The Business Times

Stocks likely to continue last Friday's rebound

Analysts expect week ahead to be an important test of investor confidence

Published Sun, Aug 10, 2014 · 10:00 PM
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LAST week, US stocks slid into negative territory for the year after Italy's surprising retreat into recession hinted that the Ukrainian conflict was taking its toll on the eurozone's economy.

This week, stocks will likely continue the rebound that began on Friday unless another shock comes from Ukraine or eurozone gross domestic product (GDP) data. At 16,555 the Dow Jones Industrial Average is almost flat for 2014, and technical analysts say this week represents an important test of investor confidence.

Stocks plunged in the middle of last week after Polish prime minister Donald Tusk said a troop buildup on the Ukraine border increased the odds of a Russian invasion. Stocks snapped back on Friday after reports that Russia was discontinuing military exercises on the border.

European Central Bank (ECB) president Mario Draghi acknowledged that the Ukrainian conflict would eventually have economic repercussions for the eurozone, but stressed that it was too early to attribute the slowdown seen in Italy and other nations in the second quarter to the fighting on the trading bloc's eastern frontier.

"Mr Draghi noted the difficulties in assessing the impact of geopolitical risks, indicating such an assessment was at an early stage," said analysts at Nomura Securities, in a research note. "He said that it was difficult to 'precisely define the ECB's options in the future, especially if the conflict were to escalate'."

A reading of eurozone economic growth due on Thursday could reveal whether Europe is already feeling the pinch from its Russian estrangement. To a much greater extent than the US, Europe's economy is intertwined with that of the world's largest nation. Even before President Vladimir Putin banned sales of European food products last week, Europe's bankers, carmakers and luxury-goods manufacturers were likely feeling the Russian slowdown.

Although global economic future is uncertain, US consumers appear to be finally shaking off the recession - second-quarter GDP growth of 4 per cent was much higher than forecast.

Excluding Citigroup, which booked litigation charges, the aggregate second-quarter earnings rate for Standard & Poor's 500 corporations is 10 per cent with 450 of the reports in so far, according to Thomson Reuters.

More importantly, as noted by money manager Alpha Capital Management of Austin, Texas, corporate sales are finally growing.

"For much of the past two years, lacklustre sales forced companies to boost earnings by cutting costs, squeezing suppliers and buying back stock," said Alpha Capital, in a note to clients. "But second-quarter results for companies in the S&P 500 index show signs of a return to basic revenue growth. Overall revenue at the 500 largest US companies by stock-market value is on track to climb about 4.3 per cent from last year's second quarter," one of the strongest increases in demand reported during the recovery so far.

Some contrarian analysts say the brinksmanship in Russia, Israel and elsewhere has distracted investors from bullish "fundamentals", namely the improving outlook for US economic and corporate growth.

"As some of this plays itself out from a geopolitical point of view, investors will realise that some of these companies are doing OK, that we had a not-great but OK jobs report, that GDP is pretty good," said Joe Kinahan, chief derivatives strategist at TD Ameritrade.

"You start putting a few (more) things together in a row, and suddenly the market's in pretty good shape."

From a technical perspective, the behaviour of the S&P500 index last week was promising for the bulls, said Mr Kinahan. The broad index tested a key support level around 1900 and rebounded convincingly to finish at 1930.

Nothing sums up the contrarian nature of stock markets better than the Argentinian situation. Even as it defaulted on its bonds after negotiations with legacy debt holders failed, overseas investors have bought into its promise as a major oil extractor, corn grower and steel maker.

A US exchange-traded fund of Argentinian stocks, the Global X FTSE Argentina, is one of the strongest performers of any stock fund in recent months, up more than 40 per cent from its lows in February.

Investors don't worry about what's happening today; they worry about what might happen tomorrow.

Even outside war zones, several portents allow for worries about the near future. Statistics from the housing market, for example, suggest that rising prices are putting a dampener on a sector that remains the foundation of the US economy.

This week, economists expect data to show modest gains for retail sales and industrial production in July.

"With . . . consumer confidence at its highest level in nearly seven years, the economy is finally showing some signs of improvement," said Ryan Detrick, a technical analyst.

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