AT the beginning of last week, equities were heading lower. On Tuesday, major US stock indices such as the Dow 30, Russell 2000, and S&P 500 traded below levels last seen at the beginning of August, although all three subsequently snapped higher on the same day. The S&P is now up over 8 per cent from last week’s intra-day low. The trigger for this sharp reversal was a story that European finance ministers were close to agreement on action to shore up their fragile banking system. After this, short-covering did the rest as the bears were squeezed hard with many capitulating. Stocks, precious metals and copper were among the main markets to benefit from the turnaround, and all were lifted further following a better-than-expected reading on US non-farm payrolls. Friday’s release showed a gain of 103,000 with sharp upward revisions to July and Augusts’ numbers. But investors appear wary of reading too much into this latest print, aware that the US needs to add around 130,000 jobs each and every month just to accommodate fresh entrants into the labour market. This takes no account of the estimated 7m-plus jobs lost since the start of the financial crisis.
In any case, despite the abundance of political rhetoric, the European debt crisis continues to weigh. Policymakers have failed to back up their vague promises with any firm action. Sunday’s meeting between German Chancellor Merkel and French President Sarkozy produced more of the same. For now, their promise to deliver a solution before the start of the G20 summit on 3 November is viewed as a sign that the two core countries will patch up their differences. Yet there is a wide gap between the two. France favours tapping the European Financial Stability Facility to shore up its banks, while Germany believes that France should deal with its banking problems on its own.
Later this evening, Alcoa unofficially kicks off the third quarter US earnings season. Investors will be paying more attention than ever to forward guidance. If the recent rash of downgrades to global growth now feeds through to the corporate sector, analysts will have to lower their earnings estimates. If so, then expect the current stock market rally to come to a sudden halt.