Weekly Radar: Global PMIs; US/UK GDP; FOMC; Heavy earnings, inc Apple
Whoosh! The gloomy start to the final quarter seems to have been swept away again by the beginnings of a half decent earnings season stateside – at least against the backdrop of dire expectations – and a steady drip feed of economic data surprises from the United States and elsewhere. Moody’s not downgrading Spain to junk has helped enormously and the betting is now that the latter will now seek and get a precautionary credit line, which would not require any bailout monies up front but still unleash the ECB on its bonds should they ever even need to – and, given Thursday’s successful sale of 4.6 billion euros of 3-, 5- and 10-year Spanish government bonds, they clearly don’t at the moment (almost 90% of Spain’s original 2012 borrowing target has now been raised). What’s more, Greek euro exit forecasts have been put back or reduced meantime by big euro zone debt bears such as Citi and others, again helping ease tensions and defuse perceived near-term euro tail risks. Obama’s bounceback in the presidential polls after the latest debate may be helping too by rolling back speculation that a clean sweep rather than a more likely gridlock was a possible outcome from Nov 6 polls. China Q3 GDP came in as expected with a marginal slowdown to 7.4% and signs of growth troughing — all adding to the picture of relative calm.
So, in the absence of the world ending in a puff of smoke – and the latest week of data, earnings and reports suggests not – we’re left with a view of a hobbled but stabilising world economy aided by hyper-easy monetary policy that is bolting core interest rates to zero. Tactical investors then, at least, are being drawn into the considerable pricing anomalies/temptations across bond and credit markets as well as the giant equity risk premia and regional price skews.
The upshot has been a sharp bounceback of some 2.5% in world equities since last Wednesday, falling sovereign bond spreads in euroland and in credit and emerging markets, a higher euro and financial volatility gauges still rock bottom. Dax vol, for example, is at its lowest in well over a year. Year to date, developed market equities are now scaling 15-20%! Germany stands out with gains of some 25%, but the US too is homing in on 20%. These are extremely punchy numbers in any year, but are doubly remarkable in year of so much handringing about the future. So much so, you have to wonder if the remainder of the year will be remain so clement. That doesn’t mean another shock or run for the hills, but shaving off the extremes of that perhaps?
Next week’s earnings slate in the US and Europe is heavy – with everything from Apple to VW And BASF to Santander. Global flash PMIs for October will be crucial as will Q3 GDP reports from the UK and US. The FOMC rounds off the top dirary items although, reasonably, how much more can or even should the Fed do at the this point?
Spanish local elections in Galicia Sun
US Q3 earnings Mon: Caterpillar, Texas Instruments, Yahoo etc
Weekly Radar: Q3 earnings; China GDP; EU summit; US debate
Markets have turned glum again as October gets underway and the northern winter looms, weighed down by a relentless grind of negative commentary even if there’s been little really new information to digest. The net loss on MSCI’s world stock market index over the past seven days is a fairly restrained 1.5%, though we are now back down to early September levels. Debt markets have been better behaved. The likes of Spain’s 10-year yields are virtually unchanged over the past week amid all the rolling huff and puff from euroland. The official argument that Spain doesn’t need a bailout at these yield levels is backed up by analysis that shows even at the peak of the latest crisis in July average Spanish sovereign borrowing costs were still lower than pre-crisis days of 2006. But with ratings downgrades still in the mix, it looks like a bit of a cat-and-mouse game for some time yet. Ten-year US Treasury yields, meantime, have nudged back higher again after the strong September US employment report and are hardly a sign of suddenly cratering world growth. What’s more, oil’s back up above $115 per barrel, with the broader CRB commodities index actually up over the past week. This contains no good news for the world, but if there are genuinely new worries about aggregate world demand, then not everyone in the commodity world has been let in on the ‘secret’ yet.
So why are we all shivering in our boots again? Perennial euro fears aside for a sec, the latest narratives go four ways at the moment. 1) The IMF’s World Economic Outlook (WEO) downgraded world growth and its Financial Stability report issued stern warnings on the extent of European bank deleveraging 2) a pretty lousy earnings season is just kicking off stateside, 3) U.S. presidential election polls are neck and neck again and unnerving some people fearful of a clean sweep by Republicans and possible threats to the Federal Reserve’s independence and its hyper-active monetary policy 4) it’s a new quarter after a punchy Q3 and there’s not much new juice left to add to fairly hefty year-to-date gains. Maybe it’s a bit of all of the above.
But like so much of the year, whether the up moments or the downers, there’s pretty good reason to be wary of prevailing narratives.
Next Week: “Put” in place?
Following are notes from our weekly editorial planner:
Oh the irony. Perhaps the best illustration of how things have changed over the past few weeks is that risk markets now fall when Spain is NOT seeking a sovereign bailout rather than when it is! The 180 degree turn in logic in just two weeks is of course thanks to the “Draghi put” – which, if you believe the ECB chief last week, means open-ended, spread-squeezing bond-buying/QE will be unleashed as soon as countries request support and sign up to a budget monitoring programme. The fact that both Italy and Spain are to a large extent implementing these plans already means the request is more about political humble pie – in Spain’s case at least. In Italy, Monti most likely would like to bind Italy formally into the current stance. So the upshot is that – assuming the ECB is true to Draghi’s word – any deterioration will be met by unsterilized bond buying – or effectively QE in the euro zone for the first time. That’s not to mention the likelihood of another ECB rate cut and possibility of further LTROs etc. With the FOMC also effectively offering QE3 last week on a further deterioration of economic data stateside, the twin Draghi/Bernanke “put” has placed a safety net under risk markets for now. And it was badly needed as the traditional August political vacuum threatened to leave equally seasonal thin market in sporadic paroxysms. There are dozens of questions and issues and things that can go bump in the night as we get into September, but that’s been the basic cue taken for now. The backup in Treasury and bund yields shows this was not all day trading by the number jockeys. The 5 year bund yield has almost doubled in a fortnight – ok, ok, so it’s still only 0.45%, but the damage that does to you total returns can be huge.
Next Week: Big Black Cloud
Following are notes from our weekly editorial planning meeting:
Not unlike this year’s British “summer”, the gloom is now all pervasive. Not panicky mind, just gloomy. And there is a significant difference where markets are concerned at least. The former involves surprise and being wrongfooted — but latter has been slow realisation that what were once extreme views on the depth of the credit swamp are fast becoming consensus thinking. The conclusion for many now is that we’re probably stuck in this mire for several more years – anywhere between 5 and 20 years, depending on your favoured doom-monger. Yet, the other thing is that markets also probably positioned in large part for that perma-funk — be it negative yields on core government debt or euro zone equities now with half the p/e ratios of US counterparts. In short, the herd has already hunkered down and finds it hard to see any horizon. Those who can will resort to short-term tactical plays based on second-guessing government and central bank policy responses (there will likely be more QE or related actions stateside eventually despite hesitancy in the FOMC minutes and Fed chief Bernanke will likely give a glimpse of that thinking in his congressional testimony next week); or hoping to surf mini econ cycles aided by things like cheaper energy; or hoping to spot one off corporate success stories like a new Apple or somesuch.
So has all hope been snuffed out? The reason for the relapse mid-year depression is only partly related to the political minefield frustrating a resolution of the euro crisis – in some ways, things there look more encouraging policywise than they did two months ago. It stems as much from a realization of just how broken the banks credit creation system remains – a system that had hinged heavily on extensive collateral chains that have now largely been broken or shortened and starved of acceptable high-quality collateral. Curiously, QE – by removing even more of the top quality collateral – may even be exaggerating the problem. Some even say the extreme shortage of this quality “collateral” may require more, not less, government debt in the US and UK and would also benefit from a pooling of euro debt – but everyone knows how easy all that’s going to be politically.
Next Week: Managed expectations
Here’s a view of next week from our team’s weekly news planner:
Not unlike England’s performance at the Euro 2012 football tourament, EU summit expectations have been successfully lowered in advance by all concerned and so it will be hard to disappoint as a result!
The gnawing realization in markets is that the really game-changing steps by Germany on some form of debt pooling now look unlikely before next year’s general election there and so investors may have to hang on tight to what can get done in the meantime if the system is to hold together. Yet for all the understandable policy scepticism, there are a lot of big changes on the table — from banking union, more flexible budget-cutting programs, infrastructure growth pushes, a roadmap at least to euro bonds and a euro finance ministry and the launch of the ESM next month (barring a last-minute torpedo from the German constitutional court at least). It may be a little too easy to dismiss all that is happening just because there’s not going to be a grand instant fix ready for Monday. The ESM alone should have powerful stabilization powers for markets at least. What’s more, Merkel says ”over my dead body” to Euro bonds in one breath, and then “when conditions are right” in another. Assuming she’s referring to her political body, then even these may not be a million miles away.
Next week: Half time…
QE, some version of it or even the thought of it, seems to have raised all boats yet again — for a bit at least. You’d not really guess it from all the brinkmanship, crisis management and apocalyptic debates of the past month, but June has so far turned out to be a fairly upbeat month – weirdly. World equities are up more than 6 percent since June, lead by a 20 percent jump in European bank stocks and even a 20 percent jump in depressed Greek stocks. The Spanish may found themselves at the centre of the euro debt storm now, but even 10-year Spanish debt yields have returned to June 1 levels after briefly toying with record highs above 7% in and around its own bank bailout and the Greek election. And the likes of Italian and Irish borrowing rates are actually down this month. Ok, all that’s after a lousy May that blew up most of the LTRO-inspired first-quarter market gains. But, on a broad global level at least, stocks are still in the black for the year so far. It was certainly “sell in May” yet again this year, but it’s open question whether you stay away til St Ledgers day in September, as the hoary old adage would have it.
On the euro story, the Greeks didn’t go for the nuclear option last weekend at least and it looks like there are some serious proposals on the EU summit table for next week – talk of banking union, EFSF/ESM bond buying programmes, euro bills if not bonds, EIB infrastructure/project bonds to try and catalyse some growth, and reasonable flexibility from Berlin and others on bailout austerity demands. The Fed has announced that it will twist again like it did last summer, by extending the Treasury yield curve programme by more than a quarter of a trillion dollars, and there are still hopes of it at least raising the prospect of more direct QE. The BoE is already chomping at that bit, as well as lending direct to SMEs, and most investors expect some further easing from the ECB in the weeks and months ahead.
Of course all that could disappoint once more and expectations are getting pumped up again as per June market performance numbers. The EU summit won’t deliver on everything, but there is some realization at least that they need to talk turkey on ways to prevent repeated rolling creditor strikes locking out governments out of the most basic of financing — only then have those very same creditors shun countries again when they agree to punishing fiscal adjustments. A credible growth plan helps a little but some pooling of debt looks unavoidable unless they seriously want to remain in perma-crisis for the rest of the year and probably many years to come. It may be a step too far before next year’s German elections, but surely even Berlin can now see that the bill gets ever higher the longer they wait.
Stumbling at every hurdle
Financial markets are odd sometimes. For weeks they have fretted about the outcome of the Greek election and its impact on the future of the euro zone as a whole. But today they appeared to dismiss the outcome despite a result that was about as positive as global investors fearful for euro zone stability could have hoped for. So what gives?
The logic behind the weeks of trepidation was fairly simple and straightforward. After an inconclusive election on May 6, a second Greek poll on June 17 was due to give a definitive picture of whether Greeks wanted to stay in the euro and with all the budgetary conditions necessary to keep EU/IMF bailout funds in place. If a victory for parties wanting to scrap the bailout agreement and austerity led to a halt of EU/IMF funds, the fear was that Greece would inevitably be forced out of the single currency bloc in time too. And if that unprecedented event happened, then a chain reaction would be hard to avoid. If one country goes back to its domestic currency, despite all its debts being denominated in euros, investors would then find it impossible not to assume at least some element of euro exit risk for fellow-bailout recipients Portugal and Ireland and possibly even Spain and Italy, where doubts remain about their market access over time.
Extreme tail risk or not, this set the scene for the jittery markets that ensued during the Greek electoral hiatus of May 6- June 17. Athens stocks lost more than 17%; Spanish 10-year government bonds lost more than 7% and the euro/dollar exchange rate was down almost 4%. etc. The fear of euro-wide contagion was so-great that the Spanish bank bailout in the interim had a little or no positive impact. And with the global economic growth picture weakening in tandem with, and partly because of, the euro mess, then prices reflecting world demand in general were hit hard by concerns that another shock to the European banking system could trigger a reversal of trillions of euros of European bank lending from around the globe. Crude oil dropped almost 14%, broad commodity prices and emerging market equities lost about 8%.
Next week: Call and response?
The Greek vote next Sunday now stands front and centre of pretty much all investment thinking, but the problem is that it may still be days and weeks before we get a true picture of what’s happened, whether a government can be formed and what their stance will be. If the new parliament cannot clearly back the existing bailout, even after a bout of horse-trading, then a game of chicken with Europe ensues. Eurogroup meets again on Thursday and there’s a German/French/Italy/Spain summit on Friday. But G20 leaders gather in Mexico as all this is unfolding, so they will certainly be quorate if some sort of global response is required to any initial market shock. What’s more, the FOMC is meeting Tuesday and Wednesday should Bernanke feel the US needs urgent insulation from the fallout regardless of broader action. But it’s certainly not beyond the bounds of reason that coordinated central bank action materializes next week if markets do indeed go skewways after the Greek poll. They have all clearly been consulting on the issue lately via telephone and bilaterals. And the assumption of more QE is there among investors. Three quarters of the 260+ funds polled by BoAMerrill Lynch this month expect another ECB LTRO by the end of Q3 and almost a half expecting more Fed QE over the same time.
And maybe it is this assumption of massive policy response that’s preventing markets capitulating outright. Money is gradually going to ground, but it’s not yet thrown in the towel completely as you can see from major equity indices, volatility gauges and interbank spreads etc. And there are a lot of headwinds everywhere over the next six months, the US election, fiscal cliff, end of operation twist stateside – and that’s in one of the few major western economies that was generating any significant growth this year. In other words, there are no shortage of arguments for another monetary boost. A heavy econ data slate during the week will also reveal just how much the world economy has run into sand this quarter. The standouts are the flash PMIs for June, the US Philly Fed index for June and UK jobs and inflation numbers.
As to the lack of response to last weekend’s Spanish bank bailout, it was weird in many ways that anyone really expected a major rally on this just six days ahead of a Greek vote which could throw the whole bloc into chaos. Even if you thought the Spanish bailout was good, and it was certainly a necessary if not sufficient step, you would still not return to Spanish debt until the next couple of weeks of events had cleared. So, in that respect, it’s unlikely the market made any real judgement on it either way. The subsequent credit rating cuts from Moody’s have not helped and yields have spiked to the 7% level flashing red lights. But it’s hard to see how any exposed frontline euro market, from Spain to Italy and Ireland to Portugal, can really stabilise ahead of the weekend. One fear on the Spanish rescue was of private investors’ subordination to EU/IMF creditors in any workout of Spanish debt. But even that too may have been overstated when it comes to the sovereign. For a start, the interest rate charged on the funds means a massive saving for Madrid compared with prevailing market rates and, as Barclays argued, actually increases the overall pie available for any workout, with a possible increase in projected recovery rates compared with the pre-bailout setup. If that was the big concern, then the subsequent rise in Spanish yields most likely is more Greek than Spanish in origin.
Research Radar: Greek gloom
Greek gloom dominates the start of the week as new elections there look inevitable and talk of Greek euro exit, or a Grexit” as common market parlance now has it, mounts. All risk assets and securities hinged on global growth have been hit, with China’s weekend reserve ratio easing doing little to offset gloomy data from world’s second biggest economy at the end of last week. World stocks are down heavily and emerging markets are underperforming; the euro has fallen to near 4-month lows below $1.29; safe haven core government debt is bid as euro peripheral debt yields in Italy and Spain push higher; and global growth bellwethers such as crude oil and the Australian dollar are down – the latter below parity against the US dollar for the first time in 5 months.
Financial research reports on Monday and over the weekend were just as gloomy, but plenty of interesting takes:
Bank of New York Mellon’s Simon Derrick’s view of the Greek political impasse concluded “there is at least an evens chance that the latter part of this summer will see what had officially been seen up until last November as an impossibility: a nation leaving the EUR.”
Play the mini-cycles, not the euro crisis
For all the headline attention on euro zone political heat over the next six weeks or so (Spain is already in the spotlight, Sunday is the first round of the French presidential elections, Greece goes to the polls on May 6, Ireland votes on the EU fiscal pact on May 31 etc etc), global investors may be better rewarded if they follow the more mundane runes of the world’s manufacturing cycle for tips on market direction.
As showcased by the IMF this week, the big picture global growth story remains one of a relatively modest slowdown this year to 3.5% before a substantial rebound in 2013 to well above trend at 4.1%. Of course, there are some who think that’s hopelessly optimistic and others who may quibble about the absolute numbers but agree with the basic ebb and flow.
Yet within even these headline numbers, many mini-cycles are playing out — especially within manfacturing, which accounts for about 20% of global GDP. But problems in deciphering these twists and turns have been compounded over the past year or so by the impact from natural disasters and supply chain disruptions such as Japan’s devastating earthquake and Thailand’s floods.
