Equity bulls got a fresh shot of monetary stimulus courtesy of the European Central Bank (ECB). The ECB took the unprecedented step of becoming the first major central bank to deploy a negative deposit rate, effectively charging banks to park reserve holdings over and above their minimum reserve requirements. The move is aimed at prodding banks into lending more to Europe’s small- and medium-size business sector, which is a key job creator. At the same time, the ECB stepped up efforts to promote a greater asset-backed securities market to further assist private enterprises. Both moves assume that European loan demand is being held back by credit availability — which is unclear, however.
Finally, there were few surprises in Friday’s monthly employment report, as U.S. stocks rose to fresh record highs. Nonfarm payrolls grew by 217,000 in May, right in line with consensus expectations for a 210,000 gain.
For the month of May, the S&P 500 rose +1.34%, the Dow Jones Industrial Average gained +1.24%, and the MSCI EAFE (developed international) added +0.91%.
Here are the 3 stories this week that rose above the noise:
The Nifty Fifty Market
While market volatility remains at benign levels, “a massive divergence is going on between the haves and have-nots, or the largest capitalization stocks and the rest of the U.S. equity market.”
As of June 2, the 50 largest stocks in the Russell 3000 Index are up 4.1% in 2014 while the average return for the rest of index (51-3000) is -1.1%. The question looking ahead is whether this performance variability is based on the attractive relative valuation of larger companies or a harbinger of more difficult times ahead. Pension Partners LLC argues that the rotation points to the latter.
Why the Euro Is Strong after ECB Went Negative
A The Wall Street Journal blog posting discusses why the euro has not continued to sharply weaken following the European Central Bank’s (ECB) announcement last week that it would be the first major central bank to implement a negative deposit rate. The article points out that the ECB’s policy announcement was really just an incremental move relative to the large quantitative easing programs implemented by the U.S. Federal Reserve and the Bank of Japan.
Moreover, analysis by Ned Davis Research showed that overnight deposits at the ECB have already fallen by 96% and what remains is not enough to have a material impact on the Eurozone economy. Thus, the ECB’s move to a negative deposit rate largely looks like a policy designed to get headlines and impact psychology. If this analysis proves correct the euro may not weaken as much as the ECB desires and deflationary pressures in Europe may persist.
Robust Earnings Cloud Reason for Worry
As the S&P 500 hits new highs, it has once again become short-term overbought and a pullback would not be unexpected. One reason for the correction could be earnings and the potential for disappointment around the second-quarter earnings season.
An article in The Wall Street Journal points out that while nearly 70% of first-quarter 2014 earnings reports beat analyst expectations, there was less to meet the eye to the latest reports and that could give the bulls some pause. First, there was a record number and percentage of companies issuing negative guidance. Second, margins may have peaked. Finally, the multiple investors have placed on earnings may not show significant further expansion since they are close to the high of this bull market from 2009.
Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.
