Report from Europe: Traders are Buying the Earnings Story

The Dow jumped 132 points Thursday as there was a bout or renewed optimism about earnings which continued to escalate. Travelers (TRV) led the benchmark, soaring 7.7% on Q3 profits which more than quadrupled. Bellwether stocks like 3M (MMM) and McDonalds (MCD) also beat up analysts' estimates, while Amazon (AMZN) impressed after the bell as their Kindle eBook reader is proving a real winner and outselling rivals. Wells Fargo’s (WFC) shares rebounded after investors took another look at the bank’s third-quarter earnings from mortgage servicing rights.

Today’s highlight thus far earnings wise has been Microsoft (MSFT) who, after the rollout of its new Windows 7, came in with an 8c beat on Street EPS estimates. Ingersoll-Rand (IR), Whirlpool (WHR), Honeywell (HON) and Schlumberger (SLB) have also reported better than expected numbers for Q3. So the song remains the same and it looks like tech will be well supported Friday. Interesting that American Express (AXP) said customers reduced spending 11% in the third quarter, sending its quarterly net down 21%. Commercial lender CIT (CIT) is liable to be bid up on a DJ News report that they have reached a tentative agreement with the devil, aka Goldman Sachs (GS), over a disputed $3 billion financing agreement. The S&P 500 is now trading at its highest level relative to reported earnings in the last five years.

We’ve just had the US Existing Home Sales number which at +9.4% is a blowout on the +4.9% expected print.

Today’s Market Moving Stories

• The Germany Ifo business climate index rose from 91.3 to 91.9, the seventh consecutive increase and the highest level since September 2008. What especially catches the eye is the fact that export expectations continued their upward trend despite a seemingly unstoppable euro exchange rate. Hence, until recently, there are absolutely no signs of a new “euro-sclerosis,” which may befall export-dependent companies and act as a highly unwelcomed growth brake. I think that there are two major reasons for this pattern. First, new-order-to-inventory ratios in many countries are still at very favorable levels. Second, sentiment in the euro zone as the most important German export market improved further. However, given historical experience, it is absolutely clear that German companies are not Superman. If the euro exchange continues appreciating, this will hurt companies in a few months’ time.
• While Eurozone October PMIs came in above expectations, thanks once again to a very strong French performance, the euro area factory index eventually breached the 50 threshold and rose to 50.7 vs. 49.3, the highest level since April 2008. The services PMI was up to 52.3 vs. 50.9. Positive news. Bottom line – while I acknowledge that the recent data points to a continuation of the recovery trend, I remain cautious on the growth outlook, and so will the ECB.
• Chicago Fed President Charles Evans stated that an exit strategy is not the Fed’s primary concern, with the current focus (still) on policy accommodation due to the meaningful slack out in the economy. He added that inflation expectations are accordingly stable and that he expects inflation to remain at around “1.5% over the next couple of years.” Commenting subsequently on the USD, he said that he was not especially concerned over the “USD shifts” and their implications on inflation.
• While Philly Fed President Charles Plosser said that he is willing to raise interest rates “sooner than other [Fed] members.” He added that the Fed must reduce its balance sheet “before its too late” and that it must be forward looking with regards to inflation.
• In China, the Ministry of Commerce researcher Liu Xueqin stated that exports are likely to resume year-on-year growth this quarter as global trade slowly recovers.
• The China Securities Journal stated that a recent circular from the China Banking Regulatory Commission has instructed lenders to carry out quarterly stress tests as part of a drive to strengthen credit controls and liquidity management.
• While in Japan, the government announced an emergency package to create 100,000 jobs by the end of the fiscal year. The Cabinet Office said that the money for these programs will come from the current budget compiled by the previous LDP-led government.
• Fresh cycle highs for commodity heavyweights. After a period of relative calm over the summer, heavyweights copper and crude oil have broken through key technical resistance levels and surged to new highs, attracting fresh investor interest in the sector. Brent crude oil has hit a 12-month high, up over 120% from its low, while the RBS base metal price index has reached a 13-month high, up 92%. Despite snippets of supportive news on the metals front, the recent leg higher was largely driven by further US dollar weakness, triggering technical buying. So where do we go from here? I expect base metal prices to plateau in the next 12-18 months. Although I believe a big correction is unlikely (particularly in copper), headwinds including lower Chinese imports, reactivation of idled capacity and a relapse in auto sales post ‘cash for clunkers’ may limit upside in the near term.
• On the return of the bubble, Gillian Tett quotes from a letter from a market insider who wrote that after previous shocks it took several years until the market were back to champagne corking mode. This time, it has taken only months. The reasons are the ultra-low nominal interest rates, which have led to a renewed amount of leverage in the system. The extremely low spreads in the bond markets are mainly the result of excess liquidity.
• Naked Capitalism has a wonderful entry about the return of the hedge fund manage John Meriwether, the guy who run Long Term Capital Management and whose character stood model for the lead character in Bonfire of the Vanities. The line is that Meriwether is back; it must be a bubble.

No Early Pullout Of ZIRP And QE
The biggest threat for now comes from any signs of an early exit from ZIRP and Quantitative Easing. The financial commentariat will huff and puff over the risks (e.g. an FT article overnight is suggesting that the Fed is mulling whether it must alter its “extended period” language or not). However, the litmus tests are what central bankers say, and the data. True, recent equity and commodity market rallies demonstrate a strong appetite for risk and support the idea of an early exit. However, the macro conditions are just not in place. The macro prerequisites for an exit:

1. Lending trends – still depressed, with US consumer credit down seven months in a row.
2. Unemployment and consumer confidence – only see modest improvements in the US over the coming months. All the hoopla over the weekly jobless claimants drop died a bit of a death yesterday when they actually rose again.
3. Trends in core inflation – 1.5% and expected to go lower. Also inflation expectations are high.
4. Housing is still in the doldrums – note yesterday’s little noticed Federal Housing
   Finance Agency House Price Index unexpectedly fell 0.3% month-over-month also in August this despite the tax credit for first time buyers.

UK Fails To Emerge From Recession
The UK economy defied expectations of a return to growth in Q3 (+0.2% expected) with the first estimate of GDP for the quarter revealing a 6th back-to-back contraction (-0.4% actual). This is a run of declines unmatched since comparable records began in 1955. Sterling went reeling. While preliminary estimates of output are notoriously prone to revision, the clear indication here that the UK remains mired in an unprecedented recession provides a compelling argument in favour of the BoE opting for a precautionary increase in the QE limit. While this week’s minutes saw that looking like the most the Bank would do, today’s number arguably brings the risk of more aggressive action back into view. UK interest rates are going nowhere soon.

All That Glitters
As gold tops $1,060 and heads for it 4th weekly gain, it's worth remembering that the latest leg of the media attention-grabbing rally reflects a lack of confidence in fiat (paper) currencies, and especially in the dollar. Gold is also being widely touted as a hedge against inflation. As it happens, gold’s track record as a store of value is far from perfect. However, during times of rapid inflation it has proved its worth, notably after the oil price shocks in the mid- to late-1970s.

As others often like to stress, gold is still trading well below the all-time high of around $2,300 in real (inflation-adjusted) terms, which was seen briefly in 1980. But this fact is less impressive than it might appear. Prices soared in 1979-80 due to the exceptional combination of double-digit inflation, geopolitical crises (the US-Iran hostage crisis and the Russian invasion of Afghanistan), and falls in gold output from South Africa (which in the 1970s accounted for 70% of global production). Of course, gold bugs would argue that the circumstances are similar today. However, the inflation risks are a lot lower, the geopolitical environment (aside from ever-present Middle East tensions) is less uncertain, and gold production is much more diversified.

Even if we are heading for a rerun of early 1980, the other lesson is how quickly gold prices fell back again. After peaking at around $850 on 18th January 1980, gold quickly slumped to $650 by the end of January and below $500 again by April.

Nonetheless, current gold prices are not yet a bubble -- gold is close to its long-run averages relative to oil and to equity prices. But assuming at least a partial recovery in the dollar in the coming months, I continue to expect gold prices to fall back below $1000/oz by the end of this year, and as low as $800 during 2010.

Equity News

• BSkyB (BSY) issued a strong set of Q1 results this morning, with adjusted operating profit rising 9% to £198 million (£188 million expected) on revenues up 10%.
• Diary giant Danone’s (GDNNY.PK) Q3 sales figures came in stronger than expected with like for like sales rising 4.1% against an advance of 1.6% in H1. The improvement was primarily down to a strong rise in Dairy and Water sales, as price cuts helped drive volumes and overall sales levels.
• Volvo (VOLVY.PK) Q3 revenues were in line with expectations whilst operating income was ahead of dire forecasts. Nevertheless, the picture remains bleak – revenue was down 31%. There was also little sign of a rebound in demand though management commented that demand had bottomed out.
• Élan (ELN) is down 15% on news that European Biotechnology (BTC) regulators are reviewing Élan and Biogen Idec’s (BIIB) multiple sclerosis drug Tysabri following reports of 23 cases of a potentially deadly brain disease linked to the therapy.
• The EU has approved Merck’s (MRK) acquisition of Schering-Plough.

And Finally… Halloween On wall Street

Disclosures: None

Comments

[Roger Knights:]

"Even if we are heading for a rerun of early 1980, the other lesson is how quickly gold prices fell back again."

Part of that was due to the implementation in the 80s of the heap-leaching technique, which brought new supplies of gold onto the market. And European central banks began a long-lasting selling project.

"But assuming at least a partial recovery in the dollar in the coming months, I continue to expect gold prices to fall back below $1000/oz by the end of this year, and as low as $800 during 2010."

You may be right that the dollar will bounce. See Karl Denninger's article today here: seekingalpha.com/artic... But things are different at the macro level in the gold market. Central banks in Asia will be looking to buy on dips. CBs in Europe are tailing off their sales. And it's becoming conventional wisdom among funds and advisors that portfolios should have a bit of gold in them, as a diversifier. So there's not as much downside as there was a year ago.

Also, gold doesn't need inflation to rise. Systemic uncertainty will do--and the foundations today are wobbly (uncertain), not just the shingles, as in the past. Today's economic bounce is artificial; the pump-priming hasn't caught and become self-sustaining. Many rich people understand that; so gold will find support just under $1000, even if the dollar rises for awhile.

Oct 23 05:45 PM

[drwkrumholz:]

Goldman Sachs is the Devil. It has Rahm Emanuel, Barack Obama, Tim Geithner, and Bernancke, bedeviled and under its control. Everyone, is phoning Lloyd BlanKfein, who's manipulating the U.S. economy from his Throne in HELL. Hell Is Goldman Sachs Headquarters or better known as Hades. Goldman Sachs is Robbing US taxpayers Blind, by borrowing money under false pretenses and enriching itself. Its also Guilty of Fraud, in 2006 for betraying its private clients for recommending and selling them "Vomit" or rapidly depreciating CDO's,and lying about it. While they were shorting the same CDO's in open market to the tune of billions of dollars. They should be sued for Fraud for abrogating their fiduciary responsibilities by lying to their clients and stripped of their trading License. They should should be Prosecuted, not rewarded by Obama, the WEAK. They are also, using Flash trading computer programs, and dark pools to rip off, and steal money from the retail investor They are also guilty of conflict off interest as an investment advisor firm, a hedge fund, a market maker, and a holding bank. Paul Volker, called Goldman, A "walking Conflict of Interest"

Oct 24 01:51 PM