Gloomy Weather Overshadows World Economy
Last week global equities finally managed to finish the week with significant gains, but October was still a very poor month overall. Barry Ritholtz of The Big Picture highlighted just how volatile the last month has been. October was the worst month for the S&P 500 since the 1987 stock market crash, not only that, it was also the most volatile in the market's 80 year history. There was also volatility on the currency markets as the Dollar managed to reverse most of the week's early losses against the Pound and Euro. This volatility is partly a function of the unwinding of the global carry trade, and a rapid depreciation in most other western currencies. Many have attributed the recent rise of the Dollar to confidence in the strength of the US economy. This may not be the case, recent currency movements may be primarily a rebalancing act, as currency traders adjust their positions to factor in European and UK rates plummeting to nearer 2% over the next 6 months. America and Japan already have the lowest rates in the western world, but other western nations are set to follow with further deep cuts. Last week's volatility was a function of continuing speculation of how quickly and how far the MPC and ECB will go in following the FOMC's and BOJ's lead.
Last week's rally is all the more impressive as it came in the face of more gloomy economic news. At times, this wave of poor economic data has kept a lid on any sustained buying. US house prices are down 16.6% year on year, having slumped over 30% since their peak in 2004. In the face of a continual erosion of the value of their homes, and the ever present warnings about the biggest slow-down since the great depression, it is little wonder that US consumer confidence figures came out at record levels. Today's reading of 38.0 is the lowest in the indicator's history going back to 1967. Interestingly consumer confidence if often a timely contrarian indicator in the medium term and if last week's rally is anything to go by, it may be again.
Markets were still extremely jittery as evidenced by Tuesday's wild ride on Volkswagen, which temporarily became the world's largest company by market capitalization. It overtook ExxonMobil for a short while when it rose above 1,000 Euros in the morning. Just two days previously, it was trading at 200 Euros. Porsche increased their stake in the company to 75%, but the real reason for the huge spike was the squeeze on short traders. Volkswagen has the highest short interest of any stock on the German DAX index. Although shareholders in Volkswagen are rather happy right now, last week's spike is more a symptom of the lack of liquidity in today's market place. The German DAX index massively outperformed other markets, with the Volkswagen spike having a disproportionate effect on Germany's benchmark index.
Next week has a busy economic calendar, starting with UK and US manufacturing numbers on Monday. BOE Governor King's speech in the afternoon may provide clues as to the likely size of Thursdays expected interest rate cut. Analysts are anticipating a cut from 4.5% down to 4.0%, but a cut of larger magnitude may not be out of the question. Wednesday's ADP Non farm employment change will provide clues as to the likely outcome for the week's hottest trading ticket, Friday's Non farm payroll figures.
Last week's rally helped ensure that October 2008 was spared the embarrassment of being one of the worst months on record, but we are far from being out of the woods yet. Although October could mark an intermediate term low point, it is highly unlikely that it will be plain sailing from here. What is more likely over the next 3-6 months is continued volatility, with many more days rising or falling by 5%. If, and it is a big if, we can get some follow on buying over the next week or so, we could continue to back and fill higher over the next few months.
Analysts are expecting the bank of England to cut rates down to 4% next week, but industry leaders are calling for deeper cuts to help reduce the severity the coming recession. Last week the pound recovered some of the ground lost against the dollar, but this may only be a temporary respite, especially with the current level of debt taken on by the UK government. Last week the GBP/ USD exchange rate held above the 1.5000, but that level may not hold for long. A one touch trade with BetOnMarkets predicting that the GBP/ USD exchange rate will touch 1.5000 at any time during the next year could return 23%.
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