Markets got rocked on Thursday after we learned Malaysia Airlines flight MH17 was shot out of the sky in Eastern Ukraine, killing all 298 people aboard.
However, markets bounced back sharply on Friday.
Markets continue to be incredibly resilient despite these shocks that threaten to destabilize the geopolitical status quo.
For now, investors seem to be more focused on the major economic themes that are out there. They’re paying attention to the recent boom in M&A. And they’re continuing to consider what all of the improving economic data means for monetary policy and the timing of higher interest rates.
Here’s your Monday Scouting Report:
MH17 And Geopolitics: The CBOE Volatility Index spike on Thursday in the wake of the Malaysia Airlines flight MH17 tragedy. Surging 32%, the “fear gauge” had its biggest one-day gain since April 2013.
However, it plunged again on Friday as stocks rebounded. “It’s one thing to add to the geopolitical risk premium – that’s how you get a 1 per cent move,” said Bespoke Investment Group’s George Pearkes to Reuters. “But it’s another thing to say we’re going to be in a bear market because of some conflict between the United States and Russia, or the West and Russia. For that to happen, you’d have to see some trade war but we don’t see that as likely.”
“Over time MH17 will be seen as a human tragedy with regional implications more than a geo-political crisis and next week should see the focus return to yield-hunting,” said Societe Generale’s Kit Juckes.
But this is also no time to get complacent. “Geopolitical risk is ever-present but unpredictable by nature,” warn Deutsche Bank’s Raj Hindocha and Marcos Arana. “While a large scale geopolitical risk event is not our base case, investors should be mindful of alternative scenarios relative to the benign outcome currently expected by markets.”
- Consumer Price Index (Tues): Economists estimate CPI climbed by 0.3% month-over-month in June and 2.1% year-over-year. Excluding food and energy, prices are estimated to have risen 0.2% and 2.0%, respectively. “Higher energy prices should boost headline CPI,” said Credit Suisse economists. “Unadjusted gasoline prices moved up in June, and seasonal factors expect a decline … Recent CPIs suggest core is normalizing from a period of unusual weakness. Goods prices have stabilised, and the more ‘persistent’ segment of inflation (especially shelter) seems to have turned up. Labour costs remain subdued, however, so any pickup should be gradual.”
- FHFA House Price Index (Tues): Economists estimate prices increased by 0.2% in May. “We look for the FHFA Home Price Index to remain unchanged in May, consistent with the behaviour of other home price indices during the same period,” said Barclays economists.
- Richmond Fed Manufacturing Index (Tues): Economists estimate this regional activity index climbed to 5 in July from 3 in June. “The New York and Philadelphia Fed surveys already have been released for July,” said UBS’ Kevin Cummins. “Both suggested further improvement in the growth of manufacturing output.”
- Existing Home Sales (Tues): Economists estimate sales climbed 2.0% to an annualized rate 4.99 million. “Pending home sales surged 6.1% in May, which suggests improvement in closed contracts in subsequent months,” said Bank of America Merrill Lynch economists. “Moreover, inventory has picked up, even controlling for the typical seasonal patterns, which should allow for greater transactions. The inventory figures are worth monitoring, as months supply has already reached 5.6 months.”
- Initial Jobless Claims (Thurs): Economists estimate weekly initial claims ticked up 310,000 from 302,000 a week ago. “Initial jobless claims probably remained near the 300,000 mark as seasonal factors likely continued to misestimate actual claims activity during the July auto factory shutdown season,” said Citi’s Peter D’Antonio. “We posit that filing have been artificially low, relative to the May-June average, reflecting in part the inability of the seasonal factors to account for two post-crisis trends in the auto sector: (1) the auto sector is much smaller, resulting in fewer hourly worker claims than before; and (2) many factories stay open in order to accommodate stronger demand. Separately, beneficiaries and the insured rate likely also remained low due to factory retooling period seasonal factor idiosyncrasies.”
- Markit US Manufacturing PMI (Thurs): Economists estimate this index climbed to 57.5 in July from 57.3 in June. “The Markit PMI has been rising gradually, in parallel with the traditional ISM index,” said UBS’s Cummins. “Based on the solid gains already reported in the New York and Philly Fed manufacturing indexes, we expect a solid rise in the Markit PMI.”
- New Home Sales (Thurs): Economists estimate sales fell 5.8% to an annualized pace of 475,000. “Given the outsized increase in May, a downward revision is also possible,” said Bank of America Merrill Lynch economists. “Smoothing through some of the monthly swings, we see an improving trend for housing demand after a weak winter.This is also consistent with the modest recovery in the NAHB homebuilder sentiment survey.”
- Kansas City Fed Manufacturing Activity (Thurs): Economists estimate this regional activity index was unchanged at 6 in July.
- Durable Good Orders (Fri): Economists estimate orders climbed 0.4% in July. Nondefense capital goods orders excluding aircraft is forecasted to have climbed by 0.4%. “Pullbacks in the volatile defence goods and civilian aircraft categories will probably restrain overall orders for a second month, but business surveys continue to point to improvement in core capital goods orders, including our MBSCI survey, which showed the highest capital spending plans of the year in June,” said Morgan Stanley’s Ted Wieseman. “The 0.5% rise we’re forecasting for nondefense capital goods ex aircraft orders would leave them up 15% annualized in the past four months after a winter weak patch.”
In his new quarterly letter to GMO clients, Jeremy Grantham warns that the current M&A boom we’re witnessing could expand to never-before-seen levels.
“Don’t tell me there are already a lot of deals,” he wrote. “I am talking about a veritable explosion, to levels never seen before.”
Grantham’s reasons include cheap debt, high profit margins, slack in the labour market, and low capital spending.
“I think it is likely (better than 50/50) that all previous deal records will be broken in the next year or two,” he continued. “This of course will help push the market up to true bubble levels, where it will once again become very dangerous indeed.”
He believes this could send the S&P 500 to 2,250.
For more insight about the middle market, visit mid-marketpulse.com.
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