Growth worries about Europe and Ebola headlines provide the unsettling backdrop for today’s stock market action. Stock have faltered lately, with a combination of global growth worries and Fed policy uncertainty weighing on sentiment. I am of the view that the Q3 earning season that ramps up in the coming days will give stocks a clear directional nudge one way or the other.
Germany’s August industrial production data missed expectations, down -4% vs. consensus estimates of -1.5% drop, while the same for the prior month was revised down. This follows the bigger-than-expected drop in factory orders on Monday and a host of other economic indicators that are expected to weigh on German growth outlook in Q3 and beyond. The country’s economy contracted modestly in the second quarter, and most July data appeared to indicate a reassuring start to Q3, giving greater confidence to consensus estimates of a modest growth rebound in the quarter.
But recent factory sector readings, including today’s industrial production numbers, raise serious doubts about Germany’s — and the broader Euro-Zone’s — GDP growth estimates for the third quarter. Tensions with Russia over Ukraine and the resulting sanctions appear to have been a drag on the region’s economic outlook.
[Must Read: As Germany Loses Battle for ECB, QE Goes Global]
Germany has the fiscal capacity to respond to this weakening trend, but the tight-fisted Merkel administration is unlikely to go that route. This adds to pressure on the European Central Bank (ECB), which has been working hard to jump-start activity levels to fight deflationary pressure in the region’s economy. The markets expect the ECB to eventually come around to implementing an aggressive quantitative easing program along the lines of the U.S. Fed, but it’s taking the ever-cautious ECB much longer to reach there.
The dithering ECB notwithstanding, the markets have already priced in some sort of QE program from the central bank that has pushed down government bond yields and the euro’s exchange value, particularly relative to the U.S. dollar. Something similar is at play with Japan, with a combination of weak growth economic growth and loose monetary policy weighing on the yen-dollar exchange rate. What all of this means is that there is an economic growth and monetary policy divergence between the U.S. and the Euro-Zone and Japan.
This divergence has been showing up in the strengthening exchange value of the U.S. dollar and will likely serve as a headwind for earnings growth in the Q3 earnings season that starts taking the spotlight following Alcoa’s (AA) release after the close on Wednesday. The negative pre-announcement from SodaStream (SODA) this morning wasn’t reflective of this global growth issue, but the profit warning from agriculture equipment supplier Agco (AGCO) is directly a function of dollar strength and weak global demand. We will likely see more of these as the Q3 reporting cycle ramps up in the coming days.
