North America

  • The housing sector continues to be strong, as demonstrated by the surge in housing starts in September - - handily beating consensus forecasts. Unfortunately, the rest of the data on economic activity point to a softer outlook for the economy than many have been expecting. The latest reading of the index of leading economic indicators, which is down for the fourth month in a row, tells us that, at the very least, economic growth is likely to remain weak in the short run.
  • Currently, industrial production is slipping, and struggling hard to get a footing. The trade deficit has widened, acting as a drag on the economy. And, manufacturers are busy cutting inventory, indicating that they see few signs of sales growth picking up. Normally, inventory reductions feed back into lower industrial output.
  • In the past two weeks, the stock market has largely ignored economic data, focussing instead on earnings reports. Investors have clearly liked what they have seen, leading them to drive the major indices sharply higher. The earnings scorecard, according to Thomson First Call is as follows: of the companies in the S&P 500 that have reported thus far (about 200 firms), 61% have beaten consensus analysts’ earnings estimates, 29% have met them and 11% have missed them. At this point, the percentage of companies that have beaten estimates is higher than in the four previous quarters.
  • The earnings reports appear very heartening except for the fact that, as usual, expectations had been managed downward, ahead of time, to prevent nasty surprises. More importantly, sales growth, which would really help the corporate bottom line, still looks weak. Management is unable to provide much guidance on this matter, which means that earnings visibility remains poor. This hasn’t stopped analysts from forecasting a substantial rise in fourth quarter earnings growth for the S&P 500. If the recent past is any guide, these estimates are going to be revised lower, in due course. So, it seems likely that the current rally will have occasion to retrace at least a few steps before investors can hop on the escalator again.
  • The possibility that Brazilian presidential candidate, Luis Inacio "Lula" da Silva, will be elected to power has already been discounted by the markets. In the meantime, to shore up the currency and cap inflation the central bank, in an extraordinary meeting, has jacked up interest rates by 300 basis points. This is very damaging to the economy as well as government finances. Growth will be squeezed, tax revenues reduced and the cost of rolling over public debt will increase. To allay fears of radical changes in policy and the implications for roaring inflation, Lula’s party has said that it would present a bill to Congress, granting operational independence to the central bank.

Europe
  • Growth in the Eurozone is likely to stall in the fourth quarter and pick up slowly next year. For all the talk about a looser application of the Stability Pact, which constrains the growth of government debt and deficits, there is not much to be expected, in the way of fiscal stimulus to the economy, coming from expansive policy actions. This is in marked contrast with what is occurring in the United States.

Asia/Pacific
  • Brave words by high officials about vigorously tackling the banks’ bad debt problem is giving way to some backtracking in Japan. It looks like a softer approach will be effected, which means no shock therapy and a longer process of adjustment.

Bonds
  • Treasury yields have continued to climb and the curve has steepened. The sharp movements we have been experiencing in the bond market have few historical precedents and have caused a lot of pain among some hedge funds.
  • Expectations about Fed policy have also been revised substantially by the market. The fed funds futures market is now discounting a low probability of an interest rate cut at the November 6 FOMC meeting, whereas just two months ago there was strong expectation of easing action by the Federal Reserve.
  • What was notable about the performance of the U.S. bond market, last week, was the way in which investors chose to ignore weak economic statistics that would normally have led to a rally. In addition, geopolitical events failed to register any effects either. Some of the selling pressure came from asset allocators switching from bonds into stocks, profit takers cashing in high-priced holdings and technically related liquidations as prices breached support levels.

Currencies

  • The U.S. economy is showing signs of weakness, as is the Eurozone economy. On balance, this should still be more favourable to an upward move in the euro - - looking towards 2003 - - because expectations of out-performance by the American economy have always been higher than for Europe. In the short term, geopolitical issues and concerns about loosening fiscal conditions in core Eurozone countries may be dollar supportive.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.