A febrile time for financial markets this week. The conjunction of a number of key reports in the US this week, overlain by the possible default by Argentina on up to $US29 billion of its debt, could trigger another bout of fear and loathing on all financial markets in the coming week.
At the same time, the markets will have to digest the surprising news that equities bull Goldman Sachs produced a surprise downgrade of its three month outlook for US and global markets.
Goldman Sachs analysts also cut their view on corporate credit on Friday as well.
News of that downgrade emerged after trading closed in the US on Saturday morning, our time.
Our market will start flat to lower this morning, with the Aussie dollar trading just under 94 USc as tensions rise in financial markets about the possible default by Argentina, plus growing concerns about US stock valuations and the Fed’s monetary policy.
The Dow lost ground over the week, the S&P 500 was flat and the Nasdaq rose as American markets missed the confidence seen in offshore markets.
That saw European shares rise 0.5%, Japanese shares rise 1.6%; Chinese shares jump 3.2% and Australian shares add 0.9%.
In fact Australian shares rose to their highest since June 2008. Commodity prices were mixed, with oil down, gold flat and copper up.
Argentina is negotiating with US hedge funds (vulture funds, actually) creditors to resolve a dispute over $US1.5 billion in unpaid principal and interest.
The hedge funds bought the debt at very low prices in the hope of forcing Argentina to repay the debt and accrued interest.
Favourable US court judgements have helped the hedge fund and forced Argentina back to the negotiating table, but it is refusing to negotiate.
Argentina will default for the second time in 13 years, if it’s unable to reach a deal with the hedge funds before July 30.
It will also be the eighth time in the country’s history that it has defaulted.
The debt mediator in the dispute met with Argentine officials in New York on Friday.
But the Argentine mission returned home on Friday night, according to US media reports, without any further talks being scheduled.
Following a US District Court judge’s ruling, Argentina can’t pay investors who accepted lower-valued bonds after its record $US100 billion default in 2001 unless it also pays off bondholders who didn’t participate in previous bond swaps.
The holdout hedge funds accuse Argentina of refusing to negotiate to avert the default, Argentina says these funds are ghouls.
There is a total of $US29 billion worth of new Argentina debt that will be impacted by any default.
There could be a move to extend the deadline past July 31, but that might not come until the last minute. No one wants to trigger a default that would damage global confidence.
But Argentina’s problems are coming in one of the biggest week for market moving news for some time, especially in the US.
The Fed meets, the US jobs report for July, the first economic of US second quarter growth and second quarter earnings reports, all have the potential to hit market sentiment in the coming five days.
The one area that is worrying more and more analysts is the corporate bond market, especially so-called high yields (junk) where there a sell-off has already started in the past ten days.
Credit spreads are widening and investors are withdrawing billions of dollars from mutual and Exchange Traded Funds which invest in high yield securities.
So far these concerns have not shown up in the high yield/emerging sovereign bond market (think Turkey, Brazil, Greece, Portugal, Italy and Spain). But a default by Argentina would focus attention very quickly on this fragile sector.
News that Brazil pumped $US20 billion into its bank sector on Friday to try and boost liquidity and bank lending will also be noted as a move to watch.
So amid these growing (but still muted) concerns it was probably not much of a surprise that US markets weakened on Friday with Wall Street finishing on a decidedly negative note.
The Dow lost 0.7% on Friday and the Nasdaq and the S&P 500 lost half a per cent each.
The Dow fell 0.8% for the week and the S&P was flat, but the Nasdaq rose 0.4% (thanks to better than expected reports from Microsoft and Facebook). And not only did equities fall, but US Treasury yields fell, with 10-year bond yields falling for the third week in a row and ending around 2.47%.
And the VIX index, which represents anticipated volatility on the S&P 500, jumped by close on 7% on Friday and was up 5% for the past week in one of its biggest moves for weeks.
The surprise was the move by Goldman Sachs to cut its three-month view on global shares to neutral, while maintaining the 12 month optimistic view of shares.
According to media reports Saturday, Goldman’s strategy team warned that "a sell-off in bonds could lead to a temporary sell-off in equities.
"This makes the near-term risk/reward less attractive."
The team recommended an overweight view over 12 months, calling equities "the best positioned asset class" over that time.
"We expect reasonable returns for the U.S. on an absolute basis over the coming year, but relative to other markets, the longer-term recovery potential is smaller given already high margins and strong performance so far," the analysts wrote.
The note comes after Goldman Sachs analysts raised their year-end target for the S&P 500 index, making them among the most bullish among Wall Street analysts.
Goldman strategists downgraded corporate credit in its report Friday to underweight over both three and 12 months.
"We think spreads will narrow slightly, but given already tight levels, rising government bond yields are likely to dominate the returns especially for US IG credit where spreads are the lowest," they wrote.
That might be the more important of the downgrades, especially if Argentina defaults and sets off tremors in high yield markets (which many analysts reckon is overbought and overvalued).
