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Monday, July 23, 2012

Europe is again in the news this morning, with Spain centric fears reminding investors that the region’s problems are far from settled. With yields on Spanish government bonds reaching Euro-era highs, market participants are justifiably wondering whether the government will need much more than a banking lifeline.

These fears are showing up in the government markets of Italy and Germany as well, with yields on the former moving up and shorter maturities of the latter now in negative territory. This is a clear sign of heightened market anxieties that investors are paying the German government for lending it money. It is not much different this side of the Atlantic either, with yields on U.S. Treasury instruments at historically low levels.

These low yield levels are likely key contributors to the Fed’s hesitation to announce more QE despite market clamor. These calls on the Fed will only increase in the coming days as more evidence of economic slowdown shows up. We don’t have a particularly busy economic calendar this week, though the first read on the second quarter GDP on Friday morning will show sharp deceleration in growth. Consensus expectations are for the GDP report to show a growth rate of 1.3%, compared to 1.9% in the first quarter and 3% in the fourth quarter of 2011.

Estimates for the second quarter GDP kept coming down in recent weeks in response to soft incoming data, but the same for the third quarter and beyond still remain north of 2%. Downward adjustments to those expectations will be a key risk factor in the coming days. Other major economic reports on deck this week include New Home sales for June (Wednesday), Durable Goods Orders for June (Thursday), Jobless Claims (Thursday) and the University of Michigan Consumer Sentiment survey for July on Friday.

We also get into the thick of the second quarter earnings season this week, with reports from more than 850 companies coming out, including more than 160 companies in the S&P 500, taking us past the halfway mark by the end of this week. The results thus far have belied pre-season fears of sharp deterioration in corporate earnings. In fact, by most measures, the second quarter earnings season may not be that different from what we saw in the preceding two quarters. That said, a couple of things do stand out. Companies are finding it difficult to achieve top-line gains in the face of the synchronized global slowdown. The strength of the U.S. dollar relative to other major currencies, primarily a function of the flight-to-safety trade, is proving as another headwind for companies.

We have seen these two elements show up repeatedly in quarterly reports in recent days, including this morning’s reports from McDonald’s (MCD - Analyst Report) and Eaton Corp. (ETN - Analyst Report)). We will get results from a number of companies that are effectively pure plays on the global economic outlook, including Caterpillar (CAT - Analyst Report), DuPont (DD">DD), and UPS (UPS - Analyst Report)). But it is perhaps fair to assume that the mighty Apple (AAPL - Analyst Report)), which reports after the close on Tuesday, is immune from these trends.

Sheraz Mian
Director of Research

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