LONDON, 20 October 2003 — The S&P 500 index gained some 5 percent since the end of September. During the same time period, the 10-year US Treasury yield increased by nearly 50 basis points. Should we not take profits by selling equities now? Our answer is not is true, that the equity risk premium (prospective equity earnings yield divided by the 10-year government bond yield) has reduced considerably. But the equity risk premium still signals, that equities are cheap relative to bonds.

According to our chart-technical analysis, the short- and long-term up-trend in equity prices is intact. And finally, we think that the upward revisions of earnings estimates will continue, as the global economic upswing is gaining pace.

We have a closer look at the newest macroeconomic releases concerning the two most important aspects of the US economy: Manufacturing activity and consumer spending.

The US Empire Index increased very strongly on Oct. 15, the Empire State Manufacturing survey covering the New York region was released. The Empire index is always the first regional purchasing manager index (PMI) to be published. The index increased considerably in October compared to last month. However, it has to be kept in mind that the New York region is not very important for US manufacturing. This is the reason, why the Empire index moves quite erratically and sometimes gives misleading signals for the direction of the US manufacturing as a whole.

For example, in July and August, the Empire index decreased whereas the national (ISM) PMI continued its up-trend. In contrast to the Empire index, the Beige Book collecting anecdotal evidence from the different Fed districts, reports a strengthening of manufacturing activity during September. The next important releases concerning US manufacturing are:

Oct. 28: Durable goods orders September

Oct. 31: Chicago PMI October

Nov. 3: ISM PMI October

We expect that the recovery of manufacturing activity will continue. We would not be surprised if the surveys would decline somewhat as the ISM currently indicates around 4 percent GDP growth, whereas we expect only a growth rate in the order of 3.5 percent for the next year.

It is true that retail sales decreased by 0.2 percent in September. However this decrease comes after three quite strong months. The annual growth rate of 7.5 percent also indicates that retail sales are still in a strong up-trend.

At the moment the consumer surveys point in different directions. The Conference Board survey suggests a growth of private consumption of only 1.5 percent, whereas the Michigan survey implies consumption to grow by 3.5 percent. We expect the expansion of (real) consumption to cool down slightly (from around 3.5 percent at present to 2.7 percent in 2004). Why?

Tax incentives will expire, the mortgage refinancing boom already has come to an end as the mortgage rates have increased and consumers are starting to save more from their disposable income.

(Habib F. Faris is vice president at Clariden Bank, London.)

(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information)