Progress Depends on Political Progress 18 July 2012
Stocks Hold Steady During a relatively modest week in terms of trading activity, stocks managed to stage a rally on Friday that helped erase the declines of the previous four days. For the week as a whole, stocks were flat to mixed, with the Dow Jones Industrial Average up fractionally to 12,777, the S&P 500 Index advancing 0.2% to 1,356 and the Nasdaq Composite falling 1.0% to 2,908. Taking a slightly longer-term view, we would note that stocks have been rising gradually since early June and are currently up about 5% from their early June lows.
European Progress Depends on Political Compromise The stock market gains over the past month can be largely attributed to the perception that policymakers in Europe have been making some progress combating the ongoing debt crisis. Political leaders have continued to discuss a variety of ways to recapitalise the banking system to prevent further contagion, and the European Central Bank did announce an additional cut in interest rates.
The problem with the European crisis is that the speed at which policymakers are acting continually appears to be slower than what the markets would like. There have been some tentative signs that Europe will move toward a tighter fiscal and political union, but the means of implementation are still murky. The eurozone has the ability to stem the crisis, but politics remain the biggest question mark. Looking ahead, it seems clear that signs of political compromise in Europe would be positive for risk assets, while political bickering and policy paralysis would equate to heightened volatility and a more bearish environment.
Uncertainty Remains for the US Economy There is a broad sense of uncertainty over the state of the US economy, and that uncertainty is making investors, companies and consumers wary about the future. To some extent, this type of environment can become circular and lead to a self-fulfilling prophecy.
Compared to where it was earlier in the year, the US economy appears to have entered a soft patch in recent months. The June payrolls report was a near-perfect indicator of how the economy has been trending. The headline numbers were relatively disappointing, showing that only 80,000 new jobs were created for the month. Yet, the silver lining is that jobs still are being created and there were some improvements in terms of hours worked and average hourly earnings.
Markets Remain in a Balancing Act At present, the macro environment appears to be balanced between a range of positive and negative forces. The negatives are well-known and are the same ones that have been in force for some time: the eurozone debt crisis, the potential slowdown in China and the looming fiscal cliff in the United States. For the positive factors, we would cite easing monetary conditions around the world, falling oil prices that should benefit consumers in the second half of the year.
We expect this tug-of-war environment will continue to dominate the world financial markets. The euro debt crisis and weak global growth should continue to cast a shadow on the global economy, but the positives we mentioned should also encourage some investors to engage in additional risk taking. Our sense is that the global economic recovery should continue, if unevenly. The US economy is likely to continue to expand and Chinese growth should remain relatively high. The problems in Europe are a long way from being solved and will likely remain a drag on risk assets.
For stocks, the softness in the global economy is likely to continue to make for a difficult environment, but that has been the case for some time. Stocks have come a long way since the market bottom in October of last year (marked by 1,075 for the S&P 500) and an even longer way since the lows of the credit crisis (666 for the S&P 500 in March 2009). Equity gains from here are likely to be uneven.
Currencies On currency markets, the euro lost ground against the dollar impacted by lingering worries over the Eurozone debt crisis and weaker Chinese growth data, hitting a two-year low of $1.2160, before recovering later in the week. The â‚Ź/$ rate ended the week at â‚Ź1.22.
Oil Oil prices endured a choppy week, as investors digested weaker-than-expected Chinese growth data, uncertainty about the situation in Iran along with Norway’s move to avert a shutdown of its oil industry. Despite this uncertainty, expectations of Chinese monetary stimulus in the second half of the year provided support, and the West Texas oil price ended the week over $87 a barrel, a weekly gain of 3.0%.
Bonds Despite most peripheral yield spreads falling over the course of the week, growth concerns caused investors to continue seeking the safe haven status of German sovereign debt. In other core bond markets, Austrian, French, Finnish and Belgian yields also fell to record low levels. Italian bonds were downgraded by Moody’s but completed a successful three-year bond auction on Friday. Longer-dated auctions were less well received. The Merrill Lynch over 5 year government bond index ended the week up almost 1.0%. Source: Zurich Investment Managers, Bloomberg, Blackrock, Aviva Investment Managers & FT.com