Over the last month, the equity markets have drifted downwards after the SPX failed to move beyond the 950 level after multiple attempts. During this period, the 200 day moving average has provided the market with a well defined level to trade off, with equities bouncing off this level multiple times. The 870 level on the SPX also held firm with sharp rebounds during intra-day probes of this level. The market is waiting for the earnings season, and if early signs are any indicator, corporate America seems set to please the bulls.
Meredith Whitney Moves the Market
Over the past year and a half, former Oppenheimer & Co analyst Meredith Whitney has been moving the market down with her bearish calls on the financial sector. However, this past Monday, she came out with a bullish call on Goldman Sachs (NYSE:GS) and a not so bearish view on the rest of the banking sector.
This triggered a strong rally in the banking sector, which was aided by Goldman’s blowout results on Tuesday morning. General wisdom suggests that the overall market cannot move up without the financials leading the way, and the healthy action in financial stock is music to the bulls.
Intel Blows Through Estimates
After the close of the market, Intel (NASDAQ:INTC) announced its earnings which beat Wall Street estimates by a mile. To add fuel to the fire, their outlook for the next quarter was significantly better than the average street estimate. The markets have responded very favorably to these moves, with the Nasdaq100 futures (NQ) up more than 1.6% after hours.
Intel is attributing the strong performance to renewed growth in emerging markets, especially China. Since Intel’s chips power almost all computers sold today, Intel’s rosy forecast is seen as a sign of improving health for the entire semiconductor and technology sector.
Did Wall Street Underestimate China?
Recovery in China is a key component of Intel’s forecast. The Chinese government’s stimulus package has been focused on turbo-charging internal demand via very loose purse-strings. The total amount of lending in the first four months of 2009 has exceeded the total amount lent in 2008. Incentives to purchase new automobiles have led to a 35% surge in sales, to an annualized rate which may beat the US new auto sales figures. It seems that Intel is now seeing the impact of the massive spending binge and factoring that into its forecast.
Intel’s result and forecast suggest a mismatch between Intel’s expectations and current Wall Street expectations of the impact of Chinese stimulus. It is not obvious whether this mismatch stretches to other segments of the market.
However, Intel’s forecast is likely to result in a thorough review of Wall Street’s existing view of the impact of Chinese stimulus. I definitely expect upward revisions of earnings estimates for other players in the technology sector; with some spillover to industrials and materials.
Liquidity Driven Rally to Continue
Intel’s results and the market reaction to it suggest that pronouncement of Jeremy Grantham of a massive rally are likely to come true. Grantham believes that the massive coordinated stimulus injected into the financial system will create a liquidity driven rally. There is already some speculation that a significant amount of the Chinese stimulus has found its way into financial markets and is the driving force behind the meteoric recovery of equity prices in China. The bullish spring run in crude oil too is being attributed to excess liquidity finding a home in commodities.
But Will It Last?
Assuming the market rallies, the big question will be whether those levels can be sustained. Unless economic fundamentals catch up with the equity markets, that is unlikely to happen. I believe that government action can delay or soften the pain, but cannot eliminate the effects of structural changes occurring in the global economy.
The US consumer will be weighed down by high unemployment, a lack of available credit and high taxes. China will have to engineer a massive shift towards domestic consumption from its export led growth model. The problem there is that the Chinese are habitual savers, and are unlikely to go into a spending binge when the collapse in exports is resulting in millions of lost jobs.
I agree with Mr. Grantham’s thesis that the global stimuli will do more to spruce up equity markets, with a little lasting impact on the underlying economic fundamentals.
The SPX corrected almost 10% from its early June highs and held the key 875 level on a closing basis. Though many market technicians are pointing to a well formed head and shoulder pattern which suggests a downward move towards the low 800s, the earnings surprises are likely to weaken the bearish bias.
Assuming that other technology heavyweights come out with strong earnings, I expect the tech sector to lead a rally in equities, which will test the recent highs. A clean break above the recent highs would put 1000, a key psychological level in play.
However, any bullish bias has to be tempered with the knowledge that the underlying economic situation remains precarious. This rally is going to be driven by high expectations which may or may not materialize.
The key as always, but more so now, will be to observe the animal spirits: how equities react to news both good and bad. In a bullish tape, all news is bought; in a bearish tape, even good news is sold.
As long as fundamentals remain questionable, sentiment will perhaps be the best guide in navigating the markets.
Disclosure: Vikram actively trades the US financilal markets and holds long and short positions in many instruments and securities mentioned in this article.