Earnings versus economic data

Whether on the sports field, political platform or anywhere else nothing makes compelling viewing quite like a close run contest. Right now global equity markets are subject to two key dynamics both vying to dictate market direction. In the red corner stands the champion, downbeat US economic data accompanied by high unemployment and operating under an ‘unusually uncertain outlook’. The challenger, a robust US earnings season, is relatively new on the scene with lofty aspirations and under no illusions as to the huge task ahead.

If US Federal Reserve Chairman Ben Bernanke’s semi-annual testimony was available on pay per view, the box office receipts would have been handsome. With second quarter earnings beating expectations despite grim economic numbers, Bernanke had the attention of the globe. His declaration though that the outlook for the US economy remains ‘unusually uncertain’ has poured water on hopes of anything more than a moderate rate of recovery.

With the US economy delicately poised and equity markets on tenterhooks it was no surprise that Bernanke’s appraisal was the cue for equity investors to head for the exits. However growth (albeit moderate) was the key theme of the testimony rather than a fresh economic downturn and calm was soon restored.

Of course robust earnings reports work wonders to calm investor jitters and whilst Bernanke was in full flow US heavyweights Apple, Morgan Stanley, Wells Fargo and Coca-Cola delivered just that.

Having been propelled out of the traps by Alcoa and Intel, there were signs that US earnings were running out of gusto as General Electric, IBM, Texas Instruments, JP Morgan and Citigroup all failed to provide the market the sales growth it was looking for. However, Apple got things back on track and with the announcement that it had shipped 1 million iPads in less than 30 days whilst Coca Cola unveiled stellar North American sales stopping years of decline.

Today brought more of the same and earnings continued in their attempts to redress the balance. Telecommunications giant AT&T reported a 26% year on year increase in second quarter earnings after robust performance in its wireless division, a beneficiary of the launch of Apple’s latest iPhone. And equipment manufacturer Caterpillar added to the optimistic outlook with profits surging ahead by 91% on growing demand for equipment used in mining, energy and other projects. The company is a barometer for the health of the industrial sector and management upping of full year profit forecasts paints a different economic picture altogether.

Whilst corporate performance during this year’s second quarter is currently under the microscope, forward looking statement of management teams are just as critical… particularly in light of the Bernanke’s comments. Management at package shipper UPS is the latest to raise its guidance for profits citing a greater level of confidence in the economy than at the beginning of the year.

However, in the current climate downbeat US economic data is never out of reach. News that housing starts in June declined by 5% after a near 15% percent plunge in May provided a stiff body shot and a timely reminder of the strong headwinds which remain. In addition, new claims for US unemployment benefits rose more than expected last week and place the spotlight back on the weak labour market which remains at the core of US economic woes.

Whilst the ding dong battle between company earnings and economic data in the United States rages on, Europe will top the bill tomorrow as results of bank stress tests are announced. Last year, at a time of heightened nervousness a rigorous stress testing of the US banking system resulted in a return to calm and Europe will be hoping to see something similar.

The jury is out on whether the results will actually lay the platform for an economic gear change or simply prove a damp squib. Since the announcement that 91 of Europe’s banks were to be put through their paces, the basis of the testing has come under increased criticism and global equity markets have remained dubious as to the merits.

The tests promise to provide a ‘warts ‘n’ all’ view of the European banking space, a key battle ground in battle for economic recovery and will dissect the banks' books, run the rule over bad losses, and assess capital adequacy in light of a potential new financial crisis. A stringent ‘audit’ should reveal whether Europe's banking sector is standing on firm ground and will highlight areas where additional capital is required, bringing to the fore any painful home truths before it is too late.

In theory eliminating uncertainty is just what the market requires. In reality the lack of information surrounding the nature of the tests has arguably fuelled further uncertainty and the tests have become somewhat of an irritation. If fewer banks fail than expected, will it be seen as a green light by investors? Rather than the being reflective of the strength of the banks, it may just confirm the weakness of the tests.

As Spain’s recent credit rating downgrade and Hungary’s failed debt auctions both attest, Europe is not exactly a hotbed of economic optimism right now however bright spots do exist.

Exporting heavyweight Germany for example has emerged as the Eurozone’s star player and has underpinned resilient economic performance. Markit’s Flash Eurozone PMI composite index, for example, came in ahead of expectations adding further weight behind the case against a double dip. The index rose to a three-month high of 56.7, compared with 56.0 in June… expectations were of a decline to 55.5.

Focusing in on Germany in isolation, both manufacturing and service sectors showed significant signs of improvement. Whist the manufacturing output index reaching 63.1, compared with 60.3 in June, the services activity index rose to almost 3 year high of 57.3.

Having handed out a football lesson to the English in South Africa, these numbers suggest that the Germans are threatening to do the same on the economic front. The economy is expected to exceed the official growth forecast of 1.4% for the year and whilst trade with those located nearby has laboured, German exports to China are picking up the slack. From fridges to cars, the Chinese are still demanding and in our view the Chinese growth story remains anything but ‘unusually uncertain’.

Turning to the charts, the technical picture for the FTSE is starting to improve as the 5,000 level looks to have provided good support to prices once more. The FTSE 100 is currently testing its recent downtrend while horizontal resistance lies just above at the recent high of 5,331. As it stands at present the interpretation of the current situation is still a counter trend move in a downtrend. However, a clean break of this downtrend would change the near term trend from down to sideways.



A subsequent new higher high followed by a higher low would define a new uptrend and would be cause for bullishness as we would target the 2010 highs and beyond. A break above the 5,331 high would be very significant and could lead to a resumption of the uptrend that has been in effect since March 2009.

Meanwhile, the Dow is currently testing the recent downtrend that has been in place since the June 10th high. A break of this downtrend and a move back above the 200 day moving average would be very bullish and suggest a move back to the June high and beyond.



Downside support lies at the key psychological 10,000 level, followed by firm support at the July 2 intraday low of 9,614.32. Overhead resistance is located at the 200 period moving average. More positively, the upward move since July has been supported by the rising RSI which is a bullish sign.

Finally, gold has been flirting with the 50 period moving average (green line) over the last week, trading in between the US$1,200 – US$1,210 region. A flag formation was formed, which resulted in a sharp retracement last Friday night. Current trading below the US$1,200 psychological level suggests weakness in the near term. This is supported by the RSI divergence. Should a continued decline result, we would expect the May 5 low of US$1,156 to offer initial support, followed by major support at the 200 period moving average (red line) at US$1,137.



Though gold is likely to experience short term weakness, there is no change to our longer-term bullish view. Indeed, the broader uptrend remains very much intact and we continue to believe it is just a matter of time before the US$1,500 is reached.