Fed Flinches First: With the economy now faltering further, the Fed and the ECB once again seem obligated to monetize. The Fed is leading the charge, expanding its purchases of Treasuries by $12 billion by the close of Wednesday’s trade. The ECB has yet to act, and may be hamstrung by laws restricting it. However, most economists agree that an effort to step up bond purchases in Europe (starting with Spain) is of timely and crucial need.
Earlier this week, stocks took it on the chin after reports last week showed lackluster US “jobs created” growth (non-farm payroll) and inflation that had accelerated in China. The slide in stocks was arrested quickly on speculation that the Fed would come to the rescue. As we surmised, the Fed didn’t disappoint, thereby holding stocks to modest losses in what otherwise could have been the beginning of a true dislocation. Metals on the other hand began to detach from previous trading patterns, showing support despite weak stocks and the strong dollar trade – see the box scores.
On the earnings front, Alcoa’s report was considered good news since it beat expectations. However, earnings were down 69% YoY as costs continued to rise faster than finished goods prices. Google matched expectations, and that stock was slammed by 4% in Friday’s trade. On the brighter side, banks JP Morgan and Wells Fargo reported solid numbers stemming from substantial increases in trading revenue and mortgage refinancing. Earnings seem to be “in line” so far, but still may take a back seat to Fed activity in coming weeks.
US debt was downgraded by Eagan Jones to one of the lowest levels among rating agencies (AA+ to AA). Eagan cited debt growth in the US outpacing GDP growth by a significant margin. We would add that debt growth is outpacing wage growth as well. Of course, the Fed is either oblivious or doesn’t care.
US non-farm payrolls for March increased only 120,000 – far short of typical “recovery” levels. Jobless claims also rose to 380,000, working their way back to 400,000. Embedded within the household survey of the NFP report, a record 87.89 million people are considered “not in the labor force.”
Overseas, there has been more of the same, as Europe struggles under a burdensome debt load. EU Industrial Production fell 1.8% YoY in February, while Greek unemployment rose 0.9% to 21.8% in January (apparently still not fixed). The overall UK deficit widened from 2.5 billion in January to 3.4 billion in February. Spanish debt auctions continued to struggle as Spain’s sovereign debt came close to breaching the 6% level. Local governments/regions are still reluctant to impose the austerity measures ultimately needed to qualify for ECB bailout funds.
China’s output gap continues to rise. By that, we mean inflation is growing faster than GDP. China reported par GDP growth of 8.1% and an inflation rate of 3.6% in Q1 2012. Food inflation was 7.5% in the same quarter.
With inflation an issue for Europe, China, and the US, it’s still unclear how aggressive the central banks can be with “QE.” The catch-22 of course is that they must be quite aggressive or there will be no chance of maintaining a low rate environment for the “spendthrift” global economies. It will be interesting to see how stocks react to this conundrum in coming weeks, as they remain priced to perfection.
The general attitude toward the metals, as we stated previously, is improving. Mining shares (up this week by 4 to 5%) rebounded nicely; as investors may be recognizing valuations in this group are comparable to the low set in 2008. It’s still too early to tell if the metals are ready to advance again; recent market action may suggest only posturing ahead of a needed catalyst. With the Fed at a loss for options that don’t include inflation – a similar predicament to that of the Chinese – it seems to us only a matter of when, not if, the metals recapture some wind at their backs.
VP Investment Management