Still risk of further correction in equity market
The stock market has proved fairly resilient this week given the US government shutdown and downward revision to Chinese PMIs early in the week. MSCI World is down only about 1% and European stocks are broadly flat.
So does this mean the political uncertainty is already priced in? We think not and still see a risk of further correction in coming weeks. As we get closer to the deadline of raising the debt ceiling on 17 October, anxiety is likely to rise. While we do expect a deal to be struck to avoid a US default, it will probably be struck at the very last minute as we have seen before when the debt ceiling was raised in 2011 and when the fiscal cliff was avoided before new year. We also still see the market as technically overbought leaving it vulnerable to more bad news.
During the week European markets in particular got support from the positive outcome of the political turmoil in Italy where Silvio Berlusconi was the big loser and Italian prime minister Enrico Letta the big winner as his government won the confidence vote in parliament. It seems clear that the troublemaker in Italian politics over the past two or three years is now out of the game which is positive for Italian bonds and stocks.
Still divergence between soft and hard US data
We continue to see a very divergent picture in US data with forward-looking indicators being strong whereas hard data for consumption and investment is soft. This week ISM for both manufacturing and service pointed to stronger growth. A similar picture is evident in the initial jobless claims as the four-week moving average fell to 305k this week – the lowest level since 2007. However, this week, car sales saw a decent decline in September which added to the picture of still weak hard data. In the chart to the right we have compared manufacturing ISM with a domestic demand indicator based on core retail sales and core capex orders. While ISM has turned up, we have yet to see it in the actual demand. GDP for Q3 is only tracking 1.5-2.0% in line with the average for the first two quarters. The expected pick-up in growth is instead moved to Q4.
In some ways this is a sweet spot for the stock market because leading indicators are giving optimism for equities. But actual growth and employment are still weak, keeping the Fed sidelined leaving the punch bowl for longer. However, it is important we soon see actual growth rise in line with the leading indicators and that the forward-looking data stays fairly upbeat. In that respect, we got a warning sign this week as the order-inventory balance in the ISM report declined a bit. It suggests that ISM may be close to a peak.
In this respect, it is also problematic that we now have renewed uncertainty in the US with the deadlock in fiscal talks. Next week we will get the first indication how much this will hit consumer confidence with the release of the index from University of Michigan – one of the few numbers we get to chew on during the government shutdown.
To Read the Entire Report Please Click on the pdf File Below.
The stock market has proved fairly resilient this week given the US government shutdown and downward revision to Chinese PMIs early in the week. MSCI World is down only about 1% and European stocks are broadly flat.
So does this mean the political uncertainty is already priced in? We think not and still see a risk of further correction in coming weeks. As we get closer to the deadline of raising the debt ceiling on 17 October, anxiety is likely to rise. While we do expect a deal to be struck to avoid a US default, it will probably be struck at the very last minute as we have seen before when the debt ceiling was raised in 2011 and when the fiscal cliff was avoided before new year. We also still see the market as technically overbought leaving it vulnerable to more bad news.
During the week European markets in particular got support from the positive outcome of the political turmoil in Italy where Silvio Berlusconi was the big loser and Italian prime minister Enrico Letta the big winner as his government won the confidence vote in parliament. It seems clear that the troublemaker in Italian politics over the past two or three years is now out of the game which is positive for Italian bonds and stocks.
Still divergence between soft and hard US data
We continue to see a very divergent picture in US data with forward-looking indicators being strong whereas hard data for consumption and investment is soft. This week ISM for both manufacturing and service pointed to stronger growth. A similar picture is evident in the initial jobless claims as the four-week moving average fell to 305k this week – the lowest level since 2007. However, this week, car sales saw a decent decline in September which added to the picture of still weak hard data. In the chart to the right we have compared manufacturing ISM with a domestic demand indicator based on core retail sales and core capex orders. While ISM has turned up, we have yet to see it in the actual demand. GDP for Q3 is only tracking 1.5-2.0% in line with the average for the first two quarters. The expected pick-up in growth is instead moved to Q4.
In some ways this is a sweet spot for the stock market because leading indicators are giving optimism for equities. But actual growth and employment are still weak, keeping the Fed sidelined leaving the punch bowl for longer. However, it is important we soon see actual growth rise in line with the leading indicators and that the forward-looking data stays fairly upbeat. In that respect, we got a warning sign this week as the order-inventory balance in the ISM report declined a bit. It suggests that ISM may be close to a peak.
In this respect, it is also problematic that we now have renewed uncertainty in the US with the deadlock in fiscal talks. Next week we will get the first indication how much this will hit consumer confidence with the release of the index from University of Michigan – one of the few numbers we get to chew on during the government shutdown.
To Read the Entire Report Please Click on the pdf File Below.