Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: The EU Summit closed last week and investors received a pleasant surprise as European leaders agreed to use bailout funds to help recapitalize troubled banks and lower borrowing costs for Italy and Spain. How much did this development change the near to intermediate-term outlook for the market?
Stovall: Investors know that Spanish and Italian banks need a shot in the arm in terms of capital inflows, but the way that the European leaders had set up the bailout of the Spanish banks was going to cause the country of Spain itself to increase its debt load and investors were not very happy about that. At the same time, it put investors at a disadvantage to the international lenders. If Spain’s banks went under, then the non-government lenders would have to be second in line. So what ended up happening is that investors thought the government, which is serving as the lender of last resort, would end up being the lender of only resort because nobody is willing to buy if they knew they’d have to wait in line and get pennies on the dollar. With Europe agreeing that they will lend money directly to the Spanish banks and not take a superior position on repayment, that’s really what has allowed the recapitalization of these banks to go forward and has made global investors feel so much better. As a result, it has precipitated what I call a “compromise catapult” in equity prices.
EQ: Now that some of the pressure on Europe has been alleviated for the time being, does this put more pressure back on the U.S. economy and Q2 earnings?
Stovall: Basically, I think investors go from one worry du jour to the next. Last week, it was the worry over what Europe would do with the Spanish banks, and the kind of compromise that the German Chancellor would make toward that effort. There was a little overhang this week on what the European Central Bank would do with interest rates in Europe, but really the focus is back again toward the U.S. market. Are corporate earnings coming down as estimates currently foresee? In the first quarter, it was estimated originally that we would only see a 1-percent growth but we ended up seeing a 7.5-percent growth.
I think investors are trying to figure out if we are really slowing or if it’s corporate management’s adept ability to ratchet down expectations, only to beat them when they finally report earnings. Sooner or later, I think earnings growth will be decelerating, and as a result, if it isn’t this quarter, it might be the next.
EQ: Earnings season is set to kick off next week. Expectations seem to be pretty weak for this quarter’s growth. Do you think the bar is set too low similar to the previous quarter, or do you think these estimates are more in line?
Stovall: The employment data on Friday could help us to figure this out. If we continue to see weakness in employment, then the implication is we really don’t see corporate demand for hiring, because the corporations themselves are not seeing a pickup in orders. A lot of them have already indicated that weakness is stemming from Europe, but also from China and other parts of the globe. The U.S. economy is only projected to grow at a 2-percent rate this year, which is about half speed of what it should be as we enter the fourth year of economic expansion. So with China slowing from the more than 9-percent growth from 2011 to the mid-7 percent estimated for this year, and with Europe expected to show a year-over-year decline in real GDP, I think there’s a good possibility that while the bar is set pretty low, it might not be elevated that much as the earnings projections become reality.
