LONDON, 1 December 2003 — Despite generally positive economic news and a consensus forecast of 4 percent US growth in 4th quarter, the stock markets last week looked depressed because equities sold off, oil prices were up, the mutual fund scandal spread, the FBI arrested a group of currency traders and the bombings in Istanbul echoed memories of Sept. 11. Investors’ sentiment quickly shifted to pessimism, as was mirrored in the short rise in the volatility indices.
While the Nikkei is clearly tracing out the correction expected to lead the markets into a December bottom, most other stock market indices managed to recover again. Given last week’s spike in volatility and investor pessimism, there was no surprise to see yet another recovery high in most indices. Still, it seems that the risk of a sharper correction in December is still great to warrant caution.
The US initial jobless claims last week declined by 11,000 and, four-week average broke the support from early 2001, while the leading indicator continued to rise. US orders for durable goods climbed in October the highest in 15 months. These improvements explain why business confidence has improved. Semiconductor equipment orders are starting to go up, though gradually. In addition, top US executives now say that the economy is clearly expanding, having turned dramatically positive in their view.
On the other hand, there was an indication of some slowdowns, possibly in China, given the sharp fall in the Baltic Freight Rate Index and the decline in the copper price. Moreover, US auto sales were discouraging. The inventory rebuilding is more likely to be seen medium term in 2004 than short term.
Meanwhile, the US goods trade gap, while still in a major downtrend, has stabilized since earlier this year. But a reversal to the upside is not yet discernable. The stability may be due to the dollar’s decline over the past year and due to the recovery in the global economy. While it would be negative for the dollar in the long-term, the stabilization may allow for a dollar rebound at one point. Moreover, the markets are likely to become more concerned about a move toward broad-based protectionism, which is likely to be a negative for the dollar.
Inflation remains tame, even though the latest PPI report was on the upside. But the Philadelphia Fed Outlook Price Index — a leading indication of future price inflation/deflation — remains below the falling long-term downtrend line, which connects the inflation peaks back to 1980. The Philly Fed indicator started to rise last June at -9.5 and reached a peak in October at 5.4. The latest reading showed a minor downtick to 3.4, just above the zero line, which separate inflation from deflation. A breakout is still possible, likely on the upside toward higher inflation. But this could take several months until a signal is triggered.
Generally speaking, the US dollar is still in its long-term downtrend. However, the investor consensus point that it will fall further. Given the stabilization in the trade gap, it could soon enter a medium-term rebound. Meanwhile, sentiment on commodities and gold, in particular, has turned somewhat optimistic.
(Habib F. Faris is vice president at Clariden Bank, London.)
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