Brewin Dolphin Holdings plc : Equity markets set bad news aside and wait for earnings.

16 January 2012

Last week's lowering by Standard & Poor's (S&P) of the credit rating for more than half the members of the eurozone serves as a reminder that a long hard slog still lies ahead for eurozone's leaders in resolving the issue of sovereign debt sustainability.

It is doubtful though that the downgrading of sovereign debt for France, Austria, Italy, Spain, Portugal, Malta, Cyprus, Slovakia and Slovenia will have more than a passing influence on bond yields and stress in bank funding markets. The ECB is likely to support sovereign markets with its Securities Market Programme, that is, if it judges the action to be at all warranted. The banks on the other hand may simply be encouraged to take up more medium terms funds that the ECB will make available at its second three-year Long-Term Refinancing Operation at the end of February.

Hopefully, what the S&P downgrades will do is apply pressure on eurozone leaders to sign up to the fiscal compact with its enforcement mechanism on the desired date (March 1). The S&P action may also add to the downward pressure on the euro which will be no bad thing at a time when the eurozone is heading for recession, if not already in one. On Greece, the talks that broke down with its creditors at the end of last week over the bond swap are due to resume this Wednesday but the prospect of a default is getting to be touch and go, as is its survival in the eurozone.

It's not all bad news though. Good or better news could come with the reporting of US earnings this week. Some 46 companies in the S&P 500 will report, followed next week by over 120, by which time the results season will be well underway. The earnings are for the period when the US economy regained momentum. Bearing in mind that consensus earnings estimates have been seriously downgraded over the past months - according to Thomson Reuters expected earnings growth for the quarter has dropped from 15 percent at the start of October to 6.6 percent as of last week - the surprises could be on the upside, both in terms of top and bottom line growth.

That said, with something around 35 to 40 percent of the sales for the S&P 500 originating overseas and with the lion's share of this (some 40 to 45 percent) coming from Europe, including the UK, a few disappointments cannot be ruled out.

Another bit of good news, as the latest from Consensus Economics Inc shows, is that the prospects for the US economy in 2012 are looking up. For two out of the past three months, consensus forecasts for GDP growth have been revised up while the underlying trend for employment continues to point towards improvement. Compared to what the consensus had in mind several months ago for the US economy, notably the one-in-three chance of recession, the likelihood now is that the economy surprises on the upside this year thus offering a promising set of prospects for earnings.

Might China surprise on the upside? Fourth quarter GDP is released tomorrow. A figure in the region of 8.5 to 9 percent is likely. The economy has been losing momentum since the second quarter of 2010 but much of this has been policy induced, as the chart below on reserve requirement ratios and interest rates suggests. Rising inflation has also been squeezing real income growth. China's loss of momentum is not just eurozone related.

China has started to reverse its policy tightening and inflation is falling. Aside from a hard landing, what the authorities keenly wish to avoid is a re-heating of the economy. The authorities are aiming to control for a soft landing through micro as well as macro managing the economy and we suspect they will achieve this with GDP growth averaging in excess of 8 percent for 2012.

Equity markets are always vulnerable to bad news but they can be more so when they are overbought. Last week attention was drawn to the UK equity market's technically overbought condition on two of four indicators I keep. The interesting point is that, as we start this week, last week's bad news is having little impact on the UK and European equity markets.

This might be because the bad news was mostly discounted. It might because Wall Street is closed today. It might because on the remaining two of the four indictors I look at, the UK equity market is not overbought. Or it might because the markets are waiting for the news on US earnings. I suspect it is the latter. If earnings prove to be at least as good as expected and maybe a touch better, Wall Street can be expected to lead equity markets up.

IMPORTANT NOTES
The information contained in this report represents an impartial assessment of the value or prospects of the subject matter. Graphs, performance data etc are as at the close of business on the day preceding the date of the note. The information contained in this report has been taken from sources disclosed in this presentation and is believed to be reliable and accurate but, without further investigation, cannot be warranted as to accuracy or completeness. The opinions expressed in this document are not the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd. accepts liability for any direct or consequential loss arising from the use of this document or its contents. We or a our website at www.brewindolphin.co.uk. The value of your investment or any income from it may fall and you may get back less than you invested. Past performance is not a guide to future performance. If you are in any doubt concerning the suitability of these investments for your portfolio you should seek the advice of a qualified investment adviser. Brewin Dolphin Ltd, a member of the London Stock Exchange, authorised and regulated by the Financial Services Authority. Registered office: 12 Smithfield Street London EC1A 9BD. Registered in England and Wales no 2135876.

If earnings prove to be at least as good as expected and maybe a touch better, Wall Street can be expected to lead equity markets up.