TWO major stories have been dominating market sentiment this week. The first was the run-up to the Eurozone bank stress tests; we will know results this afternoon but few are convinced of their rigour. It won’t quite be a whitewash but many Club Med banks will be let off too easily. The second story has been the US earnings season; these days, the single most important variable determining whether the UK markets open up or down is the previous night’s performance on Wall Street.
I have argued numerous times in recent weeks that fears of a double-dip have been overblown; we are facing difficult times ahead but no return to shrinking output, assuming no major geopolitical catastrophe and that no major country defaults on its debt. What is interesting is that the US earnings data is increasingly confirming this, and the markets have begun paying attention after weeks of obsessing about the chance of another recession. Caterpillar, 3M, UPS and AT&T all beat earnings forecasts yesterday and raised their outlooks; other firms have also been doing well and those that haven’t – such as Goldman Sachs – are not being dragged down by the overall economy. So while the US is slowing a little, companies are recovering, suggesting greater investment spending and growth in the medium term.
There was even some good news in Europe. The Eurozone’s July composite purchasing managers index, which marries the manufacturing and services figures, rose to 56.6 in July from 55.6 in June, its first increase in three months. Industrial good orders rose 3.8 per cent in May, taking the year on year rise to 22.7. Capital Economics thinks second quarter Eurozone growth may come in at 0.8 per cent, which would be a pretty good result.
That said, the US news is far from disastrous; the worst problem remains the labour market, with jobless claims still high. Existing home sales fell 5.1 per cent last month but it makes sense for the housing market to be subdued given the crazed journey of the past few years. The Conference Board’s leading indicators index fell 0.2 per cent but this follows a 0.5 per cent increase in May.
It is easy to confuse cautious, evidence-based realism – my position – with absurd optimism. Of course, there are huge headwinds, monetary policy remains ludicrously loose, Chinese growth is slowing to a more manageable rate, interest rates and yields over all maturities have yet to return to normal, the first burst of post-recession growth is running out of steam and economies are much less flexible than they used to be, which is crimping the private sector and hitting jobs creation.
But there is simply no evidence in the data to back up the Armageddon scenarios being dreamt up by the perma-bears – at least not yet. My biggest worries over the coming months are not what concerns the mainstream (which is obsessed with the impact of fiscal tightening) but rather what will happen to the US money supply (there have been some worrying signs that it may be dropping uncontrollably) and the impact of new rules on the US financial system, including increased capital requirements (which force banks to lend less) and Barack Obama’s new mammoth reform bill (which is already threatening chaos for asset-backed securities and could hit corporate financing). In the meantime, the earnings numbers suggest a traditional cyclical recovery; let’s enjoy it.