Key Lessons On 3 Central Banks, Earnings, Cracks In the EU, Stock Bubble Babble, And How To Profit
The following is a partial summary of conclusions from our weekly fxempire.com analysts' meeting in which we share thoughts and conclusions about the key lessons we learned from last week's action in global asset markets that matter for the coming week and beyond. These lessons apply to virtually all liquid global asset markets, particularly currencies, equities, commodities and bond markets.
First, a summary of what moved markets each day. This is always our starting point for interpreting the week's action and what it meant for the coming week.
Prior Week Top Market-Movers Wrap
The following are the headlines from our recent weekend post Global Market Movers 2 Minute Drill And The Week's Big Question. See it for details on each of the following. The best quick summary of what was really moving most global asset markets last week, and a good starting point for understanding what's likely to move markets this week.
- MONDAY: Mixed Data, Earnings, Interest Rate Speculation Bring Mixed Results
- TUESDAY: Global Indexes Overall Lower On Mixed Earnings Results, Caution Ahead Of ECB, US Services PMI That Jeopardizes QE
- WEDNESDAY: Bullish earnings and Fed taper speculation vs. bearish ECB rate outlook
- THURSDAY: Markets Drop On Fears Of Inadequate ECB, Fed Support
- FRIDAY Asian and European Markets Down On Fears of US Jobs Report, US Unexpectedly Soars On It
Next we look at the top market movers last week and lessons we can derive for this week and beyond.
Lessons For The Coming Week
Taper Tamper Timing: Speculation Still The Top Market Mover
Speculation about when the taper starts remains by far the top market mover. So did the dramatic events of last week change the likely timing and pace of QE's eventual demise?
Short Version: Probably not. Despite last week's bullish surprises Thursday and Friday, the likely start date remains no earlier than March 2014, with an outside chance of an earlier small, symbolic taper, and an even better chance of a later start.
See our report here for details. See conclusions section below for some ideas on how to profit.
ECB Surprise Rate Cut: Lessons Learned
See here for lessons learned for the coming week and beyond from the ECB rate cut
China's Latest Data Dump: Lessons
On Saturday we got a large dose of data from China. We had already gotten data on manufacturing and services last week. Here are the lessons for this week and beyond.
- Both manufacturing and services sectors beat expectations, as did exports and imports, albeit by modest percentages.
- The big positive surprise was in the trade surplus figures Saturday, which came in at $31.1 bln, crushing expectations of $24.1 bln.
- The big negative surprise was that annual inflation hit an 8 month high of 3.2%, and more worrisome, the rise was due to rising food costs, a sensitive issue for the Chinese government. This raises market worries about possible PBOC tightening, though it has yet to do anything in the wake of rising rates in the past weeks.
Thus we've a picture of continued recovery, dampened by a risk of PBOC tightening. However the PBOC has shown no sign of doing so in the near future. Overall, a bullish week for China and its suppliers, which includes pretty much everyone.
Earnings: US And Lessons
The earnings news has been good; about 70% of companies have reported earnings above analyst expectations. This is higher than the long- term average of 63% and is above the average over the past four quarters of 66%. However progress growing top line sales revenues from current ongoing operations hasn't been as good.
Per Goldman Sachs' David Kostin, much of the sales growth reported in Q3 came from acquisitions. "Year/year revenue growth equaled just 1% in first-half 2013 but surged to 5% in 3Q," said Kostin. "Notably, just 20 companies accounted for 25% of aggregate sales but 50% of growth. 18 of the 20 firms completed acquisitions during the past year. The 20 stocks boosted 3Q sales by 13% versus just 2% for other firms."
The results fit with the overall US picture of improvement, but we don't believe these results, or those of the US economy, come close to justifying current prices [Fill in Bit From Blodgett On Metrics]
Europe: Earnings, Deflation Debt And Banking Issues, And Lessons Earnings
As expected, earnings in Europe haven't been as good. Per Thomson Reuters StarMine data, 49 percent of companies in the STOXX Europe 600 index miss consensus expectations, a greater proportion than in recent quarters.
Debt & Banking
Meanwhile, the selloff in European equities and other risk assets after the ECB press conference last Thursday was not solely due to the early taper fears raised by the good US GDP report. The ECB cut rates, but it failed to mention any new LTRO program, which is needed by many of the EU's weaker banks. In the end, the ECB, or somebody, is likely going to be forced to help these banks out, if for no other reason than so that they can turn around and buy more of their own governments' bonds. It's either that or the EU or ECB buys them, or the sovereigns have to actually sell these bonds in the open market at a yield that reflects their true risk.
All it takes is a hint of trouble with these bonds, and suddenly yields soar, bond values drop, banks are undercapitalized and can't buy their own government bonds, etc. The EU crisis comes roaring back.
For all the scary details, see our more in-depth look here.
Bottom line: EU banks need a new source of cheap funding or the EU crisis comes back, this time with even more bad debt and bigger insolvencies threatened on the banking and sovereign level.
Just remember all this next time someone tells you it's safe to invest in the EU.
Bubble Babble: The Stock Great Valuation Debate
This post is long enough already, so I'll keep this part brief. With stocks at new highs, the ongoing debate over whether they're overvalued continues, even though central banks have diligently shut off other options for yield seeking investors hoping to build some savings.
Even the bearish articles I read have the author reluctantly staying put in stocks for lack of a better alternative. As Henry Blodgett writes here:
Meanwhile, every valid valuation measure I look at suggests that stocks are at least 40% overvalued and, therefore, are likely to produce lousy returns over the next 10 years.
Which valuation measures suggest the stock market is very overvalued?
These, among others:
--Cyclically adjusted price-earnings ratio (current P/E is 25X vs. 15X average)
--Market cap to revenue (current ratio of 1.6 vs. 1.0 average)
--Market cap to GDP (double the pre-1990s norm)
He goes on to suggest the possibility of a 50% crash, yet concludes:
...despite this, I'm not selling my stocks. (In short, because I am a long-term investor, I am mentally prepared for a crash, and I am planning to ride out any crash, the same way I did with the 2008-2009 crash. And also because there isn't anything else compelling to invest in.).
Others are not so sanguine. For example, investors withdrew billions from US stocks this week.
No "Real" Early Taper Likely
OK, maybe, maybe a symbolic one in hopes of easing markets into the idea and avoiding rate shock, particularly if:
- Data remains supportive, which is far from clear given the question marks hanging over the otherwise solid GDP and jobs figures
- The initial taper is small enough to be seen as symbolic and thus allow incoming Fed Head Yellin the option of holding off on any material cuts if growth data stalls without appearing to reverse course. Remember, the fed is improvising based on the data, but it likes to maintain the appearance of having some grand master plan based on some (non-existent) proven financial models. It makes people feel better and thus calms markets somewhat.
Fed, ECB Slowly Heading In Opposite Directions
The operative word here is slowly. As we note in our article No Taper Before March At Earliest: 6 Reasons, we don't think the fed is tapering as quickly as many think. Similarly, because the ECB has already cut rates, it is less likely to do much more in the near future.
The ECB's overall bias is towards easing, and the Fed's to tightening. The gap between their benchmark rates has shrunk, and likely will continue to do so, although progress may be neither straight nor steady.
See ECB: Inevitable Easing Begins And How To Profit for full details on the ECB's decision and some ideas on how to play it.
- No taper tampering likely to start before March 2014. There is an argument for a small, symbolic taper just to ease markets into it, but the odds favor Bernanke leaving this change to Yellin.
- That means for all the noise, taper based selloffs in rate sensitive risk assets are potential buying opportunities. Similarly, USD strength on taper concerns may be fleeting, though we continue to believe this will be a long-term trend, particularly vs. the EUR and JPY, because their underlying economies face greater challenges. Of the two, the EUR is the better play, so we continue to like shorting the EURUSD or its proxies (FXE, French bonds, etc.) in times of strength.
- Europe remains a dormant crisis that is not being healed. The ECB bank stress tests may force a lot of critical, hard decisions about how costs of defaults will be distributed and whether the EU nations are prepared to sacrifice most of their sovereignty (budgeting, taxation bank supervision, etc.) for the sake of a needed centralization of control over the EU economy, economic policy, and banking system.
- Financial repression in the form of low yields from stimulus programs keeps stock prices hitting new historic highs without supporting fundamentals. When that stimulus goes, asset prices can be expected to plunge and interest rates to rise. Where do you run? Where do you hide?
- We suspect stocks (or eventually bonds?) that offer a combination of relatively safe, high dividends will be the refuge of choice for most. That said, we'd urge everyone who is based in the most abused currencies, the USD, JPY, EUR and others subject to central bank sponsored debasement seek assets in better managed currencies for both greater safety and returns.
Disclaimer: The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.