Equities
We are now halfway through the US reporting season with, so far, positive surprises for earnings (especially Financials). Despite this, we do not expect Q3 earnings to start a new wave of positive profit estimate revisions like seen in the aftermath of the Q1 and Q2 reporting seasons. Surprisingly, profit margins are still expanding in Q3 but with muted output prices and a slowdown in sales volumes, it is only a matter of months before profit estimates for 2011 will start to be revised lower. In the short term, we anticipate market headwinds coming from continued soft job and housing markets, weak small business and consumer confidence , industrial slowdown and in the short term the likely outcome of the US mid-term elections, which leaves the US political system in a deadlock at a critical time for the US economy. We reiterate our recommendation to overweight financials and defensives against cyclical.
Furthermore, we expect a soft stock market in the near term which could bring down global stocks by 5-10%.
Fixed income
We do not think that the current correction in the bond market will continue. The EONIA market has stabilised, the Fed is on the move with QE II and European/US PMI data are expected to weaken a tad further toward year-end. Hence, we expect long bond yields to move lower again in the coming months. That said, we may not see new lows in German bond yields due to the normalisation in the EONIA market.
We expect a trough in bond yields early next year and forecast rising yields throughout 2011 as economic growth reaccelerates.
Intra-Euroland and Scandi: We are long Germany and Italy versus Spain and France. We also recommend buying T-bills issued from Italy, Ireland, Greece, Portugal and Spain. We are overweight Scandinavia versus Euroland.
Credit
We remain of the opinion that credit is a good place to be invested. Companies are still acting conservatively with modest investments and focus on cost-cutting although we believe that event risk is on the rise as companies embark on more shareholderfriendly actions.
We remain positive on credit for the moment, but it is becoming mainly a carry play as the spread tightening we have seen makes the upside smaller. Primary market activity is high and we expect more in the coming weeks before we close off for the year in December.
FX outlook
While the range of possible outcomes at Wednesday’s FOMC meeting is large, we expect the dollar to weaken on the majority of these. That is, we expect the knee-jerk reaction as the Fed announces QE2 to be that of a higher EUR/USD. With QE2 expectations having been scaled back, we suspect that it will take a quite small asset purchase programme to trigger a dollar rebound – though of course with the market being very short the dollar, such a rebound could be violent. Hence, overall we still look for a weaker dollar, Sterling and Swiss franc in the short term, while there should be potential for a renewed appreciation of AUD, NZD and CAD.
Both Norway and Sweden revised lower their rate paths this week. In general they stroke a more dovish rhetoric and especially the Riksbank is now increasingly putting weight on currency developments. However, we still expect the Riksbank to hike once again in December, whereas Norges bank will not hike before May next year at the earliest. Both NOK and SEK have been suffering in the aftermath of the monetary policy meetings and though we expect both EUR/NOK and EUR/SEK to trade lower on a three-month horizon, utmost cautiousness is warranted as stop-loss levels are currently being triggered in both crosses.
Commodities
The past week has generally seen commodities trading higher although it is worth noting that support from EUR/USD has waned. Overall, we remain bullish on commodities in 2011 on tighter market balances and a weaker dollar.
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Full reports: November 1st Week Financial views
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