A trading week made up of a bit of the old year and a bit of the new caused some anxiety in financial markets as economic woes escalated and weighed on investor sentiment. The problems related to the housing market and the subprime implosion seemed to be coming to a head. After all, the Dow Jones Industrial Index recorded its worst three-day start to a New Year year since the depths of depression in 1932, according to Barron’s.
Stock markets were left in the shade as both gold and oil hit all-time highs. Nouriel Roubini, professor of economics at New York University, wrote on his blog: “… the stock market started the year with another bearish fall … a lousy stock market in 2007 will look good compared to an awful stock market in 2008.”
Santa Claus failed to call upon the traders on Wall Street. The “Santa Claus Rally”, as defined in the Stock Trader’s Almanac, is the propensity for the S&P 500 Index to rally during the last five trading days of December and the first two of January. This year’s Rally saw the S&P 500 Index down 2.5% and the Dow Jones Industrial Index (-2.9%) and the Nasdaq Composite Index (-3.3%) were not spared either.
It is pointed out by the Stock Trader’s Almanac that the lack of a rally had often been “a harbinger of a sizable correction or a bear market in the coming year.” Hence the saying: “If Santa Claus should fail to call; bears may come to Broad & Wall.”
John Mauldin, author of the Thoughts from the Frontline newsletter, is also of the opinion that the equities bull market may finally succumb in 2008, and said in his 2008 forecast: “I think that we are in a recession for most of the first half of this year, and that we begin a slow recovery in the second half. It will be a Muddle Through Economy for at least another year after that. That would suggest that most companies will come under serious earnings pressure. If history is any indicator, that means we should see a bear market in the first half of this year. How deep will depend on how fast the Fed cuts, but I don’t think we are looking at anything close to the bear market of 2000-2001. Still, I wouldn’t want to stand in front of a bear market train.”
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.
The past week’s economic reports fueled concerns about the spillover effect of the subprime crisis leading to an economic recession.
The much anticipated US employment report on Friday, which showed weaker-than-expected job growth and a rise in the unemployment rate, compounded investors’ worries.
According to the Institute for Supply Management, national manufacturing activity shrank unexpectedly in December. Specifically, the ISM Index fell to 47.7 from 50.8 in November – a reading below 50 indicates a contraction in manufacturing activity.
These reports provide strong support for further Fed easing. An interest rate cut of 25 basis points at the FOMC’s next meeting on January 30 seems a foregone conclusion, but the Fed Fund futures now also indicate a 46% chance of a 50 basis point reduction. “There are those who hope that the Fed will ride to the rescue with more rate cuts. I believe they will, but it is a case of ‘too little, too late’,” remarked John Mauldin.
WEEK’S ECONOMIC REPORTS
|Date||Time (ET)||Statistic||For||Actual||Briefing Forecast||Market Expects||Prior|
|Jan 2||10:00 AM||Construction Spending||Nov||0.1%||-0.3%||-0.4%||-0.4%|
|Jan 2||10:00 AM||ISM Index||Dec||47.7||52.0||50.5||50.8|
|Jan 2||2:00 PM||FOMC Minutes||Dec 11||–||–||–||–|
|Jan 3||12:00 AM||Auto Sales||Dec||–||5.4M||5.5M||5.6M|
|Jan 3||12:00 AM||Truck Sales||Dec||–||7.0M||6.8M||6.8M|
|Jan 3||8:15 AM||ADP Employment||Dec||40K||–||–||173K|
|Jan 3||8:30 AM||Initial Claims||12/29||336K||340K||–||357K|
|Jan 3||10:00 AM||Factory Orders||Nov||1.5%||1.0%||1.0%||0.7%|
|Jan 3||10:32 AM||Crude Inventories||12/28||-4056K||NA||NA||-3299K|
|Jan 4||12:00 AM||Auto Sales||Dec||5.2M||5.4M||5.5M||5.6M|
|Jan 4||12:00 AM||Truck Sales||Dec||7.1M||7.0M||6.8M||6.8M|
|Jan 4||8:30 AM||Nonfarm Payrolls||Dec||18K||75K||70K||115K|
|Jan 4||8:30 AM||Unemployment Rate||Dec||5.0%||4.8%||4.8%||4.7%|
|Jan 4||8:30 AM||Hourly Earnings||Dec||0.4%||0.3%||0.3%||0.4%|
|Jan 4||8:30 AM||Average Workweek||Dec||33.8||33.8||33.8||33.8|
|Jan 4||10:00 AM||ISM Services||Dec||53.9||53.0||53.5||54.1|
Source: Yahoo Finance, January 4, 2007.
The next week’s economic highlights, courtesy of Northern Trust, include the following:
International Trade (Jan 11) – Higher imported oil prices probably played a role in the widening of the trade gap to $58.5 billion in November from $57.8 billion in October. Exports are predicted to have risen largely due to a weak dollar, while imports are not likely to show impressive growth due to soft economic conditions. Inflation adjusted exports of goods and services grew at an annual rate of 19.1% in the third quarter, while inflation adjusted imports of goods and services posted a paltry gain of 4.4%. Consensus: $58.5 billion
Other reports – Pending Home Sales (Jan 8), and Import Prices (Jan 11).
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 6, 2007.
As this article deals only with the past week’s performance, a separate performance review of 2007’s market movements was posted on the blog last week. This round-up makes for interesting reading and also provides pointers of what to expect in the year ahead. Please click here for full the article.
Global stock markets began the year on shaky ground, trading lower during the past week amid escalating concerns about the fallout in the housing and credit markets. The MSCI World Index lost 3.2% during the course of the week, but a number of emerging markets helped to stem the overall losses.
The US markets were at the forefront of the sell-off with the blue-chip Dow Jones Industrial Index losing 4.2%, the broader S&P 500 Index 4.5% and the technology-heavy Nasdaq Composite Index 6.3%. Small caps and the sectors for REITS, financials, housing and consumer discretionary spending, in particular, were not spared the selling pressure.
Government bond yields declined in both developed and emerging markets as the global economic outlook worsened and investors switched stocks to what is perceived to be a safe-haven asset class.
On the currency front, the US dollar came under renewed pressure as markets started pricing in the possibility of the Fed reducing interest rates by 50 basis points at the end of January. Concerns about the deteriorating prospects for the UK economy resulted in the British pound recording a four-year low against the euro.
The star performers among the major currencies were the Japanese yen (+4.1%) and Swiss Franc (+2.0%) as increased risk aversion resulted in unwinding of carry trades. The Chinese yuan also caught the limelight on the back of its uptrend (as reported in the “quotes section” below).
Commodities were the big winners during the past week as investors piled into oil and precious metals.
Crude oil hit a record level of $100 a barrel early in the New Year, but subsequently eased back somewhat. Factors driving the oil price included a weaker dollar, geo-political tensions over the Middle East and supply concerns.
The gold price also reached a record high during the past week, soaring above the $850 an ounce level last achieved in January 1980. In addition to the factors driving the oil price, gold benefited strongly from mounting inflation jitters.
Agricultural commodities again put in a strong performance and gained 3.6% during the week.
This week promises to be a key week for the direction of financial markets. Hopefully the words (and graphs) from the investment wise below will assist in guiding us through the stormy waters and making the correct investment decisions. But firstly, to cheer you up, here is nature’s way of saying “have a nice day!”.
Hat tip: Jim Sinclair’s Mineset
Financial Times (Alphaville): Marc Faber – when surrounded by rubbish and danger, buy gold
“‘The credit bubble is just beginning to unwind, and while US borrowers are being blamed for the mess, they were really just a pawn in a global game.’ So says Marc Faber, aka Dr Doom.
“In the New Year issue of his Gloomboomdoom.com monthly market commentary for subscribers, Faber muses darkly on the direction of the US economy, markets, bond insurers and Wall Street banks, and concludes – as he has increasingly in the past months – that gold, among other commodities, is a very good place to put your money.
In the US, the severity of the housing recession is evident from the record level of existing home inventories as a percentage of US households, he notes. ‘It should therefore, only be a matter of time until housing starts decline further and will also signal the onset of a recession.’
“He sets out three key observations:
I have never experienced a bull market in equities without the participation of financial stocks. In addition, when financial stocks across the board collapse it is a very negative sign for the overall health of the stock market.
The fact that a stock has declined from the peak by 50% or even 90% does not make it necessarily inexpensive. In 1985, I recommended the purchase of a basket of Texas banks, which at the time had declined by 95% from the peak, as a contrarian play. Subsequently, they all went bankrupt.
As I have explained before, the financial sector has become disproportionally large over the last 15 years or so. Therefore, I would also expect the reversion to the mean of the financial sector to take several years and not to be completed in just six months! In short, I would avoid purchasing financial stocks for now and would also defer new commitments to equities.
“Emerging stock markets are definitely to be avoided, he adds, ‘following their significant out-performance over the last few years’.
“So, where would Dr Doom put his money? He likes sugar, cotton and he still recommends accumulating gold, which he expects to continue to out-perform equities for several years. Still, nothing goes up in a straight line, notes Faber, and, therefore, investors need to be aware that gold could still correct to around $750 or so.’
“In Faber’s opinion, ‘the gold bull market will come to an end when Sovereign Wealth Funds – sick and tired of their investments in financial stocks – will finally purchase gold – probably at above $3,000 per ounce.’”
Source: Gwen Robinson. Financial Times – Alphaville, January 3, 2008.
Richard Russell (Dow Theory Letters): Stock market’s primary trend turning down
“Question – Russell, you’ve been talking about a third phase to the stock market. Where are you now on this subject?
“Answer – As you know, I’m guided at all times by the action of the stock market itself. When the market doesn’t agree with me, I stop, revise my thinking – and get in harmony with the market. Which is what I’ve been doing over recent weeks.
“Something has interrupted the major rising trend of the market. It’s not a little thing, no, it’s something very big, very powerful, very basic. Frankly, I don’t know what it is. Could it be that the dollar is in serious trouble? Could it be that the US economy is in chronic trouble? Could it be that the US consumer is finally throwing in the towel on spending? Could it be that the real estate situation is a lot worse than we think? Could it be that the situation is so major that it is beyond the Fed’s ability to manipulate? I don’t know, I honestly don’t know.
“But I do know one thing. The primary trend, the great tide of the stock market, appears to be in the process of turning down.”
Source: Richard Russell, Dow Theory Letters, January 4, 2008.
Asha Bangalore (Northern Trust): Weakness in US labor market points to recession
“The civilian unemployment rate rose to 5.0% in December from 4.7% in November. The December reading is the highest since September 2005. The jobless rate has now risen from a cycle low of 4.4% in March 2007. The increase in the unemployment rate reflects a widespread loss of jobs … Historically, sharp increases in the unemployment rate are associated with recessions.”
Note: Shaded areas denote recessions.
Source: Bureau of Labor Statistics /Haver Analytics
Unemployment Rate and Recessions
“Payroll employment rose only 18 000 in December, the smallest gain since August 2003. Revisions to October and November payroll estimates show a net gain of 10,000 jobs. Private sector payroll employment fell 13 000 in December, the first monthly record of private sector job losses since July 2003. Total payroll employment increases averaged 111 000 per month in 2007 versus a 189 000 per month in 2006. On a year-to-year basis, total payroll employment slowed to a 0.9% gain, down from a peak growth rate of 2.14% in March 2006. Household survey data also show a similar decelerating trend in hiring.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, January 4, 2008.