Weak US Earnings Cast Shadow Over Risk Appetite

A slew of weak U.S. corporate earnings results have brought concerns about the global economic outlook back to the fore with a vengeance, threatening to end a four-month long rally in world stock markets and other risk assets.

Weak US Earnings Cast Shadow Over Risk Appetite
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The Dow Jones Industrial Average on Tuesday suffered its biggest one-day drop since June after large companies such as Dupont, United Technologies and 3M reported disappointing results.

"Not only did traders see more below-expectation third-quarter results from blue chips like 3M and DuPont, but the job axe also reared its ugly head as firms announced staff cutbacks. This will be a hammer blow to the latest U.S. unemployment figures which dipped below 8 percent for the first time in three years recently," Justin Harper, a market strategist at IG Markets in Singapore said in a note.

"All this negativity weighed heavily on U.S. equities last night and threatens to undo the rally that has built up amid central bank policy easing," he added.

Dow Chemical said it would cut 2,400 jobs, about 5 percent of its workforce, while DuPont said it would axe about 1,500 workers, about 2 percent of its global headcount.

Tuesday's ratings downgrades of several indebted regions in Spain have added to concerns about global growth, while in Asia, weak earnings results from South Korea's POSCO, he world's fourth-largest steelmaker also weighed on sentiment.

Just a Pull-Back?

Weak corporate earnings news from the U.S. deals a blow to risk appetite, which has received a significant boost in recent months from positive U.S. economic data, easing concerns about the euro zone debt crisis, monetary stimulus from major central banks and some signs that a slowdown in the Chinese economy is finally bottoming out.

"A lot of good news had been priced into stocks, especially in the U.S., so it is natural to see a pull-back in risk assets," said Timothy Riddell, head of global markets research at ANZ Bank in Singapore.

"That pull-back could continue ahead of the U.S. election and the change in Chinese leadership next month," Riddell said, adding that the massive monetary stimulus by central banks in recent months should help limit the sell-off.

Indeed, in Asia news on Wednesday that the China HSBC Flash Manufacturing Purchasing Managers Index hit a three-month high of 49.1 in October boosted hopes of a stabilisation in China's economy and helped Asian markets rebound from early sharp falls.

Despite a sell-off this week, global markets remain in good shape -- the S&P 500 is up about 12 percent from a low hit in June, while Asian and European shares are up around 15 percent from their June lows.

To some analysts, a general retreat in stocks is justified by uncertain economic outlook.

"We've seen GDP numbers continue to come through at the lower end of the range, which has been a negative for us. Unemployment has improved but not drastically, and in Europe, it continues to rise, while interest rates are still on their way down generally," Martin Gray, a fund manager at MitonOptimal told CNBC Asia's "Squawk Box."

High unemployment is seen as a major roadblock to a strong U.S. economic recovery and the key reason behind the aggressive asset-purchasing program unleashed by the U.S. central bank last month, which pledges to purchase $40 billion of mortgage-backed bonds a month until labor market conditions improved substantially.

Cue the Fed

The Fed concludes a two-day monetary policy meeting later on Wednesday and the tone of its statement could be the next driver for the now jittery markets.

"If they (Fed officials) sound encouraged by the improvements in U.S. data, stocks could rebound, helping to ease some safe haven flows out of the U.S. dollar and Japanese yen," Kathy Lien, managing director of FX strategy for BK Asset Management, said in a note.

"If they err on the side of caution and express skepticism about how long the improvements will last, the sell-off in equities and currencies could deepen," she added.

- By CNBC's Dhara Ranasinghe; Follow her on Twitter: @Dhara CNBC