Prieur Perspective: Too Soon To Celebrate?
Bulls may be getting ahead of themselves.
Equity bulls experienced another good week based on the viewpoint that the worst of the credit crisis might be behind us. A further improvement in investor sentiment and increased risk appetite caused market participants to cast aside a mixed bag of economic and corporate data and look across the "economic valley."
This raises the question of whether the stock market euphoria is premature. Bill Gross of PIMCO (Money News) said the recovery is primarily due to federal policy moves to restore liquidity. It won't last long, Gross warns. "Recession, and its vicious-cycle effect on employment and consumer spending, remains a threat," Gross says. "This recession, though currently mild, and, as of yet, not even officially validated, may not be your garden-variety, father's-Oldsmobile type of downturn."
Bill King (The King Report) views the current stock market improvement as a sucker rally, warning that an autumn debacle is a very high probability. "For obvious reasons, permabulls, Street paper pimps and their stooges in the financial media mitigate the fact that financial firms are raising and must continue to raise enormous amounts of capital and overemphasize purported good news. Ergo, as benign earnings as possible are crafted, and the U.S. government crafts benign economic statistics," said King.
Talking about monetary authorities, Federal Reserve Chairman Ben Bernanke acknowledged on Tuesday that U.S. financial markets remained unsettled and that the Fed would continue to increase its auctions of cash to banks as needed. Bernanke added that although the markets had improved, they remained "far from normal" and that it would take "some time" for financial institutions to resolve the sub-prime/credit crunch.
Let's review the financial markets' movements on the basis of economic statistics and a performance round-up.
Global business confidence slipped to another new record low last week, according to Moody's Economy.com. The results of its Survey of Business Confidence suggest that the US and European economies are contracting, while the Asian and South American economies are growing below potential.
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The past week witnessed a myriad of U.S. economic reports of which the following were of particular interest:
- The University of Michigan Consumer Sentiment Index dropped by 3.1 points in May. The index came in at 59.5, the lowest reading since June 1980.
- The NAHB Housing Market Index for the U.S. as a whole decreased from 20 to 19 in May 2008, indicating that the housing market is continuing its downward slide.
- Housing starts increased by 8.2% to 1.032 million units in April. Despite the increases from a month ago, starts remain well below their year-ago levels.
- Industrial production fell by 0.7% in April, more than twice the consensus estimate. Manufacturing output fell by 0.8% – half of the decline owing to a large drop in auto production. Capacity utilization fell from 80.4% to 79.7%, its first sub-80% reading since 2005.
- Total retail sales fell by 0.2% in April, following a revised 0.2% gain in March. Sales at auto dealers tumbled. Hence, ex-auto sales rose by 0.5% after gaining 0.4% in March.
- The Consumer Price Index increased by 0.2% in April, down from 0.3% in March. Over the past year, the CPI has increased by 3.9%, although top-line inflation has slowed in recent months. The core CPI, excluding food and energy, increased by 0.1% in April, down from 0.2% in March. Over the past year, core CPI has increased by 2.3%.
John Cassidy (Condé Nast Portfolio.com) reported: "Simulations carried out by Frederic Mishkin, one of Bernanke's colleagues at the Fed, imply that the typical American family will cut its spending by up to 7 cents for every dollar in housing wealth it loses. Given a 20% fall in prices, this adds up to a nationwide reduction in consumer spending of about $350 billion a year, or 2.5% of the US's gross domestic product. That's a big number – more than big enough to tip the economy into recession."
Summarizing the economic situation, John Mauldin (Thoughts from the Frontline) said: "I think the Fed will be on hold for a rather long time. We are in a Muddle-through Economy. Even if the economy gets worse, the problems in the economy would not be helped by lower rates. And until the economy starts growing at a rate above 2%, it will be difficult to justify raising rates in the face of such slow growth. Given the pressure on consumer spending and housing prices, I think the recovery that should begin later this year is going to be a rather tepid one."
Elsewhere in the world, the Bank of England reported a particularly downbeat economic outlook, while both consumer and producer prices accelerated significantly in April. Industrial production cooled in the Eurozone, but consumer inflation (3.3% year on year) remained significantly higher than the European Central Bank's 2% inflation target.
Further to the East, Japan's first-quarter GDP increased at a better-than-expected rate of 0.8% quarter on quarter, boosted strongly by exports. China ordered banks to set aside more deposits as reserves for the fourth time this year after inflation accelerated, approaching the fastest pace since 1996.
Here's a look at this week's economic reports, courtesy of Yahoo Finance, May 16, 2008.
In addition to the minutes of the FOMC meeting of April 29 and 30 getting released on Thursday, the next week's economic highlights, courtesy of Northern Trust, include the following:
1) Leading Indicators (May 19): Interest rate spread, vendor deliveries, initial jobless claims, building permits, and stock prices advanced in April. Consumer expectations and the manufacturing workweek are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defence capital goods are used in the initial estimate. The index is likely to show a steady reading. Consensus: -0.1%.
2) Producer Price Index (May 20): The Producer Price Index for Finished Goods is expected to have risen 0.4% in April, reflecting higher food and energy prices. The core PPI is most likely to have risen by 0.2%, matching the gain seen in March. Consensus: +0.4%, core PPI +0.2%.
3) Existing Sales (May 23): Sales of existing homes are predicted to have declined to an annual rate of 4.85 million units in April from 4.93 million units in March. Consensus: 4.85 million versus 4.93 million in March.
4) Other reports: OFHEO Price Index (May 22).
This performance chart from May 18, obtained from the Wall Street Journal Online shows how different global markets performed during the past week.
Global stock markets were in rally-mode and added to the gains of the past two months, with the MSCI World Index closing 2.9% higher on Friday. The Nikkei 225 Average (+4.1%) fared the best among the mature markets. Emerging markets (+4.3%), however, showed mature markets a clean pair of heels.
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The Russian market was a highlight of the week, with the Russian Trading System Index surging by 8.5% to hit an all-time high. The Bovespa Stock Index (+4.5%), the Toronto Composite Index (+3.2%) and the South African FTSE/JSE All Share Index (+1.8%) also scaled new peaks.
The strongest US stock market index was again the Nasdaq Composite Index with a gain of 3.4% (YTD -4.7%), followed by the Russell 2000 Index with +2.9% (YTD -3.2%), the S&P 500 Index with +2.7% (YTD -2.9%) and the Dow Jones Industrial Index with +1.9% (YTD -2.1%).
From a technical point of view, a number of key indices are up against resistance levels at their 200-day moving averages, most notably the S&P 500 Index at 1,425 (closing level: 1,425) and the Dow Jones Industrial Index at 1,300 (closing level: 12,987).
Fading concerns about an economic Armageddon and commensurately less safe-haven buying, together with mounting inflation worries, resulted in investors switching from government bonds to equities, pushing government bond yields higher in most parts of the world.
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The yield on the two-year US Treasury Note closed the week 23 basis points higher at 2.46%, whereas the ten-year US Treasury Note yield increased by 9 basis points to 3.86%. Worrying inflation reports, in particular, caused the two-year UK Gilt to jump by 41 basis points (its biggest weekly rise in 14 years) to 4.80% and the ten-year UK Gilt by 19 basis points to 4.78%.
Government bonds elsewhere in the world followed a similar pattern, thereby resulting in flattening yield curves.
US mortgage rates also increased, with the 15-year fixed rate rising by 8 basis points to 5.53% and the 5-year ARM rate edging 4 basis points higher at 5.38%.
Credit market stress eased with spreads tightening considerably in both the US and Europe.
The past week again saw volatility in the currency markets, with the US dollar improving during the first half of the week, but dropping back later on poor economic data, suggesting that an interest rate increase by the Fed was unlikely any time soon.
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A hawkish stance by policymakers in the Eurozone caused the US dollar to weaken by 0.4% against the euro over the week.
The Bank of England presented a gloomy economic outlook for the UK, resulting in the British pound declining to a three-month low against the US dollar by mid-week, but sterling recovered on Friday on the back of the poor US consumer confidence data.
High-yielding currencies such as the Australian dollar and New Zealand dollar strengthened markedly, as a result of a resurgence of carry trade transactions. On the other hand, low-yielding currencies such as the Japanese yen and Swiss franc came under pressure.
On the commodity front, the Baltic Dry Index of freight costs surged to an all-time high, indicating accelerating demand for commodities such as coal, iron ore and grains.
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Crude oil was again in the limelight with West Texas Intermediate hitting a new peak of $127.82 a barrel on Friday before an announcement by the Saudis to boost production pulled the price down to a more modest gain of 0.3% for the week.
Goldman Sachs forecast that oil prices would average $141 a barrel during the second half of 2008.
The strong oil price and somewhat weaker US dollar positively impacted on gold (+1.6%), platinum (+1.4%) and silver (+0.3%).
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