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Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 24 October 2011 at 10:41 GMT

Weekly commentary: all eyes on EU; energy glows on earnings

Head of Equity Strategy / Saxo Bank
Denmark
Last week certainly held up in terms of volatility of political comments affecting the stock market. Stocks started higher Monday following the better than expected retail sales from the U.S. but the high hopes were quickly killed as Germany's Finance Minister Wolfgang Schaeuble was out saying the expected Sunday EU Summit would not provide any definitive solution to the debt crisis (the Sunday meeting was later postponed to this week's Wednesday). The rest of the week saw volatile markets that swung up and down in synch with comments from various European politicians. Late Friday Fitch said that it did not see changes to the European Financial Stability Facility as posing a risk to France's AAA credit rating which immediately ignited a rally in risk assets until the close of U.S. markets. The late week optimism pulled the S&P 500 Index higher by 1.1 percent, Euro STOXX 600 Index was up 0.3 percent and the Nikkei 225 Index was up 1.9 percent.

What can we expect from the EU Summit?
The solution or not to the European debt crisis holds the key to sentiment on risk assets this week which is why every investor's eyes are on the outcome of Wednesday's EU Summit. So what can we expect?

We will probably get 1) a Greek haircut with voluntary private sector involvement to avoid a CDS credit event, 2) recapitalisation of banks worth around EUR 100 billion, and 3) guidelines for how policy makers will leverage the EFSF to EUR 2 trillion. We do not expect the upcoming EU Summit to be the definitive solution as many variables can change and thus it will probably be an iterative process going forward.

Given no definitive solution and the risk of the EU Summit disappointing the market we think investors should be positioned slightly net long and wait for more clarity on Europe before gauging the medium-term trend in stocks.

Emerging market involvement in debt crisis solution
However, more importantly we need to understand what animal we are dealing with here. Since the credit bubble burst in '07 and '08 the developed economies have been in a deleveraging phase with massive credit contraction only mitigated by loose monetary policies through asset purchase programmes. The world right now is divided into two parts with developed countries as debtors and emerging countries as creditors, and despite decoupling theories the global trade structure is such that the two worlds cannot live without each other, so we are all in the same boat. This is exactly why it is not unthinkable to imagine some participation from emerging markets in solving the debt crisis in the developed world.

In a world of deleveraging policymakers are faced with different options such as transferring wealth (e.g. from Germany to the rest of Europe through the EFSF), printing money or writing down debt, and all of these have certain consequences. No matter what solution policymakers choose, the most important goal for any plan is to keep things orderly; and on Wednesday we will get a hint if that will be the case for Europe's debt crisis.

US earnings season: 21% reported with energy and technology shining

The earnings season that started with Alcoa's 3Q earnings release 11 October is now two-weeks old and so far 21 percent or 106 out of the 496 companies scheduled have reported.

The chart below shows the trend in the S&P 500's EPS and corresponding consensus EPS estimates since we began the current economic expansion as of the first quarter 2009. A number of things can be observed on the chart. First, actual EPS has expanded rapidly with estimates trying to keep up. As we have progressed the surprise factor, illustrated by the grey bars, has come down and recently quarterly estimates have flattened out in terms of QoQ growth. As we get more earnings releases we will update the chart below to show the current surprise in the 3Q.

The winning sectors in this earnings season are so far energy and technology which have seen quarterly sales YoY of 40 and 19 percent respectively, and quarterly net income YoY of 44 and 20 percent respectively. The loser is obviously the financial sector which has seen sales drop by 3 percent YoY. In terms of growth in net income the healthcare sector looks most weak with only 2.5 percent growth YoY.

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