Financial Markets analysis

Wow. Its been an incredible last few months for the financial markets where we have seen all time highs in the US equity indices as stated in my last post due to investors seeking a higher yield for their capital in addition to large capital outflows to the U.S. A variety of reasons include the uncertainty over Europe with regards to a resolution of the sovereign debt situation and the higher unemployment seen in countries within the EU (an example is Greece). Furthermore there has recently been unrest in various other nations (Turkey) which is starting to drain confidence in the EU framework. 

 In terms of a Macro perspective the fundamentals in the U.S are looking more robust where the NFP data has been steadily improving and consumer confidence reaching levels not seen for a number of years due to rising house prices and the 'wealth effect'. The dollar seems like the place to be and this is expected to strengthen substantially over the next 6-12 months. We have also seen incredible moves in the USDJPY currency pair due to 'Abenomics' where the Japanese have injected large sums of liquidity into their financial system to help weaken their currency in order to drive economic growth (making exports cheaper to foreigners) which has the smell of an underlying theme of currency wars.

US Treasuries yields have also risen substantially whilst prices have decreased (the price/yield inverse relationship) due to the rotation of investors out of bonds and into the equities domain. A low interest rate environment has helped as theoretically the price of borrowing is cheap but the likelihood of an increase in interest rates has increased (US fundamentals are more robust and the headline unemployment rate has ticked down) whilst simultaneously there should be a pickup in volatility. This should be over the summer and into the Q3 period as from a historical perspective there is a high probability whist also the German elections will demonstrate uncertainty and that is one element that financial markets have a disliking of.

Thoughts on the Markets

So over the last couple of weeks the U.S has looked quite interesting. The UMCSI came in at 72 which was below the forecast of 73.5, housing starts came in at 760,000 above forecasts and building permits gave a figure of 755,000 which was down from the previous month (784,000) and also below the Bloomberg survey of 765,000. Other interesting stories was the close to 50% drop in earnings from Morgan Stanley which would probably lead to job cuts in the next quarter. Also the probability of QE happening this year has been significantly reduced due to the robust performance in the USD against the major and emerging economies in addition to the weakness in the 10 year treasury yield which is < 1.5%. Instinct also suggests that the yield isn't at record lows because the U.S economy is in good shape but because the rest of the world is not in the best of shape. Also quite recently the ratings agency Fitch gave a little reminder to the United States of their current rating and outlook which is AAA (Negative Watch) so maybe a possible downgrade not too far down the line. A cut by the ratings agencies doesn't necessarily mean that yields will go up. However last year this was the case with the S&P downgrade of the U.S. and the majority of the sell off in Equities markets came beforehand due to a slowdown in GDP growth. As GDP growth stabilised the market then rallied.

Also recently Moodys posted a negative outlook for Germany which was interesting possibly on the back of GREXIT fears.

In conclusion there are severe headwinds and the much discussed fiscal cliff is real due to the risk of severe GDP contraction in the U.S., political risk in not fixing the situation and the automatic spending cuts which come in from Dec 31st. We expect a market correction by a minimum of 10% due to these factors. However regardless of the situation this is a cyclical bull market

Thoughts on the Markets

China Manufacturing PMI at 50.2 in June from a previous of 50.4. The consensus was a drop to 49.9. This is positive given the number is above 50 which signals an expansion. However there is still uncertainty and no clear direction. If the number did come in below 50 then we could say that the Chinese economy is contracting and would therefore expect a recession within 12-18 months as this is a leading indicator (an indicator that changes before the economy as a whole changes) and powerful to the business cycle. Just waiting now to see the HSBC Manufacturing PMI number which had a previous value of 48.4. Also looking forward to the US ISM Manufacturing number which had a reading in May of 53.5. A number above this for June will be positive for the markets especially in the USA and could continue a risk on rally seen at the end of this week due to a positive outlook from the EU Summit which eased repayment rules for Spanish Banks, relaxed conditions for possible aid to Italy and unveiled a $149 billion growth plan for the regions economy. In addition this could be a technical short squeeze to flush out the weak players. Also looking ahead to Non-farm payrolls data due on 06/07/2012. This isn't a leading indicator but traders love moving the markets on this number. Lets see how this week plays out for the global markets.