A dose of cautionary comments on three things that seem to only go up lately: the euro, stocks and corporate earnings.
First on the euro, which surged through $1.43 today its highest level vs USD since January 2010, and looks as if it’s left any and all concerns about sovereign debt in the dust.
Nomura says in a report that it’s too early for the euro to shed that risk. “The uncertainties about the economic outlook, debt dynamics, and the political framework around managing sovereign insolvency are simply too great,” firm says.
It estimates “a debt restructuring isolated to Greece/Ireland/Portugal would trigger direct and indirect losses around $240bn for core Eurozone banks, while bank losses would rise to $480bn in a restructuring including Spain.” German banks have the largest exposure to the periphery, Nomura says, with estimated losses of $185B in a restructuring scenario involving Spain.
Implied risk premium on the euro “has compressed significantly since January,” firm says, as the single currency “decoupled from sovereign risk.” That process “has probably run too far at this point: a persistent risk premium is still needed.”
On to stocks and some thoughts from BofA Merrill small-cap strategist Steve DeSanctis. He points out that weaker economic news, higher energy prices and disaster in Japan tripped up stocks in early March, but a “liquidity driven rebound” has put the Russell 2000 within 1% of its all-time high.
“Volatility came tumbling down despite the fact that none of the earlier concerns…have been resolved,” he writes, and small caps “are now very close to the full year’s return we have been expecting.” DeSanctis says he’s been “taken back by the strength of the overall equity market and in small caps in particular given the economic backdrop and where absolute and relative valuations stand,” and thinks 1Q earnings estimates are too high.
Meanwhile, DeSanctis’ colleague at BofA Merrill, quant strategist Savita Subramanian, suggests analysts may be underestimating the impact of higher costs on 1Q earnings.
“One looming risk in the upcoming earnings season is that earnings misses could be more plentiful, particularly in sectors that have historically been hurt by inflation, as we are seeing signs that analysts may not be building cost pressures into margin expectations,” Subramanian writes.
“That said, we expect overall large-cap margins to do nothing worse than stabilize, as they generally do at this point in the cycle,” Subramanian adds.
To which we would add: Nothing worse than stabilize? Investors may be okay with stabilizing margins if the S&P 500 was down 22% since August instead of up, but we’d guess they don’t have “stabilize” in mind as they pay higher and higher prices for stocks.