Breakout

What the Market Wants to See From Europe & U.S. GDP

Jeff Macke
Breakout

After weeks of operatic plot twists, investors are braced for something tangible to come from European leaders. Details of Europe's long awaited debt crisis rescue plan are scheduled to be released Wednesday after a weekend of negotiations between the 17 member nations of the Eurozone as well as representatives from all 27 countries of the European Union.

Adding to the drama for U.S. investors, preliminary figures for U.S. third quarter economic growth are set to be released on Thursday morning. Official consensus estimates for Q3 are 2.5%, up from 1.3% in Q2. Couple the two key news events with yet more earnings releases from corporate America and you have a recipe for even more confusion in a year already set to go down as one of the most baffling in recent memory.

With stocks now virtually flat for the year, the question for investors comes down to what the market actually wants to hear in order to justify October's massive rally. To help figure it out Breakout welcomed Joe Quinlan, chief investment strategist at U.S. Trust (a subsidiary of Bank of America which is Breakout's sponsor).

Quinlan says the market needs to see a plan from Europe that addresses debt restructuring, a bank recapitalization, and a big facility to assure investors that the strategy has enough money behind it to last. The key to the debt restructuring is Greece, with the debate centering on just how much the Greek paper held by European banks needs to be marked down. Early estimates were for a 20% haircut, a figure now rumored to be three times higher. "The larger the markdown the bigger the problem for the banks," Quinlan says, because the banks will have to raise money to comply with liquidity regulations.

Noting that the EU has been "playing for time" Quinlan says now is the moment to end the theater and start producing. Eurozone leaders could start by actually meeting their self-imposed Wednesday deadline and releasing a coherent strategy.

Less dramatic, but no less interesting is the the release of U.S. GDP on Thursday. After spending much of Q3 arguing whether GDP could top 0%, economists have now upped their viewpoints to a relatively robust 2.5%, nearly double the Q2 growth rate. Quinlan is even more sanguine with his view that 2.5% is a distinct possibility.

With unemployment stuck over 9% it's hard to see any sort of tangible improvement in America's economic condition. Quinlan says cuts in government jobs are masking strong exports and even hiring in corporate America. "The big guys are hiring because exports are strong," he says. That observation is supported by an earnings beat from Caterpillar (CAT), a company on the front lines of both global and domestic growth.

Consumption, which seems to hang in there regardless of the idea that domestic consumers "shouldn't" be spending, is Quinlan's favorite data point. Beyond that the strategist says "all roads lead to Washington," a rather discouraging prospect in light of DC's dedication to act as a roadblock to anything but preserving the crummy status quo.

Add it up and Quilan says investors should stick to Information Technology and Industrials. Regardless of slowing growth overseas, he's also a long-term energy bull based on Emerging Market growth.

That's Quinlan's playbook. How do you see it? Let us know in the comment section below.

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