Wall Street weighed down by multiple challenges
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E-mail Xinhua, July 3, 2012
This summer, Wall Street faces more challenges, such as eurozone uncertainties, a lackluster domestic economy and companies' lower-than-expected earnings.
The eurozone situation will surely impact the U.S. market in the next few months. However, as the domestic economy continues to slow down, the Federal Reserve may push for more aggressive monetary policies. A "fiscal cliff" is looming.
Eurozone drama continues in summer
In the past several months, eurozone hops led the U.S. equity market to close with a big rally in June.
Defeating previous expectations of a "sell-off in June after sell-off in May," the Dow Jones industrial average logged its best June gain since 1997, while the S&P 500 and the Nasdaq posted their strongest performance since 1999 and 2000 respectively.
Over the past six months, the blue-chip Dow gained 5.4 percent. The broader S&P 500 jumped 8.3 percent while the tech-heavy Nasdaq rallied 12.7 percent.
Investors' sentiment was lifted by upbeat news from a two-day EU summit in Brussels last week. Leaders of the economic bloc agreed to support countries that comply with EU budget policies to access rescue funds. With Germany caving in, they also agreed to recapitalize banks directly from the bailout funds.
However, some other factors also contributed to the rally. For instance, in the last trading day of the second quarter, some institutions pushed up stock prices to get a better performance.
Evidence was a very tame sell-off in U.S. Treasuries, Stephen J. Guilfoyle, a U.S. economist from Meridian Equity Partners, told Xinhua.
Arthur Cashin, a managing director at UBS, said that although investors might be tired of the non-stop eurozone news, the region would still be a leading factor to impact the U.S. stock market in the coming months.
FED may push qe3 in september
The U.S. economy seemed quite doomed in the second quarter and was stuck in a vicious circle. On a quarterly basis, consumer sentiment was low; factories were hesitant to expand their business; the unemployment rate remained high, which again hurt the consumption.
With no signal for a pickup in the domestic economy and a bad market performance, many expected that the Federal Reserve would launch more aggressive easing programs this summer to boost market confidence, such as the third round of Quantitative Easing policy, or QE3.
However, in its June 20 statement, the central bank only announced an extension of the the Operation Twist, which was set to end in June, without launching QE3 or injecting liquidity into the market.
Operation Twist, or OT, was a monetary process in which the Fed swaps short-term bonds for longer-term ones to help keep long-term interest rates low.
Many blamed the Fed for doing almost nothing to remedy the market. At the Fed's June 20 news conference, Steve Liesman, a CNBC senior economics reporter asked Federal Reserve chairman Ben Bernanke whether he thought the Fed policy was too incremental.
Bernanke denied that and diplomatically left some room for more easing policies in the future.
More and more investors now bet that the Fed will adopt QE3 in late August or September.
Bo Peng, a New York hedge fund manager, told Xinhua that the Fed action clearly took the five-year inflation expectation in the market as a good proxy.
"If the inflation expectation falls below 1.3 percent, there might be an easing policy, either by lowering rates or printing money," Peng said, "If the inflation expectation goes above 2.5 percent, there will be more tightening policies, such as raising rates or withdrawing money."
Peng believed that the Fed's comfort zone for the inflation proxy was between 2.0 percent and 2.5 percent whereas he inflation rate in May was 1.7 percent, quite below its "comfort zone."
If the euro crisis does go global or otherwise causes severe stress to the financial system, the Fed would take some emergency action and inject liquidity into the system, Peng added.
As fiscal cliff looms, EPS will decline in 3Q
Besides the European debt crisis and a global economic slowdown, the U.S. economy will soon face another serious challenge known as "fiscal cliff."h "It is unlikely that the cliff is fully priced into the markets," said Ethan S. Harris, North American economist for Bank of America Merrill Lynch.
Harris recently prepared a lengthy analysis on the effects of the so-called fiscal cliff -- a term coined by Federal Reserve Chairman Bernanke to describe the automatic financial triggers that would happen if the Congress didn't reach a deficit-reduction agreement before the end of the year.
Harris predicted the fiscal cliff triggers would impose a total damage of nearly 720 billion U.S. dollars, or 4.6 percent of the GDP on an already sluggish U.S. economy.
Under such a circumstance, investors expected company earnings to drop in the third quarter.
Alec Young, a strategist from S&P Capital IQ, recommended a balanced U.S. sector stance.
"Recent consensus EPS (Earnings per Share) revision trends have been solidly negative. We think a myriad of macro risks are fueling EPS skepticism, limiting multiple expansion," Young said.
"Therefore, the current S&P 500 valuation of 2012 consensus estimated EPS represents fair value, in our view, until potentially better macro economic news boosts forward EPS visibility, justifying further P/E expansion."
2012 Capital IQ consensus S&P 500 EPS for 2012 growth is seen to have slowed to 6.1 percent and all these estimates are in a downward trend.
Most investors believe that only with a credible EU crisis endgame, a solid U.S. June payroll report and signs of easing in China could the 2012 EPS in 2012 show some better-than-expectation results.
In this case, more investors bet the safest shares in the U.S market are the domestic Consumer Discretionary sector which shows some benefits due to its lower exposure to global risks.
According to Young, one of the underweight sectors will be utilities, due to high valuations coupled with negative 2012 consensus EPS growth expectations. And another sector will be materials shares, as a sluggish global growth is constraining commodity price appreciation, and hence, the sector's valuation.
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