Prieur Perspective: Improved Attitudes, Strong Gains
Investors beginning to feel worst is over.
"The world's favorite season is the spring. All things seem possible in May."
- Edwin Way Teal
And so it seemed during the past week as we witnessed a further improvement in investor sentiment and risk appetite, supported by the viewpoint that the worst of the credit crisis might be behind us. The end result by Friday's close was strong gains for stock markets (with the Volatility Index at its lowest level since December), a further recovery of the U.S. dollar, a sell-off of most commodities, and a weak undertone in government bond markets.
The Federal Reserve laid the foundation for investors' actions at its policy meeting on Tuesday and Wednesday, the outcome of which was the FOMC cutting the Fed funds rate by 25 basis points to 2.0% – the lowest level since late 2004.
The accompanying press statement cited weakness throughout the U.S. economy and stress in financial markets. It noted higher inflation, but also said that inflation should moderate in the near term. In a departure from the previous wording, the statement made no reference to downside risks to growth.
Overall, the market interpreted the Fed's directive to imply that it was most likely to pause and await the impact of the 325 basis point reduction in the Fed funds rate, the economic stimulus package, and other programs put in place. Interest rate futures price in a rate rise towards the end of the year.
The U.S. dollar's strength was rooted in the expectation that the Fed was possibly done with reducing rates for the moment. However, the Fed was not done with its efforts to improve liquidity in stressed markets as indicated on Friday when it raised the amounts available for depository institutions at its biweekly term-auction facilities by 50% and broadened the types of acceptable asset-backed collateral.
Although the U.S. GDP growth rate was very weak in the first quarter – just 0.6% at an annualized rate – this was better than the consensus expectation of 0.2%. Growth was also 0.6% in the fourth quarter of 2007. Compared with the fourth quarter, however, investment in inventories was a positive for growth. This was offset by stronger imports, a decline in non-residential construction, and weaker growth in consumer spending.
But investors have also nervously wondered whether stock markets were nor getting ahead of themselves. After all, May has a reputation as the advent of six "bad" months in the stock market, hence the axiom "Sell in May and go away." (Click here to read my recent post on whether this is fact or fallacy.)
Before highlighting some thought-provoking news items and quotes from market commentators, let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.
In addition to the FOMC's rate announcement and the GDP numbers, the past week saw a myriad economic reports.
Summarizing the upshot of the most recent batch of statistics, John Mauldin (Thoughts from the Frontline) said: "Real (inflation-adjusted) retail sales have been flat for the last six months. Incomes are stagnant. Consumer spending is showing every sign of slowing even more. This employment report was ugly, when you look at the numbers under the headline statistics. Consumer sentiment is at 25-year lows.
"You can count on it that the National Bureau of Economic Research (NBER) will show a recession starting in the fourth quarter of last year and continuing at the least through the first quarter of this year. This one could last another six months. I still think long and shallow with a very slow recovery."
Elsewhere in the world the European Commission's economic sentiment indicator fell sharply in April, the Eurozone's manufacturing PMI continued to ease, and German retail sales contracted as households struggled against higher prices for food and energy.
In the U.K., the Nationwide Housing Price Index fell by 1.0% in year-ago terms in April – the first contraction in annual price growth in more than a decade. Consumer confidence continued to slide as households worried about their finances and the UK economy.
The Bank of Japan held interest rates unchanged at 0.5%, but cut its growth estimates for the year ahead, citing higher raw material prices and a slowing U.S. economy.
Here's this week's economic report, courtesy of Yahoo Finance on May 2, 2008.
The next week's economic highlights, courtesy of Northern Trust, include the following:
1) International Trade (May 9): The trade deficit is predicted to have narrowed to $61.5 billion in March from $62.3 billion in February, based on the assumptions in the advance estimate of GDP. Consensus: $60.8 billion.
2) Other reports: ISM non-manufacturing (May 5) and Pending Home Sales (May 7).
This performance chart, obtained from the Wall Street Journal Online on May 4, shows how different global markets performed during the past week.
Global stock markets were in rally mode and added to the previous week's gains, with the MSCI World Index closing 1.1% higher on Friday.
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