Talk in financial markets during the past week was dominated by increasing worries about the US economy, as illustrated by the reaction to the US Labor Department’s poor August jobs report. Before gleaning some wisdom from an assortment of quotes from market commentators, let’s briefly review the week’s ups and downs on the basis of a few bar charts.
US equities were adversely affected by economic concerns and closed the week in negative territory. The Nasdaq Composite Index, however, bucked the trend with a positive return (albeit in the second decimal), thereby extending its recent relative strength. Emerging markets again occupied the top of the performance table, with China and Hong Kong looking unstoppable (but very overbought).
GLOBAL STOCK MARKETS
Bond yields were lower across the yield curve during the week, discounting softer economic activity. US 3-month Treasury Bills, however, jumped as liquidity concerns persisted. On the exchange rate front, the US dollar came under renewed pressure in the expectation of lower interest rates. The yen rose strongly, focusing the attention on the implications of the reversal of carry trade positions.
FIXED-INTEREST AND CURRENCY MARKETS
The commodities markets were characterized by strong increases in precious metals (with gold breaking the psychological barrier of $700), energy (with oil approaching its highs) and agriculture. The notable exceptions were industrial metals and livestock, where losses were registered.
Now for words from the investment wise to cast some light on the increasingly complex set of circumstances confronting investors.
Business confidence for world
“Businesses are losing faith in the economic expansion. Sentiment has fallen sharply since the sub prime financial shock began in late July. Confidence is now at its lowest level since in the midst of the Iraq invasion in early 2003 and consistent with an economy that is close to recession. Assessments of present conditions and expectations regarding the six-month outlook are both firmly negative. Sales have notably weakened, as has investment. Hiring has also softened, although it is holding up better. Pricing pressures have vanished, despite still very high commodity prices.”
Source: Moody’s Economy.com, September 5, 2007.
Beige Book for United States
“There were few surprises in today’s Beige Book with most Fed Districts reporting moderate economic growth. There were many comments of the deepening housing correction and tightening mortgage credit, but nothing not previously known. Perhaps the most significant comments were that wage pressures are intense only in isolated professions in short supply; most Districts reported little change in overall price pressures. This provides a window for the FOMC to ease monetary policy at their meeting later this month.”
Source: Moody’s Economy.com, September 5, 2007.
What created the conditions for the crisis?
“It took foolish borrowers, foolish investors and clever intermediaries, who persuaded the former to borrow what they could not afford, and the latter to invest in what they could not understand. In fact, even the borrowers might not have been foolish — if one owns nothing, it might be quite sensible to speculate on ever-rising house prices in the knowledge that personal bankruptcy is a way out.”
Source: Martin Wolf, Financial Times, September 5, 2007.
US house prices: still too high?
“The slide in US nominal house prices is on track to be the deepest in the post-WWII period. The US residential real estate bubble has been deflating since early 2006, but prices are still very high relative to rents and wages. For example, the house price/wage ratio is still well above the average of the past two decades. … house prices would need to fall about 10% (peak to trough) to bring this ratio back to historical trends. Similarly, the housing affordability index (which incorporates prices, wages and interest rates) continues to erode, and a return to attractive levels would require significantly lower house prices and/or interest rates. As previously noted, we expect the corrective phase in housing to play out over a long period, and thus a persistent headwind.”
Source: BCA Research, August 31, 2007.
A September 18 cut in federal funds rate is very likely
“The payroll numbers for August and revisions of employment estimates for June and July make a strong case for a lower federal funds rate at the September 18 FOMC meeting. In addition, the employment numbers for August were from a survey conducted at the start of the current financial market crisis and prior to the Fed lowering the discount rate on August 17, implying that future employment data are likely to show more weakness. The FOMC is in a stronger position to defend a cut in the federal funds rate which will now be based on weak economic data as opposed to lowering the federal funds to address the liquidity and credit problems. Retail sales and industrial production numbers for August will be published on September 14, prior to the September 18 FOMC meeting.”
Source: Asha Bangalore, Northern Trust’s Daily Global Commentary, August 30, 2007.
Aggressive Fed action on house prices
“I think the White House is worried and that this will outweigh any more conservative views at the Fed. And in a pre-election year, both are under considerable pressure to stimulate the economy. Democrats won’t carp overly because they will favor anything which helps beleaguered homeowners.
“My guess is that an aggressive Fed, now in rate cutting mode, will underpin the government bond market for the short to medium term, producing a somewhat bigger rally of longer duration, before the secular trend of rising yields resumes.
“This should cushion downside risk for the stock market, although we can expect some further choppy, ranging action in a convalescence phase.
“The US Dollar Index should remain generally weak against the background of Fed reflation and a soft economy. This would be bullish for gold, which has also strengthened against other currencies this week.
Source, David Fuller, Fullermoney, September 7, 2007
Should the Fed cut interest rates?
“Rising unemployment. A housing market looking at the deepest recession in values since the Great Depression. A consumer under siege. A visibly slowing economy.
“After today’s unemployment number, the futures market is pricing in a rate cut for the September FOMC meeting. If they do not get it, their will be lynch mobs forming. You do not want to be long the S&P if there is no rate cut. It will be ugly.”
Source: John Mauldin, Thoughts from the Frontline, September 7, 2007.
Outlook for equities
“… the market climate for stocks remained characterized by unfavorable valuations and unfavorable market action. The market has now cleared the oversold condition that we observed several weeks ago, yet breadth and trading volume have not evidenced the strength and persistence that we typically associate with more sustained recoveries from oversold conditions. That’s not to say that we can’t observe further market strength, but at present we have no evidence either from valuations or from market action to reliably speculate on such strength.”
“In the face of such a whiplash (referring to equities’ rebound subsequent to the US discount rate cut), most investors (ourselves included) are currently breathing a deep sigh of relief and wondering what to do next? Should they increase, or curtail, risk in portfolios? As we see it, looking at today’s investment environment, it might be more sensible to err on the side of caution. After all:
|We now face a much tighter liquidity environment.|
|2.||Economic growth (at least in the US and Europe) is likely to disappoint.|
|3.||Higher volatility has forced many previous buyers of risky assets to reduce exposure.|
The markets are already fully pricing in a more dovish Fed and ECB. But … if the Fed fails to deliver a rate cut, then the markets could take another turn for the worse.
All of the above might argue for a more cautious approach to risk in portfolios.”
Source: Checking the Boxes, GaveKal Research, September 3, 2007.
Richard Russell on gold
“… yesterday gold finally closed above the psychological 700 mark. Now it only remains for gold to advance to a new high above the 2006 high of 728.
“At this point, gold fundamentals are being helped tremendously by the various central banks. No nation wants a strong currency, since a strong currency equals contracting exports. US M-3 has been expanding at a 13% rate, Britain’s M-4 has been doing the same, Russia has been grinding out rubles at a fantastic 50% rate, and all over the world the blizzard of “counterfeit” paper continues. The fundamental escape from hyper-paper-creation is to buy anything tangible. The wealthy of the world are well aware of this. Classic paintings, gem stones, diamonds, collectibles, seaside real estate, and gold are rising steadily in terms of paper. The incredible fraud of fiat currency goes on and on. It will continue on until – well, until it morphs into dreaded hyper-inflation.”
Source: Richard Russell, Dow Theory Letters, August 31, 2007.
“Some people get so rich they lose all respect for humanity. That’s how rich I want to be.”
Source: Rita Rudner