Global Markets

All equity indexes followed here sank dramatically last week. Continued concerns over subprime lending and wider credit issues put markets in a volatile state as the week began. While news that two subprime mortgage-backed hedge funds were virtually worthless wasn't news at all, better news from another fund did calm investor nerves. However, the calm did not last for long and the flight to safety which buoyed government bonds picked up steam — equities sank as worries over the impact of subprime loans persisted. Equity volatility continued Tuesday as investors fretted over disappointing corporate earnings, downbeat comments on U.S. housing and fresh weakness in credit markets. There were earnings disappointments from Dow components while the fragile state of the housing market, in addition to disappointing existing and new home sales reports, was underlined by poor figures in the corporate sector from a major mortgage lender and a building materials group. Jitters in the credit markets have sparked fears that the leveraged buy-out boom is over and these were exacerbated after several high profile deals were delayed or canceled by unfavorable market conditions. Private equity buy-outs and takeover speculation have boosted share prices for some time, but turmoil in the credit markets threatens to make funding of deals more difficult.

Stock prices tumbled across much of the world on Thursday and Friday. (Only the Bolsa managed to gain on Friday.) They were driven sharply lower by worries over slowing economic growth in the United States and worsening borrowing conditions that could make everything from corporate buyouts to buying a new home more difficult. For most, Thursday’s declines in North America and Europe were the worst since markets plunged worldwide in late February after an investment scare in Shanghai. And the losses picked up in Asia on Friday. On the week, all indexes tracked here were down anywhere from 3.1 percent (Hang Seng) to 5.7 percent (S&P/TSX Composite). The FTSE ended the week below its end of 2006 level by 0.1 percent.

Global Stock Market Recap

Europe and the UK

The CAC, DAX and FTSE were hit hard by last week’s stock market turmoil. At week’s end, stocks suffered their biggest weekly decline in 2007 on concerns that financing difficulties in the credit markets will stifle mergers and acquisitions, a main driver to rising equities. Even better-than-expected U.S. GDP data on Friday could not overcome credit worries. Last week’s losses were larger across the board than the February/March stumble which was triggered by a rout in Chinese equities. Some early Friday losses were recouped after second quarter gross domestic product data showed that the U.S. grew at an annualized rate of 3.4 percent — the fastest pace in more than a year. But the positive was overwhelmed and all three indexes lost more ground on Friday. Equities that were hurt included autos and energy companies as some mining companies feel the pinch from recent losses in the commodity markets. On Thursday, fears about an end to the leveraged buy-out boom sparked heavy selling and triggered the FTSE’s worst one-day slide since March 2003. And at the end of trading on Friday, the FTSE had given back all of its gains in 2007 and then some. Its weekly loss was 5.6 percent — its worst performance since January 2003.

Asia/Pacific

All Asian/Pacific stock indexes followed here plummeted to multi-month lows, primarily on declines incurred on Thursday and Friday. After Tuesday’s positive finish, only the Kospi managed to rise to a new high on Wednesday before investors fled to risk adverse positions. In Japan, the Nikkei and Topix were dragged down by both export-focused stocks and sectors whose price to earnings valuations had raced up over the past year, before grinding to a halt in recent months on fears of overvaluation. Japanese investors have also been nervous about Sunday’s (July 29) Upper House elections where polls suggest a further slide in support for the ruling Liberal Democratic party.

Tuesday’s reprieve was brought on by expectations of strong corporate earnings in Japan and Hong Kong, but markets fell slightly in Shanghai and Seoul as investors took profits following recent gains. In Hong Kong, Chinese insurers and property companies led the Hang Seng to a third-straight record close. Wednesday’s bright spot was the Kospi, which had surged close to a 40 percent gain so far in 2007. It closed above the 2000 threshold for the first time.

The declines in stock indexes that began on Wednesday picked up steam on Thursday and Friday when Asian stocks fell the most in four months. All of the region's markets declined, except China. The Nikkei 225 Stock Average fell 2.4 percent and in the process erased almost all of this year's gains. The Kospi dropped more than 4 percent, paring its gain this year to 31.3 percent. Exporters continued to be hit including auto makers and electronics firms. Investors sought the relative safety of government bonds after selling equities. Losses were comparable throughout Europe, and larger in many developing countries.

Currencies

The dollar was down against the yen and up against the euro last week as the turmoil in the equity markets affected currency values. But not before the currency dropped to a record low against the euro in intraday trading of $.1.3852 and a 26-year low against the pound sterling of $2.0654. Additional pressure on the dollar are expectations that the Federal Reserve will keep U.S. interest rates on hold at 5.25 percent while other central banks will continue to raise rates. Analysts said fears over the turmoil in the U.S. subprime mortgage and credit markets are also putting pressure on the dollar.

The dollar was volatile against the yen, as polls indicate that the ruling Liberal Democratic party is heading for defeat in Sunday’s (July 29) Upper House elections. But yen declines were negated after traders reported heavy selling from Japanese exporters above the ¥122 level. The yen strengthened against currencies including the euro and the pound as a decline in global stocks encouraged traders to pare investments financed by low cost loans in Japan. The yen has declined in recent months as investors have sold it in carry trades, in which low-yielding currencies are sold to fund the purchase of riskier, higher-yielding assets elsewhere. The U.S. dollar continues to be the safe haven asset when investors become risk averse and sell off riskier assets — they turn to the dollar for safety.

Indicator scoreboard

EMU — May M3 money supply jumped by 10.9 percent after climbing by 10.6 percent in May. This matched the highest reading seen since February 1983. The persistent buoyancy of M3, one of the key indicators for ECB policy, will inevitably keep the central bank poised to raise interest rates again possibly as soon as September. The three-month moving average, which monetary authorities attach the most weight, actually stabilized in June at 10.6 percent, but this is still more than double the ECB’s reference point of 4.5 percent. Probably of most concern for the ECB is the ongoing strength of private sector credit demand. Loans to the private sector accelerated to 10.8 percent in the year to June, up significantly from the 10.4 percent pace seen at mid-quarter and the fastest rate since last December.

Germany — July Ifo business sentiment survey edged down to 106.4 from 107 in June. The slippage in overall sentiment made for the weakest reading since October 2006 and reflected mainly a drop in the assessment of future conditions to 101.8 from 102.8. Current conditions were essentially unchanged at 111.3 after 111.4. Sentiment was down modestly across the board although retail and manufacturing performed better than most. Higher interest rates and record levels of the euro seem to be the main culprits for the decline and with both issues unlikely to go away in a hurry the chances are that upcoming surveys will also show some further losses. While this report largely supports the findings of the latest ZEW survey, the overall picture remains relatively positive.

France — June consumer spending on manufactured goods jumped 1.6 percent — the largest gain in ten months. On the year, spending was up 3.1 percent. The monthly gain reflected hefty increases in textile consumption (8.3 percent, the largest in more than four years) and household goods consumption (2.7 percent). The jump in overall spending was all the more impressive in the wake of a nosedive in the auto sector where the 2.1 percent surge in May was more than reversed as sales sank 2.7 percent last month.

Italy —May retail sales edged up a meager 0.1 percent and were up 0.6 percent when compared with last year. In April, sales were down 0.3 percent on the month and up 0.5 percent on the year. Underlying sales were even weaker with the non-food sector flat on the month. Food was up 0.3 percent following a drop of 0.6 percent in April. Both headline and non-food retail sales showed essentially no growth in the second quarter with non-food demand standing 0.4 percent below the year ago level (compared with up 0.3 percent in April).

Asia/Pacific

Japan — June unadjusted merchandise trade surplus was ¥1.2 trillion, up 53.4 percent from the same month a year ago. Imports were up 10.7 percent while exports were up 16.2 percent on the year. The balance with the U.S. was up 7.8 percent with exports up 6.7 percent while imports were up 5.6 percent. Japan posted a deficit of ¥84.8 billion with China, down 36.1 percent on the year. On a seasonally adjusted basis, the merchandise trade surplus was ¥823.8 billion, up slightly from May’s surplus of ¥801.6 billion. Exports were up 1.1 percent while imports were up 0.9 percent on the month.

Tokyo consumer price index was down 0.2 percent and down 0.1 percent when compared with the previous year. Core CPI excluding only fresh food was down 0.2 percent and down 0.1 percent on the year. June national CPI was down 0.2 percent both on the month and on the year. The consensus forecast was for a decline of 0.3 percent on the year. Core June CPI was unchanged on the month and down 0.1 percent on the year.

June retail sales were better than analysts expected. Sales were down 0.4 percent on the year rather than the 0.6 percent decline expected. Large scale retail stores, however, were up 1.8 percent on the year.

Australia — Second quarter producer price index was up 1.0 percent and up 2.3 percent when compared with last year. First quarter PPI was unchanged on the quarter and up 2.8 percent on the year. Domestic prices were up 1.5 percent and 3.5 percent on the year while import prices sank by 1.6 percent on the quarter and were down 5.1 percent on the year. Domestic prices were up due to price increases for building construction, petroleum refining and other agricultural products.

Second quarter consumer price index was up a slightly more than expected 1.2 percent and was up 2.1 percent when compared with the same quarter a year ago. In the first quarter, the CPI was up 0.1 percent and 2.4 percent on the year. The quarterly increases were led by a 3 percent jump in transportation prices followed by a 2.1 percent increase in health. Food prices were up 1.7 percent while clothing & footware were up 1.4 percent. Drought in Australia, the world's third-largest dairy and wheat exporter, has cut milk, cereals and fibers production. Wheat prices surged more than 50 percent in the past year and rose to a record last month. Milk product prices have reached records as lower output has reduced global supplies.

Americas

Canada — May retail sales surged 2.8 percent and were up 2.3 percent when compared with the same month a year ago. The increase reflected substantial rises in most sectors and constituted both the largest increase since December 1997 and the fourth monthly gain in a row. Even excluding autos (4.0 percent ), sales were up 2.3 percent — and while the Quebec public service pay equity settlement was a factor (provincial sales leapt some 4.9 percent) without this region sales still grew 2.2 percent. Sales advanced in all sectors with the exception of furniture, home furnishings & electronics stores (down 0.8 percent). Strong figures elsewhere may have been partly a function of warmer–than-usual weather following an unseasonably poor April, but the size of the increases suggests solid underlying advances. In particular, building and outdoor home supplies were up 6.0 percent, the largest increase since August 2003 while clothing and accessories were up 4.6 percent. Miscellaneous retailers saw a gain of 3.7 percent and general merchandise was up 3.2 percent. A 2.5 percent jump at pharmacies and personal care stores was the strongest since January 1999. Price effects were minimal with total volume sales rising 2.5 percent, the largest increase since November 2001.

Bottom line

Financial markets continued their volatility last week with all indexes followed here declining 3 percent or more on the week. It was a sparse data week which gave investors little to distract themselves as they focused on corporate earnings and subprime market woes. They were concerned that credit market issues will curtail merger and acquisition activity which has played such an important role in appreciation of assets. The Federal Reserve released its Beige Book for the upcoming August 7 FOMC meeting. It largely indicates that the U.S. economy continues to grow at a moderate pace and above the first quarter's flat pace with relative strengths and weaknesses continuing pretty much as they have in recent months.

The pace picks up next week. Both the Bank of England and the European Central Bank hold policy meetings. Neither is expected to change their interest rate from 5.75 percent and 4 percent respectively. There are numerous important data releases including unemployment data from France, Germany, the EMU and the U.S.

Looking Ahead: July 30 through August 3, 2007

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