Worry In the Wake of a Wild Week
Investors digested news regarding the ongoing credit market problems and deepening gloom about the global economy.
The past week witnessed mounting uncertainty as investors digested news regarding the ongoing credit market problems and deepening gloom about the global economy. In the words of Richard Russell, author of the 50-year old Dow Theory Letters:
"If you're standing on the railroad track and the train is bearing down on you at 90 miles per hour, don't stand there trying to decide whether the oncoming train is the 'Midnight Special' or the 'Wabash Cannon Ball.' Just get... off the tracks. Which train was coming at you can be determined later – right now that's not the problem."
In a speech on Thursday (January 10), Fed Chairman Ben Bernanke acknowledged a weaker economy and the need for further relaxation of monetary policy. He assured the American public at large that the Fed would "take substantive additional action as needed to support growth and to provide adequate insurance against downside risks."
However, this was cold comfort for the Street as Stock Trader's Almanac pointed out that eleven of the last twelve easing periods have proved to be tumultuous times for the markets. It certainly does not inspire confidence when considering that the S&P 500 Index registered its worst since 1950 for the first five trading days of 2008. Also, the fact that the Dow Jones Industrial Index closed below its December closing low (on January 2) and continues to trade below it, points to further weakness. Since 1950, 27 of 29 such occurrences saw continued declines with an average loss of 10.1%, according to Stock Trader's Almanac.
Below is a brief review the financial markets' movements on the basis of economic statistics and a performance chart.
Philadelphia Fed President Charles Plosser said on Friday (January 11) that the Fed's biggest worry was potential weakness in consumer spending. Many investors fear that consumer weakness could push the U.S. economy into a recession, a concern exacerbated by overall disappointing retail sales. Rising energy prices, weakening housing markets and slower job growth are all weighing heavily on consumer moods.
The annualized growth rate of the ECRI Weekly Leading Indicator continued on its way down, with Moody's Economy.com remarking that the trajectory was increasingly looking similar to past periods preceding a recession.
With a barrage of economic data coming from all corners of the world, perhaps the more insightful information was the ECB and BOE decisions to leave their benchmark interest rates unchanged at respectively 4.0% and 5.5%. Although growth in the Eurozone is slowing, inflation remains of greater concern to central bankers than a slowdown in economic activity.
On the other hand, the U.S. seems to be heading towards a half-percentage rate cut at the FOMC's next meeting on January 30. Fed funds futures indicated an 88% chance of a 50 basis point rate cut, up from the pre-Bernanke speech level of 74%. Goldman Sachs sees three further rate cuts after January of 25 basis points each, bringing the Fed funds rate to 3.0% by mid-year.
Week's Economic Reports
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(Source: Yahoo Finance, January 11, 2007)
The next week's economic highlights, courtesy of Northern Trust, include the following:
Retail Sales (Jan 15): The small increase in auto sales during December (16.26 mln versus 16.19 mln in November), soft non-auto retail sales and a drop in gasoline prices will be reflected in steady retail sales headline. There is a possibility of a minus sign in the headline. Consensus: 0.0% versus +1.2% in November; non-auto retail sales: -0.1% vs. +1.8%.
- Producer Price Index (Jan 15): The Producer Price Index for Finished Goods is expected to have fallen 0.1% in December after a 3.2% jump in November. The decline is mostly due to lower energy prices. The core PPI is expected to have risen by 0.1% after a 0.4% increase in November. Consensus: +0.2%, core PPI +0.2%.
- Consumer Price Index (Jan 16): A 0.2% increase in the CPI is predicted for December after a 0.8% jump in November. The core CPI is expected to have moved up 0.2% versus a 0.3% gain in November. The core CPI could show a milder gain because apparel prices tend to drop in a given month after a sharp increase the previous month. The apparel price index rose by 0.8% in November. Consensus: +0.2%, core CPI +0.2%.
- Industrial Production (Jan 16): The 0.7% drop in the manufacturing man-hours index for December implies a drop in factory production. If production at the nation's utilities rose sharply in December after three monthly declines, there could be an overall gain in December. Assuming the absence of a large contribution from utilities, there should be a 0.3% drop in industrial production. The operating rate is projected to have dropped to 81.2%. Consensus: -0.5%; Capacity Utilization: 81.2.
- Housing Starts (Jan 17): Permit extensions for new homes fell by 0.7% in November, marking the tenth monthly drop in the last eleven months. This declining trend suggests continued weakness in the construction of new homes. Starts of new homes are predicted to have fallen to an annual rate of 1.05 mln in December vs. a 1.187 mln mark in the previous month. Consensus: 1.14 mln.
- Leading Indicators (Jan 18): Interest rate spread, initial jobless claims, consumer expectations, and the manufacturing workweek made negative contributions. Vendor deliveries, real money supply, and stock prices made positive contributions. The net impact was a steady leading index during December after a 0.4% drop in November. Consensus: -0.1%.
- Other reports: Business Inventories (Jan 15), Survey of National Home Builders Association, Beige Book (Jan 16), Federal Reserve Bank of Philadelphia's Factory Survey (Jan 17), and University of Michigan Consumer Sentiment Index (Jan 18).
The performance chart obtained from the Wall Street Journal Online indicates how different global markets fared during the past week.
Click to enlarge image
(Source: Wall Street Journal Online, January 13, 2007.)
Equities rallied on the back of Bernanke's assurances, but it did not take long for sub-prime fears to resurface and most stock markets closed sharply lower on Friday. The MSCI World Index declined by 1.9% during the week, with Japanese stocks (-4.0%) falling to a 26-month low and European stocks (-2.4%) to a 13-month low.
Friday's sell-off marked the third straight weekly decline for the U.S. stock markets, with the Dow Jones Industrial Index suffering its steepest first-eight-sessions-of-the-year slide in 17 years.
The S&P 600 Small Cap Index (-2.8%) underperformed the larger caps of the S&P 500 Index (-0.8%). Defensive areas that are more resistant to an economic downturn, such as Pharmaceuticals (+3.3%) and Utilities (+1.5%), were among the few sectors registering positive returns for the week.
The depth of the problems faced as a result of the sub-prime fallout was underscored by Bank of America's (BAC) rescue of troubled mortgage lender Countrywide Financial (CFC), Merrill's (MER) expected additional $15 bln write-down, and Citigroup's (C) second capital-raising effort ($14 bln) in as many months.
Government bond yields fell further around the world as the global economic outlook worsened and investors switched stocks to what is perceived to be a safe-haven asset class. However, fears that inflation could become a problem slowed the decline in long-dated maturities.
On the currency front the U.S. dollar fell somewhat against the euro as expectations of aggressive cuts in U.S. rates increased. Worries about the deteriorating prospects for the U.K. economy resulted in the British pound hitting a record low against the euro.
The precious metals complex, however, was propelled higher by inflation jitters, with both gold ($898) and platinum ($1,564) recording all-time highs. Silver played catch-up and rose by 7.1% for the week compared with gold's 3.8% and platinum's 2.5%.
Base metals and agricultural commodities also performed strongly. A report by the U.S. Department of Agriculture warned of extremely low inventories and pushed wheat prices to an all-time high, corn prices to an 11-year high and soya bean prices to a 34-year high.
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