In Europe, an election and a collapse in budget talks renew the turmoil and are now likely to dominate market sentiment but across the pond there is a different and positive story for the markets.
For the US, either someone has done a great job ‘beating’ down analysts’ earnings estimates for the current reporting round, or Wall Street really does face the prospect of genuinely better fundamentals as the year progresses. More on this shortly.
In Europe, round one of the French elections has gone Francois Hollande’s way thus casting uncertainty for the markets over what the prospect of a Socialist victory on May 6th could mean for ratifying the Inter-governmental Treaty on the fiscal compact and resolving the debt crisis. Among other things, Hollande has indicated an intention to re-negotiate the terms of the fiscal compact to include measures aimed at growth, an ambition that will take some doing.
In Italy, fiscal austerity and the weak economy are leading to slippage in deficit targets as demonstrated last week by a document due to be approved by parliament this week. GDP growth is forecast to fall more than previously expected, thus forcing the government of Mario Monti to raise next year’s budget deficit to 0.5 percent of GDP from a previous target of 0.1 percent and pushing out to 2014 the target of budget balance. In the Netherlands, the leader of the centre-right coalition has had to acknowledge the collapse over the weekend in talks on budget cuts thus making elections likely and adding further to the concern about a resolution to the eurozone’s debt crisis.
As the latest from Consensus Economics Inc shows, economic activity for the eurozone is expected to contract this year and grow by less than 1 percent next year. Meanwhile, the US economy is expected to grow faster than any other major economy not only this year but also next. There has been a sudden loss of momentum in the recent pace of job creation but the trend for employment remains firmly upwards, as does the trend for total bank credit outstanding, part of which reflects a recent pick up in credit outstanding for real estate. That is reflation for you!
On earnings, the contrasting fortunes of the US and Europe could not be sharper. It is still early days for the US reporting season. That for Europe is just getting underway too with a little more than half of the companies in the Dow Jones Stoxx 600 Index expected to report. For the limited sample of European companies that has reported thus far, the results are disappointing. Earnings growth is negative, the ‘misses’ outnumber ‘beats’ and earnings estimates are being revised down.
Over on Wall Street, a little more than a fifth of the S&P 500 has reported. Not only is the proportion of ‘beats’ at its highest level on record according to Thomson Reuters, but also first quarter earnings growth is coming in at nearly twice the pace expected at the outset of the results season. Analysts are thus taking up their earnings estimates for the remaining quarters of the year. That’s reflation for you too considering that the lion’s share of earnings is still derived from the domestic economy.
This more promising earnings story for US companies has been reflected by the rise in the major indices to new post-Lehman crisis highs this year. Moreover, as pointed out in recent notes, the broad upward trend of the S&P 500 is characterised by a technical pattern of rising highs and rising lows, a bullish feature not present in other major indices. The correction to date in the S&P 500 from this April’s high has been modest, with the result that the S&P 500 has outperformed the FTSE All-World Developed ex US Index. Neither the FOMC, which meets on Wednesday, nor the Fed Chairman’s press conference, which follows shortly afterwards, is likely to indicate any readiness to ease up on policy. Although no further steps to stimulate the economy are likely either, the renewed phase of turmoil in Europe and the risk of more market upheaval are likely to mean that the extended period message behind the Fed’s efforts to reflate the economy will be reinforced.
Eurozone equity markets have been testing the support of the 200-day moving average but this will now haven given way. With a bit more selling, these markets will look oversold. For the US equity market, the challenge has been in overcoming the resistance offered by the 50-day moving average, but in retreating, we doubt the selling will take the index anywhere near its 200-day moving average. The latter lies a long way down and the S&P 500 will look oversold well before it gets anywhere near there. Also, with Fed policy geared to reflation, the profit-taking will offer a credible buying opportunity – especially if the rebound, when it comes, is off a ‘higher low’.

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