Earnings Disappoint Markets

Whilst economic data was mostly positive this week, with the European contraction slowing and US GDP pushing forward, news from the corporate sector was largely negative and it was this that focussed most investors’ eyes.

According to official figures, it seems that the Olympic fervour I the UK managed to pull its economy round and out of recession, After three quarters of decline, its GDP grew by a far stronger than expected 1% annualised rate of growth in this year’s third quarter. However, as if to mark the fragility of this data, and the wider economy itself, the news coincided with Ford’s announcement that it is to close two plants in the UK with the loss of 1400 jobs.

From the chilly north to the warmer south, where it seems that Greece’s next bailout instalment is under threat. Greece’s austerity measures are hitting the country hard, and it is currently encountering a worse than expected recession. Though Greece’s government has cut spending and raised taxes in efforts to bring its finances under some sort of control, it is two years adrift in its budget targets and has requested additional aid from the European Commission. The situation is so bad in Greece that there are stories of doctors who have not been paid their base salaries for two months and more.

Non-payment of commitments, however, is not a problem limited to Greece. In Spain, the Valencian region owes pharmacists around six months payments for health prescriptions honoured by those pharmacies. This amounts to around €600 million, and has been earmarked to be paid from emergency funds requested from central government.

Perhaps it is stories like these that have contributed to data that shows efforts to close budget deficits by taking severe austerity measures have been counterproductive. Indeed, where budget gaps have closed most, such as Greece and Spain, the ratio of debt to GDP has actually grown.

The impact of the territorial dispute between China and Japan is beginning to hit home. Japanese exports to China fell by 14% in September compared to a year earlier as the two countries continue to argue over a group of East China Sea islands. Hardest hit sector was automobiles which saw a near 50% fall in volumes exported from Japan to China.

The best economic news came from the US, which conversely saw some poor company reports. GDP growth in the third quarter came in at 2% annualised, following the first quarter’s 2% and second quarter’s 1.3%. Demand for durable goods in September rose by 9.9%, though the volatile aircraft numbers accounted for much of this increase. New home sales saw a further rise, and stand 27% higher than a year ago. With inventories near a record low, the new homes outlook is rosy. However, tempering the general upbeat mood, first came the announcement from the Fed that it sees a slow growth trend continuing with growth in jobs set to remain sluggish. Underscoring this view was the jobs report showing the four week moving average of jobless claims rising this week.

US company reports seem to fly in the face of economic statistics.

UPS saw a fall of 56% in its third quarter earnings as the global slowdown pushed revenue lower.

Caterpillar announced a magnificent rise of 49% in its profits for the third quarter, though revenues fell by 5%, but then said it sees sales and profits falling in the coming months: again blaming the global slowdown.

Apple’s profits rose by 24%, but this was less than expected. Some analysts are now beginning to question Apple’s product mix, with its revenues and profits so reliant on just the iPhone and iPad.

The giant chemical company, DuPont, said its revenue fell 9% in the third quarter and its net income fell through the floor. It also announced a cut of 1500 jobs, or 2% of its workforce.

Over the week, the Dow Jones Industrial Index fell by 1.8% to close at 13,107.21, and the S&P by 1.48% to 1411.94. The Nasdaq 100 also fell, but by a more modest 0.46% to 2665.83, while over in London the FTSE fell by more than 1.5% to close the week at 5806.70.

Trading View

I’ve been saying for some time now that it will be corporate profits that will dictate the direction of the market in the months to come. Investors are becoming used to hearing negative economic reports, and these are largely ignored with positive reports held as proof of the impending global upturn.

Try telling the Ford workers laid off this week in the UK that the economy is out of recession. Then head over the pond to DuPont, and tell its sacked workers that the economy is looking great.

We are now clearly approaching a time when slowing and falling company earnings will dictate company policy, whether that is to cut staffing levels further (how else can costs be cut now?) or to raise end prices to the consumer. Both scenarios are bad for the economy. It is my firm belief that the US economic numbers are being massaged as we move into the election, and that revisions to growth figures are likely to be seen after administrative change (or not as the case may be).

On top of these issues is the Fiscal Cliff now rapidly approaching: I may be the eternal bear, but I see very little upside to this market from current levels, though the downside risk is substantial.

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.