Market Outlook | August 29, 2016

“Rules are for the obedience of fools and the guidance of wise men.” Douglas Bader

Misguided Calmness

As the Fed chatter and massive obsession continued last week, the battle between the Central bank and bond markets continued to play out. The Federal Reserve continues to operate with public relation tactics, sending out an army of economists to “talk-up” the financial markets and economic conditions. Once again, a rate-hike is on the table, stirring up headlines, but the skeptical crowd is smelling some desperation. Others sense an election year has its own nuanced story and impact to the Fed’s reactions. Some have  all types of explanations, but the mystery of how this cycle ends lives on. It is a mystery that’s been contained with near-term calmness, but the “quiet” bullish run is justifiably reaching questionable ranges despite no visible signs of worries. 

For a long-while, the bond markets have been skeptical about US growth and fundamental economic expansion. As US 10 year yields remain below 2%, the concept of a rate-hike has not been taken too seriously as the data is murky.  Further improvement in economic data, less fear of recession and some additional revival in the energy sector can provide a further boost for rate-hike justification.  Yet,  strong growth is not clear-cut, mixed data fails to tell the whole story and the status-quo is actually making participants more  anxious.

 The debate whether to raise or not to raise interest rates has turned to more of a theatrical spectacle for financial media and investors' circles. However, the last few years have showcased a tangible pattern of low to negative interest rates, subdued volatility and increased demand for “riskier assets”. Within this context, the Fed faces a skeptical crowd,  unimpressive economic growth and a stock market that’s not quite cheap. Altering messages from the Central bank have stirred enough confusion and created a doubt of creditability, but has not harmed shareholders and bulls significantly. In fact, the bears have capitulated various times as the Federal Reserve attempts to strong-arm the audience into their thesis.

In or Out.

At this stage of the rally, investors are facing a critical question: Whether or not to chase returns in equity markets as the S&P 500 index flirts with all time highs. As the stock rally continues, there is pressure mounting for investors to feel the urge to jump along with the trend. However, there is a risk of assets topping. The warning is there, but the event itself has yet to occur.  Nonetheless,  still there is escalating risk in abiding by Yellen & Co’s plans and views.

How many times have markets heard of a chance of a rate-hike? Last year symbolic rate-hike was not quite earth shattering or convincing. Seriously, there is a credibility problem. Equity markets and other assets have appreciated to make headline splashes, but the substance-light rally is under scrutiny. The Fed, entangled between near-empty promises and loss of credibility, is trying to manage the same bubble it created. Calling a market top for experts has been a brutal exercise, and hedge funds have under-performed, especially with volatility muted. However, it's the invisible that's more worrisome than the more visible market-related headlines. The Fed's bluff is tiring investors, so  much so that they may question if they are with the Fed or willing to sit on the sidelines.

Short-term Digestion

The Dollar strength will be watched closely in the near-term as it relates to rate hike chatter. ‎Asian markets and EM currencies will be evaluated closely as well for some clues.  China’s weakness is being revealed slowly; and US banks are another source that may look at rate-hikes favorably, assuming shareholders believe it’ll actually happen. Amazingly, Yellen's speech itself is enough to stir further speculations on pending actions. Unless, there is a notable market move, most bulls may feel less compelled to sell, especially in a world where Eurozone remains grim, Asia’s growth is not impressive and other markets are still feeling the commodity price readjustments.

Short-term over-reactions and under-reactions can create more confusion rather than clarity. Thus, the next few weeks ahead are tricky from an analytical point of view, but investors must have a firm stance before making a move.  It should be reiterated that to listen and to trust Central Banks narrative is ultimately a choice. Investors have the choice to double down on the Fed's narrative or reduce exposure to Fed-driven markets. More than speculation, courage is one way to dodge major bullets from a risk perspective. Some sparks of rising volatility were seen last week in VIX (Volatility index for stocks). Short-lived or not is another matter, but for now staying disciplined and not overreacting to each new piece of data is a valuable approach.

Article Quotes:

“China’s banks are set to be the biggest losers in the sweeping bailouts of the country’s steel and coal industries. Local governments hoping to save their steel mills and coal miners have announced a series of restructuring plans, enlisting the banks to take the hit by improving the terms of the loans or swapping them for bonds or equity in the struggling groups. The reliance on the banking system to shoulder the burden comes at an inopportune moment, with China’s banks already mired in bad debt — about Rmb15tn ($2.25tn), or 19 per cent of total commercial lending by some accounts. Profit growth at the banks has also fallen over the past two years and could deteriorate further as many of the country’s largest industrial players renege on loans for better state-brokered deals…. The contentious debt-for-equity programme announced earlier this year, in which banks will be asked to swap debt in exchange for equity in ailing companies, would help the banks remove bad debt from their loan books in the near term.” (Financial Times August 28, 2016)

“In recent years, bond yields have been behaving in strange ways. The yields on many government bonds have fallen to historically low levels; in some countries, like Germany and Japan, some have actually turned negative. An investor who pays €100 for a 10-year German government bond will receive less than €100 back if he holds that bond until it matures. Such weirdness looks even more bizarre in Japan, where the government has racked up debt worth nearly 250% of GDP: an obligation one might expect to dent confidence in the government’s credit. Some investors blame central banks for these oddities; they have been printing money and buying bonds (raising the price and pushing down the yield) in order to encourage firms to do more borrowing and investing. Others blame a shortage of safe assets, like government bonds, which are increasingly used as collateral in banking systems and as the savings vehicles of choice in emerging markets. Still others see in low yields a sign that the long-run growth potential of the world economy is declining. The debate cannot easily be resolved. But freakishly low yields do suggest that something strange has happened to financial markets, to the global economy, or to both.” (The Economist, August 24, 2016)

Key Levels: (Prices as of Close: August 26, 2016)

S&P 500 Index [2,169.04] –  August 15, 2016 highs of 2,193.81 set the near-term barometer. This is a very mild short-term pullback in recent trading sessions. More stronger selling is needed to suggest a pending shift in trend.

Crude (Spot) [$47.67] –  A very sharp rise from August 3^rd lows ($39.19) to August 19 highs ($48.75). The suspense remains regarding Crude price's ability to stay above $40, especially after a quick run-up.

Gold [$1,318.15] –  Heavy resistance is forming around $1,350. Investors recall Gold’s inability to surpass $1,400 in 2014, which remains a psychological hurdle for gold bugs.

DXY – US Dollar Index [96.19] –  Most of this year, the dollar has not maintained the same similar strength as before, but it has stabilized around 94. Some signs of a turn are developing but further evidence is needed.

US 10 Year Treasury Yields [1.62%] –  After breaking below 1.70% in June, yields have attempted to climb up as the bond markets fully rejected the “growth” stories. Now investors await a climb back to 1.70%. 

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 | August 22, 2016

 “But this long run is a misleading guide to current affairs. In the long run we are all dead.”  (John Maynard Keynes 1883-1946)

Collective Revival

After a brutal January 2016, US stocks climbed back up, demonstrating strength and 

reaching record highs. Even Brexit worries did not derail the S&P 500 index, Nasdaq and developed markets. Simply, various market-related concerns mainly ended up being very short-lived and the rally marched on. For every investor the assessment of risk gets trickier by the day. Elevated markets these days are not limited to stocks, since bonds have also rallied significantly.

Interestingly, commodities and Emerging Markets have recovered from “desperate” levels, further emphasizing the ongoing tolerance for “riskier” assets.  Finding bargains is not that easy across many well-established areas, especially at mid-year. Even less than quality areas have found enough buyers either out of desperation for yield or some “perceived” fundamental improvements. The market participants are hardly shy; investors may talk as if they’re nervous, but recent actions suggest further trust in Central Banks and less panic. 

Chasing returns at the wrong part of the cycle is a deadly and dangerous game, as many cycles before have proven. Hedge Funds have tried to revive themselves after a difficult period where differentiation has lacked between thousands of managers. China is not much of a reliable story, and faces its own woes in terms of financial systems. Political uncertainty lingers in the Eurozone to other less established nations, but it is not quite a market moving matter. The US dollar remains a critical barometer for asset classes and currency moves, but the dollar has been mostly trading in a small range and not setting any alarming trends.  Investors have plenty to digest, but the art of knowing which macro trend is relevant at what specific time is highly precious. Otherwise, some of the macro noise may not be too relevant in financial markets despite the multiple brewing macro related factors.

The Credibility Game

For a long-while the bond market has not been buying the strength in the economy.  With US 10 year Treasury yields below 2%, it reconfirms that the Fed’s constant “posturing” lacks credibility. Plus, the Fed’s very limited execution on rate-hikes, besides last December, begs further questions about their trustworthiness. It is a period of calmness on the surface, but terrifying precariousness below. Amazingly, the Fed may force a rate hike because crying wolf too many times is a very damaging blow.

Recently, 3-month Libor rates have  risen, Crude has somewhat stabilized and even 10 year yields have moved up, albeit slowly. All these give the appearance of less worries and more calmness than before. In fact, the sentiment is shifting toward a more positive territory, but 

perception of the risk is all out of whack.

Regarding Junk Energy Bonds: “It seems as if traders are simply disregarding the possibility of another decline in oil prices, or another wave of bankruptcies, simply in their zeal to capture any extra yield they can find. They justify this by telling themselves that the shakeout has already happened and that the energy market is in full recovery mode… It seems investors are demanding a remarkably small premium for all those uncertainties.”  (Bloomberg, August 18, 2016)

Courageous Thinking

The bold and courageous move in this climate is to walk away from the all-time highs in stocks and elevated bond markets.  The Fed may seem untrustworthy with their messaging, assets are too pricey by several measures, and increasingly more market behaviors are driven by the desperation of yield or investors chasing returns. Regardless, the sentiment is shifting more bullish and the upside limit is the big unknown in days and weeks ahead.

Bond markets have not feared a rate-hike for most of this year. That’s been interpreted as bond markets not buying into the economic strength  painted by federal government data; this is a recurring pattern. Interestingly,  as Libor begins to rise a bit and a new round of Fed posturing regarding rate-hikes emerges, there is a growing anticipation of some Fed action.  Yet, an elevated stock market and housing prices fail to capture the struggles of the real economy’s growth potential  Several failed policies and shaky confidence in small businesses add to the stress. Disruptions in multiple sectors also create further damage to many business models on top of all this.  One example of bearish, real economy is the retail sector:

“Sluggish sales at Macy's are hurting more than just the mega-retailer itself. The department store chain recently announced that it would be closing 100 stores in a bid to shore up business. That could impact about $3.64 billion in commercial mortgage-backed securities debt, according to a report by Morningstar Credit Ratings' Steve Jellinek and his team…. These anchor tenants make up a sizeable chunk of mortgage-backed deals, and regional malls typically suffer large losses when vacancy rates surge and loans go into default.” (Business Insider, August 17,2016) 

The damage to the US retail sector goes beyond the sector, impacting other investors, which is another reminder of the weak economic status despite the posturing from the Federal Reserve.

Article Quotes:

Chinese leadership: “Since coming to power almost four years ago, Mr Xi has waged a campaign against corruption. On one reading, this is to clean up the system before he undertakes political reform. On another, it is at its heart an old-fashioned purge of his enemies. Similarly, Mr Xi has centralised power, taking jobs and responsibilities that his predecessor delegated to others. Some observers think this shows he is strong; others conclude that he has been forced to act because he feels weak. Such contradictions are the backdrop to rumours about the forthcoming leadership changes. The only certainty is that the churn will be enormous. By late next year, five of the seven members of the Politburo’s Standing Committee will have reached retirement age. One-third of its 18 other members are due to go with them. In the coming months, as the combination of promotion and retirement cascades through official China, leadership posts will be shaken up at every level of the party. Hundreds of thousands of jobs will be affected, down to the level of rural townships and state-owned enterprises.” (The Economist, August 20, 2016)

Europe struggling to find growth: “Some central bank watchers think the ECB will also ease the rules governing which bonds can be bought under the flagship QE programme. The minutes offered little clue as to how the rules could be relaxed, saying only that the lack of evidence on how the latest headwinds would affect the eurozone meant “it was widely felt among members that it was premature to discuss any possible monetary policy reaction at this stage”. Research published by S&P, a rating agency, on Thursday suggested the UK leaving the EU could limit the effectiveness of the ECB’s negative interest rate policy, by lowering the value of the pound against the euro — though policymakers are more concerned about the exchange rate to the dollar. Financial markets has weathered much of the turmoil that followed the UK’s Leave vote, but share prices for financial companies were still volatile and remained below their pre-referendum levels. This reflected concerns over banks’ low profitability in an environment of low rates and weak growth, as well as high volumes of bad loans.” (Financial Times, August 18, 2016)

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

S&P 500 Index [2,161.74] – Breaking above 2,100 was noteworthy this summer. Several all-time highs beg further questions. A 20%+ rally since February 2016 lows suggests a remarkable turnaround.

Crude (Spot) [$48.52] – Attempts to re-visit June 9, 2016 highs of $51.67. Interestingly, earlier this month Crude sold-off quickly to $39.19.  The lack of ebb and flow in recent trading action calls into question price stability.

Gold [$1,346.40] –   An ongoing rally continues this summer and calendar year. December 17, 2015 lows of $1,049.40 marked a new bottom.  As the dollar's  strength slows down, Gold has gained further ground.

DXY – US Dollar Index [96.19] –   After establishing strength in 2014, the dollar has traded in a narrow range for the last 18 + months.

US 10 Year Treasury Yields [1.57%] –    In the last month, yields traded in a very narrow range between 1.50-1.60%.  July lows of 1.31% stand out as a possible major low in yields (top in bonds), yet the narrow current range does not provide a clear picture of a trend.

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 | August 8, 2016

“When an empire fears for its survival, its prime has passed.” (Martin Dansky)

Further Chase

As another week ended, S&P 500 index and Nasdaq posted another set of all-time highs. Now that begs a familiar question: If the US labor market and other indicators suggest an improving economy, then why has the Fed not raised rates?  Yes, the answer is not that simple, as many will say. However, the Fed's message fails to match the institution's actions. First, is there actual growth or is it just cosmetic deception? Second, what’s the definition of noteworthy “growth”? The answer for both questions appears rather murky. Yet, constant record highs drive up further demand for stocks, especially when investors psychologically begin to feel that they’re missing out. History teaches us that the urge to participate in order not to be “left-out” is dangerous at the end of a cycle.

As participants decipher the Fed’s next move, one thing is certain: The narrative of financial markets is heavily controlled by the Central Banks from Japan to Europe to the US. The “narrative” is the story line that analysts, financial media and large institutions believe as the dominate theme.  In the US, the Fed mastered the art of controlling the news flow, influencing analyst interpretation and institutional investors' mindsets. Of course, investing is optional, but sentiment is too influenced. It is rather stunning how independent thinking is less vibrant in today’s market and “centralized” thinking is more prevalent. In other words, the Federal government’s hands are too involved in the market, making few question if the “free-market” is still in play. One must wonder if capitalism is still alive as bureaucratic approaches expand in DC and the Eurozone.

“More government” is a theme that’s felt in regulatory discussions as well as “bail-outs”. Now the Fed embodies that national power of conducting the market orchestra. Thus, stocks are at an all-time high even when bond markets have been skeptical of economic vibrancy.

Digesting Trickery

This year, from January to May, a few macro trends stood out:

1.      The Dollar was weaker than in prior years.

2.     US 10 Year Treasury Yields decelerated sharply.

3.     Commodities firmed up until peaking in June.

4.     US stocks re-accelerated after bottoming in early February.

The first two trends are noteworthy themes that are driving current momentum. Until Yields go higher, the status-quo remains in a place in which a sideways economic pattern encourages further investing in stocks, as other options are limited.

At the same time, the fist two trends  don’t answer key questions that lay ahead: Is a weaker dollar equivalent to a stimulus? Does a sub 2% yield in US 10 Year Treasuries reflect the lack of convincing growth? What clues does this provide regarding interest rate decisions?

It seems like a lower rate is a very established theme and investors are used to it. In fact, even a “good” US labor result is not going to whip out the skeptical bond market response. More guidance is awaited from Central Banks, as most begin to believe that the CB’s have exhausted all their options. As to how this all plays out is mysterious, but disregarding any risk potential is as negligent as it gets. 

Mysterious Risk

It is a puzzling time for asset managers who knowingly do not want to take risks on “inflated” ideas. At the start of the year, Emerging Markets and Commodity-related areas presented an attractive risk/reward, and where mainly relatively cheap for investors. With negative to zero yielding assets expanding and a political climate of extremism resurfacing, there is a justified unease that’s felt, but not always reflected in the financial market scoreboard. The mystery remains if US stocks are peaking or under-owned. Yet, with liquid investments being overly saturated and many investors sharing similar views, there is a risk that’s building. Part of the herd mentality is driven by desperation for yields, while the other driver is a Fed-led response. That being said, the action seems like a synchronized melt-up, which can be followed up with a synchronized collapse. Quantifying risk these days is challenging, thus many are left to trust their guts and instincts.

Article Quotes:

“Plunging global interest rates have made borrowing cheaper than ever. But instead of spending on aging roads, bridges and buildings, many state and local governments are scaling back. New government-bond issues have dropped to levels not seen in the past 20 years. Municipal borrowers issued about $140 billion in bonds for new projects last year. Adjusted for inflation, that is 53% lower than in 2006 and 21% lower than in 1996. So far this year, municipalities have borrowed $95.1 billion, about $10 billion more than at this time last year. Seven years after the recession ended, voters and government officials remain scarred by the deep budget cuts they endured at the height of the financial crisis and the sluggish revenue growth that has constrained spending since then….Federal grants to state and local governments for capital investment are expected to total less than $68 billion in 2016, according to data from the Office of Management and Budget. They hovered around $80 billion in the early part of the last decade and surpassed $90 billion in the aftermath of the recession. Estimates are in 2009 dollars.” (Wall Street Journal August 7, 2016)

“Despite rising defaults, the government hasn't allowed any major firm to collapse for fear of triggering a crisis. Yet stresses are rising in China's banking system, and with public debt a more serious problem than official figures let on -- and still rising -- the government is increasingly constrained. There are a number of steps Beijing could take to address this mess. Deleveraging should be first. Restrictions on what local governments can borrow simply encourage new and creative ways to hide their debt, which actually makes them more difficult to rein in. More effective -- if less politically appealing -- would be allowing zombie firms to collapse, slowing the rate of investment and accepting slower GDP growth. Instead, Beijing seems to be praying to the Keynesian multiplier, hoping that with yet more stimulus it can grow its way out of its problems, much as it did a decade ago. But the post-2000 period was a unique one, as China joined the World Trade Organization, global growth pushed up export receipts and budgets magically righted themselves. The government must accept that history is unlikely to repeat itself.” (Bloomberg, August 7, 2016)

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

S&P 500 Index [2,161.74] – A continuation of all-time highs.  Like July, in which the index hovered around ­­ 2150, which was an early sign of re-acceleration. 

Crude (Spot) [$41.80] –     After peaking at $51 on June 9^th, the commodity has dropped by nearly $10. It is attempting to stabilize at $40; however, the downside pressure remains in place.

Gold [$1,340] – Appears to be stable around and above $1,260.However, in the near-term, it is unclear if there is further bullishness.  There have been very early signs of peaking at $1,360 range in the past 30 days.

DXY – US Dollar Index [96.19] – Since May, the Dollar has strengthened.  Interestingly, for the majority of this year the Dollar declined and showcased some weakness.

US 10 Year Treasury Yields [1.58%] –   Digging out of new recent lows 1.31%. Based on recent performance, the bond markets have yet to confirm the strength of the 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 | July 25, 2016

“The art of simplicity is a puzzle of complexity.” (Doug Horton)

Order Restoration

The rampant stock market acceleration continues as the S&P 500 index hit another all-time high. In an environment with mounting macro and political risks, the theme of rising equity prices is hardly as shocking as before. Basically, that’s the status-quo move since the participants are quite conditioned from this pattern. This is a testament to Central Banks imposing their will by driving the overall sentiment and capitalizing on their well-devised messaging.

At this point, the sensational reactions to a “disconnected” market are not surprising but rather simply numbing to observers and clue-seekers. In other words, the real economy does not appear strong enough to raise rates, and global growth is too sluggish, yet, shares of large US corporations continue to appreciate. Of course, with so much capital seeking returns, it is understandable that investors flock into the more liquid and well-recognized US equities. Not to mention, capital is desperate for yield, so risk-taking is not only an optional luxury but a necessity for more and more investors.  Here is one example of inflow into EM bonds:

“Net inflows to funds that buy emerging-market bonds reached an all-time high in the week through July 20, according to Bank of America Corp. — $4.9 billion, to be precise.” (Bloomberg, July 22, 2016)

Interestingly, asset appreciation is taking place in an environment of muted volatility. Potential market turbulence is valued “cheap” and Brexit effects have been modest, except for the decline in the British Pound. Perhaps, the slow summer months are not an ideal inflection point, but here is a reminder regarding the volatility index development:

“The last time spot VIX Volatility Index closed under 13 for four consecutive sessions was in early August last year.  In fact, the VIX back then stayed sub-13 for four straight sessions ended August 3rd, and registered three more sub-13 readings by August 14th. By the 17th, the S&P 500 Index peaked, dropping north of 11 percent in the next six sessions. History seldom repeats itself, but it may rhyme.” (See It Market, July 20, 2016)

Risk Chasing

The massive chase towards winning ideas comes with its own set of risks, but with so many headlines about worrisome issues failing to topple the stock market, euphoria is in full gear, again. Occasionally, there are actual breakdowns, like Netflix, as one of the tech horses (in FANG stocks), witnessing a sharp drop. There are moments where specific names or business models end up falling out of favor. Yet, the broader indexes are hovering much higher and creating a feeling of a roaring bull market. Part of this is driven by more Merger & Acquisitions and buybacks.  

At this stage, investors, who missed the rally or were roused by recent headline cheers, face the inevitable risk of overpaying at the late end of the cycle. Like usual, latecomers have a price to pay, but this comes at a time where valuations and central bank objectives are not fully understood. There is an additional risk that looms from rate hikes, currencies and political destabilization.  For now, risk is still misunderstood and the Fed-led market can attract more flow and push higher until new sets of data confront ugly realities. Yet, when volatility is very low and stocks are at all-time highs – one needs to reexamine their expectations. What’s the upside? What’s the practical expectation from now to year-end?

Inflection Point

The run in commodities from the first half of 2016,is now facing a major test. Some signs of stalling in commodity pricing are visible by technical indicators as momentum is slowing a bit. The inverse relationship between Commodities and the Dollar is worth watching again. The dollar is stabilizing and has the potential to go higher, which might inversely impact commodities.  Currency factors go hand in hand with commodities.   

 In terms of Crude, there are signs of rolling over, which begs some questions about supply glut and global demand. Clearly, the supply glut was a critical driver that drove Crude much lower in recent years. Plus, the unstable climate in Middle East (i.e Syria, Turkey, Iraq etc.), political fragility in Europe and unclear growth in China make the commodity outlook even more unpredictable.  That said, commodity bulls are eagerly awaiting confirmation in strength and the suspense of the next few weeks await. 

Article Quotes:

Currency Factors:

“If People’s Bank yen purchases couldn’t force up Japanese investment, by necessity Japanese savings had to decline in line with its current account surplus. There are only two ways the inflows could cause Japanese savings to decline. First, a domestic consumption boom could cause the Japanese debt burden to rise, which Tokyo clearly didn’t want. Second, Japanese unemployment could rise, which Tokyo even more clearly didn’t want. There is, in short, no way Japan could have benefited from People’s Bank purchases of its yen bonds. Only the United States permits unlimited purchases of government bonds by foreign central banks — not because, however, it is immune to the problems Japan and other advanced countries face. Like them, the United States can easily fund productive domestic investments without foreign capital, and so rather than cause productive investment to rise, foreign investment causes domestic savings to fall, which can only happen with a rising debt burden or rising unemployment.” (Foreign Policy, July 22, 2016)

Lower Expectations:

“Respondents to the ECB’s Survey of Professional Forecasters (SPF) for the third quarter of 2016 have revised downwards their expectations for growth in euro area economic activity for both next year and the following one. The average point forecast now stands at 1.4% for 2017 (revised down by 0.2 percentage point) and at 1.6% for 2018 (revised down by 0.1 percentage point). Based on the information provided by the respondents, these revisions largely reflect an expected negative impact on the euro area from the UK referendum result. The Q3 2016 SPF average point forecasts for inflation in 2016, 2017 and 2018 stand at 0.3%, 1.2% and 1.5% respectively. This implies that forecasts for 2016 are unchanged, while those for 2017 and 2018 have been revised slightly downwards, by 0.1 percentage point, compared with the survey round from the second quarter of 2016. Average longer-term inflation expectations (for 2021) remain unchanged at 1.8%. The balance of risks around this forecast is assessed as remaining on the downside.” (ECB, July 22, 2016)

Key Levels: (Prices as of Close: July 22, 2016)

S&P 500 Index [2,175.03] – Another all-time high. The index is up over 20% since the lowest point on February 11^th.  A resounding response to recent lows.

Crude (Spot) [$44.19] –   Since June 9, 2016 highs of $51.67, the commodity has declined and has attempted to maintain around $45.

Gold [$1,320.75] – From December 2015 to July 2016, Gold has rallied about 30% from the lows. However, it is potentially stalling at current levels. In the past, heavy resistance at $1,400 was visible both in 2013 and 2014.  Breaking above the $1,400 can mark additional positive momentum.

DXY – US Dollar Index [97.46] – Range bound since March 2015. A well-defined range between 94-100 seems to be the trend. March 2015 and December 2015 marked a top around 100. Interestingly, the lowest point was reached in early May 2016 (91.91).

US 10 Year Treasury Yields [1.56%] –  Some signs of stabilization have appeared; although, July 6^th  lows of 1.31% occurred earlier this month, so it is too early to tell. A minor hurdle at 1.60% and major hurdle at 1.80% have created a slight stall; a breakout above these points can signal a more convincing rising rate environment.

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 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.