Financial Professionals


Today's Heroes and Villains


Wednesday, July 13, was certainly a volatile day for the capital markets. It was also a day in which I gained valuable further insight in determining potential "heroes" and "villains" for the second half of 2011.
As we awoke that morning, a higher S&P futures market, a higher euro currency, and an overall "risk on" sentiment flourished in the early hours of trade. That "risk on" sentiment was supported by China's overnight Q2 GDP release of +9.5%, well ahead of the +9.3% estimate. The stronger-than-expected Chinese growth strengthens my confidence in expectation that China will cast itself in the hero role in the second half of the year.
In addition, the euro currency reversed the uncomfortable declines of Monday and Tuesday. Speculative capital that had taken advantage of a summer liquidity vacuum reversed bearish bets on Italian and Spanish CDS (credit default swaps). Yields on 10-year Italian and Spanish debt fell along with CDS values. The euro currency quickly reclaimed its bullish technical formation in the wake of today's price action.
As the morning progressed, commodities benefitted from strong capital inflows. That theme remained present throughout the session and should be a second half constant.
Later in the morning, Federal Reserve Chairman Ben Bernanke gave testimony to the U.S. Congress. Plain and simple, he spoke in a surprisingly dovish tone, catching most off guard, and positioned QE3 as plausible if conditions warranted. With his comments, the volatile trading session progressed as did the advance in risky assets.
However, late in the day, the S&P 500 Index gave up much of the day's gain as word from D.C. suggested an impasse on a resolution to raise the debt ceiling. The situation worsened after the close of trading when Moody's increased the probability that the U.S. rating will be lowered as the risk of a short-term default, although highly unlikely, continues to rise. In the after-market, S&P futures declined further, as did the U.S. dollar index.
Also after the close, Yum Brands (YUM) released earnings. Company sales in China rose +18% significantly above the +10.5% expectations. Despite raising prices at its China Pizza Hut and KFC locations, sales growth remained robust and ahead of rising estimates. Consistent with my expectation that China's growth will reaccelerate in the second half, YUM earnings provided concrete evidence to that effect.
July 13 was clearly a volatile and frustrating session but provided further clarity on potential second-half heroes and villains: 

  • Confidence in my expectation that China will be a second-half hero strengthened considerably today. (YUM & Q2 GDP) 
  •  Today's price action in the euro currency and U.S. dollar was supportive of my expectation that both currencies will maintain their respective prevailing trends to the benefit of U.S. multinational corporations.
  •  I expect Bernanke's QE3 talk today was a reactionary response to last Friday's poor labor report and not predicated on evidence that deflationary concerns are resurfacing. 
  •  I do not believe investors should position for QE3, nor would I expect the introduction of QE3 to be supportive of risky assets. Rather, QE3 would be an ominous signal that a second recession is unfolding. 
  •  Finally, I learned global markets crave stimulus; in this case, however, NOT monetary - rather FISCAL. 
  •  My confidence increased dramatically today that any resolutions on prudent global fiscal policy measures would be an immediate catalyst for risky assets. 
  •  Currently, U.S. and European policy makers are clearly villains for the capital markets, but they have the opportunity to be heroes. The ultimate question to be answered: "Does the political will exist for necessary fiscal policy measures to be enacted?"

Stay tuned, the plot thickens late today.
Mini S&P Futures Price Action, July 13-14, 2011

Source: Bloomberg
Euro Currency, July 13, 2010 to July 14, 2011

Source: Bloomberg
Spain 10 -Year Government Bond, June 3, 2011 to July 13, 2011

Source: Bloomberg
Italy 5-Year CDS Debt

Source: Bloomberg
2011 U.S. Unemployment Rate

Source: Bloomberg
Year-On-Year U.S. CPI

Source: Bloomberg

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.