All “volunteers”, please step forward

By David Andrews | March 12, 2012 | Last updated on March 12, 2012
5 min read

Wow! What a busy week. Things started poorly for investors as markets violently adjusted to the prospect of slower global economic growth. Greece also weighed with the lack of progress on the Private Market Initiative (PMI) to swap existing bonds for new bonds.

Finally the Greek Finance Ministry announced that 85.8% of Greek-law bondholders had begrudgingly agreed to the terms of the largest sovereign debt restructuring in history. In volunteering to forgive Greece a substantial portion of her public debt, bond holders agreed to take roughly a 75% loss on their original investment.

Sadly, it was many of the Greek pension plans that end up doing much of the “volunteering” which will only serve to add further misery to the Greek people down the road.

The technical credit default, the first in Euro zone history, stirred little market reaction and now paves the way for Greece to receive its second bailout. Reaching this agreement lifts one of the overhangs on the market but it does not mean that Greece (or investors for that matter) is out of the woods.

Central bankers took center stage this week although none of them decided to really do anything. The Bank of England, the European Central Bank, and the Bank of Canada all agreed to leave interest rate policy unchanged.

In Canada, Governor Carney’s debrief contained his recurring warning about the risks of the rising personal debt loads of Canadians. His warnings must have been music to the ears of shareholders of Canada’s largest banks however.

Scotiabank and CIBC wrapped up another solid Q1 reporting season with results that beat expectations. As with the other banks, the domestic banking divisions have continued to provide resilient earnings growth. Despite the strong earnings, the shares of the Canadian banks finished pretty much unchanged from when reporting began at the end of February. It seems much of the good news may have already been factored in.

In other macro news, Chinese inflation has dropped to a 20-month low leading to speculation additional Chinese policy stimulus may be imminent.

Perhaps the most important data were the strong U.S. monthly employment figures. 227,000 positions in February and a revised 284,000 in January cap the best six-month streak of jobs creation since 2006…

Investors feeling queasy

The bullish sentiment of stock market investors reached a three-month low this week as Tuesday’s market plunge clearly made investors uncomfortable. According to the weekly American Association of Individual Investors survey, which measures the percentage of investors who have a bullish, bearish, or neutral outlook, the percentage of those who are bullish fell even though the stock market is off to a spectacular start.

Investor sentiment is often viewed as a contrarian indicator suggesting markets have room to rally until everyone responds as a bull. We note, however, that last year sentiment fell as stocks continued to rally but the failing sentiment did precede the significant summer correction.

Trading week ahead

With the plethora of central bank meetings, economic data releases, and earnings results now in the rearview mirror, investors can expect a somewhat quieter week. Spring Break kicks off in earnest which will see many institutional investors out of the office making their annual mid-March pilgrimage to warmer climes. Sun and Snow seekers will be thrilled to hear the threat of an Air Canada labor stoppage has been mitigated ensuring their travel plans remain uninterrupted.

Central banks once again steal the spot light with the Federal Reserve, the Bank of Japan, the Central Bank of Russia, and the Bank of Mexico holding rate setting meetings.

None are expected to alter their current rate policy, however markets will pay close attention to Ben Bernanke’s post meeting press conference. Stock markets shuddered following recent Bernanke testimony where he left the impression the Fed was edging away from another round of stimulus.

Bernanke may be more concerned about the headwinds that higher gasoline prices might impose on economic growth than about gasoline’s potential influence on general price levels and inflation expectations. The menu of policy responses, then, ranges from doing nothing to easing further. Changes to the FOMC policy statement are likely, however, especially in light of rising energy prices and improved labor market data. And there may be some interesting discussion behind the scenes on the feasibility of the Fed sterilizing any additional bond purchases.

U.S. economic data will feature retail sales expected to rise at the fastest pace in five months. Consumer sentiment should be little changed and Industrial production should have picked up in February after stalling in January due to warmer-than normal weather. On the inflation front, higher gasoline prices should be the main reason the CPI and the PPI register the biggest gains in eleven months and five months, respectively. Core CPI and core PPI both should rise moderately.

There are a series of European debt auctions to be held which should be relatively uneventful given the ongoing active use of the European Central Bank’s three-year LTRO facility.

Question of the week: Is the employment recovery in the United States for real?

Ever since the official unemployment rate dipped below the 9% level last fall, there has been increased excitement and anticipation around the subsequent monthly payroll number. The February Nonfarm Payroll was another solid report with 227,000 new jobs created, and adding to the month-over-month momentum was the fact the numbers from the previous two months were also revised upwards. The figure for January moved up to 284,000, the highest recorded monthly figure since March of 2006!

What makes the recent string of employment reports such good news here is that we have not run into big downward revisions or a monthly mean-reversion due to seasonal and other factors. Since November, the recovery in the American jobs market looks like a trend that is starting to gain some momentum, but overall not yet firm enough to get the unemployment rate down to an acceptable level in the eyes of the Federal Reserve’s Ben Bernanke.

Despite the improved jobs data of late, Bernanke remains steadfast in his view that there remains a jobs crisis in America and that the rate of improvement remains too slow. We believe this preludes further monetary stimulus (a QE3 perhaps) as early as June.

We think the presidential election in November forces the Fed into action in the first half of 2012. The issue of it being a full-blown round of quantitative easing or a more targeted initiative (a second Operation Twist perhaps) remains up for debate.

A weaker employment report between now and the November election will likely be dismissed as an aberration to the current trend. It would take a sequence of two or three consecutive weak payrolls reports to really convince the market that the employment recovery is stalling. It’s taken more than three years of “pedal to the metal” stimulus and monetary accommodation to get here, but it appears the U.S. employment deficit is finally starting to be whittled away.

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP

David Andrews