Weekly Investment Commentary- 25th Jan 2012
Equities Advance in spite of weaker corporate earnings
Jan 25 2012
Equity Market Rally Continues
Risk assets advanced yet again last week as 2012 has gotten off to a strong start for the markets. Last week, investors looked past some mixed earnings results and focused on improvements in economic data, helping stocks to notch some solid gains. For the week, the Dow Jones Industrial Average climbed 2.4% to 12,720, the S&P 500 Index rose 2.0% to 1,315 and the Nasdaq Composite gained 2.8% to 2,786.
The improvements in equity markets in the early weeks of 2012 are particularly notable given that stock market gains have been global in nature. In fact, the past three weeks mark the first time since 2007 that markets in the United States, Europe and China have all advanced at the beginning of a year.
US Economic Data Remains Solid
One of the key recent economic data releases showed that US jobless claims fell by 50,000 last week to 352,000. That drop represents the largest weekly decline since 2005 and suggests that the January payrolls report could be a strong one. It should be noted that when data is released in a couple of weeks, it should show that around 150,000 new jobs will have been created.
In other economic news, this Wednesday’s Federal Open Market Committee (FOMC) meeting will mark the beginning of a new era for the Federal Reserve. In addition to the FOMC statement that the Fed typically releases at these meetings, the central bank will also begin to release forecasts for the benchmark Fed Funds rate and will provide guidance about the timing of the first rate hike. This represents a significant change as part of the Fed’s desire to become more transparent about its decision making.
Earnings Growth Looks to Moderate
It is still quite early in the fourth quarter 2011 earnings season, but results to date have been mixed and are weaker than they have been in recent quarters. About 15% of companies have reported, with just over half delivering better-than-expected results. At this point, it looks like overall earnings will exceed estimates by somewhere around 1% to 2%, the lowest rate we have seen in some time.
At present, analysts are downgrading their 2012 earnings forecasts. The current bottom up consensus estimates are that earnings will grow by around 12% in 2012. Growth will probably come in at around half that rate.
What Will it Take for the Rally to Continue?
The recent bounce in stocks and other risk assets can be attributed to a combination of some improved US economic data, a lack of significant new negatives in the euro debt crisis and further evidence of a soft economic landing in China. For the rally to continue, at least two developments need to occur. The first is that policymakers in the euro area continue to stabilize conditions. The second is that global economic data continues to improve enough to support corporate earnings growth.
Regarding the first, it does appear that the European Central Bank is working diligently to address the weakness in the European banking system, which was the source of much concern in 2011. While we still expect to see a recession in Europe and while some of the less competitive European countries will likely face fiscal and debt challenges for years to come, Ireland included, we do believe that contagion risks can be contained if global economic growth continues (and we believe it will, at a subpar pace).
At some point, it is inevitable that markets will take a break from the pace they have been on since the year began, but the outlook for stocks remains a positive one. Despite the likely moderation in earnings growth, stocks remain attractively valued, and we would reiterate our forecast that equities should outperform cash and bonds in 2012.
Bonds
German bond yields rose to their highest in a month as a result of investors moving to risk-assets in the light of equities rising. In addition, sentiment grew more positive that policy makers moved closer to resolving the region’s debt crisis. French and Spanish borrowing costs also fell after both conducted successful bond auctions. The Merrill Lynch over 5 year government bond index ended the week relatively unchanged.
Currencies
In currency markets, the euro broke its weakening streak against the dollar as it gained on the back of good bond auctions in the region. The dollar also saw some weakening, due to investors seeking higher-yielding currencies, as the global economic picture showed further signs of improvement. The €/$ rate finished the week just above 1.29, a gain of 2%.
Oil
Oil prices retreated from the $100 a barrel mark, mainly due to a contraction in Chinese manufacturing activity. Oil finished the week slightly above $98 a barrel.
About
Neal Kelly is a Co-Founder and a Director of Thomond Asset Management and can be contacted @ neal@thomondam.com
