Market Outlook | July 19, 2016

“The English never draw a line without blurring it.” (1874-1965)

Blurred Reactions

As US stocks hit all-time highs, some may view this as a signal of massive improvement and vibrant real economy. Others might see this as large corporations with exposure to multiple countries having a relative appeal. Meanwhile, for some this is a result of very low interest rates that limit the option of “attractive”, liquid investments, which ends up benefiting the US equity markets. Whichever theory is more right is not  relevant, but looking at the headline number only may send a misleading message about the market dynamics and potential risk ahead.

On July 6, 2016 following the Brexit reactions and some overreactions, the US 10 year Treasury Yield hit a low of 1.31% while Gold reached its annual highs of $1366.25. Low yields and higher Gold prices are the classic result of participants rotating to “safer” assets.  Both are critical inflection points that may be revisited if flight to safety turns  rampant, or they will be a reference point until the next unease and notable unrest. Have investors felt less nervy since early July? Are investors even clear what to worry and what not to worry about? 

Surely, Gold’s gains this year are driven by several factors. Commodities were cheap at the end of last year following a multi-year downturn.  Central Banks are running out of monetary tools / solutions, which makes Gold the anti-Central Bank bet.  In a world of too many negative yielding bonds, the urge to move to other asset classes (i.e Gold)  is an incentive that helps Gold prices. 

The initial Brexit response drove the Volatility Index (VIX) to 26 on June 27^th. Since then a complete collapse of the volatility index fell to below 15. This showcased the perceived risk of Brexit was very short-term oriented.  A complete lack of fear led to S&P 500 index hitting all-time highs despite so many tangible concerns. Through most of July, fear has been losing value and now trading “cheap”, while the status-quo (higher stocks) has been in favor again. Brexit risks on US markets are not quite understood. The market  overreacted, but then marched on to a very familiar beat. Interestingly, the impact on London Real Estate and funds that have links to the UK are feeling some pain, with investors feeling a bit panicked. Yet, that hasn’t caused a widespread global reaction as of yet. Plus, more Brexit deliberation will provide some color, but Europeans' woes will be discovered as well.

Fuzziness Persists

Financial markets may not be reflecting the precipitating concerns related to weaker growth, increasingly negative global yields, an aging population, dynamic political risks, policy risks in Europe and the Central Bank’s shaky credibility. All these factors are on the table  because they cause mild anxiety, but the consequences are either greater than expected or not fully realized. Much of day to day economist and political strategist discussions circle on the issues above, but the markets are not responding to this.

In some cases, the political and economic worries are brewing and playing out viciously. However, the lack of meaningful reaction to Brexit and lack of volatility towards the wishy-washy Central Bank attitude confirms three things: 1) Liquid markets are very efficient in digesting information 2) Liquid markets are very short-term oriented and not overly bothered with long-term implications 3) Lack of desirable yields make US equities and other developed world equities attractive even if the fundamentals are hardy stellar. 

Amazingly, all-time highs in stocks via S&P 500 index  fail to match the political and economic anger that’s brewing on the ground-level. This disconnect causes confusion for some, rage for others, but is out of sync for the general population. This fuzzy set-up is tricky in managing risk as illusionary perspectives cause further uncertainties.

Long-term Shifts

Anti-West leaders from Turkey to Iran to Russia and China are beginning to shape the future of Asia and Europe. At this moment, the markets are inundated with short-term matters, such as possible rate hikes (or rate cuts) and relatively appealing investments in a very low interest rate environment.  But as anti-west regimes such as Erdogan and Assad continue to stay in power, the ambitions of Putin and the communist Chinese government is the wild card for those looking at their business interest. Many “worrisome” matters have been shrugged off by public financial markets.  From Ukraine to Syria, to Brexit a spark in volatility or massive sell-offs have been measured. We’ll see if the failed Turkish coup causes any meaningful panic-like response. 

In a period where globalization is being challenged by Western political leaders, the not-so-friendly partners of the West are re-visiting their personal ambitions. Operators need to remake their business models, attempt to find growing areas and cut losses in unstable areas. At this stage, the myopic nature of liquid markets is where the desperation for yield is bigger than the fundamental nuances.

Article Quotes:

“Asian investment-grade dollar bonds offer a premium of 347 basis points to 10-year German bunds, 190 basis points more than similar-maturity U.S. Treasuries and of 58 basis points to similar-rated debt of American companies, based on indexes from JP Morgan Chase & Co. and Bank of America Merrill Lynch. While the return on the region’s corporate notes has trailed their U.S. and global peers this year, they’ve outperformed both since 2014, the indexes show. The amount of sovereign and corporate bonds with zero or negative yields has doubled to $10.1 trillion since Britain’s June 23 vote to exit the European Union. A shrinking supply of debt from Asian issuers is enhancing their allure, especially for those who can fund investments by borrowing money at negative interest rates, according to Credit Suisse. The European Central Bank’s purchases of investment-grade corporate bonds since June is also starving investors of opportunities in that continent.” (Bloomberg, July 14, 2016)

“According to China International Capital Corp., the country's pension funds may invest about 100 billion yuan ($15 billion) in domestic stocks this year as they hand over some of their money to the National Council for Social Security Fund. This could inject a good deal of institutional chutzpah into a market plagued by excessive participation of individual investors and perhaps start a virtuous cycle of allowing professionals to manage retirement savings. Statistics on the make-up of trade in Chinese markets are scant, but the general understanding is that about 80 percent is your average Joe, or Zhang, rather than portfolio managers who are paid to analyze companies and trends. Even last year's crash wasn't enough to abate the common man's growing love of A-shares: Stock-trading accounts increased 51 percent in 2015.” (Bloomberg, July 11, 2016)

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

S&P 500 Index [2,161.74] – All-time highs appear again.  The breakout above 2,100 was sharp and mainly driven by a near 9% rally following the Brexit lows. Sustaining above 2,100 for an extended period remains the near-term challenge.

Crude (Spot) [$45.95] –   Stabilization mainly defines recent action. The last few years showcased oversupply of Crude, which is well known and reflected in prices. Since the last 7 trading sessions, Crude is attempting to stay above $44 as maintaining $50 proved to be short-term.

Gold [$1,327.00] – Major acceleration since the May 31, 2016 lows of $1,212.10. Topping July 6^th  highs of $1,366 is a key challenge for Gold bulls. Most of the year has been favorable for Gold, since the market has been in a period of unstable central banks and political climates.

DXY – US Dollar Index [96.58] – May and June have witnessed strength in the US dollar. A recently reversal after a slow start to the year where the Dollar weakened a bit. Growing unease of other currencies will determine much of the dollar strength in the near-term.

US 10 Year Treasury Yields [1.55%] –   Although yields closed a bit higher than annual lows of 1.31%, clearly yields are much lower than most expected at the start of the year. The rush to safety and lack of anticipation of rate hikes continue to drive yields much lower.

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 | July 5, 2016

“Confusion now hath made his masterpiece!” William Shakespeare (1564-1616)

Early Digestion

The post-Brexit market reactions turned into perceived “overreaction”, as global equity markets rebounded and volatility calmed down dramatically. As the second half of 2016 begins, there is this feeling that “all is manageable” by the Central Banks, and the ongoing thesis of low rates, higher markets will continue in a smooth sailing manner. Perhaps, that’s a desired outcome of those deeply entrusting the Central Banks' narratives and their PR efforts. Many institutions and investors are typically taking commands from the Central Banks and might be gravely mislead.  Sure, markets did rebound and the “panic” mode transferred quickly into business as usual, as calmness resumed to the good ol’ status quo. However, it is not quite convincing that the status-quo thinking  is reliable when moving forward.

Further Questions Piling

That said, is a zigzagging market a reflection of stability or a collection of clueless participants? Is there any confrontation in concluding that Brexit effects are understood? Isn’t nervousness warranted, as more Italian Banks are in crisis mode, Brexit negotiation are still misunderstood and the Eurozone is weaker than before? Isn’t a market rally disconnected with real economy hardships and frustrations? Aren’t low rates signaling potential fear, lack of growth and loss of central bank Credibility? More questions to ponder.

Perhaps, the massive sell-off and the “resilient” recovery illustrate one thing: confusion. If last week’s action is viewed as market confidence rather than confusion then that can pave the way for another negative shock.

1)   Bond markets do not buy into strength in the real economy = Lower interest rates.

This applies not only in US markets but across developed markets where yields are either very low or negative. There is over $11.7 trillion of negative yielding government bonds in the world led by Japan and Europe. This is phenomenal from a historical point of view, and entering uncharted territory. Certainly, negative yields are not a one-time skew, rather a well-established trend.

Central banks are waging a war against those realists and skeptics who are dumbfounded by the monetary policy. The Fed is not conceding easily regarding prior mistakes, and are shamelessly willing to move from rate hikes to possible rate cuts in the UK and US.  The long drawn out weakness showcases the fragile Western economies, which has been ignored.

2)   Commodities viewed as a bargain as well as a relative “shelter” = Price recovery.

The CRB Index bottomed on January 22, 2016, starting a recovery. Of course, commodities were butchered for about 5 years or so (2011-2015). Certainly, Gold has received a lot of attention, climbing out of the so familiar $1,200 range. Importantly, the less trust investors have in central banks, then the more likely that Gold becomes the “go to” asset through customary practice. There is still a debate if Gold acts likes currency or a commodity. Gold tracks closely with commodities when examining the last boom and bust behaviors. Yet, the accelerating uncertainty in currencies and central bank actions is mounting. 

At the same time, copper is reviving itself and, for some, it is a leading indicator of global growth. Unlike Gold, which is relished as a defense position, copper is viewed as a barometer of economic strength and used by some analysts as a leading indicator.  The strength in copper might be a barometer for global growth or further reflection of a commodities uptick. Deciphering this will be critical in the near-term. However, commodities at this cycle are not near the “top” and are attracting few bottom-pickers.

3)   Shift in perceived Emerging Markets = Buying opportunities. 

The weakness in Europe and the rampant demand for nationalism is making developed world appear not as stable as a year or so ago. If another element of uncertainly is circulating in the Western world (economic, political and /or military) then the additional risk of Emerging Markets does not seem overly “scary”. Surely, EM is recovering after an abysmal period of slow growth, FX damages and an inevitable cycle peak that materialized few years ago. That said, as the BRICS attempt to dig out of a hole and commodity reliant nations seek to stabilize, there is some risk-reward opportunities that participants will consider, especially when desperate for yields. 

Mismatching Story

Central Banks are clashing with the day to day realities, as the bond markets are not buying it.  As Yellen claims, recession possibilities are “very low”, the 10 Year Treasury is below 1.50% (hitting annual intra-day lows last Friday at 1.37%). The Fed is massively struggling to convince participants about their stale and usual narrative. In other words, the Fed’s story is not matching the economic data, business climate and unfolding political dynamics. The obsession with stocks in the US may cloud the vision of average observers in terms of economic health. However,  with populism and nationalism becoming a theme in the Western world, a wake-up call is quite visible at this stage.

Perhaps, the S&P 500 index is hinting another signal, where buyer’s momentum is stalling around 2,100. Maybe, the stock biased observers need to see a correction; even though, the bond markets flat-out are declaring soft economic growth. In addition, the quick rise and fall of the volatility index showcases further a long bias that’s deeply ingrained in this market. There are cracks in the Fed’s messaging and theories, but they are not collectively appreciated. Perhaps, the harsh reality check of “confusion” by the Fed can create  a quicker migration into safer or non-developed world assets.

Article Quotes:

“Europe and America have economies of a similar size, but the aggregate market value of the top 500 European firms is half that of the top 500 American firms. Aggregate profits are 50-65% smaller, depending on the measure used. Of these firms, the median American company is worth $18 billion, with net income of $746m in the past year. The median European firm is worth $8 billion and earned only $440m. It wasn’t meant to turn out like this. In the 1980s corporate Europe was held back by a patchwork of national boundaries, the heavy hand of the state and cross-shareholdings with banks and insurance companies. Starting in the late 1980s new ideas emerged to reinvigorate European business. There was a trend towards privatizing industries and making them answerable to investors. There was a push to create pan-European firms that would compete across the EU’s single market using, in most countries, a single currency. And there was a drive to take European firms global, exploiting the historical links of their home countries around the world.” (The Economist June 30, 2016)

“Italian banks never recovered from the last crisis. Larded with bad loans, several depend on support from the Italian government-organised private investment fund Atlas, as well as the ECB’s liquidity facilities. Still more capital is required. Buyers could be found for non-performing loans if they were marked down far enough. But those markdowns would make official the well-known holes in the banks’ balance sheets. This in turn would require the banks to raise more equity — for which there are no buyers apart from Atlas, which is just about out of money. The worst case scenario would be if depositors, many of them the small- and medium-sized enterprises at the core of Italy’s economy, moved their cash to banks that are perceived as less risky, causing a liquidity squeeze. More immediately, banking wobbles could create political trouble for Matteo Renzi, the prime minister, who is facing opposition from Italy’s populist Five Star Movement and worries about losing a constitutional referendum he called for October.” (Financial Times, June 30, 2016)

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

S&P 500 Index [2,102.95] – Once again, 2,100 is proving to be a critical point. In the past, buyers' momentum faded near this range. However, at the same time, sellers' momentum stalls at the 2,050 range.  Thus, the bullish bias remains intact while sideways action sums up the recent moves.

Crude (Spot) [$48.99] – Further signs of stabilization appear between $45-50. The February 12, 2o16 lows of $26.o5 seems like a while ago. Since then there has been stabilization.

Gold [$1,340.00] – Positive momentum since the start of the year. A positive trend accelerated above $1,300; August 2013 highs of $1419.00 will be the next target.

DXY – US Dollar Index [95.64] – For over three months, the dollar index stabilized around 94. Unlike in 2014 and 2015, the dollar strength is not surging at the same pace. Fair to say, a relatively strong dollar is still in place.

US 10 Year Treasury Yields [1.44%] –   Since peaking on December 4, 2015 at 2.35%, yields have resoundingly declined below 1.50%. Again, the bond markets are not seeing a vibrant growth in the real 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 | June 27, 2016

“Surprises are foolish things. The pleasure is not enhanced, and the inconvenience is often considerable.” (Jane Austen 1775-1817)

Digesting Surprises

To the surprise of many, Brexit materialized and markets reacted. In short, results were historic. The element of surprise is not pretty, especially when the stakes are much higher. Hence, Friday’s (June 24) swings and demonstrative reactions across key markets.

“The $2.08 trillion wiped off global equity markets on Friday after Britain voted to leave the European Union was the biggest daily loss ever, trumping the Lehman Brothers bankruptcy during the 2008 financial crisis and the Black Monday stock market crash of 1987, according to Standard & Poor's Dow Jones Indices.” (Reuters, June 26, 2016)

Brexit is not the cause of a multi-year decline in global growth. Rather the effect of a weak European Union, frustration over lack of real economy vibrancy, reflection of poor Western pool leadership (on local and global basis) and a reality check for overly-inflated markets. What has inflated select markets can be attributed to the "disconnect" that's been persistently in developed equity markets ‎and select real estate investments.

Several basic questions need to be asked about the formation of the European Union in 1993. If European countries were in a position of strength in the first place, why form a union? If the Economy was strong then, why would “Brexit” be such a big deal? If the Union was so great, why did Brexit materialize?  In answering all these questions, one must grasp the biases and agendas of this storytellers. All that said, there is no denying that the union is weak, just like the Eurozone economies.

Early Conclusions

The last four years have showcased three grand themes:

• The US and other nations failed to stimulate real and vibrant growth that sustains the middle class and small-mid size businesses.
• The loss of Central Bank’s creditability, who have kept rates low while failing to admit the minimal impact on stimulating economies. Now with more desperation, Central Banks will look to provide liquidity while orchestrating “crisis management”     
• The lack of future faith in globalization since the flow of goods, capital and people has not translated to wealth creation across local economies.

One critical perspective to keep in mind: The interest rate hike discussion in the US is looking more and more off the table, regardless of Brexit. Perhaps, now Yellen may have found an excuse or an "out" to claim that a rate-hike is not feasible due to the current uncertainly. However, prior rate hikes were unjustified, the Fed’s narrative was misleading (albeit not fully recognized), and the economic reality in being confronted in a harsh manner has set in. Central Banks from Japan to England to ECB are forced to adjust to current conditions, but most of this is caused by self-inflicted wounds. The complete dismissal of the truth by financial leaders has postponed the inevitable correction, which is way overdue.   

Days Ahead

As reactions and over-reactions are being understood and executed, the broader question relates to market behavior over the next six months. Digesting the news quickly is more vital than being consumed with the theatrics of volatility and media obsession.

Exploring the Next 6 Months:

1)     A US Interest Rate hike is very unlikely in 2016.

In a world already consumed with negative rates, that theme is not bound to change. US 10 Year Yields already hinted at further decline months before, and bond markets are unimpressed with US economic data. Thus, unless there is a miraculous real economy revival, further economic weakness may trigger discussions of rate cuts rather than rate hikes. Perhaps, that’s the surprise of all surprises ahead.

2)     Volatility in public markets to continue.    

                                           

      Turbulence is a function of two issues. First, the surprise element leads to shock-like responses, which turn into violent short-term moves. Basically, emotion-driven responses. Second, the unknown will be even more mysterious than usual. Thus, timing the end of the turbulence is extremely difficult, which makes more investors seek “safer” assets for shelter.

3)    Brexit can trigger new themes and opportunities.

In the last five years, both commodities and Emerging Markets (assets and currencies) witnessed massive price corrections. Gold is attracting new momentum, while other commodities still appear cheap relative to last decade prices. Meanwhile, EM themes that were in desperate conditions may look relatively appealing as the Eurozone mess is exposed once again. Plus, in a world of low interest rates, further risk taking may be welcomed in less overvalued areas. From Argentina to China, bargain hunters may seek ideas as developed markets wrestle with ongoing volatility.

Bottom-line: In the weeks ahead, the market is gearing to rotate from digesting a surprise to grasping the new landscape. However, this rotation may materialize much faster than the consensus expects. Capitalizing on quick changes early might be where the big reward lies. 

Article Quotes:

“China responded to a surge in the dollar by weakening its currency fixing by the most since the aftermath of August’s devaluation. The People’s Bank of China set the reference rate 0.9 percent weaker at 6.6375 a dollar. A gauge of the greenback’s strength climbed 1.8 percent on Friday, the most since 2011 as the U.K.’s vote to exit the European Union ignited turmoil in global financial markets. The victory for Brexit pummeled the pound and high-yielding assets as more than $2.5 trillion was wiped from global equity values. China shared $598 billion in trade with the EU last year, second only to the U.S., and slowing growth and capital outflows make the nation vulnerable to the effects of the Brexit vote, according to Bloomberg Intelligence economists Fielding Chen and Tom Orlik. If Brexit does trigger a significant adverse impact on European demand and global investor sentiment, China could be among the Asian economies least well-placed to respond, they say.” (Bloomberg, June 16, 2016)

“The UK makes up just 1.6 per cent of world oil demand, so crude should not be too affected by a Brexit vote, many traders think. But some analysts think the market is being blasé. The oil market, while primarily driven long term by supply and demand, can be heavily influenced in the short term by currency moves and traders’ risk appetite. In the event of a Brexit the US dollar is expected to strengthen sharply, weighing across dollar-denominated commodities as they become more expensive for holders of other currencies. There may also be a flight to safety — in such a sell-off oil tends to get dumped by the fast-money in favour of assets like gold. The Greece crisis in 2012 helped trigger a near 30 per cent drop in the oil price, albeit from a level well above its current price of $50 a barrel. Demand is also not entirely removed from the equation. While the UK’s 64m people consume only 1.6m barrels a day — compared to 19.6m b/d in the US, the world’s largest oil consumer — the total EU bloc covers more than 500m people and accounts for almost 15 per cent of global oil demand (12.5m b/d). A Brexit is expected to be followed by greater uncertainty across the EU, probably hampering growth in an area where oil demand was already declining for much of the past decade.” (Financial Times, June 23, 2016)

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

S&P 500 Index [2,037.41] – Failed at 2,100 in April and again in June. In the near-term stabilization around 2,050 will be watched closely. However, based on the recent moves in the 2+ years, a move to $1,900 appears like the next target.  

  

Crude (Spot) [$47.64] – The commodity is trading within a set range of $46-50 at a  50-day moving average of $46.79, which will be tracked closely by technical observers.

Gold [$1,315.50] – A break above $1,280 marks a new, positive momentum. Staying above $1,300 seems feasible if the shift toward safe assets continues to emerge. Even before Brexit, stabilization was forming.   

DXY – US Dollar Index [95.44] – A massive one-day move. Before the Brexit commotion, the currency index was slightly dull in a range bound trade.

US 10 Year Treasury Yields [1.60%] –   The break below 1.80% earlier this month showcased the weak global economy and lower chances of a rate-hike. Meanwhile, the post-Brexit response was very pronounced, hitting the extreme range of 1.40% at one point during Friday.

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 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.