Macro Better, Micro Bad
An ongoing issue since the earnings season kicked off has been the general shift of focus from the macro to micro. That is to say that investors are less concerned about economic trends in Europe, China, and the U.S. than they are with industry and company trends as discussed in earnings announcements over the past two weeks. In addition, there is a very odd discrepancy between company management sentiment and consumer sentiment. They are at odds with one another. So which one is right?
The answer is simple, but first let’s discuss some of the macro and micro catalysts that are vying for your bullish or bearish prospective. Let’s talk about the macro picture. To put it simply, the issues that have been plaguing the market from March to August have possibly reversed. European and Chinese economic trends are turning at the margin and recent data suggests that trend is progressing nicely.
Below is the manufacturing PMI for China. We got the “flash” initial look on how the October data is progressing on Wednesday night. It has increased to 49.1 from the final reading of 47.9 in September. The PMI data has been hugging close to “flat” growth since last year. The holiday season is right around the corner. It is highly likely that manufacturing will continue to increase, because who else makes goods other than China.
The Co-head of Asian Economic Research at HSBC had this to say about the data:
“October’s flash PMI reading continues to recover for the second month, thanks in part to a gradual improvement in the new orders index which picked up to a six-month high (albeit marginally below 50). This is helped by the filtering-through of the earlier easing measures. However, external challenges still abound and the pressures on the job market are lingering. This calls for a continuation of policy easing in the coming months to secure a firmer growth recovery.” HSBC
This seems to confirm some of the comments we heard from Peoples Bank of China Vice Governor Yi Gang who said that China has undertaken a package of measures since the summer to support growth, which is focused on investment projects that will improve people’s livelihoods. He said that those measures would begin to work through the economy and show results in Q4. That looks to be true with new orders trending up for the last six months. New orders are a good leading indicator on future results. Although the indicator is still in the contraction area, as economists, we should be concerned about the changes at the margin.
While on the subject of China, and although I’m getting a little ahead of myself, there were some comments this week from Caterpillar (CAT) and United Technologies (UTX) that confirmed at the micro level conditions are improving in China. While Caterpillar continues to reduce inventory levels to match sales, they believe recent government fiscal and monetary policy actions will lead to growth in the construction industry in 2013. United Technologies voiced similar hopes in China at their Otis Division, which is the primary driver of growth at the company.
If you recall, the market began a mini free-fall in May when the U.S. jobs data worsened and Greek elections failed to form a coalition. There also was the prospect that a radical prime minister was considering telling Europe to fly a kite, which would have resulted in a Greek exit of the EU and euro. Additionally, there was growing concern that Spain would need a bailout. The market corrected, economic indicators plunged, and consumer sentiment fell as European bond yields rose.
Spain got the €100 billion bank bailout at the EU summit in June, and since European Central Bank President Mario Draghi drew a line in the sand on the euro and monetary policy, conditions have improved. Sovereign yields have been fallings across the board. Beyond Draghi’s comments in July and August, the announcement of the Outright Market Transactions (OMT) has held yields down despite recent events. That includes Spain’s hesitancy to request a full bailout package as well as an ongoing banking regulatory debate at the recent EU summit. Germany doesn’t want all banks regulated, only the systemic “too big to fail” category.
While sovereign yields continue to fall, which has really been a trend since December when the ECB announced Long-Term Refinancing Operations (LTRO), the Eurozone PMI has not been as encouraging as China’s. The flash numbers hit Wednesday, down to 45.8 from 46.1 in September, a 40-month low. While business activity and new orders showed a slower rate of decline, there was a faster contraction in the goods-producing sector. And as per usual, Germany had a mild decline compared to the rest of Europe, but especially versus France, one of the core countries of the Eurozone. This will need to be watched more closely towards the end of the month. So far, the market hasn’t been concerned about France. This was not a good omen; however, yields haven’t moved very much based on the continued contraction.
Despite the contraction in business activity in Europe, stock markets have responded very positively to direct bank capitalization (discussed June 4th), the June EU summit, Spanish €100 billion bank bailout, and central bank accommodation. The Dow Jones Europe Index has consolidated sideways under major resistance, unlike our S&P 500 and is resting on the 50-day moving average. European stocks are at a critical junction here: breakdown from a triple top at the top of a one-year trading range or breakout of a major basing pattern.
Draghi has done much to establish support for the euro and the European markets by announcing his defense of the currency in July. He provided what the EU could not, a credible firewall to support the credit markets. While this is not pure capitalism, I had used the analogy of an anesthetic in an operation, which eases the pain of an operation to allow the doctors (politicians) time to open the sovereign debt wound and clean it out with stronger regulation and unification. The deadline given in June for a bank regulator was year-end 2012. During the EU summit last week, they continued to hold the year-end as a deadline on an agreement - we’ll see.
I didn’t want to spend too much time on the macro, but suffice it to say, U.S. economics continue to improve almost across the board. Recent indicators continue to point towards improving conditions including the rise in the flash PMI number for October, which was 51.3, edging up from last month’s increase to 51.1. While overall the conditions are still sluggish, we have been seeing a deceleration in the recent contraction, holding just above a flat 50 reading.
By now, I’m sure you’ve read and heard that the U.S. housing market is recovering rather nicely, not only in sales, but also in price so I won’t belabor the point. I will point your attention to two very big surprises as of late. The first is consumer sentiment which guides purchases and retail sales.
The University of Michigan Consumer Sentiment Survey was released last Friday, and the number blew away economic estimates, up to 83.1 from 78.3 while consensus was for a reading of 78. This was the highest level for the index since late 2007. Despite investor concerns over the elections and the Fiscal Cliff, the future expectations component grew the fastest while present conditions also improved very nicely. With housing prices rising, low mortgage rates, and a stock market that was up near 16% in mid-September, it’s no wonder the wealth effect is helping consumer sentiment. Despite the positives, the elections and job developments over the next quarter will likely have a greater influence on consumer sentiment in the near-term and we’ll get the next jobs data report next Friday, a week from tomorrow.
Another factor we can use to gauge the consumer is retail sales data. The figures in September showed an increase of 1.1% following an upward revision to August’s surge of 1.2%, the third straight gain. We’ve had three sizable gains in retail spending, which is puzzling when we hear some of the results from companies reporting in the past two weeks. The consumer is happy and the consumer is spending, but you wouldn’t know that if you just listened to company earnings reports.
Micro – Main Street vs. Wall Street
While it’s typical for companies to guide low (under promise) and beat estimates (over achieve), one ongoing issue this earnings season has been the ongoing disappointment from companies concerning forward guidance. Many are saying that the slow growth during the summer months when European fears smacked everyone across the face, are continuing through the end of the third quarter.
Some of the big earnings selloffs last week were in AMD, BBT, CMG, ETFC, GE, GOOG, MCD, MRVL, and MSFT. One of the biggest volume down days in the market was last Friday after a major sell off in Google, coupled with the morning earnings from MSFT, GE, and PH really hurt investor sentiment. While the majority of companies continue to beat earnings estimates, few can beat revenues, and a good many are revising their full-year guidance down which is probably the most important factor. Even after the market closed today, Apple revised its next quarter’s earnings well below estimates. Everybody wants the bar lowered. Lower guidance – more than the fiscal cliff and the assumption that “safe haven” stocks like GOOG and IBM are no longer safe anymore – is what is spooking investors. The S&P 500 is now down close to 4% since the mid-September highs.
Besides company earnings, I think the lack of macro catalysts, trading volumes, and the break in the market’s trend is what’s influencing a lot of the market tape. We simply lack buying interest here. The EU summit last week was a nonevent. They could have had the platform to announce a banking union, but the politicians couldn’t agree. Additionally, Spain continues to skirt around asking for a bailout, officially, probably until after their elections as politicians seek a voter mandate. Finally, Greece hasn’t received its next tranche as political parties are again split to act on Europe’s demands.
Looking at technical indicators, the S&P broke down from its 1430-1470 trading zone, but it did so on light selling and buying volume. Last Friday showed some signs of deleveraging with 2311 declining issues on the NYSE, but volume has dropped off since that day even though the S&P is trading 20 points lower. There are signs that the bulls are trying to level out the decline with advancing issues picking up over the past two days, but there hasn’t been a big jump into stocks like on July 26 and 27th due to Draghi’s bumblebee speech defending the euro. So while the S&P 500 has broken trend, and formed what looks to be an intermediate-term top, a declining trend has not been established.
Macro Tends to Win
While conditions continue to improve overseas, fears have turned away from Europe during the summer and China last month, to the U.S. company earnings and the Fiscal Cliff. Nobody knows the absolute effects we’ll see based on the fiscal cliff. There’s still some time for the politicians to compromise like they have at previous crossroads regarding the Bush tax cuts. I think that every rational American expects taxes to increase in our future, considering the massive debt bubble we've constructed. The issue is whether the economy can sustain economic growth. Central banks continue to pump liquidity into the market to combat fiscal deleveraging, which isn’t a new concept since 2008. Ray Dalio of Bridgewater Associates has labeled it a “Beautiful Deleveraging”.
As one of David Rosenberg’s macro economic rules suggests, #12, get the U.S. consumer right and everything else will take care of itself. From what we’ve seen at PFS Group, leading economic indicators, consumer sentiment, and housing continue to improve. If macroeconomic conditions worsen, and the facts change, we’ll change our minds too. For now, we’re looking at the recent correction as a buying opportunity. And lower guidance from companies will set the bar pretty low, especially if conditions continue to improve.
About Ryan Puplava CMT
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