A cautious set of Federal Reserve minutes gave the market pause for thought yesterday evening as they downgraded their growth forecast and warned in sober tones of a slow recovery on the jobs front. These factors point to a longer period of ZIRP and more QE. Other headwinds for the market came in the form of crude oil, which popped back above $62 a barrel on an unexpected decline in inventories as gold chugs ever higher ($900).
The stock market rally is now being driven by the same force that set up the excesses that led to the bust in the first place – an abundance of liquidity. The world is awash with government money, both central bank “quantitative easing” (money printing) and budgetary stimulus, and this is, in turn, driving a re-run of the hedge fund speculation that popped the market in 2007. You can’t drink yourself sober.
Today’s Market Moving Stories
- Overnight we got news of Japan’s tertiary industry index, Mar: The economy remains under pressure as service-sector activity fell by 4%, which was the biggest fall since 1997.
- UK: The International Monetary Fund warns that the “success of the current policy package hinges on the continued trust in the sustainability of the fiscal position.” It adds: “The focus of this adjustment profile should be to put public debt on a firmly downward path faster than envisaged in the 2009 Budget.” It calls for the government to specify how it plans to limit public spending, to allocate any surprise tax revenue growth to deficit reduction and to build a broad public consensus for bringing the government books closer to balance.
The fund notes that it favours cutting spending plans rather than tax increases to improve the public finances, because the fund believes that evidence from Canada, Australia and Denmark shows lower public spending is the more durable policy. The fund also notes: “The financial system may not yet be repaired to a level where banks are ready to increase lending sufficiently to underpin a strong recovery. Although banks are expected to continue to remain above minimum regulatory capital requirements, further shocks will lead to an erosion of capital buffers.” It adds that the Government must encourage banks to raise more capital, and to “stand ready to provide
- Confederation of British Industry President Martin Broughton says that the recent budget represented a “serious failure” to come to grips with the country’s fiscal challenge. He adds that “it is the time to develop credible plans to get the deficit under control and bring back stability in the medium term.” He adds that the use of “heroic growth assumptions” in the budget “amounted to a serious failure to address the deficit in a way that gives confidence to buyers of our public debt.”
- Ryanair (RYAAY) called on Aer Lingus to cut the salaries of its Chairman and its directors due to the airline’s 'stated need to significantly reduce costs’.
- Good to know that Uncle Sam’s tax Dollars are being wisely spent and that someone is minding the shop.
- The spectre of terror returns to haunt us.
- Is Dr Doom Prof Nouriel Roubini lucky or just good?
- Proof of what many hapless investor knows to their cost. Jim Cramer is a lousy stock picker.
- Fancy a modest pad in New York?
Merrill Lynch Fund Manager’s Survey Results
The key results kind of support my point that the Emerging Markets are seriously overbought and ripe for some profit taking. May survey of 220 investors with $617bn assets under management showed a surge in macro and market optimism but not to extreme levels and argues for market consolidation rather than sell.
Four data points to illustrate optimism:
- 57% see stronger global economy - highest since Feb 2004.
- First positive reading for profit expectations since 2005, more than 1/4 of survey thinks +10% profit growth next 12 months.
- Cash balances down to much more normal level of 4.3% (from 4.9% last month and a recent peak of 5.5% Nov/Dec).
- Top three global sectors are technology, energy and materials. Big reduction in exposure to pharma, staples and utilities.
The main conclusions are:
- Pain trade no longer up. Apocalyptic bearishness of March has vanished, investor positioning is more balanced and more cyclical.
- Outside of Emerging Markets/China where there are signs of irrational exuberance, optimism is not extreme, i.e. it argues for consolidation rather than a “Sell in May”.
- The uber-contrarian would buy telco and sell tech, buy Japan and sell China.
Dollar Bears in the Ascendancy
The USD has been coming under growing pressure for some time against the background of improving risk appetite and overnight it was given a further push from the minutes of the 28-29 April FOMC meeting. The USD index plunged close to 5-month lows and remains vulnerable to further selling. There was always a risk that a Fed discussion about increasing Treasury purchases would play negatively for the USD given the 4% drop in the USD when the Fed initially announced its Treasury purchase programme. In the event, the minutes did just that, with some members highlighting that the Fed may need to step up Treasury purchases “to spur a more rapid pace of recovery”.
In addition, the Fed revised down its growth outlook and revised up its estimates of the increase in the unemployment rate whilst noting that economic recovery will be gradual in the years ahead. The FOMC minutes resulted in some disconnect between equities, which erased earlier gains to close lower, and the USD which slid further. Bonds were supported, however. Equity markets also did not take too well to the warnings from American Express that new US legislation to curb credit card fees may also reduce lending to “consumers who need it”. Although this may just be sour grapes from credit card companies, one of the restraints to recovery remains tight lending standards and if the new legislation results in tighter lending conditions, it will add to the difficulties in obtaining financing and in turn restrict spending.
The Day Ahead
With holidays in some parts of Europe today (depending on your religion), flows should be lighter than usual. It’s also a a bank holiday in the UK on Monday as well as Memorial Day in the US. All times UK.
UK retail sales, Apr (09:30): Sales should be up a further 0.3% in April, putting annual growth at 2.3%, although note that it is hard to seasonally adjust the numbers for the impact of Easter.
UK public finances, Apr (09:30): The public finances are getting worse as revenues fall and spending overshoots projections. We expect a cash deficit of GBP2.5b and an accruals deficit of GBP7b.
US leading index, Apr (15:00): The index should jump by 1.1%, the largest rise since 2005, boosted by equities, consumer expectations and the yield curve.
US Philadelphia Fed survey, May (15:00): Manufacturing should contract at a slower rate, improving further to -18, up from the recent low of -41.