I have spent the past week doing a series of presentations with business partner John Mauldin in South Africa. A rather busy schedule, together with poor Internet access, has resulted in my not being able to assimilate all the necessary material for “Words from the Wise”.

My apologies for any inconvenience, but rest assured that the normal blogging service will be resumed this week.

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As illustrated by the table below, the MSCI World Index is still 9.5% down from its high of October 31, 2007 after its 18.1% drop to a low on March 17, 2008 and a subsequent 10.5% improvement.

The MSCI Emerging Market Index fared better by recovering by 15.8% since a 22.2% drop to a low on January 22, 2008, but is still 9.9% down from its previous high.

Within the emerging markets category, the Chinese Shanghai Stock Exchange Composite Index turned out to be the biggest loser with a decline of 49.2% to its low on 18 April 2008. The Index managed to recover by only 15.7% and is still 41.2% down from its previous high. The Hong Kong Hang Seng Index put in a better performance, dropping by 33.4% to its low on March 17, 2008 and recovering by 21.5% since. The Index is therefore still 19.1% lower than its previous high.

The biggest surprises (at least in local currency terms) were the US and the UK stock markets, as these countries’ economies were the most affected by the credit crisis.

• The Dow Jones Industrial Index dropped by 17.1% to its low on March 10, 2008, but has already recovered by 9.1% and is now 9.5% down from its previous high.

• The S&P 500 Index declined by 18.6% (a little more than the Dow Jones Industrial Index) to its low on March 10, 2008. The Index has gained 11.0% since hitting bottom and is 9.4% down from its previous high.

• The UK FTSE 100 Index dropped by 19.6% to its low on March 17, 2008, but has recovered 16.6% and is now only 7.0% down from its previous high.

The comparison of returns in local currency terms provides a distorted picture as the declining US dollar has negatively impacted returns for non-US dollar investors. The two tables below show returns in euro and US dollar terms respectively.

Comparing historical returns makes for interesting reading, but becomes more meaningful when read alongside valuation tables. David Fuller (Fullermoney) compiled a very useful table of 96 global stock market indices ranked in ascending order by price-earnings (P/E) multiples and in descending order by dividend yield (DY).

Not surprisingly, P/Es rose somewhat in the last month, in tandem with a number of stock markets moving above their February highs. However, European indices continue to dominate the table when arranged according to P/Es and globally very few markets have moved to new highs following the December/January correction. Most noteworthy were South Africa and Brazil.

Some of the Middle Eastern markets also remain at elevated levels having remained insulated, so far, from the travails of other indices.

“For the most part, this earnings season has not resulted in a swathe of missed estimates and stock market performance has been most responsible for increased multiples,” said Fuller.

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In order to try to gain more clarity on the issue, I asked readers to express their opinions on the direction of the Dow Jones Industrial Index by posing the following two questions:

• Where do you see the Dow Jones Industrial Index by June 30, 2008?

• Where do you see the Dow Jones Industrial Index by December 31, 2008?

Before sharing the poll results with you, I thought it could be of interest first to have a quick look at the specific stock market environment that characterized the voting period. As shown by the graph of the Dow below, the market was generally bullish during the six-day voting period, although the second, third, and fourth days (when a significant amount of voting took place) were down days.

Source: StockCharts.com

The reason for focusing on the market situation at the time of the poll is simply because people are very often influenced in a big way by the environment at the time of casting their votes.

A total of 944 people participated in the June poll and 829 in the December poll, answering as follows:

The following observations are gleaned from the results:

1) The normal distribution of the June results assigns a smaller probability to the outlying index values (i.e. tails). This indicates that most participants are sticking to index values not deviating substantially from the current index level over the next two months.

The distribution of the December results assigns a bigger probability to the tails. This points to a larger number of participants expecting the stock market to deviate significantly from current levels by December 31.

2) 84.6% of the participants were neutral (19.7%) or negative (64.9%) regarding the outlook for June 30. The figure decreased somewhat to 74.8% (made up of 11.8% neutral and 63.0% negative) for the December 31 period.

3) The weighted average index level is 12,338 for June 30 and 12,083 for December 31. These figures represent declines from the current index level of 12,970 of 4.9% and 6.8% respectively for the two measurement periods. (This compares with a Citigroup institutional client survey expecting gains of 3% to 5% for the S&P 500 Index by year end.)

The results seem to lie in the same direction as one of my previous polls (April 20, 2008) regarding the stock/bond ratio where 70.3% of the participants did not see stocks outperforming bonds over a six-month period.

However, a recent Barron’s poll among US professional money managers showed a different result, with 88% of the participants in the “bullish/very bullish” (50%) and “neutral” (38%) categories. Furthermore, 90% of the managers considered the US stock market to be “fairly valued” (35%) or “undervalued” (55%).

Where do the poll results leave us? Are the results consistent with a contrarian view that the herd mostly tend to be on the “wrong side” of the market, i.e. should the bearish readings perhaps be interpreted as bullish? These are perplexing questions as the stock market edges higher in the face of a deteriorating economic environment. Whereas I am doubtful about the longevity of the rally, I am also not in the Armageddon school. Is the answer perhaps a “muddle-through” market, characterized by below-average returns? That is my hunch, for what it’s worth.

PS: Barry Ritholtz (The Big Picture) could unfortunately not take up the challenge to test his readers’ prediction skills against those of the Investment Postcards readers as a result of a major revamp of his website. Don’t worry, Barry, there will be many more opportunities to show your readers’ skills.

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Mert Erkal: Prieur, please tell us about an investment professional’s life especially when alarm bells are ringing for global economy.

Prieur du Plessis: The investment environment is notoriously dynamic (or, perhaps, volatile) in the sense that different political, economic and a myriad other variables are forever changing and influencing the course of financial markets – sometimes irrationally, at least on the face of it.

An investor’s unique “investment personality” plays an important role in the way he/she copes with decision making, especially when confronted with lots of “noise”, but experience (i.e. grey hair) does provide one with a framework within which to assess situations logically and calmly.

I find investment to be totally absorbing – nothing short of a very specific (albeit exhilirating) lifestyle – allowing one not only to cope with “alarm bells”, but also to seek out opportunity when the world seems to be falling off a cliff. It is in such situations that the wheat is separated from the chaff and true dedication and professionalism invariably lead to superior investment returns.

Mert Erkal: You have 25 years’ experience in investment research and portfolio management. What was the motive behind creating your own blog?

Prieur du Plessis: I write primarily to organize my thoughts about financial markets and this has become a way of life. The truly original ideas usually come to me when I do my daily run.

I only started blogging in May 2007, but more than 1 200 of my articles on investment-related topics have been published prior to that in various regular newspaper, journal and Internet columns. I have also published a book, Financial Basics: Investment.

Although I am an investment professional, I have always seen the blog site as something personal rather than a commercial venture, but it has created global awareness for our investment management business, Plexus Asset Management, which may lead to monetary gain in the longer term.

Mert Erkal: How did you name your blog? Please describe your blog.

Prieur du Plessis: I’ll first answer the last part of the question. Investment Postcards from Cape Town is an international investment blog, focusing on the macro-outlook for stock markets, bonds, currencies and commodities (including gold).

In addition to investment articles, the blog also features a delightful section on investment humor (for those moments when the weight of down-markets becomes just a little too much to bear), podcasts, an index ticker, stock market polls, video clips and a translator.

The blog offers objective comment packaged in an easily comprehensible manner and has attracted in excess of 5 000 subscribers over a relatively short period.

As far as the blog site’s name is concerned, my aim is to write short and punchy posts on investments, in the same way as one will strive to convey a message within the space limitations of a postcard.

The “from Cape Town” bit has been added to the title in order to create some distance, literally and figuratively, between the hustle and bustle of the world’s premier financial centres – where the herd instinct is often prevalent – and the more tranquil Cape Town surroundings where I find it easier to formulate independent and objective investment ideas.

Mert Erkal: When reading your biography, I noticed that you like long-distance running. Do you see similarities between blogging and long-distance running?

Prieur du Plessis: There are numerous similarities between blogging and long-distance running, suffice to highlight the following four:

* Both blogging and long-distance running have as goal to excel over the longer term, i.e. to endure to reach a marathon personal best, or to provide high-quality blogging content that will build a loyal subscriber base and withstand the test of time. (It is, however, also tempting to be ahead at each 100-yard interval!)

* Success in both instances depends partly on natural talent, but also on dedication and perseverance. In reality, self-discipline is paramount.

* Both blogging and long-distance running are individual “sports”, rather than team “sports” where the momentum of a group of people can spur you on to greater achievement. This requires a “self-starting”-type of temperament in order to get the job done, and eventually to excite a large number of spectators / readers.

* Long-distance runners continuously fight the adversity of injury. Bloggers, similarly, get “injured” by writer’s block, comments in bad taste, wrong market calls (in the case of investment bloggers), etc. Fighting injury and regaining top form in both instances require mental toughness.

In short, I have become quite dependent on both blogging and running to provide my daily dosage of adrenalin. And the bonus is that they both work just fine on my travels across the globe.

Mert Erkal: What are your (investment) wise suggestions for Bloghology readers in 2008?

Prieur du Plessis: We are dealing with a rather unusual set of investment circumstances in the wake of the sub-prime fallout. Frequent comparisons with the Great Depression are the order of the day. In my opinion, the world may not quite be faced with Armageddon, but the uncertainty nevertheless calls for a prudent approach when it comes to money management. I therefore recommend that investment strategy should emphasize capital preservation, i.e. the return of capital rather than the return on capital.

The key to successful long-term investing remains compounding, i.e. investing regularly over a long period in a portfolio of solid dividend-paying stocks that can weather most short-term storms. But do accept that the investment world is becoming increasingly specialized and that it makes sense for most people to seek out professional help, particularly from advisers who have shown their mettle in both bull and bear markets.

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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 US dollar, a sell-off of most commodities, and a weak undertone in government bond markets.

The Fed 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 US 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 US 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 US 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.

Economy
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 UK, 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 US economy.

WEEK’S ECONOMIC REPORT

Source: Yahoo Finance, 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).

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

Source: Wall Street Journal Online, May 4, 2008.

Equities
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. European stocks (+2.3%) fared the best among the mature markets, whereas emerging markets (+0.3%) lagged the major markets.

The Brazilian market was a highlight of the week with the Bovespa Stock Index surging by 6.4% to hit an all-time high on the back of Standard & Poor’s awarding the country an investment grade rating. The Bovespa Stock Index has registered a gain of 438% since its low of August 2003.

The Chinese market also performed well with the Shanghai Stock Exchange Composite Index improving by 3.8% (on top of the previous week’s gain of 15.0%), while the Hong Kong Hang Seng Index and the Bombay Stock Exchange Sensex 30 Index both finished 2.8% higher.

The strongest stock market index was again the Nasdaq Composite Index with a gain of 2.2% (YTD: -6.6%), followed by the Dow Jones Industrial Index with +1.3% (YTD: -1.6%), the S&P 500 Index with +1.1% (YTD: -3.7%) and the Russell 2000 Index with +0.5% (YTD: -5.3%).

A number of key technical resistance levels were breached as a result of the improvement in prices, most notably the S&P 500 Index’s 1,400 level (closing level: 1,414). The next resistance level is at 1,435 where the Index will encounter its 200-day moving average. The Dow Jones Industrial Index already crossed this barrier on Friday.

Fixed-interest instruments
US government bonds rallied for the first four days of the week, but sold off on Friday on the back of better-than-expected jobs data.

The yield on the two-year US Treasury Note closed the week three basis points higher at 2.46%, whereas the US Treasury Note yield declined by two basis points to 3.86%.

Government bonds elsewhere in the world followed a mixed pattern.

The lower Fed funds rate pulled US mortgage rates down sharply, with the 15-year fixed rate dropping by 16 basis points to 5.41% and the 5-year ARM rate falling by 33 basis points to 5.48%.

Money market stress eased somewhat as far as the three-month US dollar interbank rate was concerned, but euro rates tightened further.

Currencies

Following the FOMC’s rate cut on Wednesday many pundits argued that it could be the last reduction for a while. This boosted the US dollar to a five-week high against the euro and a two-month high against the Japanese yen.

The euro declined on the back of a perception that the ECB may be moving closer to a rate cut as the economic outlook in the Eurozone deteriorated further.

The stronger dollar impacted negatively on commodity prices and the currencies of commodity-producing countries such as the Canadian dollar.

High-yielding currencies such as the Australian and New Zealand dollars strengthened markedly as a result of a resurgence of carry trade transactions. On the other hand, the Japanese yen and Swiss franc came under selling pressure.

Commodities
The improving US dollar caused the correction in commodity prices to intensify, as illustrated by the following graph:

Source: StockCharts.com

Now for a few news items and some words and charts from the investment wise that will hopefully assist in steering our investment portfolios on a profitable course.

Hat tip: Barry Ritholtz’s The Big Picture

Business News Network: Donald Coxe – How to structure a global portfolio

Source: Business News Network, April 30, 2008.

MarketWatch: Peter Bernstein – Saving for survival

Click here for a written version of E.S. Browning’s interview.

Source: MarketWatch, April 29, 2008.

CNBC: Bill Gross – “Euphoric” stock market rebound may be premature

Source: CNBC, May 1, 2008.

(more…)

It is therefore no wonder that even so-called “pop analysis”, including some legendary axioms, is resorted to in a quest for direction. And besides “buy low and sell high” few other axioms are more widely propagated than “sell in May and go away”. A Google search revealed an astounding 126 000 items featuring this phrase.

As stock prices are rising strongly, investors are justifiably questioning the longevity of the rally. And they nervously wonder whether this May will not only herald longer days in the Northern Hemisphere, but also live up to its reputation as the advent of a corrective phase in the markets.

The important issue, however, is whether this axiom actually has any scientific basis at all. While the figures obviously vary from market to market, long-term statistics seem to show that the best time to be invested in equities is the six months from early November through to the end of April of the next year (“good” periods), while the “bad” periods normally occur over the six months from May to October.

A study of the MSCI World Index, a commonly used benchmark for global equity markets, reveals that since 1969 “good” periods returned 8.4% per annum while investors were actually in the red during the “bad” periods by -0.4% per annum. Interestingly, this phenomenon – of “good” period returns outperforming those of “bad” periods – applied to all 18 markets where MSCI computed index returns.

“Sell in May and go away” also holds true for the US stock markets. An updated study by Plexus Asset Management of the S&P 500 Index shows that the returns of the “good” six-month periods from January 1950 to December 2007 were 8.5% per annum whereas those of the “bad” periods were 3.2% per annum.

A study of the pattern in monthly returns reveals that the “bad” periods of the S&P 500 Index are quite distinct with every single one of the six months from May to October having lower average monthly returns than the six months of the good periods.

But what exactly does this mean for the investor who contemplates timing the market by selling in May and reinvesting in November?

Further analysis shows that had one kept the investment in the S&P 500 Index only during the “good” six-month periods, and reinvested the proceeds in the money market during the “bad” six-month periods, the total return would have been 11.2% per annum. But, the best strategy would in fact have been to discard the “sell in May” axiom and rather ride out the “good” and “bad” periods as the annual return on this investment was 11.9% per annum.

The difference of 0.7% per annum may seem insignificant, but over such a long period of time this would have made a very sizeable difference in monetary value.

These calculations also do not take tax into account, and as the returns on the money market have been calculated gross of tax, the result would have been even more in favour of remaining fully invested in equities. And, of course, every time one switches out of and back into the stock market there are costs involved, which would also reduce the returns for the market timer.

The axiom “sell in May and go away” in itself seems to be a rather doubtful basis for timing equity investments in the US. However, it may serve a useful purpose as input, together with other factors, to otherwise rational decision making.

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Stock markets see-sawed as investors assimilated the various economic and earnings reports, with the S&P 500 Index eventually eking out a positive return of 0.5% for the week, thereby consolidating the previous week’s gains (+4.3%).

Evidence of a more relaxed undertone among equity investors was confirmed by the Volatility Index (VIX) falling to its lowest level of the year and below the psychological 20 barrier, i.e. the level that had set the ceiling for fear until the credit crunch began in July 2008.

The real action, however, was in the government bond markets where prices plunged (i.e. yields jumped) as investors were spooked by life-time high oil prices, stoking inflation pressures (see graph alongside of the price of the 10-year US Treasury Note). Furthermore, safe-haven considerations, which were dominant for most of the duration of the credit crisis, took a back seat on the prospect of a better US economy ahead.

A word of caution, however, came from John Hussman (Hussman Funds) who said: “Aside from short-term speculative pressures (largely driven by relief about Bear Stearns), nothing in recent data suggests a material abatement of recession risk, mortgage risk, profit margin risk, or dollar risk.”

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.

Economy
Last week saw only a handful of economic reports, showing further declines in the housing market, better-than-expected news for weekly initial jobless claims and durable orders, excluding transportation, and another depressed consumer sentiment reading coming in at a 26-year low.

Asha Bangalore (Northern Trust) said: “Although the National Bureau of Economic Research is yet to announce that a recession is under way, incoming data strongly suggest that the economy is in recession. The more important questions now are about the depth and duration of the recession and what the nature of the recovery process is. In terms of duration, the recession could be close to the average post-war recession of 10 months, but the severe credit crunch that is hampering the smooth functioning of financial markets supports forecasts of a prolonged and sluggish recovery.”

As far as Wednesday’s interest rate announcement by the FOMC is concerned, the graph below indicates that the Fed fund futures see a 70% chance of a 25 basis point rate cut from 2.25% to 2.0% (green line) and a 25% chance of no rate cut (orange line). One month ago, the futures saw an 88% chance of a 50 basis point cut; one week ago it was a 46% chance. Now the futures see only a 5% chance of a 50 basis point cut. This serves as confirmation of how market participants’ apprehension about the credit crisis has lessened.

Source: Paul Kedrosky, Infectious Greed, April 24, 2008.

Elsewhere in the world, the Bank of England on Monday announced a massive operation to support liquidity in British banks. The BoE will offer to acquire asset-backed securities from banks in exchange for Treasury bills, expecting to swap £50 billion to help restore confidence to the sector.

Germany’s Ifo Business Climate Index came in below expectations in April, suggesting that German industry and trade are starting to feel the pinch of the strong euro and high commodity prices.

Further to the east, Japan’s headline core CPI rate, which includes fast-rising energy prices, leapt 1.2% year-on-year, the highest in 10 years. This is seen as an indication that Japan could be close to shaking off 10 years of deflation.

With prices rising strongly throughout the world (as shown in the graph below), investors appear to be placing more emphasis on the inflation outlook than on credit-related matters at the moment.

Source: Stanlib

WEEK’S ECONOMIC REPORTS

Source: Yahoo Finance, April 25, 2008.

In addition to the FOMC’s interest rate announcement at the end of its two-day meeting on Wednesday (April 30), the next week’s economic highlights, courtesy of Northern Trust, include the following:

1. Real GDP (April 30): The US economy is most likely to post the first decline in GDP (-0.1%) since the third quarter of 2001. Broad-based weakness inclusive of significant decelerations in consumer spending and business investment expenditures and a sharp decline in residential investment expenditures are predicted to have held back the growth of GDP in the first quarter. Consensus: 0.3%. The forecast range for GDP growth in the first quarter is -0.2% to +1.5%.

2. Personal Income and Spending (May 1): The earnings and payroll numbers for March indicate only a small gain in personal income (+0.1%). Auto sales fell in March (15.1 million versus 15.4 million in Feb.) and non-auto retail sales were noticeably weak, which points to likely drop in goods outlays. An offset from services should leave consumer spending nearly flat in March. Consensus: Personal income +0.3%, consumer spending 0.3%.

3. ISM Manufacturing Survey (May 1): The consensus for the manufacturing ISM Composite Index is 48.0 versus 48.6 in March. If the consensus forecast is accurate, it would be the fourth monthly reading below 50 in the last five months. Consensus: 48.0 versus 48.6 in February.

4. Employment Situation (May 2): Payroll employment in April is predicted to show the fourth monthly decline (-75,000) following a loss of 80,000 jobs in March. The jobless rate is predicted to have risen to 5.2% from 5.1% in March. Consensus: Payrolls – -75,000 versus -80,000 in March, unemployment rate – 5.2% versus 5.1% in March.

5. Other reports: Consumer Confidence (April 29), Employment Cost Index (April 30), and factory orders (May 2).

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, April 26, 2008.

Equities
Global stock markets added to the previous week’s gains but in more modest fashion, with the MSCI World Index closing 0.6% higher on Friday. Japan’s Nikkei 225 Average (+2.9%) fared the best among the mature markets, whereas emerging markets (+1.1%) also put in a good performance.

The Chinese market was a highlight as the Shanghai Stock Exchange Composite Index jumped by 15.0% after news of a cut in the share-trading tax. That helped the Hong Kong Hang Seng Index surge by 5.5%, while the South Korea Seoul Composite rose by 3.0%.

As the first-quarter earnings season in the US got into full swing, the strongest stock market index was again the Nasdaq Composite Index with a gain of 0.8%, followed by the S&P 500 Index (+0.5%), the Dow Jones Industrial Index (+0.3%) and the Russell 2000 Index (+0.1%). The Dow Jones Transportation Average is now up 10.6% for the year, which is particularly interesting as the “trannies” are often viewed as a leading indicator of economic activity.

All eyes will be on the S&P 500 Index during the coming week as the Index is just a whisker away from the key 1,400 resistance level. Please let me know how you see this panning out by clicking here to participate in a quick poll on the direction of the stock market.

Fixed-interest instruments
Fading concerns about an economic Armageddon and commensurate less safe-haven buying, together with mounting inflation worries, resulted in investors switching from government bonds to equities, pushing government bond yields sharply higher in most parts of the world.

The yield on the two-year US Treasury Note jumped by 19 basis points to 2.37%, thereby exceeding the Fed funds rate of 2.25% for the first time since June 2006. The 10-year US Treasury Note yield rose by 10 basis points to 3.85% and the 30-year Bond yield to by 5 basis points to 4.57%, resulting in a flattening of the yield curve.

Government bonds elsewhere in the world followed a similar pattern, with Japanese bonds in particular taking a beating as a result of inflation reaching its highest level for a decade.

Bond prices are facing their first monthly decline since June 2007.

US mortgage rates also increased, with the 15-year fixed rate rising by 3 basis points to 5.57% and the 5-year ARM rate increasing by 8 basis points to 5.81%.

Currencies

The past week again saw quite a bit of volatility in the currency markets. On Tuesday the US dollar hit an all-time low against the euro of $1.6018, but then reversed course to close at $1.5618 – its strongest level in a month.

The turnaround in the US dollar’s fortunes came on the back of a perception that the Fed may be close to halting its recent slew of interest rate cuts, whereas the economic outlook in the Eurozone has deteriorated.

The US dollar strengthened by 1.2% against the euro during the week, 0.7% against the Japanese yen, 1.5% against the Swiss franc and 0.7% against the British pound.

Elsewhere, the Australian dollar rallied to a 24-year high against its US namesake on the back of stronger inflation data.

Commodities
The Dow Jones-AIG Commodity Index (-0.6%) took a breather as the stronger US dollar impacted negatively on some agricultural commodities, industrial metals and precious metals.

The West Texas Intermediate oil price (+2.1%) came to within touching distance of $120 a barrel on news of strikes in Scotland and Nigeria, another pipeline attack in Nigeria, and a report on Friday that there had been a skirmish in the Persian Gulf between a US cargo ship and Iranian fast boats.

The rebound in the US dollar caused further profit-taking in the precious metals complex, with gold losing 2.8%, platinum 5.0% and silver 4.8%.

Rice again traded at record levels, reaching prices in excess of $1,000 a ton.

Now for a few news items and some words and graphs from the investment wise that will hopefully assist in making sense of a week that is filled to the brim with important happenings that include earnings reports from over 100 S&P 500 members, an FOMC meeting and a batch of influential economic data.

Source: Slate, April 2008.

Moody’s Economy.com: Global business confidence at record low
“Global business confidence fell to a record low in mid-April. Businesses’ assessments of current business conditions are bleak as are their views on the strength of sales. Equipment investment is holding up much better, but it too has weakened notably in recent weeks. Hiring intentions in April are consistent with another month of job losses. Financial services firms are glum. The only good news in the report is tentative indications that the inventory drawdown is abating. Asian confidence is also holding in better.”

Source: Moody’s Economy.com, April 21, 2008.

CNBC: Wilbur Ross’s world tour
Fresh from his around-the-world tour, Wilbur Ross grants CNBC’s Maria Bartiromo an exclusive interview.

Source: CNBC, April 25, 2008.

CNBC: Where’s the economy going? Nobel winners weigh in
“CNBC’s ‘Squawk Box’ hosted a meeting of the minds this morning: Past Nobel Prize winners shared their insight on the future of the markets.”

Nobel thoughts
“‘The real important point from an economic perspective is the gap between the economy’s potential growth and its actual growth. And without a doubt, there’s a big gap. I think we’re probably in a recession. The real concern is how long, how deep. This is one of the worst – clearly going to be the worst … downturns since the Great Depression.’

Joseph Stiglitz, 2001 Nobel Prize winner and Columbia University professor

Nobel optimism
“‘I think that we’ve got a lot of strength that’s going to come out of the export sector, the technology sector. We’ve seen good earnings reports from some of them. They’re thriving on this weak dollar. It’s giving them a chance to sell goods all over the world. And I think that’s going to probably pull us out.’

Robert Engle, Nobel Laureate Economist winner 2003 and New York University professor

“‘The rise of the unemployment rate has been mild, and it started from a very, very low level of 4.3 just ten or twelve months ago. By that metric, this is a mild downturn.’

Edmund Phelps, Nobel Prize winner in economics 2006

Nobel innovation
“‘I think that we should be thinking forward to creating new mortgage institutions that are relatively immune from this moral hazard and that shelter people from it – what I’m talking about is what I’m now calling a continuous workout mortgage. These would be mortgages privately issued so that the cost would be priced into the rate. And they would be mortgages that are flexible in the sense that the payout scheme responds to changing economic conditions and changing ability to pay.’

Robert Shiller, Yale University professor of economics

Source: CNBC, April 25, 2008.

CNBC: Nobel prize-winning e-mails
Answering viewer e-mails with Robert Hormats, Goldman Sachs International, Joseph Stiglitz, Nobel Prize Winner 2001 and Columbia University professor, and Edmund Phelps, 2006 Nobel Prize winner in economics.

Source: CNBC, April 25, 2008.

GaveKal: Statistics show US economy is in recession

Source: GaveKal – Checking the Boxes, April 21, 2008.

(more…)

I recently borrowed the word “muddle through” from business partner John Mauldin (Thoughts from the Frontline) to describe what would otherwise have been called a sideways market. So many Johns, so many terms: John Hussmann (Hussman Funds) highlights a number of phrases currently been bandied about by pundits to describe the market outlook: “looking across the valley”, “last innings”, “glass is half full” and “the Fed is on top of this”. But, alas, these are often just guesses and mostly pretty useless in describing whether the stock market is going up, down or sideways.

It has become a national pastime to try to figure out where in the stock market cycle we are. Dear readers, this is where I am going to rely on your collective wisdom and ask you to express your opinion on the direction of the stock market. We will specifically focus on what is in store for the Dow Jones Industrial Index by considering two periods:

(1) from now until the close on June 30, 2008; and
(2) from now until the close on December, 31, 2008.

All you need to do is to think about this for a short while and provide your answers by clicking the appropriate button on each of the two poll images at the bottom of this post.

Challenge
But let’s make the poll even more interesting and throw out a challenge to good friend Barry Ritholtz (The Big Picture) and his cohorts: Barry, please set up identical polls on your blog site and let’s then measure whether, in the aggregate, The Big Picture fans or the Investment Postcards supporters rule the roost. There is $100 prize at stake in each of the two categories for the group (i.e. Big Picture or Investment Postcards) that nails the actual interval.

This prize money will be paid by Barry if the winner comes from the Investment Postcards team and by me, in the unlikely event of the Big Picture team claiming the spoils. The winning proceeds will be donated to a charity of the winner’s choice. (Individual side bets are totally in order, but please then let us know about these by posting the details in the comments section on the respective blog sites.)

STOP PRESS: Barry has accepted the challenge and will put the details on The Big Picture site early next week.

Please share your thoughts on the direction of the stock market with other readers by clicking the appropriate buttons in each of the two polls below (and then start rigging the markets to give the required result!).

The polls will run until 17:00 EST on Friday, May 2, 2008.

Opinion Polls & Market Research

Opinion Polls & Market Research

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Thomson Financial estimated at the start of the week that first-quarter earnings would decline by 14.1%; however, when the financial sector is excluded, the growth rate for the remaining nine sectors would be 6.4%.

Against the backdrop of a US recession, this round of earnings reports is of particular interest for the stock market in order to ascertain specifically how the earnings for the non-financial sector stack up, i.e. whether more earnings announcements surprise on the downside than upside. (Earnings expectations for financials have already been reduced by so much that the potential for shocks is probably fairly limited.)

Mike Lenhoff (Brewin Dolphin) highlights the following: “… with nearly 20% of the S&P 500 having reported, the non-financial earners are doing comparatively well by surprising on the upside. For example, if one excludes the results for financials and consumer discretionary, we’re talking about almost 5 companies surprising on the upside with their earnings for every one company surprising on the downside. The corresponding ratio for the entire set of companies that has reported so far is closer to 2.”

It is quite apparent that the US currently has a two-stream economy, with multi-nationals such as Coca-Cola (KO), IBM (IBM) and Intel (INTC) being cushioned against the slowdown in the US by the weak US dollar and stronger growth abroad.

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.

Economy
The Beige Book for the US was released last week and concluded that the economy was characterized as weakening over the past six weeks. “This downbeat report is consistent with our assessment that the economy is in recession,” said Moody’s Economy.com.

The past week witnessed a number of inflation reports causing concern about rising prices.

The Consumer Price Index (CPI) increased by 0.3% in March after holding steady in February. During the three months ended March, the CPI rose at an annual rate of 3.1% compared with a 4.1% gain in 2007.

Wholesale prices stoke concerns of hawks, with the Producer Price Index (PPI) for finished goods having risen at an annual rate of 10.2% in the first three months of 2008 versus an 11.5% increase in the fourth quarter of 2007 and a 6.3% gain in 2007.

Elsewhere in the world, higher fuel and food costs also saw price increases in Germany hit an annual rate of 3.2% in March. This helped drive inflation across the 15-country euro region to 3.5% last month – a 16-year high. Japanese inflation is also back, with consumer inflation now more than 1% for the first time this decade.

Back to the US, the Conference Board’s Index of Leading Economic Indicators (LEI) declined by 1.8% in the first quarter of 2008. This is the largest quarterly drop in the current economic expansion. “Historically, negative year-to-year readings of LEI are associated with recessions,” said Asha Bangalore (Northern Trust).

Furthermore, the housing starts and permits data in March suggested that the bottom for construction of new homes was not yet in sight.

Given the weakness in the housing sector, retail sales and employment conditions, the FOMC is most likely to lower the Fed funds rate by 25 basis points to 2.0% at its meeting of April 30. However, the upward pressure from rising import prices due to a weak dollar could result in the Fed deciding to adopt a wait-and-see approach after the April 30 meeting.

WEEK’S ECONOMIC REPORTS