Stocks extend decline - volatility could spike

May 2, 2016

This week’s inaction from two major central banks, namely the US Federal Reserve and the Bank of Japan, has caused the global equity indices – Japan’s Nikkei, in particular – and the US dollar to weaken as the yen and safe haven precious metals soared. В On top of this, weakness in US data persisted as fresh data showed the world’s largest economy grew only by 0.5% in the first quarter on an annualised format, which was less than expected. Japan’s economy fell back into deflation and household spending there slumped more than 5% in March compared to the same period in 2015. Meanwhile in Europe, the UK economy grew by a meagre 0.4% in the first quarter, although this was in line with the forecasts, while the Eurozone GDP expanded by a better-than-expected 0.6% in the first three months of the year. However, inflation was a weak point in the Eurozone as CPI fell back below zero, printing -0.2% year-over-year for April. Along with precious metals, oil prices repeatedly surged to new 2016 highs on the back of a weaker dollar and signs of a more balanced oil market on dwindling US crude production. So, commodity stocks outperformed globally.

In the US, it was a busy week for earnings with lots of tech giants, social networks and consumer discretionary names producing their quarterly results. Facebook’s solid earnings caused the social network stock to soar to a fresh record high, while Amazon posted its largest quarterly profit ever on Thursday, boosted from surging growth in its Web services division. But falling iPhone sales, revenue and profit was all bad news for Apple’s stock which moved further into the official bear territory. Other tech giants, including Google, Netflix and Twitter all reported disappointing numbers. As of Thursday morning, some 55% of the S&P 500 companies had reported their results. According to Thomson Reuters, overall earnings are set to decline by 6.1% in the first quarter compared with a year earlier. This is mainly due to the energy sector because of the earlier collapse in oil prices. Excluding energy companies, S&P 500 profits are still likely to fall by 0.5%. Meanwhile overall revenues are expected to drop 1.4%. If so, this would be the S&P 500’s third quarter of falling earnings, the longest streak since the global financial crisis. Worse still, revenues will have dropped for five straight quarters in a row.

Against this backdrop, it is difficult to see how the US markets will be able to break to fresh record highs. But the markets are forward-looking and expectations of better performance from energy companies is one big reason why the markets have held up this well. Added to this, the US dollar has weakened noticeably amid receding Federal Reserve rate hike expectations this year. The weaker dollar should help support US exports generally and boost profits and revenues realised aboard when exchanged back into the domestic currency. В Above all, these are not normal times due to all the central bank support in the form of low or negative interest rates and huge programmes of asset purchases designed to depress long-term yields. So, the focus is not entirely on earnings or the economy for that matter; many yield-seeking investors are thus forced to the higher-yielding stock markets in spite of the overstretched valuations.

Look ahead: irregular trading but plenty of data and earnings next week

But as we come to the end of another interesting week in the financial markets, European stock markets and Wall Street share were sharply lower at the time of this writing, following on from Thursday’s slump. Next week is likely to be another volatile one for the markets, although trading will be irregular as China and UK markets will be closed on Monday while Japan is out for most of the week and mainland European markets will be shut on Thursday. Nevertheless, there will be plenty of data from the world’s first and second largest economies to keep us busy.

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