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.

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.