to reappear and the unsolved concerns do not evaporate. Thus, the Fed’s magical power is being questioned as volatility is slowly resurfacing.

Echoes of Panic

Last week’s trading pattern implies that global investors woke up from comfort or an illusionary status. From Greece to Dubai markets, most global markets witnessed aggressive sell-offs and increasing volatility. Brazil and Russia hiked interest rates to stabilize their economies. Interestingly, the increase in rates comes in a period where the status-quo is deeply engraved in low interest rates and low inflation climate. Surely, US interest rate decision is geared to have bigger implication on currencies and bond markets. Already the rising dollar, along with decline in commodities, hurts emerging economies, which have been reflected since last year.

“Governments borrowing abroad in dollars (and frequently also pegging the currency to the greenback) were hit by an increase in local currency liabilities when the dollar rose.” (Financial Times, December 10, 2014)

Some of the worries looming are similar to the Eurozone crisis of 2011 where perceived risk began to reawaken. In terms of fixed income, the Greek markets were warning of danger—yet again.

“The yield on Greek 10-year bonds has surged about 200 basis points this week, the biggest leap since the height of the euro-area sovereign-debt crisis in May 2012. Worse still, the yield on three-year notes, issued in July as part of Greece’s emblematic return to capital markets, have jumped more than 450 basis points, climbing above the longer-dated rates in a sign that investors are increasingly concerned the nation will be unable to pay its debt.” (Bloomberg, December 12, 2014)

The global housing market, from China to Southern Europe to Brazil, suggests another sign of near-term trouble. Momentum is slowing across EM in terms of housing. In fact, even the Canadian market could be peaking, too. Thus, the warning signals are not only from stock or currency markets. Now, the housing “bubble-like” traits are confirming the ongoing concerns of EM.

Well-being Examined

In the US, there is this feeling of improving economy and optimism for consumers given the lower gas prices. Yet week after week the status of the middle class is not just a political chatter, but a practical macroeconomic concern. For months the so called disconnect between record stock markets and tangible economy has been debated ad nauseam. Now, in looking ahead and in terms of an upside, some wonder if the real economy is in better shape than the stock market.

Certainly, the US financial markets remain relatively attractive considering the dollar, treasuries and stock markets. However, consumer trends are mixed, but overall perceived as a net positive. Surely, the US economy, in terms of jobs and housing value, appears attractive— especially versus Eurozone and EM. That’s clearly defined in sentiment indicators. However, the well-being of the US economy might be appealing by some measures, but wage and small business growth are not overly stunning. Further evidence is awaited by the Fed and by the eager market that’s obsessed with interest rate policies. Surely, the anticipated FOMC this week should shed more light on this and that will help redefine the suspenseful script.



Article Quotes:

“France is sliding into a deflationary vortex as manufacturers slash prices to keep market share, intensifying pressure on the European Central Bank to take drastic action before it is too late. The French statistics agency INSEE said core inflation fell to -0.2pc in November from a year earlier, the first time it has turned negative since modern data began. The measure strips out energy costs and is designed to “observe deeper trends” in the economy. The price goes far beyond falling oil costs and is the clearest evidence to date that the eurozone’s second biggest economy is succumbing to powerful deflationary forces. Headline inflation is still 0.3pc but is expected to plummet over the next three months. French broker Natixis said all key measures were likely to be negative by early next year. Eurostat data show prices have fallen since April in Germany, France, Italy, Spain, Holland, Belgium, Portugal, Greece and the Baltic states, as well as in Poland, Romania and Bulgaria outside the EMU bloc. Marchel Alexandrovich, from Jefferies, said the number of goods in the eurozone’s price basket now falling has reached a record 34pc.” (The Telegraph, December 11, 2014)

“And earlier this week, the U.S. Congress voted to impose sanctions on Venezuelan officials found to have violated the rights of political protestors during the demonstrations that began last February. That political unrest continues, most recently reflected in the indictment of opposition politician Maria Corina Machado over an alleged plot to assassinate the president. All of this is unfolding in the context of Venezuela’s rapidly shrinking foreign reserves, a reality that has been exacerbated by this year’s 38 percent decrease in oil prices—a five-year low. As of Monday, December 8, they had fallen below $67 per barrel. And Morgan Stanley cut its 2015 forecast, predicting that prices could average as low as $53 per barrel in 2015 (down from an earlier estimate of $98). Venezuela in particular faces interesting challenges with this price drop, as its national income dwindles and its economy slowly grinds to a halt. Among the largest global producers of oil, Venezuela has the largest reserves in the world (totaling something in the range of 300 billion barrels of crude oil). Oil comprises some 95 percent of Venezuela’s total export earnings. And given the political instability and economic stagnation the country already faces, the International Monetary Fund (IMF) estimates that the Venezuelan government requires an average prices of about $120 per barrel of crude oil to balance its budget.” (CSIS, December 11, 2014)



Levels: (Prices as of close: December 12, 2014)

S&P 500 Index [2,002.33] – Retraced from December 5th highs of 2079.47. Still above the October 15th lows of 1820.66. Interestingly, the 50 day moving average stands at 2000, which has proved to be a key psychological level.

Crude (Spot) [$57.81] – Over a 45% drop since June 2014 highs highlights the pace of price deterioration. As some expect, stabilization around the $60 range; however, others will point out the lows of 2008, which stood at $32.40.

Gold [$1,209] – Once again around $1,200 proves to be a potential bottom in the last two years. Yet, the upside momentum has not been overly convincing as the 200 day moving average is $1,269.31.

DXY – US Dollar Index [89.33] – Signs of stability around and above 88. This shows the uptrend is intact.

US 10 Year Treasury Yields [2.08%] – The dramatic decline in yields continues as signs of the rush for safety are mixed with ongoing rate expectations. Annual lows of 1.86% set two months ago do not seem too far off.


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 | December 8, 2014

“Trust the instinct to the end, though you can render no reason.” (Ralph Waldo Emerson 1803-1822)

Magical Perspective

Several weeks ago in mid-October, the S&P 500 index stood around 1,850, volatility picked up a bit and Crude was above $80. Then a remarkable turnaround took place in less than two months: Stock markets continued to re-accelerate from short-term worries, Crude demise decelerated with urgency and rising volatility evaporated at a fast pace. A mild twist and turn was witnessed as the end result restored the bull market. Responses from broad indexes illustrate the lack of worry of external macro events.

During this same period, the Dollar did not flinch while maintaining its strength; while commodity related currencies and indexes seem more fragile than imagined. The Crude demise reminds risk-takers that commodities cycle is regrouping after peaking from last decade’s upside momentum. Various explanations aside, the commodities cycle strongly coincides with most Emerging markets such as Russia and Brazil, which are seeing their currencies and stock markets sell-off rapidly. This marks a sour period for economies heavily reliant on oil and other commodities.

The themes are well defined for now, the status-quo is more understood and ugly surprises seem rare. Thus, panic and anxiety about US markets have been silenced again as we head into year-end. Amazingly, perception seems more vital for financial markets than real economy, perhaps. Wage and job growth are tricky measures of well-being, but the stock market is an easier indicator to frame a positive perception. Conditions in European economies are not overly rosy, this includes in Germany and France. More data points await, but a softer growth is not a new discovery. As stock values rise easily there is a feeling that conditions are improving. That’s the magic of perception, after all.

Trust Emboldened

In the “Fed investors trusted,” so inevitably any break to this trend is most likely to be driven by Central Banks. Considering all options is the situation that awaits in looking ahead. The Fed created a magical appreciation in stock value, erasing volatility and skepticism. The same familiar themes keep repeating:

1) Investors flocking to stocks and other risky assets due to lack of alternatives.
2) Anticipation of further QE in Europe – following US and UK footsteps.
3) Volatility at very low levels as the Fed driven script is successful to synchronize investors responses.
4) Developed markets favored in this climate than Emerging Markets.

For many years these themes above resurfaced and betting against them has not been overly wise. At this stage, guessing the market or volatility turning point is a daunting task that would be categorized as near gambling. Yet, one has to wonder about pending catalysts in the months and years ahead. As the brilliance of the Federal Reserve is touted in academic and media outlets, the nature of risk-reward still exists. The Fed might have eliminated the severe volatility in recent years, but can the Fed eliminate the nature of risk-reward? The same reward the Fed created surely can become the undesired risk.

Sanity Check

Plenty of economic data points have illustrated the struggles of global markets since 2008. From China’s data to consumer demand to wage growth, there are data points that illustrate a concerning element. As US real estate and stock prices rise in a profound manner, sentiment and perception are easily and generally influenced. If perception is more powerful than reality, then one shouldn't be surprised if this perception turns negative very quickly. The mere fact that volatility is low does not suggest it will be lower for a decade or so. The low-rate environment, albeit a three decade trend, is not quite a given for next 30 years, either. The multi-year highs in the Dollar index and multi-year lows in commodities remind us that sudden shifts do occur.

Article Quotes:

“I have long been worried that the European Central Bank has been slow to address the threat of deflation. But a fall in energy prices is not a good reason for panic because deflation can be good, bad or something in between. In the depression of the 1930s it was undoubtedly bad, because it reflected excess supply and deficient demand. In the late 19th century it was good. During the misnamed Great Depression of 1873-96, there was average annual real growth of 2 per cent despite a decline in the general price level, spurred by shrinking land values and falling prices in older industries. The experience of falling energy prices comes closer to the 19th century example than the 1930s. The problem with a malign deflation is that consumers defer spending decisions because they expect things to become cheaper. Yet history suggests that a rise in real incomes resulting from falling energy prices is more likely to encourage people to spend. That said, there are other very powerful deflationary forces at work in the eurozone, such as the restrictive German fiscal diktat and an ECB monetary policy that is delivering below-target inflation of just 0.3 per cent. By putting downward pressure on inflation, the fall in energy prices will add to the pressure on the ECB to move to full US-style quantitative easing.” (Financial Times, John Plender, December 7, 2014)

“With U.S. output at a 31-year high and imports at the lowest level since 1995, producers seeking the best possible price for crude are straining at having to keep sales at home. Removing the ban could erase an imbalance between U.S. and foreign crude prices by expanding the market for shale oil… The Government Accountability Office, Congress’s investigative arm, in an October report concluded that exports may lower pump prices by as much as 13 cents a gallon, even as they raise U.S. oil prices. That would happen because gasoline is pegged to Brent, a global benchmark price, rather than West Texas Intermediate, GAO said” (Bloomberg, December 5, 2014)

Levels: (Prices as of close: December 5, 2014)

S&P 500 Index [2,075.37] – Since the October 15th lows, the index has gained 14% to yet another all-time high. A dramatic turnaround to the established bullish trend. No tangible signs or clues of a stop forming at this stage.

Crude (Spot) [$65.84] – Struggling to find a bottom. The intra-day lows on December 1st of $63.72 suggest some sign of a desperately needed clue. Nonetheless, the price reflects low investor demand and expanding supply, and that realization has led to a powerful sell-off.

Gold [$1,209] – Another attempt to stay above $1,200. Inability to stay above this mark may signal another wave of selling. For now, the long drawn out bottoming process remains intact.

DXY – US Dollar Index [89.33] – The explosive run continues. The next critical range is passing the 90 range to re-ignite continuation of these multi-year highs. Momentum for the dollar continues to be positive.

US 10 Year Treasury Yields [2.30%] – The last two months showcase a form of stability between the 2.20-2.40% range. June 2007 highs of 5.32% seem far removed. In a similar manner, the July 2012 lows of 1. 37% seem farther away (in terms perception) than closer at this point.







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 | December 1, 2014

“In times of rapid change, experience could be your worst enemy.” (Jean Paul Getty, 1892-1976)

Rapid Reminders

A year ago (2013) some Emerging Market economies like Brazil and Turkey saw their stock markets collapse. Around the same period, gold prices began to crumble reminding investors that cycles do turn very quickly. In fact, the gold bugs fixation was overly enthusiastic with ambitious forecasts that seem rather moot now. The biased and hyped opinions dominated financial circle discussions but eventually the market behavior has the last say (or laugh).

Similarly, the spectacular growth of some EM seems like an old classic movie script. The record highs for EM fund (EEM) were last seen in October 2007. Active participants must be careful when digesting passionate views from so called pundits and analysts. A dogmatic approach (ignoring clues) to market comes with a heavy penalty when the script changes.

This year the strength of the dollar (relative to other currencies) has turned into a vital macro trend. At the same time, crude prices have dramatically decelerated by resetting all types of expectations and forcing analysts to reexamine implications from consumers to oil rich nations. Intended or unintended consequences are lurking, but the trend for oil is much clearer.

Sudden, unexpected shifts should serve as a collective reminder. How many expected Gold below $1,200 and Crude below $70? Not many! Perhaps these are lessons to recall when thinking ahead to the next theme and the next year. Beloved themes and ideas can crumple quickly where a proper time to react can be limited. That’s been the message from currencies and commodities, and there is wisdom to take away and apply for other markets in the near-future. Invincibility for a trend is not an option, but timing is always an intriguing challenge.

Dissecting the Narrative

For few years, stocks have been the “reliable and rewarding” global investment, especially in US equities. Investors have witnessed positive returns and that itself speaks the loudest for short-term decisions. Essentially, the current stock market dynamics create comfort and builds false future assumptions, too.

“According to the weekly sentiment survey from the American Association of Individual Investors (AAII), bullish sentiment increased from 49.12% up to 52.15%. This marks the eighth straight week that bullish sentiment has been above its bull market average of 38.6%, which is also the longest streak we have seen in 2014.” (Bespoke, November 28, 2014)

When risk taking is fueled further by low interest rate climates then it further justifies the lack of alternatives. So the suspense of interest rate directions has not been overly mysterious (in hindsight). Rather, it’s been one sided—Low and lower. In a similar manner the volatility measures continue to dip lower, reaffirming further calmness. In 2015 -How low can rates and volatility go? The conditioning from the Fed’s actions and messages may trouble many to see a world of rising rates or rising volatility. For now arguing both is rather visionary and not backed by near-term performance.

Importantly, lessons from the supply-demand dynamics for crude suggest that one day/moment reality sinks in and prices adjust quickly and the cheerleading analysts will depart from their charged views. It may seem normal to keep thinking low rates equal higher stock prices for the months ahead. Yet, it's rather adventurous to expect this and that is the unknown risk. The mental challenge of thinking something is predictable and to be expected is a dangerous approach as record highs blind participants. Thus, the mystery for the next equity move awaits as for now, and the record highs are celebrated.

The Mindset

The claim that equities are the favorable investment is gaining more merit, more acceptance and raising fears of participants— being hubristic is not deemed as a major factor in the claim. The last 24 months have proved to the casual observers that naysayers are missing out on an upside. The psychological impact of missing an opportunity leads to a rush of capital allocation and that’s been a theme for months and months. Amazingly calling bubbles in stocks have been the wrong choice from a timing perspective, and moving ahead it is a test of nerves for those looking to double down on the risk-reward.

An overriding theme that shapes minds revolves around interest rates, as usual. No matter how many data points cross the wires, the endgame for risk-takers is: Where do I allocate capital? Even if the real economy is not vibrant, even if small business health is not fully resorted, there is more emphasis on chasing returns. The buyback magic that lowers the shares of stocks is an influential trend that should not be dismissed. Corporate profit is a powerful statement, but weakness in sales may surprise many ahead. Planning for surprises is what most analysts struggle to do and the herd mentality is less willing to hear and, perhaps, this is the time to reshape the mindset before 2015.

Interconnected Message

On one end interest rates are low because of the soft global growth from Eurozone to Emerging Markets and even the not so robust growth in the US. Meanwhile, the decline in crude prices reflects slower and weaker global growth. In both cases, the economic growth is slow when viewing it through the oil and interest rate patterns that are screaming. There is a weakening economy that’s masked by heating stock markets; and surely this message is hardly surprising these days.

How much longer can this economic weakness be ignored? The conductors of financial markets might have an edge in crafting a message to justify the unimpressive economic conditions and impressive stock behavior as good progress. As for interest rates, there is a mysterious element that lingers with the ECB awaiting to decide on easing policy. The world fixated on easing policy (i.e QE) has shaped the status-quo and it feels like the norm, but safe to say it is not fully understood. However, the unimpressive economic conditions are being slowly understood by various indicators.

Article Quotes:

“Russia, the world’s largest producer, can no longer rely on the same oil revenues to rescue an economy suffering from European and U.S. sanctions. Iran, also reeling from similar sanctions, will need to reduce subsidies that have partly insulated its growing population. Nigeria, fighting an Islamic insurgency, and Venezuela, crippled by failing political and economic policies, also rank among the biggest losers from the decision by the Organization of Petroleum Exporting Countries last week to let the force of the market determine what some experts say will be the first free-fall in decades… Oil and gas provide 68 percent of Russia’s exports and 50 percent of its federal budget. Russia has already lost almost $90 billion of its currency reserves this year, equal to 4.5 percent of its economy, as it tried to prevent the ruble from tumbling after Western countries imposed sanctions to punish Russian meddling in Ukraine. The ruble is down 31 percent against the dollar since June.” (Bloomberg, November 30, 2014)

“The ECB warned that riskier corporate bonds and some forms of bank debt are already looking overpriced as investors search for yield in an environment of ultra-low interest rates. The central bank identified an abrupt reversal of this search for yield as the main danger to financial stability in the region. That threat would be exacerbated if, as expected, the ECB extends its purchases of asset-backed securities and covered bonds to include mass government bond buying, a policy which works in part by boosting the prices of riskier assets… While there were signs of “excessive froth” in the market for high-yield corporate bonds and some Cocos – a form of bank debt which behaves like equity should a bank fail – the ECB’s report found that “normal” corporate bonds and equities did not show any indications of overvaluation. The problem highlights a challenge facing central banks across the world. Many monetary authorities have taken on more responsibility for safeguarding the health of the financial system, while at the same time pursuing an aggressive monetary policy that some believe has done more to spur asset prices than revive growth.” (Financial Times, November 27, 2014)

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

S&P 500 Index [2067.56] – The second half of the year has displayed that the index can stay around or above 2000. The August and October corrections led to a bounce back to 2000, which continues to shape a more bullish signal. Yet, the 200 day moving average of 1935 seems further removed now than mid-October.

Crude (Spot) [$66.15] – The massive break-down continues. The break below $80 added further pressure; and shockingly and quickly the lows reached $65.69 last week. This massive drop is a realization of a long awaited supply-demand imbalance as emotion driven responses will need time to settle.

Gold [$1,194] – Stuck below $1,400 and attempted to bottom at $1,200. Downtrends since the July highs of $1,340 reinforce the lost momentum within the cycle peak. A quick recovery does not seem feasible, but stabilization around $1,200 appears practical.

DXY – US Dollar Index [88.35] – The mid-summer eruption of the index led to a critical shift of strengthening the dollar. The shift is setting multi-year highs, and surely reshaping the currency markets.

US 10 Year Treasury Yields [2.16%] – Yields are struggling to stay above 2.20%. Recently, resistance built around 2.60%. Any move below 2% is most likely to trigger responses. For now, annual highs of 3.05% seem very far removed.



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 | November 24, 2014

“Worry is a cycle of inefficient thoughts whirling around a center of fear.” (Corrie Ten Boom 1892-1983)
The “Simple” Tale

As 2014 draws to a close, the theme of easing from ECB to Japan to China is the key market driver— following the footsteps of US policies, of course. After all it is simple to understand: lower rates lead to higher stock prices and that's the slogan being presented and perceived by most market participants. The last few years serve as stark evidence of this slogan, and now that trend has turned into a quasi-marketing pitch masterminded by Central Banks.

The continued demise of volatility after a brief awakening this fall further confirms the strength of this resilient US stock market. Close observers will point to small cap underperformance and other worries of sustainability, but the “cautious” crowd is struggling to get mass following. The Gold aficionados and those fearing inflation have quieted down a bit after revisiting prior assumptions. The dollar is strengthening, inflation is hardly a worrisome topic and Gold prices are much lower than most expected. Similarly, beyond a 10% broad index correction, the downside pressure for stocks has been limited for equity markets.

Even European yields are much lower than imagined when compared to 2011, as the orchestrators of financial markets continue tout their brilliance via easing. Thus, believers keep piling on risk as the desperate search for yield is a reality. Turbulence in all angles has disappeared and the reappearance early this fall was short-lived. The list of issues that were feared to cause market shock (i.e. earnings, weak economy and macro instability), now seems less likely to catch the attention of risk takers. As the balance tilts again towards optimism, some see it as a result of limited option for capital to seek reliable returns. Strange dynamics shape perception, which eventually turns into a temporary (or extended) reality. Complexity aside, the herd mentality is sticking to this story with the Fed's reinsurance serving as a confidence booster.

Cycles & Sense

The commodities markets continue to reflect the fundamentals of supply-demand as well as the impact of cycles. As Crude prices showcased in recent months, in a world of slow demand and expanding supply (especially in the US via drilling), eventually come under pressure. Perhaps, the supply-demand dynamics are making more sense and are clearer for commodities than other mysterious markets. Fair to say, the boom and bust nature of commodity cycles is natural and easily understood in hindsight, of course.

Not to mention, the decade old boom in commodities reached a peak from a cyclical point of view. Most of the commodity run-up in the 2000’s was driven by Emerging Markets demand, and slowing demand has been visible even before the supply expansion. Nonetheless, for speculators digesting the oil and gold prices demise the answer might be more tangible to grasp without much mystery to dissect. Surely, the drop in oil prices sparks talk of countries negatively impacted and potential impact on foreign policies; also further regulatory discussions of commodity trading rumblings continue. However as the postmortem analysis continues for oil and other commodities, plenty of noise distracts from the basic root of market-moving forces. At the same time now that commodity prices are much lower, the impact on consumer behavior, international trade and corporate earnings begs further questions.

Deceivingly Obvious?

The parade around US stocks is not a new theme; however, the remarkable run impresses further at each record high. Reconciling why prices are going up (and why the status-quo might change) requires a few questions and explanations. Is it share buybacks that lower the supply of available stocks or lack of alternatives in this messy world? Is it the demise of commodities or the promising revival of US economy? Is it mainly Fed/interest rate driven or a reflection of optimism for very large corporations?

Although, presented as a simple tale, in the current trends in stocks may not be quite cut and dry like the boom and bust of commodities. These questions above are debated by writers of articles, casual financial observers and speculators alike. Yet, the perception of stocks being the relative favored solution in this climate is widely accepted. Awaiting surprises is a healthy approach even if all seems too simple, too sure and deceivingly obvious. Until, the rate hike expectations change dramatically the status-quo seems unshakable.

Meanwhile, the Fed is changing the script (on key indicators for economic health) as we go, thus having a basis to make future predictions is more of a wild card. The moment the trust in the Fed breaks this calmly scripted tale can face a dark awakening. For now, punditry is not going to manufacture fear or hint of rate hike timing. Living in the present seems a practical and safe approach for most investors.

Article Quotes:

“Why focus on wages and prices now when much of the developed world is concerned about deflation, or a decline in economy-wide prices? As I said at the start, everyone is focused on wages—for different reasons. The real median income in the United States is still 8 percent lower than it was in 2007. Some of the reasons for sluggish wage growth are unique to the current expansion, including the creation of a preponderance of low-wage jobs; the still large number of part-time workers (10 percent more now than before the recession) and the gap in wage growth between full- and part-timers; the ability of U.S. companies to shift production to low-wage countries; and the greater share of compensation flowing to health benefits. The unsolved question is what to do about it. Faster economic growth, the obvious solution, remains elusive as economists debate whether potential GDP has slowed permanently, in which case cyclical solutions can only do so much. In the long run, an economy can only grow as fast as the growth in the labor force and productivity, neither of which is showing much oomph. For its part, the Fed seems determined to see wages rise before it begins to normalize its benchmark rate. Given the wide gap between zero and some neutral rate, waiting for a signal from wages will be too late. It may seem like a trivial point now, with neither prices nor wages posing any kind of an immediate threat. But when the economy is finally able to walk without assistance, it is important for policymakers, in particular, to know if they are looking forward or looking back.” (Caroline Baum, The Manhattan Institute, November 18, 2014)

“The UK government delivers services and support such as defense, and financial and social protection. Sharing the costs is part of contributing to UK society. If all income tax is devolved, people living in Scotland will pay no taxes directly from their income for these quintessential UK services. That would weaken the ties that bind all member nations of the UK and erode the solidarity at the heart of it. Second, the UK is ceding a large part of its revenue base and its ability to manage the economy. Income tax accounts for 27 per cent of UK tax revenues. The result is that, for the first time in 300 years, a UK government would no longer have control over its power to raise income taxes. It could be left in a position where it determines the rate of income tax only to find it impossible to implement in Scotland, Wales and Northern Ireland. And its proposals in England could be voted down if it had no majority there. It would no longer be master in its own house… If we do not find a similar settlement we risk ending up with the same institutional strictures of the eurozone: an integrated monetary union without a fiscal union. No one voted forthat.” (Financial Times, Alistair Darling, November 23, 2014)

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

S&P 500 Index [2063.50] – Intra-day highs of 2071 set the benchmarkfor next record highs as the re-acceleration continues.

Crude (Spot) [$76.51] – The multi-month decline continues. Below $80 sparks another wave of concern as November 14th lows of $73.25 are closely watched. A 32% decline since summer highs is significant and may cause watchers to wonder if the bleeding is poised to slowdown.

Gold [$1,190.00] – Struggling below $1,200 as the multi-month decline lives on. Several occasions in the last year and half suggest strong odds for recovery at $1,200, but the weakness has not alleviated.

DXY – US Dollar Index [88.31] – Strength continues. The dollar strength reflects the continued easing pattern in Europe and China. Relative appeal of the dollar remains intact.

US 10 Year Treasury Yields [2.30%] – For about two months yields have failed to surpass 2.40%, reaffirming the low rate environment. This month the narrow range stands between 2.27-2.39% and appears firm for now.

**
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 futureinvestment performance of any securities or strategies discussed.

Market Outlook | October 20, 2014

“Things sweet to taste prove in digestion sour.” (William Shakespeare 1564-1616)

Digestion

September 19th marked a wake-up call for markets and now the digestion period is in full gear. In the game of speculation, the hunt for catalysts is usually sought after, but after bigger events the postmortem analysis creates further buzz. Risk is not avoidable, once the choice is made to participate in the speculation game. Of course before the mid-September cooling, the complacent market saw turbulence priced low and optimism priced too high. Surely, that led to an inevitable adjustment as investor appetite turned a bit sour.

Sudden but major changes do not occur on a quarterly basis and timing; the markets serve as a mystery that creates intrigue. This October plunge has brought back the dramatic flair of fragile markets. For the current generation of participants, sell-off or crisis are not unusual considering the 2011 mild panic and 2008 historic crisis. Surely, even in the “silent” and “not so silent” bull market of recent years had enough skeptics traumatized by past events. As usual, the great unknown is figuring out when will the market decide to make a big move? When do participants collectively decide to sell-off or shy away from risk? And of course, at what point does selling become exhaustive or when does the market turn back its less turbulent ways? These questions were pondered this weekend in articles and discussions as well as occupying the minds of investors. Either way, a healthy correction ends up serving as a mere sanity check for all.

Mild Shock

Relative to the first nine months of the year, the recent moves require further and sober digestion, especially at the extreme ranges of last week: On October 15th, the S&P 500 index reached lows of 1820.66, the US 10 year yields touched 1.86%, and the volatility index (VIX) peaked at 31.06. It was a period where the mild panic kicked in and emotional responses took over rational thoughts of any kind. Meanwhile, Crude hit $79.78 briefly on October 16th putting an exclamation point to the current cycle slowdown. Are all these exaggerated levels at extremes or warning signs? The market has responded. Now investors' reactions will determine how the year ends from here. General sentiment is leaning towards buying stocks and appears to support adding further risk.

It is no secret that negative market moving elements were brewing even before late September considering dollar strength and commodity weakness. Sure, a few periods of sell-off attempts were briefly witnessed in the beginning of the year and in the spring. Both corrections failed to leave a lasting effect.

Thinking Ahead

At this junction rational minds wonder if the “improving economy” story lives on. Oil prices are now dramatically down and borrowing rates remain low. Does this fuel the consumer driven economy? In terms of housing markets, the refinancing trends continue:

“A gauge of U.S. mortgage refinancing jumped 10.6 percent last week, the most since early June, the Mortgage Bankers Association said Wednesday. The share of home-loan applicants seeking to refinance climbed to 58.9 percent, the highest since mid-February, from 56.4 percent, the group said. In December of 2012, after the 30-year average rate hit a record low of 3.31 percent in November, borrowers wanting to refinance accounted for 84 percent of applications.” (Bloomberg, October 17, 2014)

Consumers may benefit from lower oil and heating prices according to some. That’s to be explored, but as for Energy investors, the price declines have hurt the commodity as well as the stocks. The energy fund (XLF) has dropped nearly 24% from June 27th to October 17th. A theme that has changed dramatically for investor’s fortune, but the impact on economy will be shortly discovered.

Before this autumn the Eurozone conditions worsened despite chatter of further stimulus. Like the 2011 lessons, Europe is trying to shake-off the damaging conditions of no growth. In addition, the Russia-Ukraine tension stirs further instability along with China, Iran and other macro developments. Not to mention, 2013 reflected massive sell-offs in Emerging Markets. Thus the sudden inter-connected panic that stirred is not overly shocking. Now sensitivity grows for short while where data points might be biased towards negative interpretations. In addition, countries that heavily rely on Oil to drive their economies will feel the effect as well, which can spark a changing geopolitical landscape (more on this below).



Unsynchronized

Perhaps the economy may revive from sluggish conditions, but market related concerns can persists. For a while the cycle between real economies versus stock prices seemed disjointed and uncorrelated. In the past many asked: How can stocks rise if the real economy is not stellar? Now, the same folks may ask: How can the economy rise if stocks are shaky? Fragile markets await corporate earnings, investor sentiment, and the Fed’s script. The reliance on the Fed, reduction of shares available, and lack of alternatives have dramatically benefited stocks in the last five years. The art of all this is the understanding that the market drums to its own beat better than the economy. To assume both move the same direction is a flaw, but to dismiss it is equally flawed, too. The rest is risk taking and dealing with the Fed’s messaging which thus far has been influential in shaping investors' minds. The pressure to keep the optimistic light on is building for the Fed. Right now enough believers may persist, but if the Fed is ever defeated psychologically then another wave of panic awaits. For now the Fed’s popularity and ability to cool concerns is still high.

Article Quotes:

“Twenty countries depend on petroleum for at least half of their government revenue, and another 10 are between half and a quarter. These countries are clearly vulnerable to big changes in the price and quantity of oil and gas that they might sell. But which ones would have the hardest time coping? One factor that will affect them is the diversification of their economies. In countries where petroleum is responsible for a lot of revenue but not much of overall economic output, there is at least the possibility of broadening the tax base. Starting with Qatar…, all the countries depend on petroleum for less than a fifth of gross domestic product. But some of them are lousy at collecting taxes, which is the revenue they'll rely on when earnings from oil and gas decline. According to estimates compiled for 2005 to 2007 by Andreas Buehn of the Utrecht School of Economics and Friedrich Schneider of the Johannes Kepler University of Linz, the shadow economy -- or black market -- may make up more than half of Nigeria's GDP, and more than 40 percent in Chad, Russia, Myanmar, and Ivory Coast. (Of course, this may be part of the reason why petroleum revenue accounts for so much of their governments' budgets.) Recovering from a dent in government revenue would be especially tough for any of them.” (Foreign Policy, October 17, 2014)

“The unorthodox steps the European Central Bank has taken since June – including a programme of private-sector asset purchases – have caused a steep fall in the euro. The single currency is down 8.4 per cent against the dollar and 4.75 per cent on a trade-weighted basis from its peaks this year. The weaker exchange rate will ease pressure on the ECB in its fight to raise inflation back to its target of just below 2 per cent. Mario Draghi, the central bank’s president, has said the currency’s earlier strength explains 0.4 percentage points of the fall in inflation since 2012. In that year, prices were growing 2.7 per cent a year. But just as this depreciation is starting to fuel inflation, the ECB must contend with a fall in oil prices that all but wipes out the effect of a sliding currency. A weaker euro should swiftly raise the cost of imported energy. Instead, Brent crude has fallen 9 per cent in euro terms this month alone. This is the main reason why eurozone inflation fell again in September to 0.3 per cent, a five-year low – a figure confirmed by data on Thursday. A cheaper euro will also please business leaders who have long called for action to curb the value of the currency. But economists warn it is hard to tell how far this bout of depreciation will help the region’s anemic recovery. In theory, a rise in company profits should support business investment, hiring and consumption. But analysts warn that the relationship between exchange rates and export volumes is far from clear-cut.” (Financial Times, October 19, 2014)

Levels: (Prices as of close October 17, 2014)

S&P 500 Index [1886.76] – From September 19 to October 15 the index fell 9.84%. A near 10% correction has taken place with a 200 moving day average sitting at 1906.02. Interestingly, 1906 is where the market closed two Fridays ago and the 10 day moving average stands at 1906 as well. Thus, it serves as a good barometer for sentiment. Either buyer momentum is short-lived or more heavy selling awaits.

Crude (Spot) [$82.75] – Fair to say, the collapse is intact as the selling pressure mounts. Amazingly, the commodity reached below $80, albeit not for long. Overall, the action suggests oil is severely beaten up and now approaching relatively “cheap” levels for some. Potential bounce back is inevitable but the duration of any pending price recovery remains a mystery.

Gold [$1,237.75] – Since last summer, Gold has danced in a familiar territory between $1,200 and $1,360-ish. Long drawn out bottoming process. The 33% correction from October 2012 to July 2013 has left a big dent in investors’ optimism. Shaking that off has taken a while. Finding a spark for a recovery to $1,400 has been talked about but follow-through has yet to materialize.

DXY – US Dollar Index [85.91] – Following a relentless run-up in the past few months’ signs of slowing. A mild pause is taking place. Hard to deny the strengthening dollar which has served as one of the key macro shifting movements in recent months.

US 10 Year Treasury Yields [2.19%] – This year, from May to late September, yields stayed between 2.40-2.60%. The dramatic turn in last few weeks drove yields below 2% for a short while.




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.