Market Outlook | February 1, 2016

“He alone is free who lives with free consent under the entire guidance of reason.” (Baruch Spinoza 1632-1677)

Summary

A much needed breather appears after the early weeks of 2016. Lower treasury yields, turbulent trading patterns, collapse of Oil prices, and murky growth outlook all played out in the first month of the year. As investors digest prior weeks’ events, January ends up leaving us with more unanswered questions. Meanwhile, it is becoming a daunting task for the Fed to defend their call of raising rates last year. The Fed’s ego /credibility versus the soft growth reality is the illustrious debate that’s going on in financial circles. In addition, the twists and turns of central bankers and their desperate stimulus efforts trigger a mixed response.

Misguidance

Participants' heavy reliance on central banks (CBs) has been well documented and clearly hits the core of the post-2008 market behavior. At what point, are CBs going to lose their credibility or are we at a desperate period where CBs are the ultimate last resort? January 2016 illustrated some doubts about the Fed’s leadership, particularly about raising rates in a less convincing economy. In fact, the health of the economy is highly debated and contested in intellectual circles, but very weak for pragmatic observers (early voters, as well). Others point to the Fed’s inability to raise interest rates early, but that’s a subjective debate. Nonetheless, if the economy is not viewed as unanimously strong and if earnings are mostly shaky across multiple sectors (not only energy), then the markets, participants, and the Fed need to acknowledge that reality. 

Amazingly, the ECB already assured further stimulus efforts in the desperate Eurozone economy. At the same time, negative interest rates in Japan illustrate the ongoing desperation for finding yields and a gruesome period of a lack of growth. Basically, investors have nearly given up on policymakers creating growth, as that’s not an opinion but rather a fact. Confidence building is not to be confused with real economy growth creation.

At the same time, there is an over-reliance on CBs that are limited with their nearly exhausted tools. During this insane period, it becomes difficult to analyze and digest. Within this context, the Federal Reserve faces further scrutiny, mainly for raising rates and over promising on the health of economic conditions. That might be the ongoing theme during the rest of 2016.  Interestingly, the next few weeks appear to have less public relation appearances from CBs, which sets up a reality check with less intervention:

“Leaving investors to their own devices for a few weeks could also be in order given that some central bankers themselves have questioned the potency of even more monetary stimulus. They also argue that it’s not their job to prop up asset markets -- even if they have the reputation for doing so….Policy makers themselves are the reason for the fewer gatherings this month. The ECB last year decided to meet every six weeks rather than monthly, while the BOJ cut its gatherings to eight from 14. That brought both closer in line with the Fed, whose Open Market Committee meets eight times this year.” (Bloomberg, January 31, 2016)

Limited Relative Options

With yields so low, commodity cycles in shambles, and growth rates anemic, the challenge remains for those looking to allocate capital. Limited options have been a theme of markets as US equities looked appealing on a relative basis. Innovation themes, such as technology and biotech, have had a relative edge, but not all innovative ideas are seeing a healthy appreciation of shares. With earnings' season upon us, the line between losers and winners are being clearly defined.  In fact, the strength of the dollar, the demise of China and other emerging markets, and collapse of oil should clearly impact most companies at this stage.  Thus, the macro events that have played out viciously may not have been fully felt in the fundamentals of various key companies.  The magnitude of recent macro movements should create further suspense and dictate the narrative ahead. 

Digesting Uncertainty

Much is being made about the correlation between crude prices and the broad US stock markets. Perhaps, that is what caused a near-term overreaction in January, where various key asset prices declined at once. This confused the commodity cycle decline, which has taken place over four years, compared with the stock market correction of few months is dangerous and misleading. At the same time, the weakness in China is a bigger reflection of slowing global growth. From Brazil to Turkey, the slowdown has been felt for several years; thus, to claim China’s sell-off and panic as a surprise is not accurate. One link that’s clear is between the soft demand for Crude and softer demand in China. Surely, there is a strong link here and the markets were screaming of this with warning.

Basically, Emerging Markets and Commodities have been sinking together and sank even faster last month. Now the risk-reward has been adjusted and energy companies are forced to reshape their business models. Chinese regulators are in semi-panic mode, as investors are presented with new opportunities and new paradigm for risk taking.

As long as investors accept the massive weakness in Emerging Markets, then downside surprises will be limited. However, if there is more denial about the severity of slowdown in global growth, then downside surprises may amaze the optimists.

Article Quotes

“As such, a slowdown in the economic growth rate of China implies a likely slowdown in increases to the defense budget. China's military resources are somewhere between $150 billion and $200 billion a year—far less than America's $600 billion, but far more than any other country. When Chinese GDP growth rates approach 10 percent, so typically have military budget increases. With a base of a $200 billion military budget, 10 percent GDP growth translates into an annual real increment in military resources of $20 billion each year. By contrast, at 5 percent growth, China might be expected to grow its defense budget from, say, $200 billion to $210 billion this year, and wind up around $250 billion by decade's end. That would leave the United States the unquestioned dominant world military power well into the 2020s (and probably far beyond). Even if China ultimately does approach American defense budget levels, the pace at which it does so is important. A slow convergence gives time—for Chinese political systems to mature, for Beijing to adjust to the responsibilities of global leadership, and for America and its allies to respond and increase their own defense levels if needed. Thus, annual growth rates closer to 5 percent are far less disruptive strategically than the recent norms closer to 10 percent.” (Brookings, January 29, 2016)

"During the month of January, analysts lowered earnings estimates for companies in the S&P 500 for the quarter. The Q1 bottom-up EPS estimate (which is an aggregation of the estimates for all the companies in the index) dropped by 4.7% (to $27.76 from $29.14) during this period. How significant is a 4.7% decline in the bottom-up EPS estimate during the first month of a quarter? How does this decrease compare to recent quarters? During the past year, (four quarters) the average decline in the bottom-up EPS estimate during the first month of a quarter has been 3.3%. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 1.9%. During the past 10 years, (40 quarters) the average decline in the bottom-up EPS estimate during the first month of a quarter has been 2.2%. Thus, the decline in the bottom-up EPS estimate recorded during the first month of the first quarter was larger than the one-year, five-year, and 10-year averages. As the bottom-up EPS estimate declined during the first month of the quarter, the value of the S&P 500 also decreased during this same time frame. From December 31 through January 28, the value of the index has decreased by 7.4% (to 1893.36 from 2043.94)."  (FactSet January 29,2016)

Key Levels: (Prices as of Close: January 29, 2016)

S&P 500 Index [1,940.24] – Some signals of stabilization appear around 1,900. Prior bottoms were 1,871.91 in September 2015 and 1,867.01 in August 2015. This showcases that near 1,900 is where buyers and sellers continue to debate.

Crude (Spot) [$33.62] – January 20^th lows of $26.19 are expected by some to be the ultimate lows of this cycle. Meanwhile, in the near-term, reaching $40 would set off some bullish optimist. Yet, in the big picture the demise of Crude prices is alive and well. Below $40 still suggests distressed conditions.

Gold [$1,111.80] – A possible bottom around $1,080, but doubt remains if prices can climb above $1,120. The multi-year bear cycle continues to stand out as multiple false bottoms have not proven to be sustainable.

DXY – US Dollar Index [99.60] –  Since November, the index has stayed above 98, showcasing the Dollar's relative appeal that it seems to be stable. Unless there is a major macro shift, the strength remains intact.

US 10 Year Treasury Yields [1.92%] – Critically failing to hold above 2%, which illustrates demand for safety as well as lack of US economic growth. The last two months showcase increased volatility and lack of growth potential, which is reflected in the yields.

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 25, 2016

“Life is a succession of lessons which must be lived to be understood.” (Helen Keller 1880-1968)

Hopeless Reliance

Just when the markets learned that prior stimulus efforts by central banks were a failure, more central banks continue to sell hope via stimulus efforts. As mind-boggling as it seems, investors may be willing to put further faith on the same central banks that collectively misled and over promised.  Others might say, it’s quite clear that central banks are limited in their ability to spur economic growth. Either way, share prices that went through a cleansing process have not quite served as a severe warning. The European Central Bank (ECB) announced “encouraging” words about further stimulus; it was strange but familiar to see a relief rally after massively, bloody trading days. Basically, the (QE and related) remedy that’s been used again and again by the Federal Reserve has clearly failed to produce tangible growth.  The disconnection between the real economy and the central bank-led rally was revealed.  Those were the harsh lessons in 2015 and the first two weeks of 2016. Is anyone learning from previous lessons? That answer remains unclear, but the debate is alive and well: 

“Yet the debate over QE within policy circles is heating up. Some experts even warn that extreme measures could undermine faith in the authorities themselves, which would have alarming implications” (The Telegraph, January 22, 2016).

Old Habits

Desperation is beginning to define the narrative of the global market, as the ECB and Bank of Japan continue to play and encourage further low rates. Perhaps, that’s one trigger that uplifted the markets last week after sharp sell-offs. The habit of waiting for stimulus efforts for higher stock markets has been profitable at times, but illusionary in real terms. The market is debating and wresting with this as reality is clearly grimmer than the Central Bank messaging. 

Hopelessness explains the market narrative where desperation has kicked-in. Somehow, desperation does not lead to asset price destruction, as seen‎ in China and Commodities. Selling Hope by Central Banks has become a method of propping up prices while deferring an inevitable consequence. Lack of inflation and growth in the Eurozone should raise more concerns rather than comfort. However, in a world marred with low growth, investors are seeking “relative” areas of strength. As long as Emerging Markets struggle, Eurozone may attract more capital. However, the brewing problems can only be dismissed in the near-term as debt related and political issues remain a hurdle:

“Because new EU banking rules now require a bank’s investors—including senior bondholders and uninsured depositors—if a bank is on the verge of failing, Italy has to work out problems in its financial systems with much tighter restraints” (Wall Street Journal, January 24, 2016).

Even if asset prices in Europe continue to rise, the fundamental concerns will linger. Therefore, risk should not be grossly underestimated.

Bottoming Search

The dramatics of the Oil market have captured many observers' attentions. The fallout will remain from Saudi Arabia to Texas. It clearly impacted the Russian market, forcing their leader to pursue wars and other foreign policy distractions. That said, regardless of where Crude trades in the next 3-6 months, the damage to companies and countries will be felt and revealed.  In terms of US stocks, earnings this time around may cause sensitive responses, unlike the past few years.

First, the dollar strength impacts corporate earnings. Secondly, even non-commodity related areas should feel some pain from China and other consumer related areas. Finally, innovation themes that focus on human capital (i.e. Technology or Healthcare) may have a broader appeal. However, specific ideas will be rewarded, and expecting a broad rally might end up being too ambitious. Therefore, this might be the year for veteran investors who can dig into specific ideas. The smooth-sailing bullish market with Fed backing may have run its course, at least in the US. Thus, suspenseful weeks lay ahead, as the directional path remains unsolved. Those that strive in mysterious markets might do well based on nuanced grasp and execution on areas of high conviction. Otherwise, thrilling action ahead for observers.

Article Quotes

“Global investors and companies pulled $735 billion out of emerging markets in 2015, the worst capital flight in at least 15 years, the Institute of International Finance said. The amount was almost seven times bigger than what was recorded in 2014, the Washington-based think tank said in a report on Wednesday. China was the biggest loser, with $676 billion leaving its markets. The IIF predicted investors may withdraw $348 billion from developing countries this year. Emerging-market stocks are trading at the lowest levels since May 2009 and a gauge of 20 currencies has slumped to a record. A meltdown in commodity prices and concern over the slowdown in China’s growth to the weakest since 1990 are spurring investors to dump assets from China to Russia and Brazil. The 31 biggest developing markets have lost a combined $2 trillion in equity values since the start of 2016.” (Bloomberg, January 20, 2016)

“Shareholders in China’s rural commercial banks have been offloading their stakes on Taobao, the biggest online Chinese auction site, in a sign of the increasingly desperate steps being taken by cash-strapped investors. The stake sales in the lenders at the bottom of China’s financial system, which are also appearing on the China Beijing Equity Exchange and an over-the-counter market, require minimal regulatory approval, if any at all. Until this month, an official freeze on initial public offerings in Shanghai and Shenzhen has trapped shareholders from divesting as valuations fall. The backdoor methods for cashing out of the banks reflects a new urgency among shareholders to leave the sector amid dwindling returns and mounting bad debt. State-backed Securities Daily called the marketing of bank shares on the Beijing Equity Exchange a “clearance sale” of the deposit-taking institutions once carefully regulated by the state. (Financial Times, January 24, 2016)

Key Levels: (Prices as of Close: January 22, 2016)

S&P 500 Index [1,906.90] – Going back to August and September, there is some evidence of buyers' appetite around 1,900.  The weeks ahead will measure the conviction of buyers ahead, as the technical data suggest an oversold rally.  However, after topping at 2,100 on several occasions, buyers in early 2016 require even more conviction (acceptance of higher risk-reward) than prior buyers in summer 2015.

Crude (Spot) [$29.42] – January 20^th lows of $26.19 sets a new radar. Interestingly, in August and November 2015, the commodity failed to hold above $40. Climbing back to $40 is not as surprising as staying above $40. The supply-demand mix does not justify a climb back to $60, yet there are still few factors being sorted out.

Gold [$1,093.75] – After trading between $1,100-1,200,  the new range is between $1,050-1,100.  There are attempts to bottom or settle, as upside catalysts are desperately missing.

DXY – US Dollar Index [99.57] –   Without a surprise, the Dollar is maintaining strength. The further demise in EM and further easing policies in Eurozone justify an elevated Dollar/ at least in the near-term.

US 10 Year Treasury Yields [2.05%] – Back at a very familiar range.  Staying above 2% may prove to be a challenge unless there are massive upside surprises.

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.

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Market Outlook | January 18, 2016

“I'm not upset that you lied to me, I'm upset that from now on I can't believe you.” (Friedrich Nietzsche 1844-1900)

Credibility Lost

Yellen's much anticipated interest rate hike last December was symbolic, not driven by substance. Now, investors are not buying the Federal Reserve’s recent upbeat “trickery,” as reality is sinking in quickly.  For close data observers, the bleak picture was evident from corporate earning to retail sales to grim sentiment of business owners.  These factors were somewhat dismissed by the Fed, including low inflation which was screaming that central bank stimulus is ineffective. Theoretical and public-relation driven approach by the Fed has now failed to produce tangible or lively recovery. Instead rage is mounting, and Central Banks are desperate and surely unreliable on the depiction of ground-level reality.

Hardly Surprising

As alluded above, signs of weakness have persisted for a long-while and the recent correction is not a random shock.

First, the global economy has been slowing for several months, which has become clearer in the last 24 months. From China to Brazil, sharp declines in economic growth were clearly evident. BRICS collapsing has been a daily theme for a long while:

“For starters, world trade is growing at an anemic annual rate of 2% [in 2015], compared to 8% from 2003 to 2007. Whereas trade growth during those heady years far exceeded that of world GDP, which averaged 4.5%, lately, trade and GDP growth rates have been about the same. Even if GDP growth outstrips growth in trade this year, it will likely amount to no more than 2.7%” (Bruegel, January 5, 2016).

Not to mention the capital outflow as Emerging Markets investors began to take their money off, reflecting lack of confidence. Of course, that capital outflow was driven by weakness in real economic situations again and again. 

Secondly, the commodity decline in the past few years reflected the soft demand, not only from China, but from other economies as well. In addition to the commodity weakness, EM currencies collapsed, as the US Dollar became the safe haven and heavily sought after currency. As if that wasn't enough, the US real economy got praised given its relative appeal. No question, when EM is burning the US looks "amazing.” However, on an absolute basis, tons of mixed data suggests a conflicting story, which at best can be described as a slow/ sluggish recovery.

Finally, the lack of wage growth was one issue, decline of small business another, and now the terrible policies to boost growth are harshly revealed. By the start of 2016, the murmurs around a flat broad index were highly discussed. Many company’s stocks got crushed beyond energy and China related areas, so to think this was an isolated sell-off appears flawed. To cheerlead Yellen & Co's unjustified rate hike was a reckless acceptance of lies. To ignore the decline of Crude as confirmation of slowing global growth was ‎thoughtless and dangerous, at least for "seasoned" professionals. In other words, plenty of clues suggested a slowing global economy.

Digesting Big Moves

To act surprised about this sell-off is rather naïve or putting too much faith on central banks. Otherwise, it is a deliberate acceptance to be lied to by the central banks' ineffective stimulus. Now, central bank credibility is vanishing, election year uncertainty is brewing, and corporate earnings are confirming weakness with specific data. These factors unsettle those who bought into the status-quo narrative, which was too smooth sailing. The history of cycles train one to be skeptical and cautious, yet the "cautious" bunch were trashed during the Fed-led bull market.

As if the bloody two week period was not quite an awakening, some still doubt the continuation of this synchronized decline across asset classes. Basically, when it, rains it pours, and the current junction defines that.  Short-term or drawn out selling is a key question. Yet, do many see Crude below $20 for sustainable period? Do most see this bleeding continuing or is wishful thinking of a quick turnaround more common? Already, banks are feeling the bad energy loans, and corporations are feeling the slowing Chinese economy. This inter-connected world is too linked to ignore.

The US 10 year yields never surpassed 2.50%, Crude struggled to stay above $40 (of course it is below $30 these days), and stock markets flat-lined in 2015. What did one expect? All of the clues were there and now the confirmation is kicking in.  The panic-like behavior needs to settle at some point. However, flushing-out various worries takes time, as the process is in full gear. 

Article Quotes

“Banks have remained relatively lenient with cash-strapped energy companies rather than set tougher lending constraints that could make their survival harder. But losses and reserves, which come out of earnings, are starting to tick up in a number of banks’ energy portfolios. Pittsburgh-based PNC said charge-offs rose in the fourth quarter from the prior quarter but didn’t specify whether that was due to issues in its relatively small $2.6 billion oil-and-gas portfolio… Beyond the big banks, isolated energy problems also swayed earnings at smaller lenders in the fourth quarter. Regions Financial Corp., Birmingham, Ala., said its fourth-quarter charge-offs jumped $18 million from the prior quarter to $78 million, largely because of problems with a single unspecified energy borrower. More than one-quarter of Regions’ energy loans were classified as “criticized” at the end of the fourth quarter. BOK Financial Corp., Tulsa, Okla., said Wednesday that its fourth-quarter earnings would miss analysts’ expectations in part because its loan-loss provisions would be higher than expected, also because of a single unidentified energy-industry borrower.” (Wall Street Journal, January 15, 2016)

“China’s biggest military shake-up in a generation began with a deliberate echo of Mao Zedong. Late in 2014 President Xi Jinping went to Gutian, a small town in the south where, 85 years before, Mao had first laid down the doctrine that the People’s Liberation Army (PLA) is the armed force not of the government or the country but of the Communist Party. Mr Xi stressed the same law to the assembled brass: the PLA is still the party’s army; it must uphold its “revolutionary traditions” and maintain absolute loyalty to its political masters. His words were a prelude to sweeping reforms in the PLA that have unfolded in the past month, touching almost every military institution. The aim of these changes is twofold—to strengthen Mr Xi’s grip on the 2.3m-strong armed forces, which are embarrassingly corrupt at the highest level, and to make the PLA a more effective fighting force, with a leadership structure capable of breaking down the barriers between rival commands that have long hampered its modernisation efforts. It has taken a long time since the meeting in Gutian for these reforms to unfold; but that reflects both their importance and their difficulty.” (The Economist, January 16, 2016)

Key Levels: (Prices as of Close: January 15, 2016)

S&P 500 Index [1,922.03] – The index sank below August 2015 lows, which showcases the severity of a sell-off.  Being close to 1,880 signaled a bottom in August and October last year. Some may anticipate the same; however, the current meltdown may deter previous buyers. 

Crude (Spot) [$29.42] – Below $30 marks the fear of over-supply and dreadful demand. A bottoming process has not formed, yet, suggesting the price pressure remains intact.  

Gold [$1,093.75] – Sell-off pressure has eased in the near-term, suggesting a possible bottoming between $1,060-$1,080.

DXY – US Dollar Index [98.95] – Strength remains intact. Further re-acceleration appears plausible, as the Emerging Market currency debacle persists. For several months, the dollar index has stayed above 96.

US 10 Year Treasury Yields [2.03%] – Lower and lower. Yields sharply declined after failing to hold 2.30%. A combination of lack of economic growth and a rush to own safer assets has helped push yields lower to 2% or so. 

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 11, 2016

“In the middle of the road of my life I awoke in the dark wood where the true way was wholly lost.” (Dante Alighieri 1265-1321)

Truth Uncovered

The accumulated angst that was felt last week is a reflection of suppressed, negative sentiments. The broad indexes were wobbly in fourth quarter and now that fragility is center-stage. Interestingly, August 2015 warnings regarding China came and went, and then last week were ferociously revisited.  The truth cannot be deferred, and upbeat interpretations are proving to be inaccurate again and again.

Now that the first week has produced some known drama and some vicious responses, investors are asking, “What now? What next?” When one sees the S&P 500 index down 6% in any week, it is rather stunning. To judge a year by one week is a bit premature and reactionary. However, a frantic start in the first week of a year stirs even more reactions, but keeping the seven -year perspective in mind is very critical.

Some may allude to one of the worst starts to the years as sign of urgent caution. But more than that, the synchronized sinking across asset classes stands out as a vicious response. This is front page material even for casual observers. From equities to commodities and from fixed income to currencies, the action-packed market responses are strongly felt.

Thinking Ahead

The question is not only about the uncertainly in China, but what other areas are also vulnerable?

To only isolate market concerning matters to China is not only a convenient narrative, but is also a misleading narrative. It fails to tell the full story. It highlights an area that's been hurting severely for months, as growth rate expectations have come down.

The NASDAQ 100 index last week felt the bleeding (down 7%) like other areas; even big known winners, such as Apple & Google, showed some weakness. Momentum ‎stocks (previous winners) that went up when commodities and Emerging Markets are showing some weakness. Investors that felt insulated by investing in Tech/biotech or developed markets (e.g. Germany, Japan etc.)  were equally rattled.  Inter-connected markets who responded in a similar worrisome way raised turbulence. The Volatility Index (VIX), which has stayed below 20 for a while, finished trading last week at 27. In recent years, turbulence has been short-lived and shrugged off, and the consensus view seemed to be based on the near-term history. Nonetheless, the confidence of those holding on to the “status-quo” mindset are bound to be tested.

Credibility Dissected

Reliance on the Fed (and other central banks) is bound to be scrutinized heavily, as that's the most likely  risk factor to trigger more emotional responses— a habit that’s formed in recent years. When all the dust settles with Oil and China's selling-pressure, then the observers are set to shift their attention to the overly idolized Central banks. At the same time, attention is bound to shift to US economic growth and the dangers of the stimulus game that's been played ‎in recent years. The credibility of the Federal Reserve has been shattered for some experts, but not for the mainstream. Was there basis to hike interest rates last year? Was Yellen & Co eager to accomplish their goal rather than accepting the data? Is their narrative wrong and can they admit it? Eagerly, answers are awaited, but until answers are clear, panicking may remain.

The risks that are appearing today are not shocking. Credit risk was unveiled, as few credit hedge funds closed last year; the Chinese and Emerging Market (EM) struggle are well documented, and that caused many to  ponder possibilities; EM currencies crumbling was a theme from 2014; and the central bank bubble that's been brewing is nothing new, either.

The Dollar strength tells a lot of stories: flight out of EM currencies, distrust of asset growth in BRICS, and the edge of the US financial system and lack of "reliable" (at least in perception) currencies and system, for that matter. Fragility of the developing world is widely acknowledged, but the desperate situation is slowly being understood. There is ugliness to be discovered from Russia to Brazil to Saudi Arabia and other nations. Central banks cannot deny the anemic global growth, which stirs further tensions in foreign policy. The drawn-out disconnect between the real economy and financial markets is narrowing as the reality sinks in. Slowly, but finally, the truth discovery will prevail and false narratives will be called out.

Article Quotes

“Regarding China: It seems that a falling stock market sends too transparent a signal of negative sentiment for officials to bear. The fingerprints of the “national team”—a motley crew of state-owned financial institutions—were all over the buy orders that swooped in when the market tumbled. The regulator was supposed to end a ban this week on share sales by big investors. Now it has drafted permanent restrictions, in effect telling investors that they are welcome to buy shares, but not to sell. It would be hard to conceive of a better plan for scaring money away. The poor design of circuit-breakers, trading halts ostensibly designed to calm the market, has added fuel to the fire. The tension between reform and control is also evident in the currency market. The central bank has started to back away from obsessive management of the yuan’s exchange rate. But the more leeway that it creates for trading the currency, the bigger its headache. The central bank judges that the yuan is more or less at fair value; the market disagrees and has pushed it steadily lower. Selling dollars to prop up the yuan so as to make for an orderly depreciation, China has run down its foreign-exchange reserves by some $300 billion over the past half-year. The government still has a plump cushion, but its reserves are not limitless. Accepting more volatility, even if that means a sharper depreciation now, would be better.” (The Economist, January 9, 2016)

“The ultra-defensive stance reflects investors’ skittishness about global economic growth and uncertain prospects for further gains in assets. Pension funds have the added need to cut more checks as Americans retire in greater numbers, while mutual funds want cash to cover the risk that investors spooked by volatile markets will pull out more of their money. Large public retirement systems and open-end U.S. mutual funds have yanked nearly $200 billion from the market since mid-2014, according to a Wall Street Journal analysis of the most recent data available from Wilshire Trust Universe Comparison Service, Morningstar Inc. and the federal government. That leaves pension funds with the highest cash levels as a percentage of assets since 2004. For mutual funds, the percentage of assets held in cash was the highest for the end of any quarter since at least 2007… The movement of longer-term money to the sidelines has left the market increasingly in the hands of investors such as hedge funds, high-speed traders and exchange-traded funds that buy and sell more frequently, potentially leaving it more vulnerable to sharp swings, according to some money managers.” (Wall Street Journal, January 10, 2016)

Key Levels: (Prices as of Close: January 8, 2015)

S&P 500 Index [1,922.03] – In August and September last year, the index dropped below 1,900 briefly before rallying sharply. Now, re-visiting this level creates a suspenseful action ahead for buyers or sellers. Since November 3, 2015 the index has been down around 9%.

Crude (Spot) [$33.16] – Since November 3^rd highs of $48.36, the commodity has drooped over 30%. In the mid 1980’s up to the late 90’s, Crude was mostly around the $20 range.

Gold [$1,101.85] – After a multi-week bottoming process, early signs of recovery in gold prices have appeared. The next upside target appears near $1,180, as seen in mid-October last year.

DXY – US Dollar Index [98.54] – Remains mostly unchanged. Its strength remains intact, as the relative appeal of the dollar as a currency is still a defining theme. 

US 10 Year Treasury Yields [2.11%] – Yields remain low. In recent months, the pattern has been in a tight range between 2.10% and 2.30%. The lower yields reflect the ongoing rush to own treasuries in a period where volatility is accelerating.

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 4, 2016

“There is nothing as mysterious as something clearly seen.” (Robert Frost, 1874-1963)

Early Perspective

It has not even a month since the Federal Reserve mildly or symbolically hiked US interest rates.  It has not been six month since Crude has traded in the $30’s range. It has not been a year since the escalated feud between Russia and Turkey in Syria.  Not quite a week has passed since the grand tension between Iran and Saudi Arabia. Time will tell as the list of uncertainties build.

Years have passed since the low interest rate policies became the norm from the US to Japan to Europe. It has been several years since commodities along with Emerging Markets began to decline on a consistent basis. Several months have passed since the massive China scare in August 2015, and  the ripple effects have yet to fully materialize. 

The S&P 500 index and Dow Jones index both closed negative last year (first time since 2008 – more on this below), reminding us on average it was a tough year to invest, speculate, or even observe financial markets. The US dollar roared again as a symbol of strength and shelter from the ugliness that persisted everywhere.  With all that brewing, a new calendar year starts; however, importantly focusing on the first quarter is more logical and relatively digestible for investors seeking a road map.

Near-Term Considerations

1.      Crude below $20 in Q1 2016? Iran entering the crude oil market leads to further expansion of the already over-supplied market.  Combined with China’s soft (and softer) demand puts additional pressure on prices; not to mention the recent US entry to the Oil market, which certainly rattled supply, as well.  Here is another supply expansion example:  “Russia’s oil output is poised to reach a post-Soviet record of 10.86 million barrels a day this week as the nation’s producers continue to withstand the slump in prices, according to Energy Ministry data” (Bloomberg, December 31,2015).

This has been a textbook supply-demand set up at a grand level, where the recent prices are fully justified. Thus from $100 to $3o, the change in crude prices is understandable for analysts or causal observers. However, the implication of very cheap crude prices is the big unknown. Fallout of this drives energy investments to go sour, from companies to fixed income impacting overall global growth. How does it impact employment, economies, financial services, wealth creation, and, of course, “distressed” opportunities? The first quarter may settle some nerves, but emotions are seeping back in the market. From credit funds and energy investments that already collapsed there will be more to follow. Perhaps, the energy crisis may remind us of the credit crisis from 2008.

2. Non-commodity themes, such as German and Japanese equities along with NASDAQ, were attractive versus other ideas. Israel and India are in the mix given the innovation based industries, which are less reliant on commodities. Saudi Arabia and Russia appear in trouble economically and soon maybe even militarily. Harsh lessons are discovered about non-diversified economies from South Africa to Nigeria to Venezuela. Hence, more diversified economies, such as US and Germany, look much more appealing.  

One can feel this in the escalation of tensions in foreign policy: from the heated battle between Iran and Saudi Arabia to Syria divided into four as it crumbles over proxy wars. All these are factors, not only for Oil, but for immigration, weapons sales, and next wave of military risks. Certainly, all these issues hit at the heart of international trade as investors are realizing the great impact of commodities, which was underestimated by average analysts. Cash flowing out of these commodity heavy nations is a harsh reality.  Similarly, Brazil is set to be a bigger mess after the Olympics. just like it was a mess after world cup:

“Since its peak growth in 2010, the Brazilian economy has done nothing but decelerate, entering negative territory in 2014. Growth was -2.6%  in the second quarter of 2015, while there are no signs of improvement.” (Bruegel, November 6, 2015)

3. Bureaucratic influences: Election year apathy in Washington means less willingness than usual for bold moves (with very few exceptions). From Fed supported market to uglier real economy realities, key policy responses ahead are greatly awaited. On a whole, as a global growth is not impressive and Fed hike remains questionable, even the relatively appealing US market cannot rely only on relative appeal. Some substance is needed to propel tangible growth.  In an election year, the truth should be revealed quickly as some decisions remain in a standstill. Similarly, in Europe the “Brexit” and victory from the far-right stir a debate between national interests and the union. After the 2011 Greece crisis, this debate and vulnerability of the union has been exposed. Further angst or at least harsh verbal responses can cause some market reactions. Lingering issues that are unsolved can annoy or worry investors, which may translate to sentimental response. 

Seeing It Through

So many pundits expect more volatility or extended equity markets and further crumbling EM/Commodities. That said, if the sluggish growth and choppy trading action persists, then how does one respond when expected events actually materialize? It is easier to call market tops or identify concerns, but the fruitful reward comes from executing ideas that were thought-out well before the panic-like madness. Essentially, there is a three step process to consider before entering ideas:

1.       Identify the riskiest segment of the market.

2.      Opine on possible time-frame and catalysts.

3.      Pinpoint the specific investment to match the thought.

To get all three right is what makes a story. To reach this point every quarter or year is not truly possible given nature of markets (with very few exceptions).

Financial markets are overly competitive for those seeking gains, since too much capital is chasing limited ideas. From efficient trading to widespread information to computer generated ideas and execution, the industry has elevated its tools very sharply. At the end, like Crude and Emerging Markets proved, defining for logic for too long is impossible. Eventually, valuations and risk are reassessed and investors do reset their expectations. 

A 7 Year Reflection

Since December 31, 2008, the S&P 500 index increased by 126%, Crude declined by 17%, and the Dollar index increased by 21%. When all is said and done, in the last seven years, placing once capital into US equities via US dollar exposure proved to be a net winner.  Yes, that was also the vividly clear case during the last few years. Interestingly, since the last major crisis, these results reflect the strength of the dollar and ongoing positive influences (i.e buybacks, demise of EM and Eurozone etc)  that contributed to stronger equity markets. The S&P 500 index is not overly rational at times, but the boost from the Fed plays a critical part, as well.  Therefore, if the low rate “crutch” (or boost) nears an end while the energy establishment unravels, then a new cycle is bound to reset. A vicious reset awaits, perhaps.  The unraveling is ugly, the emotional sparks cause further damage, and calling the bottom is a risky exercise. Thus, not only a start to a year, but an end of a presidential, economic, and credit cycle.

Article Quotes

“Central banks and finance ministries in emerging markets have few options once their currencies start plummeting, and often must intervene in exchange markets in what is usually a futile effort to stabilize the rate. Countries such as Argentina, Brazil, Indonesia, Russia, and Thailand depleted their foreign reserves to prop up their currencies and ultimately turned to the IMF to stem the losses. Tapping the fund comes with conditions, and countries must agree to introduce structural changes to their fiscal policies and financial system. The IMF has received much criticism for proposing stringent conditions, known as the "Washington Consensus," on Asian borrowers in 1997–98, which stipulated austerity measures and the removal of capital controls. The IMF has altered its approach over the years and is now more flexible on government budget cuts, but its stabilization policies still spur popular discontent… The policy dilemma that faces central bankers and governments in emerging markets with current account deficits is that supporting currencies by raising interest rates, thus making domestic financial assets more attractive to foreign investors, can also slow the economy.” (Council on Foreign Relations, October 28, 2015)

“Lending to companies and households across the euro zone picked up again in November, recording year-on-year growth of 0.9 percent and 1.4 percent respectively, the European Central Bank said on Wednesday. The development is positive news for the euro zone's economy, which has long struggled with slack credit, and indicates some success for the ECB's money-printing scheme to buy chiefly government bonds.

The ECB also said, however, that the annual growth rate of the M3 measure of money circulating in the euro zone, which is often an indicator of future economic activity, had lost pace. Growth in M3, which includes items such as deposits with a longer maturity, holdings in money market funds and some debt securities, was 5.1 percent in November. This result compares unfavourably with 5.3 percent growth in October and is also lower than analysts polled by Reuters had expected.” (Reuters, December 30, 2015)

Key Levels: (Prices as of Close: December 31, 2015)

S&P 500 Index [2,043.94] – For several weeks, the index traded between 2,100 and 2,050. Now it stands at a fragile range where a break below 2,000 can stir further scare. Yet, the neutral state of the index is becoming very common.

Crude (Spot) [$37.04] – Crude traded below $40 for nearly all of December 2015. Gauging a bottoming process is rather difficult and unclear. What is certain is the multi-year deteriorating trend.

Gold [$1,068.25] – The search for bottoms has resulted in ongoing new lows. A break below $1,000 would not be overly surprising, but would mark a new wave of downturns. $1,180 seems like the first range needed to mark a meaningful bottom. 

DXY – US Dollar Index [97.98] – The dollar is strong and poised to get stronger.  The multi-decade data combined with easing policies by other central banks continues to make the case. During the second half of 2015, the index comfortably stayed above 96, confirming the strength.

US 10 Year Treasury Yields [2.24%] – The last several weeks witnessed a tight range (2.20-2.30%). The next direction lacks major conviction. Yet, the lack of upside movement in yields ahead of the Fed confirms one or all of the following:  1) The Fed will raise rates moderately, 2) global growth will continue to be slow, and/or 3) the US Treasuries will still be deemed as safe and appealing.

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 28, 2015

“Don't tell people how to do things. Tell them what to do and let them surprise you with their results.” (General George S. Patton)

Summary

The first wave of global weakness is being recognized as uncertainty looms even greater than in years prior. The market and participants have observed and reacted already. The disconnect between the investor world vs. the real economy cannot be sustainable for too long. Thus, a second wave of discovery and responses awaits for this cycle as we head into an election year. That said, there are a few thoughts and themes to ponder for early 2016.

Slow Economic Growth Escalates Global Tension.

The demise of EM and drawn-out negative cycle for Commodities come with major consequences beyond investors. There is a critical Foreign policy element to this cycle slowdown where wealth creation has dissipated. Clearly, Russia has felt the pain from oil decline as much as Saudi Arabia and other oil producing nations. The Turkish economic slowdown has led to a regime focused on arrogance, nationalism and anti-secular behaviors. All these impact the business world. The proxy war in Syria reflects the sharp escalation in desperation; and leaders build nationalism, since glorifying poor economic growth is not an option. Iran entering the Oil market not only impacts supply, already filled with glut, but also creates more tension with rival neighbors in sectarian wars (Saudi Arabia). Brazil's abysmal performance has failed to revive creating more capital outflow, as social tensions have been brewing a long while; and shattered investors’ confidence of all kinds has yet to be flushed out.

The impact on oil-heavy economies is huge. It is being felt and will continue to be felt. The fall out is ugly and uglier as exhibited in Nigeria recently:

“Nigeria is running against strong economic headwinds right now with oil prices below $40 and foreign reserves below $30 billion—enough to pay for maybe six months of imports at most. The Central Bank governor, Godwin Emefiele, has introduced ‘demand management’ in response to the challenges he’s faced with.” (Quartz, December 24, 2015)

Clearly, the weak eurozone has triggered political changes (via vibrant responses) from immigration to "Brexit" to varying resolutions to the Greece collapse, which is still playing out. ‎The far-right is gaining a voice in Europe as nationalism appears like a substitute to the failed "globalization" model. In other words, a nostalgic approach by politicians is gaining traction rather than the ambitious wealth creation hopes of the past. This is due to the sluggish, "barely above-zero" growth rates that have created frustration rather than optimism. Of course, the low interest rate policies can actually lift stocks, so investors might take a closer look. For example, the German stock market has had a positive 2015. Perhaps, momentum chasers look to double down in Europe by betting on some help from ECB and the relative attractiveness given the limited options. This would be hardly surprising.

‎Varying Central Bank Policies Create Opportunities and Volatility

The uniform approach by central banks to maintain low interest rates has been a common and overly-familiar ‎approach in recent years. With US raising rates, albeit symbolically rather than meaningfully, it sets the stage for further suspense. Is the Bank of England going to raise rates? And is the ECB going to maintain low rate policy? Further divergence in interest rates creates a new dynamic to markets as the risk-reward paradigm begins to shift. In other words, global equities may not dance in tandem; some moves can turn out more pronounced than others and set the stage for a new era/ cycle. Not to mention, the merits of interest rate hikes are still questionable. The set up of slow growth and vastly declining commodity prices do not present a convincing story for a rate hike. If a strong US economy fails to materialize then markets might respond in a nasty manner to any surprises.

Further Revelations Await

As the US approaches an election year, the odds of major policy changes are very slim. Plus, the unraveling of the energy sector is being discovered globally from Texas to the Middle East. Thus, along with the credit market implosion (i.e. junk bonds) and Emerging market weakness, one can expect further revelation of risk in riskier assets. Basically, the concept of risk-reward will be reset and adjusted to a new cycle. For now, assessing potential/pending damage is the task for investors from retail to distressed energy opportunities, which should occupy the minds of risk takers. Relying on central banks for the description of ground level economic activity is seemingly less potent these days.

Meanwhile, Chinese data points scared market participants in the summer of 2015, which served as a reminder of what was greatly feared before: Unsustainable growth rate. The Chinese slowdown has now converted to major government reforms. Yet, reforms do not occur overnight and the growth of the middle class consumer market is still being digested early-on. Markets are bound to be extra sensitive in digesting Chinese news. Good or bad news should get tons of attention and influence sentiment.
Non-commodity related themes from Germany to Japan to Nasdaq may be appealing at first sight. However, the commodity demise has created (and continues to create) appealing risk-reward set ups. Thus, 2016 will force investors to decide between going with proven winners versus searching deep value in less favorable areas. One of these two is going to win big. The answer for what will work is simply mysterious because the risk is still being understood.

Article Quotes

"In 2011, China became Russia’s largest trading partner. In 2014 alone, China’s investment in Russia grew by 80 percent—and the trend toward more investment remains strong. To get a sense of the growth in economic ties, consider that in the early 1990s, annual bilateral trade between China and Russia amounted to around $5 billion; by 2014, it came close to $100 billion. That year, Beijing and Moscow signed a landmark agreement to construct a pipeline that, by 2018, will bring as much as 38 billion cubic meters of Russian natural gas to China every year. The two countries are also planning significant deals involving nuclear power generation, aerospace manufacturing, high-speed rail, and infrastructure development. Furthermore, they are cooperating on new multinational financial institutions, such as the Asian Infrastructure Investment Bank, the New Development Bank BRICS, and the BRICS foreign exchange reserve pool. Meanwhile, security ties have improved as well. China has become one of the largest importers of Russian arms, and the two countries are discussing a number of joint arms research-and-development projects." (Foreign Affairs, January 2016 Issue)

“No country has ever devalued its way to prosperity. If it were possible to achieve economic growth by printing money, buying bonds or setting interest rates at negative rates, then many countries would be rich. The reverse is true: Weak currencies lead to slower growth, as we have observed from recent experiences in the Western world and Latin America. Negative rates disadvantage particular groups within the economy. Savers, retirees, pension funds and insurance companies are all harmed by negative and zero interest rates. Thrift, which means putting aside money today in case of a rainy day tomorrow, makes no sense with negative rates. There is no reason to delay current spending to save for tomorrow's capital stock. Negative rates drive people on fixed incomes into risky assets. Some, including senior citizens, need income from their savings. They are driven into risky assets such as equities and junk bonds in order to get the 5 percent return that they would normally receive from savings accounts. They are forced to take on more risk than they prefer.” (Manhattan Institute, December 17, 2015)

Key Levels:
(Prices as of Close: December 24, 2015)


S&P 500 Index [2,060.99] – A severe resistance has maintained at 2,100 for several months. Interestingly, the index hovered around 2,100 during the summer months, ahead of the August sell-offs. A similar pattern continues to form.

Crude (Spot) [$38.10] – An eagerly awaited bottoming shape appears to be forming, but not yet fully convincing. Staying around $40 for a sustainable period seems to be the major test. Yet, the downturn remains intact.

Gold [$1,068.25] – Previously, Gold failed at $1,180. Now, it appears to fail at $1,080. The multi-year decline remains in place despite some signs of a bottoming revival.

DXY – US Dollar Index [97.98] – Trading around familiar range. Dollar strength remains intact despite a very mild pause. Recent action suggests high probabilities of the Dollar index staying above 94, baring major shifts.

US 10 Year Treasury Yields [2.24%] – The 50-day moving average is 2.20%, which tells the story about the dull, sideways action. Basically, no major change has occurred as yields remain trading near the low end of the range.


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.