Markets Fall on Negative Europe Sentiment
By Chris Maxey and Ryan Davis
May 21, 2012
Equity markets declined sharply last week as European sovereign debt concerns intensified. The S&P 500 fell 4.3% and the Dow Jones Industrial Average declined 3.5%, the worst performance week of 2012. The 10-year Treasury yield closed Thursday at an all-time low of 1.70%, and finished the week at 1.71%. The instrument has yet to hit its intra-day record low of 1.67%, although that fact may be short-lived.
Worries over the European sovereign debt crisis worsened this week as Greece’s political instability increased concern that the country could depart the Eurozone. Greece saw a virtual run on its banks during the week, as depositors withdrew €1.2 billion in two days on fears of massive devaluation from a return to the drachma. While this represented just 0.75% of Greek deposits, it foreshadows a potentially larger crisis if a Greek Eurozone departure becomes imminent.
Ironically, the threat of devaluation may be the one factor that prevents Greek citizens from fully embracing anti-bailout political parties. Many of these fringe parties experienced strong results in the country’s national elections held May 6, fueled by a populist backlash against austerity. This was enough to create a non-consensus and essentially crippled the country’s legislature. Recent polls, however, suggest the mainstream New Democracy party, which is fighting to remain in the Eurozone, has reclaimed the lead among voters.
Investors will learn more next month when Greece holds a second round of national elections on June 17. This should provide clarity on which of the many competing political factions will lead Greece and whether they intend to honor commitments associated with aid provided to them by the ECB and the IMF.
Minutes from the Federal Open Market Committee meeting held in late April revealed little new information as to the Fed’s outlook. Overall, the committee appeared more confident about its economic outlook and adjusted its growth, employment, and inflation targets higher. The committee maintained its pledge to extend near-zero interest rate policy into 2014, and did not introduce any new unconventional monetary policies.
Economic data was modestly positive last week in aggregate, as muted retail data was offset by strong positive surprises in housing and production data.
On Monday, the Census Bureau reported that retail sales advanced 0.1% in April. This was in line with expectations, and followed an abnormally strong March reading of 0.8%. Some analysts theorized that an earlier Easter holiday distorted the monthly data.
Auto sales continued to show strength, with sales increasing 0.5%. In a reversal from recent trends, however, gasoline sales contracted modestly. Declines in oil prices have started to filter through to gasoline costs, as the national average has fallen back to the $3.70 range from nearly $4.00 earlier this year.
This development was evident in consumer inflation data, also released on Monday. The Bureau of Labor Statistics reported that its headline consumer price index was flat in April. Energy prices fell 1.7% during the month, led down by gasoline which declined 2.6%. The core rate, which strips out the volatile food and energy components, rose 0.2% during the month.
On Wednesday, the Census Bureau reported housing starts rose to an annualized rate of 717,000 in April. This was sharply above expectations for a 690,000 gain, and represented a healthy uptick from March’s disappointing figure of 654,000. There were concerns that abnormally warm winter temperatures had pulled forward some of the Spring homebuilding activity. April’s report suggests the series may be working through these distortions.
Building permits fell 7% in April, but this followed several months of strong increases, including an 8.8% surge in the month prior. The recent activity in permits could indicate forward momentum in the construction of new housing. Unfortunately, historically weak new home sales levels continue to be a headwind for this sector.
Industrial production was very robust in April, rising 1.1% and more than doubling consensus estimates. This followed a negatively revised March figure, however, taking some of the luster off the strong report.
Until recently, utilities output had been a headwind for the industrial production series. In the first quarter, the component declined at an annualized rate of 13.8%. The sector rebounded in April, though, rising 4.5%.
The manufacturing component of industrial production was also strong in April, rising 0.6%. This followed a contraction of 0.2% in March, mirroring a slowdown in other notable manufacturing series.
Two important regional manufacturing reports released last week were mixed. On Monday, the Federal Reserve Bank of New York’s Empire State Manufacturing Survey index increased from 6.58 to 17.09. This topped expectations for an improvement to 10.0. Positives were found throughout the report, with new orders and employment figures improving over the month. May’s index levels were a welcome rebound from an unexpected drop from 20 to 6.56 in April.
The other Federal Reserve report, the Philadelphia Fed Business Conditions index, was not as sanguine. In direct contrast to the New York survey, the new orders and employment components of the Philly Fed index moved into negative territory in May. This caused a negative reading in the headline index, which fell from 8.5 to -5.8. Economists expected an uptick to 10.0.
The two reports, which are typically useful indicators for ISM’s monthly manufacturing PMI series, offer little guidance for that report due in early June. April data turned out positive for the PMI and industrial production reports, despite a contraction in both of these regional surveys. With equity markets deteriorating and negative sentiment on Europe returning to the forefront, investors will hope that phenomenon happens for a second consecutive month.
Lower levels of initial jobless claims continued in the week ending May 12. Claims rose slightly to 370,000, but this was still well below the 385,000 average level witnessed in April. For those concerned about seasonal distortions in the data, unadjusted year-over-year data suggests a general downtrend in the series since last year, indicating that at least some measure of improvement is afoot in the labor market.
The rash of negative economic data seen recently in the US continued to weigh on the Citigroup Economic Surprise Index (CESI), which measures data relative to consensus expectations. After rebounding in Q4 last year, following an extremely weak summer period, the index fell back into negative territory in late April. The index has worsened in May, falling from a reading of -14.0 on April 30 to -25.1 last Friday.
Unfortunately, markets tend to track well with this index, spelling trouble for investors in the near term. The breakdown in the CESI has been accompanied by deterioration in investor sentiment. The American Association of Individual Investors’ Sentiment Survey recently saw bullish sentiment fall to the lowest level in nearly two years. The spread between bullish and bearish sentiment reached -22.4 points, which is the most negative spread since September 22, 2011, according to Pragmatic Capitalism.
Source: Pragmatic Capitalism
Contrarians may find reasons to be optimistic about the current levels of these reports. Extreme bearish territory in the AAII has been notoriously ill timed with respect to actual market movements, as retail investor opinion tends to lag the market cycle. The current pace of negative economic surprises should also lead economists to become more conservative with their estimates – potentially setting the stage for another late year outburst in positive data points. Either would provide some welcomed good news to markets, which are currently awash in negative headlines emanating from Europe.
The Week Ahead
Investors will receive more news on the housing front this week with expected reports on existing and new home sales, as well as the FHFA Home Price index. Durable goods data is also on tap, although volatility in that series makes month-to-month readings difficult to decipher.
Earnings season continues to wind down with results expected from Dell, Vodafone, Burberry, Hewlett-Packard, Tiffany, and HJ Heinz.
Rate announcements are due from the central banks of Japan and South Africa this week.
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