Market Outlook | January 27, 2014

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

Collective awakening

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

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

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

Risk resurfacing

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

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

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

Bracing

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

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

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

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

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


Article quotes:

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

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

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

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

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

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

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

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



Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.

Market Outlook | January 13, 2014

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

Art or magic?

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

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

Interconnected

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

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



Unease accumulating

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

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

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

“Surprises”

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

Article quotes:

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

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

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

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

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

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

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

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



Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.

Market Outlook | January 6, 2014

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

Cheerful expectations

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

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

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

Adding up disconnects

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

Themes for 2014

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

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

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

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

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

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

Article quotes:

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

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

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

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

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

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

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

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





Dear Readers:

The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.

Market Outlook | December 23, 2013

“The capacity to be puzzled is the premise of all creation, be it in art or in science.” (Erich Fromm, 1900-1980)

Wildcards accepted

Two less predictable market-moving mysteries ended up surprising observers while not dramatically shifting the narrative. First, despite the consensus view of not expecting the first taper announcement this December, the surprise unfolded with a mild tapering. For months, this event was labeled a major unknown to the status quo of low rates and higher asset prices. Simply, it was feared that the start of a taper would produce some mild shocks or a rise in volatility. The interesting element was the market response; it so far has not reacted in a fearful manner. Instead of concern, the market responded with an intra-day explosion, which matches the multi-year bullish response. That action propelled the S&P 500 index back to all-time highs, reiterating the ongoing and overly familiar trend of 2013.
Doubters of this rally remain even more puzzled. The taper was shrugged off quickly, similarly to prior earnings weakness. Plus, changes to QE policy and the arrival of a new chairperson have yet to rattle the thought processes of capital allocators or new, eager participants. Most likely, this joyful response is temporary, as the taper will be digested and refined with better clarity in the next three months. Patience is required here to digest the nuances and footnotes of the Fed’s messaging behind the taper decision.

Secondly, the economic growth recovery did not quite match the asset boom that’s noticeable. Labor numbers have been questioned despite a mild recovery, and GDP growth has been slow and not always a pleasant picture. Nonetheless, last week’s announcement of 4.1% third-quarter GDP restored further confidence and was a confirmation of economic “success” that was desperately awaited. This was certainly a headline that surprised many.

“[The] biggest contributor [to GDP] was what the government calls ‘gross private domestic investment.’ That includes construction, purchases of machinery and software, and accumulation of inventories that can be sold in future quarters.” (Bloomberg, December 20, 2013)

Again, this burst in GDP is only for one quarter. Most experts do not expect a further economic boom to sustain this recovery, but for the time being, the risk-takers have another data point to cheer and investors may rationalize this as the real economy playing catch-up to financial markets. Puzzling dynamics persist, as the light taper suggests that inflation is not a concern and economic growth is not quite robust. In addition, the labor and housing improvements remain skeptical. It’s unclear whether the pace is sustainable, and organic growth in the real economy remains very difficult to showcase openly. Nonetheless, the current atmosphere appears relieved to have a cheerful spin rather than skepticism, which has been out of favor for a long while.

Less imaginable

Consensus is hardly reliable based on recent examples which included expectations of high gold prices and inflation being a major factor. Gold is down, deflation is the concern and gloom and doomers are realizing the power of Fed-driven markets. Here we are at year-end, trying to dissect the status quo and speculate on potential surprises while relentlessly pursuing the attainable truth that’s interwoven with many messengers and events. Surely, the current levels of US stock indexes were unprecedented for most.

The level of stock market optimism has resurfaced, and there is no shortage of hubris when gauging basic investor sentiment. Yet, progress in tangible economic measures will provide the final say on the Fed’s QE efforts. One would be hard pressed to find many balanced forecasters calling for a stock market sell-off. In fact, with buybacks shrinking the supply of shares and momentum accelerating, it is harder to visualize a crisis-like feel. Yet, the question of slowing growth and the lack of further momentum needs to be asked rather than dismissed. A unanimous crowd of performance chasing is not a sufficient reason to take on further risk. Thus, winners are most likely the critical thinkers who challenge and grasp the status quo. Perhaps, the catalyst might revolve around a macro concern that’s low in the pecking order. Unlike common concerns of an earnings slowdown, Fed policies, a government budget deal, the potential risk of government shutdown, inflation, etc., maybe the less-discussed threat is the valuable catalyst worth understanding.

Seeking the undesirable

The decline in commodities and emerging markets has been well documented and a notable macro trend this year. In terms of emerging markets, since 2010, the US markets have outperformed emerging markets, as the relative argument for US markets has been a rewarding play for several years. Now, value seekers may consider finding a spot in unloved areas. Recently, bank analysts (like Goldman Sachs) have suggested reducing exposure in emerging markets for months ahead. Certainly, with globalization less vibrant and the continuation of a sluggish performance, being bearish is not a surprise. Not to mention, weakness in commodities is burdensome to developing country performance, too. Yet, if the lesson of going against the grain pays off, some may have to consider value bargains within emerging markets.

Here is one point to consider for contrarian thinkers:

“The economic growth in emerging markets is about four times faster than in developed countries, the fact that all exchange reserves are very high in these countries and the debt to GDP (gross domestic product) levels of these EM (emerging market) countries are much lower. The combination of these factors means that we are very much into a sweet patch going into 2014. So, we believe that emerging market equities will do quite well going forward.” (Mark Mobius Interview, Live Mint / WSJ, December, 23, 2013)

Perhaps, the theme of fathoming the unfathomable, as once coined by a money manager, continues to apply in the year ahead as it did in the year past.


Article quotes:

“Much of the euro’s design reflects the neoliberal economic doctrines that prevailed when the single currency was conceived. It was thought that keeping inflation low was necessary and almost sufficient for growth and stability; that making central banks independent was the only way to ensure confidence in the monetary system; that low debt and deficits would ensure economic convergence among member countries; and that a single market, with money and people flowing freely, would ensure efficiency and stability. Each of these doctrines has proved to be wrong. The independent US and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility. Likewise, Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. The crisis caused the deficits and high debt, not the other way around, and the fiscal constraints that Europe has agreed will neither facilitate rapid recovery from this crisis nor prevent the next one. Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. But migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialized), has been hollowing out the weaker economies. It can also result in a misallocation of labor.” (Project Syndicate, Joseph Stiglitz, December 4, 2013).

“How fearful should we be of deflation? It depends on why prices are falling. Bad deflations stems from a ‘demand shock’ in a highly indebted economy, say, a housing market implosion or collapsed banking system (the story of the Great Depression and Great Recession). The downward spiral of debt deflation is potentially ominous. The greater the deflation rate, the higher the real interest rate, the more difficult it is for borrowers to service debts, raising the risk of widespread bankruptcies. The big risk at the moment, especially in Europe, is for the onset of a debt-deflation downward spiral. Deflation isn’t always bad, however. Sometimes, mild deflation can signal a vigorous, creative, healthy economy. Good deflation stems from a positive supply shock, e.g., a string of major innovations that combine to push down costs and prices while opening up new markets and opportunities. Productivity-driven deflation was common during the last part of the 19th century. For instance, the wholesale price level fell about 1.5 percent annually from 1870 to 1900, yet living standards improved as real incomes rose 85 percent, or about 5 percent a year. The U.S. economy grew threefold, and by 1900 America was the world’s leading industrial power. …. The commonplace assumption is that the zero-bound, quantitative easing and other extraordinary measures taken by the Federal Reserve and, more recently the European Central Bank, are aberrations from the normal ways of central banking business. The belief is misplaced. The unusual will become normal, with deflation the main price trend in a hypercompetitive global economy and quicksilver technological change.” (Bloomberg, December 19, 2013).

Levels: (Prices as of close December 20, 2013)

S&P 500 Index [1818.32] – Breaking above 1800 again and reaching intra-day highs of 1823.75. Buyers demonstrated confidence at 1780 on three occasions in the last few weeks.

Crude (Spot) [$99.32] – Showing signs of recovery around $95. Buyers’ conviction should be tested around $100-105.

Gold [$1196.00] – Prices are barely clinging on and are a few points removed from annual lows of $1192.00 set on July 5, 2013. The debate is set for bargain hunters who may re-enter versus optimists losing confidence if prices below $1200 turn into the new norm.

DXY – US Dollar Index [80.57] – Since December 11, the index has risen more than 1%, suggesting some strengthening in the dollar. Not quite a noteworthy move, but it raises the question of whether the dollar strength is a new trend.

US 10 Year Treasury Yields [2.88%] – Yields have moved higher this month, from 2.76% to 2.88%, showcasing a combination of strength in economic numbers and a recent resurgence to revisit the annual highs of 3% set on September 6, 2013.

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 16, 2013

“More important than the quest for certainty is the quest for clarity.” (François Gautier)

Lack of clarity

Participants and observers continue to buzz from recent appreciation in stocks and real estate prices. Certainly, the risk-reward in both areas has been fruitful as it restores the collective faith in the actions of central banks. Having a clear thought process on unfolding events ahead is not easy but leaving room for surprises and volatility is wise. Hence, the true risk of betting in risky assets is about to be revealed, and assessing this landscape is the collective challenge. Economic strength is somewhat visible and labor numbers have shown some promise, but the level of real economy strength is debatable.

And as debated all year, the sync between financial market appreciation and growth in the real economy needs clarity. Skeptics have pointed out this disconnect, which discredits some of the Fed’s messaging. Low interest rates are not quite the solution for job creation. Celebrating portfolio appreciation is not quite economic growth, either. Crafty tactics aside, the simple perception of QE success is not a clear-cut victory. To call QE a defeat at this point might be premature, but up for debate. In addition, inflation was feared for a while, but deflation might be the near-term concern. Thus, risk-takers demand a few answers, and collectively, the crowd waits.

The risk narrative

The buzz from a spectacular stock performance lingers for the casual observer, while the less settling topic of “taper” faith is speculated upon with pending clues ahead this week from the central bank’s meeting. In terms of the taper – changes to quantitative easing – most analysts expect the tapering to take place in the late first quarter of 2014; only very few suspect earlier. According to Bespoke Investment Group data:

“The January 29th meeting received 19% of the votes, so when combining the December, January and March meetings, 66% of poll participants think there will be a ‘taper’ announced before the end of the first quarter of next year.” (December 9, 2013).

Perhaps, there is a surprise is in the making, as odds makers give the taper a very small probability this month. However, one should not forget that in September, a taper was highly anticipated by experts and failed to materialize despite the fancy coined term – “Septaper.” It is fair to say that the fate and timing of quantitative easing is hardly understood by most experts and frankly, it is unknown. Again, risk is inevitable when guessing events or chasing returns – a reminder to those who are caught up in this bullish run. Equally, imagining the less imagined is not as crazy as it seems for risk-takers.

Amazingly, the substance of recent economic trends is mixed to most observers, yet the “art of messaging” from the central bank is what’s awaited to shape investor perception. The Fed’s ability to dictate what to think and how to act in terms of investment risk is such a powerful force. It is typical for suspense to build, especially when worries (and volatility) were suppressed for too long. Equally, markets are near all-time highs in which the status-quo trend became a profitable habit. Surely, near-term risk-taking habits are hard to change rapidly, especially when they have produced profitable portfolios for individual and institutional investors.

Early clues

The collapse of commodity prices in the last twelve months showcases a major shift in cycle from the previous decade, when gold and crude witnessed gains, along with high investor demand and tons of investor attention. Now, the pricing of commodities may appear cheap to some, but a loss of momentum is fair to declare at this point. Since May 2011, the commodity index (CRB), which serves as a barometer for 19 commodities, is down 25%. This illustrates the stage of the cycle where last decade’s run in commodity prices is slowing or at least taking a breather. Surely, a near-term recovery in commodities such as gold may entice bargain hunters.

As US markets continued to flirt with new highs and with European markets attracting new capital inflow, there is a trend worth noting. Emerging markets are far removed from all-time highs. In fact, the EEM (Emerging Market Fund) made all-time highs in October 2007. Currently, it is 26% below those levels, suggesting the relative weakness of emerging markets. Plus, EEM showed signs of peaking yet again late this October, as a new wave of weakness persisted. In some ways, the link between emerging markets and commodities tells us a similar story where growth has slowed. Weakness is felt among BRIC nations. Of course, some frontier markets have witnessed more quality performance than the traditional emerging markets. Nonetheless, this year has convincingly showed investors that all markets do not rise collectively, and any fruitful runs must come to an end. Interestingly, weakness in commodities and emerging markets ended up boosting already elevated US equities. Thus, clues from actual performance provide valuable signals.

Article quotes:

“As much as $US50 billion of proposed coal mine developments in Australia could be at risk due to changes in China’s anticipated demand, with these assets likely to become ‘stranded’ if they proceed. The study, by Oxford University and the Smith School of Enterprise and the Environment, found that China now accounts for around one fifth of Australia’s coal exports, up from less than 5 per cent a few years ago. And since China now absorbs half of global coal production, with a domestic market which is three times the size of the international coal trade, China has increasingly become the price setter in the Asian coal market. Pressure to improve air quality and to cut carbon emissions – China has begun to move to place a price on carbon – and switching to gas away from using coal, are also factors that are ‘all likely to reduce China’s growth in coal imports below levels currently expected,’ the study warned. … Not only would sub-par returns on these projects hurt their developers and financiers, but would also hit the developers of the required infrastructure needed to get the coal from the mine to port.” (The Sydney Morning Herald, December 16, 2013)

“How can the legacy of high debt-to-GDP ratios be addressed in a less damaging way (Crafts 2013 )? As the interwar experience underlines, a key starting point is for the ECB to ensure there is no price deflation in the Eurozone. Then, the alternatives to fiscal consolidation as a means of reducing public debt ratios are well known, namely, financial repression, debt forgiveness, or debt restructuring/default. Financial repression works on the interest rate/growth rate differential by way of the government being able to borrow at ‘below-market’ rates. Current EU rules severely limit the scope for this. History suggests that a combination of financial regulations designed for the purpose, the re-introduction of capital controls, and a central bank willing to subvert monetary policy in the interests of debt management might be required. Debt forgiveness would be very expensive for the creditors – forgiving a quarter of the debts of Greece, Ireland, Portugal, Italy, and Spain would cost about €1,200 billion – and, in the absence of watertight fiscal rules to prevent a repeat, risks a serious moral hazard problem. Paris and Wyplosz (2013) suggest that forgiveness could, however, play a part if the ECB were to buy up government debt in exchange for perpetual interest-free loans – in effect monetising part of the debt.” (VOX, Nicholas Crafts, December 13, 2013).

Levels: (Prices as of close December 13, 2013)

S&P 500 Index [1775.32] – Down nearly 2% for the week – a slight retracement after making new highs for several weeks. The next test is around 1760, where buyers have previously shown interest. Interestingly, that’s a point away from the 50-day moving average (1761.54).

Crude (Spot) [$96.60] – Technical/chart observers are noticing mild selling pressure developing around $98, where buyers are not quite convinced. The supply-demand dynamics continue to suggest further downside, which matches the trend since early autumn.

Gold [$1225.25] – Remains in its annual downturn. Barely above annual lows of $1217.50 reached on December 4, 2013. Trading at a key level where bargain hunters may take a risk here, yet the intermediate-term momentum is not sending a positive view.

DXY – US Dollar Index [80.68] – Since November 8, the dollar index has failed to make new highs. There have been minor signs of a weakening dollar over the last few weeks. Recent moves are not quite volatile or massive, so further clarity is needed.

US 10 Year Treasury Yields [2.86%] – In a slow and steady move since late October, yields are moving higher. Above 2.80%, as the next level stands at 3%.



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 9, 2013

“An era can be said to end when its basic illusions are exhausted.” (Arthur Miller, 1915-2005)

The known story

Signs of improvement in last month’s labor numbers are an additional factor that contributes to the existing story of strength and confidence. Surely, the decline in unemployment headline is not quite an obvious statement of reviving economic growth, but it’s possibly a “selling point” for confidence restoration. Deflation is visible, but not quite addressed, and global growth is attempting to make a case for recovery. Yet, assets are blossoming and participants are chasing returns.

Then there is the US 10 year Treasury yield that’s rising as bonds continue to sell off. Clearly, there is an outcry of demand for stocks rather than bonds for eager risk-takers and skeptical observers. With this brewing, there is ongoing speculation as to how these market-moving factors are viewed by the Fed. It’s no surprise that the central bank more or less remains the conductor of the market narrative as well as the self-anointed data interpreter, holding several press conferences. The mighty Fed's perception at times remains more vital than collective investor perception. Thus, in taking risks, one has to view facts, understand participants’ mindsets and engage in getting into the heads of central banks to make their next move.

Back to basics

Perhaps, this bull market is flirting with and reaching some plateau where few items are unexplainable with the exception of the following: Limited investment options are driving up stock market demand and a lack of shares is available in liquid and highly sought-after company stocks.

“Corporations have been on a buyback binge in recent years. S&P 500 companies purchased $118 billion of their stock in the second quarter of this year, up 18 percent from the first quarter, according to S&P Dow Jones Indices.” (Reuters, December 2, 2013).

Supply-demand explains plenty and maybe that's the factor that counts in this stock market run-up. Investor demand is not met by market supply (available shares and /or risky assets with high return potential), leading to higher and higher prices.

At that point, any speculation or artful explanation may go far beyond what's needed. The end-date to this status quo has been and will be suspenseful to risk allocation. Therefore, changes in sentiment most likely are set up by changing dynamics in investor demand. That's where the taper discussion fits within the context of what has happened – all-time highs and low volatility that's lingered for a long while. Perhaps, this explains the lack of meaningful sell-off that occurred this year. Demand for liquidity and 20%+ returns make US stocks overly attractive for traditional yield seekers. Expecting the same explosive returns next year might be asking too much, but is hardly an uncommon thought surfacing in folks’ minds here at year-end.

Sorting out noise

Underneath the investor demand versus market supply relationship, there is noise that's polluting, entertaining and plainly distracting. All-time highs create invincibility, which is proven to end in an ugly manner. Yet, the peak is hard to time and remains costly for mistiming. Pile on winners is the message from advisors, and the gloom-and-doomers have quietly evaporated. In fact, the housing market is seeing similar excess demand and remains an asset that continues to rise from low rates policies as well. Yes – a global theme indeed, where returns are a top priority and risk is not as overly feared as in prior years. Asset managers sense that producing returns is more an issue of survival and some naysayers are ignored too quickly. Sure, there has been an overdose of “bubble” studies produced in this multi-year run.

“Many economists have struggled to accept that bubbles exist, as that is difficult to square with the idea of efficient markets. If assets are obviously overpriced, why don’t smart investors take advantage and sell? Edward Chancellor of GMO argues that investors can find it hard to arbitrage away a bubble. Manias can last much longer than investors think, as many contrarians discovered to their cost during the dotcom boom of the late 1990s. Nor do investors know whether a bubble will be resolved through a sharp fall in prices or a long period of stasis, in which inflation erodes prices in real terms.” (The Economist, December 7, 2013).

At the end of reading thoughts, concrete studies and expert comments, one is left to admit that timing the market is tricky and the real economy is not as rosy as presented. Clearly, that’s the humbling answer. In terms of financial markets, turbulence is predictable to some extent, but the catalyst for early shock is not quite easy to target. Plus, the status quo of an all-time high market sounds appealing and the easy path is to preserve the ongoing trend and not doubt the Fed. Clichés and trader sayings aside, there is a point where the market narrative becomes tiresome and exhausting. Have we reached that boiling point? Fair question yet again. It should be noted that emerging markets did suffer heavy sell-offs in the first half of this year. It is not clear if collective hubris is reaching extreme ranges, but the dynamics of interest rates are the last resort for clue seekers. The not-so-pleasant real economy serves a purpose to remind us that the glitter and glamor of headline numbers is not a reliable source for comfort, even in a year where stocks have been glorious.

Article quotes:

“But there is also another kind [of deflation]. This is where falling costs and increasing efficiency of production create a glut of consumer goods and services. In other words, supply persistently exceeds demand. Some people regard this sort of deflation as benign. After all, consumer prices are falling, people need less money in order to live well … what’s not to like? Well, it depends on your perspective. In this world, if you are fortunate to have a well-paid job, you can indeed live well. But this sort of deflation causes unemployment. Or if it doesn’t, it pushes down wages in lower-skill jobs. After all, for production costs to fall, either there must be fewer people earning wages, or wages must be lower. So we end up with a bifurcated labour market – those in high-skill, well-paid jobs, who enjoy a rising standard of living, and those who are either unemployed or in poorly-paid low-skill jobs, who become increasingly dependent on state support. Government welfare expenditure therefore rises. However, the well-off don’t like paying taxes to support the unemployed and the low-paid, so they use their electoral muscle to pressure governments to cut welfare bills. As welfare bills are cut, poverty rises among the unemployed and poorly paid. Governments may adopt draconian measures to force the unemployed into work, even at starvation wages, and to quash civil unrest.” (Pieria, Frances Coppola, December 8, 2013)

“American investors who make decisions by weighing sell side research or listening to cable news are underestimating the risks of the fragmentation of the euro area’s economies and banking systems. Europeans are far more aware of the degree to which banking systems and government bond markets have become renationalised, with proportionately much thinner cross border capital flows. The combination of fiscal austerity and private sector depression in peripheral Europe – the so-called ‘adjustment’ – has if anything increased the risk of capital controls, even, in some cases, outright exit from the euro area. For example, Greece is now on track to have a primary surplus, and is marking its self-sufficiency on a cash basis by refusing to submit its budget for approval by EU authorities. There was an implicit agreement by the Greek government and the Europeans to postpone ‘Official Sector Involvement’ until after the September German elections and the formation of a new government. That is now past, and you can expect Greek OSI next year. Fully discounted, you say? What happens when there are then popular demands in Portugal for similar treatment for that country’s official debt? Where does the process of successive losses imposed on creditor-country taxpayers stop? It might be difficult under these circumstances for, say, a French government to succeed in persuading the German electorate to agree on ‘more Europe’ in the form of a common fiscal policy.” (Financial Times, December 6, 2013).


Levels: (Prices as of close December 6, 2013)

S&P 500 Index [1805.09] – Although slightly down for the week, the index is not far removed from all-time highs.

Crude (Spot) [$97.65] – After a multi-month downtrend that saw prices down as much as $91.77, the last few trading days produced a spike. Prices to stabilize once there is a clear grasp of inventory.

Gold [$1222.50] – The annual commodity demise continues nearing the 1200s. In upcoming trading days, the question lingers whether gold will flirt with annual lows of $1192. About a year ago, prices were around the $1680 range, as the annual decimation of commodities continues.

DXY – US Dollar Index [80.68] – Appears stuck for weeks. The 50-day moving average is 80.34, which is hardly far from current levels. The dollar has remained subdued even tough yields have been rising recently.

US 10 Year Treasury Yields [2.85%] – Since October 23, 2013, yields have made a strong move from 2.46% to above 2.80%. This trend of higher yields mirrors action witnessed late spring to early fall. Perhaps, the perception of a rising economy along with the potential revisit of 3% reignites this momentum of bond sell-offs.

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 2, 2013

“With most men, unbelief in one thing springs from blind belief in another.” (Georg Christoph Lichtenberg, 1742 - 1799)

Digesting

Entering the last month of the year traditionally means embarking on a period where strategists participate in the guessing game for the next year. As 2014 approaches, forecasting the next twelve months might have a different twist than usual. As a start, digesting the explosive year in stock markets is one matter and in looking ahead, replicating this so-far 25%+ performance appears to be a tremendous hurdle to overcome. Of course, being swept away in recent price momentum is to be expected, but overemphasizing risks and dangers is not earthshattering either for keen observers.

Instead, one has to wonder if corporate earnings are a key driver versus the more tangible and more substance-driven economic growth. In fact, by the time one fully understands the dynamics of labor numbers or job surveys, the whole accuracy is a questionable science in itself. A few notable issues have been deferred and future risk is being quantified while sentiment may be more important. Yet, understanding the handful of market-moving narratives is crucial before speculating on a new narrative.

The relative message

Turning pages of articles and watching news of developing trends, it is hard to boast about visible global growth. How much of the broad indexes’ annual gains are attributed to quantitative easing? How much of the current landscape is shaped by a drop in commodities or severe decline in emerging markets? What is the true status of the Eurozone? Sometimes, a process of elimination is a beneficial factor and certainly there is a case to be made for that when viewing the stock performance of top US companies. Of course, multi-national firms at some point should feel the impact on earnings from overseas revenues. Even recently, IBM stated in the recent quarter that sales growth from emerging markets declined by 15%.

Certainly in looking ahead, earnings are an ongoing worry, but weak earnings have not been the main story for headline makers. For now, US real estate and US stocks confirm how American assets are highly preferred and regarded with value. Collective participants have “voted” through action, and that’s the takeaway in the past two years. Despite US domestic issues of a lack of growth in small business, government dysfunction and deflated optimism, there is a fragile US edge that’s been rewarding for risk-takers. The risk of being swept away is even greater, but denying the relative edge is undermining the visible market message. In fact, the relative edge of US financial markets has been rewarding to money managers who stuck through and doubled down on this thesis.


Global growth mystery

Commodity prices have weakened, and continue to reverse last decade’s run. Gold and oil are declining for two different reasons, but weakness is confirmed in the commodity cycle. Part of the slowdown in commodities is a result of weak global demand, which is the other big story this year. Unlike the low volatility index and very high stock market prices, the OECD forecasters are expressing a view that’s not as rosy:

“The world economy will probably expand 2.7 percent this year and 3.6 percent next year, instead of the 3.1 percent and 4 percent predicted in May, the Paris-based OECD said in a semi-annual report today.” (Bloomberg, November 19, 2013)

As witnessed in the first half of the year, emerging economies began to show signs of crumbling, leaving US markets relatively attractive both as an investment and an economy. For financial market observers, a not-so-stable emerging market economy should also signal a lack of stability and increased disruption from last-decade BRIC-driven markets. For example, Russia, which has ambitions of being a global power, reflects the slow global demand.

“Russia’s economy has recently been extremely weak. It fell into technical recession in the first half of the year and it looks likely to post growth of only about 1pc this year, down from an average over the past decade of just under 5pc.” (The Telegraph, November 24, 2013)

There is an ongoing theme underneath exchanges and economic forecasts. Globalization is being questioned more abroad, even religious leaders have questioned capitalism recently and possibilities of a reasonable recovery are the bigger question that waits. In fact, the macro climate these days is centered around avoiding damage rather than growth creation. Interestingly, within this context, the US maintains key advantages relative to other nations. These range from a strong financial system to dependable currency to adequate resources, which is noteworthy in recent oil expansion.

“The U.S. has gained more control of its energy supplies, thanks to the adoption of hydraulic-fracturing and horizontal-drilling techniques that have unlocked vast new oil and gas deposits in South Dakota, Pennsylvania, Texas and elsewhere. About 7.3 million barrels of oil a day were produced in the U.S. on average during the first eight months of 2013, according to the Energy Information Administration.” (Bloomberg, December 1, 2013).

The quest for creditability

Meanwhile, the financial system that was once fragile is facing a challenge of creditability with ongoing low interest rate policies both in the US and the Eurozone. If QE is more of a driver for growth than earnings or economic strength, then long-term investors must reevaluate. The influence of status-quo trends (low interest rates and higher asset prices) may have numbed and forced a capitulation of skeptics who relied heavily on data driven by the real economy. Sure, risk takers and money allocators seek what works, while chasing returns and capitalizing on the common perception. Yet, the nuances and paradoxes of the current marketplace are where the drama and truth quietly reside. At some point, the edgy crowd may not be satisfied by calming words and policies of the Federal Reserve. Perhaps, the lack of alternatives is what keeps the fuel of this bull market going. “All-time highs” sound appealing, of course, but misleading as well. The slogan of increase in asset values only welcomes further greed, which is around the corner. Inflow of capital into risky assets is making a splash and even subprime is booming as short memories evaporate so quickly. Thus, if investors’ memories are short-lived, then why should one expect next year to offer amazing returns like this year?

Article quotes:

“The first problem with deflation is that it tends to raise the real (inflation-adjusted) interest rate above its equilibrium level. As there is a zero lower bound to the nominal interest rate, the central bank may well find itself unable to drive the interest rate/inflation differential to a low enough level, which may result in a slump and even a downward spiral. True, some central banks (Sweden in 2009 and Denmark in 2012) have charged banks for taking deposits, thereby posting negative interest rates. But there are limits to such tactics, because if depositors are being charged, at some point it becomes preferable for them to buy safes and store banknotes. This problem is highly relevant for the eurozone, which is emerging from a long recession, with GDP still below its 2007 level and the recovery, though real, still lacking momentum. Having recognized the danger, the ECB has lowered its benchmark interest rate twice in recent months, to 0.25%. The problem is that this may be too little too late to move the real interest rate to where it should be in order to foster sufficiently strong enough economic recovery. The second problem with deflation is that it makes economic rebalancing within the eurozone much more painful. From October 2012 to October 2013, inflation was negative in Greece and Ireland, and zero in Spain and Portugal. But these countries still need to gain competitiveness by lowering the relative price of their export goods, because they need to sustain external surpluses to correct accumulated imbalances.” (Project Syndicate, November 30, 2013).

“Between 2010 and last year, brands from the comparatively small and exclusive Hermès to the bling of Louis Vuitton have seen the mix of China’s emerging wealth and its population’s love of all things luxury fatten an entire industry – during the leanest times almost anyone can remember. But the mighty Chinese engine is moderating – at least by its own high-revving standards – and the new government is cracking down on exuberant personal spending and gift-giving by officials. As a result, people in the €217bn-a-year luxury industry find themselves staring at an uncomfortable but inescapable question: is the era of double-digit growth over? The answer has huge implications for brand strategy in the world’s most populous country – as it does for luxury groups’ approaches in other markets. It also has direct implications for the valuation premium that investors have placed on the sector compared with other companies. For the past three years, revenue in the luxury sector has grown at an average of more than 11 per cent a year in euro terms, spurred on by Greater China, where revenue grew a heady 19 per cent in 2012, according to a study by Fondazione Altagamma and Bain & Company. But this year, growth in Greater China is expected to fall to 4 per cent, dragging down overall revenue growth to just 2 per cent.” (Financial Times, November 29, 2013)

Levels: (Prices as of close November 29, 2013)

S&P 500 Index [1805.81] – Another week where the key broad index finished a few points above the prior week’s high. Again, that ended up registering new record highs. Before Thanksgiving, the index made its 38th all-time high for 2013, reflecting a momentum-driven year.

Crude (Spot) [$92.72] – Downtrend intact. In more than three months, the commodity has dropped by $10 per barrel, signaling a noteworthy shift. A similar trend was visible between February and June 2012, where crude fell from $110-$77, then rebounded. Worth tracking if the same pattern takes hold.

Gold [$1245.00] – Further price erosion, as gold is below the 200-day moving average, which stands at $1390. Amazingly, last year’s highs stood at $1791.75, reinforcing the cooling commodity cycle and the misunderstood supply-demand dynamics.

DXY – US Dollar Index [80.68] – Mostly unchanged the whole month of November. Catalyst for currency movement has remained relatively quiet, which mirrors the volatility index.

US 10 Year Treasury Yields [2.74%] – Since the start of November, Treasury yields have moved higher from the 2.50% range, potentially suggesting that economic numbers are not viewed as overly weak. The 3% mark remains the key benchmark, and it’s unclear if that’s achievable from year-end.


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 25, 2013

“Whoever is winning at the moment will always seem to be invincible.” George Orwell (1903-1950)

Invincible?

Low US presidential sentiment combined with an all-time low congressional approval rating is not stopping and has not stopped markets from reaching all-time highs. This stresses the lack of correlation between confidence in political leaders and actual asset class appreciation. Unimpressive economic growth is not bothersome to a smooth-sailing rise in stock and home prices.

Numerous expert calls for “bubbles” have not resulted in the market flinching or overreacting. Short-term memories of crisis or panic-like behaviors and contemplation of gloom and doom have yet to bother the volatility index, which loudly points to fearlessness. A sign of calmness, justified or not, is for risk managers to debate. Talks of a new Federal Reserve chairman and over dependence on quantitative easing are not viewed as risky, despite overwhelming chatter. The taper discussion came and went and is to be revisited soon, as conflicting messages from Fed speeches are common.

For market participants, the government shutdown of early autumn was a near non-event for markets then, despite sour sentiment and the usual political bickering. Unmoved, undisturbed, these markets are barley worried. Common as it has been for months, the status quo trend remains a forceful trend that’s influencing markets.

Lack of answers

At this junction of the bullish run: How many latecomers (participants) wait to jump on this bullish ship? This is a pending question that’s fair to ask but murky to grasp as the celebratory sentiment persists. Beyond reason or logic, investors are forced to accept the following:

1) No visible and dramatic symptoms of a macro shift have materialized. Timing is difficult to gauge even with bizarre market dynamics.

2) As long as the majority of participants believe the Fed’s ongoing story, what is believed becomes and remains an ongoing reality.

3) Lack of alternatives in investment areas present further relative strength to US equities versus bonds, commodities or cash.

Catalyst search

Conventional wisdom of identifying trend-changing catalysts has not proved to work thus far. At least, there has not been a major disruption to risk-taking, which leads to less conventional thoughts. For a while, rising interest rates as well as inflation were feared to stir some response. Perhaps, deflation is the issue at hand rather than inflation, and the central banks will have to acknowledge this at some point.

“All of the past week’s data point to heightened deflationary risks. Paltry U.S. consumer price index (CPI) figures, German producer prices undershooting and another bout of weakness in commodity prices, particularly oil, suggest deflation is winning the battle over central bank stimulus. The U.S. inflation rate fell to 1% annualised in October, the lowest figure in almost 50 years, excluding the 2008 financial crisis. …. The German producer price index (PPI) fell 0.2% month-on-month in October, more than expected.” (Financial Sense, November 21, 2013)

Perhaps, deflation is the primary concern that was not overly anticipated. Certainly, declining commodity prices contribute to this threat in developed economics. In months ahead, that’s an issue that awaits, given slowing growth as well. This potentially forces action by the Federal Reserves and changes the market narrative of QE in the US, Europe and Japan and its consequences.

There is a growing chance that the search for a game-changing market catalyst is not a grandiose mystery after all. If the tune of the economy and financial markets march to different beats, then at some point both have to be in sync. In other words, the gap between cheerful corporate profits and economic strength (labor and growth) will be confronted soon enough. It is important to note that corporate profits contribute to stock market strength as much as QE. Corporate profits as a percentage of GDP remain above average. Certainly, this has impacted stock prices, and pending sensitivity to corporate earnings might serve as the clue to minor disruption. Until then, speculators can speculate, doubters can doubt, but the established momentum will determine its own slowdown. For now, the bullish narrative has been made simple and appears invincible. Detecting illusionary market patterns is a risk manager’s valuable asset.

Article quotes:

“Turks are fiercely hoarding foreign currency. The reason? Their own remains weak and could get weaker. The lira has been one of the worst performing emerging markets currencies since May, when investors first took fright at the US Federal Reserve’s plans to start scaling back its vast stimulus. Despite periodic rallies in riskier assets – reflecting changing bets on the timing of tapering – the lira remains 12 per cent down against the dollar since January. Usually, Turks are sanguine about such fluctuations: households tend to sell foreign currency when the lira weakens and build dollar and euro deposits when it snaps back. But since May, households’ foreign currency deposits have risen about 6 per cent to more than $70bn, suggesting savers expect rising inflation and further falls in the lira. International investors share this view, considering Turkey to be one of the countries most vulnerable to a withdrawal of the Fed’s easy money, because it relies on short-term capital inflows to finance a gaping current account deficit. Net outflows from Turkey’s bond market since the end of May jumped to $3.1bn in the second week of November, while net outflows from equity markets over the same period moderated to $154m.” (Financial Times, November 21, 2013)

UK Housing: “Mortgage lending is ‘back with a bang’ with borrowing rocketing 37 per cent in a year as first-time buyers surge into the housing market, according to latest figures. Banks and building societies advanced a total of £17.6billion last month, more than at any time since the financial crisis five years ago, said the Council of Mortgage Lenders. First-time buyers are leading the charge with London agents reporting a near doubling in numbers registering with them this autumn. The latest data came as the Bank of England once again played down fears of a crippling rise in interest rates coming as early as next year. Last month’s total is the first time £17billion has been breached since October 2008 when the British financial system’s ‘near death experience’ condemned the home loans sector to a deep freeze. Loans to buyers with only small deposits are up by 80 per cent. Experts said the revival is set to continue into next year fuelling further house price gains but increasing fears of a dangerous housing ‘bubble.’” (London Evening Standard, November 2013).

Levels: (Prices as of close November 22, 2013)

S&P 500 Index [1804.76] – A few points above last week’s finish led to another all-time high mark last Friday. Since November 2012, the index is up nearly 35%, showcasing a strong run.

Crude (Spot) [$94.84] – Since peaking in late August, prices have declined constantly. A key junction is forming now between a short-term relief rally and notable confirmation of further pricing breakdown.

Gold [$1240.00] – Deceleration continues as felt throughout the year. Annual lows of $1192 are on the radar for some as the bottoming process waits. For now, the unwinding process continues and value seekers may not be overly eager to reenter.

DXY – US Dollar Index [80.70] – Barely moving in the last few weeks. The 15-week moving average is in around 80, which sums up the familiar range.

US 10 Year Treasury Yields [2.74%] – Strong case building for rates to stay above 2.60%. That’s been the case for more than five months. Appears to be stable but overly neutral for trend seekers.

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 18, 2013

“It is dangerous to be right in matters on which the established authorities are wrong.” (Voltaire 1694-1778)

Swept away

Five years after the 2008 crisis, the volatility level is low, showcasing the lack of anxiety by market participants. In fact, the volatility index is around its lowest level in the post-crisis period. Alarmingly, it feels that the fear of disaster is not quite as powerful as the fear of missing out on the ongoing stock market rally. That’s been the case for months now with ongoing enthusiasm. Additionally, some can proclaim US equity as having a “safe haven” status on a relative basis. Nonetheless, there is no such thing as safe when involved in risk taking, which is obvious when examined in a sober way. For some, being swept away in record highs comes with less visible danger of not knowing the end date to a massive run. As usual, the thrill of momentum is forceful and illusionary unless profit is realized in a very timely fashion. The script is familiar to historians, but the catalysts are mysterious for now.

Deception or not, this bullish market vibe is alive and explosive as skepticism seems to have quickly run out of favor. In fact, recording all-time highs for stock indexes has become a normal event, considering it has happened on several occasions. Perhaps, it’s fair to say that 2013 is the year when this “silent bull market” turned into a grand parade of capital inflow with decorative performances leading into further risk enticement. Amazingly, as year-end approaches, the question arises of what awaits next. On one hand, the capital that stayed on the sidelines in recent years has flowed in. Secondly, the worrisome topics have been dismissed for a while and most likely are being collectively misunderstood. For now, capital is persistently chasing:

“Investors poured some $34.1 billion into all equity mutual funds and exchange-traded funds in the past four weeks that ended November 13, the biggest four-week total since January, according to data from TrimTabs Investment Research.” (Reuters, November 17, 2013)

Weighing danger

Occasional speculation on future Fed actions and policies remains a guessing game that mostly does not disrupt the prevailing theme of quantitative easing. In the financial circles, there is potentially a growing comfort of knowing what to expect in 2014, especially in regards to the playbook and policies of a new Federal Reserve chairman. It is reasonable to wonder if this hubristic multi-year run collides with an overly complacent crowd who may be wrong in “taper” assumptions. For now, the year is nearly winding down and the early part of next year will clarify if the term “bubble” is legitimate.

One item that came and went was the budget debate, which is bound to be revisited soon by policymakers. A contentious political climate hovers around this momentum-driven market that’s been numb to economic slowdown, government shutdown or further labor concerns. The pain-free attitude of the stock market fails to match some real economy patterns, both in the US and Europe. Thus, it’s only wise to look for the sudden shift of sentiment, as the narrative may switch to more practical versus perception-based results. Perhaps, one should not use the stock market as a barometer of the nation’s wellbeing, especially when the approval rating for lawmakers is very low and confidence is even shakier. Thus, the dangers of a recovery are murmured, dissected daily but not quite reflected in the volatility or stock indexes.

Changing tones

The market dynamics around oil prices suggest a different tone than last decade. Primarily, the supply-demand picture is changing, with more supply visible and demand slowing recently. Plus, international events will determine if more supply is due to flood the market. In turn, the pricing pressure on crude is quite visible.

“Last month, for the first time since February 1995, the U.S. produced more crude oil than it imported: 7.7 million barrels per day in October, versus 7.6 million of imports. Domestic output ticked up further to a level just shy of 8 million barrels per day in the week that ended Nov. 8, according to data from the Energy Information Administration.” (Bloomberg, November 14, 2013)

Participants who had estimates clouded by previous decade assumptions are considering adjustments. If crude begins to move below $85, then that might raise some alarms and even be seen as a positive for consumers. The economic implication of oil at this junction is too intriguing and equally impactful, as crude prices failed to reach above $100. For now, six consecutive down weeks in crude prices are catching the attention of market observers.

Meanwhile, the close link between commodities and emerging markets is where the shift has taken place versus last decade. Interestingly, commodities and emerging markets underperforming versus US stocks and other benchmarks begs the question of timely entry points versus further deceleration. In other words, bargain hunters may look to purchase emerging market shares or commodities that have retraced recently.

Yet, slowing global growth makes the upside potential too questionable. At the end of the tactical messaging and perception game, it boils down to global growth and avoiding credit bubbles. Those are the tangible elements that count. Until then, the perception-driven market fragilely impresses (especially US stocks) and draws more risk-takers, but timing as usual is the bigger mystery.

Article quotes:

“According to China’s Foreign Ministry, Medvedev said the following at the meeting: ‘Russia-China relations are comprehensive strategic cooperative partnership both in name and in fact. Russia is ready to further expand the scale of trade and investment with China.’ Trade between China and Russia reached US$88 billion in 2012. While in China, Medvedev said the two sides hope to raise that to US$100 billion by 2015 and US$200 billion by 2020.Given their historically competitive relationship, the booming ties between China and Russia have puzzled many analysts. However, there is growing evidence that Moscow is seeking to balance against China’s influence by expanding its bilateral relationships with China’s neighbors. Over the weekend, for instance, Japan's Foreign Minister Fumio Kishida and Defense Minister Itsunori Onodera held Japan’s first ‘2+2’ meeting with their Russian counterparts, Foreign Minister Sergei Lavrov and Defense Minister Sergei Shoigu.The two sides agreed to hold a joint naval drill aimed at countering terrorism and piracy, and also to hold 2+2 meetings an annual event. Lavrov reportedly told a press conference after the meeting that bilateral cooperation with Tokyo would help resolve security issues on the Korean Peninsula as well as territorial disputes.” (The Diplomat, November 5, 2013).

“There are three reasons why he [Mario Draghi, the ECB president] should now look beyond the conventional. The first is, of course, the economic outlook, and the associated downside risk on inflation. When German commentators such as Hans-Werner Sinn criticise the ECB’s decision to cut rates they never discuss the decision in connection with the inflation target – which should be the primary benchmark. The current inflation rate of 0.7 per cent is below target, and forecasts tell us that it will remain so for at least two years. The second reason is a lack of further policy tools after the next rate cut. The main ECB interest rate is now 0.25 per cent. The deposit rate – the one levied on commercial bank deposits at the ECB – is zero. The central bank could cut its main rate one more time and impose a small negative deposit rate. At that point, the ECB will have run out of policies. That would be an uncomfortable position. The third set of reasons relates to Mr Draghi’s lender-of-last-resort promise – the outright monetary transactions he launched last year. The OMT has no doubt calmed down markets over the past year, but it is not a monetary policy instrument. It is an insurance policy. Its purpose is to reassure investors by reducing the likelihood of a country’s being forced from the eurozone. But it is still only a backstop. Quantitative easing, by contrast, is a monetary policy instrument. Its purpose would not be to bail out countries but to reduce medium to long-term interest rates in specific sectors of the economy.” (Financial Times, November 17, 2013).

Levels: (Prices as of close November 15, 2013)


S&P 500 Index [1798.18] – Making all-time highs yet again this year. More than 30 times, new highs were reached. Nearly 10% above the 200-day moving average.

Crude (Spot) [$93.84] – Sharp drop continues in the last three months, from $110 to below $94. This suggests a notable shift in the supply-demand dynamics supporting lower prices. The next noteworthy point on downside potential is closer to $85.

Gold [$1286.00] – Recent months showcase increasing odds of a bounce at the 1280 rage. If positive momentum is not mustered, then this showcases ongoing negative momentum that has persisted in the last twelve months.

DXY – US Dollar Index [80.71] – Hardly changed. Annual lows stood at 78.99 on October 25. Potentially a turning point of a weak dollar from a very near-term perspective.

US 10 Year Treasury Yields [2.70%] – In the last five months, the low end suggests around 2.50%, while the upside is somewhere between 2.70-3.00%.


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 4, 2013

“Pleasure may come from illusion, but happiness can come only of reality.” Chamfort (1741-1794)

Unanswered questions

Illusion versus reality appears more difficult to distinguish. It is overly confusing to put market observers, economic data gatherers and policymakers in one room to gauge overall wellness. On one end, asset prices are rising in developing markets while economic strength is not at comforting levels. On the other hand, global growth is not overly promising. Essentially, the usual questions persist despite the feel-good headlines of rising markets. At this junction, even the most seasoned experts are forced to ask the same old questions to seek some clarity.

Why do asset (stock) prices rise? Is it because the value is understood or perceived to be massively amazing? What’s the connection between a robust economy and increasing asset prices – if there is any strong connection at all? What is the effectiveness of QE and GDP – if any? Are these two factors unrelated, potentially overblown or possibly misunderstood? Are recent US macro concerns of dysfunctional government and Fed “taper” discussions still a concern or less concerning than imagined? Have markets lost their creditability as a barometer of economic strength, or has having a disconnect been normal in other, prior periods? What’s the connection between fading confidence in government and optimism toward stocks? Is there any wisdom to take away from the recent shutdown decision to defer issues? After all, markets did not bother to panic; therefore, what signals a peak in confidence?

Recent inflow into US equities has been quite massive; who is left to pour more money to US stocks? “Investors poured some $54.2 billion into all equity mutual funds and exchange-traded funds in October, the third-largest inflow on record, data from TrimTabs Investment Research showed on Sunday. All three of the largest monthly inflows into all equity funds have occurred this year, and this year's inflow of $286 billion into all equity funds is the biggest since 2000, TrimTabs added.” (Reuters, November 3, 2013).

Answering all these questions in one page is not an easy task, but to unglue the illusions, one would have to start by asking these questions that are washed away in brief mainstream summaries. Certainly, these answers are not found by looking at a chart of the S&P 500 index or tracking varying earnings results.

Uncertainty deemphasized

In any area, there are misconceptions, trickery and illusionary forces that end up driving the collective thinking. Explanations of these types of behaviors are best left to behavioral finance experts and other psychological experts. However, at this junction, these market dynamics are mysterious to some but rather dangerously familiar to others. Of course, claiming a bubble is not quite the simple explanation. Denying the bubble-like symptoms isn’t overly wise, either. Thus, this limbo will persist until a major shock or newsworthy discovery. For example, the elevated ranges of Chinese property values is one matter unfolding. As many times as “bubble” is thrown around, it is only taken seriously after the fact. Naturally, it’s fair to say some are fatigued from hearing “bubbles” discussed. Yet those on the ground level of risk management are either admitting confusion or denying tough choices in categorizing the current reality. What’s convenient for those proclaiming the Fed’s success is to loudly declare the ongoing euphoria as indexes make all-time highs. Is that run justified? That’s a question that’s debated hourly by traders and has gone unanswered for weeks. Justified or not, the reality is felt on actual returns, which is the bottom line sought after. Mapping out a five-year investment plan is shaky for any risk manager or analyst. Soft job numbers combined with a mixed to weak economic outlook enhance the suspense of trends and pending policies. This week, US labor numbers will provide further clarity, at least for shorter-term participants. The lack of yield-generating assets leaves few investment options for asset managers. Perhaps, the inflow into stocks is not surprising given the scarcity of worthwhile and liquid investments.

Digesting recent moves

The commodity markets remain fragile – a theme that’s hardly debatable. The CRB (Commodity index) is down more than 7% since late August. Obviously, gold struggled to maintain its strength and peaked about a year ago. It was October 5, 2012 when gold bugs were too confident and the price of an ounce of gold stood at $1791.75. Today it is barely above $1300, and price stability is unclear. The same applies for crude, which has failed again to stay above $110, then struggled to hold $100 and is now in the mid-$90s. Basically, the commodity decade run is slowing and, as witnessed earlier this spring, the waning global growth plays a part in this. In fact, emerging markets sold off earlier this spring with similar concerns. The EEM (emerging market fund) is 24% below its all-time highs reached in October 2007. Again, this reinforces that commodities and emerging markets are not quite as explosive as US equities. Although emerging markets are recovering, commodities are facing several pressures after an impressive multi-year run. Changes in commodity prices can impact consumer behavior as well as key foreign relations. Perhaps, these developments are macro events with powerful catalysts that are worth tracking for upcoming months.

Article quotes:

“It has become something of a cliché to predict that Asia will dominate the twenty-first century. It is a safe prediction, given that Asia is already home to nearly 60% of the world’s population and accounts for roughly 25% of global economic output. Asia is also the region where many of this century’s most influential countries – including China, India, Japan, Russia, South Korea, Indonesia, and the United States – interact. One future is an Asia that is relatively familiar: a region whose economies continue to enjoy robust levels of growth and manage to avoid conflict with one another. The second future could hardly be more different: an Asia of increased tensions, rising military budgets, and slower economic growth. Such tensions could spill over and impede trade, tourism, and investment, especially if incidents occur between rival air or naval forces operating in close proximity over or around disputed waters and territories. Cyberspace is another domain in which competition could get out of hand. … In fact, the regional security climate has worsened in recent years. One reason is the continued division of the Korean Peninsula and the threat that a nuclear-armed North Korea poses to its own people and its neighbors. China has added to regional tensions with a foreign policy – including advancing territorial claims in the East and South China Seas – that would be described diplomatically as ‘assertive’ and more bluntly as ‘bullying.’”(Richard Haass, Project Syndicate, November 4, 2013).

“Just beyond the mainstream, though, there's a growing view that QE could continue at its current rate for even longer – until, say June 2014. That would bring the QE total, including the subsequent taper, to some $5,000bn, equivalent to more than 30pc of America's annual GDP. Last Wednesday, at its monthly meeting, the Fed's monetary committee voted to keep QE going – ordering the purchase of another $40bn of mortgage-backed securities and another $45bn of Treasuries, so $85bn in total. While the wording of its statement was very close to that of the month before, one key sentence was removed. In its September statement, the Fed had said that ‘the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market.’ In the October minutes, that sentence was gone – causing some to argue that tapering is now more likely, because the economy is improving. Yet, the only reason that ‘tightening of financial conditions’ has gone is because, since early September, when it lost its nerve, the US central bank has stopped talking about tapering. This illustrates the Fed's Catch-22. If Bernanke starts preparing the world for tapering again, yields will start to spiral, choking off recovery and robbing the Fed of its resolve to taper. So US policymakers are caught in a trap – a seemingly inescapable dilemma that stems directly from the massive scale of QE.” (The Telegraph, November 2, 2013).

Levels: (Prices as of close November 1, 2013)

S&P 500 Index [1761.64] – Slightly up for the week which was enough make another all-time highs. Since March 2009, the index has risen more than 1.6 times. Prior all-time highs of 2000 and 2007 remain in some investors’ minds as unchartered territory continues to be explored.

Crude (Spot) [$94.61] – Substantial drop since September, in which crude has fallen by nearly $18 a barrel. Normalizing to ranges seen in the spring between $88-$96. Downside momentum continues to build.

Gold [$1324.00] – Clearly, this year has marked a significant breakdown in prices. Between October 4, 2012 and July 1, 2013, gold declined by more than 33%. Overcoming that sell-off has led to range-bound trading. Momentum is tilted to negative, with oversold recoveries being a possibility for risk-takers.

DXY – US Dollar Index [80.71] – After hitting the lowest point of the year, the dollar index has slightly recovered back to the 80 range.

US 10 Year Treasury Yields [2.62%] – Attempting to bottom around 2.60%. Glimpse of signs for rising rates in the last few weeks, as the 50-day moving average is at 2.70%.


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.