December 2nd, 2013
by Cliff Wachtel, FX Empire
A new threat to the rally beyond fears of a fed taper, high asset prices, or the EU
The following is a partial summary of conclusions from our weekly fxempire.com analysts' meeting in which we share thoughts and conclusions about the weekly outlook for global equities, currencies, and commodity markets.
Here are the lessons we learned last week that can be applied for the coming week. One of the obvious new developments is the emergence of multiple new geopolitical concerns. See our special report here for details.
1. Fed Taper Speculation Remains Dominant
There was no data in the US-holiday shortened week to move fed taper speculation, but it remains the leading consideration through which investors view data. As we noted in out 2013 Outlook Year End & Beyond, the taper's influence extends well beyond US borders, as it presents challenges for the EU, Japan, and emerging market economies, raising rates for them as well and counteracting their efforts to ease liquidity as US assets offer higher yields.
On Tuesday the Conference Board's consumer sentiment fell for the 3rd straight month to its lowest level since April. So the last minute deal in Washington to end the shutdown and avoid default failed to bolster consumer confidence. This report bolsters belief in a later taper, because the sharp rise in non-farm payrolls has not been confirmed by other reports. Even if there are more jobs, consumers need to be confident enough about their own future earnings in order to spend. Retailers are fear this holiday shopping season may be the weakest since 2009. If they're right, it will be very difficult for the Fed to justify tapering this year. We continue to believe that the central bank will wait until 2014 to reduce asset purchases
Next week's calendar has more top tier events that could alter taper expectations than any for the rest of the year.
- A Bernanke speech Monday
- ISM manufacturing (and its jobs component) report Monday
- New home sales Wednesday
- US Preliminary GDP Thursday
- US monthly jobs reports Friday, as well as related reports like the ADP NFP report Wednesday and the jobs components of the ISM manufacturing and services PMI reports Monday and Wednesday
- Preliminary UoM consumer sentiment
See our article on coming week market movers here for details.
2. Stock Market Bubble Babble: Focus on Need for Earnings to Support Valuations
As US markets hit new all-time highs, and many other global indexes approach their own multi-year or historical highs, the great debate over whether the rally still has legs continues. Many analysts continue to warn of rising risk of a pullback. Per Citi's Tobias Levkovich, "euphoria" has returned to the markets. , "Euphoria readings (Per Citi's proprietary stock market model) indicate the market may retreat with an 83% historical probability of losses in the next 12 months," said Levkovich. Nothing new here, as even the many who also see continued upside potential warn of shorter term pullbacks along the way.
Better Earnings Needed
In researching our 2013 Outlook Year End & Beyond, a repeated theme among both bulls and bears was that was that 12 month trailing PE of the S&P 500 was getting close to historically "bubble-ish" levels.
Even stock bulls believe that earnings need to keep improving in order to justify further gains and keep the S&P 500's trailing PE ratio from rising beyond its current 16.5 level. Anything higher is considered by many to suggest an overextended market due for a pullback. For example, in his bullish 2014 outlook, LPL Financial's Jeff Kleintop noted here that
...the 17 - 18 PE (is) where every secular and cyclical bull market has ended since WWII (with the exception of the late 1990s that ended much higher) a better pace of growth must materialize; just more bond buying by the Fed is not enough to lift valuations from current levels to propel further gains.
3. It's Official: Europe's Earnings Season Stank
Europe's earnings season's results have been disappointing. About half of companies missed profit forecasts and nearly two-thirds have missed revenue forecasts, per data from Thomson Reuters StarMine.
4. No Relief From Deflation Concerns
Societe Generale bank analysts issued a note warning that falling commodity prices are another symptom of a growing deflation threat. On Monday night ECB member Coeure was again in the media reminding us that the ECB is considering more exotic easing measures (negative deposit rates for banks, a new LTRO or a European version of QE-style bond buying to keep rates low) now that it has already lowered rates to 0.25%, exhausting most of the potential for further conventional rate cuts. The EURUSD rose despite these comments, demonstrating that as long as Germany remains opposed, the chance of such actions remains remote. The EURUSD remains firmly in its 16 month uptrend, with solid support around 1.3500.
As we discussed in our 2013 year end forecast, a coming fed taper, believed to start no later than March 2014, presents additional deflationary pressures and could force additional easing measures from the ECB and BoJ.
Indeed it's worth remembering that fed taper risks extend well beyond spiking US interest rates that could dent the American economy.
- There could be a domino/ knock-on effect on global bond rates, as international bonds must now compete with increasingly high yielding US bonds, thus counteracting ECB and BoJ efforts to keep rates low.
- Many emerging market nations' bonds would thus see their bond prices fall and interest rates rise as yield seeking capital is increasingly drawn to what are now higher yielding and safer US bonds
- They feed deflationary forces in Europe, the EU, and emerging markets, as rising rates hurt risk assets like commodities, which are a big part of many fragile emerging market nation exports.
The latest inflation data last week did nothing to ease these concerns.
- On Tuesday Spain and Saxony showed better (i.e. higher) than expected CPI readings, which helped ease deflation fears for the moment.
- On Friday EU and Italian CPI results Friday showed mixed results, with Italian CPI below expectations, and EU flash CPI a bit above forecasts.
The bottom line however is that EU inflation remains well below its target 2%, and deflation remains a concern likely to pressure the ECB into further easing measures at some point.
MARKETS SHRUG OFF OTHER DISAPPOINTING EU DATA, BUT FOR HOW LONG?
Looking at the charts, the uptrend in most of the European stock indexes remains intact but from a fundamental perspective we can't ignore the downside surprises in European data Thursday and Friday. Not only did German retail sales drop 0.8% in October (versus an expected 0.5% rise) but also unemployment increased 10k last month. German consumers have now cut spending 4 out of the last 5 months. Consumer spending in France also fell for the third straight month, by 0.2%, and like Germany this represented the fourth monthly decline in five months. It is this weakness in demand that makes us skeptical of the rally in European stocks, and also in the EUR/USD, because if spending does not rebound in the fourth quarter, the ECB will be forced to seriously consider the need for negative rates.
5. German Coalition Deal: The Good ,Bad, And Worse News
The Good News
German PM Angela Merkel's center-right party finally got a coalition agreement signed with the center-left Social Democrats (SPD) to form a broad based coalition. That's good news because it should be stable, and move Germany past months of political paralysis. As we noted here Germany has been without a coalition since the elections. That created unwanted uncertainty and political paralysis. Of particular concern, it rendered Germany incapable of approving any bank stabilization plan that will be needed before the ECB bank stress tests can begin. These are a key step to the ECB's assuming overall supervision of EU banking.
The Bad News
However, the deal now needs the approval of SPD's 474,000 members, and the vote isn't until December 14.
Both sides are opposed to any softening of Germany's stance against 'risk sharing' (funding countries pay for debtor nations' banks' mismanagement) via Eurobonds or other means, and want each nation responsible for their own banking recapitalizations. However the SPD is considered to be a bit more pro-EZ (i.e. more willing to volunteer taxpayer funds for the GIIPS).
The Worse News
EU finance ministers charged with forging an agreement for how the EU would deal with banks that fail the coming ECB stress tests were well aware of Germany's objections to any terms that could leave it paying for others' mismanagement or corruption. Thus the wording of the agreement was altered to allow Germany the chance to avoid that. So if that wording stays, we'll have an agreement, but not one that provides assurance that the EU can prevent contagion risks if the stress tests reveal too much bad news (which was kind of the whole point of the deal).
As we learned in 2011-12, bailout deals that lack details or funding increase doubts about the EU's ability to manage a crisis, rather than ease them, and so just inflame market fears rather than ease them.
6 & 7. Rising Geopolitical Threats from Iran, China
Stocks, risk currencies and other risk assets have so far managed to shrug off concerns about a coming Fed taper (and rising rates), the EU, and asset price levels as leading global indexes and risk currencies continue to rally.
Yet last week brought some worrisome geopolitical developments:
A transparent capitulation by the P5+1 group to Iran's nuclear ambitions
An escalation in China-Japan tensions over disputed islands
See our special post here for details.
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.