Will equity markets keep rising?

Some equity strategists predicted nothing but doom and gloom for the summer of 2012, but most markets globally have managed to post positive returns since the beginning of June.

The main driver behind this positive sentiment has likely been economic data that suggests the global economy continues to struggle. So why does the market appreciate if economic data is poor? The market appears to be using the poor data as justification to expect further stimulus and monetary policy to help get the global economy back on track.

In other words, investors are now expecting the Federal Reserve, the European Central Bank and other central banks to take further action through different policies which could include further bond buying programs or interest rate cuts.

Investors are likely expecting further policy announcements from Ben Bernanke either at his Jackson Hole speech in August or at the September 13 meeting of the Federal Reserve. The European Central Bank is also expected to take further action to stem the European debt crisis.

Read: Ride the summer stocks wave

As to whether or not the positive trend will continue, it simply depends on whether or not policy makers actually come forward with the stimulus the market is expecting. If not, the markets could easily return to pre-June levels. If we see some new policies implemented then recent gains could be maintained, although the effectiveness of further quantitative easing (QE) is debatable.

While the Fed’s QE1 was effective, it is easy to argue that QE2 may have caused more harm than good by driving up commodity prices and hindering any progress made from the financial crisis recovery. So we can’t say with certainty that the introduction of new policies will provide long-term equity market gains for investors – a short-term pop is possible, but the longer term effects are questionable.

If we want to see sustainable gains, politicians have to step up and provide some leadership by introducing new fiscal policies that will help create jobs. For too long politicians have relied on central bankers to find solutions to the global economic slowdown, which is why such problems have lingered much longer than expected.

Last week in review

The data from China stood out as inflation continues to fall. However, so does exports, which is further evidence that the European debt crisis is being felt in other parts of the world. The good news is that with inflation falling, the Chinese central bank has more wiggle room to cut interest rates if required.

In Canada, the focus turned to employment as the Canadian economy lost 30,400 jobs in the month of July while the unemployment rate rose to 7.3% from 7.2%. Economists were forecasting employment gains of 6,000 jobs, making this morning’s statistic disappointing and basically putting an end to the consecutive months worth of job creation we’ve seen since the beginning of the year. Perhaps Canada is now showing signs that it is also feeling the effects of the global economic slowdown.

Commodity prices continued their impressive run, except for Friday where the disappointing Chinese export data caused commodity traders to step in and take some profits. Crude oil and gold prices managed to finish the week slightly higher, while agricultural commodities continued to see support at current levels as the U.S. drought kept speculators busy.

Naturally, higher commodity prices tend to be good for the Canadian dollar and this week was no different as the loonie closed above parity for the first time since May. In fact, it strengthened further and is now very close to breaking back through the US$1.01 level.

CHINESE DATA ALLOWS FOR STIMULUS

China released its regular stream of monthly economic data last week. Most data points, including industrial production, fixed asset investment, and retail sales were all just slightly below economist expectations. However, two statistics in particular stood out. First was the 1% growth in exports year over year when economists were looking for 8% growth, thus illustrating the impact Europe is having on China’s economy.

Read: More room for stimulus in China

The second statistic was Chinese inflation, which continues to fall. July’s print was an increase of 1.8% year over year when inflation was growing at 6.5% a year earlier.

Chinese inflation has not been this low since the financial crisis recovery in 2009. With inflation falling, it is easier for the Chinese Central Bank to cut interest rates to stimulate the economy. Earlier this year the People’s Bank had refrained from cutting rates due to fears that prices, especially in housing, would escalate. With inflation slowing, further rate cuts could materialize before the end of 2012.

TRADING WEEK AHEAD

With most major central banks done with their meetings and policy announcements until September, we don’t expect to see many headlines this week, although anything is always possible when it comes to Europe.

Instead, investors will likely continue to watch for indications that further monetary policy announcements are forthcoming over the next few weeks. This means that focus could possibly turn back to economic statistics and corporate results.

On the economics front we’ll get a good dose of U.S. consumer indicators: Retail Sales figures will be released on Tuesday and the University of Michigan Consumer Confidence Indicator will be released on Friday. In addition, inflation indicators on both sides of the border will be released; however, the reported numbers are not expected to alarm monetary policy makers in any way as core inflation is expected to hover around the 2% level.

Read: Canadian consumer confidence rises

Three Dow Jones companies will report earnings this week, including Home Depot, Wal-Mart, and Cisco Systems. The first two will also provide us a snapshot of consumer behavior in this difficult economic environment.

In Canada, we will continue to see a number of second quarter earnings reports, mostly coming from REITs and small-to mid-cap miners. Resources will remain in focus as oil prices have rebounded since the beginning of July, as have many other commodities due to expected U.S. dollar weakness if the Federal Reserve introduces further quantitative easing.

Commodities will also be the focus for the Canadian dollar which continues its impressive run from US$0.96 since June, although currency traders will be watching next week’s inflation data very closely to see if there are any hints that the Bank of Canada may increase rates sooner than later. We still expect rates to remain low for the remainder of 2012.

Gareth Watson is the Vice President, 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. @Gareth_RGMP