Stock market volatility trends lower
We have pointed to two possible developments that would assist a further recovery in global stock markets from which the JSE and the rand continue to take their cue. The first was a further reduction in stock market volatility allowing less risk to be priced into equity values. We had attributed the stock market recovery from its March lows to a decline in volatility from extraordinary agitated levels. Our sense was that volatility measures remained elevated and so provided lots of room for further improvement. Risk aversion registered on the US stock market has continued to decline as we show below and the influence on the equity markets has been predictably helpful as we also show.
Implied and realised volatility of the S&P 500, 1 April to 16 July 2009
Source: I-Net Bridge and Investec Private Client Securities
Volatility (the VIX) and the S&P 500, May – July 2009
Source: I-Net Bridge and Investec Private Client Securities
Economic forecasts are being revised higher
The second development that we thought would help take the markets higher would be an upward revision of economic forecasts. The economic outlook we thought would not have to be absolutely good, but in the estimation of credible forecasting agencies, central banks and their like, should appear less damaging.
We have had such upward revisions earlier from the OECD as well as better news about the US and especially the Chinese economy, where growth stimulated by domestic spending encouraged by bank lending seems very robust.
This week the Federal Open Market Committee (FOMC) released the minutes of its June meeting. Compared with the sense of the economy the Fed Staff reported to the FOMC at the May meeting, their tone was much improved. We quote a selection from these minutes below.
Minutes of the Federal Open Market Committee
June 23-24, 2009
…….Real personal consumption expenditures rose somewhat in the first quarter after falling in the second half of 2008, and available data suggested that spending was holding reasonably steady in the second quarter. On the basis of the latest retail sales data, real expenditures on goods other than motor vehicles appeared to have risen slightly in May and to have changed little, on net, since the turn of the year. Sales of light motor vehicles in April and May were slightly higher than the first quarter average. Real outlays on services were reported to have picked up some in April from the average monthly gain seen over the first three months of the year. The fundamental determinants of consumer demand appeared to have improved a bit: Despite the ongoing decline in employment, real disposable personal income rose in the first quarter and posted another sizable gain in April as various provisions of the American Recovery and Reinvestment Act of 2009 boosted transfer payments and reduced personal taxes.
In addition, equity prices recorded substantial gains in April and May, reversing a small portion of the prior wealth declines. Measures of consumer sentiment, while remaining at levels typically seen during recessions, improved markedly from the historical lows recorded around the turn of the year……..
http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20090624.pdf
The important feature of this report is that consumer spending in the US, accounting for a very large portion of total spending, has now stabilised. While spending has stabilised, the output of goods and services has been managed significantly lower, with additional unemployment being one of the unfortunate consequences of the adjusted budgets and operational plans of US business. Yet in aggregate the current depressed levels of production are running well below current, not so depressed levels of final demand.
Demand is now running ahead of supply
This means inventories of goods on the US shelves and in the production pipelines must run down. If so this will lead in turn to a revival of order flow and in turn higher levels of production and output with favourable influences on hours worked and later also on employment.
Outside of the financial sector, the average US company is being well managed for weaker demand. Balance sheets are typically sound having been bolstered by an unusually high share of profits in GDP that were realised over the past decade. In general, again outside of the much disturbed financial sector, the bottom line of the average US company has indeed held up better than the revenue line.
Will the consensus about the pace of US recovery be surprised on the upside?
The consensus is firmly for a very gradual recovery in output from what is now widely accepted to have been a bottom for the business cycle in Q2. That residential housing activity is now clearly picking up from its deep bottom will help reinforce this year. The consensus could well be surprised by the pace of new order flow and output gains from very depressed current levels. If so the flexibility of the non-financial US company to shed labour and adjust output in the face of unexpected reductions in their revenue lines, will again impress the observer and the potential equity investor.