Can equity markets retain their gains?
Mike Lenhoff – Chief Strategist
Brewin Dolphin
Investment Research
31 October 2011
Not only is this a busy week for economic data but, with much of it for the US and coming from market sensitive ISM surveys and Non-farm payrolls, it is one that will focus attention on how the US economy is stacking up for the final quarter of the year.
Although the FOMC and the ECB also meet this week no new policy initiatives are likely and nor is any change in the overall messages. However, the Fed has been expecting a better second half to this year than first half, something to which last week’s third quarter GDP data has already given support. A good start to the final quarter of the year with this week’s numbers could add a bit more conviction to the view that the economy is regaining momentum and that the risk of a US recession is diminishing.
Elsewhere, the call by the Presidents of the European Council and European Commission for a ‘re-newed collective spirit of common responsibility and purpose’ at the G20 meeting later this week is likely to chime with Britain’s Prime Minister, David Cameron, who intends to set out his own thoughts on how best to push for a more balanced world economy.
But it will also chime with Japan, which has its own axe to grind. Having just intervened again in the forex market following the yen’s rise to a new all-time high again against the dollar, it is thus likely to make its own voice heard on the desire to ensure global recovery and balanced growth. The way Japan’s policy makers sees it, the strength of the yen is a product of worries over the eurozone’s debt crisis and also the loss of momentum in the US economy at a time when its own economy is struggling to overcome domestic difficulties following the earthquake and its nuclear crisis. The relentless rise in the yen along with its disinflationary influence is exactly what the economy does not need.
Returning to the US and the earnings season, some 85 percent of the S&P 500 will have been reported by the end of this week. Thus far, for every company that missed its earnings forecast, four companies have beat them with the result that earnings growth for the quarter is now expected to come in at 16.3 percen instead of the 13.1 percent expected at the outset of the quarter.
Such double digit growth is impressive considering that some 60 to 65 percent of the sales for the S&P 500 originate in the domestic economy, which is still growing slowly. Although third quarter demand has picked up job growth remains weak so it is likely that productivity gains are still supportive of the earnings growth.
Equity markets look seriously overbought after this month’s near 14 percent rise in the FTSE All-World Index, a rise that gave the S&P 500 the distinction of being the one major index to register a positive gain for the year as of the end of last week. Given the technical condition of the markets a bout of selling on any excuse would not be unexpected.
As noted last week when commenting on what eurozone leaders managed to achieve, notably an outline for a workable agenda where none existed before, there are likely to be plenty of glitches along the way in nailing down the detail of it all. However, the conclusion was that, even though caution still applied, progress was made.
While it is hard to imagine less obsessive attention being paid to every basis point rise (or fall) in Italy’s government debt, the prospect is that more positive economic news on the US combined with what is proving to be a favourable set of earnings results will not only help equity markets all round hang on to their October gains but also strengthen their valuation case and reinforce the view that government bond markets, notably US Treasuries, gilts and bunds, are too highly rated.
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