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Prieur Perspective: Oil, Unemployment Triggered Sell-Off


Friday's volatility marked down week.


After stock markets have held up bravely in the face of the credit crises and mounting economic woes, a combination of renewed concerns about the financial sector, a record-breaking spurt in the oil price, and a rotten unemployment number claimed their toll on Friday, triggering a sharp sell-off in most parts of the world.

"Today was a bona fide panic day. They threw 'em in," said Richard Russell, author of the Dow Theory Letters for the past 50 years. The bears were out in force, as personified by Bill King (The King Report): "The technicals, seasonals, fundamentals and financial system conditions are negative. And now the Federal Reserve is suggesting that it will no longer cut rates. Rallies should be viewed as a gift from the trading gods."

Angst about banks' credit and funding problems resurfaced strongly last week on the back of Lehman Brothers' (LEH) rumored quarterly loss and capital raising exercise, the ousting of Wachovia's (WB) CEO, a Wall Street Journal report that the SEC was investigating AIG (AIG) for its swaps accounting, and the downgrading of the credit ratings of bond insurers MBIA ((MBI) and Ambac Financial (ABK).

Fed Chairman Ben Bernanke broke tradition on Tuesday when he, rather than the Treasury, commented on the U.S. dollar. He said the Fed was "… attentive to the implications of changes in the value of the dollar for inflation and inflation expectations" and that price stability and maximum sustainable employment would be key factors ensuring the dollar remains a strong and stable currency.

Bernanke's remarks, together with generally better-than-expected economic reports, reinforced expectations of the Fed keeping interest rates on hold for the months ahead. However, Friday's huge jump in the unemployment rate caused pundits to revisit this belief, leading to increased volatility in all financial markets. By way of example, the CBOE Volatility (VIX) Index surged by 26.5% to a two-month high on Friday.

Let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.


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In contrast to how pundits perceived the investment picture by the close of business last week, Moody's reported: "Global business confidence notably improved in May. While sentiment remains very weak and fragile it is well above its April low. Expectations regarding the six-month outlook are negative but are as strong as they have been since the end of 2007. Confidence remains weakest in the U.S. where they suggest the economy is contracting, and remains best in Asia where expectations are consistent with an economy growing near its potential."

U.S. economic reports throughout the week were generally more robust than expected, starting with the ISM Manufacturing Index and Construction Spending reports, and continuing with the Factory Orders, Jobless Claims, productivity growth and wholesale inventories reports.

The influential employment report, however, failed to meet the market's expectations. Non-farm payrolls fell by 49,000 and the unemployment rate shot up to 5.5% – the largest monthly increase in 22 years. Although the payroll decline was smaller than expected, the surge in the unemployment rate suggests considerable weakness in the pipeline, especially regarding consumer spending.

Elsewhere in the world, the ECB left its refi rate unchanged at 4.0%, but President Jean-Claude Trichet confounded the markets when he expressed his concerns about inflation and said that a Eurozone rate hike in July was a possibility.

The Bank of England held interest rates steady at 5%, notwithstanding a darkening outlook for the UK economy as manifested by, among others, a contraction in the services sector and falling house prices.

Here are this week's economic reports, courtesy of Yahoo Finance, June 6, 2008.

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

1) International Trade (June 10): The trade deficit is predicted to have widened to $59.5 billion in April from $58.2 billion in March. Consensus: $59.5 billion.

2) Retail Sales (June 12): Auto sales fell in May. Non-auto retail sales may have received an extra boost from tax rebate checks. Weekly retail sales data present a mixed picture. There was a significant gain in gasoline prices in May. Net, the headline (+0.2%) may show a small increase to reflect the impact of these diverse trends. Consensus: 0.5% versus -0.2% in April; non-auto retail sales: 0.7% versus 0.5% in April.

3) Consumer Price Index (June 13): A 0.3% increase in the CPI is predicted for May following a 0.2% gain in April. Higher gasoline prices should be the major culprit. The core CPI is expected to have moved up 0.2% versus a 0.1% increase in April. Consensus: CPI +0.5%, core CPI +0.2%.

4) Other reports: Pending Home Sales (June 9), Beige Book (June 11), Inventories, Import Prices (June 12), Consumer Sentiment Index (June 13).


This performance chart from the Wall Street Journal Online on June 8 shows how different global markets performed during the past week.


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The past week witnessed four down days on most world stock markets, culminating in plummeting prices by the close of the week as a result of a sharply higher U.S. unemployment number, soaring oil prices and renewed fears about the financial sector.

The MSCI World Index dropped by 1.8% during the week, with Continental European stock markets bearing the brunt of the declines as a result of ECB President Trichet's hawkish statement regarding Eurozone interest rates. The The FTSE Eurofirst 300 Index shed 3.8% to a seven-week low.

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The Nikkei 225 Average (+1.1%) was the only mature market to record a gain. David Fuller (Fullermoney) said: "I maintain that Japan currently has the most interesting technical patterns among non-resources, developed country markets."

The U.S. stock markets were in the thick of things, as shown by the last week's index movements: Dow Jones Industrial Index -3.4% (YTD -8.0%), S&P 500 Index -2.8% (YTD -7.3%), Nasdaq Composite Index -1.9% (YTD -6.7%) and Russell 2000 Index -1.1% (YTD -3.3%).

Energy (+2.9%), materials (+2.1%), and gold/silver stocks (+1.3%) were some of the few to keep head above water during the sell-off. Worst hit were banks (-8.2%), broker dealers (-3.6%) and financials (-2.9%).

The Dow Jones Industrial Index and the S&P 500 Index hit two-month lows on Friday on heavy volume. These indices, as well as the Nasdaq and Russell 2000, are now all below their 200-day moving averages.

Stock markets have been characterized by a truly roller-coaster pattern of late, as illustrated by the up and down nature of the S&P 500 Index over the last six weeks (beginning with last week): -2.8%, +1.8%, -3.5%, +2.7%, -1.8% and +1.2%.

Fixed-interest Instruments

Trichet's concerns about inflation and unexpected indication that the ECB might raise Eurozone interest rates in July put strong upward pressure on European government bond yields. The two-year German Schatz yield rose by 33 basis points over the week to 4.65% – 23 basis points higher than the 10-year yield.

U.S. bond yields, on the other hand, declined as a result of the jump in the unemployment rate, triggering safe-haven buying. The two-year Treasury yield dropped by 23 basis points and the 10-year yield by 11 basis points.

Credit market stress increased as shown by the widening spread of the Markit iTraxx Europe Crossover Index, jumping by 30 basis points to 477.


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The U.S. dollar started the week off by gaining ground as a result of Chairman Ben Bernanke's remarks that the Fed was working with the Treasury to "carefully monitor developments in foreign exchange markets" and that the Fed was aware of the effect of the dollar's decline on inflation and price expectations. However, the dollar reversed course after Trichet's surprising suggestion of an ECB rate hike in July. The dollar received a further setback from the disappointing unemployment number and the spike in the oil price.

The euro gained 1.4% against the US dollar during the week, but the British pound had to contend with a dire UK economic outlook and lost 0.6% against the dollar and 1.8% against the euro.

Both the Swiss franc (+2.2%) and Japanese yen (+0.6%) closed the week higher as the carry trade fell out of favor due to increased risk aversion.


The commodity complex mirrored the movements of the U.S. dollar, with the CRB Index closing the week 4.6% higher.

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Although all commodities were higher by Friday, crude oil was again in the limelight, with West Texas Intermediate jumping $16 on Thursday and Friday, resulting in an improvement of 8.8% over the week. Friday's increase of $11.3 represented a record one-day gain, spurred on by the lower dollar, suggestions that an Israeli attack on Iran's atomic facilities looked "unavoidable", short-covering, and a view from Morgan Stanley that prices could hit $150 by Independence Day on July 4.

The weaker dollar, together with renewed concerns about inflation and expectations that US interest rates might remain negative in real terms for quite a while, positively impacted on gold (+0.9%), platinum (+3.4%) and silver (+3.4%%).

As far as agricultural commodities were concerned, U.S. corn prices jumped to record levels as a result of bad weather across parts of the Midwest.

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