Market Review 12 July 2011

Although the equity market rally of late June continued into the first week of July, it skidded sharply on Friday afternoon in the wake of poor jobs data. Despite being down 0.7% on Friday, the S&P500 ended the week up 0.3%. Japan had a very strong week, with the Nikkei up 2.8% and back above 10,000, as the post-Tsunami recovery was reflected in the positive Tankan survey. Asia was strong, with China up 2%. Oil, gold and silver were all strong.

The recent optimism in the US evaporated on Friday as the Department of Labor’s Employment Report for June showed that nonfarm payrolls rose just 18,000 last month, much fewer than expected. The June jobless rate in the United States increased for the third straight month, to 9.2% from 9.1%, and is at its highest level since December 2010.

Part of the shock to investors was the contrast with positive data on chain store sales and the ADP employment survey earlier in the week. This week the FOMC minutes are released and Chairman Bernanke makes his twice yearly testimony to the House Committee on Financial Services.

It seems likely that he will conclude that while economic growth and, particularly, labour market performance, has been disappointing, inflation remains too high to combat the weakness with additional monetary easing. A third round of quantitative easing is likely to be held in reserve to fight any signs of deflation.

Is it only a week or so ago that Greece passed her austerity measures and global markets rallied in relief? The EU Council President has called an emergency meeting today for officials dealing with the euro zone debt crisis, although a spokesman described it as merely a “co-ordination” meeting.

Last Monday Standard & Poor’s announced they would view any rollover of Greek debt as a form of default. Then on Tuesday Moody’s downgraded Portugal’s long term debt rating to Ba2, junk status, from Baa1, contending the May bailout would not succeed. On Friday Italian 10 year bond yields jumped to 5.25% as concerns mounted of contagion in the eurozone crisis.

Fears centred on signs of cabinet squabbling over the recent Italian austerity plan, and late on Sunday Italy’s market regulator approved new transparency measures following the selling wave which hit Italian banks last Friday. The rules are effective starting today and will remain in place until 9th September.

Traders will have to disclose any short-selling order involving shares that represent 0.2% or more of the capital of a company. Eurozone problems are still a big risk to the economic outlook. The risk is known, but its scale isn’t. The big concern must be that events overtake policymakers. This week will end with the publication of the EU-wide bank stress tests.

The third area of potential concern is China, which reported higher than expected year on year CPI, at 6.4%, and strong, but slowing, exports (up 17.9% year on year) in June. The inflation was mainly due to high food prices, particularly the rocketing price of pork after a decline in the porcine population at the start of the year, which is now reversing.

The debate will now focus on whether June is the peak in year on year inflation. Capital Economics noted June as the worst month for Chinese imports since January 2010, with industrial commodity imports down 14% in Q2. This suggests weaker growth and less underlying inflationary pressure, and many expect CPI to ease in the coming months towards 4.5 %, allowing policy makers to ease monetary conditions.

Issued by: Rupert Caldecott, CIO of the Global Asset Allocation Team, Dalton Strategic Partnership LLP, an investment management boutique in London founded in 2003 by the late Andrew Dalton