U.S. corporate results bode well for Canadian earnings season. Photo By Deborah Baic/The Globe and MailDeborah Baic/The Globe and Mail
North American markets managed to grind out steady gains last week despite political brinkmanship on both sides of the Atlantic. This week, with the debt crises in both Europe and the U.S. inching closer to resolution, investors may re-set their sights on economic data and corporate fundamentals.
Europe
Early this week, expect the markets to pass judgment on whether the Greek crisis is truly over or just postponed. Certainly, optimism prevailed Friday, after an agreement on a second bailout for Greece. But the devil is always in the details.
Jonathan Loynes, chief European economist with Capital Economics in London, doesn't think the optimism will last long. He says the package represents a significant advance in the European Union's response to the crisis, but falls short of addressing the fundamental challenges that plague the region.
Even with Greece's default, which reduces the value of outstanding bonds by 20 per cent, the country's debt-to-GDP ratio remains at an "unsustainable" level of about 130 per cent, he noted.
Among economists' concerns is whether the rescue fund that European leaders set up last summer has sufficient resources to carry out its new assignments. Known as the European Financial Stability Facility, it has been handed greater flexibility to give credit lines to states before they are shut out of credit markets, lend governments money to recapitalize banks, and intervene in the secondary market to buy sovereign debt.
"Our initial reaction is that progress was made, but not the sort of game changer that the situation has been demanding," said Martin Schwerdtfeger, senior economist with Toronto-Dominion Bank.
Earnings
Earnings season has taken a back seat to sovereign debt issues recently, but it deserves attention. Among the 121 S&P 500 companies that had reported second-quarter earnings by last Friday, 83 per cent exceeded the average analyst estimate, according to data from Bloomberg. Canadian reports begin in earnest this week.
"The data that we are seeing out of the U.S. does bode very well for what we should expect in Canada," says Daniel Bain, president and chief investment officer with Thornmark Asset Management Inc. in Toronto.
Mr. Bain thinks that investors are ready to put European and U.S. debt problems behind them and start making decisions again based on corporate performance. Canadian firms are likely to show similar growth trajectories as U.S. companies, which, combined with low interest rates and a job market that favours employers, should support corporate earnings until at least the end of the year, he said.
"If you pair that up with valuations, you get a pretty good recipe for a healthy return on equities," Mr. Bain added.
GDP
The week is relatively light in economic data, except for gross domestic product figures on Friday in both Canada and the U.S.
Economists expect the numbers will show that U.S. GDP grew in the second quarter at an annualized rate of 1.7 per cent. That figure would represent a slight decrease from the first quarter. The problem? Consumers, who tightened their belts in the face of higher prices for gasoline, food and automobiles.
In Canada, economists forecast that GDP rose 0.2 per cent in May, following no expansion in April. However, growth for the whole of the second quarter appears on track for an annualized rate of about 1.3 per cent and should pick up pace to nearly 3 per cent in the third quarter, according to Douglas Porter, deputy chief economist at BMO Nesbitt Burns.
One other data highlight this week out of the U.S. will be the U.S. Conference Board's measurement of consumer confidence for July. The reading is expected to decline for the third month in a row, with rising unemployment, elevated gasoline prices, a moribund housing market and financial uncertainty in Washington all weighing down sentiment.