European Progress Depends on Political Compromise
- The stock market gains over the past month can be largely attributed to the perception that policymakers in Europe have been making some progress combating the ongoing debt crisis. Political leaders have continued to discuss a variety of ways to recapitalize the banking system to prevent further contagion, and the European Central Bank did recently announce an additional cut in interest rates.
- The problem with the European crisis is that the speed at which policymakers are acting continually appears to be slower than what the markets would like. There have been some tentative signs that Europe will move toward a tighter fiscal and political union (a step we believe is critically important), but the means of implementation are still murky. In our view, the eurozone has the ability to stem the crisis, but politics remain the biggest question mark. Looking ahead, it seems clear to us that signs of political compromise in Europe would be bullish for risk assets, while political bickering and policy paralysis would equate to heightened volatility and a more bearish environment.
Uncertainty Remains for the US Economy
- There is a broad sense of uncertainty over the state of the US economy, and that uncertainty is making investors, companies and consumers wary about the future. The US economy appears to have entered a soft patch in recent months. The June payrolls report was a near-perfect indicator of how the economy has been trending. The headline numbers were relatively disappointing, showing that only 80,000 new jobs were created for the month. Yet, the silver lining is that jobs still are being created and there were some improvements in terms of hours worked and average hourly earnings. The labour report reinforces our view that the economy will be growing, but will be doing so at a modest pace.
- Investors are also starting to focus on second-quarter earnings, as the earnings season begins to kick off. From our perspective, the combination of modest levels of economic growth, weaker growth outside of the United States and some renewed strength in the US dollar should mean that profits will be relatively muted. Expectations for earnings and profits have declined compared to where they were at the beginning of the year, which suggests that companies should be able to meet these expectations, but that is not a foregone conclusion.
Markets Remain in a Balancing Act
- At present, the macro environment appears to be balanced between a range of positive and negative forces. The negatives are well-known and are the same ones that have been in force for some time: the eurozone debt crisis, the potential slowdown in China and the looming fiscal cliff in the United States. For the positive factors, we would cite easing monetary conditions around the world, falling gasoline prices that should benefit consumers in the second half of the year, improving credit conditions and a modest recovery in housing.
- We expect this tug-of-war environment will continue to dominate the economy and the world financial markets. The euro debt crisis and weak global growth should continue to cast a shadow on the global economy, but the positives we mentioned should also encourage some investors to engage in additional risk taking. Our sense is that the global economic recovery should continue, if unevenly. The US economy is likely to continue to expand and Chinese growth should remain relatively high. The problems in Europe are a long way from being solved and will likely remain a drag on risk assets.
- For stocks, the softness in the global economy is likely to continue to make for a difficult environment, but that has been the case for some time. Stocks have come a long way since the market bottom in October of last year (marked by 1,075 for the S&P 500) and an even longer way since the nadir of the credit crisis (666 for the S&P 500 in March 2009). Equity gains from here are likely to be uneven, but we think the bull market should remain intact.
Tags: average hourly earnings | banking system | bob doll | contagion | debt crisis | eurozone | interest rates | labour | new jobs | perception | policy paralysis | policymakers | political compromise | political leaders | question mark | silver lining | stock market gains | strategist | uncertainty | volatility