Last week’s accusations of Spanish government corruption and news of Italian election uncertainty should remind investors that despite the European Central Bank assertion that it would do ‘whatever it takes’ to preserve the Euro, significant risks continue to lurk below the surface.
Spanish newspapers claimed they had evidence showing Prime Minister Rajoy took illegal cash payments, and the opposition party was calling for him to resign. This comes just as the beleaguered Spanish leader tries to keep his austerity package on track in the face of a deteriorating economy.
Concurrently, former Italian Prime Minister Berlusconi has been closing the gap with front runner Pier Luigi Bersani as Italy gets set to head to the polls February 24-25th. The chief concern is Berlusconi could unwind the fiscal restructuring put in place by outgoing Prime Minister Mario Monti.
Throw in a €1 billion loss from Italy’s third largest bank and the Eurozone caused the first noticeable pullback for stocks this year. It was short lived, however, as stocks shook off the negative news and managed to rise, albeit only slightly, for a sixth week. The S&P500, NASDAQ, and Canada’s TSX had modest gains while the Dow had a small weekly loss – its first for 2013.
How did stocks overcome the Eurozone stumble? For the most part, it’s the positive influence of earnings results offsetting the negativity. Q4 earnings season has turned out better than the street was expecting, with two-thirds of the companies reporting revenues and three-quarters reporting profits that beat consensus projections.
STOCK MARKET VALUATIONS CLIMB
The January rally in stocks has continued, pushing U.S. stock index levels to 5-year highs. From a valuation perspective, the 2013 surge has pushed up the Price/Earnings ratio by 25% to 14.9x since the lows of October 2011.
While the valuation discount has closed considerably of late, the P/E multiple is still 10% below the average multiple of 16.6x over the past 10 years. The question is, have current expectations for growth been properly priced into stocks?
The S&P500 has more than doubled since its lows of 2009 and is currently 3% below its record high (1565) set in October 2007. Over 75% of the S&P500 companies have already reported Q4 results, so there are fewer “positive” catalysts on the immediate horizon to propel the stock market higher. At the same time, the news from Spain and Italy has awoken the European debt crisis from its winter slumber, so caution is warranted.
TRADING WEEK AHEAD
With Earnings Season tapering off in the U.S. and a relatively light economic calendar, corporate Canada becomes the focus this week with our own earnings parade moving into high gear. Several influential bellwethers including TransCanada, RioCan REIT, Barrick Gold, Rogers and Telus are set to reveal how the slowing Canadian economy impacted them in the final quarter of 2012.
The economic data will be mostly U.S.-centric as only Canadian manufacturing and existing home sales data are due. On Wednesday, the first retail sales report since the payroll tax increase went into effect at the turn of the year should point to resilience of the U.S. consumer.
On Friday, Industrial Production should show only a small decline due to weakness in manufacturing hours worked and reduced motor vehicle production. One of the first February data points is Friday’s University of Michigan Consumer Sentiment, which should rebound from the fiscal cliff worries affecting confidence in early January. No new bad news from the government and strong stock market returns could support sentiment.
QUESTION OF THE WEEK
There has been lots of talk about what is happening with the U.S. and Chinese economies, but what has been happening at home in the Canadian economy?
Canada reported a disappointing January employment report last week, which supports the view that the Canadian economy has been and will continue to lose momentum in early part of 2013.
The net change in employment in January was an unexpected fall of 22,000, compared to estimates of an increase of 5,000. December’s job gains were revised lower, suggesting January was not an anomaly. The unemployment rate fell to 7% from 7.1% in December and the participation rate ticked down to 66.6% from 66.8%.
Read: How to fix the Eurozone
The weak job market in January supports the slowdown in November retail sales and the falling exports noted in December. Canadian housing starts plunged 19% in January to their lowest since the end of the 2009 recession as builders scaled back plans for new condominium projects. Homebuilding is set to swing from an economic positive in 2012 to a drag in 2013. The Bank of Canada has also backed away from its imminent tightening language as they now suggest sluggish growth here and around the world will delay tightening, possibly until next year.
We expect Canada’s economy will follow rather than lead the other developed economies in the first half of 2013. We expect positive, but only modest 2013 GDP expansion, continued low short-term rates but possibly higher longer-term interest rates, and the Canadian dollar should neither surge nor plunge from around parity for most of the year.