The last few days of August and the start of September continued the previous week’s rally in risk assets, but this came to a halt on Friday afternoon with the release of data showing that no more new jobs were created in the United States in August. The US and European stock markets fell very sharply.
Global equities represented by the total return on the MSCI All Countries World Index (“ACWI”) in sterling, ended the week up 1.7%, and are now down 10% so far in 2011. On a regional basis the emerging markets led the way, Korea and India were both up over 7% and the MSCI Emerging Markets index posted a total return of 4.9% in sterling for the week. The Materials and Bank sectors led the market up, although both are among the worst performers year-to-date.
Two defensive sectors also did pretty well over the rally, Food, Beverage & Tobacco and the Pharmaceutical sector. The Bank sector is now on 8 times next year’s forecast earnings compared with Food on 14 times, although Pharma is on a relatively modest 10.5 times, in line with ACWI itself on 10.3 times.
Earnings revisions, despite the lull in corporate reporting, are now beginning to show the impact of the summer’s market falls and weaker economic outlooks. Over the past month global earnings forecasts for the next two financial years have been revised down 1.4% and 2.2%. It is the shift in momentum for top down and bottom up forecasts continues to trump valuation levels right now.
Most of the major equity indices are on the cusp of entering, or have entered, downtrends based on their longer term moving averages. Investors are unlikely to take comfort in valuations if they see the immediate path of future earnings is increasingly downwards.
The world is divided. In the developed world equities are doing badly, despite monetary policy remaining very loose, as concerns grow over deteriorating economic conditions, and traditional safe harbours continue to draw investors. The yield on 10 year US Treasuries and German Bunds closed the week below 2%, and gold was up 4%.
However where concerns over poor growth are coupled with significant concerns over government finances, there is no safe harbour in bonds. Both Spanish and Italian 10 year yields remain above 5%. In the developing (or commodity reliant) world the balance of concern is that still resilient growth will lead to inflation, and short term interest rates remain high.
The path ahead in Europe is still fraught with difficulties, and it is now clear that there will be much less help than hoped for from the economic background. In Germany, Chancellor Angela Merkel faces the results of the regional vote in Mecklenburg-Western Pomerania, and the Constitutional Court is set to demand conditions on the German government’s support for the euro zone. That support is not proving a smooth path.
Greek talks with the ECB/IMF about meeting budget deficit targets set six weeks ago were put on hold on Friday, with 8 billion Euros of the rescue package dependent on a successful outcome. And in Italy the austerity measures announced by Prime Minister Berlusconi just a few weeks ago are under pressure, with a union protest strike set for Tuesday. There was good news in Spain, where the lower house approved budgetary controls to be added to the constitution, which may help discipline the persistent profligacy of the regional governments.
In the United States Non-Farm Payrolls for August were unchanged month-on-month, when a modest gain had been expected, and this soft number was taken badly. Jobs are clearly the focus for policy attention and perhaps the new battleground after July’s budget deficit fight. President Obama addresses a joint session of Congress on prime time TV, and will outline more measures aimed at stimulating job creation. This and any monetary policy action from the FOMC two day meeting on 20th September may boost market confidence.
It is a busy week for economic announcements. This week’s events include trade balance data for the US, Germany, and Taiwan and the release of Chinese industrial production, retail sales, and CPI. There will also be industrial production numbers for Germany, Spain, France, and the UK, and GDP for Australia and Italy. There are also central bank meetings in Europe, the UK, Japan, Australia, Canada, Indonesia, Korea, the Philippines, and Malaysia.
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