CAPITAL MARKET COMMENTARY
WORLD STOCK MARKETS ARE “HIGHER” THIS MORNING: With Japan closed for the Golden Week holiday, the real focus is upon Europe this morning where stocks are rising across the board by roughly +0.5%. This is due to stronger-than-expected Eurozone business sentiment that rose to its highest level in five-years. The question is whether today’s ECB meeting will result in their benchmark interest rates moving higher to 3.0% from 2.75%. Of 66 economists polled…not one believes they will be; therefore if there were any risk here…it would be if they had determined now was the time to act and they wanted to “surprise” the markets. Certainly it would surprise us, and would likely turn European equities lower.
Turning to the currency market for just a moment, we note the Euro has risen rather archly over the past several months versus the US dollar, and the prospects further rises are quite good. This, coupled with the fact European bourses are at multi-year highs, suggest a potential trade is in the making. Europe is beholden to a rising currency, and thus a Euro that trades much higher than current levels will start to raise the ire of European politicians and at that point…we are likely to see some profit taking materialize. Nothing more than a customary -10% correction would be expected, but certainly this would bring the market back to technical health after its recent parabolic and seemingly unfettered rise.
TRAPPED…AND NOWHERE TO GO!: This, we think, sums up the technical makeup of the market as it builds a topping formation. The S&P 500 traded 1295 during the 2nd week of January; while yesterday’s close was roughly 1308.. Of course the S&P has traded upwards of 1318 and as low as 1256, but the fact of the matter is it has gone nowhere in what should be a bullish period given “better-than-expected” earnings and a “hotter-than-expected” economy. The catalystfor this: rising interest rates leading to P/E compression.
The problem is that next year’s earnings comparisons will be very difficult given the leading economic indicators as well as the coincident-to-lagging indicators ratio are both trending lower. This would suggest the economy is peaking either in 2Q or 3Q; remember, at the top of every economic cycle…things look rosiest. Therefore, until the S&P 500 can breakout of its current 1300 to 1325 range, then be prepared for maximum frustration.
ECONOMIC PREVIEW/REVIEW: Today provides us with the much vaunted 1Q Productivity number; consensus is for a gain of 3.3% after the downside “surprise” in 4Q of -0.5%. We won’t disagree with the consensus too much, but safe to say that employment has ticked up modestly since 4Q, and thus we would think productivity probably was a bit less than consensus. If there is a risk to this number, then it would have to be if productively surprises to the downside once again. This would stock inflation fears as employers would have to “ante up” to pay workers more; ostensibly this would have the effect of sending bond market yields higher.
Also of interest was yesterday’s absolutely “hot” ISM services activity survey; for April it rose to 63.0 from 60.5…far above the consensus calling for a drop of 58.0. This data simply reiterates just how “hot” the economy is at this very moment, we further note the bond market vigilantes are going to raise rates to their appropriate level regardless of what the FOMC members believe the natural rate for fed funds lies. With 10-year bond yields moving to 5.15% and the prospects for higher yields quite good…we don’t think the FOMC will send stop raising rates until some weakness is seen in the economy.
A FED THAT IS “ON THEIR HEELS”: Yesterday in The Wall Street Journal, for those who may not read the newspaper, there was a front page story titled “Fed struggles to Convince Markets of its Own Uncertainty on Rates”. Greg Ip was the author, and is thought to have to be the tacit “spokesman” for the Fed when trying to communicate with the market. The story clearly was intended to show the Fed was committed to keeping inflation down, but we think questions surrounding Mr. Bernanke’s inflation fighting street cred suggest the Fed may be a bit less likely to pause at the June meeting if the data looks strong as has been the case in April and risks remain skewed toward inflation than seemed to be the case last week. In any case…volatility in the bond market is likely to become even more pronounced given the sharp rise in yields in the past 2-months.
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