Bermuda: Financial Summary on North America, Europe and Asia-Pacific Regions

The ISM manufacturing index spiked up unexpectedly, last week, and U.S. equity indices followed suit. There weren’t too many bears around and the beginning-of-year good mood got off to a roaring start among the bullish folk. Not too many people stopped to ask whether the sharp rise in the index might have been a statistical quirk. Meanwhile, the ISM’s equivalent measure for the services sector slipped a bit but was still strong enough to indicate expansion in the large non-manufacturing part of the economy. Separately, expectations regarding the possible elimination of dividend taxes cheered up the market even more.

When the data on fourth quarter GDP finally arrives - - and everybody expects Q4 to be weak - - we will find that the average growth rate in 2002 wasn’t all that bad. Granted it was pretty volatile from quarter to quarter, with the growth rate swinging up and then down again but, overall, it was a decent performance - - and way better than what the Europeans and the Japanese are going to record. So why are there still so many squeals of pain? The reason, as many have noted, is that, thus far, it has been a jobless and profitless recovery. Now, judged by historical standards, this statement is largely true. But it is also true that we did not experience a nasty recession, which we would normally have expected after the bursting of a considerable stock market bubble. In its place we have got a longer period of adjustment, which, actually, hasn’t been particularly painful - - the Dow did not plunge to 6,000 or the unemployment rate rise to 8%.

Last year, around this time, investors were banking on the expectation that it was rare for stocks to be down three years in a row. These hopes were sadly disappointed when the market, oblivious of past precedent, swooned again. Some peoples’ confidence is now bolstered by the historical statistic that having four successive losing years is even rarer than a triple whammy. However, such statistical calculations though useful in indicating broad probabilities are not, by themselves, totally convincing. Investors use statistical measures rewardingly all the time. For instance, we often calculate how many points an index has risen over a given period of time and whether, on this basis, it is near exhaustion or has further to run. But to make the argument more decisive we also need to marshal support from economic, fundamental, technical and psychological factors. Just looking at the fundamental factors, corporate profitability is set to improve this year and it could be argued that the S&P 500 is fairly valued in terms of forward earnings. So any upside earnings surprises would afford an opportunity for the index to move higher. But it comes down to the question of what P/E multiple investors are willing to pay and it may be that, in contrast with the nineties, we may not see an expansion of multiples.

With unemployment high and confidence low in the core Eurozone economies; Europe has got off to a slow start in 2003. The rise in oil prices is bad for inflation, but its effect is offset by the appreciating euro, so that the overall outlook is still for lower inflation. However, the rising currency is very unhelpful for the Eurozone’s export sector, with Germany being the most affected.

The appreciation of the euro has the same effect as a tightening move in monetary policy. Meanwhile, the financial sector remains weak and the ability of governments to provide fiscal stimulus is limited. As a result, the probability of an interest rate cut by the European Central Bank has risen.

The Japanese economy is going to encounter difficult challenges ahead, as the government tries to solve the banking system’s non-performing loan problem, while simultaneously engaging in fiscal reform - - all this, in the context of deflation at home and uncertainty on the global scene. We do not yet have a crisis situation to break the logjam of inertia. However, there are indications that the pain may be getting severe enough to bring about some remedial measures.

The current governor of the Bank of Japan is to retire soon and Prime Minister, Koizumi, is keen to appoint somebody willing to adopt active anti-deflation policies. This would involve quantitative easing as well as inflation targeting - - measures that have long been advocated by various economists but opposed by the present governor of the BoJ.

Treasury yields are gyrating again. On the one hand, government bonds provide an attractive safe-haven when geopolitical uncertainty increases. On the other hand, there is growing fear of widening government budget deficits and the effect on inflation of a rise in oil prices that have yet to decline.

Meanwhile, with the nasty backdrop of rising global political tensions, a declining U.S. currency and low expected yields on many asset classes, the opportunity costs of holding gold have declined, resulting in higher prices for the yellow metal.

The U.S. dollar has continued to weaken relative to the euro. It is not just that investors have doubts about the ability of the American economy to perform at the stellar levels that were previously used as benchmarks. There are also a number of other factors entering into the equation, including large budget deficits, a troublesome foreign policy, a wide current account gap and sloshes of easy money from the Fed.