Optimism heading into 3Q earnings

The global markets surged forward last week based on better than expected economic data, some positive early earnings reports and a general attitude in the equity market place that earnings estimates by analysts were conservative leaving companies likely to meet or exceed them. Technology buying led the stock market higher Monday as well, as investors extended last week’s rally on the optimism about the third-quarter earnings albeit on less volume.

The best news for the week was the release on Friday in the United States of a stronger than expected monthly employment report, which showed a rise in payrolls with 57,000 new jobs created in September. Unemployment in September held at 6.1% when the consensus had predicted a rise to 6.2%. We have mentioned in previous articles that most of the fundamentals were in place to fuel the economic recovery but one key that we needed to see was better employment figures to really cement ourselves into the next economic growth phase. Last Friday’s news was a welcome figure. Although one month does not a trend make, this was the first time in eight months that the US has reported job growth, showing that at least for now, the US economy is moving forward on all cylinders. With job growth onside with most of the other economic data, the news seems to have reassured investors worried about the recent lacklustre economic reports which some argued indicated that the economic recovery had hit a roadblock. Instead it seems, we are set to move forward further with the equity markets to year end.

That said, let’s look at fair market value and see where the indexes really are. In reviewing, we note that for the first time in recent history, the US indexes are trading mostly in the fair value range. The chart below shows the current fair value position of the Large, Medium and Small Cap S&P indexes. Also encouraging was the recent analyst revision of 3Q earnings reports for the S&P, up from the previous figure of 13.5% to 15.9%. Other good news from the US was released by the Commerce Department, personal spending rose from July to August and personal income, assisted by cuts in taxes also rose over the same period. As for what to expect over the earnings announcements to be released over the next few weeks, we agree with Tom Schrader, head of Listed Trading at Legg Mason, “I think we’re going to see some sideways action this week. We had a nice run last week and there’s a significant amount of economic and earnings news due out later in the week. I think people are taking a ‘wait and see’ approach ahead of that.” In bonds, the benchmark US ten-year note was ahead 5/16 of a point in price to 100-23/32, lowering the yield to 4.16 percent from 4.20 percent late Friday. The 30-year bond added 17/32 of a point to 104-19/32, pushing its yield down to 5.01 from 5.10 percent late Friday. We expect the US currency to stay weak to help correct the increase in negative trade balance for the United States in August. The trade imbalance is expected to increase 1.0 billion to USD 41.3 billion putting more pressure on the greenback.

As we look to the United States to continue to lead the global economic recovery, key data to be released in the near term would be the US Trade Balance Report, and the US Producers Price Index on Friday, US retail sales on Oct 15 and the all important US Consumer Price Index on Oct 16. Although, the large cap stocks are doing well, we still feel the small and mid cap stocks will produce better returns over the longer term and recommend an overweight position in these groups. In closing we would like to mention that Manchester United Plc, the world’s biggest soccer club, boosted second-half profit to a record after the team sold England Captain David Beckham, and success on the field buoyed revenue from tickets and broadcasting.

e-mail: darcy@investments-intl.com