The word ‘albatross’ is sometimes used metaphorically to mean a psychological burden that feels like a curse. Investors reacted as if cursed by the proposed European financial transaction tax tabled at a meeting between the French President and German Chancellor this week. The meeting produced little more than more of the same rhetoric of ‘cooperation’ which has investors asking themselves if European policy makers are either unwilling or unable to develop policy responses sufficient to address the escalating debt crisis.
Unfortunately for stock markets, this leadership vacuum comes as the weaker economic data continues to pile up. German Q2 GDP shows its economy stalled out in the second quarter and the U.S. Philly Fed index (manufacturing in the Philadelphia area) fell to the lowest level since March 2009 when the economy was in recession. Stocks slumped and gold prices soared as the data showed the primary economic engines in the developed world were in danger of shrinking.
The S&P500 has its fourth consecutive weekly decline finishing down about 4% on the week. The tech-heavy NASDAQ index fell almost 6% as economically sensitive technology stocks adjust to the prospect of slower economic growth. In what could be termed ‘piling on’, Morgan Stanley added to the growing chorus of naysayers with its ‘timely’ release of its slower global growth forecast for 2012. Their customers must be asking what the heck took them so long to join in?
Oil prices dropped and pushed Canada’s S&P/TSX to its third down week in the past four. The S&P/TSX dropped 4%. The silver lining (faint as it may appear) is that domestic inflation remains tame and with 10-year Canada bonds yields at a record low of 2.25%, funding costs are minimal. With U.S. interest rates on hold until 2013, the Bank of Canada will also be reluctant to increase interest rates for a similar time period. Patient RIM shareholders took solace in Google’s dot-com era bid for Motorola Mobility this week. Relatively speaking, this deal puts RIM’svalue at about $25 billion, a far cry from the peak value of about $83 billion, but shares did jump 10% this week!
The world continues to run toward the safety of selected government bonds, Swiss francs, U.S. dollars and of course, Gold. The gold trade looks crowded evidenced by the fact it has only taken 9 trading days to jump from $1700/oz up to and through the $1800/oz level. Gold is indeed the currency of choice with investors believing policymakers are likely doing nothing right and everything wrong to fix our fiscal problems.
The Trading Week Ahead
The Global beat down for equity investors returned this past week as global growth forecasts continued to be cut and the word “recession” is now creeping into conversations more and more.
The week ahead will likely be just as bumpy as we lead in to the much anticipated Bernanke speech next Friday at Jackson Hole, Wyoming. This marks the one-year anniversary of his most infamous Jackson Hole speech. The Fed Chairman returns to Wyoming with the U.S. and global economies in a similar state of weakness. The biggest difference this time is now we have higher inflation coupled with slower employment growth and a weaker outlook. Last year, deflation was the primary issue which led to the announcement of a second round of quantitative easing or QE2.
Following the launch of QE2, the S&P500 rose a stunning 30% to its peak in April of this year. Despite the setback since the April high, the stock index is still up a respectable 8.25% since his last Jackson Hole speech. Investors wonder if Bernanke has another trick up his sleeve and is he prepared to reveal it next week? With respect to Europe, the European Central Bank President Trichet speaks after Bernanke at Jackson Hole on Friday.
The economic data cupboard is relatively bare which, given the sad trend of late, might turn into a small positive for stock markets. One data point worth noting is Tuesday’s New Home Sales for July. To call U.S. housing ‘dismal’ is hardly a stretch but home sales are likely to fall with the risk that they tumble below the 300,000 unit level for the first time since February.
Bank of Canada Governor Carney and Finance Minister Flaherty agreed the economy stalled or shrank in Q2 but agreed growth would resume without further monetary or fiscal stimulus. Canadian Bank earnings season kicks off with Bank of Montreal on Tuesday. Analysts expect an ‘in-line’ quarter with few positive earnings surprises. But be aware that earnings misses are possible as some business segments likely struggled during the quarter. Trading revenue in particular could be soft which means wholesale earnings will not be as strong as in past quarters. No dividend hikes are expected.
Question of the week
With equity markets getting pummeled and recent economic data falling off a cliff, why would the Federal Reserve not act decisively and announce a third round of Quantitative Easing in order to prevent a global recession?
Contrary to popular belief, the first two rounds of Quantitative Easing by the Federal Reserve (QE1 and QE2) served their purposes well.
The stated purposes were to provide the financial system with sufficient liquidity, counteract the massive organic contraction of the money supply, and to accommodate the massive growth of the fiscal deficit. Following the two rounds of QE, there is now ample (albeit unused) liquidity in the banking system. This is evidenced by the massive excess reserves and very low funding rates. The money supply, which was contracting throughout much of 2009 and 2010, has passed from moderate growth to growing very rapidly as of a few weeks ago and the U.S. government is having no problem financing its massive deficit as evidenced by 10-year Treasury yields at historic lows of 2%.
At this point, the Fed would accomplish nothing substantial in terms of credit creation and/or employment growth by injecting more liquidity into the financial system. Banks are awash with liquidity and both funding rates and lending rates are extremely low. Substantial economic activity would not be stimulated in this manner but it would likely cause food and energy prices to rise back to peak levels which we have argued in the past is a root cause of the economic malaise we are currently experiencing.
Thankfully, Fed officials understand this. Psychology also plays a key role. From their last formal statement, it appears there would be substantial internal dissent within the Fed if a new round of QE were proposed. An openly divided Fed, could produce a negative psychological effect that could negate any minor stimulus that a third jolt of QE could provide the economy.