Global Markets

There is no doubt about it — it is earnings season. And although earnings were of major concern for investors last week, U.S. economic data including the consumer price index and congressional testimony from Federal Reserve Chairman Ben Bernanke also captured interest. While the strength of oil prices left equity markets largely unfazed, investors continued to focus on the unfolding U.S. second-quarter earnings season and continued merger and acquisition activity along with the subprime mortgage saga.

Wednesday was a tumultuous day as global equity and credit markets came under pressure, government bond yields sank and the dollar hit another lifetime low against the euro as renewed concerns about U.S. subprime mortgages unsettled investors. A major U.S. investment bank disclosed that two of its hedge funds that were heavily exposed to the sector were effectively worthless. The mood was further darkened by Bernanke’s downbeat comments on the U.S. housing market. He warned that housing sector problems were likely to get worse before they improved.

The Fed trimmed its economic growth forecast. Its semiannual GDP forecast was revised lower by about a quarter percentage point from the February forecast. For 2007, the central tendency range forecast is 2.25 percent to 2.5 percent for real GDP in 2007 on a fourth-quarter-over-fourth-quarter basis. The Fed's 2007 forecast for inflation is unchanged with the core PCE price index at 2 percent to 2.25 percent. The Fed sees the civilian unemployment rate for the fourth quarter of 2007 coming in at 4.5 percent to 4.75 percent. Bernanke does see the economy continuing on a moderately healthy pace with the economy having recovered from a flat first quarter of 2007.

European stocks were burdened by currency concerns as the euro touched a record high against the dollar. It was a similarly gloomy picture in Asia as the indexes declined there too. However, on Thursday, they reversed themselves once again with all 14 indexes followed here regaining positive territory. The positive turn carried over into Asia on Friday, but not to Europe and the Americas where stocks were down on the day once again thanks to disappointing earnings from a major Dow component and to subprime worries. Only the Hang Seng, Kospi and All Ordinaries in Asia and the S&P/TSX Composite in Canada were up on the week.

Global Stock Market Recap

Europe and the UK

The CAC, DAX and FTSE were down in the third week of July after spending the first two weeks of the month in positive territory. The FTSE closed one day in five on the positive side as mining stocks fell out of favor after their recent rally. This was also a heavy week for economic data in the UK. On Tuesday, increases in the consumer price index eased but remained at a high level. And core CPI which excludes energy, food, drink and tobacco continues to climb steadily. The labor market remains tight with claimant unemployment remaining low. The proof of the resiliency of the UK economy was evident on Friday when the first estimate for second quarter gross domestic product continued to grow at an above trend pace. All three indexes took a drubbing on Wednesday and again on Friday on disappointing earnings and mounting concern that subprime mortgage losses in the U.S. may grow.

Bank of England remains split

In minutes from the July meeting, the Bank of England's monetary policy committee voted six to three to increase interest rates to 5.75 percent. The pound sterling, which had soared above $2.05, ran into some selling as investors first took the minutes to be less hawkish than expected. However, sterling soon regained its poise after a more considered examination of the MPC's deliberations suggested there was little need to alter the view that interest rates would still need to go up again by the end of the summer. The minutes showed that while most on the MPC accept that the economy is growing at a healthy pace, the disagreement among members seems to focus on to what extent previous rate increases are about to curtail demand.

Asia/Pacific

After three noticeably weak days, the six indexes followed here climbed with confidence as technology company earnings attracted investor attention. However, the gains on Thursday and Friday were not sufficient to carry the Nikkei, Topix and STI into positive territory for the week.

Japan’s week began with a powerful earthquake that rocked the northwestern part of the country and tempered an otherwise benign holiday Monday. The quake placed downward pressures on Japanese stocks when markets reopened on Tuesday for trading. Investors sold casualty insurers’ stocks as the earthquake damage was calculated. However, this did not carry through to other indexes in the Asia/Pacific area. The Hang Seng rebounded above the psychological 23,000 resistance level and regained about two-thirds of Monday’s losses.

Stocks sank on Wednesday as utilities and technology stocks weighed negatively on the Japanese market while oil companies paced declines in Hong Kong and Australia. In Japan, stocks were led lower by high tech shares and with the Nikkei briefly dropping below the key 18,000 level. Shares sank on worries that the shutdown of a nuclear power plant in northwest Japan following the earthquake would affect power company earnings. Stocks were also pressured by the fall out from subprime woes which could prompt investors to favor government bonds instead of equities. Japanese exporters’ shares were down on concern that a stronger yen would lower the value of overseas revenue. A weakening yen had been the biggest support for exporters.

Another rate increase for China

After GDP data showed a 12-year high of 11.9 percent in the second quarter, the Peoples Bank of China once again increased its interest rate by 27 basis points — this time to 6.84 percent. The PBoC has now increased rates three times this year in its attempt to cool the economy. It increased its rate to 6.39 percent in February and again in May to 6.57 percent. In addition to torrid growth, consumer prices jumped 4.4 percent and the most in almost three years while spending on factories and property has  surged. In addition to higher interest rates, the Bank has already ordered lenders to increase reserves five times this year. The move went largely unheeded by the markets — it had been expected following the release of strong inflation and growth data on Thursday.

Currencies

The dollar fell to a fresh lifetime low against the euro and was also down against a basket of currencies and the yen last week as well. According to analysts, the dollar has been negatively affected as investors worry that losses in subprime mortgages will worsen a slowdown in U.S. housing and curb economic growth. The currency dropped against the yen as traders cut their risk exposure. The yen rebounded as losses in equities prompted investors to pare holding of riskier assets funded by loans in Japan, in the so-called carry trade.

Sterling continues to climb

Sterling hit fresh 26-year highs against the dollar on Tuesday and again later in the week after higher-than-expected UK June consumer price inflation and robust second quarter GDP growth increased the probabilities of more interest rate increases. The dollar was down Wednesday as moderating U.S. inflation and a continued sluggish housing market briefly revived the possibility of interest rate cuts later in the year. Comments by Fed Chairman Bernanke to Congress also added downward pressure on the dollar. He said that although some inflationary pressures had moderated, pricing pressures remain a concern for the Fed. He also said that he expected home sales to remain sluggish for some time. Earlier, the dollar had wilted as financial markets were rocked again by investor worries about the fallout from problems in the subprime mortgage sector.

Indicator scoreboard

EMU — June harmonized index of consumer prices was up 0.1 percent and 1.9 percent when compared with last year. Core inflation (excluding food, alcohol, tobacco and energy) was unchanged on the month and up 1.9 percent. HICP has now held below 2 percent since last August and at the same rate since February this year. Among the major categories, inflation was little different from the May levels with education up 9.2 percent on the year and at the top of the heap followed by alcohol and tobacco, up 3.6 percent, and hotels & restaurants, up 3.2 percent. Geographically, inflation was again highest in Slovenia (3.8 percent) and lowest in Belgium and France (both 1.3 percent).

May merchandise trade balance continues to be in surplus at €1.7 billion as annual growth in exports (7.0 percent) more than doubled that of imports (3.0 percent). This compares favorably with the €3.9 billion deficit in the same month a year ago. However, while the data stand very favorably with their May 2006 counterparts, the geographical breakdown provides more evidence of the potential threat of euro strength and U.S. dollar weakness. Thus, the bilateral trade surplus in 2007 with the U.S. (€19.9 billion) has shrunk by 10 percent.

Germany — July ZEW expectations declined to 10.4 from 20.3 in June. This is still below its historical average of 32.8 points. The indicator for the current economic situation remained on a high level but decreased slightly by 0.5 points to 88.2 points in July. Financial market experts expect an economic downturn within the next six months particularly in the consumption and construction sector, which could be attributed to the upward trend of the oil price and higher interest rates. Economic perspectives for the U.S. are more critical according to the experts. The expectations indicate that the German economy will start off with less momentum in the year 2008. The survey is conducted monthly by the Centre for European Economic Research (ZEW), Mannheim. The 306 analysts and institutional investors that participated were interviewed between July 2 through July 16 about their medium-term expectations concerning economic activity and capital markets.

June producer price index was up 0.2 percent and 1.7 percent when compared with last year. Basic and capital goods prices showed no change from their respective May levels and although consumer goods prices jumped 0.4 percent, inflation in this sector is still only 1.8 percent on the year. However, in line with previous months, weaker oil prices were a key factor helping to depress the overall index (energy prices were flat on the month), but recent developments in energy markets make for upside risk going forward. Excluding energy, the PPI rose 0.2 percent on the month and accelerated to 2.8 percent from 2.7 percent versus June 2006.

United Kingdom — June consumer price index was up 0.2 percent and 2.4 percent when compared with the same month a year ago. The increase of 2.4 percent was the lowest reading since October 2006. Core CPI, which excludes food, alcohol, tobacco and energy, was up 0.2 percent and 2 percent on the year for the fastest pace since March 1997. The overall CPI is continuing to benefit from the effects of current and planned cuts in gas and electricity prices this year and the 2006 increases in tariffs which together are making a significant negative contribution to the housing and household services sector of the overall CPI basket. Prices in this category fell another 0.5 percent last month on top of the 0.5 percent drop posted in May. There were also declines in recreation and culture (0.5 percent), and clothing and footwear (0.2 percent). The largest monthly increases came from furniture & household equipment (2.2 percent), transport (0.6 percent) and food & non-alcohol drinks (0.5 percent).

June claimant count unemployment fell for the ninth consecutive month. While not quite enough to reduce the jobless rate, a decline of 13,800 was above expectations and followed a larger revised drop of 11,800 in May. The ILO measure of unemployment dropped by 35,000 over the three months to May, enough to reduce the jobless level to 1.66 million and the unemployment rate by 0.1 percent to 5.4 percent. At the same time, the number of employed increased by 93,000 for the same period adding 0.1 percent to the working age employment rate (74.5 percent).

Average earnings decelerated in the three months to May to leave the headline rate at 3.5 percent, the lowest pace seen since November 2006. The drop in overall earnings growth is only to be expected as the effects of earlier large bonus payments fade away, but the dip in the ex-bonus rate (3.5 percent from 3.6 percent) is surprising in the face of the ongoing decline in unemployment. Acceleration in manufacturing sector earnings to 3.7 percent from 3.4 percent could reflect labor shortages. However, private sector services fell sharply to 3.6 percent from 4.5 percent.

June retail sales volumes were up 0.2 percent and 3.4 percent when compared with last year. However, all of the weakness was restricted to food where sales dropped a hefty 1.1 percent from May. More significantly, non-food sales were up a solid 1.3 percent reflecting broad-based gains among major sub-categories. In particular, sales of household goods jumped 1.6 percent on the month and for clothing & footwear, 0.5 percent. It appears bad weather adversely affected food demand but the aggregate impact is less certain as some stores said shoppers stayed at home but others said the heavy rainfall boosted floor traffic at larger malls.

Second quarter gross domestic product was up 0.8 percent and 3 percent when compared with the second quarter last year. Manufacturing sector rebounded with a 0.6 percent increase after dropping 0.4 percent in the first quarter. Services slowed a notch (0.8 percent from 0.9 percent) but, with year-on-year growth of 3.6 percent, continue to expand well above their trend rate. Indeed, within this sector, there were strong gains on the quarter across the board with transport (1.4 percent) and business services particularly robust (1.3 percent). Elsewhere, construction continued to grow very strongly (1.1 percent after 0.7 percent) while the only major category to post a decline was electricity, gas & water supply which dipped 0.4 percent.

Asia/Pacific

Japan — May tertiary activity index edged down 0.1 percent but was up 0.7 percent when compared with the same month a year ago. Analysts had expected the index to increase 0.2 percent. After dropping in March, the index rebounded by 1.6 percent in April. Activity slowed for information & communications, services, transport, utilities (including electricity, gas, heat supply & water), real estate and eating & drinking places. Wholesale & retail trade, finance & insurance, medical, health care & welfare along with compound services and learning support sectors gained on the month. 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.

May all industry activity index unexpectedly dropped 0.3 percent but was up 0.7 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.

China — Second quarter gross domestic product accelerated to 11.9 percent when compared with a year earlier and the fastest pace in 12 years. First quarter GDP expanded by 11.1 percent on the year. Growth was powered by strong exports which soared 28 percent on the year along with continued heavy investment in new factories and infrastructure.

Americas

Canada — May manufacturing shipments edged down 0.1 percent but were up 2.6 percent when compared with last year. At a sectoral level there were declines in nine of 21 industries with durable goods producers again performing particularly poorly, posting a 1.2 percent loss following an even larger 2.0 percent drop in April. New orders were down 0.5 percent but were up 4.9 percent on the year. However, the report is much more mixed than first appearances suggest. Nondurable shipments were up 1.2 percent while unfilled orders jumped by 1.8 percent. In volume terms total shipments rose 0.4 percent and now stand at their highest level since the beginning of 2006. Inventories dropped 0.4 percent in May to leave the inventory-to-shipment ratio unchanged at 1.27, only slightly above the recent 1.25 low seen in March and not in any way indicative of any significant stock overhang.

May consumer price index was down 0.2 percent and up 2.2 percent when compared with last year. For the third month in succession, the higher cost of owned accommodation (4.9 percent) was the main upward force driving the annual change in price levels with an increase in the cost of mortgage interest (5.7 percent) particularly significant. This was augmented by another jump in homeowners’ replacement costs (6.1 percent) alongside more expensive vehicle costs (2.8 percent). The rise in gasoline prices eased somewhat (1.7 percent versus 5.7 percent in May) while restaurant meals and food bought at grocery stores rose 2.3 percent and 3.4 percent respectively. Helping to keep prices in check once again were computer equipment & supplies prices which fell 17.3 percent and video equipment which dropped 9.5 percent. Clothing costs were also weak again with prices for men off 2.7 percent and for women down 2.1 percent. Core CPI (excluding food and energy) was unchanged on the month and was up 2.2 percent on the year.

Bottom line

Equities retreated last week for the most part as disappointing earnings results and continuing subprime woes took their toll on investor morale. Economic data in the UK were favorable for the most part while in the U.S. they were mixed. A lower growth forecast from the Federal Reserve did not help. A 27 basis point increase in Chinese interest rates yesterday went largely unheeded by the markets. The move had been expected following release of strong inflation and growth data on Thursday.

Although there are few economic releases next week, they are important. The most important is the first estimate of U.S. GDP growth for the second quarter. In Australia, both the second quarter producer price and consumer price indexes will be released and will help analysts project interest rates there. The June CPI will also be available for Japan. The reading will help to determine when the Bank of Japan will next increase interest rates.

Looking Ahead: July 23 through July 27, 2007

Anne D Picker is the author of International Economic Indicators and Central Banks.