Markets Show Volatility on Mixed Data and Poor Earnings

Contradictory economic data this week combined with poor earnings reports to confound market traders. After a promising first four days, US markets ended the week barely changed as Google, Microsoft, IBM, and Intel disappoint.

In Europe, Moody’s refused to follow Standard & Poors’ lead of last week when keeping its rating of Spanish government debt unchanged at Baa3 (though, like Standard & Poors’ rating, one rung above junk). Spain’s bonds continued the rally begun last week, as institutions continue to bank on a bailout followed by ECB buying of the country’s bonds. Spain’s 10 year yield has now fallen to 5.46%. However, Spain’s banks continue to suffer in one of the worst hit economies in Europe, and bad loans now account for more than 10% of all loans made by them.

Bonds continued to be in focus at another Eurozone country standing on the brink. Italy sold €18 billion of bonds at auction on Thursday, easing concerns over its ability to finance its deficit this year.

Meanwhile, Eurozone leaders have agreed to have the region’s new banking supervisor in place by next year, which may ease the provision of direct relief to ailing banks. Of some concern, however, was Moody’s warning to German banks, saying that it believes they are overexposed to troubled Eurozone nations.

In China, GDP slipped again in the third quarter, to an annualised 7.4% from the previous quarters 7.6%, though industrial production showed a surprising 9.2% year-on-year rise as exports jumped 9.9% and retail sales by 14.2%.

In the United States, housing starts are increasing at their fastest rate since mid-2008, and sales of the iPhone 5 are considered to be behind September’s rise of 1.1% in retail sales. Of more concern, and helping to spur a market sell-off of 200 points on the Dow Jones on Friday, was the jobless claims number rising by 46,000 to 388,000 after a fall of 27,000 the previous week.

On the corporate front, there are strong signs of the period of rising profits coming to an end. Microsoft (MSFT) saw its quarterly revenue and earnings fall, 8% and 22% respectively, Intel (INTC) reported a fall of 14% on its third quarter profit number, and IBM (IBM) also saw revenues fall.

Google (GOOG), not only reported rising costs denting profits in a quarter that saw revenues grow by 45% year-on-year, but also released its figures in error at midday. The move led to a hit of 9% on Google stock, before trading was suspended. Most worryingly, advertising rates fell by 15% per click from a year earlier, reflecting a trend seen across the market.

Over the week, the Dow Jones Industrial Index rose by just 0.1% to close at 13,343.51, and the S&P by 0.3% to 1433.199. The Nasdaq 100 was hit by flailing profits reports, falling 1.5% to 2678.32. In the UK, the FTSE 100 Index rose by 1.7% to stand at 5896.15.

Trading View

I’ve maintained for some time that the ability to continue to cut costs to raise earnings must come to an end at some time, and I think we are on the cusp of seeing this. It is this that investors may now begin to focus on, as earnings growth drifts lower and dividend growth starts to come under pressure over the coming months.

Whilst the announcement of a new banking supervisor for the Eurozone should be welcomed, the language used in the announcement was rather ambiguous. The 11 hours of talk in Brussels led to the ‘aim’ of a legal framework for a bank supervisor to be in place by the end of the year, and ‘hopes’ that it would be up and running during 2013. The head of the ECB warned that setting up the mechanism ‘would take some time…It’s not a matter of one or two months.

Economic reports over the last couple of weeks have generally been stronger than expected, though this week’s jobless claims number was disappointing. The cynic in me would point to the political necessity of better economic news coming through, with the pre-Presidential election period notorious for such.

Certainly, better than expected numbers in Europe don’t seem to be feeding through to grass roots: just this week we have seen more demonstration in ailing European nations, and these are increasingly turning violent. Not a great indictment of the previous week’s award of the Nobel Peace Prize to the European Union for its efforts at containing and beating the European debt crisis.

Perhaps the most worrying aspect for me is the way that high levels of debt, and the supporting of that debt by central banks around the world is once more becoming accepted practice. Banks and investors are now positioning ahead of potential bailouts and the buying of bonds that would then follow by the ECB.

I see nothing but a postponing of the inevitable, and a storing up of problems for the future. When the next financial crisis hits, which surely it will, it will be more severe than any before. Investors should be prepared. In the meantime, waning profits could lead to a slow bleed downturn in stock markets.

Eurozone Concerns Rise and Markets Fall

The Eurozone once more found itself at the heart of the matter this week, as concerns over rising debt and falling economic numbers marched front and centre. And marches were the order of the day in both Spain and Greece, where workers demonstrated against further austerity measures. With the honeymoon period after the ECB QE action just four weeks old, markets seem to doubt the long term effectiveness of the measures, and reacted negatively to further poor news from the region, despite China’s central bank joining in the global cash giveaway.

On Thursday Spain announced further austerity measures, confirming some already passed through into the law of the land and adding some new. The spending cuts and tax rises confirmed for 2013 now stand at €13 billion (though mostly part of the €65 billion austerity package announced earlier this year). As the announcement was made, yields on Spanish bonds, which had been falling since the ECB’s promise to buy €40 billion of member countries bonds each month, rose above 6% again. Protestors flooded the streets of Madrid, in scenes that were replicated on the streets of Athens, where a nationwide strike on Wednesday was used to protest against another €13.5 billion of austerity measures currently moving its way through the Greek parliament.

On Friday, the independent audit of Spanish banks confirmed that capital adequacy needs were in the order of €60 billion. The country has already been pledged up to €100 billion from central European coffers earlier this year to recapitalise its banking sector that is struggling under the weight of Spain’s failing property market.

Meanwhile, as Greece and Spain struggle to swim against the tide of their faltering economies and still increasing debt, economic figures from Germany paint a gloomy picture of Europe’s largest economy. Jobless claims rose for the sixth straight month and business confidence fell for the fifth month in succession.

Over in China, the economy continues to falter. From roaring strength a year ago, the pace of slowing growth is gathering. Increasing costs and a tightening export market has now begun to damage corporate profits significantly. For five months now, profits at China’s major industrial companies have been falling, and in August now stand 6.2% below a year earlier. However, China injected around $58 billion into the money market in an attempt to lower rates and spur growth.

In the United States, economic numbers have turned south again. The GDP growth in the second quarter was downwardly revised from 1.7% annualised to 1.3%, and durable goods orders fell by a whopping 13.2% in August, despite a rise in non-defence goods of 1.1%. Business activity in the US declined for the first time in three years, according to the Institute for Supply Management, with its key index falling from 53 in August to 49.7 in September indicating a marked slowdown on its way. Despite this, home prices rose by around 1.5% in July, making a 12 month gain of some 17% for new homes, and new home sales were nearly 28% up on this time last year (though August did see a small retraction from July).

Over the week, the Dow Jones Industrial Index fell by 1% to close at 13,437.13, and the S&P slipped by 1.4% to 1440.67. Technology shares were hardest hit, with the Nasdaq 100 falling by more than 2% to 2799.19. In the UK, shares as measured by the FTSE 100 Index fell by 1.9% to stand at 5742.07 at the close of business on Friday.

Trading View

China’s move in the money markets has followed central bank action by the ECB, Fed, and Bank of Japan in the last few weeks. Despite huge quantitative easing programs to date, the economies of both the US and Europe have failed to show consistent and sustainable progress to growth. Indeed, the announcement of a sizeable downward revision in second quarter US growth figures indicate the precarious situation that the world’s largest economy is in.

QE has, in fact, done little else other than help house prices recover in the US. This has fed through to some better consumer confidence numbers, but the follow through to sales has not been robust enough to promote a marked turnaround. Hence unemployment continues to hold stubbornly high.

Governments – both local and central – around the world will continue to be forced to cut spending and raise taxes in efforts to bring debt under control. QE is merely a ‘papering over the cracks’ exercise that will increase pent up inflation -  already being seen in US housing stats – and delay the inevitable.

The European Finance Ministers’ meeting on October 8^th, when Greece’s request to delay the meeting of its budget targets by another two years will be discussed, could prove important in the short term market momentum. I expect the meeting to ratify Greece’s request, with a stern warning of dire consequences should the budget deficit reduction target not be met in two years. Markets may move higher in the short term on the back of any such announcement, but without solid financial proof of an improving debt and economic situation in Europe, the inevitable is just being delayed.

Equity markets have trod water for several years, though the waves have been choppy. I expect they will continue to do so as corporate profits, which have been bolstered by job cuts and cost cutting measures, are squeezed over the coming years. It would not surprise to see dividend growth slowing and equity valuations react accordingly.