Tower Private Advisors
Short one this week…
Equity markets rallied sharply from this week’s lows, and they’ve sustained the rally for two days. If I’m not mistaken, it also breaks a series of Friday declines. The reason for the rally is a general swing to optimism by investors on the comments of one man, European Central Bank chief Mario Draghi, who said–during our waking hours the morning of July 26th–that…
Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
Those are pretty strong words, and the market took part of them at their face value. Unfortunately, the markets neglected two key things.
- The ECB and other figures in Europe have been long on talk; short on doing. So, while the ECB may stand ready to “do,” it has yet to.
- The phrase ”within our mandate” eliminates a few things. For example, “within its mandate,” the ECB cannot buy unlimited quantities of sovereign debt like our Federal Reserve can. The ECB can, however, provide unlimited liquidity to a bank. That’s a key allowance, in that the European Stability Mechanism, the ESM, is said to be the salvation for the European crisis. Indeed, our BCA Research service includes this as one of the final steps to–once and for all–ending the crisis, if not the underlying problem of not enough growth in over-leveraged, uncompetitive countries. There’s just one problem: the ESM isn’t a bank yet.
A couple of things belie the rally of the last two days. From the table above, one can see that Emerging Markets were down on the week, while they would be big beneficiaries of a healing of the Europe problem. Second, I did not confirm this, myself, but I had heard that sovereign bonds had not responded with as much vigor as the [what seem to me to be just oversold] stocks.
Gold responded as strongly as any of the major (i.e. non-country) equity indexes above, and that suggests that the notion of quantitative easing (in the U.S.) and the ESM becoming a bank (in the end, money printing, aka quantitative easing) are getting some traction.
Oh, and wouldn’t you think that an open-ended, final-answer promise to “save the Euro,” would have prompted a rally in…uh…the Euro?
Eight economic releases stood out this week. In chronological order…
- Richmond Fed Manufacturing Index – plummeted; went from -3 to -17
- House Price Index – better than expected; equal to prior figure
- New Home Sales – worse than expected; worse than the prior figure
- Capital Goods Orders – double what was expected; triple the prior figure
- Initial Jobless Claims – back to the lowest level of the last five years
- Pending Home Sales – fell sharply; worse than expected
- Second Quarter GDP – dropped from 1.9% Q1 pace to 1.5%; better than the 1.4% expected
- University of Michigan Consumer Confidence – virtually unchanged from prior figure
So the tally is four worse than before; two unchanged; two better than the prior release. Versus expectations, it was almost a flip-flop, where five were better than expected; just three were worse than expected.
It’s the comparison against expectations that allowed the Citigroup Economic Surprise index to turn up, and the stock market with it, as is on display below.
The whole money game is about expectations–from earnings estimates to economic forecasts. Those guesses about the future get priced into securities and markets, while actual results either surpass, meet, or fall short of the estimates, leaving markets to recalibrate their assessments of securities, markets, and economies.
As can be seen from the top panel of the chart above, there is a pattern to economists’ estimates. They aren’t entirely a random walk. Instead, economists–for extended periods of time–consistently over or underestimate the strength of the–in this case–U.S. economy. We’ve just gone through one of those stretches of underestimating the strength of the economy, and it appears that the economy is transitioning to a period of better strength than economists are expecting. That says nothing about whether the economy is strengthening, just whether or not it’s beating economists’ consensus forecasts.
Next Friday, we will see the release of what will arguably be August’s biggest economic release, Nonfarm Payrolls. From July 2011 through February 2012, the number of jobs added exceeded what economists had forecast, so economists ratcheted up their forecasts until the number of jobs started coming up short, and from March 2012 through July 2012, the number of jobs created was less than expected; i.e. economists have been too optimistic, and that has to be getting old.
As a consequence–as of today–economists think that 100,000 jobs will have been added to the establishment payrolls. They will revise those estimates through next Thursday, and the consensus estimate will likely change after Wednesday, when ADP releases its Employment Change index.
I’ve talked to a number of folks
who believe in aliens who believe that everything is a conspiracy, and the conspiracy du jour is that the figures are all bunk (I don’t necessarily disagree, per se, but they’ve been bunk because they’re faulty measures for some time) and the White House will pull out all stops to ensure its present resident gets to renew his lease on one Pennsylvania Avenue set of digs. So, combine that with chastened economists who want to get a forecast right–they’ve been on the wrong side (optimism) and need to get on the right side (currently, pessimism)–and you’ve got a recipe for a positive surprise in the Nonfarm Payrolls–August’s biggest release–which kicks off the second half rally that is typical of election years. I’m just guessing, not promising.
Graig P. Stettner, CFA, CMT
Chief Investment Officer
Tower Private Advisors