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Retail Sales Weigh Heavily

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Latest economic figures promote dismal outlook.

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Financial markets ended the past week on a subdued note as economic data, credit concerns and recession talk dominated investors' mood.

The Fed kept itself in the headlines during the week. Ben Bernanke spoke before the Senate Banking Committee on Thursday morning and reiterated that the Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks." He also noted that "the outlook for the economy has worsened in recent months, and the downside risks to growth have increased." Bernanke's comments caused renewed worries among many pundits.

The rather disturbing developments in the bond insurance market also gave investors food for thought, as they pondered the outcome of Warren Buffett's "rescue offer" to the monolines and New York governor Elliot Spitzer's deadline for those companies to find fresh capital within three to five business days in order to avoid a "tsunami-like disaster."

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

Economy

The economic news during the past week saw an unexpected rise in retail sales last month, industrial production for January back at the record level of September 2007, and the trade deficit falling by 6.9% in December – a bigger improvement than expected.

On the other hand, manufacturing activity in New York recorded its biggest decline on record, the University of Michigan's consumer sentiment dropped to its lowest level in 16 years, and import prices surged by 13.7% from a year ago – the highest reading since the start of the data series in 1982.

The combination of these reports was interpreted by many as a deterioration in the U.S. economic outlook. Reacting to President George W. Bush's statement that the economy remained "structurally sound", Bill King (The King Report) remarked: "If things are so structurally sound, why all the Third World bailouts of leading U.S. financial institutions, a stimulus package and 125bps of rate cuts within 8 days?"

The week's economic reports can be seen here, courtesy of Yahoo Finance.

The next week's economic highlights, courtesy of Northern Trust, include the following:

1) Consumer Price Index (February 20): A 0.2% increase in the CPI is predicted for January following a 0.4% gain in December. The core CPI is expected to have moved up 0.2% compared with a 0.2% increase in December. Consensus: +0.2%, core CPI +0.3%.

2) Housing Starts (February 20): Permit extensions for new homes fell 7.1% in December, which leads me to conclude that there was a large drop in housing starts during January (965 000). Starts of new homes fell 25.8% in 2007. Consensus: 1.01 million as against 1.0 million in December.

3) Leading Indicators (February 21): Interest rate spread, stock prices, and projected orders of durable goods posted declines in January. Initial jobless claims, consumer expectations, vendor deliveries, and real money supply made positive contributions. The manufacturing workweek held steady in January. The net impact is a 0.1% drop in the leading index during January following three consecutive monthly declines. Consensus: -0.1%

4) Other reports: NAHB survey (February 19) and Philadelphia Fed Survey (February 21).

Markets

The performance chart obtained from The Wall Street Journal Online, February 16, indicates how different global markets fared during the past week.


Click to enlarge


Equities

Global stock markets closed the week broadly higher with the MSCI World Index gaining 1.9%. Japan was the star performer among mature markets and rose by 4.7% on the back of better-than-expected fourth-quarter GDP data.

Investors were relatively upbeat during the first three trading days of the week and U.S. stocks recorded their first three-day rally since December 27, 2007, but the mood turned for the worse after Ben Bernanke's testimony on Capitol Hill. The net result was nevertheless still a gain for the leading indexes, with the Dow Jones Industrial Index and the S&P 500 Index both improving by 1.4% and the technology-heavy Nasdaq Composite Index edging 0.7% higher. Gold and silver stocks (-2.2%), financials (-1.1%) and retailers (-1.1%) were the notable decliners for the week.

Emerging markets in general outperformed developed markets, with Russia (+6.3%), Brazil (+3.7%), India (+3.7%) and Hong Kong (+2.9%) all chipping in useful gains. The New Year celebrations resulted in the Chinese markets being closed for the first two days of the week.

Bonds

The yields on longer-dated government bonds were pushed higher as a result of mounting inflation concerns, whereas shorter-dated maturities fared better on the expectation of rate cuts. The U.S. 10-year and 30-year bond yields closed the week 12 and 14 basis points higher respectively, but the two-year yield declined by three basis points. This resulted in a gap of 187 basis points between two- and 10-year yields – the widest since July 2004.

The yield curve also steepened in the U.K., Germany and France, albeit on a more modest scale than in the U.S.

Currencies

The U.S. Dollar Index declined by 0.2% for the week on Ben Bernanke's grim economic outlook and the prospect of further rate cuts in the U.S.

Elsewhere, the Swedish krona appreciated by 2.3% against the U.S. dollar and 1.1% against the euro after the Riskbank's surprising increase of the Swedish base rate by 0.25% to 4.25%. The British pound (+0.9%) also gained against the U.S. dollar as a result of poor UK inflation data tempering expectations for aggressive rate cuts by the Bank of England.

Commodities

The Reuters/Jeffries CRB Index (+2.3%) powered ahead during the past week, resulting in an all-time high.

Leading the pack was platinum that jumped by 9.6% to a record level of $2 060 as investors remained concerned about electricity rationing in South Africa – which represents 80% of world production – adversely affecting global supplies. The gold price was less fortunate and declined by almost $20 from Monday's high.

U.S. wheat also experienced significant interest last week, necessitating the doubling of the trading band before limits up or down are triggered. Hard red spring wheat jumped by 28% to a record of $19.88 a bushel.

The West Texas Intermediate oil price rose to a one-month high of more than $95 a barrel on supply concerns of refinery problems and Hugo Chavez threatening to cut off sales of Venezuelan oil to the U.S. Cold weather in the U.S. also supported the prices.

What's Subprime Debt Worth?

Ask Einstein.


Source: John Hussman, Hussman Funds


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