As the market hits new highs and the current bull market passes its five year anniversary, we are bombarded by the media with stories and commentary full of foreboding. While the bull market run has already exceeded the long term average length of four years, there is nothing that points to its imminent end or the arrival of a bear market.
Bull markets typically end with the onset of recession. However, interest rates remain low, monetary policy is generally accommodative, employment is expanding, corporate earnings are rising and economic growth is expected to pick up—none of which are consistent with a rising risk of recession.
That’s not to say that some unforeseen “black swan” event can’t come out of left field to temporarily send the market into a tailspin, but it seldom pays to sit on one’s hands until then.
While preliminary fourth quarter GDP came in at a better than expected 3.2%, subsequent revision brought growth down to 2.4% as consumer spending was weaker than first estimated along with modest upward revision to inflation. Our view of the economy is unchanged from last month as we still expect a normal sequential slowdown in economic growth during the current quarter to about 2% (further aggravated by the harsh winter weather over much of the country) with the rate of growth advancing sequentially through the balance of 2014.
Overwhelmingly negative EPS guidance for the first quarter by US companies appears to support our modest near-term expectations. Guiding earning expectations lower (and subsequently exceeding them) has been the pattern for more than a year.
Revenue growth has assumed greater significance for investors as an indicator of global growth. Among S&P 500 companies, 63% beat revenue estimates for the fourth quarter, which is far above the 54% average over the last four quarters.
As we’ve mentioned previously, deflation is still a real risk facing Europe. The Eurozone remains at risk of falling into deflation partially due to the constraints that still encumber the European Central Bank; chief among them is the lack of authority to print money.
In spite of Mario Draghi’s continual reminders, this point seems to be lost on most market participants, especially currency traders that have been on the wrong side of a weaker euro bet for the better part of two years. In our opinion, the euro will prove stronger and more resilient than most traders anticipate for 2014.
Despite drastically reduced sovereign yields, the problems that led up to the European debt crisis remain largely unresolved with uneven progress as politicians have once again lost their sense of urgency without the threat of imminent collapse.
As we detailed last August, debt levels continue to escalate with Italy’s burgeoning government debt burden especially troubling since Italy has no appetite for further austerity or structural reform to enhance competitiveness given the country’s penchant for weak-kneed revolving door coalition governments.
The lack of bank liquidity within the Eurozone restricts lending, thereby impeding growth while bank balance sheets remain precariously overexposed to sovereign debt (which is becoming even more concentrated as an unintended consequence of more onerous stress tests being implemented under new banking regulations).
Nonetheless, confidence on the Continent continues to improve as the economic recovery gains strength, which as we stated earlier should lead to relative outperformance of European equities. This also bodes well for those US companies reliant on Europe for a share of their revenues.
In fact, most major US multinationals reporting fourth quarter results, also reported sales growth in their European operations, providing anecdotal evidence that the European economy is improving, which is also confirmed by the most recent European PMI numbers.
Shanghai Chaori Solar Energy Science & Technology company became China’s first domestic bond default when it failed to meet interest payments due on March 18 of 89.8 million yuan ($14.6 million).
This is a watershed event as domestic bondholders have been conditioned into believing that the government or a financial institution would always step in to prevent default. The key takeaway is that the reformers are asserting themselves within the Party and gaining credibility as they follow through on the goals outlined last October during the Third Plenum.
Beijing is sending an unmistakable signal that it’s no longer business as usual and that the political will exists to let some of these highly indebted domestic companies fail.
Beijing likely chose to make an example of Shanghai Chaori because of the relatively small size of the debt involved and the overcapacity in the solar sector. This will be an easily digestible learning experience for the government that may eventually pave the way for a regulated mechanism allowing for bond default since it’s unlikely that anyone at this juncture will dispute that more defaults are coming.
We view this event positively. An orderly handling of the process might calm those worst fears over moral hazard and growing systemic risk and actually improve sentiment. Although very early in the process, this signals that China is serious about financial market reforms and provides further anecdotal evidence that the country continues to move forward toward a more market-oriented economy.
Recent weakness in the economic data may be temporarily overshadowing this movement. We attribute some of the recent volatility in China’s economic data, such as the surprisingly large decline in February’s exports, to the initial struggle to adapt to unfolding reform efforts in addition to the distortions often seen at this time of year. In our view, it projects a weaker picture of the economy than conditions actually warrant.
DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance is no guarantee of future results.
