(Insider Stories) - The following is an extract of a report by London-based research provider Capital Economics.

 

-    Ifo may suggest German’s nascent recovery might already be losing pace (09.00 BST)

-    UK GDP may have risen by around 0.5% q/q in Q2 (09.30 BST)

-    US durable goods orders were probably boosted by aircraft orders in June (13.30 BST)

 

Key Market Themes

The S&P 500 remained within a whisker of 1,700 on Wednesday, buoyed by a growing sense of relief that US monetary policy will remain accommodative for a long period and an upbeat Q2 earnings season so far. But we are sceptical that the stock market will be able to make further substantial gains from current levels even as the Fed treads carefully and the recovery gains traction.

 

For a start, it appears as if the market has already fully shaken off concerns about the future stance of Fed policy. After all, the S&P 500 is now trading well above its close on 21st May, the day before the publication of the FOMC minutes of that month, which triggered the initial large sell-off in financial markets.

 

It will therefore be harder for US equities to make additional gains purely on the back of extra reassurances from Fed officials that policy will remain accommodative. It is also worth noting that other risky assets, such as emerging market equities, have not recovered from their slump as quickly.

 

Additionally, the US equity market seems to have benefited from some encouraging news on profits. Of the one third or so of the companies in the S&P 500 that have now reported for Q2, most have matched or beaten expectations for operating earnings.

 

However, the flipside is that margins now appear even more stretched. At the aggregate level, the ratio of operating earnings to sales of S&P 500 companies could even conceivably eclipse its 2006 cyclical peak. A similar picture is painted by some measures of macroeconomic profits. For example, US non-financial firms’ domestic profits from current production are close to multi-decade highs as a share of their value added.

 

Of course, if margins do eventually fall back, further gains in the stock market will depend heavily on increases in its price/earnings ratio. But history suggests this is unlikely once margins have peaked. And in any case the price/earnings ratio is already at a high level, even allowing for structural factors that may have raised its equilibrium level over time: the ten-year cyclically-adjusted price/(reported) earnings ratio of the S&P 500 has increased to around 24, a level last seen at the start of 2008 and eight points above its geometric average since 1900.

 

Our existing forecast is for the S&P 500 to end this year at 1,600, and then for it to climb to 1,750 by the end of 2015. The implied sell-off in the second half of this year now seems rather unlikely and we will be reviewing our forecasts in the coming days. Nonetheless we think the scope for gains much larger than those we have already projected for the next couple of years is limited, even if – as we expect – the Fed is very cautious in withdrawing its stimulus. (Jessica Hinds & John Higgins)

 

What to watch for today: North America

We estimate that total durable goods orders (13.30 BST) rose by around 4.0% m/m in June, which would be similar to May’s 3.7% m/m gain. Boeing has reported that it took 287 aircraft bookings last month, up from 232 in June. The relationship between Boeing’s figures and the official series for the value of commercial aircraft orders suggests that the latter may have risen to $26bn. After incorporating a small seasonal adjustment, we estimate that aircraft orders may have risen by around 45% m/m. That would be enough to generate a 13% m/m rise in total transport orders. Orders outside of the transport sector, however, are likely to have been much weaker. Despite the rebound in June, the new orders index of the ISM manufacturing survey remains consistent with soft core durable goods orders. We have pencilled in no change in June. (Amna Asaf)

 

Meanwhile, new home sales jumped to a five-year high of 497k at an annual rate in June. (Data released on Wednesday.) Downward revisions to back data offset some of the good news, but the recent rebound in the NAHB survey and the prospect of further house price increases suggests that the upward trend will continue, despite higher mortgage rates. What’s more, the flash manufacturing PMI (produced by Markit) rose from 52.2 in June to 53.2 in July, mirroring the improvements already reported in the Philly Fed and Empire state surveys. There is therefore little in the latest housing and manufacturing data to prevent the Fed from starting to taper its asset purchases under QE3 later this year. We still favour September.  (Julian Jessop)

 

Continental Europe

We expect the Ifo Business Climate Indicator (BCI) (09.00 BST) to fall slightly this month to 105.5, adding to evidence that the German recovery will be far from spectacular. July’s fall in the ZEW investor sentiment survey perhaps suggests that Ifo business confidence should edge down too and May’s trade and industrial production figures suggest that the nascent recovery might already be losing pace. (Jennifer McKeown)

 

The rise in the euro-zone PMI in July (published on Wednesday), from 48.7 to a better-than-expected 50.4, left the index above the 50 “no-change” level for the first time since January 2012. On past form, the headline index is now consistent with flat GDP, a touch better than Q1’s 0.2% quarterly decline. Nonetheless, the PMI and other business surveys have signalled several false dawns in the recent past, suggesting that it is still too soon to conclude that the region is in recovery mode.

 

Meanwhile, Q2’s ECB Bank Lending Survey (also published on Wednesday) brought mixed news for the euro-zone. Although the same proportion of banks reported a net tightening in credit conditions for firms as in the previous quarter, banks reported a net easing for consumer loans. Banks also reported that the net demand for credit from firms and households fell again in Q2, but at a slower rate than previously. (Ben May)

 

Japan

Both export and imports continued to rise strongly in value terms in June due to the weak exchange rate, which is mechanically boosting the value of overseas sales as well as the import bill. (Data released on Wednesday.) On this basis, exports rose by 7.4% y/y. However, imports surged by an even larger 11.8% y/y (boosted also by adverse base effects) and the overall trade balance remained in deficit. What’s more, trade was much weaker in volume terms, where both exports and imports are still lower than a year ago. Despite some misleading headlines, few Japanese firms are actually taking advantage of yen weakness to improve competitiveness by cutting prices set in foreign currency. (Julian Jessop)

 

China

The flash manufacturing PMI for July from HSBC and Markit, released on Wednesday, fell to 47.7 from 48.2 in June and was worse than most had expected. This is the fourth consecutive decline in the headline index, which is now back almost to its trough in August of last year. That said, the manufacturing PMI covers only one (admittedly important) part of the economy. By contrast, our China Activity Proxy suggests that conditions in the broad economy were improving at the end of Q2. (See Tuesday’s China Activity Monitor and Wednesday’s China Data Response for more.) (Qinwei Wang)

 

Other Asia-Pacific

We expect the Reserve Bank of New Zealand (RBNZ) to have kept its policy rate on hold at 2.50% on Thursday (22.00 BST, Wednesday). Although the central bank has expressed concern over developments in the housing market, it would like to see the New Zealand dollar fall further to help exporters. Meanwhile, inflation was just 0.7% y/y in Q2, below the RBNZ’s target range of 1-3%, and is unlikely to become a problem for the central bank any time soon.

 

Similarly, we think the central bank of the Philippines (BSP) will keep its policy rate on hold at 3.5% at its meeting on Thursday (09.00 BST). Growth remains robust, meaning further rate cuts are unlikely. Meanwhile, price pressures are subdued and are unlikely to be a concern to the central bank. On balance, we expect interest rates to remain on hold for the rest of 2013, before the BSP starts tightening monetary policy gradually in 2014.

 

Korea will release its first estimate for Q2 GDP on Thursday (00.00 BST) and we expect to see a further slowdown. Industrial production has been subdued, while retail sales growth has been very weak. The export sector remains in the doldrums amid weak growth in Korea’s main trading partners. We believe growth will remain subdued over the next year. A stronger recovery is more likely in 2014, when the global economy should be on sounder footing. (Krystal Tan)

 

Other Emerging Markets

No major data or events scheduled for today.

 

Key Data and Events

Wed 24th    22.00  NZ   Interest Rate Announcement (Jul)   

Thur 25th   00.00  Kor  GDP (Q2 Prov.)   

            00.50  Jpn  Corporate Service Price Index (Jun)

            08.00  Spa  Unemployment Rate Survey (Q2)

            09.00  Ger  IFO Business Climate Index (Jul)   

            09.00  EZ   M3 Money Supply (Jun)  

            09.00  Php  Interest Rate Announcement   

            09.30  UK   GDP (Q2, 1st Est.)     

            09.30  UK   Index of Services (May)

            13.30  US   Initial Jobless Claims (20th Jul)  

            13.30  US   Durable Goods Orders (Jun)   

            14.00  Bel  Business Confidence (Jul)

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