A Tale of Two Continents

Through the turmoil and gloom of Superstorm Sandy, US economic data this week was largely a bright spot. The same cannot be said of news from Europe where better than expected economic reports of recent weeks have been dented by this week’s worsening unemployment numbers and crumbling business confidence.

Turning to Europe first and we see that unemployment has now reached yet another record. Across the Eurozone unemployment now stands at 10.6%, with a whopping 18.5 million out of work. Unemployment in Spain and Greece is above 25%. Austria has the Eurozone’s lowest unemployment rate at 4.4%.

Consumer and business confidence has fallen away dramatically, and now stand at 3 year lows. Even the ‘stronger’ economies of France, Germany, and Finland are following the downward confidence trend.

As if things aren’t bad enough in Greece already, its latest call for a further €31.5 billion in emergency funds from the Troika (EU, IMF, ECB) have been knocked back, with ministers requesting the country take further austerity measures. However, Greece will be given more time to reach targets on debt levels and ratio of debt to GDP.

In China, China’s PMI has risen above 50 for the first time since July, indicating expansion may be on the horizon. Meanwhile, the Bank of Japan has upped its monetary easing policies after industrial production fell through the floor.

In the United States, it is estimated that Superstorm Sandy will cost the US economy around 0.5% in the fourth quarter, with uninsured losses accounting for $30 billion and lost business another $20 billion. However, with infrastructure rebuilding and the clean-up required, the impact could be short lived.

On a more positive note, US non-farm payrolls increased by 171,000 in October, though the unemployment rate picked up slightly to 7.9%. Weekly initial jobless claims fell, as did the four week average (to 367,250). Home prices rose by 2% in August, the biggest gain since July 2010. Consumer confidence rose to its highest level since February 2008, and personal spending increased by 0.8% in September. Finally, US factory orders increased by 4.8% in September, the highest rise in 18 months.

On the corporate front, GM, ExxonMobil, Chevron, BP, and Shell all reported lower earnings, as corporate profits continue their downward trend at quite a pace. UBS announced 10,000 job cuts as part of its efforts to restructure its cost base.

After losing two days to Superstorm Sandy, the Dow Jones Industrial Index fell by 0.11% to close at 13,093.16, and the Nasdaq 100 by 0.36% to 2656.28. The S&P, however, managed to post a small gain of 0.16% to rest at 1414.20. In London, the FTSE 100 rose by 1% to close the week at 5868.50.

Trading View

The views of business and consumers in Europe seem to be finally coming into line with my own. Confidence is falling away, as so-called stronger economies such as Germany and France begin to see a less rosy future.

Europe’s leaders have given Greece more time to hit debt to GDP targets, and yet with more austerity measures being taken, which in turn will push its GDP further negative and tax returns fall again, I see this as a very long game. Interestingly, the Troika is taking a far harder line with Greece: is this the beginning of the end game for Greece’s membership of the Euro? I believe that during the last 24 months, Europe and the world’s banks have been positioning themselves to protect against such an event. Whilst I think that, politically, for the time being Europe will want to see Greece remain, I cannot help but believe it will be Germany’s elections next year that see Europe being remoulded as the German public begin to raise concerns about continuing funding of ‘weaker’ countries.

The better and continuing improvement in the US economy is a conundrum to me, and one that I am finding hard to work out. Unemployment is stubbornly high, corporate profits are tumbling, and trade with the rest of the world falling. And yet, economic reports point to a better situation than for years. Perhaps the enormous quantitative easing programs have finally begun to work, though I feel this will lead to a rate of systemic inflation that will be unsustainable after the election. Or, perhaps, and more likely, is that consumers and businesses are spending before the impending Fiscal Cliff next year. My worst fear is that the anomalous US economy is due to a combination of both factors.

Needless to say, I am a seller into any strength in equity markets at this time.

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.

IMF Warning runs Counter to Data Releases

Economic news was mixed through the week, with the positives in Europe and the US overshadowed by a damning forecast from the IMF.

Firstly to Europe, where the EU was awarded the Nobel Peace Prize for its work to contain the Eurozone debt crisis. Further positive news came when industrial activity numbers showed a second consecutive month of growth. Though output was 2.9% below the level seen at the same time last year, countries where the economy has been weakening markedly saw a bounce, with August output expanding by 1.5% over July in France and Spain, 1.7% in Italy, and a whopping 6.8% in Portugal. However, Germany’s industrial output fell by 0.4%.

On the debt front, Greece failed to agree terms with its creditors and Standard & Poors downgraded Spanish government debt to one notch above junk grade. The market expects the move will force Spain to request a bailout, which in turn will trigger buying of its bonds by the ECB, under the new unlimited bond buying program. Because of this, Spanish 10-year bonds actually saw support and the yield eased back slightly. In the United States, consumer confidence rose to the highest level since 2007, home sales improved again, and foreclosure filing numbers in California collapsed to a near 6 year low.

Perhaps the best news of all came with the release of the jobless claims numbers, which showed a fall of 30,000 to 365,000 for the week ending October 6.

Meanwhile, flying in the face of all this positive news, the IMF cut its global growth forecasts for this year and next, and warned of a greater downside risk. Its forecast for 2012 is now 3.3%, and for 2013 just 3.6%. It stressed that it sees ‘an alarmingly high’ risk of a far worse slowdown, and a near 20% chance of sub 2% growth this year and next. Within these figures is a dark forecast for the Eurozone: a contraction of 0.4% this year and a bounce of only 0.2% next. It also sees growth in the US throughout the period of no more than a shade above 2%.

Over the week, the Dow Jones Industrial Index fell by 2.1% to close at 13,328.85, and the S&P drooped by 2.2% to 1428.59. The Nasdaq 100 was worst hit, falling 3.2% to 2720.14, as Apple and Facebook moved lower. In the UK, the FTSE 100 Index dropped 1.3% to stand at 5793.32.

Trading View

With demonstrations against austerity measures forced by the EU in countries such as Greece and Spain in recent weeks, some of which have turned violent, and calls for autonomy from national governments and the EU itself, it seems an inopportune moment for the EU to receive the Nobel Peace Prize. But, then, I’ve felt for a while now that the Nobel Peace Prize is a waste of time.

I have to question the growth in industrial production seen in the weakest of the Eurozone countries. Is this the beginning of a sustainable rally, or a blip in the downward lurch? We mustn’t forget that most of the austerity measures already announced don’t kick in until next year, and then the following 12 months. A ‘dead cat bounce’ is a phrase that springs to mind, particularly with Europe’s largest economy now seeing industrial contraction.

As for Standard & Poors’ downgrade of Spanish Government debt: the market reaction says all it needs to. The market expects Spain to request a bailout, and this will pave the way for buying of its debt by the ECB. Traders are positioning themselves ahead of this, buying bonds now to offload to the mug punter who comes in at the wrong level later. This mug punter, however, is the muggest of the lot: it has already said that this is exactly what it will do. Banks buy the bonds now, with money that they mostly received from the ECB and the EU to bail them out, then they wait for the Spanish bailout and the buying of bonds by the ECB to begin. They then sell the bonds to the ECB, banking a healthy profit. The ECB then gives the banks a better than average interest rate on the cash they deposit with it as part of the ‘bond sterilization program’ that goes hand in hand with its bond buying program.

Net effect? No extra cash is pumped into the economy to help it grow, the Spanish tax payer will be landed with a debt bill stretching beyond the horizon of time, Spain’s government will be forced to accede to further and deeper control by central Europe, but at least the banks will be making a bigger profit.

As for Greece’s situation: we’ve been here before. The country is a basket case, and Mother Europe will take it home from its latest shopping spree. It can’t do otherwise.

The big worry looking forward must be the way the market is beginning to accept high levels of debt as the norm. This sentiment may be good for investors in the short term, but the fall will be harder and faster when it comes.

Global Markets rise as American Star Strips Away Wider Gloom

Despite further Eurozone and Asian economic weakness, and sovereign debt issues seemingly increasing not retracting, positive jobs and economic data from the United States and Canada through the week buoyed stock markets around the globe.

Unemployment numbers from the Eurozone continue to reach record highs. September’s rate of 11.4% across the 17 member states masks wide variations, with the worst numbers still seen in Spain, where unemployment has now hit 25.1% with over 50% of under 25’s out of work. A poll of purchasing managers by Markit showed a further economic retraction in the third quarter: if proved correct with official figures then the Eurozone will officially declared in recession.

The ECB waits to activate its bond buying program, announced last month. With the objective of pushing bond yields down and decreasing borrowing costs for the indebted Euro nations, the ECB is waiting for requests for assistance. Main target, Spain, is stalling with its politicians baulking at the requirement to give up even more fiscal and economic control to European central government. Meanwhile, mass protests in the Catalan region – one of the more prosperous regions of Spain – are calling for independence from the rest of Spain. The yield on Spain’s 10 year bonds, which had fallen from above the dangerous 7% level to nearly 5.5% after the ECB’s bond buying announcement, have risen to around 5.9%.

Greece finds its problems deepening, as the so called troika –IMF, ECB, and European Commission – have rejected part of the country’s austerity plans. Greece is due yet another round of financial aid soon, and this action could put that in jeopardy.

Over in Asia, the Asian Development Bank lowered forecasts for growth across the region, including China and India. The downward revision is dramatic, from 6.9% to 6.1% for this year, and 7.3% to 6.7% next year. It sees Chinese growth this year of 7.7%, but falling next year to 5.6%.

As if to prove the Asian Development Bank correct, Chinese service sector numbers came in weaker than expected, though this helped to lower crude oil prices (China’s oil demand is 10% of world total).

The United States, however, is bucking the trend of global weakness. The world’s largest economy has this week seen manufacturing PMI numbers and New Order figures both rebounding to growth from August’s contracting indications. Consumer confidence has risen for six weeks in a row, with sales at store open more than 12-months increasing by 3.9%. Conversely and strangely, US Factory Orders fell by 5.2% in August: something of a conundrum.

The big news came at the end of the week, with massive revisions to previously-released US unemployment figures. August’s number of payroll increase had been reported at 96,000 but has now been revised upwards to 142,000, and July’s number of 141,000 has been upped to 181,000. September’s estimated number has come in at 162,000.

Over the week, the Dow Jones Industrial Index rose by 1.3% to close at 13610.15, and the S&P slipped by 1.4% to 1460.93. The Nasdaq 100 gained a little less, just 0.4% to 2811.94, as Apple and Facebook gave away gains on Friday. In the UK, the FTSE 100 Index rose by 2.2% to stand at 5871.02.

Trading View

Everywhere the economic numbers seem to be pointing to further contraction and slowdown, and rising unemployment, except in the United States.

In fact, the United States is showing remarkable resilience in the face of massive adversity elsewhere. The way markets have reacted indicates a bit of ‘laisez faire’ on the part of investors: a sense of ‘we’ve been here, seen it, done it’.

Though Spanish bond yields are again rising, the country is putting off the inevitable. This indecision by the Spanish may be more political than economic management. Can the country’s leaders really afford to cede so much to the centre, when its own regions are rising up to try to force a breakaway?

Call me a cynic, but this market seems to have gone into political phase. In the United States, economic numbers are improving rapidly and the unemployment rate has fallen from 8.3% to 7.8% as the Presidential election comes ever closer. Of course, we’ve seen revisions and revisions to numbers before: what odds on a downward lurch coming after the election? If a new President is in, it will be his fault. If Obama stays in, then what does he really care – he’ll have another four years.

In Europe, the masses are protesting against further austerity measures and centralised government, and countries like Spain and Greece are holding back the weight of pressure from its people and the European leaders to act in the manner each side wants. It’s a two way pull, which will snap at some time.

My view remains the same, there’s always calm before the storm.

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.

Markets on Hold as World waits for an Economic Turnaround

As widely forecast last week, the Bank of Japan followed the lead of the ECB and the Fed by announcing an increase in its quantitative easing program. The world’s markets are now in a phase of treading water as they wait to see what effect the massive proposed injection of cash around the globe will have.

Over the last three weeks the ECB has announced a never ending bond buying program, and the Fed that it will buy $40 billion of mortgage backed securities every month with a ‘zero’ interest rate policy through to 2015: the so called QE3 Program.  Now the BoJ has increased its own asset buying program  to 80 trillion Yen form 70 trillion, and extended it through to the end of 2013.

Recent economic figures for Japan have pointed to a marked slowdown in activity, and a worsening of its trade balance. The BoJ move has been taken in an attempt to stimulate the economy and force its exports up by driving the value of the Yen down.

Meanwhile, markets ignore the latest statistical releases as being lagging and historic, taken before the actions of the triumvirate of the world’s dominant central banks.

In China, manufacturing PMI data has now shown a decrease in activity for 11 straight months.

Economic releases were somewhat mixed in Europe. The PMI for manufacturing and services across the Eurozone fell once more, to stand at 45.9 in September. However, the trade surplus grew in July and wages are rising. These last numbers were taken before the summer period that has seen German industrial activity slide, and the world economy decline. It’s likely that slowing world demand will damage export numbers for the region.

In the UK, recession is biting into government finances hard. August’s budget deficit was the largest on record as spending on welfare ballooned and tax revenue shrank.

In the United States, the housing market continues to respond to stimulus. Housing starts rose by 2.2% in August from July, and sales of previously owned homes rocketed by 7.8%. Overall, sales were 9.3% higher than the same period last year.

With central bank stimulus growing, and the winter period drawing close, it might be expected that oil prices would rise again. However, after touching $100 per barrel last week, crude futures retreated to $93. The fall has been attributed to a lack of conviction that central bank action will have a lasting impact and a rise in supplies as Middle East concerns ebb. However, gold has risen to 6 month highs as the QE measures taken globally seem likely to stoke pent up inflation.

The Dow Jones Industrial Index fell by just 14 points to 13579.47 this week, while the S&P 500 sagged by 5 points to 1460.15. The Nasdaq put on 6 points to end the week at 2861.64. In Europe the FTSE shed 63 points to close on 21 September at 5852.62.

Trading View

The BoJ’s move is clearly part of a concerted and pre-arranged global effort to stimulate the economy. However, domestic demand remains subdued. Massive boosting of money supply by QER, and the relaxing of monetary policy, would be expected to devalue a currency. However, when all central banks are taking similar action, surely devaluation will remain a pipe dream – a new state of multi-devalued currencies will exist and equilibrium remain at a lower level.

I expect that the overall idea is to excite the housing markets, and promote further building (as seen in the US). If house prices can recover, then this will generate a healthier sentiment among consumers and promote economic growth. The problem is, we’re seeing a recovering housing market in the US but with no follow through to the wider economy and job creation.

I have to question if the world’s governments are simply putting off the inevitable and moving us more slowly and more painfully to another, even deeper and harmful, financial crisis, when the world realises the extent of the new debt build-up coupled with pent up inflation.