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Global Markets Weekly - 26 October 2009

• US Q3 earnings - upside surprises predominate.
  The Q3 US earnings season is now in full swing with over a third of the companies in the S&P500 index having reported. As last quarter, profits are surprising on the upside, with over 80% of companies exceeding analysts’ expectations by an average of 15.6%. This represents an improvement on Q2 when 75% of companies beat expectations by an average of 10.2%. Cost cutting driven earnings surprises have helped the S&P 500 index rise by 2% since the earnings season began and last week pushed it to 1,100, a new intraday high for the year. However, a combination of higher valuations and a lack of surprises on sales means that the market has nevertheless risen by less than the 11% it did at this point in the Q2 earnings season.
• UK economic newsflow disappoints…
  Counter to market expectations, the UK economy contracted for the sixth consecutive quarter in Q3. The consensus forecast was for a GDP rise of 0.2% as opposed to the -0.4% contraction. Indeed, none of the 33 economists surveyed ahead of the data were even expecting a contraction. Weakness was broad-based, with every major sector contracting, except government services which remained flat. The best that can be said about this is that the -0.4% decline marks an improvement on the previous two quarters in which the economy contracted by -2.5% and -0.6% respectively. At least the pace of decline is slowing. The UK economy has now lost 6% of output, a decline on a par with the early 1980s recession.
• …making UK rate rises unlikely in the short term.
  With the level of activity so far below potential, the Bank of England will be in no rush to increase interest rates. More significantly, Q3’s fall in GDP opens the door to a £25 billion extension of the Bank’s quantitative easing programme at November’s meeting of the MPC. This would bring the amount of money injected into the economy via bond purchases to £200 billion or almost 15% of GDP. This is negative for both bond yields and sterling - something the Bank will probably welcome. While lower bond yields drive investors into higher yielding assets boosting their price and hence the wealth effect, sterling weakness helps exports.
• China's economic upturn bolsters global recovery.
  In stark contrast with performance of the UK economy, Chinese growth broke through the 8% barrier in Q3. With growth in Q3 hitting 8.9% and 7.7% year-to-date, it is well on the way to reaching the government’s target of 8% for 2009. Investment was the key driver, backed by the four trillion yuan budget stimulus. It accounted for virtually all of the economy's growth. Although consumer spending contributed 4% to growth, this was offset by the collapse of China’s trade surplus which cut growth by an almost equivalent 3.6%. This latter statistic suggests the extent to which China has supported growth in its trade partners, notably commodity exporters.
• Dollar weakness supports commodity price rises.
  Commodities continued rising last week on the back of dollar weakness and the ongoing improvement in global activity. The flow of investors seeking to swap zero yielding dollars into higher yielding currencies and/or risk assets is driving both currency and commodity markets. Given that commodities are priced in dollars but traded all over the world, commodity prices tend to have an inverse relationship with the dollar, rising when the dollar falls against other currencies. The availability of cheap dollar funding also supports speculative investment into commodity markets. That is not to say that there are not underlying fundamental motives to be buying commodities at this stage in the economic cycle when global demand is recovering led by China, just that a weak dollar provides both the means and opportunity for investors.

Indices, Interest rates and Inflation

 

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