Swine Flu And Stress Tests Versus Green Shoots

The bulls and bears called it a draw yesterday (Tuesday). Despite a continued escalation in the number of reported swine flu cases, horrible numbers for US Steel and fretting over financials needing more capital, equities held up well. News that IBM (NYSE:IBM) is boosting its dividend and doing a buyback, improving consumer confidence numbers and data from the Case Shiller survey which pointed to the rate of decline in house prices easing off all provided a fillip.

Today’s (Wednesday) Market Moving Stories

• At least six of the 19 largest US banks require additional capital according to preliminary results of the stress tests. Most of the capital should come from converting preferred shares to common equity. The FT reports that Citigroup (NYSE:C) has told regulators that any capital shortfall can be filled by selling assets and converting preferred shares as opposed to needing further government help.
• The US ABC consumer comfort index improved to -45 in the latest week from -47, confirming the message from other measures that consumer sentiment is gradually picking up.
• The Chinese Minister of Commerce Chen Deming said that aggressive monetary and fiscal policies put in place over the past few months are being effective in supporting China’s economy but the current improvement is not solid. He adds that China cannot turn around its country in isolation and needs improvement elsewhere in the world. On currencies, he said that using the US Dollar as a main currency for international trade has many deficiencies.
• The German ‘Bad Bank’ plan announcement is imminent according to unconfirmed reports. Officials have decided on two separate models, one for commercial banks and one for Landesbanks. Details of the commercial bank plan are expected next week with a view to implement in the summer. The Landesbank plan reportedly needs more work. The German FinMin estimates toxic assets worth €300bn and the important question now is who will pay for it - the central government or some kind of special purpose vehicle? The former will obviously have an immediate impact on German debt funding programme, but either way, Germany’s debt quality will be questioned for a change.
• German industrial heavyweight Siemens (NYSE:SI) shares are on the up after posting better than expected quarterly numbers on a jump in sales of wind turbines, transformers and medical scanners.
• French drug maker Sanofi are also on the rise after its Q1 profit climbed 16% on strong demand for its diabetics medicine Lantus.
• Grafton Group today released an Interim Management Statement (IMS) showing a fall in Q1 turnover by 22% on a constant currency basis to €470m due to what was described as “the most challenging trading conditions in decades”. Poor weather, the decline in the value of Sterling and reduced spending on housing and residential repair were all strong headwinds for the group’s retailing and merchanting divisions in the period.
• So what’s the worst case scenario with swine flu? Well, the virus could be expected to claim the lives of about 2% of the 90 million Americans affected, which would be just under 2 million. And that’s just for the US.
• Old habits die hard as Citigroup seeks approval to pay out bonuses.

Stressed By The Flu? Don’t Forget The Stress Tests!
This little piggy may have gone to the market and news about the increase in the death toll due to the swine flu are overshadowing leaks, rumours and comments about the US banks’ capital adequacy tests. However, the results of the tests will have a more significant market impact in the next few sessions.

The news about the possible pandemic outbreak are making the first pages of all the major newspapers and catching most of the headlines in the newswires. This is perfectly understandable, as the threat of the beginning of a pandemic similar in scale to the 1918-19 Spanish flu is by far the greatest risk that humanity could possibly run. However, preliminary analyses and data does not seem to justify the amplitude of the media coverage, especially if we consider that this process is expected to last for many months ahead. The swine flu virus is likely to become a real threat only once it has completely adapted itself to the human body, so to become fully transmissible human-to-human. And this probably will happen in the next wave of the pandemic, if it eventually becomes so.

For the time being, however, the event that is most likely to impact the markets is going to be the release of the outcome of the US banks stress tests conducted. Admittedly, the stress tests poses a ‘lose-lose’ situation. If no bank turns out to be undercapitalised, the market will question the severity of the test and ultimately will lose further confidence in the ability of the American institutions to deal with the situation, which may result in an equity sell-off. If a sufficiently large number of banks turns out to be undercapitalised, this could trigger a renewed wave of risk aversion and prompt a stock market sell-off, providing the catalyst for the new leg down we are looking for. However, even if the market reaction seems to be biased on the downside (in terms of equity prices), this should still be regarded as the most important piece of information the market should focus on in the next couple of weeks.

Data Ahead Today
Euro area economic sentiment for April is released at 09:00. It should be a little less gloomy, improving to 66.1.

Later at 13:30, there’s a first stab at US GDP for Q1, which is expected to fall by 2.8% saar, less than half the drop seen in Q4. There should be a more favourable composition of growth (consumption should stabilise and inventories should account for most of the contraction). Domestic final sales to domestic purchasers should fall by 3.5% saar, compared with a 5.8% drop in Q4. At 19:15, we have a US interest rate decision. The post-meeting communiqué shouldn’t be market-moving, with the main focus on the language describing the economy.

Earnings highlights today include Visa (NYSE:V) (expected EPS $0.64), Aetna (NYSE:AET) ($0.93), Time Warner (NYSE:TWX) ($0.38), Starbucks (NASDAQ:SBUX) ($0.16), Wyeth (NYSE:WYE) ($0.88) and Goodyear (NYSE:GT) ($-1.38).

And Finally… Extreme Home Makeover

Disclosures :None

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