THE WEEKLY TRACK – STILLNESS
SUNDAY, AUGUST 10, 2014, 2:43PM
by BOB SAVAGE, Track Research
Like an early walk in the morning after a late night, there is a certain kind of stillness for markets as we start another week for trading markets in August, but this shouldn’t be confused with peace. There were wild swings in stocks everywhere and in bonds, FX and commodities.  The evidence for the last week’s volatility is strewn like cigarette butts and empty beer cans – with the pain in Europe and Asia notable. There is a lingering doubt about European growth, China reform and Japan’s BOJ and government response to the VAT hike hit to growth.  The next 2 weeks are the heart of summer vacations in the US and Europe – but that doesn’t mean the hangover from the last move has been forgotten. Corrections in the German DAX and French CAC40 contrast sharply with the US S&P500. The rally and capital flows into China’s Shanghai Composite stands out against the rest of the emerging markets.  The technical forces behind the rally in equities unwinding globally is another factor many consider given the urge to cut risk into vacation and into key chart points – making the 55-day and 200-day moving averages more important than usual.  The economic surprises are in favor of good news – the Citigroup index is positive globally for the first time since May and growth predictions for 2014 are higher now than last month – but the price action hasn’t caught up to the news.  This makes for an uneasy stillness as geopolitics fights economics for supremacy.
What matters most – rates or growth or geopolitics?  Next week will test the markets on growth. The fear in the markets rests on the need for a more substantial correction.  But the sentiment shift seems to have gotten ahead of the markets. This means the Friday bounce may have some legs until there is worse news.  The GDP reports from Japan, Europe and the UK will be contrasted against the US 4% 2Q and will be viewed through the present geopolitical crisis in the Ukraine and Iraq for what it means for 2H2014 forecasts.  This leaves markets likely stuck in an uneven stalemate with bond yields as the most powerful barometer for risk.  Not too different than last week with European bond yields – particularly Germany – leading most markets.   The focus on Europe again in the summer is not a surprise – it’s a continuation of themes that started with Greece in 2011 and continues with the present Autumn risk from the bank stress tests, more political unrest and ongoing doubts about fiscal and labor reform leaving the ECB in an uncomfortable spot.  The ECB is behind the curve suggested by the Taylor Rule.

The ECB and its use of new tools will be in play next week as markets question the reaction function of Draghi to the pressures on fiscal stimulus, demographics, banks and credit. The ability for emerging markets to outperform Europe may be a key factor in tracking money flows in the last few weeks of summer.

Market Recap:

Equities: With 2 up and 6 down of the major 8 stock markets – focus is on corrections.  The support from news is likely shifting in the US as we are almost over with 2Q earnings – With 446 of the S&P500 reporting 2Q earnings the details support the market – 73% beat earnings estimates, 64% beat sales estimates. Earnings growth for 2Q was 8.4% with telecoms the best and financials the worst – this according to the Factset weekly earnings insight. This compares to 4.9% earnings estimates on June 30 for 2Q and is the best growth since 4Q2011. Revenue for 2Q was 4.3% – better than the 2.8% expected in June.  This puts valuation of 12M forward P/E at 15 with EPS at $128.  However, the 3Q EPS guidance is worse than usual with 56 of 80 companies warning (70%) – well above the 64% average. 3Q earnings are expected at 7.1% with 4Q at 9.9%.

The US S&P500 gained 0.33% to 1931.59 on the week – this all came Friday when shares rose 1.2% – the most in 5 months – to erase 1.1% of losses.  The index fell 3.9% from July 24 and touched 1904.78 Thursday, back to May 27 lows, then bounced sharply but remains under the 55-day at 1951.  6 of the 10 industry groups rallied in the S&P500 this week led by consumer-discretionary as telecoms lagged.  The DJIA rose 0.37% to 16,554 – bouncing from its 200-day moving average at 16,368 – and the NASDAQ rose 0.42% to 4370.90.  The CBOE VIX fell 7.4% on the week to 15.77 after touching a 17.25 peak Thursday – still well below the 2014 peak of 21.48 Feb 3.
The Stoxx Europe 600 fell 2.1% to 325.2 on the week – its first back–to back weekly loss since March.  The index is off 7.1% form June 10 2014 highs – the best since Jan 2008. The VStoxx Index rose to 21.24 back to Mar 17 highs.
The MSCI Asia Pacific index fell 2.5% to 144.09 on the week – to 7-week lows.  Japan led the drop off with the Topix off 4.1% on the week – its worst performance since April.  In contrast the China Shanghai Composite rose 0.4% for the fourth weekly gain.
The MSCI Emerging Market index fell 1.3% to 1046.55 on the week – its second weekly drop – with Brazil Bovespa off on Dilma polls and the India Sensex off 0.6% with EM outflows.

Fixed Income:  US bonds rallied sharply on risk-off sentiment with curves flattening and overall levels back to 12 month lows as the US bombed Iraq and Russia/Ukraine conflict dominated fears. Spreads to Europe drove much of the buying. 2Y off 2.5bps to 0.445%, 5Y off 3bps to 1.625%, 10Y off 7bps to 2.42% – with 2.40% a pivot that broke early Friday to test 2.35% lows back to June 20, 2013 levels – 30Y off 5bps to 3.23% with lows of 3.18% also back to June 2013 lows.  Next week will be dominated with supply concerns – $27bn in 3Y notes Tuesday, $24bn in 10Y Wednesday and $16bn in 30Y Thursday.

Canadian 10Y bond yields fell 5bps to 2.07% on the week.  The bonds touched 2.03% back to June 2013 levels on Friday after jobs rose just 200 in June.
UK Gilts 10Y yields fell 13bps to 2.42% with trade and BOE key drivers for the rally – pull back in rate hike expectations with Scottish vote next worry.
German Bunds 10Y yields fell 8bps to 1.05% on the week – they hit 1.0222% record lows Friday with 2Y rates back below 0% but close 0.006% – to levels last seen May 2013.  This is the 5th week of Bund gains the best winning streak since June 2012 at the height of the EUR crisis.
French OATs  10Y yields fell 6bps to 1.455% – with growth views mixed as IP better and BdF survey suggesting 3Q 0.2% q/q GDP.
Italy BTPs 10Y yields rose 5bps to 2.81% – hurt by weaker GDP confirming double-dip recession.
Spain Bono 10Y yields flat on the week at 2.55% with focus on growth vs. Italy.
Greek Bonds 10Y yields rose 35bps to 6.35% – fears of growth and politics unravel leading to profit taking – some pain in 2014 issues notable.
Portugal Bonds 10Y Yields up 12.5bps to 3.825% – BES remains center of storm for Portugal with doubts about who will pay E4.5bn.

Foreign Exchange: The US dollar index rose 0.1% to 81.39 – its fourth week of gains with G10 volatility rising in FX markets – The JPM vol index closed 6.24% on the week up from 5.29% July 3 lows.  Argentina saw the Peso gain 2.3% to 3M NDF at 8.9450 – as speculation for a private bank deal on defaulted bonds rose. The Philippine Peso led weakness in Asia – with PHP off 08% to 44.13 – and it touched 44.278 lows after the World Bank cut growth forecasts. CNY rose 0.4% to 6.1564 in contrast to the rest of the region.  India saw its Sensex index drop 0.6% on the week and the INR fall 0.3% to 61.3675. KRW rose 0.1% to 1036.45. MYR rose 0.1% to 3.2078, IDR fell 1.8% to 11,788 – but markets were closed most of last week – and TWD was flat at 30.066.

EUR: 1.3410 off 0.15% on the week. Focus was on ECB and Draghi with little more than jawboning driving EUR – risk off in Italy, Greece left market confused.
JPY: $102.05 up 0.6% on the week – its best weekly gain in a month. The JPY touched 101.51 lows and bounced. EUR/JPY fell 0.3% 136.85.  Focus is on 101.40 holding.
GBP: 1.6775 off 0.25% on the week – BOE on hold and data wobbles – with GBP less a reserve currency with Russia conflict. EUR/GBP .7995 up 0.2%
AUD: .9275 off 0.45% for the second week – jobs and RBA rethinking drives with .9210-20 support key. NZD fell 0.6% to .8460 with weak milk prices key.
CAD: $1.0954 off 0.5% on the week – its 3rd weekly drop – with jobs Friday disappointing and sending yields to 2014 lows. The currency is off 1.4% in August so far.
CHF: .9055 off 0.1% on the week.  FTQ buying with JPY left the EUR/CHF lower at 1.2145 off 0.2% on the week. CPI was as expected, jobs stable.

Commodities: The S&P/GSCI was off less than 0.1% to 4,800.84 with gold and grains up, industrial metals lower and oil and its products mixed.  The focus was on geopolitical noise with oil the main barometer. The GSCI spot index was 617.07 from 617.50 last week.

Oil: $97.35 off 0.28% on the week. Brent $104.76 rose 0.2% on the week. The spread to WTI fell back to $7.37 Friday from $8.10 most of the week. US intervention in Iraq is viewed as supporting oil supplies. Gasoline futures were up 0.3% on the week with better US growth outlooks key. WTI focus is on $96.50 base for $100 retest.
Gold: $1310.60 up 1.35% on the week.  The focus in gold is on geopolitical risks – US bombing in Iraq drove gold to $1324.30 highs on the week – best since July 18.  Focus is on $1281 base for $1329 retest. Silver closes down 2.15% to $19.941 off for the fourth week. Platinum rose 1% on the week to $1478.30 and Palladium fell 0.47% to $860.50.
Corn: $3.52 up 0.14% on the week with Dec futures $3.635 up 0.3% – this ends a 6-week slump – the worst performance in 3 years. Soybeans rose 2.5% to $10.8475 – with $10.85 touched – back to July 31 highs.  Imports from China were key driver. Wheat rose 2.75% on the week to $5.4925 but fell 2.2% on Friday on inventory speculation.  USDA updates forecasts on supply August 12.
Copper: $3.1735 off 1.3% on the week.  Industrial metals fell with China importing less, more geopolitical concerns – US bombing Iraq, and doubts about inventories being drawn down.

Conclusions: Buy the bounce?  The markets have been battered by headlines not usually associated with being the fundamental driver for large corrections.  Between Ukraine, Ebola and Iraq – most associate these stories as short term drivers dislocating some neighboring markets and some commerce but not starting a more structural change in the way the world works.  The maps between Syria and Iraq, between Russia and Europe those pictures suggest less about the present and more about the future risks to energy.  Oil prices are not flashing red or even yellow – making clear that the pressure on global asset prices is less about supply disruptions and more about something else – call it global demand.  How important Europe or Japan is to the US stock markets will be a central test next week.  The role of the FOMC and rates will be a close second as we get little data or earnings that will shift the way analysts see the Fed policy reaction function.

This leaves the US watching for how important the rest of the world is to its own national demand function.  For now the best indicator remains labor markets – with wages the central focus.  The latest chart from the Atlanta Fed maybe the right way to think about the FOMC reaction function to data in the weeks and months ahead as it tries to move from QE to rate normalization without driving a significant correction in prices at home and abroad.

GOOD LUCK