Russia Smiles . . . Or Maybe Bares Its Teeth

 Observations on the Capital Markets – Week Ended May 9, 2014

On Thursday, Putin suggested the separatists postpone their vote (a suggestion they appear to have ignored). He also said Russia had pulled troops back from the Ukrainian order (NATO said no such pullback had occurred). Finally, Putin also called for a ceasefire and talks between the new government and separatists on equal terms . . . a move which would effectively confer recognition on the separatists. Markets—notably the Russian stock market—rallied on this hint of peaceful behavior.

Nevertheless, the separatists have said they intend to push forward with a May 11 “independence referendum.” Independent polls suggest that the majority of the local populations do not favor secession but, inasmuch as the separatists are likely to collect ballots only in areas they control, that they are likely to present at the polling booths, and that no impartial authority will be counting the ballots, a small actual turnout, a high reported turnout, and a pro-secession vote are likely outcomes.

On Friday, Russia commemorated Victory (over Hitler) Day . . . it’s a very big holiday in Russia—think July 4. On Friday, Russia apparently also conducted military drills—not on the Ukrainian border, but across Russia—simulating (with ICBMs and strategic bombers) the ramp-up to global nuclear war. Was it routine and pre-planned, as they say, or a threat of escalation? You decide.

The Ukrainian separatists have adopted the colors orange and black as their symbol—this was apparently the color scheme adopted by Ukrainians fighting with Stalin against Hitler (other Ukrainians fought with Hitler against Stalin).

In a Friday speech in Crimea, Putin—wearing an orange and black ribbon—said that other countries should respect Russians’ right to self-determination as if ethnicity trumps nationality,  and as if minority rights were respected in Russia. Note: Ukrainian national elections (run by “usurpers” in Kiev, not the “separatists” in the east) are scheduled for May 25.

Last week in the capital markets: OK economic news balanced by rising Ukraine tensions

Equities: The Dow ended the week at a new all-time high but S&P 500 ended the week down 0.1%; within the S&P 500 Telecoms (+2.7%) and Consumer Staples (0.9%) led; Consumer Discretionary (-0.7%), IT, and Utilities (each -0.6%) lagged. MSCI Japan (-0.7% on yen strength) lagged; MSCI Europe was down a bit; MSCI Emerging Markets was up a bit.

Bonds: Bond markets were calm: the 10-year’s yield rose 2 bps to 2.62; the 10-year TIP yield rose 3 bps to 0.44% . . . still very close to 2014 lows. High yield was quiet. Dovish noises from Yellen and a notably poor 30-year auction (dealers ended up with half the bonds) resulted in the yield curve steepening.

Commodities: Gold and oil were each up about 0.5%.

Currencies: The Euro, which had been rising toward $1.40, a psychologically important level, dropped back after the European Central Bank implied it would ease in June, ending the week down 0.8% against the dollar; the Yen and Yuan each rose roughly 0.5% against the dollar.

U.S. economic data didn’t contain any big surprises

  • ISM’s non-manufacturing Purchasing Managers Index (PMI) came in at 55.2, boosted by new orders. Markit’s April service PMI came in at 55.0.
  • The March trade deficit shrank month over month (m/m), but the decline was less than had been assumed in flash Q1 GDP; if nothing else changes (things will) this would push Q1 GDP into negative territory.
  • Winter weather impacted Q1 labor productivity, which shrank at a 1.7% annualized rate as non-farm output declined 0.3%, while hours worked rose 2%; as a result, unit labor costs rose at a 4.2% rate. Year-on-year, productivity was up 1.4% and unit labor costs were up 0.9%. I’d expect strong quarter-over-quarter productivity gains in Q2 as the weather impacts wash out.
  • Wholesale inventories rose, but rising sales meant the critical inventory:sales ratio ticked lower.
  • Initial unemployment claims dropped to 319k . . . a low number after a couple of big ones . . . good no big deal . . . recent data has been volatile.
  • The JOLTS (Job Openings and Labor Turnover Survey) report showed small drops in job openings, hirings, and separations.
  • The latest Fed Senior Loan Officer Survey showed a pickup in commercial loan demand and banks easing credit standards on business loans but becoming incrementally tightening credit standards on residential lending.
  • Mortgage purchase applications jumped 9% for the week but are still down 16% year over year (y/y).
  • Credit card debt ticked up $1.1 billion following a $2.7 billion decline in February. Auto loans and student loan debt continue to rise.

140512 Commercial and Industrial Loans

S&P 500 earnings reports continue to beat expectations

  • With approximately 90% of S&P 500 companies having reported, about 75% are beating earnings estimates (66% is normal) and the magnitude of the beats is above average. Revenues are up 2.5% y/y and earnings are up 5% y/y

Yellen’s Congressional testimony was dovish, but offered no clearer forward guidance

  • She reiterated the theme that employment has improved but that substantial slack remains; the outlook is positive, but risks remain, so “a high degree of monetary accommodation remains warranted.”
  • She singled out the stalling-out (at roughly 1 million units/year) of homebuilding as a downside risk to the economy (so watch housing starts this week).
  • She refused to give clear guidance on when the Fed Funds rate might rise, saying: “There is no mechanical formula.”

The ECB left policy unchanged but almost promised a June easing (but only one “within its mandate”).

  • ECB President Draghi said the Governing Council is “comfortable with acting next time” but remains data dependent (it wants to see more data before actually deciding).
  • The prepared statement also said “The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation.”
  • Comment: the phrase “within its mandate” is one that commentators keep dropping out of their summaries, but I see as critical. The ECB’s mandate effectively prohibits its engaging in US-style QE (e.g. the outright purchase of government bonds) . . . a restriction backed up by a key German Constitutional Court ruling. Don’t expect QE from the ECB . . . don’t be surprised to see the ECB’s target rate drop from 0.25% to zero or even a negative number.

Europe: mixed economic data . . . nothing nearly as important as what happens in the Ukraine

  • The Markit Eurozone Services PMI index rose to 53.1 . . . its 9th month above 50 and the highest level since June 2011. Last week, the Markit Eurozone Manufacturing PMI rose to 53.4. As a result Eurozone composite PMI came in at 54.0 . . . encouraging (but don’t ask me to explain how the composite is higher than either of its components). France continues to be the laggard.
  • The European Commission now projects Eurozone 2014 real GDP growth of 1.4% with 0.8% inflation; the 2015 forecast is for 1.7% growth with 1.2% inflation.
  • The Bank of England left monetary policy unchanged.

China data: encouraging, but no big surprises

  • April y/y inflation was 1.8%, continuing a slowing trend as food price inflation fades.
  • HSBC’s final April manufacturing (48.1) and services (54.8) PMI readings came in close to their flash estimates.
  • Both exports and imports rose in April . . . encouraging.

A couple of factoids to put China’s growth and size into perspective

  • Passenger cars on the road rose from 8 million in 2000 to over 100 million in 2013.
  • Motor vehicle sales grew from 2 million in 2000 to 22 million in 2013 (car sales in the US are about 15-16 million/year ).

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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