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Ahead of Wall Street

Friday, July 13, 2012

The market will likely find China’s second quarter GDP growth numbers reassuring as many read last week’s second interest rate cut in less than a month as a sign of much weaker growth trend. But the inline growth number notwithstanding, it is nevertheless further confirmation that the global economy remains in a precarious state.

On the home front, we got more details this morning about J.P. Morgan’s (JPM - Analyst Report) trading loss, prompting the bank to restate its prior-quarter results even as its second quarter earnings and revenue numbers came in better than expected. While J.P. Morgan’s trading woes are clouding at the true earnings power of its banking franchise, we have no such issue with Wells Fargo (WFC - Analyst Report)) results this morning, which are almost boring by comparison (perhaps we need more boring and less exciting banks). Wells beat EPS expectations by a penny on in-line revenue.

In other economic news, the June producer price index was a tad bit hot on the ‘headline’, but the ‘core’ number broadly in-line with expectations. The University of Michigan consumer sentiment survey coming out a little later is expected to show a modest gain from its last reading.

With respect to China and the global growth worries, the issue came full circle for stock market investors this week when engine maker Cummins (CMI - Analyst Report) preannounced and cited not only China, but also weakness in Brazil, India, and the U.S. Cummins is the poster child for the export centric industrial corporate players, but we have been hearing about weak economic growth affecting the earnings outlook from a host of companies in different industries ahead of this earnings season, like FedEx (FDX - Analyst Report)), Proctor & Gamble (PG - Analyst Report)) and Nike (NKE - Analyst Report)), to name just a few. This has raised concerns that we may see a material deterioration in the corporate earnings picture as the second quarter reporting season unfolds.

China’s in-line second quarter GDP growth rate of 7.6% was the lowest since the beginning of 2009 and the bellow the first quarter’s 8.1% growth pace. Many expect that the second quarter growth rate could be the low point of this year’s quarterly GDP growth readings as already implemented stimulus measures start taking effect. The proportion of growth coming from domestic consumption appears to be steadily increasing, though it will likely be a while before domestic consumption can offset weakness in exports and investments, which have thus far been the biggest drivers of growth.

Europe’s problems have contributed to China’s slowdown though the trade route, but the government’s policy of reining in speculative excesses in the real estate sector has also been significant in bringing down economic growth. Some estimates put the size of the real estate sector as high as 12% of the GDP. Tighter government regulations in the sector have showed up in reduced new construction and in demand for cement, furniture, and appliances. While government officials continue to state their determination to maintain strict controls on the sector, many observers are starting to see evidence to the contrary. This could mean that the real estate sector will stop being a drag on the economy going forward.

Bottom line, the Chinese growth numbers turned out to be less worrisome than many were fearing. And J.P. Morgan’s results, particularly its restatement of last quarter’s results, raise serious questions about internal controls at the country’s supposedly best-run bank, which also happens to be the largest by assets.

Sheraz Mian
Director of Research

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