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Market View of the Week (4 - 8 August 2008)
...how long would the Bear market hold?
The US economy is expected to deteriorate again in the second half of 2008, keeping the Fed on prolonged hold. Q2 GDP growth accelerated to 1.9% pa on the tax rebates but economic activity will likely slow down from now on unless oil prices keep falling sharply, and/or there is a new fiscal stimulus. We believe it more likely that oil prices stabilise, that any further fiscal support will have to wait until after the presidential election, and that households will resume their spending pull-back - as negative wealth effects from falling property and stock prices continue, as credit conditions remain difficult, and as employment and incomes deteriorate. The Fed next week (Tuesday) is virtually certain to keep rates on hold at 2.0%. The decision will likely not be unanimous but concerns over economic growth, and sustained financial markets fragility, should outweigh inflation worries. The Fed on prolonged hold should cap the rise in bond yields and, eventually, will likely pull yields down (prices up), and steepen the yield curve. We expect that US stocks will struggle short term (the next few months), as per everywhere else, and we are also “underweight” long term. The credit crisis looks set to continue. Financial sector stocks have rallied, the Fed has extended its liquidity support facilities into 2009, and the US Congress has finally approved a housing bill - which makes back-stop government support for Fannie Mae and Freddie Mac more explicit and provides some help for homeowners facing imminent foreclosure. But US banks (and European banks as well) entered the crisis with highly leveraged balance-sheets whilst US house prices, given the still sky-high inventory of unsold properties, probably remain some way off bottoming out. The crisis is also now clearly affecting the wider credit markets beyond housing (as per recent profit warnings from JP Morgan and American Express). Banks globally have now written off around $460bn, but we expect that total losses will eventually climb to $1,000bn+ - forcing more capital-raising. Growth in the non-US developed world will slow sharply as well. In the Euro-zone, July business/consumer confidence dropped back, showing that the sharp Q2 GDP pullback continued into Q3. Data in the UK and New Zealand has stayed terrible and both look already in, or on the verge of, recession. High inflation and the credit crunch are also now hitting household spending in Australia despite terms-of-trade gains from high commodity prices. In Japan, Q2 GDP growth (published in late August) will likely be negative - exports dropped in June, wage growth stayed very weak, and unemployment is rising. Slower growth everywhere else should make the US less of an outlier and, we forecast, will tend to keep the US dollar largely range-bound against the EUR and JPY. But the outlook in the UK and New Zealand looks even worse than that for the US, so we would stay cautious on the GBP and NZD. Inflation should fade as a threat. What happens to commodity prices remains the wildcard, but we forecast that commodity prices will generally stabilise. This, combined with slower economic growth, should eventually pull inflation down. For now, though, anchoring inflation expectations remains the top priority for many central banks and, given price increases already in the pipeline, inflation in many countries will inevitably move up further over the next few months before eventually moving lower. Rates should stay on hold in Australia next week (Tuesday), in the Euro-zone and UK as well (Thursday) - but in all three areas, interest rates should be moving down either by Q4 2008, or early 2009. In emerging markets, progress in the inflation fight remains country-specific. India hiked more aggressively than expected this week but, with real rates still negative, still needs to hike some more. Next week, rates are likely to move up in Indonesia and Korea as well. In China, however, CNY appreciation is slowing as policy shifts more toward supporting growth, and as the inflation threat fades. |
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