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Prieur Perspective: Stay Cool in Economic Heat


Keep emotions and risk in check.


T.S. Eliot might have been off by a few months – it looks as though June might turn out to be the cruelest month of the year rather than April.

Renewed fears of inflation and slower growth caused by record energy costs played havoc with global stock markets last week, resulting in the Dow Jones Industrial Average being on track to record its worst June since the Great Depression. As stocks suffered, gold bullion surged and government bond yields dropped due to safe-haven buying.

Sentiment soured as investors became more concerned that the credit crisis still had a long way to run and that the fallout was increasingly contaminating the real economy.

Credit market stress deteriorated markedly as shown by the widening credit default spreads in both the U.S. and Europe. The CDX (North American, investment grade) Index rose by 17 basis points to 143, and the Markit iTraxx Europe Crossover Index by 41 basis points to 541.

"When sorrows come, they come not single spies, but in battalions," said Claudius in Shakespeare's Hamlet.

Besides surging oil prices and financial sector woes, the focal point for the week was the FOMC's interest rate announcement on Wednesday. As expected, the Federal Reserve left the Fed funds rate unchanged at 2.0%, and its wording in the accompanying statement largely reiterated the hawkish comments leading up to the meeting.

The Fed said overall economic activity continued to expand, partially due to "firming" in household spending, but it expected economic growth would face the burdens of tight credit conditions, housing contraction and the rise in energy prices.

The directive also said uncertainty over the inflation outlook remained high, although the Fed expected inflation to "moderate later this year and next year", stating that downside economic risks had diminished somewhat, while inflation risks had increased.

"We're in a nasty environment," said Tim Bond, Barclays Capital's chief equity strategist:

"There is an inflation shock under way. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth. There is going to be a deep global recession over the next three years as policymakers try to get inflation back in the box."

These sentiments were echoed by Jim Cramer (New York Magazine), who said:

"In 25 years on Wall Street, I have never seen things this bad. We've had some tough times: the 1987 stock market crash, the collapse of the once-all-powerful Drexel Burnham Lambert, the immolation of Long Term Capital, the post-9/11 calamity, and the dot-com implosion. Every one of these events rocked the Street, causing pay cuts and layoffs and creating a sense of doom. But this time is different; it's doom itself.

"Sell everything. Nothing's working. Revisit when the prices are adjusted for a big recession, soaring inflation and a crushed consumer. Sell at 12,000 and come back at 10,000. Even better: short it," said Cramer.

Difficult as it may be, you should guard against letting your emotions get the better of you.

"Be prepared to hear a litany of dire predictions now as people jump on the 'sell everything' bandwagon by the very same people who were pounding on the table to buy stocks just a few short weeks ago. Ignore the noise and scare tactics and focus on what matters most – making good decisions and finding opportunities that do exist...," remarked Charles Kirk (The Kirk Report).

Although I did not intend to compile a "Words from the Wise" report this week, I actually managed to do a shortened version in midair from Cape Town to Europe. As I could not access the Internet for some of the usual statistics and was constrained by the laptop's limited battery capacity, the end result is significantly less comprehensive than usual. Blogging will remain slow for the next ten days as family time stakes its claim.

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

  • The Conference Board Consumer Confidence Index fell further in June to 50.4 from May's 58.1. This puts the Index at a 16-year low, and this is the fourth-lowest reading in the history of the survey, which dates back to 1969.

  • New Home Sales declined in May as housing markets continued on a downward trend. Sales of new single-family homes came in at 512,000 after seasonal adjustment, a decrease of 2.5% below the revised April total of 525,000 sales, and 40.3% below the total of 857,000 for May 2007. The supply of new single-family homes remained high at 10.9 months.

  • Personal Income soared 1.9% in May, following April's 0.3% growth. Income growth was inflated by the effects of the tax rebates. Excluding those, personal income rose by 0.4% in May, up from 0.2% in April. Spending growth jumped to 0.8% from 0.4% the previous month. Real spending rose by half as much. The core PCE deflator rose by 0.1% again, while the top-line deflator rose by 0.4%.


"Global business sentiment softened last week and remains fragile, but it is well off its late April bottom," reported the Survey of Business Confidence of the World, conducted by Moody's

"There has been a worrisome increase in pricing pressures during the past month. Confidence remains weakest in the US where it suggests the economy is still contracting, and it is strongest in Asia where it is consistent with an economy growing near its potential."

The past week's economic reports in the U.S. included the following notable releases:

The market is still pricing in two rate increases by year end. However, according to The Financial Times, Pimco's Bill Gross said he thought the Fed was just "jawboning" to keep inflation expectations under control. "By this time in December the Federal funds level is still going to be 2.0%," he said."

"My bet is that the FOMC remains on hold for the rest of the year as consumer spending softens again and headline inflation moderates in the third quarter," said Paul Kasriel, chief economist of Northern Trust.

Elsewhere in the world, Jean-Claude Trichet, the president of the European Central Bank, expressed fresh concern about inflation and wage growth, strengthening expectations that the ECB would raise its main rate by 0.25 percentage points next week to 4.25%.

Here are this week's economic reports, courtesy of Yahoo Finance, June 27, 2008.

In addition to the European Central Bank's interest rate decision on Thursday, July 3, next week's economic highlights include the following: Chicago PMI on Monday, Construction Spending and the ISM Index on Tuesday, ADP Employment and Factory Orders on Wednesday, and Initial Jobless Claims, ISM Services, and June's jobs data on Thursday. Markets will be closed on Friday in observance of Independence Day.


This performance chart from The Wall Street Journal Online, June 29, 2008, shows how different global markets performed during the past week.


Click to enlarge

The MSCI World Index experienced four down-days and plunged by 2.3% (on top of the previous week's -1.9%) during the past week as concerns about surging inflation, further credit-related trouble and deteriorating corporate earnings intensified. The MSCI has dropped by 11.7% since the beginning of 2008 – its worst first-half performance since a decline of 13.8% during the first six months of 1982.

The performance of emerging markets (-2.3%) varied from the Brazilian Bovespa Index (-0.5%) that fared relatively well, to the less fortunate Indian BSE 30 Sensex Index (-5.3%) and the Taiwan Taiex Index (-4.5%). The Chinese Shanghai Composite Index (-2.9%) is at risk of losing its entire gain of 141%, recorded during last year's eight-month rally.

The U.S. stock markets got hammered on high volume and closed trading on Friday on a weak note. The index movements tell the story: Dow Jones Industrial Index -4.2% (YTD -14.5%), S&P 500 Index -3.0% (YTD -12.9%), Nasdaq Composite Index -3.8% (YTD 12.7%) and Russell 2000 Index -3.8% (YTD -8.9%).

Nine of the ten U.S. stock market sectors recorded a decline for the week, with energy (+1.4%) the only one to end in positive territory. Of the subsectors, gold and silver stocks shone with a gain of 8.9%.

As far as specific companies were concerned, General Motors (GM) plummeted 16% after Goldman Sachs cut its earnings estimates and said the company may be forced to raise capital. Citigroup (C) and Merrill Lynch (MER) were both down about 10% on expectations that further write-downs were imminent.

The Dow Jones Industrial Index declined for eight of the last 10 trading days, leaving it at its lowest level since September 2006 and down close on 20% (i.e. bear market definition) since its October 2007 high. Although the Dow has fallen below its March 2008 lows, all the other major U.S. indices are still holding out above the year's lows.

Fixed-interest Instruments

Click to enlarge

Government bonds around the globe benefited from renewed concerns about the economic outlook and commensurate safe-haven buying.

The ten-year U.S. Treasury Note dropped by 15 basis points during the week to close at 3.99%. Similarly, the U.K. ten-year Gilt yield declined by 11 basis points to 5.04% and the German ten-year Bund yield by 10 basis points to 4.53%.


Click to enlarge

A realization that an imminent rise in U.S. interest rates was not on the cards resulted in dollar weakness, causing the greenback to decline by 0.9% over the week against the euro, 0.6% against the British pound and 0.7% against the Japanese yen.


U.S. dollar weakness and supply concerns pushed the Reuters/Jeffries CRB Index 2.0% higher for the week, on track for its largest gain in 35 years. The Index has risen by 30.1% since January, the largest increase since the 30.2% gain in the first half of 1973.

At centre stage during the past week, the price of West Texas Intermediate crude recorded an all-time high of $142.26 a barrel, before pulling back to close at $140.50 – a weekly gain of 3.8%. In addition to the lower dollar, supply concerns and unrest in Nigeria prompted the advance, as traders shrugged off an increase in inventory levels and word that Saudi Arabia was increasing output in July.

Crude oil prices could rise to as high as $170 per barrel in the coming months but are unlikely to hit $200 and should ease towards the end of the year, OPEC President Chakib Khelil said on Thursday, according to Reuters.

Click to enlarge

The declining dollar, together with rising price pressures and expectations that U.S. interest rates might remain negative in real terms for quite a while, positively impacted on gold (+3.1%) and silver (+1.8%). Friday's surge of $32 was the biggest one-day gain in gold in 27 years.

As far as agricultural commodities were concerned, corn (+6.1%) and soyabean (+3.9%) prices traded at record levels ahead of an update from the US Department of Agriculture on Monday.

Now for a few news items and some words and charts from the investment wise that will hopefully assist in keeping one's head above (the very murky) water. It's best to remain cool and collected about these markets, and not take unnecessary risks.

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