Dollar

The past week witnessed mounting uncertainty as investors digested news regarding the ongoing credit market problems and deepening gloom about the global economy. In the words of Richard Russell, author of the 50-year old Dow Theory Letters: “If you’re standing on the railroad track and the train is bearing down on you at 90 miles per hour, don’t stand there trying to decide whether the oncoming train is the ‘Midnight Special’ or the ‘Wabash Cannon Ball’. Just get the hell off the tracks. Which train was coming at you can be determined later – right now that’s not the problem.”

In a speech on Thursday (January 10), Fed Chairman Ben Bernanke acknowledged a weaker economy and the need for further relaxation of monetary policy. He assured the American public at large, that the Fed would “take substantive additional action as needed to support growth and to provide adequate insurance against downside risks”.

However, this was cold comfort for The Street as Stock Trader’s Almanac pointed out that 11 of the last twelve easing periods have proved to be tumultuous times for the markets. It certainly does not inspire confidence when considering that the S&P 500 Index registered its worst performance on record (i.e. since 1950) for the first five trading days of 2008. Also, the fact that the Dow Jones Industrial Index closed below its December closing low (on January 2) and continues to trade below it, points to further weakness. Since 1950, 27 of 29 such occurrences saw continued declines with and average loss of 10.1%, according to Stock Trader’s Almanac.

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 chart.

Economy
Philadelphia Fed President Charles Plosser said on Friday (January 11) that the Fed’s biggest worry was potential weakness in consumer spending. Many investors fear that consumer weakness could push the US economy into a recession, a concern exacerbated by overall disappointing retail sales. Rising energy prices, weakening housing markets and slower job growth are all weighing heavily on consumer moods.

The annualized growth rate of the ECRI Weekly Leading Indicator continued on its way down, with Moody’s Economy.com remarking that the trajectory was increasingly looking similar to past periods preceding a recession.

With a barrage of economic data coming from all corners of the world, perhaps the more insightful information was the ECB and BOE decisions to leave their benchmark interest rates unchanged at respectively 4.0% and 5.5%. Although growth in the Eurozone is slowing, inflation remains of greater concern to central bankers than a slowdown in economic activity.

On the other hand, the US seems to be heading towards a half-percentage rate cut at the FOMC’s next meeting on January 30. Fed funds futures indicated an 88% chance of a 50 basis point rate cut, up from the pre-Bernanke speech level of 74%. Goldman Sachs sees three further rate cuts after January of 25 basis points each, bringing the Fed funds rate to 3.0% by mid-year.

WEEK’S ECONOMIC REPORTS

Date	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
Jan 8	10:00 AM	Pending Home Sales	Nov	-2.6%	-	-0.8%	3.7%
Jan 8	3:00 PM	Consumer Credit	Nov	$15.4B	$8.0B	$8.5B	$2.0B
Jan 9	10:30 AM	Crude Inventories	01/05	-6736K	NA	NA	-4056K
Jan 10	8:30 AM	Initial Claims	01/05	322K	345K	340K	337K
Jan 10	10:00 AM	Wholesale Inventories	Nov	0.6%	0.4%	0.4%	0.0%
Jan 10	10:30 AM	Crude Inventories	01/05	-	NA	NA	-4056K
Jan 11	8:30 AM	Export Prices ex-ag.	Dec	0.3%	NA	NA	0.9%
Jan 11	8:30 AM	Import Prices ex-oil	Dec	0.3%	NA	NA	0.7%
Jan 11	8:30 AM	Trade Balance	Nov	-$63.1B	-$60.0B	-$59.5B	-$57.8B
Jan 11	2:00 PM	Treasury Budget	Dec	$48.3B	$47.0B	$52.0B	$42.0B

Source: Yahoo Finance, January 11, 2007.

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

•	Retail Sales (Jan 15) – The small increase in auto sales during December (16.26 million vs. 16.19 million in November), soft non-auto retail sales and a drop in gasoline prices will be reflected in steady retail sales headline. There is a possibility of a minus sign in the headline. Consensus: 0.0% vs. +1.2% in November; non-auto retail sales: -0.1% vs. +1.8%.
•	Producer Price Index (Jan 15) – The Producer Price Index for Finished Goods is expected to have fallen 0.1% in December after a 3.2% jump in November. The decline is mostly due to lower energy prices. The core PPI is expected to have risen by 0.1% after a 0.4% increase in November. Consensus: +0.2%, core PPI +0.2%.
•	Consumer Price Index (Jan 16) – A 0.2% increase in the CPI is predicted for December after a 0.8% jump in November. The core CPI is expected to have moved up 0.2% vs. a 0.3% gain in November. The core CPI could show a milder gain because apparel prices tend to drop in a given month after a sharp increase the previous month. The apparel price index rose by 0.8% in November. Consensus: +0.2%, core CPI +0.2%.
•	Industrial Production (Jan 16) – The 0.7% drop in the manufacturing man-hours index for December implies a drop in factory production. If production at the nation’s utilities rose sharply in December after three monthly declines, there could be an overall gain in December. Assuming the absence of a large contribution from utilities, there should be a 0.3% drop in industrial production. The operating rate is projected to have dropped to 81.2%. Consensus: -0.5%; Capacity Utilization: 81.2.
•	Housing Starts (Jan 17) – Permit extensions for new homes fell by 0.7% in November, marking the tenth monthly drop in the last eleven months. This declining trend suggests continued weakness in the construction of new homes. Starts of new homes are predicted to have fallen to an annual rate of 1.05 million in December vs. a 1.187 million mark in the previous month. Consensus: 1.14 million.
•	Leading Indicators – (Jan 18) – Interest rate spread, initial jobless claims, consumer expectations, and the manufacturing workweek made negative contributions. Vendor deliveries, real money supply, and stock prices made positive contributions. The net impact was a steady leading index during December after a 0.4% drop in November. Consensus: -0.1%.
•	Other reports – Business Inventories (Jan 15), Survey of National Home Builders Association, Beige Book (Jan 16), Federal Reserve Bank of Philadelphia’s Factory Survey (Jan 17), and University of Michigan Consumer Sentiment Index (Jan 18).

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

Source: Wall Street Journal Online, January 13, 2007.

Equities rallied on the back of Bernanke’s assurances, but it did not take long for subprime fears to resurface and most stock markets closed sharply lower on Friday. The MSCI World Index declined by 1.9% during the week, with Japanese stocks (-4.0%) falling to a 26-month low and European stocks (-2.4%) to a 13-month low.

Friday’s sell-off marked the third straight weekly decline for the US stock markets, with the Dow Jones Industrial Index suffering its steepest first-eight-sessions-of-the-year slide in 17 years.

The S&P 600 Small Cap Index (-2.8%) underperformed the larger caps of the S&P 500 Index (-0.8%). Defensive areas that are more resistant to an economic downturn, such as Pharmaceuticals (+3.3%) and Utilities (+1.5%), were among the few sectors registering positive returns for the week.

The depth of the problems faced as a result of the subprime fallout was underscored by Bank of America’s rescue of troubled mortgage lender Countrywide Financial, Merrill’s expected additional $15 billion write-down, and Citigroup’s second capital-raising effort ($14 billion) in as many months.

Government bond yields fell further around the world as the global economic outlook worsened and investors switched stocks to what is perceived to be a safe-haven asset class. However, fears that inflation could become a problem slowed the decline in long-dated maturities.

On the currency front, the US dollar fell somewhat against the euro as expectations of aggressive cuts in US rates increased. Worries about the deteriorating prospects for the UK economy resulted in the British pound hitting a record low against the euro.

The precious metals complex, however, was propelled higher by inflation jitters, with both gold ($898) and platinum ($1 564) recording all-time highs. Silver played catch-up and rose by 7.1% for the week compared with gold’s 3.8% and platinum’s 2.5%.

Base metals and agricultural commodities also performed strongly. A report by the US Department of Agriculture warned of extremely low inventories and pushed wheat prices to an all-time high, corn prices to an 11-year high and soyabean prices to a 34-year high.

Now for a few news items and some words (and graphs) from the investment wise that will hopefully assist to make sense of financial markets’ shenanigans during the week ahead.

Source: Steve Sack, Slate, January 8, 2008.

Moody’s Economy.com: Survey of business confidence for world
“US business confidence fell to a new record low at the start of 2008 and is consistent with recession. Sentiment is stronger elsewhere across the globe, particularly in Asia, although it is down everywhere since the subprime financial shock began this past summer. Expectations regarding the first half of 2008 are especially bleak, plunging to another new low last week. Businesses have also become notably cautious with respect to their inventories and office space needs. Hiring and fixed investment are soft, but holding up better. Pricing pressures have risen with oil prices near $100 per barrel, but remain very subdued compared to the pressures that prevailed during previous oil price spurts.”

Source: Moody’s Economy.com, January 7, 2008.

BCA Research: Global economy – the oil tax
“The surge in oil prices toward the US$100 threshold adds to growth risks for many of the world’s economies. At US$100 per barrel of WTI, the world’s oil bill will approach US$3 trillion, equivalent to roughly 5% of GDP. That would mark a 1% increase compared with last year and comes at a time when growth in the advanced economies is already moderating in response to the US housing collapse and tightening credit conditions. US consumers in particular will feel the pinch, increasing downside risks for the American economy.

“While strong oil demand – especially in China and the Middle East – is contributing to the surge in crude prices, the rising world oil bill is bearish for global growth. This ‘tax’ on growth adds to pressure for major central banks to ease monetary policy. While rising oil prices have temporarily push up headline inflation, the impact of crude on price pressures may already be peaking. Bottom line: High oil prices will require more aggressive stimulus from policymakers in order to support economic growth.”

Source: BCA Research, January 7, 2008.

James Quinn (Telegraph): US recession is already here, warns Merrill
“The US has entered its first full-blown economic recession in 16 years, according to investment bank Merrill Lynch. Merrill, itself one of Wall Street’s biggest casualties of the sub-prime crisis, is the first major bank to declare that a recession in the world’s biggest economy is now underway.

“David Rosenberg, the bank’s chief North American economist, argues that a weakening employment picture and declining retail sales signal the economy has tipped into its first month of recession. Mr Rosenberg, who is well-respected on Wall Street, argues: ‘According to our analysis, this [recession] isn’t even a forecast any more but is a present day reality.’

“His comments are the strongest sign yet that the gloom on Wall Street over the US economy is deepening as the sub-prime mortgage crisis and the credit rout show little sign of easing.

“Mr Rosenberg points to a whole batch of negative data to support his analysis, including the four key barometers used by the National Bureau of Economic Research (NEBR) - employment, real personal income, industrial production, and real sales activity in retail and manufacturing. … he believes that all four of these barometers ‘seem to have peaked around the November-December period, strongly suggesting that we are actually into the first month of a recession.’”

Source: James Quinn, Telegraph, January 8, 2008.

Ambrose Evans-Pritchard (Telegraph): Bush convenes Plunge Protection Team
“Bears beware. The New Deal of 2008 is in the works. The US Treasury is about to shower households with rebate cheques to head off a full-blown slump, and save the Bush presidency. On Friday, Mr Bush convened the so-called Plunge Protection Team for its first known meeting in the Oval Office. The black arts unit – officially the President’s Working Group on Financial Markets – was created after the 1987 crash.

“It appears to have powers to support the markets in a crisis with a host of instruments, mostly by through buying futures contracts on the stock indexes and key credit levers. And it has the means to fry ‘short’ traders in the hottest of oils.

“The team is led by Treasury chief Hank Paulson, ex-Goldman Sachs, a man with a nose for market psychology, and includes Fed chairman Ben Bernanke and the key exchange regulators.

“Judging by a well-briefed report in the Washington Post, a mood of deep alarm has taken hold in the upper echelons of the administration. ‘What everyone’s looking at is what is the fastest way to get money out there,’ said a Bush aide. Emergency measures are now clearly on the agenda, apparently consisting of a mix of tax cuts for businesses and bungs for consumers.

“‘In terms of any stimulus package, we’re considering all options,’ said Mr Bush. This should be interesting to watch. The president is not one for half measures. He has already shown in Iraq and on biofuels that he will pursue policies a l’outrance once he gets the bit between his teeth.”

Source: Ambrose Evans-Pritchard, Telegraph, January 8, 2008.

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