North America

  • Business capital spending in the United States remains tightly controlled as firms continue to focus on cost containment. Excess capacity and low expectations of a pickup in sales growth have checked any resurgence of optimism among executives. Prospects of war in the Middle East are also acting as a damper.
  • Earnings growth expectations have been ratcheted down by Wall Street analysts but, even at current levels, they may be too rosy. There is an underlying assumption not only of a high productivity growth rate but also that the benefits will largely flow to the corporate bottom line, rather than consumers and employees.
  • The job market will remain challenging as firms are forced to squeeze labour costs. This means that the main source of optimism and security for homeowners continues to be the, still robust, housing market. However, lately, there have been a few preliminary indications that it has topped out, even though the recent figures on new home sales were quite strong.
  • Generally, the details of the data on consumer confidence are giving mixed signals, with the present-conditions component moving down and the future-conditions component going up. So, all in all, households still appear to harbour high hopes for the future.
  • A number of reports pointing to unsteady economic recovery, accompanied by a spate of corporate earnings warnings, have led to a sell-off on the stock market. Despite the fact that major indices are hitting multiyear lows, there are few signs of disorderly selling.

Europe

  • The OECD’s lead indicator for the Euro-zone, which has a fairly good forecasting record, is pointing towards a further fall in industrial production. Meanwhile, cognisant of current economic challenges, the EU Commission will give governments two more years to balance their budgets.
  • Rising unemployment is acting as a drag on consumer confidence and this shows up in the pace of retail sales growth, which has been tracking lower in recent months. In conjunction with weak capital spending, this does not bode well for corporate profits. As a consequence, it is not surprising that business confidence is at a low level.

Asia/Pacific

  • The economic outlook for Japan is cloudy as it depends principally on sustained export growth - - even as domestic demand remains weak. As such, the economy is vulnerable to external shocks.
  • The unusual step taken by the Bank of Japan to help bank finances, via a relatively modest direct share repurchase scheme, has not impressed investors. Worries about the economy and the possibility that the expected upturn in corporate profits may fail to materialise have led to a further sell-off in the stock market.
  • A central means of putting the banks on a sounder financial footing involves sorting out the non-performing loans problem adequately. This would help stabilise the financial system, free up the banks’ ability to extend loans and increase confidence among the public. The recent sacking of the head of the Financial Services Agency has raised hopes that prime minister Koizumi is more intent than before to provide public funds to the banks and resolve the festering crisis. Investors are watching for further signs of political will.
  • Another serious issue which Japanese officials must tackle is that of breaking deflationary expectations that have been reinforced by declining asset and goods prices. It must be noted that, with falling prices, real returns on bonds and money market instruments are higher than the posted low nominal rates.

Bonds

  • Indications that some FOMC members are keen to cut interest rates may have been a factor in the decline of the two-year Treasury yield to a level below the current target fed-funds rate.
  • The ten-year Treasury yield is now within reach of 3.5% and this has led many Wall Street analysts to declare that the equity market is seriously undervalued. However, the dividend yield on the S&P 500 is still below long-run historical averages and with forward earnings-growth expectations likely to be lowered, the resulting earnings yield may imply still lower equity valuations.

Currencies

  • Japanese government moves to inject public money into banks, in order to hasten resolution of the bad debt problem, is likely to be positive for the yen in the short run. If deflationary conditions worsen because the accelerated disposal of the banks’ non-performing loans is not offset by easier monetary policy, then higher real interest rates may also be yen-supportive.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.