Market Comment - July 30

(Marco Bonelli) Are expectations for a risk-on bull market too high?

Although it is never smart to fight the Fed (or central banks in general), the question still comes up, if there could be any limitations to a flat out risk-on rally or even exceptions. In case of a QE announcement, it's hard to argue against it but what if there is/are no announcement(s)? Still, the initial reaction to any QE action - if it does get announced - is certainly and naturally positive, something that already started on Thursday in anticipation of an imminent monetary policy move by the ECB.


After strong words (from Mario Draghi) and sky-high expectations that fed the rumor mill by the hour, the ECB is almost "required" to follow through and walk the talk in the ECB Meeting on Thursday. No announcement or any kind of half-baked action (like a simple extension of LTRO or only limited or conditional bond purchases) will possibly trigger big disappointment among market participants.

How about the Fed? Hopes are certainly high and got fueled by "carefully" timed articles in the WSJ as well as comments emphasizing the "last" chance to act ahead of the summer break and possibly ahead of the election that the Fed will join the stimulus orgy, similar to the coordinated move by six central banks from November 30 last year where measures to support the financial system and increase liquidity were announced. The rebound and rally in June was mainly based on hopes for more "accommodation" and the according performance in the stock and bond market even raises the question how much QE is actually already in the prices. But here is a small problem: Although economic data further deteriorated since the June 20th meeting (as most recently displayed in the first reading of the Q2 GDP report), the economic situation is likely still not bad enough to convince the majority of members of the FOMC to launch QE3. The lack of doing so will probably trigger big disappointment among market players.

An economy not bad enough is certainly a matter of definition. While absolute numbers continue to show low growth, the weakening of the consumer sector (as seen in three consecutive misses in monthly retail sales and as also documented in a mere 1.5% growth in personal consumption in the Q2 GDP report), the slowdown in non-residential fixed investments, the inventory built and also the latest mixed readings from the housing sector (with new and existing as well as pending home sales for June dropping sharply) raise some further caution flags and are certainly worth following. Having said that, since the Chicago and National PMI and ADP Employment Change Index (all for July) will get releases before the FOMC announcement, a dramatic deterioration of those statistics could still influence their decision.

Window dressing for July, comments about performance pressure (with underperformance of mutual and hedge funds at a decade low), the Fed, ECB and ESM rumors, the shorting bans in Spain and Italy, the reduction in margin requirements for equity indexes on the CME and now the upcoming FOMC and ECB meetings appear to be the almost perfect set-up for a monster summer rally, right - almost too good to be true, against all odds and totally unexpected to the majority of market participants.

Beginning of last week, I thought the determining factors for the future market direction are 1) Q2 earnings/Q3 outlook, 2) economic data, 3) decision of the FOMC meeting and 4) the job-report/non-farm payrolls for July on Friday. Although the ECB stole the center-stage role, I continue to believe that the mentioned points will influence stock prices the most. The first two points already received a check-mark on the negative side, the Fed might disappoint with not announcing anything material, the job-report has the potential to disappoint once again (which would be the fifth consecutive disappointment) and the ECB may be constrained by regulatory and legal issues to launch a steam-roller mission as indicated by the ECB President. We will know by the end of the trading day on Friday.

Trade well.


(Marco Bonelli is the Managing Director of International for CL King & Associates in New York. The opinions expressed are his own.)