Stocks are looking oversold as the market discounts a loss of earnings momentum that is likely to follow a weakening global economy, according to Mike Lenhoff, the chief strategist at Brewin Dolphin.
While the impact of the Japanese earthquake and nuclear disaster was unexpected, Lenhoff believes the other factors behind the slowdown were not.
“The tightening of monetary policy throughout the developing world has been underway for over a year. India was the first among the BRICs to raise rates in March 2010 and Brazil followed a month later,” Lenhoff wrote in a research note.
With inflation data from China overnight pointing to further hikesfrom the People’s Bank of China Lenhoff said the latest M2 data shows money supply has fallen back to where it was just prior the great stimulus.
“On top of the central bank tightening, the rise in commodity prices, oil especially, was not only bound to squeeze real income growth but to squeeze profit margins and reflect sooner or later on earnings growth,” said Lenhoff who sees reasons to be cheerful for stock investors despite all the bad news.
“Earnings do not stop growing just because of this. Also, what matters for equity markets is whether they exceed or fall short of expectations,” he explained.
“If markets increasingly reckon on a relapse into recession, commodity markets should soon be tanking. The high yield spread, an acutely sensitive gauge of trouble ahead, should widen at least to where it was this time last year when the euro zone sovereign debt crisis ruled markets and the dollar should be flying.”
The CRB spot commodity prices index is a measly three percent down from its peak, the high yield spread has opened up a little and the dollar, in trade weighted terms, has barely moved.
But it’s all "worth watching,” Lenhoff said.
“With the media obsessing on the negative and downbeat you might have thought there is nothing but despair and hopelessness ahead for the US and Europe – just the sort of stuff that might help to bring in the buyers,” he added.