(TUESDAY 4TH OCTOBER - 8.36AM - JAMES GERRISH)...It was all about Europe overnight with the mkt ignoring some quite positive economic data coming from the US and choosing to focus on comments by German Finance Minister Wolfgang Schaeuble who said the European Financial Stability Fund should not be increased - it seems when ever Wolfgang speaks the mkt sells off a couple of hundred points given his view differs from the official German line... and highlights the lack of consensus amongst European leaders (even those from the same country).
We also had reports that the Greek government passed 6.6 billion euros ($8.8 billion) of austerity measures to cut the 2012 deficit to 6.8 percent of gross domestic product, missing the 6.5 percent goal previously set with the TROIKA - but it seems it won't impact the next round of bailout funds.
If we take a look at the chart of the Euro v the US Dollar, the discontent with the region becomes pretty clear - (very negative).
On the MKT overnight, the DOW JONES fell -258pts while the S&P 500 was off by -2.85%. Locally, the SPI FUTURES are pricing a drop of -46pts when trading kicks off here this morning which adds to the loss of -111pts on our market yesterday.
The Index is now likely to break through the contracting wedge we have on the chart below which is a negative technical setup.
We've said before that volatility is typical of a mkt low and for now, we retain this view more so based on our assessment of the news flow coming from Europe + the US rather than the technical set up that's obvious below.
3 KEYS TO MKTS
As I see it, there are three critical elements putting pressure on markets at the moment.
1. European Debt
2. US Growth & Earnings
3. Chinese Growth
Yesterday we discussed Europe and the possible plan that could be rolled out to manage the current situation whilst also providing a framework for future support.
We'll discuss US Growth/Earnings now and consider our view on China tomorrow.
US GROWTH/EARNINGS
Better than expected data on US Manufacturing and Construction was rolled out overnight with the Institute for Supply Management's factory index climbed to 51.6 last month from 50.6 in August and higher than consensus of 50.5.
The Commerce Department also said construction spending increased 1.4 percent in August, better than the anticipated 0.2 percent drop.
This comes on the back of the an upward revision of US GDP last week which showed growth of 1.3% against the previous estimate of 1%. Its also worth keeping in mind the impact of supply chain disruptions from the Japanese Earthquake which cut about 30% of auto production shaving about 0.75% off the GDP number.
Economic Surprise Index
We've looked at this measure a number of times in the past however its trend at the moment is interesting. It clearly shows that data is getting better relative to the expectations for that data.
(The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news. A positive reading of the Economic Surprise Index suggests that economic releases have on balance beating consensus).
Earnings
There was an interesting report on Bloomberg this morning centred on US company earnings relative to other recessions. I'll paraphrase some it here underlying the important parts.
"Companies in the benchmark gauge for American equities trade at 10.2 times 2012 forecast earnings, compared with the average in economic contractions since 1957 of 13.7, according to data compiled by Bloomberg.
S&P 500 profits fell an average of 12 percent on a yearly basis in the nine recessions since the 1950s, according to data compiled by Bloomberg. Should earnings drop by the same amount from the estimated $99.17 a share this year, profits will total $87.59 in 2012. Based on the S&P 500's Sept. 30 close of 1,131.42, that would imply a multiple of 12.9.
Should S&P 500 earnings hold at $99 a share next year, stocks would be trading at a 30 percent discount to the average multiple since 1954, according to Bloomberg data. The index is priced at 12.3 times earnings in the last 12 months, down from a high of 23.9 in December 2009.
MY TAKE OUT FROM THIS
As we've said before, it looks like the mkt is pricing in a recession yet history shows that earnings multiples, even during a recession are not at the levels they are now. If US corporate earnings do drop by 12% (the average of the last nine recessions), the S&P 500 would still be considered cheap.
So in Europe, it appears we're pricing ineffective action by leaders in solving the debt issues whilst in the US, we're pricing a recession. If we get progress that steers us away from these scenarios then we're likely to get some relief in the mkts.
INTEREST RATES
RBA meets today and is expected to keep rates on hold at 4.75%. the MKT however is pricing in a small chance of a cut (25% chance) which if it came, would be positive for equities.
MODEL PORTFOLIO UPDATES
Buy Write Portfolio - all options expired worthless and were resold with October expiries.
AUSTRALIAN STOCK PRICES OVERNIGHT
In New York, News Corp fell by US$0.39 to US$15.21, equivalent to A$15.98, A$0.07 below its last close on the ASX.
ResMed fell by US$0.10 to US$29.40, equivalent to A$3.09, A$0.25 above its last close on the ASX.
In London, Rio Tinto rose 76.0 pence to £36.06, A$1.23 higher in Australian currency terms.
BHP-Billiton rose 37.0 pence to £19.86, A$0.60 higher in Australian currency terms.
Henderson Group Plc rose 3.5 pence to £1.24, A$0.06 higher in Australian currency terms.
