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Seeking Direction After a Trying Week


Global stock markets began the year on shaky ground, trading lower during the past week amid concerns in the housing and credit markets.


A trading week made up of a bit of the old year and a bit of the new caused some anxiety in financial markets as economic woes escalated and weighed on investor sentiment. The problems related to the housing market and the subprime implosion seemed to be coming to a head. After all, the Dow Jones Industrial Index recorded its worst three-day start to a New Year year since the depths of depression in 1932, according to Barron's.

Stock markets were left in the shade as both gold and oil hit all-time highs. Nouriel Roubini, professor of economics at New York University, wrote on his blog: "…the stock market started the year with another bearish fall… a lousy stock market in 2007 will look good compared to an awful stock market in 2008."

Santa Claus failed to call upon the traders on Wall Street. The "Santa Claus Rally", as defined in the Stock Trader's Almanac, is the propensity for the S&P 500 Index to rally during the last five trading days of December and the first two of January. This year's rally saw the S&P 500 Index down 2.5% and the Dow Jones Industrial Index (-2.9%) and the Nasdaq Composite Index (-3.3%) were not spared either.

It is pointed out by the Stock Trader's Almanac that the lack of a rally had often been "a harbinger of a sizable correction or a bear market in the coming year." Hence the saying: "If Santa Claus should fail to call; bears may come to Broad & Wall."

John Mauldin, author of the Thoughts from the Frontline newsletter, is also of the opinion that the equities bull market may finally succumb in 2008, and said in his 2008 forecast:

"I think that we are in a recession for most of the first half of this year, and that we begin a slow recovery in the second half. It will be a Muddle Through Economy for at least another year after that. That would suggest that most companies will come under serious earnings pressure. If history is any indicator, that means we should see a bear market in the first half of this year. How deep will depend on how fast the Fed cuts, but I don't think we are looking at anything close to the bear market of 2000-2001. Still, I wouldn't want to stand in front of a bear market train."

Now, let's briefly review the financial markets' movements on the basis of economic statistics and a performance chart.


The past week's economic reports fueled concerns about the spillover effect of the subprime crisis leading to an economic recession.

The much anticipated U.S. employment report on Friday, which showed weaker-than-expected job growth and a rise in the unemployment rate, compounded investors' worries.

According to the Institute for Supply Management, national manufacturing activity shrank unexpectedly in December. Specifically, the ISM Index fell to 47.7 from 50.8 in November – a reading below 50 indicates a contraction in manufacturing activity.

These reports provide strong support for further Fed easing. An interest rate cut of 25 basis points at the FOMC's next meeting on January 30 seems a foregone conclusion, but the Fed Fund futures now also indicate a 46% chance of a 50 basis point reduction. "There are those who hope that the Fed will ride to the rescue with more rate cuts. I believe they will, but it is a case of 'too little, too late'," remarked John Mauldin.

Economic Reports

Click to enlarge

Source: Yahoo Finance, January 4, 2007.

The next week's economic highlights, courtesy of Northern Trust, include the following:

  • International Trade (Jan 11) – Higher imported oil prices probably played a role in the widening of the trade gap to $58.5 billion in November from $57.8 billion in October. Exports are predicted to have risen largely due to a weak dollar, while imports are not likely to show impressive growth due to soft economic conditions. Inflation adjusted exports of goods and services grew at an annual rate of 19.1% in the third quarter, while inflation adjusted imports of goods and services posted a paltry gain of 4.4%. Consensus: $58.5 billion

  • Other reports – Pending Home Sales (Jan 8), and Import Prices (Jan 11).


The performance chart obtained from the Wall Street Journal Online indicates how different global markets fared during the past week.

Click to enlarge

Source: Wall Street Journal Online, January 6, 2007.

As this article deals only with the past week's performance, a separate performance review of 2007's market movements was posted on the blog last week. This round-up makes for interesting reading and also provides pointers of what to expect in the year ahead. Please click here for full the article.

Global stock markets began the year on shaky ground, trading lower during the past week amid escalating concerns about the fallout in the housing and credit markets. The MSCI World Index lost 3.2% during the course of the week, but a number of emerging markets helped to stem the overall losses.

The U.S. markets were at the forefront of the sell-off with the blue-chip Dow Jones Industrial Index losing 4.2%, the broader S&P 500 Index 4.5% and the technology-heavy Nasdaq Composite Index 6.3%. Small caps and the sectors for REITS, financials, housing and consumer discretionary spending, in particular, were not spared the selling pressure.

Government bond yields declined in both developed and emerging markets as the global economic outlook worsened and investors switched stocks to what is perceived to be a safe-haven asset class.

On the currency front, the U.S. dollar came under renewed pressure as markets started pricing in the possibility of the Fed reducing interest rates by 50 basis points at the end of January. Concerns about the deteriorating prospects for the U.K. economy resulted in the British pound recording a four-year low against the euro.

The star performers among the major currencies were the Japanese yen (+4.1%) and Swiss Franc (+2.0%) as increased risk aversion resulted in unwinding of carry trades. The Chinese yuan also caught the limelight on the back of its uptrend.

Commodities were the big winners during the past week as investors piled into oil and precious metals.

Crude oil hit a record level of $100 a barrel early in the New Year, but subsequently eased back somewhat. Factors driving the oil price included a weaker dollar, geo-political tensions over the Middle East and supply concerns.

The gold price also reached a record high during the past week, soaring above the $850 an ounce level last achieved in January 1980. In addition to the factors driving the oil price, gold benefited strongly from mounting inflation jitters.

Agricultural commodities again put in a strong performance and gained 3.6% during the week.

This week promises to be a key week for the direction of financial markets.

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