Market Outlook | February 22, 2016

“The bargain that yields mutual satisfaction is the only one that is apt to be repeated.” (B. C. Forbes 1880-1954)

Inter-Connected Struggle

Since peaking in November 2015, the broad US stock market indexes are reminding investors that concerns are looming. In August and in early 2016, the selling pressure for US stocks picked-up and reality check began sinking in. The much discussed correlation between Crude oil and stock market is defying old sayings and slogans. In fact, Crude and US stocks are in desperate need for collective revival, as strange as it may seem. The common thought that lower oil prices lead to victorious results for consumers (or broader economy) is proving to be not that simple. Decline in Oil prices impacts bank loans, energy producers, and local economies as well as US producers. Surely, it impacts indexes such as the S&P 500 to Dow Jones, which are feeling the drag in 2016 down 6.2% and 5.9%, respectively.  Of course, global growth itself is murky, adding further negative pressure.

OPEC nations are feeling the pressure to stabilize the price of Crude. The balancing act between oversupply and production cut is a dramatic twist that’s playing out. Russia and Saudi Arabia are feeling the pain from the demise of Oil prices. Thus, both nations are incentivized to lessen the blow by tinkering with supply. Odd alliances between nations are created for the sake of digging out of economic desperation.  However, with supply glut already a major issue, along with Iran entering the world market, justifying higher oil prices seems like a daunting task with Crude dancing below $30 per barrel.

Anemic Inflation = Weak Growth

Way back, when QE came into the mainstream discussion, the idea was to increase "inflation expectations.” Amazingly, the quest to increase inflation ended up failing the same way economic revival has not produced a meaningful result. This is a reflection of the slow global environment from the US to the Eurozone.  Simply, it is worth noting the complete failure of QE and central bank stimulus efforts.

For those that still believe in the Fed, the warning signs are all clear, and January 2016 showcased investors' early distrust of the monetary policy. Outrage is forming, but to be fair, the Fed has limited powers and that's been clear since early-on. Like all government institutions, the Fed is forced to defend their plan and to continue to make an appealing case for their bullish outlook.  Interestingly, in the last three months, believers of the Fed’s plan are shrinking based on sharp sell-offs, rampant volatility, a spike in Gold prices, and lower treasury yields. As European Central Bank (ECB) contemplates more easing, maybe one should pay attention to the disconnect it has created. Rising stock prices are not to be confused with robust real economy, as has been stated many times. By now, US investors are fully realizing that ol’ trick, which lacks substance and is filled with “academic” hype.

Perhaps, the political climate showcases the disconnect between financial theory and ground level sentiment. The non-establishment candidates in recent US elections are representing the voices of angry voters. The real economy has been bleeding for a while and, surely, the unemployment data does not tell the full story. The Fed’s rate hike last year was hardly justifiable, and, now, the scramble continues. Beyond the conflicting data and the unconvincing message by the Federal Reserve, investors are confused— which is raising volatility.

Bargain Hunting

Now, the contrarian or forward-looking perspective suggests a revival in inflation and commodities.  Perhaps, the Dollar is overcrowded a bit and the US relative edge will continue to play out. ‎As sentiment became too negative last week, some buyers stepped in seeking early bargains. 

As Tech and Biotech appear over-valued by some measures, investors are seeking "cheap" ideas and entry points. What exactly is “Cheap”? Areas that have been battered in the last five years, which is mainly related to emerging markets and commodities. Thus, the risk-reward seems appealing for some energy areas, but there is danger looming. The energy demise impacting bank loans has yet to play out. Distress buyers flocking to the energy space may not get the timing right, but are highly motivated by bargains.  The temptation for bargains will remain, but flushing out all the negative cycle related issues takes time. Thus, the risk-takers await a suspenseful period with more than the usual volatility persisting on daily basis.

Article Quotes

“The nation's biggest banks may be in good shape even if beleaguered oil producers start defaulting on their loans, but smaller regional lenders have a lot more to lose. Loans to energy companies by the five megabanks from Citigroup (C) to JPMorgan Chase (JPM)  account for no more than 40% of common equity capital, a measure used by regulators to assess a finance company's strength, ratings firm Moody's has said. At nine regional banks, however, such loans never account for less than 40% of capital, and at some, they represent 110% of it, the New York firm said in a report this week. That compares with a median ratio of 10% to 15% at the roughly 60 regional banks that Moody's evaluates, prompting it to warn that credit scores at six of the lenders are in jeopardy…. The size of the regional banks' energy loans -- pushed higher because many have significant operations in the most oil-dependent states --Texas, Oklahoma and Louisiana -- significantly increases their risk, Moody's said in the report. ‘The credit quality of even the most conservatively underwritten energy loans could deteriorate in the current environment,’ the firm said.” (The Street, February 19, 2016)

“Foreign observers who are interested in China’s development should pay more attention to the development of China’s private sector. Its growth may have more long-term benefits for the Chinese people than the political process of democratization. After all, the private sector has assimilated the majority of China’s labor force, and its fate directly impacts the happiness and financial security of hundreds of millions of families. Each choice these private enterprises make matters to China’s economic growth and its political progress. The global expansion of these companies also has an impact on the world economy, including the United States and Europe. These economic changes might also bring new dynamics to international politics. Among China’s private enterprises one has to mention Alibaba, the Chinese e-commerce giant headed by Jack Ma and counting net assets of 255 billion renminbi ($39 billion). Though a private company, Alibaba receives generous support from the Chinese government. The World Internet Conference, for instance, has been based in Zhejiang Province since its start in 2014. Zhejiang Province also happens to be where Alibaba is headquartered; on China’s internet, the province is often referred to as Alibaba’s home base. Two months ago, when Xi attended the second World Internet Conference, Alibaba was the first company he visited. The G20 Summit in 2016 will also be held in Zhejiang. The summit will include top-level meetings between key business and industrial figures, something advantageous for Alibaba as well.” (The Diplomat, February 18, 2016)

Key Levels: (Prices as of Close: February 19, 2016)

S&P 500 Index [1,917.78] – The battle unfolds between buyers and sellers between 1,850-1,950.  However, as last year proved, buyers continue to lose steam at 2,100.

Crude (Spot) [$29.44] – As a reminder, December 2008 lows of $20 proved to be a bottom then. Now, a potential bottom is forming a little below $30. Several catalysts are needed as supply glut remains a dominate factor for prices.

Gold [$1,231.15] – Staying above $1,200 can stir further confidence for gold bugs. Some price stabilization appears to take hold. Gold is up 17% since the December 17, 2015 lows.

DXY – US Dollar Index [96.60] – Interestingly, last March and April the DXY failed to hold around 100, which seemed like a major hurdle. Dollar strength remains intact, but has stalled for several weeks.

US 10 Year Treasury Yields [1.74%] – An emphatic decline in yields in 2016 sends a strong message about risk-aversion. A rush to safety and unconvincing growth numbers are reflected in lower 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 | February 15, 2016

“The secret of being tiresome is in telling everything.” (Voltaire 1694-1778)

Crude Awakening

If there was any debate as to the health of the economy, the global market has responded resoundingly.  Weakness is highlighted on various fronts in this inter-connected world.  The US is not isolated in this, despite a relative edge that has shined in recent times.  The collective sinking in asset prices reawakens prior fears and signals the late inning of a prior bullish run.

Clearly, the anemic demand for Crude is not that difficult to spot while the supply is expanding. Thus, Crude is struggling to justify a price movement above $30. Even OPEC bureaucracy cannot hide the harsh reality. The decline in Crude prices negatively impacts Russia and Saudi Arabia. Not only are oil investors comforting the pain, but nations that are reliant on oil in their economies are concerned for their survival. That’s as desperate as it gets for Putin and Saudi leaders, but it also gets painful for energy companies, various banks, and investors, as well. A cataclysmic collapse in Crude only highlights the ongoing slowdown of the global slowdown led by China and Emerging Markets. Amazingly, the age-old claim that lower oil is better for the economy is being severely challenged.  The collapse of Crude actually hurts the real economy in the short-term more than the common narrative would have one believe. This adjustment is hitting some by surprise even months after the sharp declines.

Fed Up

The faith in risky assets is collapsing given the demise not only in energy, but in other sectors, too. From retail to tech to banks, the sour results are being discovered. Within that, there is a backdrop of negative yields, which were thought to be strange, but are now becoming more normal than before, especially in Europe, which highlights a desperate time. The Gold price stabilization (or mild revival) recently highlights that even the most out of favor commodity is in some demand, since the faith in Central Banks is crumbling quickly.  The biggest theme of all is the lack of trust in Central Banks, which the Fed is struggling to cope with in public messaging. The stimulus efforts of government-led agencies (i.e. Fed) have failed miserably to produce broader growth; and, there is no hiding from that reality either.

The gold bugs were wrong for several years as Gold prices corrected and a bottoming action in prices were nowhere to be seen. Now, desperation is so high that investors are willing to seek shelter in Gold and willing to chase negative earning yields in search of safer assets.  The ultimate desperation is here, even if the most optimistic participants want to look beyond the watershed events that are mounting.

Fatigued by Calming Words

To calm the sensational market responses and reactions is a difficult task: 

1. The Chinese regulators attempted to calm markets several times, and this action failed to slowdown the sell-offs.
2. OPEC nations saw the demise of Crude prices and now struggle to tinker with production cuts in search of stabilization.
3. European banks are in such a vicarious shape that bank executives had to assure stability.  The bleeding continues.
4. Central banks are ferociously feeling the skepticism and are forced to counter with calming words of confidence. 

In all these cases, delaying the reality or “spinning” the painful occurrence is not receiving a warm welcome by fatigued investors. Basically, calming words have no value when reality sinks in quickly.  Investors are fatigued since the reality has been long disconnected with the Central bank narratives. Hence the outrage, which drives up volatility and makes 2016 a brutal year to manage for risk-managers.

Fragility of Banks

Banks are facing the pressure from all angles. First, the commodity decline is creating pressure on banks as exposure to oil related areas:

“John Shrewsberry, chief financial officer, Wells Fargo & Co.‘At the end of the year, we had $42 billion of total exposure to oil and gas, including loan commitments and unutilized commitments, down 5 percent from a year ago. Loans outstanding were $17.4 billion, down 6 percent from a year ago and less than 2 percent of our total loans outstanding.’ Shrewsberry said that if oil prices remain in the $20s or low $30-range for the next six months, banks are likely to reduce the amount of credit available to energy companies.” (Bloomberg, February 9, 2016)

Second, the negative rates are changing the traditional business models and creating further concern.  In many ways, this is unprecedented and navigating through this will be filled with surprises, which scares the rational observer. The fear alone can create more worries than imagined. (More on this below.) 

Finally, the regulatory pressures since 2008 are mounting, which is well known. The banks seem more like a government agency rather than a service for wealth creating enterprises. Increased regulation, discovery of further liquid assets, and less willingness to take risk for future growth all make for a difficult period for banking.

Interestingly, the ongoing challenges facing banks is a further reflection of the broader market issues.

Article Quotes

“So what is the impact on banks of a negative refinancing rate? Clearly, since policy rates are benchmarks for bank lending rates, it forces down the price of new lending. Currently, banks like HSBC have resisted the temptation to cut deposit rates below zero in response to the ECB's negative deposit rate, because they have been able to maintain their net interest margins by keeping lending rates up. But downwards pressure on benchmark lending rates would squeeze their margins. So HSBC is giving notice that if the ECB pushes the MRO ["main refinancing operations"] rate below zero, the cost to them of reducing the price of new lending in Euros may be passed on to businesses in the form of a negative interest rate on Euro deposits. But hang on. HSBC is a British bank, and the letter has been sent to UK business customers, most of whom have sterling accounts. And these days, foreign currency payments can be made directly to sterling accounts with the bank managing the currency exchange. So who would this affect?  It would affect any business which is doing sufficient business with the Eurozone to justify having a Euro account. Particularly, businesses which are both exporting to and importing from the Eurozone, perhaps importing raw materials and parts and exporting finished goods. A negative MRO rate would, in effect, be a tax on UK businesses doing business with the Eurozone.” (Coppola Comment, February 5, 2016)

“Commodity exporters like Russia and Saudi Arabia, which ran large current-account surpluses when oil prices were high, are the main exception to this pattern of diverging foreign-asset positions. With the precipitous decline in world oil prices since June 2014, their fortunes have reversed. Their export earnings have plummeted – falling by half in many cases – forcing them to run deficits and draw on the large sovereign-wealth funds they accumulated during the global commodity boom. A radical reduction in expenditure has now become unavoidable. The industrialized economies face very different challenges. Their problem – in a sense, a luxury problem – is to ensure that their consumers spend the windfall from lower import prices. But in the creditor countries, negative rates do not seem to advance this goal; indeed, some external surpluses are even increasing.” (Project Syndicate February 9, 2016)

Key Levels: (Prices as of Close: February 12, 2016)

S&P 500 Index [1,864.78] –   The 1,850 level is becoming critical again. That’s where buyer’s conviction is being tested. The next few days will tell the story of that conviction.

Crude (Spot) [$29.44] – Attempts to hold above $30 and confronts a fragile territory. February 11^th  lows of $26.05 mark the ultimate bottom in the current sell-off. Desperate stabilization is needed.

Gold [$1,239.75] – A sharp spike recently as most asset classes shift away from risk-taking.  The March 2014 high of $1,350 is the next critical point. Interestingly, the $1,200 level has been targeted as a possible bottoming level as buyers and sellers wrestle around that range.

DXY – US Dollar Index [95.94] –   The strength weakened a bit, especially in February. Early hints of peak at 100 appeared on December 2, 2015, since then a downtrend has been well established.  

US 10 Year Treasury Yields [1.74%] – The scramble for safe assets remains in place, driving yields lower. Plus, the bond markets are not convinced of a growing economy. This is highlighted by the rapid drop in yields from 2.20% to below 1.80%.

Dear Readers:

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

Market Outlook | February 8, 2016

“Courage is the capacity to confront what can be imagined.” (Leo Rosten 1908-1997)

Truth Unravels Quickly

The US relative edge has been a common theme for several years. Tech and Biotech, which seemed insulated from any weakness, are now feeling the all-out onslaught by investors. So much attention has focused on the Central Banks and at times created an illusionary description of reality. Now, the real economy that has been hurting in most nations is translating into share price drops. Basically, the truth of corporate earnings and economic health cannot be concealed for too long. Now, the market unraveling is beyond China, Energy, and Emerging Markets.  There is no escaping of this sluggish growth atmosphere. Unlike other markets, the US markets had mostly evaded major painful sell-offs and capital outflow. Of course, there were a few corrections in August and October, but now the optimism is fading quickly as the US 10 year yields are below 1.90%, where the rush for “safer” assets is becoming popular.

Collective Pain

From financials to retail to technology, the company results are screaming of a panic-like environment. The Fed’s credibility has been questioned again and again. Fair to say, Central Banks have officially lost their “trustworthy” status (more on this below).  However, these days old tricks such as stock buybacks or relative appeal may not be enough to maintain the strength of US stocks. Banks are facing regulatory scrutiny and legal battles where revenue is absolutely hurting. Public technology companies that were either over-valued or viewed as invincible are facing harsher reality check. Retailers with old business models have faced a difficult run with the ever-so growing focus on online commerce. However, e-commerce alone does not always produce desired results.  Perhaps, a double whammy of concerns for retailers:

“The reality at Michael Kors undercuts the conventional wisdom among retailers  that e-commerce would prove to be more profitable than in-store sales because it doesn't come with the overhead expenses of operating locations, hiring clerks and cashiers,  etc. Instead, the reality is that online shopping isn't yet the saving grace retailers were counting on when they started plunging billions of dollars into new websites and shipping facilities.” (Bloomberg, February 2, 2016) 

What Next?

The penultimate question is now being asked viciously and pragmatically. If US assets were in sheer demand and fruitful in recent years, then how do investors deal with the slowing growth that's turning sour these days? Given the signs of breaking down of indexes, specific shares, and key sectors, then follow-up question is: Where does one rotate to? A question that may have sounded silly 12 months or 24 months ago since the US relative edge in the financial markets was blatantly clear.

However, now the realized weakness is real, and worrisome questions are being asked widely for US companies earnings. On one hand, the Fed-led narrative is overly tiresome and lacks backing from real economy data. On the other hand, with global assets so cheap after a very traitorous period in EM (led by China), the risk-reward profiles are shifting. That's the drastic shift  re-setting investors’ mindset.  However, there is one critical element. If a synchronized sinking (collapse across key assets) is in the making at this junction of the cycle, then the rush to safety may persist even further. ‎Underneath the crisis has been brewing across various sectors as investors are getting acclimated.

As Central Banks continue to lose credibility, it should force investors (and voters in US and Europe) to pressure actions by policymakers. At some point, beyond shareholders confronting reality, elected leaders will have to seek solutions to revive economies. Low to negative interest rates are surely not the answer to boost demand. Perhaps, that debate about the success of quantitative easing has been settled, despite ambitious and misleading narratives. In some ways, the gap between the real economy and stock markets is closing and that is the real gut check for everyone. But with the shifting narrative comes further volatility and ugly moves. Thus, bracing for further surprises seems prudent as much as practical.

Article Quotes

“The pressures on these central banks aren’t likely to ease. Over the past two years, a net of more than $846 billion has exited emerging markets and an additional $450 billion could flow out of developing countries this year, according to an estimate from the Institute of International Finance. Between 2010 and 2014, an average of $1.2 trillion worth of foreign private capital flowed into emerging markets each year, according to the IIF. Last year, these countries collectively saw their first net cash outflows since 1988. In many emerging countries, government revenue from earnings on exports has also fallen—especially for economies reliant on commodities—while deposit growth in banking systems has waned. Broad money growth, a proxy for liquidity in financial systems in emerging Asia and Latin America, dropped by 3.8 percentage points and 3.4 percentage points over the past year, according to Oxford Economics.” (Wall Street Journal, February 7, 2016)

“First, rising commodity prices were responsible for driving inflation above target from 2008 to 2012 and falling commodity prices brought it back below target from 2013 on. Since this was externally-generated inflation, you could argue that is outside the Bank’s remit. However, the Bank is targeting CPI which includes this externally-generated element. And its forecasts were consistently wrong. It keeps expecting inflation to return to target at the 18 month-two year horizon. It has to do this, by definition; if it thought inflation would be a lot higher or lower than target, then its policy should change. Still, all the highly-trained economists at the Bank failed to predict the commodity cycle.” (The Economist, February 5, 2016)

Key Levels: (Prices as of Close: February 5, 2016)

S&P 500 Index [1,880.05] – The Index struggles to hold on to the 1,900 range. A critical inflection point given the current range, which held both in August and October. Perhaps, now is the ultimate test for buyers as technical pressure mounts. 

Crude (Spot) [$30.89] – Suspense grows as investors await the sustainability of the new range $30-35.  Demand still seems mostly soft globally, and supply is abundant. A series of events is needed to spur a rise; otherwise, the downside trend remains in place.

Gold [$1,150.35] – The commodity is up nearly 10% since December 17, 2015 lows.  Some revival appears in a period of sharp equity sell-offs and distrust of central banks. However, it is premature to declare a massive turnaround. A move past $1,200 can stimulate further buying.

DXY – US Dollar Index [97.03] –   There are early signs of retracement of dollar strength. Obviously, in the last 12 months the dollar's relative strength was quite stunning and visible. A mild breather for now seems reasonable, but additional follow-through can be a game-changer.

US 10 Year Treasury Yields [1.83%] – Fails to climb back to 2%. Clearly, the bond market does not sense an economic recovery on one end. Plus, investors are reducing exposure to riskier assets. A critical barometer of current conditions is the lowering Treasury yields. A downtrend is evident.

Dear Readers:

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

Market Outlook | February 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.

---

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.