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Prieur Perspective: Keep Your Eye on the GDP


Inflation not key factor as credit crunch continues.


Almost exactly a year after the advent of the credit debacle, the term "credit crunch" has squeezed into Britain's Chambers Dictionary. It's defined as "a sudden and drastic reduction in the availability of credit."

Fittingly, the past week saw market participants focusing anew on deteriorating global growth prospects, arguing that slower growth and widespread belt-tightening could reduce inflation pressures.

A wave of weak data hit the global economic headlines. Real GDP growth in the Eurozone contracted by 0.2% in the second quarter, the first decline since record-keeping for the area commenced in 1995. Germany and France, the 2 largest economies of the group, recorded declines in GDP of 0.5% and 0.3% respectively.

The UK economy is on the verge of a recession; it now faces its gloomiest outlook since the early 1990s. Japan, the world's second largest economy, also contracted by 0.6% in the second quarter.

The notion that the US was further along in the slowdown process than foreign economies, -- along with an expectation that interest rate differentials could narrow in favor of the US dollar -- resulted in continued strength in the greenback, further weakness in commodities, lower bond yields and mixed stock markets.

BCA Research said: "[Lower] energy prices, if sustained, should begin to help cool inflation fears. ...Inflation lags economic growth by several quarters and the economy continues to slow. ... Inflation fears should gradually recede."

Further e
vidence that inflation worries were decreasing also appeared: Treasury Inflation-protected Securities (TIPS) fell to their lowest levels since January - an indicator that inflation dropped as well.

Richard Russell (
Dow Theory Letters) weighed in on the inflation/deflation debate: "With credit being restricted, a second and very serious danger surfaces. That danger is asset deflation. The very thought of asset deflation sends chills of fear up Fed chief Ben Bernanke's spine. Credit contraction, asset deflation - shades of the Great Depression.

"Very frankly, I can't come to a firm conclusion as to whether we're dealing with a bull or a bear market. Sometimes you just have to wait and allow the market to tell its story. Remember, we may be in a hurry, but the market never is," 84-year-old Russell went on to say.

And the mystery of where the markets are heading continues. It reminds me of physicist Niels Bohr's quip: "Tomorrow is going to be wonderful, because tonight I do not understand anything." (Hat tip: Paul Kedrosky's
Infectious Greed.)

As I mentioned previously, investors should brace themselves for a lengthy convalescence period. Central bank policy will shift from inflation to GDP growth as the road to the patient's eventual recovery. In the short term, however, I still give the nascent stock market rallies the benefit of the doubt - provided the mid-July lows are sustained.

Always be on the lookout for new leadership groups - and always ensure earnings and valuation fundamentals stack up before committing money to the market.


"Global businesses are very nervous. They are more upbeat than they were in the spring, but confidence is low and is fragile," according to the Survey of Business Confidence of the World conducted by Moody's The survey results suggest the global economy was just barely skirting recession. The US, European and Japanese economy were contracting, but the broader Asian economy continued to post growth near potential.

Economic reports released in the US during the past week were mixed and included the following:

  • The July Senior Loan Officer Opinion Survey from the Fed indicated further tightening in lending standards over the previous three months. About 60% of large banks indicated tighter standards for commercial and industrial loans from the previous survey. Three-quarters of banks reported tightening standards on prime mortgage loans since the spring and the share of banks tightening standards on credit-card loans has more than doubled since the last survey.

  • Total retail sales inched down 0.1% in July, following a revised 0.3% gain in June (originally 0.1%) as a decline in sales at auto dealers offset strong growth elsewhere. Sales excluding autos rose by 0.4% after gaining 0.9% in June.

  • The top-line Consumer Price Index increased by 0.8% for the month and 5.6% for the year in July compared with 1.1% for the month and 4.9% for the year in June. The core CPI rate of inflation remained level at 0.3% for July, the same as in June, though the core rate of inflation for the year was 2.5% in July compared with 2.4% in June. Energy increased by 4% for the month in July compared with 6.6% in June, whereas food prices increased by 0.9% for the month compared with 0.8% in June.

  • Industrial production rose by a better than expected 0.2% in July. Manufacturing and mining output improved during the month, while utilities production declined sharply. Overall, the report was similar to the industrial production reports seen so far this year: a soft reading, though not of the magnitude normally seen in recessions.

Almost one-third of US homeowners who bought in the last 5 years now owe more on their mortgages than their properties are worth, according to, an Internet provider of home valuations. Also, delinquency rates on single-family mortgages have reached their highest level on record (the Fed started tracking the statistics in 1991), pushing up the delinquency rate on all loans held by US banks.

Summarizing the US economic situation, Asha Bangalore (
Northern Trust) said: "Tax rebate dollars supported economic growth in the US in the second quarter. By the next FOMC meeting on September 16, the FOMC will have another month's data for inflation, employment, and retail sales. Employment and retail sales should continue to show weakness and headline inflation will likely be considerably lower. Therefore, the Fed is firmly on hold."

The incoming reports in the Eurozone and Japan strongly point to weakening economic conditions, as shown by contracting real GDP growth in the Eurozone and Japan. The following chart provides an illustration:

Click to enlarge

Here are this week's economic reports, courtesy of Yahoo Finance; next week's economic highlights in the US, courtesy of Northern Trust, include the following:

1. Producer Price Index (August 19): The Producer Price Index for Finished Goods is expected to have risen by 0.5% in July. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in June.

Housing Starts (August 19): Permit extensions for new single-family homes fell by 3.0% in June, but rose for that of multi-family homes. The weakness in the housing market, particularly the large inventory of unsold homes, points to a reduction of housing starts in July (940,000 versus 1.066 million in June). Consensus: 950,000.

3. Leading Indicators (August 21): Interest rate spread and consumer expectations are the only two components likely to make a positive contribution in July. Stock prices, money supply, initial jobless claims, and building permits are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defense capital goods are used in the initial estimate. The manufacturing workweek and vendor deliveries held steady in July. The net impact is a 0.2% drop in the leading index during July.

Consensus: -0.2% versus -0.1% in June.

4. Other reports: NAHB Survey (August 19), Philadelphia Fed Survey (August 21).

Click here for a summary of Merrill Lynch's (MER) US economic and interest rate forecasts.

A summary of the release dates of economic reports in the UK, Eurozone, Japan and China is provided
here. It is important to keep an eye on growth trends in these economies for clues on, among others, which way the US dollar is going to move and how strongly.


The performance chart at the
Wall Street Journal Online shows how different global markets performed during the past week.


Stock markets, in general, were lower during the past week, with the softer inflation outlook unable to offset gloomy growth prospects in a number of cases. The MSCI World Index declined by 1.1% for the week, with the MSCI Emerging Markets Index losing 2.4%.

Mounting concerns about the German and Japanese economies heading for recession resulted in the XETRA Dax Index (-1.8%) and the Nikkei 225 Average (-1.1%) being the worst performers among developed markets.

The emerging markets category saw large declines by China (-6.0%), Brazil ( 4.1%), Hong Kong (-3.3%) and India (-2.9%), whereas solid gains were registered by Turkey (+3.0%), Pakistan (+3.5%) and Russia (+3.6%).

Notwithstanding the past week's gains, the Russian Trading System Index is still down a hefty 28.2% from its record high of mid-May.

The US stock markets were mixed as shown by the major index movements: Dow Jones -0.6% (YTD -12.1%), S&P 500 Index +0.1% (YTD -11.6%), Nasdaq +1.6% (YTD 7.5%) and Russell 2000 Index +2.6% (YTD -1.7%).

The outperformance of small caps is significant as they have a history of often turning up before large caps at market bottoms. A breakout through the June high should be positive for the entire market.

Click to enlarge

The Russell 2000 Index and the Nasdaq Composite Index are trading above both their 50- and 200-day moving averages, whereas the Dow Jones Industrial Index and S&P 500 Index are flirting with their 50-day averages - though they still have some work to do in order to breach the important 200-day line, often used as an indicator of the primary trend.

here for a market map, courtesy of, which provides a quick overview of the performance of the various segments of the S&P 500 Index over the week.

Retailers were a notable pocket of strength despite persistent debate about consumer spending's demise in the face of high food and gas prices, falling home values, rising unemployment and tighter credit conditions. For the week, the S&P Retail Index jumped by 4.8%, bringing total gain since the July 15 low to 23.6%.

Several retailers, including
Wal-Mart (WMT), Kohl's (KSS), J.C. Penney (JCP) and Nordstrom (JWN), posted better-than-expected second quarter earnings results, although most expressed caution about the outlook for the third quarter and/or the full year.

On the other end of the scale, the financial sector (-2.8%) was the week's worst sector performer, falling on omnipresent concerns about credit market conditions and low levels of business activity. This caused several broking firms to slash earnings estimates for leading investment bank
Goldman Sachs (GS). Also, a warning from JP Morgan Chase (JPM) that it had seen a substantial deterioration in trading conditions since the end of the second quarter, acted as another trigger for the selling interest.

Fixed-interest instruments

Global government bond yields declined further during the past week, particularly in those parts of the world with the most dismal economic scenarios.

Leading the way, the
UK 10-year Gilt yield declined by 10 basis points to 4.58% and the German 10-year Bund yield by 11 basis points to 4.15%. The Japanese 10-year bond yield closed unchanged at 1.47% after hitting a 4-month low of 1.515% on Thursday.

The 10-year US Treasury Note also dropped by 8 basis points to 3.86%, as investors turned to the perceived safety of government bonds amid continued selling of mortgage securities.

Click to enlarge

US mortgage rates declined somewhat, with the 15-year fixed rate and the 5-year ARM both 3 basis points lower at 6.05% and 6.03% respectively.

Money-market rates rose on the back of strong demand for one- and three-month money lent by the Fed and the ECB.


The US dollar's surge continued for a fifth consecutive week as the currency benefited from the view that foreign central banks will be quicker to cut rates than the Fed will be to tighten rates.

reported that Goldman Sachs reversed course on its dollar forecast, saying the greenback has "bottomed" as global growth weakens, oil prices decline and the US trade balance improves. "The fundamental picture for the dollar has improved substantially in recent weeks," Goldman's Thomas Stolper wrote in a research note.

The past week saw the greenback rising against the euro (+1.6% - a 6-month high), the British pound (+2.9% - a 2-year peak), the Swiss franc (+1.3% - a 6-month high), the Japanese yen (+0.8% - a 5-month high) and the Australian dollar (+2.5% - a 7-month high).

Sterling has come under strong selling pressure as pessimism about the UK economic picture intensified, resulting in an 11-day losing streak – the longest stretch of consecutive down-days in 35 years.

The following chart illustrates the US dollar's accent against various currencies over the past month:

Click to enlarge


The dollar's strength and growing concerns of slowing demand knocked dollar-denominated commodity prices as seen in the Reuters/Jeffries CRB Index declining by a further 1.3%. The Index has plunged by 19.3% since its record peak of July 2.

Click to enlarge

West Texas Intermediate crude traded at $113.9 a barrel on Friday, extending its five-week decline from a record $147.27 to 29.3%.

The rallying US dollar and reduced concerns about inflation resulted in gold bullion falling below the $800 level on Friday for the first time since December 2007. The yellow metal plunged by 8.4% over the week, with silver (-15.7%), platinum (-11.0%) and palladium (-14.4%) also at the forefront of the selling orders.

Agricultural commodities were the only category registering gains last week as a result of reassurance from the US Department of Agriculture on this year's harvest. CBOT September corn rose by 6.3%, wheat by 8.1% and soyabeans by 2.4%.

Putting a more positive spin on commodities' fall from grace, Frank Holmes (US Global Investors) said: "This commodities sell-off, which began in July and has continued into August, also corresponds to the long-term seasonal cycle in which prices for many commodities tend to bottom out in late summer before rebounding in the fall."

In conclusion, when navigating your portfolio through the treacherous investment waters remember that the emphasis in these times should be on return of capital rather than return on capital.

That's the way it looks from Cape Town.
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