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Brighter Week For a Dark Month?

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Negative economic reports during the past week were digested by market participants with relative ease.

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The decision by the U.S. Federal Reserve to cut interest rates by another 50 basis points on top of the 75-basis-point-cut eight days earlier dominated financial headlines during the past week. On Wednesday the Fed gave stock markets exactly what they wanted and provided respite to a downward trend by slashing the Fed funds rate to 3.0%.

The Fed's accompanying statement made it clear that it was scared about the markets, which "remain under considerable stress," and the knock-on effects they could have on the economy, as "credit has tightened further for some businesses and households."

Jeffrey Saut, chief investment strategist of Raymond James, said: "The question du jour is: Will the rate cuts, combined with the economic stimulus package, be enough to prevent the normal ending to the business cycle…?"

On this score, Richard Russell, octogenarian author of the Dow Theory Letters, refers to the cover of the latest Newsweek magazine, blaring out "Road to Recession" in large letters. He remarked: "Really, let's turn to the magazine cover rule – when an item becomes so widely accepted that it makes the cover of a national magazine, the odds are that the item is either not going to happen or it's over. There ain't goin' to be no stinkin' recession. The magazine (contrary reading) says so, the stock market says so, Richard Russell says so."

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

Economy

Negative economic reports during the past week were digested by market participants with relative ease. Examples of disheartening reports include: new home sales falling to a 13-year low, weekly initial claims jumping from 306 000 to 375 000, 4Q GDP growing just 0.6%, and January nonfarm payrolls declining by 17 000.

In addition to putting their faith in a proactive Fed and hyperactive Treasury, pundits preferred to emphasize aspects such as a report that durable orders rose 5.2%, a jump in the manufacturing sector's ISM Index to 50.7 (a number above 50 reflects growth), reports of a rescue package for the ailing bond insurers, and the Microsoft buyout offer for Yahoo.

Futures signaled the Fed funds rate would reach 2.5% by the summer. Please click here to view the week's economic reports as found on Yahoo! Finance, February 1, 2008.

In addition to speeches by members of the Fed every single day next week, the week's economic highlights include Factory Orders on Monday, ISM Services on Tuesday, Productivity on Wednesday, Initial Jobless Claims, Pending Home Sales, and Consumer Credit on Thursday, and Wholesale Inventories on Friday.

Markets

The performance chart below, obtained from The Wall Street Journal Online, February 3, 2008, indicates how different global markets fared during the past week.


Click to enlarge

Equities

Global stock markets experienced a shift in sentiment during the past week, resulting in strong gains. The FOMC's rate cut and the prospect of further easing fueled a rally, resulting in the S&P 500 Index finishing the week 4.1% higher – its best weekly performance for nearly five years. The Dow Jones Transportation Index (+7.4%), the Dow Jones Industrial Index (+4.4%) and the Nasdaq Composite Index (+3.7%) all steamed ahead.

Interest-rate- and economically sensitive stocks were at the forefront of the gains in the U.S. Examples include homebuilders (+17.9%), banks (+11.2%), retailers (+7.5%), small caps (+8.8%) and REITs (+6.3%).

European markets also gained throughout, but the Nikkei 225 Average was less fortunate and recorded a 1.0% loss. The biggest casualty of the week, however, was the Shanghai Composite Index, which fell by 9.3% – the steepest weekly decline in a decade – on concerns that the worst winter storms in 50 years will reduce economic growth. The Hong Kong Hang Seng Index (-4.0%) also ended the week in the red.

The gains of most indexes during the past week masked significant declines for the month of January, with the Dow Jones World Index down 6.5% and the S&P 500 Index down 6.1% – the sixth worst in history.

Bonds

U.S. government bond yields fell after the Fed's rates announcement and indications of further easing of monetary policy. Yields in the U.K., Germany, and Japan also moved somewhat lower.

Currencies

The U.S. dollar Index lost 0.7% over the week, dropping below 75 to within striking distance of its record low after the poor jobs report on Friday, but then rebounded on the back of better manufacturing data. The Chinese renminbi, the Japanese yen, Swiss franc and euro strengthened, but the British pound lost ground after poor manufacturing and housing data.

Expectations increased that the Bank of England would cut interest rates next week but that the European Central Bank would maintain its hawkish stance.

Elsewhere on the currencies front, the South African rand dropped by 3.9% over the week after the country's central bank kept interest rates on hold and a speedy resolution of the electricity crisis appeared unlikely.

Commodities

Industrial commodities were star performers during the past week as a result of severe weather conditions and power supply problems causing disruptions in Chinese production. The entire base-metals complex gained strongly, with aluminum (+10.6%), zinc (+8.6%) and lead (+8.4%) leading the pack.

OPEC heeded expectations and maintained production quotas but crude oil closed the week almost 2% lower on recession worries and the possible impact thereof on demand.

Gold bullion dropped to $910 by the close on Friday, after having recorded a new high of $936.5 earlier during the day. Platinum, however, rose strongly (+5%) to a new all-time high as concerns mounted about the implications of South Africa's electricity rationing for the world's largest producers.



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