THE Dow and S&P 500 are both within spitting distance of the highs achieved earlier this year. It will only take a small push for both indices to surmount these heights. After that hurdle, the bulls will have their sights on the pre-financial crisis levels of 2007 – around 14,200 and 1,575 for the Dow and S&P 500 respectively. But there are question marks over this latest bull run, which has taken equities back up to very high levels. Trading volumes have been particularly light thanks to the Olympics, and there is little reason to expect them to pick up significantly now that we have the rest of the summer to get through. On top of this, stock market volatility is languishing at five-year lows. While this may suggest that investors are comfortable buying equities at current levels, it is also a warning of a high level of market complacency.
US economic data releases continue to paint a mixed picture. The latest non-farm payroll number was better than expected, although an increase of 163,000 jobs is still some way below the 200,000-plus readings that we saw in the first quarter of the year. Last week’s retail sales number convinced many analysts that the US consumer is back, and that a pick-up in spending will feed through to stronger GDP growth. But the latest data has also reduced the likelihood of further intervention from the Federal Reserve at its September meeting. All of this, however, has done nothing to halt the equity market’s rally – investors are once again anticipating a US recovery, while simultaneously expecting the European Central Bank (ECB) to grab hold of the stimulus baton. The ECB is viewed as having the available firepower, together with enough reason, to hose more liquidity into the financial system.
Not only that, but investors also expect the People’s Bank of China to ease further. At the beginning of last week, Chinese Premier Wen Jiabao said that China faces headwinds, but that the recent moderation in inflation data gives the government more room for monetary easing. Yet while the Chinese consumer price index and producer price index have slowed significantly over the past 12 months, there should still be concerns about the outlook for inflation, as food and fuel prices push higher. While the soaring cost of oil, corn and soyabeans may, for whatever reasons, fail to impact the official data, there is little doubt that it is already affecting consumers.
In the US, shoppers have been commenting, for some time now, on how food and other consumables are being sold in smaller packages while the purchase price remains unchanged. The effects of rising soft commodity prices has also not gone unnoticed in China, where the proportion of income spent on food is greater than in developed countries. China Daily reported that the authorities are set to release corn and rice from state reserves to help tame food price inflation and reduce imports from the drought-hit US. It is also worth noting that the People’s Bank of China resumed reverse repo transactions last Thursday. This indicates that there are no immediate plans to cut the Required Reserve Ratio. So the expectation of imminent monetary stimulus has been dampened, despite the rhetoric from the Chinese authorities.
Yet speculation over the likelihood of further central bank intervention remains high. Investors are looking ahead to the Jackson Hole Economic Symposium at the end of this month. Despite doubts that the US economic outlook is bad enough to warrant further Fed action, many investors still hope for a repeat of events in 2010, when Ben Bernanke signalled that a second round of quantitative easing was imminent. But, in the absence of a financial catastrophe, and with the US presidential election less than three months away, the Fed may prefer to hold off from a third round of quantitative easing and let “Operation Twist” take the strain.