Global Markets Weekly - 26 July 2010

• Markets make further progress on better corporate news. Stress tests - could do better.
  Risk assets generally made progress over the past week, driven by strong Q2 earnings results. Equities and commodities moved higher, but gold and sovereign bonds were once again resilient. Emerging markets outperformed, reflecting our view that they are currently the best source of growth and potential equity returns.The eagerly anticipated European bank stress tests had something for both optimists and pessimists. The assumptions around sovereign debt holdings and definitions of bank capital were not as stringent as they could have been and recapitalisation plans were small compared to last year's US stress tests. But the substantial amount of information released on individual banks reduces uncertainty and will allow analysts to conduct their own ‘stress tests’ over the next few days and weeks. Overall, an important step forward, but lingering doubts around the European banking system will remain, suggesting a cautious response from investors.
• Q2 earnings results generally look good, with some notable exceptions. Q3 guidance has also been positive.
  With a quarter of the global market having reported second-quarter (QoQ) earnings, results so far are convincingly beating analysts’ forecasts. There have been some casualties, most notably investment banks within the financial services sector, which has suffered declines in earnings and sales of 36% and 13% respectively. However, global quarter-on-quarter earnings have risen 10% in aggregate, while sales are up 5.6% from last quarter. This highlights that earnings are being driven by the bottom-line and not just due to cost cutting, as has been the case for four consecutive quarters. Nearly two thirds of company guidance has also been positive for the next quarter, which should support equity markets.
• Recovery momentum remains strong, but comparisons will become tougher into 2011.
  The UK economy delivered 1.1% growth in the second quarter, more than twice the pace forecast. The euro-zone composite purchasing managers index (PMI) rose from 56.0 to 56.7, against forecasts of a decline. The main driver was Germany, with its manufacturing PMI rising from 60.3 to 63.1, while its Ifo business climate survey also hit a three-year high. This does suggest a reliance on exports and is likely to contrast with more difficult conditions in those countries that have had to enact austerity policies. Nevertheless, it is clear that the economic recovery still has positive momentum, though this will naturally start to fade in the second half of the year as fiscal stimulus is withdrawn. Year-ago comparisons will also become less flattering, especially as we move into 2011, the difficult second year of recovery.
• "Unusually uncertain" environment prompts search for yield as central bankers in major economies reiterate caution.
  Despite broadly better than expected data, we saw cautious comments from US and UK central banks. US Federal Reserve Chairman Bernanke said the economic outlook remains "unusually uncertain", with risks to growth weighted to the downside, so that interest rates are likely to remain at exceptionally low levels for an extended period. The Monetary Policy Committee of the Bank of England commented that the economic outlook had probably deteriorated a little further and considered the case for further quantitative easing (though it also heard arguments for monetary tightening before voting 7-1 to hold policy unchanged). This supports our forecast of interest rates remaining low for longer, with central banks of all the major developed economic regions looking again at unconventional measures to increase the supply of credit. As a result, sovereign bond yields in these markets fell further, increasing the lure of higher yields in corporate bonds, higher-yielding equities and property.

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