Sentiment is improving mildly, and stocks can rise. But how long will it last?
Q3 postponed to September? Maybe not.
As expected, the Federal Reserve left rates unchanged on Wednesday. A "wait and see" approach was considered the wisest choice. Risks, such as the European crisis and federal fiscal adjustment, are behind the Fed's resolution. Any decision has been postponed to the next meeting of September. There are strong signs that European leaders want to finally take the eurozone to a different level of discussion. The tough negotiation between the E.C.B. and the Bundesbank has almost reached a "make it or break it" point.
In the U.S., on the other hand, congressmen have at least reached consensus about federal government funding for the first half of 2013. For now, the U.S. economy will stay under pressure. The GDP slowed to 1.7% in the first half compared to 2.7% in the second half of 2011. However, the private sector might be on the rise again. After four months of weak numbers, the labor market created 163,000 new jobs in July.
Private services employment led the way, while the construction and government sectors showed some losses. The household unemployment duration declined further. The number of unemployed for a 15-week period reached its lowest level since April 2011. Has the negative trend been reversed? One month of good data is not enough to change the picture. Wages remain very weak, and household wealth is still subdued. The unemployment rate rose to 8.3% from 8.2%, despite another decrease in the labor participation rate from 63.8% to 63.7%.
Nevertheless, with unemployment declining to 8.0%, 7.5% is still a possibility. Since 1948, the employment rate has fallen roughly 33% from the highs of the bear markets of 1952-61 and 1969-1982, before resuming the uptrend for the final third wave (7.5%-5.0%/9.0%-5.6%). As a result, September's report will be watched very closely. Good numbers will keep the Fed on hold once more. The S&P 500 is targeting 1400, corresponding to April's high. The next level could be 1500.
Mario, what happened?
Last week, the E.C.B. left interest rates unchanged. At first, the market reaction to the news was negative. Bolder decisions were expected, considering both the economic picture and the low level of inflation. The GDP probably fell in the second quarter after declining in the first quarter of 2012. The final reading of the PMI for July signaled that the index was at its lowest level since mid-2009. Core countries are now being affected by the crisis. Between April and July, the manufacturing index fell by more than 3 points in Austria, France, and Germany.
On the other hand, the index rebounded in Ireland, Greece, and Italy. The eurozone unemployment rate, however, reached 11.2% in June - its highest level ever. Greece, Portugal, and Spain are showing their worst results. The sovereign debt crisis must be challenged, and the central bank could surely help, but Mario Draghi wants to size political commitment to a stronger Union before acting again. The problem is the high level of government bond yields in the southern European countries, mainly Italy and Spain. What can happen next?
A renewed bond-buying program, known as the Securities Markets Program (SMP), is factual. Since May 2010, the institution bought more than 200 billion euros of sovereign debt. In order to succeed, the amount should be larger this time, and the process should be repeated for a longer period. Troubled countries should first request help from the EFSF and the ESM. Italian Prime Minister Mario Monti clearly stated last week that failure to take action will lead to anti-European coalitions taking power in Italy. This new scenario will not be beneficial for Europe as a whole and will not calm the financial markets.
Nonetheless, the euro can rebound to 1.26, and eventually, to 1.30 over the coming months. Most bad news is discounted in current prices. According to the latest Commitment of Traders (COT) report, short positions held by future funds are at extremely high levels. Long positions, on the contrary, have not increased since January this year. Historically, the last part of the year is favorable for the European currency, and September has been the best month.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.