Friday, August 8, 2014
Stocks are on track to open higher, but a growing list of geopolitical concerns are driving investor sentiment and market action. The Iraq situation is grabbing headlines, but Russia remains the primary worry for the markets.
The U.S. government’s announcement of targeted air strikes in Iraq adds to the uncertain geopolitical backdrop in which global markets have been operating lately. The Sunni extremists who have carved out a mini-state within Iraq and Syria have been steadily adding to their space and resources lately, with most of the recent gains coming largely at the expense of the supposedly better trained and organized Kurdish Peshmerga forces. U.S. involvement in the conflict will stall the extremist advance, but it’s hard to tell at this stage whether limited air raids will be enough to dislodge them from their entrenched positions in and around Mosul, the second largest city in Iraq.
More than Iraq, the immediate area of concern for global markets is the face-off with Russia over Ukraine. Unconfirmed conciliator comments coming out of Russia today have lifted investor sentiment this morning, with European stocks and U.S. futures reversing earlier losses. But this is a fundamentally unstable situation that is extremely difficult, if not altogether impossible, for investors to handicap.
Russia’s recent moves in the region indicate that it remains unwilling to tolerate an unfriendly unified Ukraine, and seems prepared to play the long game. The issue is to what extent Europe, particularly Germany, is willing and ready to confront Russia over Ukraine, particularly with its own economic health in a weak state.
In corporate news this morning, McDonald’s (MCD) came out with unusually weaker than expected July same-store sales numbers. Sales were down across the world, but were notably down in Asia, with comps in the region down a -7.3%. Part of the Asian problem is the food-safety issue in China, which has been problem for Yum Brands’ (YUM) KFC chain as well. But the situation in the U.S. market is no better, with comps down -2.5% relative to consensus estimates of -2.5%.
The company has faced challenges in the past as well, but these lousy numbers raise the prospect of a more enduring structural shift for the fast-food chain. Earnings estimates for McDonald’s have been steadily coming down in recent days, pushing the stock to Zacks Rank #4 (Sell), but today’s global comps numbers show that they likely have more room to go.
Stocks and other risky assets don’t do well in periods of geopolitical uncertainty, and the current period is no different. Uncertainty prompts investors to shun risky assets and take shelter in defensive ones, like U.S. treasuries and German bunds. As a result, yields on U.S. and German government bonds have been coming down. The yield on 10-year German government bonds dropping to 1.02% at one stage today while 2-year German government bond yields are in the negative – investors are paying the German government for the privilege of owning its debt instrument.
Sheraz Mian
Director of Research
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