Wall Street’s heavyweight investors bet on more QE

In this week’s bulletin:

  • Global stock markets enjoy best week for a month
  • Investors remain cautious over Spain
  • UK inflation rise a surprise for Bank of England
  • Wall Street’s heavyweight investors bet on more QE as economy softens
  • Investors seek reassurance that equity bull market remains on track
  • Corporate earnings continue to surprise on the upside
  • French election results unsettle markets
  • Pimco’s CEO, Mohamed El-Erian, discusses the likely impact of forthcoming European elections

 

Market Eye

  • Global stock markets enjoy best week for a month
  • Investors remain cautious over Spain
  • UK inflation rise a surprise for Bank of England

Global stock markets rebounded last week as investors re-discovered their appetite for risk: markets enjoyed one of their best weeks for more than a month. Sentiment was buoyed by solid first quarter company earnings, upbeat German business confidence surveys and much better-than-expected Spanish and French government debt auctions. Not that concerns over Spain’s longer-term problems have gone away – yields on the country’s sovereign debt remained stubbornly above the 6% level, indicating ongoing worries by investors. Some market observers are taking the view that the recent rise in borrowing costs reflects both a correction of yields to more realistic levels as well as concerns over the government’s ability to contain regional spending and risks to the banking sector from exposure to the real estate sector. Spain’s banks are not the only ones that are under pressure; last week the International Monetary Fund (IMF) went as far to say that European banks look set to shrink their balance sheets by €2.6 trillion over the next eighteen months as they seek to boost their capital ratios.

Here in the UK, economic data was mixed to positive. An unexpected fall in the numbers unemployed was welcomed as monthly data from the Office for National Statistics showed employment numbers up and jobless numbers down, including youth unemployment. On the retail front, sales surged in March even after stripping-out the effect of the panic petrol buying, indicating that consumer confidence and disposable incomes could be strengthening. The less welcome news came on the inflation front with official Consumer Price Index (CPI) figures showing an unexpected, albeit small, rise to 3.5% in February. The deputy governor of the Bank of England, Paul Tucker, described it as “bad news on the inflation front” and it leaves the Bank’s most recent forecast that CPI would fall to 2.5% looking extremely optimistic. Alongside this, the implication is that higher inflation will make it more difficult for the Bank of England to embark on a further round of quantitative easing (QE). There was one bright spot though: energy costs have fallen back since then, with a barrel of Brent crude oil easing from a high of $125 to close at $118 on Friday.

 

All Eyes on Ben Bernanke

  • Wall Street’s heavyweight investors bet on more QE as economy softens

“It’s in risk assets – equities, high yield, or spread assets in fixed-income – that

you will primarily see the benefit of QE”.

Rick Reider, CIO, Blackrock.

Whether the US Federal Reserve will embark on another of its own programme of QE is a much debated topic on Wall Street. For many observers the game is over, taking the view that recent evidence of America’s recovery – particularly on the jobs front – will mean there is no need of a further stimulus from the Fed’s chairman Ben Bernanke. However, there is a group of large investors biding their time in the belief that the US economy will repeat its pattern of the past two summers by entering a soft patch, which will then cause the Fed to intervene with fresh help via QE3. Bill Gross at Pimco has a very large bet on QE3: his holdings of US mortgage debt, the favourite purchase under QE, within his $252bn fund rose to 53% last month – the highest weighting since June 2009. Either way though, an imminent decision is unlikely when the Federal Open Market Committee meets next month. The doves will have to win the argument with the other members of the committee who currently doubt the need for more asset purchases, with the tone of jobs and inflation data over the coming months seen as key factors in determining whether policymakers press the start button once more on America’s dollar printing presses.

 

US stocks mark time

  • Investors seek reassurance that equity bull market remains on track
  • Corporate earnings continue to surprise on the upside

After a strong first quarter equity markets have, during April, mostly given ground as mentioned. For some the retreat is seen as being caused by weaker-than-expected data in the US and particularly China as well as renewed fretting over the eurozone. Others see the underperformance as being driven more by profit-taking following a strong first quarter rather than a fundamental weakening in the global economic outlook. Against this backdrop, investors are looking for reassurance that the equity bull market which started in 2009 is still intact, so all eyes are on Wall Street and first-quarter company earnings reports. So far the majority of companies reporting have beaten expectations, including JP Morgan, Wells Fargo, Alcoa, IBM and the rail group CSX. The big question is whether companies can keep on increasing profit margins to meet analysts’ expectations. After posting record earnings of $99 per share in 2011, analysts forecast that S&P500 companies will hit $106 per share this year and push on to $118 in 2013.

Although companies are still belt-tightening, a sharp jump in oil prices and higher raw material costs are weighing on earnings. Consumer stocks suffer a double blow from rising energy costs because not only do their own costs rise, but households are hit too by rising petrol prices, leaving less discretionary spending. The bulls argue that thinner margins have been priced-in and claim that a more convincing economic recovery in the coming months could compensate for falling margins with higher sales. Investors’ expectations should remain positioned for low growth, low rates and low inflation, according to the likes of Merrill Lynch, who comment that “Global growth is low and slowing, corporate profits will be pressured from historically high levels and central banks will continue to intervene”. To reflect such an outlook portfolios should have a balanced mix of fixed-interest and asset-backed investments with a focus on a quality income stream.

 

Markets and Politics

  • French election results unsettle markets
  • Pimco’s CEO, Mohamed El-Erian, discusses the likely impact of forthcoming European elections

European stock markets have fallen today after President Nicolas Sarkozy narrowly lost the first round of France’s presidential election to socialist rival, Francois Hollande. Mr Hollande has said he intends to focus on boosting growth through spending rather than on austerity. With this outcome in mind, together with a raft of European elections coming up in the next few weeks, you might be wondering how the results will impact longer term on the markets. Mohamed El-Erian, co-CEO of Pimco shared his own thoughts with investors last week.

“Think of this particular election cycle as starting on Sunday with the first round of the presidential elections in France. It continues in a big way on May 6th with the second round in France, as well as the Greek parliamentary elections and German regional contests. And, for now, it ends on May 31st with the Irish referendum. In each of these contests, politicians are offering voters different visions for the future. This is particularly true in Greece. In this struggling economy, the contest is defined primarily between those willing to continue with the austerity programme and those that would opt for something different. For investors, it boils down to a contest between a still-challenged Greek policy approach and one that would involve even greater credit and exit risks.

“Issues are more nuanced in France. The uncertainty has to do with Sarkozy. In his attempt to catch up Hollande in the polls, he has been altering his narrative and making new promises. If President Sarkozy fails in his re-election bid, German Chancellor Angela Merkel will lose her most important ally at the core of the Europe and it comes at a time when many are looking at the regional elections in Germany for indicators as to whether Merkel will be able to continue to govern after next year’s national elections. Then there is the Irish referendum. In what constitutes a first highly visible test, the government is seeking the electorate’s approval for the new European Fiscal Compact.

“What should markets look for? For presentational simplicity, let us assume that you happen to be one of the very few people out there who limits your preferences only, and I stress only, to how your investments would be impacted. So, in simple aggregate terms, if you are long risk assets of any kind you would prefer a Sarkozy re-election in France, the emergence of a stable coalition of the major traditional parties in Greece, regional German elections that are supportive of Merkel, and the passing of the Irish referendum. If you are short risk assets and/or looking to add, you would prefer a win by Hollande, an ambiguous electorate outcome in Greece, setbacks for Merkel, and the rejection by Irish voters of the European changes. At times, elections can lead to uncertainties and, for investors, to a changing configuration of opportunities and risks. We are entering such a phase in Europe”.

The market fall-out from yesterday’s political events in France is perhaps not unexpected and something we can anticipate being repeated as nervousness about a eurozone solution remains. What is important is that investors continue to hold their nerve and see through to the longer-term prospects for economic recovery.

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