Report from Europe: U.S. Close vs. China Rebound

The first signs of selling into the close made for a sloppy day's trading yesterday with the market in limbo and mired in a tight enough range probably until Friday’s key US non farm payrolls report (consensus is for a 230k fall). Note Monday is Labor Day Stateside.

The markets are continuing to fret about a post-stimulus future and keep asking the legitimate question “where is the engine of U.S. growth likely to come from if it’s not from consumers or China?” In Fed Chairman Bernanke’s 21 July testimony, he clearly underscored that the risk to the growth outlook was that the recent stability in consumer spending would only prove transitory. I see that as a big, ever-present risk and others now clearly do too. Yes, businesses can rebuild too-low inventories, and, yes, the stock of new homes is way too low. Even so, banks face huge potential stress from commercial real estate and consumers still have years to go before adequately closing their asset/liability gaps. It will take much time to fully repair bank and consumer balance sheets, and higher taxes and tighter regulation only slowly recovery. No wonder the Fed is sanguine about inflation pressures over the next few years and no wonder bond investors are paying heed.

U.S. data so far today has been disappointing, with both weekly jobless and continuing claims coming in higher than economists were looking for, and same store sales for the vital back to school season look soggy (seems the consumer is on strike or all blown out). Thus far today, though, equities have ignored the news.

China Goes Shopping
Reports circulate that China’s sovereign wealth fund is switching to gold investment. Mineweb.com reports “indeed with the funds available as China seems to be dumping its US dollars in favour of more concrete assets, virtually no minerals sector is safe from Chinese participation.” It said CIC is making direct investments as well, by purchasing mining companies.

HSBC now sponsors a services PMI series for China, which is the first ever service PMI for the country. The series dates back to November 2005. For August, the headline Business Activity Index rose to 60.6 from 60.1 in July, indicating China’s services sector is expanding at its fastest pace for the last two years. This implies that the investment-led recovery is more broad-based, as stimulus measures filter through to the other parts of the economy.

The services sector in China is rebounding strongly, as indicated by a rise in the Business Activity Index to 60.6 – its highest level since September 2007 and evidently higher than the historical average of 58.1. This implies that China’s investment-led recovery is more broad-based, as stimulus measures filter through to other parts of the economy, boosting sentiment and lifting both enterprise and consumer demand for various services.

Vice-chairman of the China Securities Regulatory Commission Liu Xinhua notes that the outlook for the world economy is still unclear, while China’s recovery is neither stable nor balanced, and that the combination of the two could have an impact on China’s capital markets. He states that “the CSRC will try hard to maintain the continuous, stable and healthy development of the securities market.” Note Chinese shares have responded positively to these soothing noises with a 4.8% rebound overnight.

U.S. Inflation Doves Squawk Back
The latest set of FOMC minutes provided more colour on the recent evolution of the Fed’s thinking. The discussion of growth prospects appeared slightly more bullish in the minutes than in the August policy statement. However, FOMC members remained very concerned with developments in the labour market. Personal consumption should remain sluggish, dampened by “reduced wealth, tight credit, high levels of debts and uncertain job prospects”. Substantial risks remain that the rebound is not solid enough to become self-sustaining. Comments from the dovish inflation camp appeared more belligerent than in June as “a few” FOMC members actually “saw a risk of substantial disinflation”. I believe the FOMC will remain reluctant to withdraw its policy support too soon for fear of nipping the nascent recovery in the bud.

Upcoming G-20 Finance Ministers Meeting
The upcoming G-20 Finance Ministers junket in London is likely to show tension between countries, with some wanting to prepare exit strategies and others warning that an early exit, especially from expansionary monetary policy measures, could lead to a double dip. France and Germany will press for a tough agenda including banking sector regulation and monetary policy exit strategies. The U.K. opposes this view, with Chancellor Darling warning that early implementation of an exit strategy could choke off the recovery. The ECB have moderated to European politicians and today’s ECB press conference provided the forum for J.C. Trichet to say that this was no time for talk of exit strategies. Europe seems to be the only place in the world where politicians want to have a tighter monetary policy regime than the central bank.

Euro Area Service PMI Soars
European data this morning was on the encouraging side, with euro area service sector PMI posting its largest-ever one-month gain in August, rising to just short of the critical 50 level that points to an expansion in activity. Together with the continuing recovery in manufacturing, this was sufficient to take the composite index up to 50.4, which is the first time the index has been in expansion territory since May last year. This is a particularly encouraging report. After a couple of months where the service sector looked to be making heavy going of the recovery, activity has certainly seen a huge step increase in August. It’s hard to see what exactly could have triggered this improvement except perhaps a growing confidence that recovery was beginning to take hold and policy measures are working. These results should therefore be consistent with an increase in euro area GDP in Q3 and if sustained should effectively mark the end of the recession.

And from the UK, news that business expectations have risen to pre-Northern Rock levels. At a read of 54.1 this is the highest level seen since August 2007, which was just before the run on Northern Rock pushed the credit crisis to the forefront of UK household and business attention

Citibank Warning For Equities
Citibank’s (C) equity team have a piece out today highlighting potential landmines for equities going forward. Global equity markets have risen further and faster at this stage than from any previous recession-linked bear market low, so they are clearly vulnerable if fundamentals were to start deteriorating again. Citi warns of potential:

1. Economic Risks — in the form of policy error i.e. premature monetary/fiscal tightening and unresolved weakness in the global financial system as the main risks. Both could curtail the nascent economic recovery, they say.
2. Market Risks — Earnings disappointment, concerns over valuations, changes in the supply/demand balance and seasonal effects are all seen by Citi strategists as potential risks within equity markets. Equities could also be vulnerable to weakness in other asset classes.

However, they point out that many investors have failed to participate fully in the rally and will be perhaps hoping that one or more of these risks will materialise soon to give them a second bite at the equity market cherry. Wouldn’t it be nice to be able to buy global equities 20% lower than today? But history tells us that such opportunities rarely occur in the early stages of a bull market. They look at the size of the corrections that have occurred in the two years following the major recession-linked global bear markets since 1970. There have been 14 in all, averaging a decline of 7.4%, with the worst pullback a 13% fall in the mid 1970s. So far in this recovery there has been one such pullback. Global equities fell 7.1% in June / July 2009, which is in line with past experiences.

Bloomberg is carrying a story that Investors should “sell the rallies” as the Standard & Poor’s 500 Index may drop to 880 by early November, according to technical analysts at Swiss giant UBS AG who look at the so-called Dow Theory to predict market trends. A decline below 1,012 may lead the benchmark measure for U.S. equities to the next support level at 980, UBS analysts Michael Riesner and Marc Mueller wrote in a report dated yesterday, when the S&P 500 retreated 2.2 percent to 998.04, the biggest loss in two weeks

Gold Soaring
Gold seems to be on the up once again, looking potentially as if it could break major levels. You will have seen today that the U.S. job adverts index (Monster Worldwide) recorded its biggest jump in four years. Also that JP Morgan (JPM) is predicting a synchronised recovery from Europe and the States such that both economies expand 3% next year. And finally there has been a 22m barrel draw in US crude and product inventories in the last five weeks. Economists still haven’t woken up to any of this with the G10 surprise index right at its highs. If the economists haven’t woken up to this, neither have the central banks, who are rightly going to keep short rates low for an extended period. Add to this the changes in the way oil will be priced from a cost basis to a small shift to value-added basis that is implicit in the Brazil moves, and I think we have a set-up for some price pressures. Treasury yields may stay low due to the carry trade and so the only outlet is the currency, but because it is a global issue, that price rise will come through commodities. Don’t be surprised to see gold finally break above 1000, and oil to go higher.

Equity News
Miners were gaining in Europe as gold and silver futures extended a rally from the previous session, and other metal futures also rose. Shares of Vedanta Resources [LON:VED] rose 4.7% and platinum producer Lonmin (LNMIY.PK) [LON:LMI] shares climbed 6%. This comes on the back of comments from Alcoa (AA) Chief Executive Officer Klaus Kleinfeld, who raised his 2009 forecast for global aluminium consumption because of demand triggered by China’s stimulus spending. An executive director at Vale (VALE), the world’s largest iron ore exporter, said demand in China is “good.” China is the biggest consumer of copper. Gold miner Randgold Resources (GOLD) climbed 8% after Wednesday’s $22-an-ounce rally in the yellow metal and an upgrade from JP Morgan in its price target to 5,150p (from 4,090p).

In the technology sector, Germany’s Infineon (IFX) shares climbed 5.8%. The Financial Times Deutschland newspaper reported that the firm will aim for its old target of 10% earnings before interest and tax margin in the fourth quarter of its next fiscal year. German stock exchange operator Deutsche Boerse is expected to decide that Infineon will re-enter the DAX six months after it was ejected. Nokia (NOK) shares were also strong, with the handset maker up 4.3% in Finland.

However, drugmakers weakened with Roche (RHHBY.PK) shares down 1.1% and GlaxoSmithKline (GSK) down 1.1%, as are insurer RSA [LON:RSA] (on more rights issue chatter). Shares of the chemicals giant dropped 3.3% in Frankfurt after Nomura cut its stance on the firm to reduce from neutral. The broker expects disappointment in 2010 as margins make a delayed adjustment to levels of underlying industry capacity utilization, which will remain very low despite volume growth.

Cisco Systems (CSCO) and EMC (EMC) are in talks to create a new joint venture to provide technology services. Sun Microsystems (JAVA) may be pressured by a report that the EU antitrust regulators plan an in depth probe into its planned takeover by Oracle (ORCL).

Comments

[optionsgirl:]

Another great article, Mole. Miss you in the mornings, though.

Sep 03 01:15 PM

[Larry House:]

Employment may be a lagging indicator, but how can consumers fire up with unemployment what it is now? Also, I really think--as a consumer myself--that some fundamental spending changes are happening, especially with Boomers, and the higher savings rate is here to stay for a generation. Either consumers will cease to be 70% of the economy, or the economy is going to be smaller. It is not going back to the way it was any time soon.

Sep 03 03:09 PM

[ArtfulDodger:]

Aside from the technical jargon (which I simply do not understand), another very good run down on major world markets.

Go Mole! Thanks!

Sep 04 11:37 AM

[Old Trader:]

Yes, I'd wondered about the change, as well....Mole always went well with morning coffee. At least you're still writing for your "fans"!


On Sep 03 01:15 PM optionsgirl wrote:

> Another great article, Mole. Miss you in the mornings, though.

Sep 04 08:08 PM