The first week of US Q2 earnings reports was good enough to drive global stock indexes surprisingly high and fast, considering that anything beyond a very superficial glance at the reports shows ominous signs for Q3 and beyond.
Stock indexes have generally led risk appetite, with commodities, commodity based currencies, and higher yielding currencies (which are bought as carry trade volume rises) following stocks up or down, and that correlation held up well over the past week’s rise in major world stock markets.
Thus commodities have moved up over the past week, as have the AUD, NZD, and CAD, while the JPY and USD have dropped. Those currencies in the middle of the yield spectrum have generally showed mixed results, generally gaining against lower yielding currencies and losing ground against higher yielding ones, or just chopping around in a tight trading range.
With international stocks and risk appetite already very close to their highs for the year already, markets appear vulnerable to pullback unless news in the coming weeks, especially earnings reports, can remain very upbeat regarding both results from past quarter and prospects for the future.
For now, support levels for risk assets like stocks, commodities, and risk correlated currencies established over the past few months appear to have more life in them. We suspect resistance may prove equally enduring.
Introduction: Review for the Sake of Preview
The short version is that some big name tech stocks and the too-big-to-fail (TBTF) banks and other big name techs managed to beat consensus earnings estimates and spark a rally off of multi-month lows for risk assets like stocks, commodities, and high yielding or commodity based currencies.
As I’ve repeatedly reminded readers, the most decisive earnings announcements for the past two years have come from the financial sector, the root of all major market moves for the past two years.
A Positive Start
Thus the bullish tone for the week was set Monday, before earnings reports even had begun in earnest. The trendsetter, if you will, was influential analyst Meredith Whitney who raised her rating on Goldman Sachs (GS) ahead of its earnings report to Buy from Neutral and took the occasion to suggest that she felt it was possible the financial sector could put together a rally of about 15% in the near-term.
Goldman indeed blew away estimates, and was followed by less dramatic consensus-beating by JPMorgan Chase (JPM), Bank of America (BAC), and Citigroup (C). Intel (INTC) and IBM also beat estimates and put a shine on the tech sector, and brought additional cheer to the Asian stock markets, because so much electronics manufacturing is done there.
Denial—Not Just a River in Egypt
Nonetheless, even a casual study of the details behind the financial sector announcements reveals a far more disturbing picture, for none of the heralded profits reflected results from any kind of predictable ongoing operations.
Goldman Sachs’ (GS) profits were primarily from high risk trading operations, which by nature can vary dramatically, especially with the recent theft of proprietary short term trading software. This business model is perhaps reckless but understandable, given that GS knows it can always hit the taxpayers to cover losses, but is worrisome for the markets, never mind American taxpayers.
Strong results from JPMorgan Chase (JPM), Bank of America (BAC), and Citigroup (C) came from one-time capital gains from asset sales, not sustainable operations. While JPM did have strong results from its commercial banking and asset management business, it noted declines in other key areas of operations and increasing defaults and credit risk. The rest showed profits mostly due to capital gains, not sustainable ongoing operations, and also noted rising default rates and risks of much more to come. Indeed Citigroup shows a loss if you factor out its sale of Smith Barney to Morgan Stanley (MS).
If you think this is bad, just wait. Consider that current conditions are relatively good compared to what’s coming. To give the banks a chance to earn more than they lose, Washington has thus far:
- Allowed banks to borrow for next to nothing, lend out at far higher rates
- Allowed banks to overvalue assets
- Keep consumer interest rates relatively low in order to encourage spending and fee-generating mortgage refinancing
How careful will the big banks be in lending this money, knowing that if the past is any guide, any bad loans will be offloaded onto the taxpayers? There will be plenty more bad loans. Loan losses can only grow as unemployment rises, even if the rate of job losses declines. Bank stress test worse case scenarios were for 8.9% unemployment in 2009, and it’s already at 9.5% and rising.
However, the true state of the banks is fodder for a long article of its own, so let’s leave it for now.
The point is, as long as the financial sector remains the driver of global stocks, which in turn drive commodities and currencies, and the fundamental longer term outlook for the financial sector continues to worsen, what kind of longer term picture for world markets can we foresee?
Moving beyond the banks, the overall earnings picture at this point is in fact at best mixed. Consider some big name announcements from firms that actually make and export things and employ lots of people.
- General Electric (GE) reported revenues down 17%, another double digit dip that is an especially disturbing sign about the global economy given GE’s global presence.
- Harley Davidson (HOG) reported a drop of 30% fewer units shipped annually.
Note that ultimately, stocks are priced on earnings growth, typically price to earnings (PE) or price to anticipated earnings growth (PEG). If overall earnings are declining significantly then the picture for stocks and risk assets is grim and suggests more downside than upside.
Looking beyond earnings, at numbers that are harder to manipulate, we see a similar picture
- The Port of Long Beach shows container shipments down nearly 30% annually.
- Freight railroad car loadings are down 25% annually, as reflected in CSX’s report.
- Tax receipts, both personal and corporate, have plummeted.
While economic data this past week was secondary to earnings, it too showed mixed results at best, with both core retail sales and industrial production weak, which does not bode well for the coming GDP estimates.
In sum, it appears that this past week’s rally should be viewed with at least as much suspicion as relief, especially with stocks already so close to their 2009 highs, with no more real evidence of recovery than we had before the rally. With risk assets tracking movements in stocks, and stocks already appearing to price in a recovery within the next year, it will take some very good news to get stocks and risk assets to sustain a drive above the past months’ resistance levels.
Admittedly, one could argue the past week’s rally on less than decisive evidence suggests that markets are in a mood to rally and will do so given any pretext. Overall, however the better bet seems to be on the June highs holding firm.
Conclusions for Equities
For traders, with stocks already near highs and plenty of bad news for short sellers to latch onto be ready to play the short side. Longer term investors should be preparing their lists of buy targets if / when stocks tumble.
Key Forex Trading Info for the Coming Week
With equities nearing multi-month highs and resistance, safe haven currencies like the USD (as well as the JPY and CHF) are closer to support levels and may well see a bounce if equities pull back. As analyst Kathy Lien notes, the EUR/USD has had an 82% positive correlation with the USD since January, and a 91% correlation since last week.
With almost 100 companies reporting next week (including financial heavyweights Morgan Stanley (MS) and Wells Fargo (WFC), the correlation is likely to hold, so currency traders will be watching the S&P.
The coming week’s economic calendar is relatively quiet for the dollar, however Federal Reserve Chairman Ben Bernanke’s semi-annual testimony on Tuesday and Wednesday could spark some volatility because he’s expected discuss economic and monetary policy going forward, including giving some indication about how he plans to exit the massive stimulus program without igniting an inflationary steep rise in interest rates.
Given Fed forecasts and his own recent remarks, he rightly fears a jobless recovery. However, if he indicates that the recovery is still too weak to consider a deadline for the stimulus programs, he could undermine the ongoing optimism and belief in the improved growth forecasts. If he suggests that a winding down has already begun, that could have the opposite effect. If he discusses means of exit without a date, it’s unclear if there will be any rally in the USD.
Leading indicators, jobless claims, existing home sales and revisions to the University of Michigan Consumer Confidence survey are the only U.S. data on the calendar next week. Although these reports will confirm or deny the improvements that we have witnessed in the U.S. labor and housing markets, they are not significant enough to shift market sentiment. If USD moves, the impetus is likely to come from the emerging positive or negative theme of Q2 earnings and Q3 guidance.
The pair has been trading in a tight range for the past months, for lack of any decisive news. Look to earnings or Bernanke’s testimony for some potential movement, also we have German producer prices on Monday, current account data on Thursday, followed by the German IFO and PMI reports on Friday.
It’s unclear how to read the GBP. There have been signs decreasing contraction, primarily in the labor market and service sector. Earlier this week, the U.K. reported the smallest increase in jobless claims in 12 months. However their aggressive stimulus programs including Quantitative Easing (QE) have caused concern. The IMF has warned that if the U.K. doesn’t rein in the national debt and propose a plan to rapidly improve public finances, there could be a run on the British pound. At the same time, the market actually expects the Bank of England to boost their asset purchase programs. Next week’s economic reports will tell us whether that would be really necessary to ensure the recovery stays on track. Retail sales, second quarter GDP and the minutes from the most recent Bank of England meeting are due for release. Traders will be studying these notes for indications about further QE, if any.
The CAD has been the best performing currency this past week despite mostly soft economic data. Oil rose to $63 a barrel and its expected ascent is the primary reason why the uptrend in the CAD has been so strong. There have been indications of deflation strong enough to trigger speculation that the Bank of Canada, while expected for now to leave interest rates unchanged, may feel compelled soon to initiate their Quantitative Easing program. The recent strength of the Canadian dollar spells big trouble for exporters, and Canada has already repeatedly expressed its concern about this, sparking suspicions of central bank intervention. As we’ve seen with the Swiss, recently, the mere possibility of such moves can be enough to drive the currency down.
AUD & NZD
The value of Australian exports plunged by the fastest rate in 25 years on lower commodity prices and a higher currency. New Zealand’s Home Prices declined to the lowest level in almost two years in Q1 as the housing market continues to be the “Achilles heel” of the country’s recovery. Economic releases during the next week are scarce for both Australia and New Zealand. Thus any movements in these would likely come from external sources, particularly a sharp mood change emanating from US earnings reports and rippling through global markets.
The USD/JPY has dropped and is approaching a 5 month low around 92, which will hurt Japan’s already struggling exports. Continued news of political turmoil may weaken the Yen. For next week, we can expect the BoJ Monetary Meeting Board Minutes on Monday and the Trade Balance on Wednesday. More good vibes from Wall Street could also ease the Yen back down on increasing sales from risk seeking carry traders.
These have generally also tracked stocks, which are now even more influential with US earnings season. US weekly inventory data may have some influence, but tends to get overshadowed by earnings. Gold should continue to move with perceived inflation prospects.