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Global Markets Weekly - 19 July 2010

• Markets rally sharply, but still short of the highs for this year.
  After a dreadful end to the first half of 2010, the second half was off to a strong start with global equities recovering some 6% by Thursday in a broad-based move led by a recovery in developed markets. However, despite the recovery, global equity markets are still short of any of the previous monthly highs for this year. Indeed, caution amongst investors over the outlook remained evident, with sovereign bonds broadly unchanged and gold back above $1,200/oz.
• Equity markets driven by company results and positive comments on the outlook.
  Second-quarter corporate earnings have generally been beating consensus expectations so far, with some high-profile successes. Intel reported its highest earnings per share ever, while BMW raised its 2010 sales forecast, based on strong auto demand from China, predicting 10% growth for the full year. JP Morgan, despite lacklustre quarterly results, managed to beat analysts’ estimates and reported encouraging news of declining losses on mortgages and credit card lending. While Google’s earnings were below expectations, the 3% of S&P 500 companies that have reported results so far have beaten expectations by an average of about 13%. We expect earnings to remain robust this year, but believe profit growth next year could disappoint.
• Double-dip fears for 2010 had turned into a consensus – but not supported by economic data.
  Recent press coverage has focused on the possibility of a double-dip recession. Yet the recent flow of economic data, while far from uniformly positive, has consistently failed to confirm worst fears. If anything, recent corporate results suggest that growth momentum persists. The pace of China’s growth may have slowed from a break-neck speed of 11.9% in the first quarter, but it still grew 10.3% in the second. This underpins the case for positive, albeit volatile, equity returns this year.
• 2011 is more of a concern – economic contraction appears inevitable for parts of Europe and a risk in the rest of the developed world.
  Reports from the US Federal Reserve (Fed) and the Bank of Japan highlighted concerns over next year’s growth outlook. While the latter raised its forecasts for the current fiscal year (to April) to 2.6%, it held next year’s at 1.8% and cut the following year to 1.9%. The minutes from last month’s Fed meeting revealed declining optimism in the economic outlook and stated that further policy stimulus might be appropriate if it deteriorated further. These comments reinforce our view that interest rates will remain low for longer, with growth and inflation risks skewed to the downside. This was borne out by the resilience of Treasuries and other government bonds, which largely held their recent gains as equities rallied. In this environment we continue to favour corporate bonds, which benefit from investors seeking yield and from strengthening corporate balance sheets. The increased likelihood of ‘policy stimulus’, which we take to mean quantitative easing, is a potential negative for the dollar and a positive for gold.
• European bank stress tests, due next Friday, have already boosted euro markets by demonstrating political commitment.
  While a host of unanswered questions remain ahead of the European Union bank stress tests due on 23 July, as with the creation of the European Financial Stability Facility, the mere fact that governments and institutions are seen to be acting is important for investor sentiment. This has boosted Spanish bond sales and allowed Greece to re-enter the debt market. However, there remains a gap between sentiment and reality, with Moody’s downgrading Portugal’s sovereign debt rating and euro interbank offered rates continuing to rise as banks hold back on lending to each other ahead of next Friday’s announcement, which will clarify counterparty risk. While acknowledging the benefit of the stress tests, we remain cautious, as resolution of structural issues in the euro-zone will be a long, drawn-out and risky process.

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