Can Earnings Outweigh Global Tensions?

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Until Friday, the stock market celebrated wave after wave of strong corporate earnings announcements and the market news seemed to cause a “melt up,” despite a huge snowstorm that paralyzed the Northeast.  The Dow traded above 12,000 each day last week, but couldn’t manage to close above the psychologically important level. Then, on Friday, unrest in Egypt took the Dow down 166 points, while oil and gold surged. This week, I believe that rising earnings can drive the stock market higher, but only if tensions don’t spread from Egypt to other troubled lands. Stocks got off to a good start on Monday, with the Dow rising almost 70 points.

Rising Tensions in Egypt Torpedo Wall Street’s Winning Streak

The Dow was on target for its ninth straight rising week when the chaos in Egypt became a convenient excuse for nervous traders to take profits. There had been protests in North Africa over high food prices for many weeks, but when the ruling family of Tunisia was overthrown in mid-January, that seemed to give inspiration to neighboring nations to try to overthrow authoritarian rulers in Algeria, Egypt, Libya and Yemen. When the Egyptian government shut down the Internet and cell phone communications — which had been used to coordinate the protests — the world became outraged at this act of censorship.

One other factor putting pressure on global food prices has been the horrible floods in Queensland, Australia. Grains like barley and wheat were severely damaged by the floods, causing even higher wheat prices to fuel further protests in North Africa. In fact, Australia’s floods were so devastating that Prime Minister Julia Gillard opted to raise taxes to help pay for the flood damage. She raised the income tax rate by 0.5% on taxable income from $50,000 to $100,000 (Australian dollars) and 1% on income over $100,000.

Another factor pushing commodities up is the fact that Egypt controls the Suez Canal, which handles 7.5% of global trade, including 2.5 million barrels of oil per day. Europe’s refineries could be disrupted if the Canal is crippled or shut down. In addition, lots of grains and other food staples are shipped through the Suez Canal, which helps to put even more upward pressure on food prices in the region.

Before the Egyptian situation spun out of control on Friday, the impact of rising food and commodity prices was being hotly debated at the World Economic Forum in Davos, Switzerland. In particular, the European Central Bank (ECB) President, Jean-Claude Trichet, warned that rising food, oil and raw material prices could cause higher interest rates. For instance, on Tuesday, the Reserve Bank of India raised its benchmark interest rate 0.25% to 6.5%, its seventh interest rate increase since last March.

The good news on the commodity front is that, before Friday, crude oil prices had retreated from their recent highs to hit an eight-week low. Gold, platinum and silver prices had also fallen to their lowest levels in three months. But when the Egyptian government shut down the Internet and cell phones, crude oil and precious metals rose sharply as investors fled to these crisis hedges and other defensive investments.

Stat of Week: GDP up 3.5% and ‘Final Sales’ Up 7.1%

On Friday, the Commerce Department announced that its flash estimate for fourth-quarter GDP came in at 3.2%. Even though this was below economists’ consensus forecast of 3.5%, it was still the strongest quarterly GDP growth in several quarters, pushing the overall GDP to record levels. The most important detail in the GDP report was that consumer spending nearly doubled, to a 4.4% annual pace, up from 2.6% in the third quarter, so consumer spending added a whopping 3% to the overall GDP figure. In fact, “final sales” (GDP minus business inventories), grew at an incredible 7.1% annual pace last quarter.

Also notable is the fact that government spending fell 0.5% in the fourth quarter, due largely to a 2% drop in defense spending and a 0.9% decline in state and local spending. The other silver lining in the fourth quarter GDP report was that exports rose 8.5% and imports fell 13.6%, so the improving trade situation added a whopping 3.4% to the overall GDP figure. Even though rising food prices are causing protests around the world, America’s food exports help to boost U.S. GDP growth and reduce the trade deficit.

The Fed is suddenly more upbeat on U.S. GDP growth. Specifically, the Fed upgraded its forecast for economic growth in last Wednesday’s Federal Open Market Committee (FOMC) statement, saying that “growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit.” Specifically, the Fed now expects the economy to grow between 3% and 3.6% in 2011, accelerating to 3.6%-4.5% GDP growth in 2012.

The rest of the world is also upbeat about global GDP growth. On Tuesday, the International Monetary Fund (IMF) called for 4.25% worldwide GDP growth for 2011, led by China (9.6% growth) and India (8.4%), while Brazil and Russia are both projected to grow by 4.5%. Still, the IMF remains concerned about sovereign debt risk, despite the fact that the new euro zone rescue bonds were well-received last week, helping the euro rebound to a two-month high relative to the U.S. dollar. That story follows …

Debt Concerns Shift From Europe to Japan and the U.S.

Sovereign debt concerns receded sharply in Europe last week, with the success of the new euro zone “rescue bonds.” As one banker said, “Demand has been spectacular. I do not recall an order book of this size. It filled up in the space of just 15 minutes.” Clearly, the rush to buy these new euro zone rescue bonds illustrates that investors are confident that the euro zone will remain intact and will also prosper.

The bond vigilantes are still at work, however, as their euro zone fears switched to Japan. On Thursday, Standard & Poor’s cut Japan’s long-term credit rating from AA to AA-. S&P said in a statement that it “expects Japan’s fiscal deficits to remain high in the next few years.” S&P also criticized the current Japanese government, saying that the ruling Democratic Party of Japan “lacks a coherent strategy to address these negative aspects of the country’s debt dynamics,” even though that country’s Ministry of Finance announced on Thursday that its exports rose 13% in December, significantly above economists’ consensus estimate of 9.9%. In fact, Japan’s exports to its largest trading partner, namely China, rose by 20.1%. Frankly, all the S&P credit downgrade is going to do is make Japan’s central bank continue its quantitative easing, which in turn will help weaken the Japanese yen, which will further boosts exports.

While the outlook in Europe is improving and Japan fights back, some debt storm clouds are gathering over the United States. On Thursday, The Wall Street Journal reported that, according to the Congressional Budget Office, the federal government’s budget deficit would likely reach a record high of nearly $1.5 trillion this fiscal year. In Tuesday’s State of the Union address, President Obama talked about fiscal restraint and a five-year freeze in discretionary spending, but there were few details on cuts and more talk of new spending.

Specifically, President Obama continued to call for government assistance to stimulate key technologies, such as high-speed rail, which frankly makes no economic sense whatsoever. The lack of applause during most of President Obama’s spending proposals was frankly eerie and signaled a lack of confidence in the federal government’s intention to boost key technologies and overall economic growth. In an editorial in The Wall Street Journal, Stephen Moore exposed the lack of detail in President Obama’s “investments.”

The bottom line is that as long as the Fed, the Bank of Japan and other central banks continue to pump money into their respective economies via quantitative easing, this money has to go somewhere. Until Friday, much of this money was pouring out of bonds and into stocks. Last Friday, it poured into crude oil and precious metals. The fact of the matter is that a lot of money is sloshing around the world looking for a safe oasis. Thanks to strong consumer spending in China, the United States and elsewhere, stock markets will likely rise again — based on strong corporate earnings news — but we must also see the Egyptian situation calm down. If Egypt spins out of control and unrest spreads to other countries, including Kuwait and Saudi Arabia, stocks could take another hit, so I will continue to monitor these events around the globe.


Article printed from InvestorPlace Media, https://investorplace.com/2011/02/global-tensions-vs-earnings-this-week/.

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