Wall Street buoyed by better-than-expected corporate earnings

In this week’s bulletin:

  •  Markets volatile on the back of eurozone and Chinese growth worries
  • Doubts over Spain’s resolve to cut its deficit see bond yields rise to 6%
  • China’s growth slows but Beijing ready for further easing
  • UK to avoid ‘double dip’ recession and set for stronger recovery
  • Wall Street buoyed by better-than-expected corporate earnings
  • US housing market nearing bottom and set for recovery according to JP Morgan boss

 

Market Eye

Markets volatile on the back of eurozone and Chinese growth worries

Another shortened week coupled with light trading volumes turned out to be a re-run of the previous one, with the eurozone and China dominating the news. Having mostly recovered their poise, global markets were once again buffeted by worries over a resurgence of the eurozone crisis; specifically that Spain would be the next member to need bailing out. The other theme to occupy investors’ minds was China and specifically that its slowing economy would end in a so-called ‘hard landing’; as opposed to a gentle ‘soft’ landing which, unsurprisingly, is the first choice of investors. Reaction in the markets was not perhaps as predictable as expected: whilst equity markets in the developed economies went into reverse, with European bourses worst hit, Hong Kong and Shanghai advanced, despite concerns over growth. With investors switching into ‘risk-off’ mode, gold regained its shine and government bond yields fell in response to increased buying.

Déjà vu

Doubts over Spain’s resolve to cut its deficit see bond yields rise to 6%

After the European Central Bank’s (ECB) intervention back at the end of 2011 and the beginning of this year, when it pumped some €1 trillion of cheap money into the European banking system, markets have become more positive in 2012. However, in recent weeks worries have returned about the health of some of the eurozone’s weaker members, notably Spain and Italy. It was clear that, having suffered a major heart attack, the eurozone patient needed urgent help and the ECB’s actions finally ensured survival and time for convalescence. The reason confidence is once again ebbing is the worry that the likes of Spain and Italy will not make effective use of this breathing space; diluting the steps needed to cut their deficits and put their houses in good order. Evidence of this has been apparent with the Spanish government having to tell the markets that its deficit as a percentage of GDP will be larger than originally planned. In response, investors have once again become sellers of Spanish and Italian government bonds, causing yields to rise to nearly 6.0% and thus increasing the costs to service the debt and, in turn, raising the possibility of even more government spending cuts.

So once again last week, markets fell sharply as wary investors decided to head for the safety of German Bunds, UK gilts and US Treasuries. As expected, Spanish ministers and EU officials took turns to deny that the country needed an international bailout, in an attempt to assuage the bond markets. Officials instead focused on the need for Madrid to press on and implement the tough reforms already announced. Spain has the more difficult task of bringing its 17 autonomous regions into line with central government policy – an issue on the minds of both the EU and the bond markets. However, by Thursday an element of calm returned on suggestions from an ECB board member, Benoît Coeuré, that market intervention might be possible as the central bank tries to rectify “unjustified” concern over Spain’s fiscal position. Mr Coeuré said Spain’s new government had taken “very strong deficit measures” and that what was happening in the market did not reflect the fundamentals.

Slower Boat to China

China’s growth slows but Beijing ready for further easing

Investors’ other major concern revolves around China, as we discussed last week. From the developed world’s perspective, China has a somewhat rich problem to contend with: rather than having to deal with the problem of boosting growth, it is endeavouring to slow down its giant economy in a measured and controlled way to bring inflation back under control whilst managing its social and economic reform programme. Last week, the country’s government said it will intensify policy preparations to support its slowing economy after its lowest growth in three years. The economy expanded by 8.1% in the first quarter (the UK is likely to grow by 0.4% in the same period) compared to a year earlier – below most forecasts and thus fuelling concerns in international markets about weakening demand in the world’s fastest-growing major economy. So in response, Premier Wen Jaibao said, “The domestic economy is facing downside pressure. We must strengthen our back-up plans and make room for contingency policies.” In fact, economists believe there are already signs that the government is starting to stimulate the economy; not with a headline-grabbing big bang approach but rather by quietly encouraging banks to lend more and inject more cash into the economy. In order to increase transparency, Mr Wen ended by saying that China was aiming for 7.5% growth this year, its lowest for a decade. So for now, the markets remain on close watch.

Sunnier Outlook

UK to avoid ‘double dip’ recession and set for stronger recovery

It seems that the UK is on the brink of a lasting recovery, according to the Organisation for Economic Development (OECD), as momentum builds in the global economy. The think tank took the view that the UK is at a potential turning point, citing its monthly composite indicators which have a strong record for predicting the state of the economy six months in advance. According to the indicators, activity picked up in February and whilst few if any are expecting a quick return to trend GDP growth – around 2.5% – economists do believe the recovery has started. Coinciding with this report came news from the British Retail Consortium that sales rose in March by 3.6%, the best for three months, as brighter weather encouraged Britain’s shoppers back to the high street. In the construction sector, output rose in February but less than hoped for, according to the Office for National Statistics, with the volume of construction up 6.1%. And finally, it appears that the country’s recovery is being held up by companies continuing to hoard their cash – the latest estimate is that UK corporations have a record £754 billion in cash. The independent Item Club says business investment will be just 1.2% this year as companies remain risk averse. The flip-side of this though is that shareholders can expect to see strong dividend growth again this year, according to Capita Registrars, which estimates that dividend payments for the UK market as a whole will rise around 11%, significantly ahead of inflation.

Wall Street Marches On

“Businesses are in very good shape.

They’re earning money, they’re very well capitalised, they’ve got a lot of cash.”

Jamie Dimon, Chairman JPMorgan

Despite the increased volatility in recent weeks, US stocks remain in good shape as signs of recovery continue to flow in. Last week stronger-than-expected first-quarter results from some of America’s largest businesses made for a positive mood, with the likes of aluminium giant Alcoa and bank JPMorgan reporting good earnings figures. Recovery hopes were also given a further boost when America’s two largest banks – JPMorgan and Wells Fargo – said the US housing market was nearing bottom as homeowners took advantage of record-low interest rates to refinance their mortgages and boost their spending power. JPMorgan’s chairman, Jamie Dimon, said that American consumers had cut their debt burden so that their debt service ratio was back where it was 20 years ago. US homeowners have seen house prices drop almost 34% from their peak in 2006 and signs that the market is stabilising will help rebuild confidence and potentially bolster consumer spending which will be good news for corporate America.

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