Economic Momentum Remains Strong

With negativity abundant, equity markets were faced with too much to overcome and the S&P 500 Index ultimately fell 2.5% while the Dow Jones Industrial Average dropped 1.8%.  Both indices were able to finish with solid monthly gains, however with the S&P up 1.5% and the Dow gaining 1.4% during the otherwise tumultuous month of April. 

 

Despite the weakness, strategists on Wall Street are officially buying in to the equity rally, according to recent year-end price targets provided courtesy of Bespoke Investment Group.  At the beginning of the year, analysts were predicting the S&P would close 2010 at 1,225.  That level increased slightly and now stands at 1,264, roughly 4% above current levels.  

 

Source: Bespoke Investment Group

 

At the same time, consumers are gaining confidence in the viability of the recovery.  In the chart below, we see that consumer confidence, while still depressed, is improving from stark levels experienced in early 2009.  This is important, because as the chart also shows, consumer confidence shares a high degree of correlation with personal consumption expenditures (PCE), a key driver

of economic growth and spending across the economy. 

 

Source: Haver Analytics

 

Confirming the rise in consumer confidence and spending, Gross Domestic Product grew at a 3.2% rate in the first quarter, roughly in line with economists’ expectations.  Not surprisingly, inventory restocking remained a positive contributor, accounting for 1.6% of the quarter’s growth, but perhaps indicating that the rebound has staying power, PCE rose 3.7% in the quarter, contributing 2.6% to growth.  Municipalities are one of the glaring sore spots, as troubles at the state and local level caused government spending to fall 1.8%. 

 

Source: Federal Reserve Bank of Cleveland

 

Given the sovereign concerns dominating the headlines for the better part of the past several months, it should come as no revelation that Treasury securities performed well in April, registering their first monthly gain since January.  Yields on the 10-year Treasury opened the month at 3.83% and briefly made a run at the 4% threshold before declining for the remainder of the month and eventually closing at 3.66%. 

 

That is good news for the Treasury Department, which is expected to sell $351bln of securities in the second quarter, based on a survey of primary Treasury dealers.  The government will provide its borrowing expectations in the coming week, but regardless it appears that the level of borrowing is in decline from the first quarter, when the Treasury tapped the markets for $483bln. 

 

Sovereign Woes continue to frustrate

The other major bit of news last week was the ratings agencies, which propelled the sovereign crisis into overdrive following a bevy of downgrades and ratings announcements. 

 

Markets sold off sharply on Tuesday after Standard & Poor’s move to downgrade the credit ratings of both Greece and Portugal from BBB+ to BB+ and A+ to A-, respectively.  Citing the blatantly obvious, S&P pointed to Greece’s “political, economic and budgetary challenges” as the reason for the downgrade.  More troubling for holders of Greek debt was the revelation that S&P only expects a recovery between 30% and 50% of capital should Greece be forced to restructure its debt.  The recently finalized bailout from the IMF and European Union will stave off those concerns for the time being, but Greece will not be out of the clear for several years hence. 

 

Moody’s has remained Greece’s temporary saving grace, as that ratings agency has yet to finalize its decision on a probable ratings downgrade.  This is important because, until this past weekend, in order for debt to qualify as collateral at the European Central Bank, it must hold a minimum rating of BBB- or above from at least 1 ratings agency – in this case, the two lone holdouts being Moody’s, which rates Greece A3 and Fitch, which considers Greece a BBB- credit.  The ECB relaxed those rules for Greece, but will offer less attractive liquidity as Greece’s rating declines. 

 

This is an increasingly important funding mechanism for Greek banks that are facing difficulties accessing capital markets.

 

Not satisfied with downgrading “only” 2 countries, S&P also cut Spain’s credit rating from AA+ to AA.  Spain’s Economy Minister Elena Salgado sought to reassure investors by saying “we will not have to ask for help” but with an unemployment rate that recently surpassed 20%, private sector debt at 178% of GDP and a budget deficit at 11.2% of GDP, those pleas may begin falling on deaf ears. 

 

The week ahead

With terms of the Greek bailout officially announced, investors will attempt to digest the ramifications. 

 

Economic news will focus on Friday’s April employment report.  Economists are expecting that the economy added 187k jobs last month in a continuation of the strongly positive growth experienced in March.  Auto sales will be reported on Monday.  US manufacturers are experiencing positive growth as consumer confidence shows signs of improvement. 

 

There will be a number of earnings reports left to dissect, with Lowes, Continental, Merck, Pfizer, Thomson Reuters, UBS, Societe Generale, Time Warner, Kraft, BNP Paribas, MGM Mirage, Swiss Re, Munich Re, Toshiba and Panasonic just a few of the key companies to announce results. 

 

In Britain, voters will head to the polls to elect a government on Thursday.  There is some danger of a hung parliament as recent polls show three parties (Conservatives, Labour and Liberal Democrats) garnering similar support into the homestretch.  The first major public appearance will occur on May 8, during observance of Victory in Europe Day (VE Day).  Greece’s parliament will vote on the terms of the recent bailout package around mid week. 

 

Source: BCA Research

 

 

 

 

 

 

 

 

 

 

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