David Morris

The major US, European and UK stock indices continue to grind higher. Geopolitical concerns have been shrugged aside as investors bet that Mubarak’s departure will lead to a calmer period in Egypt and elsewhere. However, it would be premature to conclude that the intensity of the civil unrest across North Africa has now passed its peak. Nor is it safe to assume that such demonstrations won’t spread to the Middle East and beyond. We saw protests in both Algeria and Yemen over the weekend and it is possible that investors are underestimating just how quickly the whole region could destabilise.

Last week investors were also forced to turn their attention back on Europe. Rumours circulated that Portugal would need to tap the European Financial Stability Fund (EFSF). Portuguese 10-year bonds saw their yields spike sharply higher, trading up to 7.63 per cent at one stage – the highest level since Portugal joined the Eurozone and well above the “danger threshold” of 7 per cent. The ECB intervened in the Eurozone bond markets for the first time in three weeks and bought Portuguese debt to ease the pressure. While this has provided some temporary relief, it will not solve the problem of Portugal’s dangerously-high budget deficit, dismal growth prospects and debt refinancing needs. Meanwhile, European leaders have failed to agree to an expansion of the EFSF and any changes will have to wait until the EU summit at the end of March.

Back in the US, around 73 per cent of S&P 500 companies have now reported their fourth quarter earnings numbers. Of these, 72 per cent have beaten analysts’ estimates. But there has been a disturbing increase in negative forward guidance with a significant number of companies warning that their profit margins are getting compressed. With commodity prices soaring and Brent crude oil settling in above $100 per barrel, input costs for corporations are on the rise. Companies are finding it difficult to pass these on to their customers as high unemployment levels and a depressed housing market means consumers are already feeling the pinch. As companies have already cut staffing levels to the bone, their profit margins will come under increasing pressure. If it turns out that analysts have overestimated future earnings growth, then we could be set for some drastic and belated downgrades, just as we saw in 2008.