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London - The coming week is likely to be crucial for the direction of financial markets until year-end, with eurozone stability at stake as well as the latest test of the one bright spot for investors, corporate earnings.
In the case of the eurozone, there is talk of a “binary”
moment next weekend in which a European leaders summit either comes up with the
goods to assuage concerns about the debt crisis or disappoints again.
The former might well be taken as a reason for a sustained
rally in riskier assets such as equities. The latter would almost certainly
spark a sell off.
A comprehensive plan for solving the eurozone debt crisis at
the summit in Brussels - with endorsement at a G20 leaders meeting in Cannes to
follow - has been flagged by Germany and France, raising expectations on
markets.
“The approval of that roadmap, that’s what the markets are looking for,” said Richard Batty, investment director at Standard Life Investments. “It has to be enough to stabilise things.”
Some idea of what is at stake for investors can be seen in their actions over the past few weeks. World stocks as measured by MSCI are up more than 12% since hitting a low on October 4.
At the same time, yields of both long term US bonds and core eurozone debt have risen well off their lows.
Part of this is in response to expectations of a eurozone
debt roadmap. But it also reflects extremely bearish positioning throughout the
northern hemisphere’s summer months.
Reuters asset allocation polls at the end of September showed safe-haven cash holdings at levels that can be a counter indicator for a rally.
In effect, investors hold cash so that they can put it to
work quickly if the investment climate changes - which may be happening.
In the meantime, given all the volatility and the severity
of both the eurozone debt crisis and the slowdown in the US and possibly
Chinese economies, the MSCI index is only down 10% for the yea
An end-of-year rally could yet put 2011 equity holders into the black.
Companies to the rescue?
For this to happen, though, the corporate earnings reporting
season, getting under way properly on Wall Street in the coming week, will have
to meet or better expectations.
Corporate performance over the past few years has been
surprisingly robust given global economic travails, mainly because unlike
governments companies took action early to get their finances in order.
The big test in the coming weeks will be whether the
relatively robust performance continued in the third quarter or whether it came
under pressure from the slump in US activity.
An early indication was not positive. Alcoa, the biggest US
aluminium producer, posted lower-than-expected quarterly earnings and warned of
weak economic conditions, particularly in Europe.
Thomson Reuters Proprietary Research nonetheless points to
expectations of a relatively healthy 12.3% earnings growth in the third quarter
for S&P 500 companies, roughly the same as in the second quarter.
But the research also shows that this Q4 projection has fallen over the past few months, it was up at 17% in July.
US investment adviser Keith Springer sees this as one reason
why the current reporting season should be good for equity investors.
“For the last few years we have had consistent positive
earnings 'surprises' in every quarter,” his eponymous firm said in a note.
“That, coupled with the fact that earnings expectations have been lowered so
dramatically for this upcoming quarter, stocks ... are setup for rally mode.”
Springer also reckons that history may play a role in at least US markets over the next few months.
He notes that in the past 30 years, US stocks have risen
more than 75% of the time in Q4 with an average of about 8%.
The third year of a US presidential cycle, which we are in,
also typically brings an average return of almost 18%.
