Global Investing

As January 2012 drifts into the rearview mirror as a bumper month for world markets, one way to capture the year so far is in pictures – thanks to Scott Barber and our graphics team.

The driving force behind the market surge was clearly the latest liquidity/monetary stimuli from the world’s central banks.

The ECB’s near half trillion euros of 3-year loans  has stabilised Europe’s ailing banks by flooding them with cheap cash for much lower quality collateral. In the process, it’s also opened up critical funding windows for the banks and allowed some reinvestment of the ECB loans into cash-strapped euro zone goverments. That in turn has seen most euro government borrowing rates fall. It’s also allowed other corporates to come to the capital markets and JP Morgan estimates that euro zone corporate bond sales in January totalled 46 billion euros, the same last year and split equally between financials and non-financials..

But to the extent that the ECB move was aimed primarily at preventing a seizure of the banks, then one measure of  success can be seen in the degree to which it steepened government yield curves in Spain and Italy. A positive yield curve, which measures the gap between short-term  and long-term interest rates,  is effectively commercial banks’ ATM — they  make money by simply borrowing short-term and lending long. This chart then shows some normality returning to the benchmark interest structure.

The problem, as highlighted by bond investor Pimco and others, is twofold. One, how does all this extra liquidity find its way to the real economy if fearful households and companies don’t or can’t borrow more or are still assiduously paying down debts — the suffocating ‘deleveraging’ process scaring investors and policymakers alike? It’s one thing lending back to governments, and that may be a necessary move to prevent economic meltdown, but that’s not going to generate renewed economic activity or job growth on its own. And then, two, what if banks — under regulatory and market pressure to rebuild shot balance sheets — simply refuse to expand “risky” lending again and hoard these cheap borrowings as cash that gets put back on deposit at the central bank?

The U.S. earnings season is over bar a handful of firms. It has been robust to say the least: Thomson Reuters Proprietary Research calculates that S&P 500 companies overall had second-quarter earnings growth of 38.4 percent. That was 11 percentage points higher than people had been expecting heading into the season.

There may be more surprises ahead -- although which sort, remains in question. The research suggests that analysts still expect solid growth in the coming quarters and that the decline in U.S. economic strength over the summer has not changed their minds much.

Third-quarter earnings growth is estimated at 24.9 percent, down slightly from July estimates but higher than earlier in the year. Fourth-quarter estimates are at 31.8 percent.

There is little doubt that the latest U.S. earnings season has been a good one for long-equity  investors. Thomson Reuters Proprietary Research calculates that with 67 percent of S&P 500 companies having reported, EPS growth -- both actual and that still forecast for those who have not filed yet -- has come in at 36 percent.

Furthermore, a large majority of the reports have surprised on the upside, as they like to say on Wall Street.  Some 75 percent of  reports have been better than expected.  Not surprisingly, the S&P index gained around 6.9 percent in July and is up another 1.7 percent in the first two trading days of August.

But given what looks like at least a faltering U.S. economy with little consumer confidence, some analysts  have begun asking what there is to get excited about. Philipp Baertschi, chief strategist at wealth manager Bank Sarasin, for example, calls it a case of micro bulls versus macro bears and warns that it won't last.

Don’t tell George Costanza, but double dipping is all the rage these days. The possibility of the U.S. slipping back into recession after a brief period of growth is a hot topic of late – and while such an occurrence is unlikely, pundits are feverishly declaring that it can’t and won’t happen. 

Here are some of their reasons, some of which appear to strain credulity:  Double-dips are “rare.” Simon Hobbs of CNBC is a vigorous promoter of this idea, but let’s face it, the last 15 years of financial-market history is a veritable compendium things that no one expected to happen – LTCM, the financial panic, Lehman Brothers. Rare means nothing. The stock market hasn’t dropped enough. Ah yes, the stock market, that stellar indicator of the economy’s future, such as in October 2007, when it hit an all-time high, two months before the onset of the worst recession since the Great Depression. Next. The yield curve hasn’t flattened enough. This indicator comes with a bit more in the way of history, as a flattened/inverted yield curve has been a reliable indicator of economic weakness ahead. But the Federal Reserve is anchoring the short end of the curve to the ground with its zero interest rate policy. It complicates the curve’s predictive value – something Goldman Sachs noted in a morning commentary. “External shocks” are responsible for the declines in economic activity, such as that in Europe. Similar shocks were enough to spark recessions in the 1930s, 1970s, and in 2008. Everything’s connected now, remember? Corporate profits are strong. As they were all the way through the beginning of 2007, once again, before the most recent eruption.  

A recent Reuters poll put the odds of a double-dip recession at about 15 percent. Gluskin Sheff’s bearish strategist David Rosenberg puts it around 50-50, and Jim Bianco of Bianco Research also put that kind of odds on it. It may not happen – but when a lot of people are trying to convince you that something’s not going to happen, it can make you believe that it’s more likely than not.

It says a lot about the way investors are thinking at the moment that very good earnings from Goldman Sachs were greeted with a mini-stock selloff and a bounce for the dollar. But it is not that people are glum and selling even on good news — more a case of them being so ebullient that anything which is not outlandish is a disappointment.

The top-of-the-pile investment bank was supposed to report quarterly earnings of $4.24 a share.  Instead, it stormed in with $5.25 a share, a good 23 percent higher and an increase of 190 percent over the year earlier figure.

But on the wilder fringes of the market, speculation had been doing the rounds that the earnings-per-share figure would be around $6. It wasn’t, so Wall Street futures tanked, the dollar went positive and world stocks pared gains.

Five things to think about this week:

APPETITE TO CHASE? 
- Equity bulls have managed to retain the upper hand so far and the MSCI world index is up almost 50 percent from its March lows. However, earnings may need to show signs of rebounding for the rally’s momentum to be sustained. Even those looking for further equity gains think the rise in stock prices will lag that in earnings once the earnings recovery gets underway, as was the case in past cycles. The symmetry/asymmetry of market reaction to data this week — as much from China as from the major developed economies — will show how much appetite there is to keep chasing the rally higher. 

TAKING CONSUMERS’ PULSE 
- A better picture of the health of the consumer will emerge this week as U.S. retailers’ earnings coincides with the release of U.S. July retail sales data and the UK BRC retail survey comes out on the other side of the Atlantic. With joblessness still rising, the reports will show how willing households are to spend and whether deep discounts, which eat into retailers’ profit margins, are the only thing that will tempt them to shop — both key issues for the macroeconomic and corporate outlook. 

CENTRAL BANK WATCH 
- After last week’s Bank of England surprise, all eyes turn to what sort of signals the U.S. Federal Reserve and Bank of Japan will send on the outlook for their respective economies and QE programmes. After the BOE’s expansion of its QE programme the short sterling strip repriced how soon UK rates would rise. But the broader trend recently in the U.S., euro zone and the UK has been to discount rate rises in 2010 — and possibly as soon as this year in Australia. Benchmark interbank euro rates have risen for the first time in two months, and central bankers everywhere, including China, face the delicate balancing act of managing monetary tightening expectations in the months ahead. 

Investors have been cock-a-hoop about the latest earnings season — and probably with some reason. There has been positive surprise after positive surprise, particularly in America. Thomson Reuters latest research shows that of the 337 companies in the S&P 500 that had reported through Friday, 74 percent came in above analysts expectations.

A wag might suggest that this only means that analysts are not very good. Chances are, however, that it reflects that they overshot in their pessimism, a not unusual factor. Are they now being overly optimistic?

Investors are now buying away and putting bad news to one side. Consider as one example how the ballooning of bad debts in European banks have not stopped the sector from rallying sharply.

Five things to think about this week:

HOLDING UP — FOR NOW 
- A good run in equities has so far been helped rather than hindered by U.S. company results. Some are questioning how long the upward momentum can be sustained given cost-cutting rather than improved revenue streams flattered profit margins. The European earnings season, which cranks up a gear this week, and the release of U.S. Q2 GDP data could be potential triggers for a pullback, but the sensitivity to bad news may depend on how much money is chasing the latest push higher. 
    

EARNINGS 
- European earnings flooding out in the coming weeks may paint a less rosy picture of the banking sector than seen on the other side of the Atlantic. While investment and trading activities should be supportive, bad loan provisions will be particularly closely scrutinised, as will the central and eastern Europe exposure of the likes of Erste. The supply/demand outlook for key commodities plans will also be in the limelight given the battery of oil and chemical firms reporting in Europe and the U.S. 

CORRELATIONS 
- There are signs of some breakdown in the lockstep moves that financial markets had become accustomed to seeing in FX/stocks or stocks/bonds. Calyon research shows correlation between the bank’s proprietary risk aversion barometer and exchange rates has been less robust in the past month. While this correlation nevertheless remains stronger than that between FX and interest rate differentials, the markets’ thoughts are turning to new linkages that might prove better trading guides. 

How do those green shoots look now?The market got all a-giddy last week after Intel (INTC.O) and Goldman Sachs (GS.N) (a barometer of nothing other than its own ability to navigate turbulent markets) posted better than expected earnings, but the latest round of earnings reports points mostly to the ability of companies to tighten their belts to anorexic levels.

The Street celebrated when Caterpillar (CAT.N) reported earnings Tuesday, but the euphoria leaked out of the early market rally when investors got a second glance. Sales looked terrible as demand has plunged. They, along with Intel, Coca-Cola (KO.N), UTX (UTX.N) and others, are all using China as a crutch right now, thanks to that country's massive stimulus package. But building earnings strength on hopes that governments will continue to spend money isn't a winning strategy for years to come.

Meanwhile, the second quarter is emerging as a repeat of the first - applause for better-than-expected results, even if the surprises mostly come as a result of cutting jobs. According to Brown Brothers Harriman, 105 S&P companies have reported earnings as of this morning. Just 27 have reported positive year-over-year revenue growth - but 36 have reported positive earnings growth. In addition, when financials are removed from the picture, companies, on the whole, are falling short of sales expectations, with an average miss of 0.9 percentage points, but beating earnings expectations by 9.2 percentage points.

Five things to think about this week: 

RESULTS RUSH 
- The early wave of Q2 earnings last week prevented any major risk shakeout but there are plenty more results this week, including from banking, technology (Apple, Microsoft), and other sectors (Lockheed Martin, Coke, McDonalds). Investors with bullish inclinations will be looking for the VIX to stay subdued after it fell last week to lows last seen in September 2008, especially if more pent up cash is to be released from money market funds. Bears will be thinking that what might be the S&P’s best weekly performance since mid-March could be setting the market up to be more sensitive to bad news.

BANKS – IS THE BEST PAST? 
-  It is hard to see how bank results this week can top the boost which Goldman and JPM gave stocks last week. More of a mixed bag is likely with the U.S. slate including Bank of New York Mellon, Morgan Stanley, Wells Fargo, Capital One, and American Express while Credit Suisse will be the first major European bank to report. Defaults and delinquencies will be in focus for banks more exposed to the retail sector — both for what it means for their outlook and for what it bodes for household solvency and spending. 

DRILLING DOWN 
-  The breakdown of company results this week (ABB, Texas Instruments, Caterpillar, DuPont, Boeing, 3M) will show the extent to which the inventory rebuilding story, which has helped lift world equities almost 40 percent from their March lows, can offer more sustainable support to stocks in the weeks and months ahead. Earnings this week will be closely scanned to see how inventories are stacking up verus orders. How deeply firms are cutting into costs to defend profit margins, as well as their business investment plans, will be key for unemployment and other macroeconomic data.