Global Markets

World markets were down for the most part last week as third quarter earnings reports rolled in from banking and other major index components. The disappointing returns reminded investors that they were just beginning to see the impact of the subprime turmoil and ensuing credit crunch on earnings. The Hang Seng was the only index tracked here that was up on the week. The index also broached 30,000 briefly, but lost its footing to end the week below that level.

Crude prices gushed to their highest, setting an all-time record above $90 a barrel in electronic trading thanks to a combination of tight supplies prior to the winter heating season combined with a weak dollar and fresh political tensions. At the same time, the U.S. dollar dropped to a new all time low against the euro of $1.4311 as speculators bet on continued weakness prior to the weekend’s Group of Seven meeting and the FOMC meeting at the end of the month. The soaring oil price also helped push spot gold to a new 28-year high of $771 per ounce.

A lower U.S. dollar suggests that oil producing countries such as Saudi Arabia may try to keep the oil price higher to compensate for more expensive imports priced in other currencies. The strength of the euro, sterling and others has insulated some countries, particularly in Europe from higher oil prices. The Organization of the Petroleum Exporting Countries (OPEC), which controls 40 percent of the world’s crude oil output, denies that the market is tight. Rather they blame the huge jump in prices to speculation, the weakening of the dollar and Middle East tensions.

IMF revises its world growth forecast

A combination of downside risks including the financial market turmoil and global trade imbalances, led to the revised 2008 growth forecasts by the IMF. World growth is now expected to be to 4.75 percent in 2008 and not much lower than its forecast for 2007 of 5.2 percent. The forecast is strong despite an expected decline in U.S. growth to 1.9 percent from the prior projection of 2.8 percent. But its central expectation is that most of the U.S. pain will remain at home and not be exported. The IMF also reduced its growth forecast of eurozone countries, the UK, Japan and the emerging and developing countries.

The striking thing about the global economy this year is how little it relies on the U.S. as the main engine of growth. For the first time in 2007, China's rapidly expanding economy has provided the largest contribution to global growth, while half the world's expansion over the past year has come from three countries ― China, India and Russia.

Global Stock Market Recap

Europe and the UK

The FTSE, DAX and CAC were down last week for the first time since the week ending on September 7. The FTSE dropped 1.2 percent Friday despite better than anticipated gross domestic product growth in the third quarter. With the economy showing little signs of slowing, analysts think there is little chance for the Bank of England will lower interest rates at their November meeting from their current level of 5.75 percent. While there was little other economic data, investors reacted negatively to banking profit news and followed North American markets south.

Bank of England minutes

The Bank of England's monetary policy committee voted eight to one to keep interest rates at their present 5.75 percent as they were concerned that loosening monetary policy too quickly could prevent the slowdown needed to keep inflation on target. The MPC discussed the possibility that a precautionary rate cut before problems were apparent in the data could prevent economic growth slowing more sharply than needed to keep inflation on target. However, the committee said the financial market turbulence had not yet had a substantial impact on consumer or business confidence, and said that “it was important not to prevent the slowdown envisaged in the August [inflation] report.”

The minutes repeated the reasons given earlier by Bank governor Mervyn King against bailing out banks saying that there was a danger of an early cut being “misinterpreted as a signal that monetary policy was focused on supporting the financial system and not on meeting the inflation target.” The MPC were also concerned a cut could imply “that the outlook for growth and inflation had shifted decisively to the downside.” So far there had been only limited signs of a slowdown, although there were signs growth would ease further ahead.

Asia/Pacific

With the exception of the Hang Seng the indexes followed here were down last week as worries about higher crude prices and credit market concerns impacted investor sentiment. A stronger yen implying that investors were bailing out of their carry trade positions also weakened equities. Australian markets ended weak after investors locked in profits. Friday was a down day for all. Last week marked the first week of losses since August 17 for the All Ordinaries and STI.

Japanese stocks were down three of five days last week with the Nikkei down to its lowest level below the 17,000 line in almost three weeks, as the yen's appreciation triggered selling across a wide range of issues. The Topix was also at its lowest level in over three weeks. Export-oriented auto and high-tech issues sank as the yen appreciated. Selling spread to other sectors such as oil, iron and steel and marine transport issues. There was also some selling ahead of the G7 meeting. As is usually the case, export-oriented stocks fell as the yen strengthened. A higher yen value puts exporters at a disadvantage price wise and cuts repatriated profits. Both the Nikkei and Topix have once again dropped below their 2006 year end levels by 2.4 percent and 5.3 percent respectively.

Currencies

The U.S. dollar continued to decline as traders awaited the outcome of the Group of Seven finance ministers. It has been anticipated that European officials, who are concerned that the rising value of the euro will cut into growth. And it was not only the U.S. dollar that was under pressure. The yen was at its highest against the euro in more than two weeks as traders deemed that Asian nations and especially China would be pressed to let their currencies appreciate. The yen also climbed as traders bailed out of declining equities reversing their carry trade positions.

Countries that share the euro are split on its strength. While French President Nicolas Sarkozy has said the euro's appreciation is hurting European exports, German Finance Minister Peer Steinbrueck said he prefers a strong euro. And during the week U.S. Treasury Secretary Henry Paulson brushed aside suggestions that he will face criticism from Europeans that a weaker dollar is taking an unfair toll on exports.

Increased risk aversion especially when equities are declining, leads investors to reduce carry trades financed by yen. In carry trades, funds are borrowed in low interest rate countries to buy assets in countries with higher rates. In Japan, the Bank of Japan's interest rate is 0.5 percent. In contrast, the European Central Bank's rate is 4 percent, the Fed's is 4.75 percent and Australia's is 6.5 percent.

Canada

As expected, the Bank of Canada left its key interest rate unchanged at 4.5 percent. Recent economic data continue to show a strong economy with second quarter GDP growing at a 3.4 percent annualized rate and a low unemployment rate. Analysts had expected a rate increase until recently when fears of fallout from the U.S. subprime mortgage crisis altered their rate expectations. Now analysts think the Bank will remain on hold until uncertainties over U.S. and world economic growth subside. The Bank is seeking to balance inflation which is at a higher level than wanted, the surging value of the Canadian dollar and slower U.S. economic growth.

In its statement, the Bank said that the Canadian economy is operating further above its production potential than had been previously expected. The core rate of inflation, which has been above 2 percent for the past year, was 2.2 percent in August. The outlook for the U.S. economy has weakened because of greater-than-expected slowing in the housing sector. The Bank has revised down its projection for U.S. growth to 1.9 percent in 2007 and 2.1 percent in 2008. U.S. growth is expected to pick up to 3 percent in 2009.

According to the Bank, the Canadian dollar traded in a range of 93 to 95.5 U.S. cents U.S. in July and August, but since then it has appreciated sharply to as high as 1.03 dollars U.S. There also has been a tightening of credit conditions stemming from the financial market developments this summer. Despite these tighter credit conditions, momentum in domestic demand in Canada is expected to remain strong. The combined effect of a weaker U.S. outlook and a higher assumed level of the Canadian dollar imply however, that net exports will exert a more significant drag on the economy in 2008 and 2009 than previously expected. As a result, the Canadian economy is projected to grow by 2.6 percent in 2007, 2.3 percent in 2008, and 2.5 percent in 2009. This growth profile implies that aggregate supply and demand will move back into balance in early 2009.

After the release of Friday’s consumer price index report, the Canadian dollar rose to the highest since June 1974. The report showed that September prices accelerated reinforcing expectations the Bank of Canada will avoid cutting rates. Canada's dollar is the best performer against the U.S. dollar this year among the most actively traded currencies. It has gained about 21 percent since December as commodity prices for the country’s exports surged and the U.S. dollar weakened. Canada's dollar reached parity with the U.S. dollar on September 20 for the first time since 1976.

Indicator scoreboard

EMU — September harmonized index of consumer prices was up 0.4 percent and 2.1 percent when compared with the same month a year ago. Notwithstanding the fact that inflation is back above the 2 percent target level for the first time since August 2006, the only significant fresh news in this report is a dip in core inflation to 1.8 percent from 1.9 percent in August. The annual change in energy prices jumped to 3.0 percent in September from a decline of 0.9 percent in the previous month.

August seasonally adjusted merchandise trade deficit expanded to €4.3 billion from €0.8 billion in July. Exports were up a solid 4.9 percent on the month or 13.0 percent on the year, easily outpacing imports which were up 2.0 percent and 7.0 percent respectively. Over the year to July, both the French (€22.9 billion) and Spanish (€53.3 billion) deficits have expanded although Germany continues to impress with a 29 percent increase in its surplus (€114.9 billion). On an unseasonally adjusted basis (graph below) the surplus was €1.3 billion.

Germany — October ZEW economic confidence index remained at minus 18.1 for the second month. Current conditions index continued to slide, but only by a relatively mild 4.2 points to 70.2. Interpreting the survey is tricky at this time since its very composition probably means that the U.S. sub-prime crisis has had a misleadingly negative impact upon recent outcomes.

September producer prices were up 0.2 percent and 1.5 percent when compared with last year. Excluding energy, the PPI was unchanged on the month and up 2.5 percent on the year. Among the other major categories, basic goods registered the only monthly decline (0.2 percent) while capital goods (0.1 percent) and consumer goods (0.4 percent) both grew moderately.

United Kingdom — September consumer price index edged up 0.1 percent and was up 1.8 percent when compared with the same month a year ago. Core CPI which excludes food, energy, tobacco and alcoholic beverages was unchanged on the month and up 1.5 percent on the year. Inflation in the goods sector edged up 0.4 percent while in the more dominant service sector, prices were up 3.4 percent. For the month, the downward effects from a drop in communication prices (0.5 percent) and steady housing, utilities and fuel costs were offset by higher prices for furniture & household equipment (1.8 percent) and a seasonal bounce in clothing and footwear. There was also a sharp 1.2 percent increase in the food and non-alcoholic beverage sector and this phenomenon is likely to be repeated over coming months as the effects of the summer floods in Europe become more apparent.

Average earnings for the three months to August accelerated to 3.7 percent from 3.5 percent. For August alone, the annual increase was 4.2 percent, a surprisingly large jump from the 3.8 percent pace seen in July. Excluding bonuses average earnings were up 3.7 percent. The bounce in the headline earnings figure reflected advances in both the public (2.9 percent from 2.8 percent) and private (4.0 percent from 3.7 percent) sectors and saw the latter attain its fastest pace since April (4.1 percent). At the sectoral level, all of the acceleration could be attributed to the key services sector (3.9 percent from 3.5 percent) since earnings growth in manufacturing (3.6 percent from 4.2 percent) more than retraced its June pick-up.

September claimant count unemployment dropped by 12,800 to its lowest level since March 2005 even though it did not lower the jobless rate from 2.6 percent. The ILO measure of unemployment was unchanged at 5.4 percent in August. There was a 5,000 drop in joblessness over the latest three months and a 22,000 gain in employment. The total number employed is the highest since records began in 1971 although with the workforce expanding the employment rate managed to edge down a notch to 74.4 percent.

September retail sales volumes surged 0.6 percent and were up 6.2 percent when compared with last year. There is little sign here that the Northern Rock crisis has had any discernible impact on consumer confidence. In fact sales over the latest quarter show an impressive 1.7 percent gain on the second quarter, the fastest pace seen since July 2006. Non-food demand was up fully 1.0 percent supported by broad-based gains in non-specialized (1.1 percent) and clothing (0.6 percent). Annual growth in this sector now stands at a whopping 8.9 percent. Meantime food sales rose a monthly 0.3 percent, or 1.9 percent on the year.

Preliminary third quarter gross domestic product was up an estimated 0.8 percent when compared to the previous quarter and 3.3 percent when compared with the same quarter a year ago. As with all flash estimates, no detail was available on the expenditure side. However, electricity, gas & water grew a strong 1.0 percent but mining & quarrying were down 0.3 percent. 

Asia/Pacific

Japan — August tertiary activity index rebounded 1.3 percent and was up 2.1 percent when compared with the same month a year ago. Six of the major industry groups increased while five declined. Those increasing included wholesale & retail trade, electricity, gas, heat supply & water, eating & drinking places, accommodations, finance and insurance, transport, and information & communications. Activity declined for services, learning support, real estate, medical, health care & welfare, and compound services. The service sector employs more than half of Japan's workforce, and spending on services such as retailing, dining and travel is closely tied to changes in income and consumer confidence.

July all industry activity index was up 1.0 percent and up 1.7 percent when compared with last year. The all industry index takes a reading of activity in the 11 industries that comprise the tertiary index (released earlier this week), along with activity in the construction, agricultural & fisheries industries, the public sector and industrial output. This index is considered a close approximation of gross domestic product growth as measured by industrial and service sector output.

Americas

Canada — August factory shipments were down 1.7 percent, more than wiping out a smaller revised 1.3 percent gain in July. Eleven of the 12 reporting industries posted declines, led by the transportation sector which dropped 9.7 percent on the back of a 12.8 percent slump in motor vehicles. Wood sales also dropped, down 2.3 percent in part due to ongoing strikes in Western Canada. However, there were gains in aerospace products (3.8 percent) and in primary metals (3.5 percent) for which the end of a two-month strike at a major Quebec plant was an instrumental feature. Nonetheless, the other major areas of the August report are still on the soft side with a notably hefty 5.0 percent drop in new orders and, for the first time in 2007, a small drop (0.1 percent) in backlogs. Total inventories edged down 0.2 percent largely due to a 1.0 percent dip in finished products. Despite this, the inventory-to-sales ratio still moved a notch higher to 1.30 although this remains close to the middle of the recent range

September consumer price index was up 0.2 percent and 2.5 percent when compared with the same month a year ago. This was the fastest pace seen May 2006 and was underpinned by a 12.7 percent annual gain in gasoline prices. Excluding food and energy, the CPI was up 2.1 on the year despite a surprisingly robust 0.5 percent increase versus August. The Bank of Canada core index similarly decelerated to 2.0 percent on the year from 2.2 percent. The main force driving the all-items index higher on a monthly basis at end-quarter was higher clothing prices (5.9 percent) caused by the arrival of new season fashions. This was supported by a bounce in passenger vehicles (1.1 percent) and higher secondary education costs (3.0 percent). These gains were partially offset by lower prices for fresh vegetables (8.9 percent), air transport (4.9 percent), fresh fruit (6.4 percent) and natural gas (2.3 percent). Core CPI excluding food and energy was up 0.5 percent and 2.1 percent on the year.

Bottom line

The implications of the subprime meltdown on profits became visible last week as bank after bank disappointed investors. And the U.S. housing woes hit the bottom lines of companies who supply construction equipment. The U.S. Federal Reserve Beige Book presented a mixed picture of the economy that will keep analysts asking the question “will they or won’t they” (lower interest rates).

Next week will provide analysts with a healthy helping of Japanese economic information including industrial production and consumer prices. And in Australia, the quarterly producer price index and consumer price index will be released for the third quarter. With soaring growth and tight labor markets, these data will be studied carefully to determine whether the Reserve Bank of Australia will sit tight or, should inflationary pressures build, increase rates from 6.5 percent in November.

Looking Ahead: October 22 through October 29, 2007

The following indicators will be released this week...
Europe
October 23	France	Consumption of Manufactured Products (September)
October 25	Germany	Ifo Business Survey (October)
October 26	EMU	M3 Money Supply (September)
Asia/Pacific
October 22	Australia	Producer Price Index (Q3.07)
October 24	Australia	Consumer Price Index (Q3.07)
	Japan	Merchandise Trade Balance (September)
October 26	Japan	Industrial Production (September)
		Consumer Price Index (September, October)
Americas
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