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Article / 21 January 2013 at 7:32 GMT

Weekly Outlook: A tale of two stories and a chink in the armour

Michael Jarman Michael Jarman
Head of Equity Strategy / H2O Markets
United Kingdom

The week gone by
Equities recorded the third consecutive weekly gain this year as investors responded to a slew of earnings and macro data. The S&P 500 set a new five year high closing at 1486, up 0.9 percent for the week whilst the FTSE 100 posted a weekly gain of 0.5 percent, closing at 6154.4

On the economic front, data remained "upbeat" as retail and core retail sales in the US rose more-than expected in December, US housing starts jumped to a multi-year high and building permits edged up, further validating signs that the housing market remains the bright spot in the current economic recovery. However the "upbeat" data was met with a note of caution as the preliminary reading of University of Michigan’s consumer sentiment index declined unexpectedly to 71.3 in January, from 72.9 in December versus an expected 75.1. This reading means the US consumer is the most pessimistic he/she have been in a year. This is likely due to the ongoing political battle between the Democrats and Republicans to come up with a credible plan to help cut the budget deficit without hurting growth prospects.  

The Eurozone continued to disappoint as Eurozone industrial and German GDP data reignited growth worries. However, concerns eased later in the week, after the European Central Bank stated that the euro-area economy should start to gradually recover later in 2013. Chinese GDP data revealed that economic growth accelerated in the last quarter of 2012 as government efforts to revive demand spurred a rebound in industrial output, retail sales and the housing market.

In currencies the euro gained against its peers during the week, following a successful bond auction in Spain and after the International Monetary Fund released the next tranche of bailout funds to Greece and Portugal. However, gains were capped, as the Chairman of the Eurozone Finance Ministers, Jean-Claude Juncker, stated that Euro is currently hovering at “dangerously high” levels. The pound ended lower against the greenback, amid rising uncertainty over the UK’s role in the EU and as Fitch warned that the UK might lose its “AAA” credit rating. The Japanese yen dropped against the US dollar and the euro, ahead of the Bank of Japan’s monetary policy meeting next week. Crude oil rose, on improved demand prospects and as a terrorist attack on a gas facility in Algeria raised concerns over supply. Gold prices also advanced, after a Thomson Reuters GFMS Gold Survey forecast that investment demand would drive average gold prices to a record in the first half of 2013. 

A tale of two stories
Banking earnings season got underway last week and the announcements gave interesting readings into how Wall Street is fairing given the wave of uncertainty surrounding the financial sector. Banks have been publicly chastised for the part they played in the sub-prime meltdown of 2008 and have since shelved out billions in compensation and had the privilege of propriety trading all but removed from their business models.

First the good, Goldman Sachs smashed estimates as earnings surged to USD 2.8 bn which is nearly triple what the bank earned when compared to the same period last year. This gave an earnings per share of USD 5.60 versus a consensus of USD 3.64; this is its most profitable quarter since early 2010. The beat was largely attributed to re-balancing towards risk in debt markets and improved asset prices that helped to strengthen the value of the banks investments. Morgan Stanley helped to further validate " a great quarter" for investment banking as the stock jumped 7.9 percent on the back of an earnings beat, earnings per share rose to USD 0.45 versus an anticipated USD 0.27.

The ugly came in the name of Citigroup and Bank of America Merrill Lynch as the lending business proved to still be under traumatic stress five years on from the sub prime mortgage collapse. Bank of America reported a 77 percent drop in fourth quarter earnings as it took a USD 2.7 bn charge to settle with Fannie Mae and Citigroup had earned  USD 0.38 per share versus an expected  USD 0.52 due to a "challenging environment and the costs of putting legacy issues behind them. The contrast between the two business models is concerning, although it is without question the market is more optimistic as we have seemed to enter a tranquil period, I am slightly worried about how two of America's top lenders have failed to gather pace in a year where a lot of tail risks were removed by the European Central Bank and the Federal Reserve.

Chink in the armour 
The FT put out a report last week about how Europe's rescue fund is undergoing a re-draft. The plan is to state that should any aid be required from the Eurozone's rescue fund to help prop up an economies faltering banking sector, then the host government will have to participate with the fund by investing into its banking sector and indemnifying the European Stability Mechanism against any loss it may incur. This leaked plan takes us back to May 2012 where the vicious circle between failed banks and their host governments remain and seems to void all discussions about creating a full effective backstop aka a lender of last resort. The news has been somewhat ignored and had little impact on dampening investor demand for risk assets however, should this plan gain any momentum (going into the German election perhaps?) I would expect investor sentiment towards Europe to change very quickly. 

Outlook for the week ahead
Macro data will be quiet state side as the US has a bank holiday on Monday and a relatively subdued week in terms of reporting economic data, so the focus is back on Europe. There are Eurogroup meetings on Monday and Tuesday whilst German ZEW economic sentiment is also reported (expected 12.2). Flash services and Manufacturing in both Germany and France are reported on Thursday whilst the stubbornly high Spanish unemployment rate is also announced on the same day, expected at 25.2 percent. 

The US corporate calendar is a busy one again this week. This week the theme is more 'tech' based as Advanced Micro Devices and Google both report Q4 earnings on Tuesday, Apple will repeat this on Wednesday (Q1), Vodafone investors should also watch out for Verizon's Q4 results on Tuesday (Vodafone owns 45% of the company). In the UK I will be paying close attention to finals being reported by Unilever and a trading update from SABMiller this week.

Last week I stated the FTSE 100's ability to run into 6150, it has done just that and futures currently indicate a higher open this morning at around 6182. The S&P 500 is only 1 percent away from the 1500 psychological barrier we are anticipating as markets look like they are running out of steam. The VIX is worryingly low and complacency seems to have got the best of the market. My book now has a total exposure of 80 percent short 20 percent long, and I am happy keeping this strategy into 6250 before I would look to re-assess. However note, I am not of the mindset that we are about to expect a correction, but a consolidation seems more likely with 1424 being the target for the S&P 500 by mid February and 5900 being the target for the FTSE 100 over the same time frame.  

Have a great week trading.


nickolas nickolas
our institutional investors are on a speculative game down


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