Euro zone double-dip recession looks increasingly likely

Positive U.S. data, particular durable goods orders in August, were able to drive North American markets higher this week. However, news from the euro zone were becoming more dire each day. In fact, Irish and Portuguese 10-year government bonds' yields reached the highest level since their entry into the euro zone, as investors increasingly perceive the investments as very risky. 

 

The situation in Ireland began in the beginning of this month, when it was reported that the Irish government needed to provide further bail-outs to Anglo Irish Bank. Subsequently, rumours persisted that the nation would need EU and IMF aid.

This week, while Ireland was able to sell all $1.5 billion euros of 4 and 8-year government bonds it auctioned, the bonds were forced to be sold at higher yields. In fact, they were sold at 4.767% and 6.023%, significantly higher than April's auction at 3.11% and 5.088%. According to reports, the ECB spent $323 million euros purchasing euro zone government bonds last week, the highest amount in 8 months.

Barclay's believes that most of the money went to buying Irish debt, in order to keep the country's yield lower. However, the effectiveness of that measure is questionable, since Ireland's 10-year bond reached a yield of 6.4% on Thursday, far higher than the 4.5% in April. In addition, Irish 5-year CDS rose to 500 basis points this week. 

As for Portugal, the nation's deficit-reducing efforts have not been successful, and economic growth has slowed. In addition, the government is consider to be unstable. Meanwhile, despite assurance by the Greek government that a restructuring of the nation's debt would never happen, investors remain unconvinced, sending the yield spread between Greek and German debt to 9%.

The picture only looked more grim as the week went on. On Thursday, Ireland's 2^nd quarter GDP surprisingly fell 1.2%, after it had risen 2.2% in the 1^st quarter. The news dramatically raised concerns that the former Celtic Tiger could enter a double-dip recession.

In addition, euro zone PMI in August fell to 53.8, which was lower than the 55.7 that was expected. In addition, it was the weakest reading since February, and the largest fall since November 2008. Research company Markit stated that the growth of Europe's engine, Germany, was rapidly decelerating. It also warned that double-dip recession risk in the euro zone is rising.

As if more evidence was needed, Reuters stated that the market expects euro zone growth every quarter before the end of 2011 to be between 0.2% and 0.4%. That is barely above 0%, meaning a slightly slower-than-expected growth rate for just 2 quarters would officially send the euro zone into a double-dip recession. One bright spot last week was Friday, with an unexpected rise in the German Ifo business climate index.

Stocks head higher on Fed report and US economic data

North American markets continued to head higher this week, as most data from the U.S. were better-than-expected. For the week, the Dow went up 2.4%, while the S&P 500 rose 2.1%. In addition, the S&P 500 is up 9.5% since September began.

Gold also continued to soar, as it broke several record highs this week, and was as high as US$1301.6/ounce on Friday. Silver was also in the spotlight, as it was at a 30-year high of US$21.45/ounce.

Positive U.S. data dominated the week

The NBER announced on Tuesday that the US recession officially ended in June 2009, after beginning in December 2007. The news caused sentiment to turn more positive, and sent markets higher. On Friday, US August durable goods orders fell 1.3%. However, after removing the transportation component, the number actually rose 2%, twice as high as the 1% Wall Street expected. July's durable goods orders were also revised up from 0/4% to 0.7%. Both news showed more strength in the US economy than had been expected.

US Fed buoys hope for QE2

The US Federal Reserve's statement on Tuesday hinted that inflation was too low (1% last month versus the Fed's target 1.5% to 2%). It also stated that the Fed will use further quantitative easing (QE2) when needed, in order to boost economic growth and increase inflation.

Investors are interpreting that the Fed will conduct QE2 after its next meeting on November 2^nd. In fact, Reuters expects QE2 to amount to US$300 billion to US$1 trillion.  This expectation caused stocks to move higher, but sent the US dollar tumbling. In fact, the weak US dollar is part of the reason why gold has been soaring.

Not everything is rosy in the US

However, not all US data were positive this week. On Wednesday, prices of US single-family houses fell for the second month in a row in July. The FHFA's house price index fell 0.5% in July after a 1.2% fall in June (revised down from the previously announced 0.3% fall). US weekly jobless claims also unexpectedly rose last week. Finally, while exisiting home sales rose in August by 7.6%, it rose from a 13-year low in July.

Likelihood of double-dip recession in euro zone surges

While positive US data were able to drive markets higher this week, news from the euro zone were turning more dire each day. In fact, Irish and Portuguese 10-year government bonds' yields reached the highest level since the countries' entry into the euro zone, as investors increasingly view them as risky investments. Since too many events have occurred in the euro zone this week to include them in this article, view the blog post titled “Euro zone double-dip recession looks increasingly likely”.

Looking ahead to next week

After a 9.5% rise for the S&P 500, markets are likely going to take a breather, making further gains in October unlikely. In fact, negative news piling up in the euro zone over the past month could finally shift the momentum of the markets away from its focus on better-than-expected US data.

In addition, a trade war between China and the US ahead of the midterm elections looks increasingly likely. The Obama administration, Congress and Senate continue to pressure China to raise its currency. Import tariffs are likely to be placed on Chinese products before the November 2^nd elections, making it likely China would retaliate. Thus, a dire situation in the euro zone similar to the Greek crisis in May, coupled with a China-US trade war could cause to S&P 500's impressive gains this month to dissipate quickly.

Next week, two manufacturing reports (ISM and Chicago PMI) will be released. On Tuesday, consumer confidence data will be released, and a personal income and spending report are to be unveiled on Friday.

All eyes on the Fed

North American stock markets headed higher this week on some encouraging news from the U.S. For the week, the Dow went up 1.4%, while the S&P 500 rose 1.5%. The Nasdaq jumped 3.3%.

Early in the week, markets received a lift when it was announced that the Basel III regulations would take effect in 2019, giving banks sufficient time to raise capital in order to meet the new requirements. On Tuesday, it was announced that U.S. August retail sales grew at 0.4%, which was double the 0.2% that economists expected. In addition, better-than-expected quarterly results from Oracle and RIMM caused the Nasdaq to end up 3.3% for the week. 

Gold continues to soar

  

Gold hit 3 record highs this week, as it rose as high as US$1284/ounce. Meanwhile, silver hit its highest level since 1980 by reaching US$20.816/ounce. This showed that while positive data continued to emerge from the U.S., investors were still concerned about the possibilities of deflation and a double-dip recession.

In fact, Germany's investor confidence index hit negative territory this week as it reached its lowest level in 19 months, and the OECD revised down its economic forecast for the G7 for the second half of 2010, from 1.75% to 1.5%. 

More trouble from the euro zone

  

Trouble continued to emerge from Ireland this week as investors worried that the government might have to seek EU and IMF aid in its bail-out of Anglo Irish Bank. The Irish government announced earlier this month that it will have to provide further capital to Anglo Irish Bank. Ireland's 10-year government bond rose to a yield of 6.4% this week, the highest since the euro was adopted in 1999. In addition, the yield on government bonds of the other PIIGS nations also rose.

Geithner criticizes Chinese currency

US Treasury Secretary Timothy Geithner stated in a Senate hearing that China's currency, the Reminbi, is severely undervalued. He also said that he will use different measures to pressure China to act quickly. With US mid-term elections in two months, it is likely that tariffs will be placed on imports from China. This would cause similar retaliatory measures by China, which could lead to a trade war. Trade disputes between the US and China, let alone a trade war, would be bad for stock markets.

Lookahead to next week 

The US Federal Reserve will announce its interest rate and policy statement on Tuesday. A positive outlook for the economy, or an announcement for further quantitative easing measures by Ben Bernanke would both have a positive impact on markets. 

Next week is heavy with housing data, with the housing market index on Monday, housing starts on Tuesday, existing home sales on Thursday and new home sales on Friday. Readers should keep in mind that US housing data have overwhelmingly been weak since the end of the recession, and that trend is unlikely to change. In addition, bad news from the euro zone, particularly from Ireland, is likely to continue next week.

Stocks edge higher in shortened week as investors brace for volatility ahead

North American indices edged higher in a week shortened by Labour Day on Monday. The S&P 500 was up 0.5%. Combined with last week's 3.8% gain, the S&P 500 is up 4.2% in the last 2 weeks, and up 5.7% since September began. 

The upward movement in North American indices this week was caused by more better-than-expected data from the U.S. US July exports rose 1.8%, the largest amount in 2 years. US initial jobless claims for last week also fell 27,000 to 451,000, which was lower than the 470,000 that was expected. Friday's news from China also boosted markets, in which Chinese imports in August rose 35.2% from a year earlier, which showed that consumer demand remained strong in the world's engine of growth.

Negative news from the euro zone

While better-than-expected data from the U.S. continued to emerge, news from the euro zone were far more negative this week. Germany's economy showed weakness as Germany's August exports fell 1.5%. The Irish government's decision to split Anglo Irish Bank into two companies, one containing deposits and the other with bad loans, sent Ireland's CDS to a record high. 

In addition, a German banks' association warned that following the new Basel III banking regulations, the 10 largest German banks would need $105 billion euros to meet Tier 1 capital requirements.  The troubling news from the euro zone sent gold to as high as $1262.35/ounce on Tuesday.

Brace for volatility ahead

Investors are using options to protect against volatility next week, as markets continue to enter what is historically the most volatile month. According to Reuters, some investors are buying the September $45 call on the VIX, indicating that they expect the volatility index to double its current level by the end of next week.

Markets will be taking direction from next week's long list of economic data, which includes retail sales on Tuesday, industrial production on Wednesday, the PPI and jobless claims on Thursday and the CPI and consumer confidence on Friday.

The trend since the beginning of September has been that data from the U.S. have beat expectations, while bad news have continued to emerge from Europe. If the economic data next week upholds this trend, then markets can be expected to be range-bound. However, if US data begins to head south, then markets can be expected to head lower, since news from Europe is likely to continue to be worrisome.

3 reasons why Canadian oil stocks could move higher in the coming months

1) Mergers and Acquisitions

BHP Billiton's ongoing $39 billion bid for Potash Corp, and Intel's recent $7.86 billion purchase of McAfee show that M&A activity has been increasing in recent weeks. In fact, according to Thomson Reuters, about $200 billion of M&A has been announced in August. From the beginning of 2010 until August 23, $1.5 trillion of M&A has occurred, which is 20.6% higher than last year.

The increase in M&A activity is due to North American companies having accumulated significant levels of cash during the recession from cost-cutting. In addition, extremely low interest rates and easier access to loans also enhances companies' abilities to make acquisitions. Furthermore, cheap valuations make targets seem more attractive. 

Chinese state-owned companies have done many deals in the Canadian energy sector in the past year. Examples include the $4.6 billion acquisition of a 9% stake in Canadian Oil Sands Trust, and a $1.6 billion purchase of a 60% stake in Athabasca Oil Sands properties. Direct investment by Chinese companies is not going to slow down in the final quarter of 2010 and beyond. This will provide a significant boost to select Canadian companies that are involved in M&A activities, and provide a smaller boost to the entire sector.

2) Hurricane Season

It is currently the middle of the hurricane season, with hurricane Earl having collided with the North American east coast days earlier. U.S. government scientists predict a very active 2010 season, with 14 to 20 tropical storms, and 8 to 12 of them becoming hurricanes. In addition, The National Oceanic and Atmospheric Administration expects 4 to 6 “major” hurricanes, which have top winds of more than 110 mph.  

A strong hurricane season could disrupt oil production in the Gulf of Mexico, sending oil prices higher and benefiting the TSX's one-third weighing in the energy sector. According to Jeff Rubin, former chief economist at CIBC, hurricanes also jeopardize 40% of the U.S. refinery capacity. The 2005 hurricane season raised oil prices by 10%, while prices at the pump rose by 50% to $3/gallon. In 2008, hurricane Ike's direct hit on the Houston refining area sent pump prices to $5/gallon. 

3) Military Conflict in the Middle East

Iran's Bushehr nuclear reactor became operational in late August. News articles have been quoting Israeli military officials for years about how much they want to destroy the reactor. Numerous military exercises have already been conducted in which the Israeli Air Force simulate striking the reactor. Israel has also conducted air strikes on nuclear reactors in the past, bombing Iraq's Osirak nuclear reactor in 1981, and Syria's North Korea-built reactor in 2007. 

According to a recent article in The Atlantic, U.S. Secretary of Defence Robert Gates stated in June of this year that it would take Iran 12 months to acquire a nuclear weapon. Israeli officials estimate the timing to be 9 months, which means Iran would acquire a nuclear bomb by March 2011. It is believed that Israeli officials will give UN sanctions a chance to work until December, then begin preparing for an air strike that will occur by March.

An air strike by Israel on the Bushehr reactor, and the subsequent political firestorm in the Middle East would send oil prices and the TSX's energy sector surging. An example is the military conflict between Israel and Lebanon militants in December 2008 and January 2009. For example, Suncor Energy's shares went from a low of C$21.51 on December 24^th to a high of C$29.78 in the week of January 6^th (a 38% gain in 2 weeks) simply because of the military conflict. Similarly, Canadian Natural Resources saw its shares rise from C$22.45 on December 24^th to C$28.60 on January 6^th (a 27.4% gain).

More bad news from the euro zone

After a relief rally occurred in North American markets in late August and the beginning of September, it appears trouble is once again emerging from the euro zone. Today, Greece's second quarter GDP growth, which was previously announced at -3.5%, has been revised down to -3.7%. It also fell quarter-on-quarter by 1.8%, which was the biggest decline since the fourth quarter of 2008. This GDP revision means that the EU/IMF's forecast of a 4% GDP decline this year for Greece is most likely.

 

As for Germany, a German banks' association stated yesterday that following new global banking regulations, the 10 biggest German banks require an additional $105 billion euros to meet the Tier 1 capital requirement. The new rules raises Tier 1 capital requirements from a previous 4% to 12% (9% plus a 3% buffer). 

In addition, the Wall Street Journal reported that the stress test for euro zone banks may have underestimated risk to the banking sector. As a result, the German stock market fell 1.5%. CDS for the euro zone financial sector rose 7 basis points to 136 bp, while the euro fell from US$1.2873 to US$1.27, a fall of 1.2%.

While bad news from the euro zone has only been periodic in recent months, it is likely that the region will be a main focus for markets in the coming weeks if bad news continues to emerge from the region.

Relief rally kicks off September as double-dip worries ease

North American markets had the best week in 8 weeks, as the S&P 500 gained 3.8%, while the Dow went up 2.8%.

The rally was caused by better-than-expected jobs data. The private sector created 67,000 jobs in August, higher than the 41,000 that was expected. Private sector jobs created in July was also revised upward, from 71,000 to 107,000. Other positive data included a better-than-expected reading from the ISM manufacturing index, and the second week in a row of lower initial jobless claims.

In addition to the rally in stocks, U.S. Treasuries also reacted to the positive data. The yield on 10-year U.S. Treasuries rose 0.22% in three days to 2.7%, as investors withdrew money from the safe asset. The yield hit a low of 2.4158% on August 25^th.

News from the euro zone were also positive this week, as the ECB raised its growth forecast for this year from 1% to 1.6%, and next year from 1.2% to 1.4%. The euro also rose 4 days in a row, to end up 1% for the week at US$1.2896.

Despite the better-than-expected employment data, the overall U.S. payroll still lost jobs in August. In fact, the unemployment rate rose in August to 9.6%, after it has remained steady at 9.5% since April.

However, it appears markets have picked up momentum this week with easing double-dip concerns, and it could continue to head higher next week. In particular, Barack Obama is expected to announce measures to help small businesses next week. It will be a light week for economic data, as U.S. trade and initial jobless data are announced on Thursday.