Uneven growth still likely 24 July 2012 Markets Post Modest Gains Despite Weak Data Notwithstanding a pullback on Friday, stocks managed to post gains last week despite a generally negative tone to the economic data. In some ways, the recent trend of relatively weak data has actually been beneficial for stocks in that it has been boosting hopes for additional policy stimulus around the world. For the week, the Dow Jones Industrial Average climbed 0.4% to 12,822, the S&P 500 Index advanced 0.4% to 1,362 and the Nasdaq Composite climbed 0.6% to 2,925. US Recession Risks Remain Low Since the middle of the spring, the global economy has been faltering. Manufacturing levels around the world have been erratic, even in such emerging powerhouses as China and Brazil. Europe is already in recession, and growth in the United States has certainly slowed from where it was late last year and early in 2012. The United States is facing a number of structural problems that are keeping a lid on economic growth. Business confidence is weak, which has translated into anaemic levels of hiring and capital spending. The looming “fiscal cliff” and the associated political dysfunction make it difficult to believe that the US debt problems will be solved and the country is still in the midst of a long-term deleveraging process. It would be an overreaction, however, to suggest that the US economy is also heading into a recession. There are a number of important sources of strength within the United States: the strong financial health of the corporate sector, a healing banking system, and historically low levels of credit card delinquencies and signs of increased discretionary spending by consumers. The view is that absent some sort of new catastrophic event, US growth should remain positive, if hardly stellar. Still tough in Europe Peripheral debt-induced stress remains in the eurozone with some commentators even questioning the existence of the euro. This, plus disappointing data in other regions, such as the US and China, has added risks to investors’ otherwise more positive growth expectations. Unless we get a surge in commodity prices – if anything the reverse is happening at the moment - price pressures should remain contained.
Countries continue to resist currency strength and this is a sign that the inflation concerns of policy makers remain modest; and in the eurozone the weakness of the currency is probably being welcomed by policymakers. Short-term interest rates remain at emergency levels in the US with the Fed intending to keep these levels for another two years. Elsewhere, other central banks are either neutral in their stance or have embarked on easing measures. The ECB cut rates as expected recently, but disappointed with no new non-standard measures. Rates will stay exceptionally low for quite some time to come, and additional measures will eventually be forthcoming, with negative deposit rates a distinct possibility in some countries. The recent EU summit announcements produced a sharp relief rally in peripheral bond markets, but this proved a very temporary relief as both Spanish and Italian spreads are now wider than immediately prior to the summit. Investors were relieved that ‘something’ happened, but remain sceptical that this is ‘the solution’. Irish bonds were the exception and have held a lot of their gains so far, although spreads have begun to widen again. The EU announcement is not material enough to alter perceptions of the global risks to growth. Allied to this are low short rates, central bank buying and disinflation concerns, the combination of which suggests that long-term interest rates in major developed countries could stay at exceptionally low levels for a considerable period of time. Global equities in euro terms have gained 13% so far this year. While this figure is flattered by a weaker euro exchange rate - in local currency terms markets are only up 7% - it is nonetheless a resilient performance. Valuations continue to be seen as reasonable, as they have been for some time now. But it is investors’ perception of the macroeconomic backdrop – partly fuelled by the eurozone crisis – that has been the main driver of sentiment this year. Thus, the recent EU summit produced a bounce in equities but this was short-lived, and sentiment quickly flipped back to being negative. Bonds Escalating eurozone debt concerns dominated market sentiment late last week, as worries that Spain will be forced to follow Greece, Portugal and Ireland and request a financial bailout pushed Spanish yields towards record highs. Italy’s ten-year sovereign debt yield also ended the week well above the 6% level. In other news, Germany sold two-year government bonds at a negative yield for the first time ever as uncertain outlook for the eurozone intensified demand for the safety of German bunds. The Merrill Lynch over 5 year government bond index ended the week up 0.3%. Currencies On currency markets, the euro remained under pressure against a basket of global currencies, after the ECB announced it would stop accepting Greek sovereign bonds as collateral and as fears resurfaced about the outlook for the Spanish economy. The euro hit a two-year low against the US dollar of $1.2143, before recovering later in the week. The €/$ rate ended the week at €1.22.
Oil Amid improved risk appetite in the first half of last week and escalating geopolitical tensions in the Middle East, the West Texas oil price rallied strongly last week. It ended the week at $91 a barrel, a weekly gain of 5.0%. Gold Gold prices edged lower early in the week as US Federal Reserve (Fed) Chairman Ben Bernanke said little about any new stimulus measures, while renewed fears about Europe's sovereign debt crisis also weighed on prices. However, the market turned more positive later in the week, buoyed by an across-the-board rally in commodities, led by oil, which was up on rising geopolitical tensions in the Middle East. Gold closed the week up 1.8% and the FTSE Gold Mines Index gained 1.0%. Source: FT.com, Bloomberg, Blackrock, Zurich Investment Managers