If equity markets leave you feeling disoriented at the end of this crazy week, well, don’t worry: you are not alone! Dovish comments from the Federal Reserve’s Bernanke on the U.S. economy, a stern warning from the European Central Bank’s Trichet on the state of the European banking system, the German government adviser Bofinger talking about a 40 to 50 percent haircut on Greek debt to clean the slate… the list of bearish news seems endless.
Yet, the U.S. and European equity markets look set to end the week about even. How much more confusing can it get?
Well, for one thing, the European banking system has not (yet) melted down and the relief stemming from the agreement between Greece and the IMF/EU firefighters may lend the sector a (temporary) lifeline. This story is of course not over as the credibility of Greek institutions is negative and the bigger Spanish headache still greatly looms. The topic will therefore remain high on the agenda in the coming week as the Greek parliament discusses the proposed austerity plan from 27 to 29 June.
Reflecting the situation, the Stoxx 600 Banks index has been teetering on the brink this week as the index keeps testing some crucial support levels:
Stoxx 600 Banks Index – Daily chart (source: Bloomberg)
If history offers any guidance, the 180-170 area is the one to watch for a “canary in the goldmine” early warning signal that European stock markets could be on the brink of a meltdown.
Meanwhile, a stealth “QE3” was launched this week: as inflation pressures threaten to stoke growth in emerging markets and apparently remain high on the ECB’s agenda, as the U.S. consumer is feeling the pressure of high gasoline and food prices, some interesting action was taken by the powers that be.
First, 60 million barrels of strategic oil reserves were unlocked by the International Energy Agency pushing WTI down 5 percent in a matter of minutes, then Russia lifted its ban on wheat exports and announced its intention to export 15 million tonnes of grain whilst India tried to push prices of sugar down with a similar announcement. All in the same day!
This is extremely important going forward: there is clearly a concerted global attempt to fight inflation at the source and thereby allow central bankers to keep fueling liquidity in the global system. A Global QE3!
Will it work? Nobody knows, but markets took note! Indeed, our growth indicator (well, Dr. Steenbarger’s really) had bounced massively by Thursday:
Growth index – Daily chart (source: Bloomberg) There is a 74 percent correlation between this indicator and the S&P 500. It also acts at worst as a coincidence indicator but was a leading indicator for the stock index on most major market moves. Hence a stabilisation of the growth index will be one of the indicators to watch out for next week.
In this news-driven market, macro-economic figures will also be essential. On that note, the infamous Citigroup Economic Surprise Index has now reached extreme levels, which beg for a swing back of the pendulum.
As one can see from the chart below, the time series of this index is clearly stationary (i.e. it works like a pendulum) so we can expect some reversal soon:
US Economic Surprise Index – (source: Bloomberg/Citigroup)
The logic for this argument is simple: after a raft of disappointments, over-enthusiastic economists have no doubt now reviewed their expectations down so much that positive surprises are more likely. Therefore this could be supportive for the market in the short term so be aware of short positioning ahead of economic releases next week.
On the technical side, well, it’s a mess: death by a thousand cuts could start to describe how the market has been treating investors and speculators alike over the past week. Yet important supports remain intact: 1,250 on the S&P 500, 2,700 on the Euro Stoxx 50 and 7,000 for the DAX 30. These are still the levels to watch on the downside.
For the coming week, both the S&P 500 and the Euro Stoxx 50 look caught between a rock and a hard place: the S&P 500 could well remain stuck between 1,250 and 1,300 whilst the Euro Stoxx 50 is clearly stuck in the 2,700 – 2,800 area.
The unpredictable newsflow will remain the driving force behind the vagaries of global stock markets (some even say it’s a random walk!). The only strategy we see fit in this upside-down market is therefore to stay on the sideline and wait for more clarity…
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