Market Outlook | March 28, 2016

“The best thinking has been done in solitude. The worst has been done in turmoil.” (Thomas Alva Edison 1847-1931)

Still Rattled

Officials publicly declaring that the Central Banks have run out of ammunition may cause an all-out panic. Ironically, the truth is more devastating than the cosmetic day-to-day trading action, as seen in the last two years. There is simply no place to hide from the painful lack of global growth, sluggish demand for commodities and overly exhausted low interest rate policies. At the same time, the uncertain status of the European Union, the sour impact of oil-rich nations, the unclear growth picture in China and the shaky stabilization in commodities add on to a list of unknowns. The status-quo or range-bound trading action appears dull and unsustainable.

Fragility Confronted

Risk-taking, these days, is taking on a whole meaning from traditional measures. The Fed-led narrative itself appears more and more like a theoretical exercise rather than a fact-based assessment of financial markets. Basically, confidence is deflating in the concept of “globalization,” as a new generation is questioning the fruitfulness of capitalism.  Seriously, this a new risk measure that was not quite pondered in the textbooks or trading books of the 1990’s. The wild card of all wild cards should worry investors more than the known, general fundamental-based risks.

Globalization being at risk is only a factor when the slowdown is significant, as witnessed in China. Plus, nationalism is a new trend. As a response, the documented slowdown in global growth appears as much as immigration concerns. Effectively, the weakness in China has unraveled the prior faith of recovery, and lack of wage growth in the US has stirred outrage, especially among voters. Perhaps, both factors are clearly out of the hands of the Central Banks, yet investors continue to glorify the powers of the Central Banks—primarily out of desperation. As American voters wrestle with a “socialist” and nationalist candidates, the state owned companies in China, under the influence of communism, are dealing with the current crisis. The Chinese are attempting to explore privatization along with stimulus efforts (more under article quotes).  The ultimate verdict on the magnitude of the Chinese slowdown is still being digested by consumers, investors and corporate leaders. Perhaps, that’s another wild card to ponder. Meanwhile, the relationship between China and the Western world is another factor that can reshape the outlook of globalization.

Grappling with Priorities

While key money managers struggled to make money last year, investors are now more convinced of the difficulty of dealing with the current market environment. On one hand, finding deeply undervalued assets in energy or emerging markets seems relatively appealing. On the other hand, riding the status-quo is a bit unsettling, despite some signs of stabilization. The major challenges involve everything from trying to predict government agencies moves from the Central Banks to “Brexit” to various elections. In terms of sole reliance on corporate profits or company specific trends, this may not be enough in a macro-centric climate. Therefore, identifying priorities is puzzling, but critical. Is it the macro picture that’s important or company (industry) specific trends that will drive the sentiment? The big picture themes are too interconnected and markets have shown strong correlation, particularly between commodities and stocks.  The wait and see game requires patience, but vision is needed to dodge some bullets. Clearly, there is unease that’s occasionally suppressed, but uncharted territories invite further trepidation.  That’s not overly shocking, but it is certainly hard to accept. 

Article Quotes:

“Beijing's main tool for reducing excess industrial capacity is the reform of China's giant state-owned enterprises (SOEs), something it has been trying to do since the late 1970s. In the 1980s, Beijing sought to make individual state-owned factories responsible for their financial performance by, for example, moving their accounts out of the state budget and onto separate income statements. In the 1990s, Chinese officials attempted to turn legacy communist production units into modern corporations. And in the first decade of this century, Beijing consolidated its oversight of SOEs by creating so-called state asset management committees, with the State-owned Assets Supervision and Administration Commission at the top of the pyramid. Throughout the course of these reforms, the Chinese state, and the Communist Party in particular, has kept a firm grip on the top management of SOEs. The government uses SOEs to support official policy, even appointing government bureaucrats as company executives (usually with massive increases in pay relative to their previous government salaries). But recently, as SOEs in many sectors have suffered big losses, such control has been less rewarding. In the past, Beijing has sought to address this problem by privatizing or shuttering smaller SOEs and maintaining control over the country's larger, more profitable ones—a practice that the government of Chinese President Jiang Zemin introduced in the 1990s under the slogan of ‘grasping the large and letting go of the small’. Today, Beijing is considering relaxing government control through further privatizations, at least in loss-making sectors such as mining, manufacturing, and other heavy industries.” (Council on Foreign Relations, March 24, 2016)

“The average euro area interest rate on new loans to households for house purchase was 2.27% in January 2016 – close to the 2.20% record low observed in May 2015 and less than half the 5.51% record high of October 2008. Interest rate levels have steadily decreased since the end of 2011 when rates were close to 4%, accompanying the decrease in the ECB main refinancing operations rate. At the same time, monthly volumes of new loans for house purchase have been increasing since the beginning of 2012. In 2015 the monthly average volume of new housing loans was €68.5 billion, the second highest peak of the decade, representing an increase of about 45% compared with the averages for the previous five years. In January 2016 new volumes fell by 15% compared with the 2015 average, a phenomenon that has been consistently observed at the beginning of each calendar year since the launch of these statistics in 2003. Interest rates on new bank loans to corporations have followed a broadly similar path to new loans to households for house purchase, reaching the low level of 1.82% in January 2016. Interest rates on corporate loans, like those on new household loans, have steadily decreased following a local peak of 3.48% in December 2011.” (Euro Area Statistics, March 24, 2016)

Key Levels: (Prices as of Close: March 24, 2016)

S&P 500 Index [2,049.58] –   Early signs of resistance appear around the 2,040-2,050 range. After a more than 10% run since February lows now the index is stalling a bit. Given the four day holiday week with low volume, one should wait to conclude before declaring a near-term top.  Failing to break 2,100 again will reconfirm the range-bound action in equity markets.

Crude (Spot) [$39.44] – Unchanged week over week. This suggests that stabilization is forming near $40 for now. An unsettled picture in the demand/supply dynamics might keep prices stable, as well. 

Gold [$1,252.10] – A lengthy bottoming process continues, considering for over two years the commodity has attempted to hold above $1,200. An upside momentum has not fully set-up.

DXY – US Dollar Index [96.14] – Once again, there is a strong bottoming formation around 95. This illustrates the established strength in the dollar, which is a dominant force in currency markets.

US 10 Year Treasury Yields [1.90%] – The last few trading days suggest positive momentum building above 1.80%. However, in the big picture, these trading ranges do not have a big impact.

Dear Readers:

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

Market Outlook | March 21, 2016

“Success builds character, failure reveals it.” (Dave Checkett)

Same Ol’ Themes

The status-quo of lower interest rates and higher stock markets remains in place despite signs of turbulence and anemic growth. Basically, no glaring changes to the big picture factors have emerged. ‎The Fed's aggressive tone about improving the economy is fading, as possibilities for interest rate hikes are less believable and hard to visualize. The illusion that stock market stabilization is an economic revival is not only absurd but dangerously misleading.

In a world where returns are limited, sources of capitals are seeking shelter or desperate exposure in riskier assets. The definition of "risky" is being discovered, but for now, piling on Western equities remains appealing. A lack of alternatives leads to decisions that are more survival driven rather than a reflection of optimism. By all means, from Brazil to Eurozone to China to US, a robust economic activity is very difficult to spot. Lowered expectations and relative arguments sometimes make investors lose perspective. After all, the harsh realization of a lack of alternatives combined with lack of growth defines the reality.

Unconvincing Growth

Desperate investors seeking yield versus limited investment options with heightened risk describes the current environment. ‎Stock markets movement is not determined by the profits of public companies or the perception of economic prosperity. Instead, it's the ‎Central Banks' and financial media's tone that determines how to digest and how to perceive risk. For now, the narrative has shifted from rate hike expectations to a Fed that needs more time for clearer decisions.  In other words, there is less eagerness to hike rates at this stage. Amazingly, there seemed to be no basis for the rate hike in late December and justifying "growth" has turned into a difficult PR exercise. Wrongdoings are not admitted by government agencies, but the slumping global economy is not recovering by any measures that's convincing to the average observer.  Not to mention:

“It is clear that the US Federal Reserve is now trapped. The FOMC dares not tighten despite core inflation reaching 2.3pc because it is so worried about tantrums in financial markets and about that other Sword of Damocles - some $11 trillion of offshore debt denominated in dollars, up from $2 trillion in 2000.” (Telegraph March 17, 2016)

Less Abnormal

The correlation between equities and commodities in the near-term begs critical questions: Are markets becoming more synchronized? If so, is that an early warning sign? Is there a collective demise ahead? Crude prices dancing along stock market indexes may not be a familiar sight, but today many areas seem out of whack. In terms of oil, the OPEC nations jointly need the price of Crude to rise in order to maintain some stability. From Russia to Saudi Arabia to Iran and even the US, rising Crude prices can lessen the blow recently felt. Therefore, it is hardly shocking if there is further supply cuts driven out of desperation. The suspenseful part of this puzzle is grasping the supply glut which is cannot be dismissed. In fact, the players in the oil market are plenty:

“Three months since the U.S. lifted a 40-year ban on oil exports, American crude is flowing to virtually every corner of the market and reshaping the world’s energy map. Overseas sales, which started on Dec. 31 with a small cargo aboard the Theo T tanker, have been picking up speed. Oil companies including Exxon Mobil Corp and China Petroleum and Chemical Corp have joined independent traders such as Vitol Group and Trafigura Pte in exporting American crude.” (Bloomberg, March 18, 2016)

However, these days unfamiliar trends are ever-so-common from negative rates to “Brexit” to outrage against establishment politicians. Basically, the free-market concept has turned into a massive bureaucracy. Instead of betting on prosperity, markets are anticipating man-made decisions by government organizations. The whole concept of speculations has turned into a massive obsession of government agencies and decision makers. In the case of “Brexit” and the US primaries, it is fair to say that a segment of the population is fed up with bureaucratic approaches. No matter what pundits say, the economic weakness is stirring all types of reactions. Perhaps, voters' rumblings globally is a more accurate measure of sentiment rather than the theoretical approach by Central Banks.

Article Quotes

“With the real possibility now emerging that Britain could exit the EU, Chinese investors are getting nervous. One of China’s richest businessmen, Wang Jianlin—founder of real estate and entertainment group Dalian Wanda and owner of a British luxury yachts company, a five-star hotel in London, and a $114 million mansion for himself—warned during a visit to the U.K. in February: ‘Brexit would not be a smart choice for the UK, as it would create more obstacles and challenges for investors, and visa problems for tourists.’ Should Britain exit the European Union, he added, ‘many Chinese companies would consider moving their European headquarters to other countries.’ The clear implication, of course, was that Brexit could bring an investment exodus….With the referendum in Britain now just three months out, Chinese stakeholders are becoming increasingly vocal. In February, the spokesperson for the Chinese Foreign Ministry reiterated Beijing’s position, saying: ‘China has always supported the European integration process, as we would like to see Europe play a greater role in international affairs.’ In a somewhat coordinated action, Wang Jianlin delivered a speech on February 25 at Oxford University, saying: ‘It’s hard to say whether they [the British] would have a better life outside the EU. It’s easy to exit but hard to re-join. There are certainly many disadvantages if Britain exited the EU.'” (The Brooking Institute, March 17, 2016)

“JP Koning writes that the U.S. provides the world with a universal backup monetary system. Removing the $100 would reduce the effectiveness of this backup. The citizens of a dozen or so countries rely on it entirely, many more use it in a partial manner along with their domestic currency. The very real threat of dollarization has made the world a better place. Think of all the would-be Robert Mugabe’s who were prevented from hurting their nations because of the ever present threat that if they did so, their citizens would turn to the dollar. Foreigners who are being subjected to high rates of domestic inflation will find it harder to get U.S dollar shelter if the $100 is killed off. Ashok Rao writes that there is an information trade-off. Imagine if criminals transacted only in $10,000 notes. It would be reasonably easy for intelligence agencies to sneak a traceable note to probe criminal networks. This would be close to impossible with a $20 note (not the least because this is a high velocity note used by normal people). Ashok Rao writes that the demand for criminal service is likely many times more inelastic than supply; especially drugs. A tax would hurt poor consumers, not drug dealers. A more direct method might be to increase the expected penalty of criminal activity.” (Bruegel, March 7, 2016)

Key Levels: (Prices as of Close: March 18, 2016)

S&P 500 Index [2,049.58] –   After double bottoms in January (1812.29) and February (1810.10), the index continues to recover. Major upside hurdles remains around 2,100.

Crude (Spot) [$39.44] – Like in equities, a double bottom formed in January and February this year, which has led to price stabilization.

Gold [$1,252.10] – A recent rally from the $1,049.40-1250 range showcases some recovery. The next critical challenge is breaking about $1,300.

DXY – US Dollar Index [95.08] – Since early December, the dollar strength has slowed. October 15, 2015 lows of $93.80 serve as a near-term benchmark. However, the $95-100 range is so familiar at this point and it is too early to call a major trend shift.

US 10 Year Treasury Yields [1.87%] – A well-defined range has formed between 1.80% and 2.20%. The bond markets are not convinced of rising rates. 

Dear Readers:

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

 

Market Outlook | March 7, 2016

“All nature is but art unknown to thee.” (Alexander Pope 1688-1744)

Unfamiliar Risks

Financial markets are facing unforeseen or less traditional sets of risks. Uncertainty is increasing as witnessed by angry voters, unstable unions, the demise of less diversified economies, and the desperate rise of nationalism. The disconnect between the intellectual circles and the real economy are being revealed viciously. In recent years, the disconnect between the Central banks and real economies were ignored for a while as markets rose and assets were inflated. The painful truth was deferred via a delicately crafted Central bank messaging, despite the boiling anger and frustrations of failed policies.

Investors in financial markets are not equipped to measure the various forms of risks. Dancing with the uncomfortable is one issue, but markets have recognized that the old analytical models are bitterly broken. Negative interest rates, lack of faith in capitalism, increased aggression by ex-communist nations (China, Russia and North Korea), and desires to break from the European Union are a brutal reminders of a new unfathomable era that lies ahead.

The so called “Brexit,” Britain’s potential breakaway from the Eurozone, is a risk where traditional banks are a bit clueless. Granted, as seen in prior European drama, the posturing ends up being more than the end result. Nonetheless, the political climate (some caused by the refugee crisis) and accumulating angst send a strong warning sign. Plus, France is on the radar as well with a new coined term “Frexit.” All these developments are a bit unsettling as traditional models have reached their limitations. The current, unfruitful results from globalization mixed with the frustration with the European Union triggered resentment and a revival of nostalgic nationalist sentiment. An unforeseeable era remains ahead, as slow growth leads to bickering of all kinds. 

In terms of the European economy ultra-low rates, further stimulus, and revival from anemic recovery seem to be overly familiar. ‎From investors' points of view, the massive addition to low rates resulting in higher share prices might actually be a positive twist. As strange as that sounds, the real economy and political crisis has not marched to same beat as financial markets—A theme that’s all too familiar even though it is quite misleading.

Impact of Oil Demise 

The ongoing damage from the recent Crude demise is being realized  by energy companies and oil-related economies, but it is reflected most importantly in banks' earnings. Amazingly, in stressful periods, true colors are revealed from weak demand, to risky banks loans, to less effective stimulus.

This is exhibited by Russia, whose economy is in shambles. Putin has chosen to spark all Russian pride, as seen by the conflicts in Ukraine and more recent involvement in Syria. Otherwise, the Russian economy is bleeding from the massive crude oil price adjustment. Saudi Arabia is equally feeling the pain, as it scrambles to tinker with supply. Countries like Nigeria and Venezuela are in a fragile mode, as their leadership's ego deflated along with economic sentiment:  

“Moody's on Friday placed Russia and Saudi Arabia on review for ratings downgrades, citing both countries' exposure to the struggling oil and gas industry. The agency put Russia's Ba1 government bond and issuer ratings on review, while it placed Saudi Arabia's Aa3 issuer rating on review. Moody's said it expected to complete both reviews within two months.” (CNBC, March 4, 2016)

Desperately Synchronized

The correlation between Crude, US stocks, and US treasury yields was vividly showcased during the last few weeks. Since the February 11, 2016 lows, Crude rose more than 40% and the S&P 500 index rose 11%. At the same time, US 10 year Treasuries went from 1. 52% to 1.87%. Surely, this begs the questions, have the decline in crude prices hurt the broader economy? Do OPEC, central banks, global banks, and investors need to be on the same page to avert further pain? Ongoing reliance on government entities or global organization is not an ideal way to run a free market or to build business confidence. However, semi-crisis symptoms are seen as the synchronization becomes pronounced.  Perhaps, any pending downside move will also be felt collectively across markets. 

Most importantly, central banks will dictate the sentiment that’s already tricky with an audience that is growing more skeptical.  Pressure is mounting.  There is no question that policy reforms (beyond interest rate “games”) are needed after the dust settles in Crude prices and Chinese economy. Both are critical in this inter-connected world, and the residue from the fallout is still being deciphered.

For now, traders, political leaders, policymakers, and observers seem to live day to day, given the multi-faceted layers of concerns. Being aware of all might be the ultimate path for survival. 

Article Quotes

“All but 2 of the top-10 trading partners of the UK belong to the European Union. The UK’s main trading partner in 2014 was Germany, which accounted for 12.3% of all UK trade in that year. In second position was the United States (9.5%), followed by the Netherlands (7.5%), China (7.3%) and France (5.9%). Together, these 10 countries accounted for 61.4% of UK trade in 2014. The UK was a net importer from 7 of its 10 main trading partners. The biggest bilateral imbalance in 2014 was the 36.3 bn euro trade deficit recorded with Germany, followed by the 26.2 bn trade deficit with China and the 12.3 bn deficit with the Netherlands. The biggest surplus position (16.5 bn) was recorded with Switzerland, followed by a 7.5 bn surplus with Ireland and a 5.1 bn surplus with the US.” (Bruegel, March 3, 2016)

“The BIS’s verdict on negative rates gives backing to the European Central Bank, the Bank of Japan and others at a time when such unconventional methods are facing increasing criticism for their potential impact on the financial industry and currency markets. A sell-off in European bank stocks this year was partly driven by fears that further rate cuts by the ECB would damage profitability in a sector still recovering from the debt crisis…. Fears that interest rates below zero would prompt banks or the public to withdraw and hoard cash rather than pay penalties so far haven’t materialized in any jurisdiction, according to the report. This is partly due to banks’ “reluctance to pass negative rates through to retail depositors,” with the exception of Switzerland, where some lenders actually increased mortgage rates to mitigate some of the costs incurred at the central bank.” (Bloomberg, March 6, 2016)

Key Levels: (Prices as of Close: March 4, 2016)

S&P 500 Index [1,999.99] – The lows of February 11^th to March 4^th showcase an 11% rise. However, taking a step back showcases a well-established, narrow trend around 1,900-2,100. Breaking out of this trend is the  next suspenseful move.

Crude (Spot) [$35.92] – A near 40% rise since the lows on February 11^th. Stabilization is forming after massive sell-offs.

Gold [$1,231.15] – Sharp rise since the start of the year. Bulls target $1,350 as the next critical level to trigger further momentum.

DXY – US Dollar Index [97.34] – Since early 2015, the dollar index has stayed above 94. That has remained in place.  At the same time, breaking above 100 has been a major challenge. For now, the well-established dollar strength trend is in full gear.

US 10 Year Treasury Yields [1.87%] – In the last 6-7 months, yields have failed to hold above 2.00%. A critical fundamental change is needed to drive yields much higher (i.e. rate hike, better economic data, etc). Unless a major catalysts resurfaces, the low yield trend seems set to hold.

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 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.