Wednesday, June 11, 2014

Economic Summary for the week ended 9th June 2014

China - China's service sector grew at its fastest pace in six months in May, helping allay fears of a sharp slowdown in its economy.
The non-manufacturing Purchasing Managers' Index (PMI) rose to 55.5 in May from 54.8 in April. The PMI is a key indicator of the health of the sector and a reading above 50 indicates expansion.
It comes just days after China reported that the manufacturing sector grew at its fastest pace this year in May.
China's service sector, which includes construction and aviation, accounts for nearly 43% of its overall economy.
Spain - Spain is set to introduce a new stimulus package totalling €3.6bn ($4.9bn) in a bid to bolster the country’s nascent economic recovery.
Spanish prime minister Mariano Rajoy has announced that the new measures will be brought in next week in an attempt to create jobs and encourage the competitiveness in the economy.
“Next Friday, the government will present a package of measures to increase competitiveness and productivity,” he said.
“The plan will include investments totalling €3.6bn, of which €2.67bn will come from the private sector and €3.63bn from the public sector.”
As part of the new package, Spain’s main rate of corporate tax will be cut to 25% from 30%.
Middle East - Qatar’s shares fell for a third day on Wednesday and bonds dropped on concern that the Persian Gulf nation may lose the right to host the 2022 soccer World Cup, potentially jeopardizing some of its $200bn investment plans.
Qatari stocks, among the world’s best performers this year, have lost 4.1% in the past three days after the U.K’s Sunday Times reported that payments were made to soccer officials in return for allowing the Arab country to host the tournament. Rashid al Mansoori, chief executive officer of the Qatar Exchange, maintaining that the nation won the bid with “credibility” and corruption allegations were“noise.”
“If countries are asking for a re-vote, this will hurt the market further,” Hisham Khairy, the Dubai-based head of institutional trade at Mena Corp. Financial Services LLC, said. “I would stay away at the moment and wait for things to settle.”
Japan - Japanese shares gained this week, with theTopix index rising for a tenth day on Wednesday, its longest winning streak since August 2009, as the yen weakened and steelmakers advanced.
The Topix rose 0.4% at the close of trading in Tokyo after falling as much as 0.1% throughout the day. About three shares rose for every two that fell. The gauge posted its longest winning streak since the 13 days through Aug. 4, 2009.
“The future is looking brighter for Japanese shares,”said Hiroichi Nishi, an equities manager in Tokyo at SMBC Nikko Securities Inc., citing factors such as a weaker yen and the relative cheapness of stock prices. “However, the danger of overheating is increasing.”
Brazil - Brazil’s industrial production in April contracted for the second month in a row, as output of capital goods and consumer durables fell.
Production dropped 0.3% from the previous month after contracting 0.5% in March, the national statistics agency said Rio de Janeiro. The decline was smaller than the the median estimate of a 0.4% fall from economists surveyed by Bloomberg. Production declined 5.8% from the year before, versus a 6.1% fall forecast by analysts.
Brazilian industry has sputtered as the central bank raised borrowed costs over the past year to combat above-target inflation, leading to a slide in business and consumer confidence. Manufacturers have also been hit by economic troubles in Argentina, Brazil’s third-biggest trading partner. Analysts expect the currency to weaken by year-end, improving the outlook for exporters.
Today’s data “add to the building sense of concern in this sector,” Daniel Snowden, emerging markets analyst at Informa Global Markets, said. “No matter what the government seems to do, no matter what the central bank seems to do, the sector just doesn’t want to put together any kind of consistent run. It’s been lifeless.”
Spotlight on: More life left in the U.S.?
Fidelity Worldwide Investment's Dominic Rossi says questions over the ability of the U.S. to keep leading global indices higher are misplaced, with the region in the middle of a bull market and capable of climbing another 25% from here.

Some investors are beginning to question whether the U.S. economy and its stock markets can continue to provide leadership to global equity markets after a strong run during which valuations have re-rated.
In my view, the answer is a firm yes. While the U.S. economy has had a subdued start to 2014, the strength and duration of its resurgence will surprise investors.
Market volatility remains anchored, valuations are not expensive, and profits can move higher despite concerns over ‘peak’ profitability.
With the prospect of supportive liquidity conditions, a return to the ‘cult-of-equity’ could drive a multi-year bull market in stocks.
Anchored volatility allows valuations to expand
It has been a solid first quarter for equity markets after a strong 2013. The resilience of markets has been particularly impressive given they had ample opportunity to take flight. But equity markets have shrugged off uncertainty over the crisis in Ukraine and weak U.S. growth.
It was striking how resilient equity markets proved to be and how contained volatility stayed during this period.
Equity market volatility is being anchored at low levels by confidence in the positive structural outlook for the U.S. economy. When implied volatility (VIX) falls below 20, we have a favourable environment that allows valuations to expand.
Lower volatility was a pre-requisite for the re-rating in markets we saw in 2013, and it is currently well below 20. While many investors got used to elevated volatility through 2008-2012, it can stay low for a sustained period, much like it did in the 1990s, so investors should be wary of only looking at the recent past.
In terms of what might trigger volatility, the interest rate cycle has become the key focus. U.S. Fed chair Janet Yellen recently let slip at a press conference the phrase “six months” in response to how soon the interest rate cycle could start after tapering is completed.
While there was a small spike in volatility and equities fell on the news, there was no reaction from U.S. 10-year treasuries, indicating the lack of concern among bond investors about inflation risk.
Resurgent U.S. will continue to lead global stock markets
In the US, the news is only going to get brighter. I think we are at an inflection point in the U.S. economy, and I am not convinced the market is fully recognising how rapidly the economy is strengthening.
The data is improving across the board, whether it is loans data, manufacturing PMIs, services PMIs, or consumer confidence data.
The speed of the improvement in the budget deficit is remarkable. Since 2009, the fiscal deficit has shrunk to around $600bn from $1.5trn. It is not implausible President Obama will finish his term with a fiscal surplus.
In this case, I think we are looking at a U.S. equity market that is similar to the late 1990s, one in which equities should be well supported by liquidity.
Valuations and earnings can go higher
Equity markets are no longer cheap, but nor are they expensive. In the U.S. market, we have a slightly unusual situation in earnings expectations at present.
Usually, we start the year with high and unrealistic earnings forecasts which have to be revised down. The opposite is the case this year, and we are likely to have a strong earnings season versus subdued expectations.
Beyond that, it is prudent to consider the standard counterargument to the buy case for the U.S., which has lately become commonplace. This argument points out the U.S. is on a P/E of 16 times, yet corporate profitability is at record highs.
If we cyclically adjust for peak profits, then the P/E is 22 times. Given we are approaching an interest rate tightening cycle, the bears say this makes the U.S. market a sell.
This is naïve in my view. Profit margins may well be at record highs, but I think they can move higher. The distribution of profits between capital and labour in the U.S. is going through a fundamental shift.
There are a number of reasons why profit margins can stay high, such as the globalisation of labour forces, less organisation of labour, technological change, and the ability of markets to press companies to focus on profit margins in a way that just did not happen 30 years ago.
Overall, the outlook for corporate earnings remains favourable.
Buy on the dips
The U.S. market is going to break out strongly on the upside from its current period of consolidation. With compressed yields on U.S. and euro credit, equities will look attractive versus credit as earnings come through.
The danger is U.S. equities have a too-strong rather than a too-weak year, given the positive outlook for both liquidity and earnings.
It is evident some investors have been left a little traumatised by the bear market in equities and are still relatively fearful.
However, I believe we are in the middle of a bull market and, in a bull market, you buy the dips.
In this light, if we get a mid-cycle correction based on the expected onset of the interest rate tightening cycle in 2015, this would be a buying opportunity, and, the S&P 500 could move to 2,000-2,300 from its current level of 1,800.

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