31 October 2011 at 11:06 GMT
EU agreement marked last week; this week is all about US macro data
Last week saw below average volume in the first three trading days ahead of the much talked about EU Summit on the region's debt crisis. Following late Wednesday's indicative agreement on a voluntary 50 percent Greek haircut, bank recapitalisation and leverage of the European Financial Stability Facility to EUR 1 trillion, the stock market had one of its best days since 1990 as investors cheered about what appeared as true leadership. The explosion in risk sentiment pulled the S&P 500 Index up by 3.8 percent, the Euro STOXX 50 Index rose 5.3 percent and the Nikkei 225 Index surged 4.3 percent.
But is everything fine now that we have an EU agreement? Well as we have been saying since the agreement was announced it is by all means only indicative and much remains uncertain in terms of implementation. More hilarious is the fact that the new EFSF structure is basically a Collateralised Debt Obligation (CDO), the toxic instrument that many politicians have said was one of the courses of the financial crisis, where Europe takes the first 20 percent loss and then the rest by a group of investors, which presumably will be a country such as China. Many things can still go wrong when it comes to the overall agreement with the voluntary haircut being at risk as the lack of CDS triggering on Greek debt does not give banks an incentive to accept the haircut; because agreeing on the haircut results in a loss and presumably government ownership dilution, according to the recapitalisation plan, where as decline of the haircut gives the banks the opportunity to get their loss recouped through hedging positions in CDS contracts in the event of a full-blown Greek bankruptcy. Highlighting the different aspects of the EU agreement and its lack of structural solution, we recommend reading the George Soros' critique in The Telegraph.
This week though is all about US macro data that will be plentiful and give investors an indication of where we are heading in the world's largest economy. Most important figures to watch are ISM Manufacturing and Construction Spending on Tuesday, ADP Employment Change and FOMC Rate Decision on Wednesday, ISM Non-manufacturing and Factory orders on Thursday and ending the week with Change in Nonfarm Payrolls and Unemployment Rate on Friday. Combined this data will set the direction in the short-term despite the temporary relief over Europe's agreement.
US earnings season insight: earnings beat estimates but margin squeeze observed in three sectors
With 60 percent of the S&P 500 companies having reported 3Q earnings some interesting observations are worth mentioning.
The chart below shows the consensus estimates on the S&P 500 Index and the actual EPS figures per quarter since the first quarter 2009. A couple of different observations instantaneously stand out. One is that the earnings expansion since the economy began to expand again has been remarkable but has also slowed in 3Q 2011. Second is that the surprise factor has come down as well reflecting that analysts have caught up with the underlying reality for companies. Third is the flattening of expectations, the bright blue line, which reflects the uncertainty on future profitability. Overall earnings are doing fine and expanding ahead of estimates but the flattening of expectations is an interesting development which will be the theme when we move into the fourth quarter earnings season in late January 2012.
Source: Bloomberg, Saxo Bank Strategy & Research
Margin squeeze was a big theme early on in 2011 but we tenaciously argued that margins would continue to expand throughout the year and so far that has also been the case. In the third quarter, at least among US companies, the aggregate profit margin has continued to expand but an underlying development is taking shape in that some sectors are now seeing a margin squeeze.
The chart below shows the aggregate profit margin (after-tax) for the 10 GICS sectors in the S&P 500 Index and the year-over-year percentage points change. What is striking is the fact that the information technology, healthcare and consumer staples sectors are beginning to experience margin squeeze with information technology seeing the worst compression. Whether this is an early sign of an aggregate compression in profit margins may be premature to conclude as cyclical sectors such as industrials, materials and energy are still experiencing expansion. If the margin contraction spreads to industrials it will be a trend we have to take seriously and analyse what it means for stocks and the economy overall.
Source: Bloomberg