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Investors are finding themselves with a new kind of balancing act — one in which they have to juggle with three major regions posing three significantly different circumstances.

Europe’s bank stress testing, the focus of much of the past week’s market focus, is but one ball in the air.

First there is the United States, which is believed to be facing another slowdown, if not a double-dip recession.

Then there is Europe, suffering a debt crisis and austerity-bound, yet suddenly surprising everyone with an unexpected burst of economic vigor.

Thirdly, comes Asia, growing away so merrily that investors are beginning to be concerned that too much zeal will be exercised in trying to slow things down.
On top of that there is the decoupling of economics and earnings — keeping bond yields down and lifting stocks. The latest investment flow data from EPFR Global showed “yield hungry but skittish” investors flooding into bonds, but world stocks are up more than 7% for the month.

“We are really in a much more difficult stage of the recovery right now,” Michala Marcussen, head of global economics at Societe Generale, said at a briefing with Reuters journalists.

She described markets as struggling with a “rotating crisis” in which one problem in one region becomes the focus of concern, only to be quickly replaced by another in another region.

“That ping pong is likely to go on for some time,” she said.

EUROPEAN TIGER?

Entering the new week, investors will first have to deal with any fallout from the stress tests of 91 European banks, due out of Friday after much fanfare.

Markets have been fairly calm about the tests, which, with Greece and other peripheral euro zone economies in mind, were designed to see how banks would fare in serious future crises.

The consensus has been that some smaller banks may fail but that the amounts needed to recapitalize them against future crises would be manageable or indeed in many cases have already been put on one side by governments.

Franz Wenzel, strategist at AXA Investment Managers in Paris, sees no broad impact for equities from the results, even if a number of small banks need to have capital hikes.

“Recapitalization will affect the usual suspects: small regional banks. But all this will be done in a smooth and harmonized way with local authorities, and it shouldn’t be a market-disruption event,” he said.

Of much more impact, however, may be highly surprising signs of economic revival in Europe.
European purchasing managers’ indexes in the past week showed private sector business activity accelerating in July, surprising economists who had expected a slowdown.

They indicated third-quarter euro zone growth of around 0.6-0.7%, double the 0.3% forecast in the most recent Reuters poll.

This was followed up by German business sentiment posting a record jump in July to its highest level in three years.

Non-euro zone member Britain also surprised with its economy growing twice as fast as expected in the second quarter of this year propelled by a sharp pick-up in services and the biggest rise in construction in almost 50 years.

Investors being investors, of course, these robust numbers triggered some new concerns about monetary tightening — hence the spike in the euro and pound against the dollar.

WEAKLING AMERICA?

The biggest piece of data likely to focus investors’ attention in the coming week is U.S. second-quarter GDP, out on Friday.

The U.S. economy is clearly coming off the boil, if, indeed, it was boiling. After three quarters of solid growth it is showing signs of slowing with firms still reluctant to hire and the housing sector seemingly unable to exit a prolonged rut.

It was enough, during the past week to prompt promises from Federal Reserve Chairman Ben Bernanke for more action if there are further signs of faltering.

This would particularly be the case if jobs don’t pick up.

“We are ready and will act if the economy does not continue to improve, if we don’t see the kind of improvements in the labor market that we are hoping for and expecting,” he told the House of Representatives Financial Services Committee.

This admission that all is not well has broad implications for investors even if other global drivers — major emerging market economies, such as China, and now Europe — are still on the upswing.

The question could turn out to be whether markets and other economies can thrive without the U.S. engine. History suggests not.
[Story Source]

This post was submitted by Harshit Agrawal.