A good number of us know that borrowing from Peter to pay Paul is a vicious circle that usually ends in some form of default. Most global equity markets are all in positive territory this month because the “bad news data results in good news stimulus” trade remains a perverted catalyst for higher equity prices.
Case in point: Overnight, China’s manufacturing PMI came in at 47.8, a nine-month low. After an initial knee-jerk selloff, speculation over rate cuts and fresh government stimulus moved markets higher. Between this and the hints from the Fed minutes suggesting that members are warming up to the idea of increased stimulus, the “risk-on” trade was back in fashion.
In the “back to reality” trade, Germany’s financial minister stated that the eurozone is already tapped when considering what’s economically viable for additional aid to Greece. In addition, if the latest data on Spanish consumer and commercial debt is any indication, then ECB President Mario Draghi’s talk better be followed by his walk. Spanish non-performing loans surged to their highest level in 18 years as shown by fresh data from the Bank of Spain. Non-performing loans increased by 8.39 billion euro to 164.36 billion euro. That’s 9.42% of total outstanding loans, up from May’s 8.95%.
Despite this bearish data point, yields on Spanish and Italian 10-year government debt are at three-month lows in anticipation of central bank intervention that would take the form of massive open-market bond purchases.
However, before this set of market-changing headlines came in, there was a disturbing development that wasn’t getting much press. China’s Shanghai Composite index tumbled to a post-crisis low this week. This sharp and stunning divergence from the upbeat performance of the U.S. stock market has analysts concerned about a harder landing for China’s economy. New worries over potential increases in commodity stockpiles is hinting at slower future demand, and talk of higher property taxes is also weighing on the world’s second largest economy.
So with all this gyration of bad news leading to high expectations of central bank intervention, how should investors view this landscape? The summer rally hit a trading wall as the S&P 500 tested its early May high of 1,426 before running into to some trigger-happy profit taking. It makes sense that, after a nice run-up led by financials and big-cap technology, some money would come off the table as earnings season comes to a close. As noted, the biggest contributor to the rally has been the highly vocal pro-stimulus rhetoric from ECB president Mario Draghi, which has provided the necessary catalyst for stocks.
After a sharp selloff in the safe haven of Treasuries, money came swooping back into to the bunker when the CBO released its report that the United States runs the risk of falling back into recession if the fiscal cliff issues aren’t addressed. More on that later. As of Thursday, the yield on the benchmark 10-year Treasury note stood at 1.72%.
Oil prices have definitely firmed up as expectations rise of an Israeli attack on Iranian nuclear facilities if they don’t reach a compromise for intense inspections and accountability. That and a surprise drawdown in U.S. weekly inventories has WTI crude trading above $97 per barrel. Natural gas prices are hovering around $2.80 per mcf, holding most of their recent gains against a hot summer climate that pulls on demand for air conditioning.
Gold and silver prices broke out to the upside this week on concern of central banks flooding monetary systems with fresh liquidity that usually has a negative impact on sovereign currencies. Notable hedge-fund buying and Mideast tensions are also contributing to the newfound upward momentum. The yellow metal is trading up to $1,668 per ounce, with little technical resistance to keep it from hitting $1,700 soon.
Corn and other grain prices popped to new summer highs as the drought enters its tenth month. A bushel of corn now sells for $8.35, an all-time high, as the U.N. calls for Washington to suspend allocations of corn for making ethanol. As you can imagine, higher grain prices hit poorer nations hardest because a higher percentage of their income goes to pay for food.
At this point, the global markets have priced in some form of widespread quantitative easing and it’s going to take more than a few good numbers from the housing market to keep the rally going. Bear in mind that very few leading companies raised forward guidance during the current earnings season, which translates to a continuation of low interest rates and strong demand for high yield assets.