Market Outlook | April 11, 2016

“Life does not proceed by the association and addition of elements, but by dissociation and division.” (Henri Bergson 1859-1941)

The Rampant Disconnect

On one end, the volatility index for US stocks is signaling calmness, as the turbulence and fear have eased a bit. That’s for folks that actually believe that financial markets are telling the truth about the real economy. However, the real economy is not so robust by several measures. How could US 10 year yields remain this low? How can anger drive the election cycle? How can small business feel embittered if there was real growth?  Basic questions. To preserve capital, difficult questions must be asked and beyond the illusionary headlines a reality check is constantly needed.

Amazingly, early in 2016 the Turkish and Brazilian stock markets appear relatively attractive, as the indexes are up 16% and 15%, respectively. Of course, both stock indexes are rising from deeply discounted levels after taking major nosedives. Appealing to the average investor's eyes at first glance, but a deeper look ignites a deeper discussion. Here is the disconnect in which the stock market fails to tell the real story. Both nations are facing the ongoing risks of weakening economic climate, a bitter voter class, lack of investor confidence and sheer political instability. Yet, stocks, which tend to look ahead, tell a message that ground level observers cannot imagine. Thus, the massive disconnects between reality and financial markets are not limited to these two emerging economies. It is a phenomenon of our modern time, and these disconnects prolong harsh truth discoveries.

Misleading Optimism

Perhaps, the example above fits the bigger picture where Central Bank-led markets have projected optimism beyond what is justified. That’s the criticism of the Fed in US markets and has been the case for a while. US financial markets have served as a shelter for those escaping the collapse of Emerging Markets and commodities. Sure, rotating capital into US assets is a  relative argument, which justifies some of the asset appreciation in the US (not only stocks but real estate in key markets) over recent years. Figuring out the justification for optimism in Brazil and Turkey only signals that investors are desperate to place capital in distressed areas. On an absolute basis, global growth is slow and sometimes it is as simple as that.

We’ve reaching a point where the stock market as a measure of sentiment is completely out of whack. That’s felt primarily in low interest rates, which do not signal strength but rather desperation. Basically, elevated stock markets are covering up the painful real economy. Even the leader of “optimism”, aka the Federal Reserve, is confronting this disconnect after years and years. Last week the following was re-discovered:

“The minutes showed committee members considered a number of distinct risks, with a softening outlook for global growth and the ensuing volatility in financial markets chief among them.” (Bloomberg, April 6, 2016)

In the next 3-6 months, shocks seem inevitable and not overly surprising. Yet, mapping out the script and timing seems overly rewarding at this stage.

Reality Confronted

Japan exemplifies an advanced market that has seen constant low rate policies. The capital flow in recent years was positive, but now the narrative is changing:

“Overseas investors, which account for about 70 percent of the value traded in Tokyo shares, bought a net 18.5 trillion yen between 2012 and 2015. Global fund managers, which were negative on Japanese shares for almost all of the five years before Abe came to power, have been overweight every month since, according to a Bank of America Corp. Merrill Lynch survey… Now that bullishness is dissipating… They’ve [Investors]  sold a net 5 trillion yen since the second week of January, the longest stretch since 16 weeks.” (Bloomberg, April 10, 2016)

Is the recent reaction in Japan a prelude to US and European markets? Again, Central Bank fueled stock market rallies had a short-term fix. Basically, it aroused positive sentiment and created an interesting investment opportunity, but the disconnect is laughable at this point. Perhaps, the Japanese capital outflow and negative returns this year confirms the shaky status of the Central Bank narrative. At some point, the optimistic storytelling is merely deception that can create further consequences. Credit to the Federal Reserve attempts to lower expectations. Yet, the rate hike from December 2015 lacks basis.

The puzzle that lays ahead for investors is to decipher what reality is untold. What’s the disconnect that’s not recognized? Perhaps, confronting the (political, economic and social factors) truth  enables one to pinpoint the required correction to adjust to reasonable ranges. For now, the sideways markets are confused. Buyers and sellers are not showcasing conviction and capital is desperately seeking a “growth” idea. A messy climate, indeed. Patience might be the most valuable asset when evaluating assets.

Article Quotes:

“Six countries lay overlapping claims to the East and South China Seas, an area that is rich in hydrocarbons and natural gas and through which trillions of dollars of global trade flow. As it seeks to expand its maritime presence, China has been met by growing assertiveness from regional claimants like Japan, Vietnam, and the Philippines. The increasingly frequent standoffs span from the Diaoyu/Senkaku Islands, on China’s eastern flank, to the long stretch of archipelagos in the South China Sea that comprise hundreds of islets. The U.S. pivot to Asia, involving renewed diplomatic activity and military redeployment, could signal Washington’s heightened role in the disputes, which, if not managed wisely, could turn part of Asia’s maritime regions from thriving trade channels into arenas of conflict…. Thousands of vessels, from fishing boats to coastal patrols and naval ships, ply the East and South China Sea waters. Increased use of the contested waters by China and its neighbors heighten the risk that miscalculations by sea captains or political leaders could trigger an armed conflict, which the United States could be drawn into through its military commitments to allies Japan and the Philippines. Policy experts believe that a crisis management system for the region is crucial.” (Council of Foreign Relations, April 2016)

“The first question is which outcome Europeans would and should prefer. Some have already written off the United Kingdom, claiming that a partner that would consider leaving is not the kind of partner they want, anyway. Whether or not one shares this opinion, the point is worth studying. Indeed, it would be naive not to ask whether retaining a member that is challenging the very principle of European integration would really be in the EU’s best interests. The reality is that the British public debate on sovereignty will not end when the votes are counted. After all, even if the majority says “yes” to the EU, a share of the population – a substantial one, according to the polls – will remain convinced that Brexit would have been much better for the UK. Given this, debates and negotiations involving the UK and its European partners will continue to feature deep disagreements over the restrictions and conditions that accompany membership in the EU. For years to come, the British will demand a constant drumbeat of reaffirmation that they made the right choice. This is an important consideration that should not be dismissed out of hand. But it should not lead the rest of Europe to favor Brexit. Indeed, if the majority of British voters decided to abandon the EU, everyone would suffer the consequences.” (Project Syndicate, March 21, 2016)

Key Levels: (Prices as of Close: April 8, 2016)

S&P 500 Index [2,047.60] – In recent months, the 2,050-2,100 range has proven to be a challenging range for bulls to reinvigorate more momentum within. In the near-term, surpassing 2,050 will be critical.

Crude (Spot) [$39.72] – The growing evidence of support around $36 confirms additional buyers' interest. The stabilization continues.

Gold [$1,213.60] – Very sluggish and lengthy bottoming process continues. It is mostly centered around $1,200, as finding additional momentum has been a struggle.  

DXY – US Dollar Index [94.23] – Slightly down week after week. For several months, the dollar strength theme has slowed down, but 94 still seems like a reasonable bottom.

US 10 Year Treasury Yields [1.71%] – Yields have failed to stay above 2%. February lows of 1.52% are a crucial near-term benchmark. This is further confirmation of bond markets not being convinced of the economic data.   

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 | April 4, 2016

“We could never learn to be brave and patient, if there were only joy in the world.” (Hellen Keller 1880-1968)

Fruitless Games

Public markets appear to be suppressing pain, volatility ‎and further uncertainty by trading within a range. The Fed-obsessed culture that's searching for the next trick, clue or message must be getting old and lacking basis. Central Banks' tiresome  messaging without conviction does not help participants.  The already less convincing data confuses investors month over month, as justification for growth is hard to prove.

Here is one example:

“The details showed that some people entering the labor force were only able to find part-time employment. The number of Americans working part-time for economic reasons rose by 135,000 to 6.12 million, the most since August.” (Bloomberg, April 1, 2016)

Add politics to the mix of the less than convincing data; then surely, the environment is a bit tricky and quite misleading on the interpretation of well-being. This includes managing the Greece/Eurozone ongoing crisis as well as potential Brexit, which is a less imagined but bigger risk. Government officials now have to manage a raging voter base in the US and Europe at a time where global growth is very weak. This creates a  stunning set-up for policymakers, a partially entertaining event for observes and an emotionally exhausting ordeal for operators in the financial services industry.

Limited Powers

The return expectations for public markets (i.e. S&P 500 index) showcase the suppression of expectations.  Returns have been too low for too long with yields, as faith in public markets is being questioned by pensions as well as individuals.  ‎Are markets a misleading sentiment indicator? That's been the case for over 24 months, as the bullish cycle continues to pause. The over-reliance in Fed statements or monthly job numbers is not providing enough clues, but leave the investor base rather clueless on the next move or decision. At the end of the day, the US 10 year yields are below 2%, suggesting the economy is not that vibrant after all.  Pundits may hype the speculative game of “to hike or not to hike.” However, finding a basis to hike rates has been difficult and bond markets are not buying the “strong” recovery story. The global slowdown from China to commodities is one clear issue. Yet, Western leaders have not resolved the issue of re-generating growth via policies and pro-business priorities. Thus, the Central Banks have reached their limited powers and giving them too much attention is a near worthless exercise for those seeking fruitful returns.

Pondering Ahead

The macro climate has remained about the same without major changes. The US dollar, yields (in developed markets) and equity prices are in trading in familiar areas without marking new trends and ranges. A deadlock in broad indexes leads to further unease and anxiousness, despite the so called calmness in volatility. More capital is seeking shelter, so the relative appeal of investor demand favors US and liquid assets. Chasing less impressive returns before unresolved issues play out seems risky. Of course, the magnitude of the risk is not fully known. 

The optimist might think that the upside is intact and worth adding to; however, even in a period where the Volatility index (VIX) is near annual lows, to feel comfortable with the current environment will be difficult for most. The daring bunch may chase returns here, as the risk-reward seem appealing. Others may look at Emerging Markets and commodities, where bargain hunting is quite alive and well. Themes that are discounted from the recent China and commodity demise may offer an appealing entry point, but even that’s a bit riskier than the average investor may desire.  Simply, overpaying for “safe assets” versus relatively underpaying for cheap asses is the quest for glory for fund managers ahead.  Reaching a high conviction level is the challenge for both types of risk-seekers. Waiting for the Fed, however, is not a way to build conviction, as conventional wisdom may strongly suggest.

Article Quotes:

“Greece and its EU/IMF lenders will resume talks on the country's fiscal and reform progress this week aiming to bridge differences and conclude a key bailout review, which will pave the way for negotiations on long-desired debt relief. The review has been adjourned twice since February, mainly due to a rift among the lenders over the estimated size of Greece's fiscal gap by 2018, as well as disagreements with Athens on pension reforms and the management of bad loans. Inspectors from the European Commission, the European Central Bank, the European Stability Mechanism and the International Monetary Fund interrupted the review last month, taking a break for Catholic Easter, government officials said. Talks are expected to resume on Monday and Athens hopes for a compromise before April 22, when euro zone finance ministers are expected to assess its progress.” (Reuters, April 3, 2016).

“Rising risks to the outlook placed Yellen’s legacy in danger. If the first rate hike wasn’t a mistake, certainly follow up hikes would be. And there is no room to run; if you want to “normalize” policy, Yellen needs to ensure that rates rise well above zero before the next recession hits. The incoming data suggests that means the economy needs to run hotter for longer if the Fed wants to leave the zero bound behind. Yellen is getting that message. But perhaps more than anything, the risk of deteriorating inflation expectations – the basis for the Fed’s credibility on its inflation target – signaled to Yellen that rates hike need to be put on hold. Continue to watch those survey-based measures; they could be key for the timing of the next rate hike.” (EconomistView April 1, 2016)

Key Levels: (Prices as of Close: April 1, 2016)

S&P 500 Index [2,072.78] – Since the February lows, the index is showing some strength. Breaking 2,100 can fuel further upside momentum. Last year in the summer and late winter, the index failed to surpass 2,100.

Crude (Spot) [$36.79] – Struggled to stay above or at $40. An unsettled bottoming process occurs as supply-demand dynamics are not clear for participants. Revisiting prior bottoms of $26 is still not out of the question at this stage. 

Gold [$1,213.60] – For several months, the bottom appeared to be in place. Yet, breaking above $1,300 has not been stable.

DXY – US Dollar Index [94.61] – Dollar strength has declined recently. 94 seems to be the ultimate low. Further tests await in terms of dollar strength.

US 10 Year Treasury Yields [1.77%] – Failed to get closer to or above 1.80%. This is a further sign of bond markets not being convinced of rate hikes or actual improving economy.

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 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.