Market Outlook | June 20, 2016

“The more you are willing to accept responsibility for your actions, the more credibility you will have.” (Brian Koslow)

One Message, Several Angles

For a long-while, the narrative of the Federal Reserve was being severely questioned by some. Now, a broader audience within the financial services is beginning to question the creditability of central banks, especially the Federal Reserve, which, now, has been caught with inconsistency. Last week may have triggered further discomfort with the Fed’s message. Frankly, pundits and observers are realizing how the Central Bank is not  firm and overly wishy-washy. Finally? In other words, the prior “misleading” realities by the Fed are now highly exposed (to those that still had faith in the Fed’s plan).

From the fuming anger in the current political climates of Western countries, to ever so growing rumblings of nationalism, to ongoing fragility in Emerging Market, clearly,  “global growth”  is convincingly weak. From a sentiment perspective, nervy mindsets are plaguing the investor base from “Brexit”, to earnings, to bank stocks that swing on rate hike anticipation. Absurdly, the sentiment never reaches a new high, but even the creative Fed had to calm the tone regarding growth. Confronting the truth is the only path for survival for those exposed to some market related risks.  Amazingly, stock indexes were reaching psychological hurdles, as showcased when the S&P 500 Index peaked at 2,100, yet again. Similarly,  US 10 year Treasury yields failed to hold 1.90% a few times and now is closer to 1.50% than 2%. Basically, the bond markets are stating that there is no noteworthy growth and a rate-hike is not feasible, as it lacks basis.  This reinforces that public markets are not budging to the “misleading” narrative that the Fed spewed for so many months before.

Uncharted Territory, Again

The suspense continues regarding Britain staying or leaving the European Union. Yet, regardless of the decision in this key macro event, there are key fundamental changes since 2008 that need to be acknowledged. The global growth weakness has been long apparent and slowdown is well recognized. Eurozone troubles are quite evident, especially when looking back at the 2011 crisis. And China being a mess affects both Western and emerging market economies. Thus, the anger in Western nations over weak economies is leading to a further demand for nationalism. At this point, hardly a shock, but the business world is scrambling with the unknown. How are profits going to be impacted? What happens to trade agreements? How do investors respond to all this? Questions that were not covered in many risk management meetings a decade ago are being asked.  

In some ways, Central banks “numbed” the investor community with indirect messaging and enhanced trickery. However in 2016, the undercurrent realities of weakness are now coming to the forefront on both political and economic discussions. Blaming “Brexit” for market demise is not an accurate description, as the symptoms have been long-brewing for those courageous enough to explore the truth.  Importantly, we’ve entered a post-globalization era where the inter-connected world is not as fruitful as before. The future of globalization is facing its darkest hours filled with debates, as new paths are being ferociously explored.  At the same time, democracies are struggling with leadership, cultural vision, long-term goals and demographic realities. 

Managing  Expectations

Rate hikes appear less likely in the US given the less than compelling economic numbers. The rush to safety is on as risk-averse assets continue to gain some traction, while yields are much lower. In some minds, fear has been “overblown” in recent years in which the market showed resilience in overcoming various concerns. Others may claim that Commodities and Emerging Markets felt the pain recently and that’s enough of a correction. Recently, the US stocks volatility index revived from a deep sleep, signaling increasing worries, but still tame relative to 2011 and, of course, 2008.  The short-term challenges are plenty, but visualizing how the dust settles is the wildcard and a rewarding event.

Underestimating risk is more dangerous than overestimating crisis-like possibilities when managing money. This cautious stand maybe laughed at during bull markets, but when reaching a cycle of plenty of unknowns, it is good to admit that markets are known to humble the overly confident as much as punishing the overly bearish crowds. The narrative needs a “reset”, truth needs to be confronted and a few shocks need to be absorbed. Until then, suspense will linger, and that’s toxic for long-term planners who’ll sit on cash or wait before taking more risk (i.e. deploying capital for R&D, innovation or general growth). Corporations have been mostly buying back their own shares or overpaying to acquire new companies rather than develop from within. To restore confidence, a genuine reset of risk/reward and valuation is urgently needed. Perhaps, these suspenseful summer months can produce a reality check which provides further direction for longer-term planners.

Article Quotes:

From 1992, prediction on how the Eurozone will fail:

“What happens if a whole country – a potential ‘region’ in a fully integrated community – suffers a structural setback? So long as it is a sovereign state, it can devalue its currency. It can then trade successfully at full employment provided its people accept the necessary cut in their real incomes. With an economic and monetary union, this recourse is obviously barred, and its prospect is grave indeed unless federal budgeting arrangements are made which fulfills a redistributive role. As was clearly recognised in the MacDougall Report which was published in 1977, there has to be a quid pro quo for giving up the devaluation option in the form of fiscal redistribution. Some writers (such as Samuel Brittan and Sir Douglas Hague) have seriously suggested that EMU, by abolishing the balance of payments problem in its present form, would indeed abolish the problem, where it exists, of persistent failure to compete successfully in world markets. But as Professor Martin Feldstein pointed out in a major article in the Economist (13 June), this argument is very dangerously mistaken. If a country or region has no power to devalue, and if it is not the beneficiary of a system of fiscal equalisation, then there is nothing to stop it suffering a process of cumulative and terminal decline leading, in the end, to emigration as the only alternative to poverty or starvation.” (London Review of Books, Wynee Godley October 8, 1992)

“China is renegotiating billions of dollars of loans to Venezuela and has met with the country’s political opposition, marking a shift in its approach to a nation it once viewed as a US counterweight in the Americas. Venezuela is facing one of the worst crises of its 200-year history, with a collapsing economy and political deadlock stoked by the oil price slump. China, which is Caracas’s biggest creditor and has loaned the country $65bn since 2005, has already extended the repayment schedules for debts backed by oil sales. Beijing has also sent unofficial envoys to hold talks with Venezuela’s opposition, in the hope that if President Nicolás Maduro falls his successors will honour Chinese debts, sources on both sides of the negotiations told the Financial Times. Its recognition of Mr Maduro’s fragile position and the rising clout of the opposition, led by Henrique Capriles, is another sign that the diplomatic noose is tightening around Caracas’s socialist government.” (Financial Times, June 19, 2016)

Key Levels: (Prices as of Close: June 17, 2016)

S&P 500 Index [2,071.22] –  After failing to hold above 2,100 in April and June, the index continues to consolidate. There is critical resistance that’s plaguing the index at this junction.

Crude (Spot) [$47.98] –   Staying above $50 remains a near-term challenge. A minor pause appears at this junction and it is too early to determine if the recent run has lost its momentum.

Gold [$1,290.70] –  Hovering around $1,300, gold follows a strong run this month, mainly driven by the rush to safety. Interestingly, gold failed to hold at current levels in summer 2014 and January 2015. This is a major test for goldbugs at this particular point.

DXY – US Dollar Index [94.02] – Index is settling in between 94-96. The dollar strength theme continues to showcases muted responses. In the near-term, the dollar is set to have several swings, but well defined ranges are intact.   

US 10 Year Treasury Yields [1.60%] –  Once again, yields failed to hold above 1.80%, especially with a sharp-drop last week as rate-hike chatter slowed down. This is further signal of weak economic climate and a Fed that lacks basis for raising interest 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 | June 6, 2016

“The truth is not for all men, but only for those who seek it.”  (Ayn Rand, 1905-1982)

Weakness Reconfirmed                                                                                     

The revelation of further weakness in US economic numbers does not come as a surprise. As global growth keeps shrinking, there was this wild optimistic view that US labor was actually improving. Even if May’s monthly data, which turned out to be abysmal and weak, was an outlier, it clearly showcases that growth projections were on shaky grounds. Not to mention, the prettied-up labor numbers of recent years reflected growth in low wage jobs, while dismissing folks that are not counted after giving up. Importantly, the number of people participating in the labor market continues to decline dramatically.  The Fed has to admit failure (the honorable path), admit weakness in the current environment or find yet another creative explanation to drag the audience along. The Fed’s creativity in messaging has entertained many, while the real economy is bleeding severely. Financial markets are feeling the pressure of the ongoing disconnect between reality and the current trading levels seem a bit insane, to put it rather mildly.

The Fed’s Crumbling Thesis

Subscribing to the Fed’s narrative of growth and possible rate hike is a big cinema show, filled with hype and misleading bluffs. The bond and stock market did not buy into the growth story even before  Friday’s weak job numbers. US 10 year yields have not reached 2% in a while, and S&P 500 index wobbling around 2,100 confirms even further uncertainty. The suppressed volatility in US stocks combined with big media’s idolization of Central Banks is the ultimate toxic climate for risk managers of all kinds. In other words, professionals shouldn’t be fooled by the PR work of a government agency (i.e. Federal Reserve); instead, the real economic data show continued flaws. In addition, the violent swings in political issues from elections to referendums shouldn’t be taken lightly in risk assessment.  The increasing danger now is assuming Central Banks know what they’re doing. The reality is they do not beyond deferring any confrontation with reality and by using up air time to calm the markets by confusing observers. The suspense game played by the Fed is insulting to many market observers, as the end result of current economic and market reality is not bound to change overnight.

Suspenseful Macros

A critical inflection point is visible across key macro indicators. In simple words, suspense awaits. The S&P 500 index failed to hold at 2,100 several times in the past few years. Stunningly, last Friday the index closed at 2,099.13, further illustrating the enthralling climate. Crude has roared back around $50, but a mild pause is warranted as OPEC deciphers the next path. The intense rift between Saudi Arabia and Iran is one critical factor in pricing as well as political dynamics:

“Saudi Arabia and its Gulf allies had tried to propose OPEC set a new collective ceiling in an attempt to repair the group's waning importance. But Thursday's meeting ended with no new policy or ceiling amid resistance from Iran. Despite the setback, Saudi Arabia moved to soothe market fears that failure to reach any deal would prompt OPEC's largest producer, already pumping near record highs, to raise production further to punish rivals and gain additional market share.” (Reuters, June 2, 2016)

Meanwhile, the recent rate-hike posturing ended up being a senseless promise without basis. That said, the US 10 year yield is far removed from 2%, even 1.90% seems distant in this climate of lower growth and low inflation. Finally, the US dollar has stalled and its relative edge is taking a break, symbolizing waning momentum. Perhaps, some EM currencies are being revived and reversing a 2-3 year trend. All these factors do not account for, “Brexit”, elections, and other less expected results.

In the days and weeks ahead, traders will have to evaluate their outlook in the Fed’s messaging. Also, those that naively anticipated a rate-hike may have lost further trust in the Fed. In all this, a disruption of the status-quo and increased volatility seems warranted at this state. Buying into illusion is not a sustainable idea and soon market participants are bound to react resoundingly.

  

Article Quotes:

China’s industrial landscape:

“Guangdong for three decades created one of those rare periods in industrial development where everything came together in the same place at the same time—capital, cheap labor, infrastructure and relative freedom from controls. The world’s biggest ships, carrying up to 19,000 containers, could dock in Shenzhen and fill up with goods for all over the world, none of which was made more than 100 miles away. By moving elsewhere in China, factories may be able to trim wage bills or gain access to cheaper land, but they lose the concentration of suppliers, logistics and services that Guangdong has built up over 30 years. Gao Dapeng, CEO of Desay SV Automotive Co., which makes car navigation systems in Huizhou, said the overall cost saving of moving to an inland province like Chongqing is only about 10 percent, and it would mean the plant would be hundreds of miles from its suppliers. He said the company is not sure if the relocation is worth that. Yet factories in the province continue to close, stirring discontent. The number of strikes and protests in China doubled last year, according to the China Labour Bulletin. Among the 886 incidents recorded in manufacturing, 267 were in Guangdong, three times as many as the next highest province.” (Bloomberg, June 5, 2016)

“Widely followed figures from EPFR Global, a Massachusetts-based data purveyor, suggest that foreign investors have dumped Asia ex-Japan equities at an alarming rate so far this year. Yet data from the Washington, DC-based Institute of International Finance suggest that foreign investors’ appetite for emerging Asian equities has  remained strong this year, hitting 30-month highs in March. EPFR’s findings are illustrated in the twin charts below. Its data suggest that investors have withdrawn a net $10bn from Asia ex-Japan equity funds so far this year, equivalent to more than 3 per cent of assets under management. This is in contrast to Latin American equities, where the return of Brazil and Argentina to foreign investors’ wish lists has helped spur net inflows equivalent to more than 5 per cent of AUM." (Financial Times, May 27, 2016)

Key Levels: (Prices as of Close: June 3, 2016)

S&P 500 Index [2,099.13] – Unchanged from last week. It is very fitting that the index failed at 2,100, yet again. It is fair to say, a massive inflection point awaits. 

Crude (Spot) [$48.62] –  After the massive move from $26 in February and until nearing the 50’s range recently, there are signs of a pause. It appears like a selling match between buyers and sellers is happening at the $48-50 range.

Gold [$1,216.25] –  Stabilizing between $1,200-$1,250. This illustrates an extended bottoming process after a multi-decade decline.  Although the upside moves are hard to predict or calculate, the recent moves have confirmed a new/redefined pricing range.

DXY – US Dollar Index [94.02] –  Sharp drop last Friday after the weak job numbers and low odds of a rate hike. Since late January, the dollar strength has paused.

US 10 Year Treasury Yields [1.70%] –   Once again, yields failed to hold above 1.80%, especially with a sharp-drop last week, as rate-hike chatter is slowing down. This is further signal of weak economic climate and that the Fed lacks basis for raising interest 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 | May 31, 2016

“I would rather live in a world where my life is surrounded by mystery than live in a world so small that my mind could comprehend it.” (Harry Emerson Fosdick 1878-1969)

Confusingly Mysterious

The reasons behind why stocks move up and down draws multiple commentaries filled with guesses of all kinds. They pollute the airwaves with pundits that guess.  Truly, who knows the day to day market moves? No one, really. It is a speculative game involving many groups of people, many small unknown events and fascinating results. Some participants try to reduce their risk and others look to take their chances based on high conviction observations.  Hence, the fascination and the constant urges to speculate are driven by mystery as much as the desire to create wealth.

Sometimes, the market narrative feels like a “quasi-casino,” where the thrill of opportunity chasing over-takes common sense. That’s quite contrary to the more common approach in which professionals view the financial markets as a tool for wealth creation. For others, it is understanding and managing the risks, like a pilot flying a plane safely.  Meanwhile, there is the public service element of markets in which pension funds and retirees rely heavily on financial markets for income, but grasping the nuances and catalysts is still a mysterious act for them and those managing their money. Risk is never out of the equation – that’s as clear-cut as it gets.  In other words, participating in markets is being part of the “mystery” and humbly acknowledging the unknown.

Not to mention, the mostly revered Central Banks pump out endless speeches, press releases and theoretical based reports of their reality.  Keep in mind, Central Banks, are a division of government which end up interfering in the so called “free-markets”.  Yet, to simplify the matters, we all observe that interest rates have been and continue to be low.  That’s the bottom-line when all the noise settles.  Low rates are such a common policy across nations, it has dampened the faith of those seeking less intervention and less “artificial” like traits. As highly documented as it gets, hedge funds are struggling in this new environment as some adjustment is desperately needed. Meanwhile, key financial media obsession with the Central Banks has made the markets even more illusionary and day to day behaviors less-grounded with reality. Of course, “irrational” behaviors, driven by emotions, were always part of the market, but now suppressed emotions create even more of a deception of reality. This still occurs despite the technological advancement of speedy trades and incredible tools for digesting information rapidly.  Perhaps, that’s why there is disconnect between the real fundamentals of countries and companies versus the financial tools that grapple with Central Bank narratives.

Thus, yield generating assets are hard to find, especially those that are reliable and more predictable. Within this context last week, Qatar issued bonds that surprised observers:

“Qatar sold $9 billion of Eurobonds, marking the biggest-ever bond issue from the Middle East where governments are tapping international investors to fill budget holes left by declining oil and gas revenues.” (Bloomberg, May 25, 2016)

There is no shortage of desperation for yield generating assets, which means more risk-taking and a further dive into the mysterious climate.

Inflection Point Revisited

The S&P 500 index is nearing and facing a major resistance at 2,100 - a level that's been seen before. In the past, buyers shied away from doubling down into stocks at this level. In recent occasions going back to last summer and late autumn, the S&P 500 index faded as sellers gained some momentum at this familiar level. A re-test of this highly tracked level for US stocks awaits, while the murmurs of rate-hikes pollute the airwaves of financial circles. Similarly, the US 10 year Treasury yields showed signs of peaking this year around 2%. This is seen in the recent peaks in March (1.99%), April (1.93%) and possibly again in May (1.88%). Therefore, both the stock and bond markets are not quite convinced that there is a robust economy to justify upside moves. Thus it is fair to ask: Is there a basis for the rate-hike? Is there inflation or noteworthy growth? When is the Fed going to capitulate to the ugly truth?

Justification for the recent upside move varies from one observer to the next, but the broad indexes have mildly re-accelerated. Being bearish is not distinct or contrarian at this stage. That's due to the well-known fact that the global economy is slow; even without a G7 meeting, observers are quite familiar with this harsh reality. Anemic growth is not a short-term event, but concerns loom. This is going to take a long while to boost global growth, collectively.

The US stock rally since mid-February appears a bit fatigued and technical levels confirm that, as stated above. The bargain hunting in commodities already took its course and entry points now are less attractive than before. (Simple risk-reward observation). After all, Goldman Sachs commodities index is up nearly 20% for 2016. Similar trends are visible in EM, as well, where sharp-recoveries have persisted following the multi-year declines. 

Confused and Battered

Economic data signaling improvements is hardly convincing; a lot of sideways / neutral results is the new norm. Many days of "mixed data" without any vigor or insight are nauseating. Stock volatility is suppressed, since there is numbness to bad news and bad news is not "news" anymore. ‎Sadly, that's been the case for a long while. China's struggles are even more mysterious than shocking these days. The global deferral of future problems and the acceptance of Central bankers as the solution provider is the most scary premise of all. Disengaging or staying idle from the current narrative has been costly to money managers who need to catch-up to their peers in terms of performance.  Relying on intuition about the real economy has been penalized, as well. Thus, to survive (via staying in line with broad indexes) in financial markets has forced professional managers to stomach the widely accepted illusion since the alternative appears hopeless or brutal. In other words, gloom and doom has been laughed at and cash earns nearly zero, and status-quo is too intertwined with bureaucratic forces.

Thus, "Denial" becomes comforting, especially when crisis-like modes have not become a tangible reality. This is the "mental game" that benefits the central banks who know the psyche of investors and asset managers.  As long as interest rates are low, the Fed has leverage to force investors into risky assets (riskier by the day and riskier with each upward tick) or face abysmally low returns in cash. But for those emphasizing "survival" and those willing to see beyond "denial", equity markets are becoming more of a "casino-like" show rather than a sentiment of financial/economic reality. It takes courage to walk-away from a multi-year bull market run, and it takes even more courage to sit-out while not participating in what's perceived as "growth". Critically, fund managers have to invest to maintain their job, while independent individuals can apply discretion, freely. And to this, the outflows have been expanding. At some point, distrust of the central bank will materialize; all the signs are there already. It is a choice between accepting the illusion and facing the reality. The warnings are here and have been there, but turning a blind-eye is massively promoted at the cost of hard earned capital that circulates in financial markets. 

Article Quotes:

Re: The Russian Economy:

“Oil prices fell to below $30 per barrel and a budget deficit of at least 5 percent seemed inevitable. But now Russia's political elite is breathing a sigh of relief. Oil is up to more than $40 per barrel and experts are predicting that prices are more likely to continue climbing than to collapse, as they did in winter. Of course, oil price trends cannot be forecast with any certainty. But financial officials recently stated that if oil remains between $40 and $50 per barrel, the economy will enter a ‘new reality.’ What does that mean? It refers to a course toward moderate belt-tightening — higher taxes and stricter collection of them, as well as limiting imports through protectionist measures. Government propaganda must be stepped up to convince the Russian people that scheming foreigners are the cause of their problems, not their leaders' failed economic policy. This is simply ‘milking the economy.’ Oil and gas revenues will fall. They totaled 7.43 trillion rubles in 2014, dropped to 5.86 trillion rubles in 2015 and could fall to 4.5 trillion rubles in 2016. Therefore, authorities will have to cut project investment, reduce funding to the regions and scale back financial incentives for state employees. That will lead to further decline in an economy kept afloat by government investment and purchases. Import volumes have dropped to half of their 2014 level, which means a decline in VAT revenues from the sale of those goods.” (Moscow Times, May 20, 2016)

China Is Not Quite Advanced:

“In developed markets, the ultimate refuge for investors in asset-backed securities is that they can always take possession of the underlying assets. That's small comfort in China. Even if … another buyer managed to get a hold of the loan rights -- a daunting task in the Chinese judicial system -- they'd be hard-pressed to collect. After a successful hostile takeover, Shanshui competitor China Tianrui was unable for several months to remove the former owners from the company's offices in Shandong, the site of its most important operations. By the time they took control, the official seals had vanished, making it difficult for the company to officially pay its debt (in China, nothing is official without the chops). Lawyers say that without support from a well connected state-owned company, collecting dues in China is near-impossible for foreigners. Buying soured loans may look like a great potential investment, in a U.S.-style legal environment. That's not China.” (Bloomberg, May 26, 2016)

Key Levels: (Prices as of Close: May 27, 2016)

S&P 500 Index [2,099.06] – Re-testing at a critical 2,100 range.  Previously the index failed to hold above this level in the summer and fall of 2015. Meanwhile, this year, April 20^th highs of 2,111.05 are on the radar for short-term traders. Can it rise above? Or is the selling pressure too vast at that psychological range? Answers await.

Crude (Spot) [$49.33] –   The commodity has nearly doubled since the lows of February 11, 2016 ($26.05). There is a strong run-up where the narrative is unclear if crude is being driven by supply or demand.  

Gold [$1,216.25] –   After peaking on May 3^rd, Gold has lost some traction. However, buyer’s conviction is being tested now around $1,220. The current range is between $1150-1300,  where is seems to be stuck.

DXY – US Dollar Index [95.52] – Stabilization has occurred in the last three months. The Dollar is in a steady range between 94-95. This reflects the sideways pattern that’s persisting across macro indicators.

US 10 Year Treasury Yields [1.85%] – Approaching an inflection point like the S&P 500 index. Behavior near and around 2% will have great implication of sentiment and is pending the Fed’s action.  There is set-up for a possible defining move. 

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 | May 16, 2016

“Organization can never be a substitute for initiative and for judgment.” (Louis D. Brandeis)

Warning Clues

Momentum is fading among equity holders, as witnessed by action in broad US stock indexes. Sentiment is shifting towards bearishness and cheery attitudes are calming down. The list of prior neglected worries is slowly being confronted. Interestingly, the bond markets are not buying the strong economy story, yet again. Simply, the economic strength that the Fed over-promised is not to be seen. To be fair, the US 10 year yield has showcased for a long-while that economic strength lacks substance and confirmation. The passive approach by the average investors will be tested. Collectively, investors, by accepting the status-quo and doubling down on the Fed’s script, are now facing the risk of reality. In other words, the financial markets have glued all worries into a mostly smooth-sailing upside move.

The August 2015 sell-offs and early 2016 sharp downside moves were noteworthy, by all means. On April 20^th, the Nasdaq peaked and the VIX (Volatility Index) slightly bottomed. Nasdaq, as the face of innovative areas with limited exposure to commodities, began to show fragility on April 20^th, as well (led by Apple's weakness a few days before). Central Banks of all kinds are dealing with a reality that’s been long deferred. But timing the ultimate “judgment” day is the frustrating challenge for participants. The status-quo that’s been prolonged is still favored even though alarm bells are mildly and loudly ringing.  One notable theme is how EM and Commodities are digging themselves out of the grave after being battered during the last few years. Rotation into “beaten-up” names reflects how developed markets are a bit saturated. (i.e Japan, Germany etc).

Liquidity Concerns

At the height of any crisis, there is one issue that comes-up: Liquidity. At this stage, investors have heard enough warnings to re-balance portfolios and make adjustments to current risk exposure. Earnings have been weak, “Brexit” is an ultimate unknown risk, the US election is still a wild card , China is hardly stable and EM tied to commodities are still licking their wounds. That’s the big picture and common concern. By digging a step or two into the mechanics of financial markets, one will find ongoing liquidity concerns. Even in areas that appear “liquid” such as bonds, the liquidity risk is severely misunderstood. The post 2008 era brought tons of regulatory changes along with Banks reshuffling their business models. Both factors present less liquidity, which creates further risk than previously imagined. Here is one example:

“Dealers are cutting back while the junk bond market swells. There are $2.2 trillion of high yield bonds outstanding, up from $741 billion 10 years ago, the Bank of America Merrill Lynch Global High Yield Index shows. Even if banks were holding the same inventories they had before, they would still own a smaller percentage of the market. With revenue from bond trading having plunged, banks including Morgan Stanley, Credit Suisse Group AG and Nomura Holdings have been shrinking trading staff.” (Bloomberg, May 12, 2016)

Beyond Drama

As most Hedge Funds struggle to make money, investors must wonder about the market dynamics and concept of risk-taking. There is this disturbing feeling of over-reliance on the Fed, which has lost credibility. Globalization is being challenged in Europe and in other circles. And policymakers have failed to uplift the business spirit for the most part, as global growth is anemic. Thus, investors have enough reasons to be reluctant and seek shelter or tax related strategies at this junction. Suppressed and very low yields have forced further risk-taking into risky assets (as stated above i.e. junk bonds).  A reset is desperately needed, and, at this stage, the atmosphere is not overly optimistic.  Perhaps, more downside moves will turn the sentiment toward panic as things remain mostly calm.

Article Quotes:

Regarding China: “After March data suggested that economic activity was finally picking up after a long slowdown, April figures released at the weekend suggested otherwise. Overall investment, factory output and retail sales all grew more slowly than expected. Private-sector investment for January to April grew just 5.2 percent, its weakest pace since the National Bureau of Statistics (NBS) started recording the data in 2012. More worrying, private-sector investment is decelerating sharply from rates near 25 percent in 2013, to just 10 percent last year and now just over 5 percent.

The reason policymakers are so concerned is that private-sector fixed-asset investment, which includes land, equipment and buildings, accounted for more than 60 percent of overall investment in January to April. The sector provides a third of all jobs in China and creates 90 percent of new urban jobs, state media have reported.” (Reuters, May 15, 2016)

“The history of the German economy since its labour market reforms of the early 2000s demonstrates that “structural reform” is most unlikely to solve this problem. The most important macroeconomic fact about the country is that it is unable to absorb almost a third of its domestic savings at home, despite ultra-low interest rates. In 2000, before the reforms — which cut labour costs and workers’ incomes — German corporations invested substantially more than their retained earnings. The opposite is now true. With households in surplus and the government in balance, a vast external surplus has duly emerged.  Why should others be able to make productive use of savings Germans cannot apparently use? Why should structural reforms elsewhere, as advocated by Germany, generate the investment surge lacking at home? Why, not least, should one expect indebtedness to have fallen when demand and overall growth is so weak in the eurozone as a whole? ‎What has happened, instead, is the conversion of the eurozone into a weaker Germany. (Financial Times, May 10, 2016)

Key Levels: (Prices as of Close: May 13, 2016)

S&P 500 Index [2,057.14] – Failed yet again to move above 2,100. Again, that signals fading buyers’ momentum. Interestingly, the index fell below 2,050, which sets the stage for a critical period in weeks ahead. Massive pressure is building on the downside.

Crude (Spot) [$44.66] – Visible signs of stability arise between $40-46. Staying above 

$42 will confirm the validity of the recent rally.

Gold [$1,271.00] – Peaked at $1,295.00 on January 2015 and, again, stalled at $1,294.00 on May 6^th. This signals fading momentum.

DXY – US Dollar Index [93.88] –  After dollar weakness for several months, there are signs of a very mild revival.  Perhaps, a re-strengthening of the dollar is setting-up at this stage.

US 10 Year Treasury Yields [1.70%] – Since the April 26, 2016 (1.93%) peak and until last Friday, there has been a significant turn around in yields, which coincides with the lack of economic confidence. 

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 | May 9, 2016

“Real valor consists not in being insensible to danger; but in being prompt to confront and disarm it.” (Sir Walter Scott 1771-1832)

Desperate Revival

Some early signs of revival commodities and Emerging Markets has set a new tone early in 2016. These recoveries are after lengthy and collective downside moves in recent years. The commodity and EM bull markets both ended in ugly fashion, especially in the last three years. They spiraled into crisis mode from Crude to Steel to soft commodities.  Importantly, the recent post-demise bounce in EM shares and prices of key commodities reflects an over-due (and natural) recovery from cheap levels rather than a fundamental shift.  Equally, the slowdown in US dollar strength contributed to the current dynamic and remains a key macro factor.  ‎Strengthening of EM currencies in the first quarter stood out as EM currencies came back to life: 

“The ones [EM currencies]  that have risen most in recent weeks are typically those—the trouble, the real and the rand—that had lost most ground since May 2013, when the emerging-market sell-off began in earnest.” (The Economist, May 7, 2016)

A reversal of sorts is either maybe a major shift or a short-term occurrence that masks other brewing problems in EM.  For now, this feels like a short-term response rather than a new trend.

However, desperation by investors for returns is forcing a re-assessment of risk and a willingness to take a shot in "cheap" assets. In a landscape where Nasdaq and other developed market shares appear overly saturated (in-turn offering limited upside), this line of thinking and action is not surprising.  Therefore, this begs critical questions: 1) Is the commodity run sustainable? 2) Will any fundamental change in supply or demand to stir further price increase?  In both cases, odds are less likely, but surprises last longer than imagined.

The oil demise has painfully hurt nations such as Saudi Arabia, Russia, Nigeria and Venezuela. Commodity-rich countries, like Brazil and South Africa, ‎have felt the pain in the country's budget impacting growth and outlook. Demand from China continues to  slow down, which further reflects the inter-connected weakness that's lingering in the global economy. In terms of China, demand is certainly weak, as confirmed by recently data:

“April imports dropped 10.9 percent from a year earlier, falling for the 18th consecutive month, suggesting domestic demand remains weak despite a pickup in infrastructure spending and record credit growth in the first quarter.” (Reuters, May 8, 2016)The EM landscape is hardly on solid footing, just like the fragile global growth climate. All the short-term cheery moves aside, the fundamentals are not pretty and risk may be even higher than most want to realize.

Disconnection Realized (Again)

As for all hopes of economic revival or any basis for rate hike, once again the job numbers confirmed ongoing weakness. The notion that US recovery is strong or even immune from global slowdown makes less sense even for optimists.  Financial shares are battered, tech-related stocks are struggling with sustaining growth and central banks are admitting the lack of basis for hike rates. There is no shortage of weakness in the globe, as the case for crisis-like action is not far-fetched by any means.

Low interest rates have spurred stock market rallies  recently, but now there is a major shift taking place. Japan and Germany are classic examples where stock prices are now much lower despite having lower interest rates. For 2016, Japan's stock index, Nikkei is down 15% and  the German DAX is down 8%. Both are developed markets with lower risk perception, but the slowdown in growth, which battered EM last year, is now seeping into shareholders' minds broadly.  This action in Japan and German is either a prelude to US sluggishness or an over-due correction that’s been postponed. 

Perspective

Notably, the Nasdaq peaked on April 20^th, sending some early clues of slowing US equities. Interestingly, the Nasdaq was immune from commodity related slowdown recently, but the script is changing a bit. Interestingly, on that same day, the VIX (Volatility index) hit annual lows. Perhaps, this can mark a major turn-point as long awaited, despite many prior false alarms. At this stage, participants have a choice to go with the Fed’s narrative or to get cautious based on real live actions.  US job number weakness, slowing Chinese demand, outflow of capital in hedge funds, excessive complacency by most investors and misleading short-term optimism are all real signals.

If the Fed has lost credibility and ran out of ammunition, then a natural correction is not unreasonable. Rate hike possibilities now require a miracle and low-rates have failed to stimulate the real economy. As “Brexit” and election uncertainty loom, much distraction awaits, but the real economy has been weak for a long while. The Fed’s adored script has created a narrative that dismissed the ground-level pain at corporate and consumer levels. Perhaps, an unraveling action at this stage is not overly strange. Money managers have to confront the current data rather than being overly hopeful of unknown pending twists and turns.

Article Quotes:

“MetLife Inc., the largest U.S. life insurer, said it’s seeking to exit most of its hedge-fund portfolio after a slump in the investments. The insurer is seeking to redeem $1.2 billion of the $1.8 billion in holdings … MetLife, which has an investment portfolio of more than $520 billion, has been looking in recent years for alternatives to bonds because interest rates are so low. While results from private equity have been satisfactory, hedge funds have been more volatile, Goulart said. Chief Executive Officer Steve Kandarian is seeking to increase the portion of earnings that can be returned to shareholders. That focus on free cash flow factored into the decision to cut the hedge-fund investments, Goulart said. Competitor American International Group Inc. is also shifting allocations after posting three straight unprofitable quarters. The company said Tuesday that it has submitted notices of redemption for $4.1 billion of hedge-fund holdings through March 31. Average invested assets in hedge funds at AIG were $10.1 billion for the first quarter. (Bloomberg, May 5, 2016)

“This golden era has now ended. A new McKinsey Global Institute (MGI) report, Diminishing returns: Why investors may need to lower their expectations, finds that the forces that have driven exceptional returns are weakening, and in some cases reversing. The big decline in interest rates and inflation is reaching its limits, global GDP growth will be lower as populations in the developed world and China age, and the outlook for corporate profits is cloudier. While digitization and disruptive technologies could boost margins for some companies, the big North American and Western European firms that took the largest share of the global profit pool in the past 30 years face new competitive pressures from emerging-market companies, technology giants, and digital platform-enabled smaller rivals. These forces may curtail margins going forward. MGI’s detailed analytical framework linking investment returns to the real economy finds that returns on equities and fixed-income investments in the United States and Western Europe over the next two decades could be considerably lower than they have been in the past 30 years. The report, written in collaboration with McKinsey’s Strategy and Corporate Finance Practice, estimates that for equities in both regions, average annual returns could be anywhere from approximately 150 to 400 basis points lower, or 1.5 to 4.0 percentage points. For fixed-income, the gap could be even larger, with average annual returns between 300 to 500 basis points lower (3 to 5 percentage points), and in some cases even lower than that.” (McKinsey Insights, April 2016)

Key Levels: (Prices as of Close: May 6, 2016)

S&P 500 Index [2,057.14] – As 2015 showcases, a major resistance around 2,100 remains a crucial hurdle for buyers to overcome.   Previously, the index peaked in July 2015 (2132.82) and November 2015 (2116.48). April highs of 2011.05 failed to hold, hinting at another potential peak. 

Crude (Spot) [$44.66] – Signs of price stabilization appear around $38. From a big picture point of view, prices are still fragile after the heavy sell-off earlier in the year.

Gold [$1,289.00] –  A lengthy bottoming process has been occurring for over 3 years. The next target of $1,300 is on the radar. Some lively momentum is visible within the bottoming process.

DXY – US Dollar Index [93.88] – Since peaking at 100 on December 2, 2015, the dollar has weakened. After being a very crowded trade in 2015, the strength is fizzling a bit.

US 10 Year Treasury Yields [1.77%] – Hardly moving at all recently. The 50-day moving average stands at 1.83% and tells much of the recent story as yields remain low.

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 18, 2016

“Greatness is a road leading towards the unknown.” (Charles de Gaulle 1890-1970)

Hardly Settled

An ongoing wave of calmness resonates in the markets in which US stock volatility is still low, yields on European debt are relatively moderate and an all-out panic in the day-to-day is not quite felt. After all, the S&P 500 index is attempting to revisit all-time highs and Crude is not quite at the desperate lows it witnessed early in the year. A breather of sorts, after a turbulent January, is creating mixed reactions. 

Meanwhile, a the quasi-settled turbulence of the financial market  fails to tell the full story.  There are plenty of unsettled nerves in the intermediate-term, as the global political climate is perceived overly turbulent from Britain to Brazil to Russia to China. Western leadership is being questioned, since the global economy is failing to drive more confidence in the globalized and well-established system. Nationalism is in demand, as witnessed in European elections; and, deciphering the consequences of this trend is the ultimate challenge for money managers. The short-term gains from status-quo preservation via stabilization in financial markets are not answering the long-term concerns. 

Important to note, most of these concerns are not new. Significant capital is seeking risk exposure and desperate for returns. Therefore, the sentiment in stock markets is not quite the same sentiment as ground level discussions. Perhaps, all the unsettling issues do not automatically deter many from deploying capital. That’s the critical factor that may explain the ongoing disconnect between the real economy and financial markets.

Sectors' Duress

Financial services are being attacked from multiple angles, as pressure mounts for operators and investors alike. Hedge Funds have under performed recently, energy loans on banks’ balance sheets are troubling, negative interest rates by central banks are troubling, increasing banks' regulatory pressure is impacting margins, populists' vicious attacks on wall street are accelerating and revenue making opportunities for banks seem rather bleak  in 2016.  These are some of the well-known and documented matters. Mounting pressure on financial services can quickly translate to less faith in capitalism and diminishing global growth. That’s a danger to Western civilization and less appreciated in generic discussions. Ultimately that’s the long-term concern and the great unknown. This is the big picture concern that’s awfully difficult to quantify and remains in the back of the heads of most investors.  Unwarranted blames for political gains aside, the financial sector is facing a challenging period in both practical and ideological debates.    

Lively Movements

Emerging Markets (EM) have shown some recovery at least in terms of stock and currency movement. After an abysmal recent run in commodities and EM, the first quarter reminded us that stability is mildly possible:

“The best rally in emerging-market stocks and bonds in seven years is sending bears back into hibernation…Traders added more than $1 billion to U.S.-traded emerging-market stock and bond ETFs this month through April 15.” (Bloomberg, April 17, 2016)

Yet, skepticism is plenty, especially since the fallout in China is not understood. From stimulus efforts in China to tensions in the pacific to demand for Nationalism in the West that can lead to adverse trade relations, misunderstandings abound. Nonetheless, the rift between China and the West is not to be downplayed and the impact is mostly unknown. China is strengthening her ties with EM, especially Russia. At the same time, political tensions with Japan will continue to linger, and, at some point, that can convert into a financial risk.  Western leaders haven’t found a stable answer for China and corporations are realizing new challenges to navigate in China, as well.  Despite the short-term rally in EM, the long-term picture is murky. However, investors are not bothering about the long-term and are willing to live only in the present, for now.

Article Quotes:

“Speaking to the FT during a trip to Beijing, Alexei Moiseev said Russia expected to sign a deal this year that would link China’s national electronic payment network into its own soon-to-be-launched credit card system as part of measures aimed at reducing reliance on the west. ….Amid several rounds of negotiations over financial integration, many see Russia’s primary aim as access to China’s debt markets. Western sanctions mean many of Russia’s largest banks and corporations are unable to raise finance in dollars. Historically low oil prices have also hurt Russia’s economy and led to an increase in financing needs. Meanwhile, China is easing international access to its onshore bond market, estimated at some $6tr — the third largest in the world. Several western banks and corporates, including HSBC and Daimler, as well as South Korea, have over the past year issued so-called 'panda bonds'.” (Financial Times, April 17, 2016)

“For equity investors across the developed world, large chunks of the past year and a half have been miserable. But for different reasons. The International Monetary Fund, in an analysis, looked at the stock-price declines in Europe, the U.S. and Japan from the beginning of 2015 to the market bottom in mid-February of this year. (The U.S. and Europe have since recovered.) For Europe, the analysis tells a particularly dismal story: Corporate earnings play a bigger role in stock slumps in Europe than elsewhere–and corporate profits don’t look good. The IMF breaks the change in prices down into three parts: the risk -free rate of interest, the equity risk premium and the change in current and expected earnings…. The bottom line is that the decline in earnings explains a much bigger share of the decline in stock prices in Europe than it does in Japan or the U.S, and the outlook on that front is considerably more miserable.” (Wall Street Journal, April 15, 2016)

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

S&P 500 Index [2,080.73] – There has been a major upside move since February 11^th lows. Nearly a 15% increase since then. The ever so familiar range between 1,900-2,100 is being revisited. The May 2015 high of 2,134.72 is the next critical point.

Crude (Spot) [$40.36] –From $26.05 to above $40 showcased a sharp recovery that coincided with the equity markets in recent weeks. Now, there is an attempted stabilization around $40.

Gold [$1,227.10] – March 4^th  highs of $1,277.50 remain a key level in the near-term. Breaking above $1,250 has been a challenge last year and early this year.

DXY – US Dollar Index [94.69] – The Dollar weakness remains a big theme thus far in 2016.  The pullback from 100 to 94 in the near-term defines the current trend.

US 10 Year Treasury Yields [1.75%] – Yields remain closer to annual lows of 1.68%. It further confirms the weakness in the economy as it is perceived by bond markets. Climbing back to 2% seems possible in the near-term.

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.