by Shawn Narancich, CFA
Vice President of Research
Start Your Engines Key stock indexes finished the week nearly unchanged, but it took a bank-fueled rally on Friday to stem the damage caused by deflating global growth and an inauspicious start to earnings season. Alcoa kicked things off Monday with better-than-expected results, but fell afterward on both the weak outlook for aluminum prices and fears that weaker macroeconomic data is beginning to wash up on the income statements of corporate America. Cummins provided another shot across the bow, warning that its quarterly sales would fall considerably short of estimates because of weaker engine sales in Europe and China and a stronger dollar. Into the pre-announcement, the stock was already down 25 percent from first quarter highs, but it fell materially more afterward. Wells Fargo and JP Morgan helped stem the tide of bad earnings news, with the nation’s largest mortgage underwriter benefiting from a recent surge in refinancing and a nascent rebound in new home sales. Sell on the rumor, buy on the news best characterized investors positive reaction to JP Morgan’s muddled earnings report; by realizing a $4.4 billion trading loss on its now infamous hedging gone awry, the money center bank appears to have put most of the issue behind it, while also reporting respectable capital markets numbers and strong mortgage loan originations. Bank earnings notwithstanding, Wall Street strategists are beginning to take the hatchet to S&P 500 earnings estimates.
Growth by Fiat As analysts began sharpening their pencils on quarterly earnings reports, China reported that its economy grew 7.6 percent in the second quarter, about in-line with estimates and clearly a relief to those who fear a hard landing in the world’s second largest economy. The takeaways here are more nuanced. If we can believe the numbers, China’s economy has slowed to the weakest pace of expansion since the “Great Recession” ended. The question is whether activity there has hit bottom. Comforting is the fact that fixed asset investment grew by over 20 percent in the second quarter, a pace slightly stronger sequentially, while loan growth accelerated in June. Chinese policymakers, eager to limit negative feedback loops into the real economy, are declaring that economic growth has bottomed and will improve in the second half. This comes despite private sales surveys showing that sales growth continues to weaken into July, a data point that conflicts with official data showing that consumption expenditures contribute to a growing share of GDP. One thing is certain, while Beijing can dictate new investment spending on steel and cement plants, it can’t force consumers to spend.
Shooting BRICS At present, other emerging markets would love to have the expansion that China is reporting. Brazil is top-of-mind . . . what happened to the growth? Industrial production in the land of natural resources has not only slowed, but it is now in decline as the country fights to eke out just 2 percent GDP growth for the year, a result that may well end up undershooting that of the U.S. While President Rousseff defends her country’s resource nationalism, a topic we touched on in a post earlier this year, deteriorating economic activity prompted the country’s central bank to lower rates to an all-time low of 8 percent. India’s growth is sub-par and Russia, well let’s just say that the more things change there, the more they stay the same.
What’s Old Is New Again? Alluding to Russia’s new, err, old leader brings to mind Italy, where sovereign debt yields rose for the week. Part of this was because of a Moody’s downgrade, but investors can’t help but be concerned about rumors now circulating that erstwhile ruler Silvio Berlusconi could seek to reprise his office in the next round of elections. Notably, Spanish bond yields fell as Prime Minister Rajoy announced a new set of austerity measures in what appears to be a quid pro quo for direct equity injections into the country’s banks. Insomuch as it relates to the bigger issue of Spain maintaining affordable access to the sovereign debt market, it’s mission accomplished for now. The conundrum for the southern European countries continues to be how they meet the North’s demands for budget reform without creating further economic contraction that could make budget deficits look just as bad relative to GDP. As the soap opera continues, all roads seem to lead to more European monetary stimulus. Amidst an abundance of America’s version, Treasuries remain well bid, trading to yield a near-record low of 1.49 percent.
Our Takeaways from the Week
- Earnings season is off to a shaky start, with reporting set to kick into high gear next week
- If evidence of a softer global economy continues, stocks could prove vulnerable to a reduction in profit expectations