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.