Investment Postcards from Cape Town

Investors had to stomach another roller-coaster ride last week as mounting concerns about a recessionary US economy and the implications for global growth and corporate earnings continued to weigh on sentiment

After Monday’s holiday, stock markets kicked off lower on Tuesday, rallied on Wednesday, fell again on Thursday and for most of Friday, and reversed fortunes during the final 45 minutes of trading before the week’s closing bell. Phew!

Besides directionless stock markets, the week saw the continuing themes of a weakening dollar and surging commodity prices.

The text of the minutes of the FOMC’s January meeting was released on Wednesday, indicating that “several participants noted that the risks of a downturn in the economy were significant”. It was furthermore clear that the Fed remained more concerned about slowing economic activity than rising prices.

The Fed cut its 2008 GDP forecast to a range of 1.3% to 2.0% from 1.8% to 2.5%. It also raised its core inflation forecast for 2008 to a range of 2.0% to 2.2% from 1.7% to 1.9%. The revised forecasts provided support for the view that further easing of monetary policy remained on the cards.

Firmly in the bear camp, Nouriel Roubini of New York University’s Stern School of Business (RGE Monitor) has been very vocal in painting a dire economic picture, stating that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”.

However, Richard Russell, author of the Dow Theory Letters, argued: “… the important fact is that the Dow and the Transports are still above their January 22 lows. In other words, the end of the world has not arrived yet. How do we know? The market is telling us so. That may change next week or next month, but so far, that’s the incredible story. And remember, the stock market is smarter than all the economists and the traders and the Treasury and the Fed taken together.

“We’re obviously experiencing a slowdown in many areas of the economy, but other areas (agricultural, mining) are booming. Let me put it this way – I don’t believe we’re going to be dealing with an old-fashioned across-the-board recession. We’re going to be dealing with an uneven economy, some areas in bad shape, some in fair shape, and other in excellent shape,” said Russell.

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
A number of important economic reports were released last week, resulting in pundits either worrying about the magnitude of a US recession, being concerned about increasing inflation, or being troubled by the prospect of stagflation.

On top of the Fed’s minutes and revised economic projections referred to above, the overriding economic influences were rapidly rising commodity prices, a jump in the January CPI rate to 4.3% year on year (+2.5% excluding food and energy) and a weak Philadelphia Fed manufacturing report, coming in at -24.0 versus a consensus estimate of -10.0 – indicating a contraction in manufacturing activity and representing the lowest number since the 2001 recession.

David Rosenberg, Northern American economist at Merrill Lynch, argued that the manufacturing slowdown in the US mid-Atlantic region showed a “collapse in business confidence” to levels not seen since the 1990s recession, according to Reuters. He added: “The debate is no longer about whether the economy is in recession. It is about how hard the landing will be.”

Rosenberg also said the Fed will likely remain in “aggressive rate-cutting mode” as a result, cutting rates by 50 basis points on March 18. The Fed funds futures now see a 94% chance of a 50 basis point cut, a 100% chance of a 25 basis point cut and no chance of a 75 basis point cut.

WEEK’S ECONOMIC REPORTS

ate	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
Feb 20	8:30 AM	Building Permits	Jan	-	NA	NA	1068K
Feb 20	8:30 AM	Core CPI	Jan	-	NA	NA	0.2%
Feb 20	8:30 AM	CPI	Jan	0.4%	0.3%	0.3%	0.4%
Feb 20	8:30 AM	Housing Starts	Jan	-	NA	NA	1006K
Feb 20	8:30 AM	Core CPI	Jan	0.3%	0.2%	0.2%	0.2%
Feb 20	8:30 AM	Housing Starts	Jan	1012K	1020K	1015K	1004K
Feb 20	8:30 AM	Building Permits	Jan	1048K	1005K	1040K	1080K
Feb 20	10:30 AM	Crude Inventories	02/16	-	NA	NA	1066K
Feb 20	2:00 PM	FOMC Minutes	Jan 30	-	-	-	-
Feb 21	8:30 AM	Initial Claims	02/16	349K	355K	345K	358K
Feb 21	10:00 AM	Leading Indicators	Jan	-0.1%	0.0%	-0.1%	-0.1%
Feb 21	10:00 AM	Philadelphia Fed	Feb	-24.0	-10.0	-10.0	-20.9
Feb 21	10:30 AM	Crude Inventories	02/16	4204K	NA	NA	1066K

Source: Yahoo Finance, February 22, 2008.

In addition to Bernanke’s semi-annual testimony on monetary policy on February 27 and 28 to the House and Senate banking committees respectively, the next week’s economic highlights, courtesy of Northern Trust, include the following:

1. Existing Sales (Feb 25): Sales of existing homes are predicted to have dropped in January. These sales have declined by 32.2% from their peak in September 2005. On a year-to-year basis sales have dropped by 23.2% from a year ago in December. Consensus: 4.84 million versus 4.89 million in December.

2. Producer Price Index (Feb 26): The Producer Price Index for Finished Goods is expected to have risen slightly by 0.2% in January, reflecting higher food and energy prices. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in December. Consensus: +0.3%, core PPI +0.2%.

3. New Home Sales (Feb 27): Sales of new homes are forecast to post a decline in January. These sales have fallen by 56.5% from their peak in July 2005. On a year-to-year basis sales have declined by 40.9% from a year ago in December. Consensus: 600 000 versus 604 000 in December.

4. Durable Goods Orders (Feb 27): Durable goods orders are predicted to reverse (-2.5%) a part of the sharp 5.1% increase posted in December. Orders of aircraft may have dropped following two consecutive monthly gains. Consensus: -3.5% versus +5.1% in December.

5. Real GDP (Feb 28): The downward revision of retail sales in the fourth quarter appears to be offset by a smaller than assumed trade deficit in the fourth quarter, with no net change on headline GDP as reported in the advance estimate. Consensus: 0.7%.

6. Personal Income and Spending (Feb 29): The earnings and payroll numbers for January suggest only a small gain in personal income during January. Auto sales dropped in January and non-auto retail sales were lackluster, which points to soft reading for consumer spending. Both of these suggest soft overall consumer spending (+0.1%). Consensus: Personal income +0.2%, consumer spending +0.2%

7. Other reports: Consumer Confidence (Feb 26) and Chicago PMI (Feb 29).

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

Source: Wall Street Journal Online, February 24, 2008.

Equities
Global stock markets closed the week generally higher, with the MSCI World Index gaining 0.8%. Emerging markets were the star performers and rose by 1.5% as a group irrespective of declines in China (-2.8%), Hong Kong (-3.5%) and India (-4.2%).

It was a fairly trendless week as investors took their lead from US economic reports. The net result was marginal gains for the Dow Jones Industrial Index (+0.3%) and the S&P 500 Index (+0.2%). The Nasdaq Composite Index, however, edged down by 0.8% on concerns about the technology sector. Gold and silver stocks (+7.1%) and oil service stocks (+3.0%) were the strongest sectors for the week.

After a down-day for most of Friday, the US markets reversed course during the final minutes after a CNBC report of an imminent bail-out of Ambac Financial Group. It was subsequently confirmed that a group of banks was preparing to inject $2 billion to $3 billion into the troubled bond insurer.

The weakest stock market among the majors was Japan, with the Nikkei 225 Average declining by 0.9% as Japanese investors were rumored to be switching equities for high-yielding New Zealand dollars on fairly large scale.

Bonds
Government bonds experienced a great deal of volatility as the week progressed from one economics report to the next. However, mounting inflation concerns resulted in global yields across all maturities closing the week higher.

Currencies
The US dollar continued its downward path during the past week as market participants focused on weaker US economic growth leading to further rate cuts by the Fed. The US dollar dropped by 1.1% against the euro, 0.5% against the British pound, 0.7% against the Swiss franc and 0.7% against the Japanese yen.

A very healthy trade balance as a result of booming commodities exports saw the Brazilian real jumping 3% to a nine-year high against the US dollar. Elsewhere, the high-yielding Australian dollar and New Zealand dollar were also exceptionally strong, rising by 1.4% and 1.6% respectively against the US dollar.

Commodities
The Reuters/Jeffries CRB Index (+4.1%) skyrocketed to an all-time high during the past week as investor inflows into commodities increased strongly. Crude oil (+3.5%), gold (+4.6%), platinum (+5.3%) and agricultural commodities (+2.9%) all reached record levels.

Leading the pack in percentage terms were industrial metals that soared by 6.0% (with copper up by 7.5%) on the back of surging demand from China and other developing countries. Major Asian steel manufactures have started signing contracts to purchase iron ore at 65% more than previous prices.

Disappointing inflation data propelled gold bullion to a new high of $953.6 before profit-taking set in. Platinum, in turn, reached a new peak of $2 148 as it started dawning upon the market that South Africa’s electricity rationing could be a multi-year problem, creating shortages not only for platinum but also for products such as thermal coal and ferrochrome.

The West Texas Intermediate oil price breached $100 by midweek on supply concerns as escalating worries about Nigeria and Venezuela, several refinery problems and cold weather in the US supported prices. The price eased back on Friday as a result of an increase in US inventories.

Supply concerns resulted in another strong week for agricultural commodities.

Now for a few news items and some words and graphs from the investment wise that will hopefully assist in guiding us through the treacherous waters and making the correct investment decisions.

Roll up consumers – save the US economy

Source: About.com.

Moody’s Economy.com: Businesses remain negative on outlook
“Business sentiment has stabilized, but at a very low level that is consistent with a contracting US economy and marginal growth in Canada and Europe. Confidence remains stronger in Asia and South America, but is consistent with growth that is at the low end of potential. Businesses remain particularly negative on current conditions and the outlook six-month hence. Real estate firms and financial institutions are the most worried, but business service firms and even manufacturers and high-tech firms are measurably more nervous. Pricing pressures remain subdued despite currently high oil prices.”

Source: Moody’s Economy.com, February 19, 2008.

CESIfo: Ifo World Economic Climate declines significantly
“The Ifo World Economic Climate has worsened clearly in the first quarter of 2008. The indicator fell to its lowest level since mid-2003. Both the assessments of the current economic situation as well as the expectations for the coming six months are more unfavourable than in the previous survey. In the opinion of the World Economic Survey experts, the US subprime crisis is critically affecting, apart from the US, the financial systems of the UK, Switzerland, Ireland and Germany. The negative impact will be concentrated on the first half of 2008 and will weaken thereafter.”

Please click the thumbnails below for Western Europe and Asia.

Source: CESifo.de, February 20, 2008.

Moody’s Economy.com: Risk of US recession – 60%
“Falling employment, slumping retail and vehicle sales, and waning confidence signal that the US economy is contracting. It is no longer a question of if, but rather how severe the