Sentiment deteriorated further during the past week as oil prices rebounded, more bad news in the financial sector surfaced, economic woes mounted and inflationary pressures intensified, compounding the already-jittery investors’ anxiety.
Status Quo’s lyrics “Down down deeper and down” came to mind as global stock markets took a battering. For example, the Dow Jones Industrial Index, plunged by 3.8% over the week to below 12,000 – its lowest level since March. Commensurate with extremebearishness, short interest on the New York Stock Exchange jumped to an all-time high during the week.
At the center of investors’ angst was the perception that the credit crisis has not yet played itself out. These fears were supported by Goldman Sachs (GS) analysts who said last week they did not expect the credit crisis to peak before 2009, and that U.S. banks might need to raise $65 billion of additional capital (on top of $159 billion raised so far) to cope with additional losses from the sub-prime fallout.
On a related note, Moody’s downgraded the credit ratings of Ambac Financial (ABK) and MBIA (MBI), citing their limited ability to raise new capital and write new business. Banks were also in focus as analysts cut their price targets for, among others, Goldman Sachs (GS), Citigroup (C) and Wachovia (WB).
In one of the most bearish reports for a while, The Royal Bank of Scotland (RBS) advised clients to brace themselves for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks. “A very nasty period is soon to be upon us – be prepared,” said Bob Janjuah, the bank’s credit strategist (who gained credibility after his warnings last year about an impending credit crisis).
Richard Russell, 83-year old author of the Dow Theory Letters, expressed concern about the stock market’s negative breadth and said:
I did a double-take when I read Lowry’s statistics … Buying Power Index at a multi-year low and Selling Pressure Index at a multi-year high. And the two Indices at about their widest (most bearish) spread in history or since the 1930s. What the devil could this mean? My guess can be summed up in one word – trouble.
However, there is still hope, according to David Fuller (Fullermoney), who pointed out that Investors Intelligence’s sentiment index (bottom section of the chart on the left) was extremely bearish.
There has never been a reading at current or lower levels that was not soon followed by a sharp rebound, including during the last bear market. This indicates to me that we are within a week or two of a bear squeeze, providing at least a tradable rally …
Lousy Fridays are often followed by rotten Mondays.
To which I add: When in doubt (and there is a ton of doubt), better to err on the side of caution than to do something stupid.
Let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance round-up:
Economy
The Survey of Business Confidence of the World conducted by Moody’s Economy.com, reported that:
Global business sentiment appears to have turned a corner. It remains weak, but it has moved measurably higher since hitting bottom in late April. Confidence remains weakest in the U.S. where it suggests the economy is still contracting, and it is strongest in Asia where it is consistent with an economy growing near its potential.
Economic reports in the U.S. were largely overlooked last week as market participants focused on corporate news, although there were several notable releases:
- The NAHB Housing Market Index fell by 1 point to 18, bringing it back to the record low reached in December and before that not seen since 1985.
- After plummeting since the beginning of this year, consumer confidence is showing tentative signs of stabilizing, according to the ABC News/Washington Post Consumer Comfort Index.
- Industrial Production fell by 0.2% in May, following an outsized 0.7% decline in April. Overall, the report is consistent with continued modest declines in manufacturing.
- The Producer Price Index for finished goods rose by a large 1.4% in June as expected, following a 0.2% increase in April. Inflation was once again led by large price increases of food and energy products.
Summarizing the U.S. economic scenario, Paul Kasriel, chief economist of Northern Trust, said:
… despite the Fed’s aggressive Federal funds rate reductions, money and credit growth have slowed significantly … to absolutely low rates. The implication of this is that real economic activity is likely to be very sluggish until financial institutions rebuild their capital positions and that the inflationary flames are likely to subside as they are deprived of the ‘oxygen’ of credit growth.
The highlight of next week’s economic news will be the FOMC policy announcement on Wednesday. Economists expect the Fed funds rate to remain unchanged at 2.0%, but uncertainty regarding the wording of the policy statement means it has market-moving potential.
Kasriel also said:
We fully expect that the FOMC will devote a relatively large amount of ‘ink’ to the inflationary threats in its no-change policy statement on June 25, but we also expect the FOMC to reiterate that the downside risks to economic growth still dominate its policy decisions in the near term.
Elsewhere in the world, escalating inflation concerns are at the top of policymakers’ agendas. In addition to rampant inflation in emerging markets, the Eurozone and U.K. are also shouldering strongly rising prices.
- Consumer price inflation in the Eurozone was up 3.7% in year-ago terms in May. The rate is far above the European Central Bank’s 2% inflation target and, given the ECB’s more hawkish tone lately, markets are increasingly expecting the bank to tighten.
- Consumer prices shot ahead in May in the U.K., rising by 3.3% in year-ago terms. The deteriorating inflation outlook has reduced the likelihood of imminent monetary easing, while a recent statement by Bank of England Governor Mervyn King suggests that rate increases are also unlikely.
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