Global Markets

Earnings season arrived in full force last week as many major companies issued their earnings for the quarter just past and guidance on the future. Investors did not like what they heard. What they heard was that the financial crisis had spread to the real economy all but confirming that the U.S. economy — and those elsewhere — are contracting. Investors were jolted by the news and responded by dumping equities. But stocks were also rocked by carry trade unwinding as investors sold now risky assets that not too long ago appeared to be a good thing. The rush to the door was fanned by a fear of the unknown — the severity of the approaching global economic recession combined with a bleak outlook for corporate earnings.

And seismic tremors took place in the currency markets as well — also thanks to the reversal of carry trade positions. Previously investors had borrowed at low Japanese interest rates to fund risky investments elsewhere. Now the sharp rise in the yen has forced further sales of risky assets, with equities, commodities and emerging markets plummeting as investors seek safe havens. In Japan a government official warned that rapid and excessive currency moves were not desirable for the economy. Emerging market assets remained under heavy pressure as risk-averse investors rushed to liquidate positions, with the dollar and the yen continuing to benefit from this deleveraging. Credit spreads widened sharply.

All equity indexes followed here were down on the week. Losses ranged from 2.8 percent for the S&P/TSX Composite and 2.9 percent for the All Ordinaries to 20.5 percent for the Kospi. Other indexes that recorded double digit declines were the Nikkei, Hang Seng, STI, Sensex 30, Jakarta Composite, DAX and Bolsa.

OPEC cuts production

OPEC cut production by 1.5 million barrels per day on Friday, but crude prices sank anyhow as investors were distracted by the selloffs in equities and the volatility in currencies. The cut was larger than expected — analysts had anticipated a cut of 1 million barrels per day. Friday’s meeting was characterized by experts as one of the most important in the cartel’s history. The goal for OPEC is to stabilize oil prices as demand plummets as the global economy contracts.

Global Stock Market Recap

Europe and the UK

No surprise. The FTSE, CAC and DAX were down last week after rising in the previous one. The CAC managed to retain some of that increase but the FTSE and DAX did not. In Europe, stocks declined on disappointing earnings results that underlined fears that the global economic slump is hurting profit growth. French business confidence declined to its lowest level since December 1993 and flash purchasing managers’ indexes showed further declines.

The FTSE was down three of five days and Monday’s 5.4 percent increase kept the index afloat until Friday when the index sank after third quarter gross domestic product showed that the economy contracted for the first time since 1992 in the third quarter. GDP contracted by 0.5 percent on the quarter and more than consensus estimates of a 0.2 percent decline. The drop when combined with the unchanged reading in the second quarter brought the economy to the brink of a recession, using the two consecutive quarter decline as the definition. Analysts anticipate that the fourth quarter figure will be negative as well as consumers retrench and investment is pared back. The FTSE is laden with energy and mineral companies and these companies have been hit hard as commodity prices sink under weakened demand. And bank stocks continue to be sold despite recent attempts to support the sector. On Wednesday, equity markets were pounded after Bank of England governor Mervyn King’s warning that the UK economy is ”entering a recession” and facing a deep and prolonged slowdown.

According to the minutes of the special October 8^th Bank of England Monetary Policy Committee, the MPC voted unanimously for a coordinated 50 basis point cut in its official interest rate to 4.5 percent after having been briefed on plans to recapitalize Britain’s banking system. Typically, an MPC meeting holds an initial meeting on a Wednesday and both votes on an interest rate decision and announces it on Thursday. However, this time members were asked on the first morning of their regularly scheduled meeting to participate in the coordinated rate cut with the Federal Reserve, European Central Bank and others.

The Swedish Riksbank cut its key lending rate by 50 basis points for the second time in two weeks. They had participated in the coordinated rate cut on October 8^th — their first rate cut in more than three years. The key lending rate is now 3.75 percent and yet another reduction within six months to cushion the economic slowdown is forecast. The Bank also lowered its forecasts for growth and inflation. The Bank has cut rates more than any other central bank in Europe outside Iceland, while the government has pledged 1.5 trillion kronor ($192 billion) to guarantee loans as part of a global effort to revive lending.

Asia/Pacific

Equities continued to plunge on fears that the economic slowdown is hurting profits. Every index followed here declined on the week, anywhere from 2.9 percent for the All Ordinaries to 20.5 percent for the Kospi. Stocks were particularly hard hit on Friday — the Kospi plunged 10.6 percent on the day while the Nikkei was not far behind and sank by 9.6 percent to a 5-1/2 year low. The Kospi settled below 1,000 points for the first time since June 2005 after the Bank of Korea reported that the economy’s third quarter growth had slowed to 3.9 percent — its slowest rate in four years. The Nikkei was propelled downward as the yen continued its rapid rise to 90.89 yen to the U.S. dollar in Asian trading for the first time since August 1995. The rising yen complicates things for exporters such as Sony, Honda and Toyota and the higher exchange rate bites into their earnings.

The hard hit Kospi plummeted to its lowest close since May 2005. The index is now down 50.5 percent so far this year after gaining about 32 percent in 2007. Steep losses in early trading forced the Korea Exchange to suspend program trading for five minutes. The economy, like Japan’s, is deeply export-oriented and is negatively affected by the worldwide contraction and its sinking currency, the won. Blue chips suffered hefty losses on massive selling by foreign investors. Shipbuilders were hit especially hard as exports and the need for shipping sink.

The Shanghai Composite Index closed the week at its lowest close since November 2006. The index is now down 65 percent so far this year despite government efforts to boost the property market sector and other measures to put a floor under the economy. Third quarter growth sank to 9 percent in the third quarter. Hang Seng did not stop for breath as it sank below the 13,000 level for the first time since October 2004. The index was down 13.3 percent for the week and is down 54.6 percent in 2008.

The Reserve Bank of New Zealand cut its borrowing rate by a full percentage point to 6.5 percent as widely anticipated. The OCR has never been increased — or reduced — by more than 50 basis points since its inception in 1999. In a statement accompanying the decision, governor Alan Bollard said that the move was made in light of dual economic problems — the ongoing financial market turmoil and a deteriorating outlook for global growth.

The Japanese government has lowered its assessment of the country's economy and says that it is likely seeing its first recession in six years. In a monthly report published on Monday, the Cabinet Office said that the economy “has weakened further” and has downgraded the exports, industrial production, consumer spending components, corporate sentiment, bankruptcies and the labor market components of its assessment.

The Reserve Bank of India unexpectedly cut its key short-term lending rate by 100 basis points to 8.0 percent to alleviate pressures caused by the global financial crisis and to maintain financial stability. The cut, its first in more than four years, will take effect immediately and follows a slew of measures taken by policy makers recently to shore up domestic financial markets hit by the global financial market crisis. The RBI has been continuously monitoring the monetary and liquidity conditions with a view to maintaining domestic macroeconomic and financial stability in the context of the global financial crisis.

Canada

The Bank of Canada cut its key interest rate by 25 basis points to 2.25 percent, its lowest rate since October 2004. The Bank took part in the coordinated rate cut on October 8^th when the Federal Reserve, Bank of England and European Central Bank among others cut their key interest rates by 50 basis points in an attempt to staunch the credit crunch by increasing liquidity and shoring up confidence in the financial sector.

In cutting its rate for the second time in two weeks, the Bank cited a slowing domestic economy along with a slower global economy. The Bank hinted that there could be more rate cuts to come. Falling commodity prices and the continuing global financial crisis are hurting the Canadian economy, which the Bank of Canada said is now projected to grow by just 0.6 percent this year and next — a sharp decline from July's projections, when the central bank forecast 1.0 percent GDP growth this year and 2.3 percent expansion in 2009. The credit squeeze is sapping demand for Canadian automobiles and lumber to the U.S., the country’s main export market.

In the Bank’s Monetary Policy Report (MPR) released on Thursday, it said that Canada is in a better position than other countries to weather the global economic crisis, and while the U.S. and global economies are expected to fall into recession, Canada's economy is not. Governor Mark Carney said that the problems besetting the world economy originated outside of Canada's borders and the Bank and federal government have acted aggressively to mitigate the impact of the financial turmoil. Carney also said Canada is starting out from a stronger position than other countries thanks to the relative strength of Canadian banks, which he noted are well capitalized.

The Canadian dollar continues to sink on speculation the economic slump will deepen and oil will decline further. The loonie, as the currency is known because of the aquatic bird on the one-dollar coin, sank to its lowest since September 2004. Crude oil accounted for 10 percent of 2007 export revenue.

Currencies

The soaring yen has not helped Japan’s equity markets in the least as exporters are getting hammered on three fronts — the exchange rate impact on repatriated earnings, higher prices making it more difficult for Japanese exporters to compete especially in the U.S. and EU and finally — if that were not enough — a global economy that clearly is contracting.

As investors ditched risk with abandon, carry trades have gone into reverse big time. Previously investors borrowed in low cost Japan to invest in high-yielding investments elsewhere. Now, these transactions are being reversed and the yen soared, hitting ¥91 to the U.S. dollar, a 13 year high and ¥114 against the euro in Asian trading on Friday. But the yen declined from these levels in U.S. and European trading. Although Japan has a current account surplus and keeps the bulk of its huge fiscal debt at home, the economy is contracting and its banks are now exposed to the sinking stock market and mushrooming bankruptcies. Both the Australian and New Zealand dollars, the darlings of the carry trade, have plummeted despite the still much higher interest rates in both countries.

The pound sterling fell to its lowest level in almost six years and had its biggest decline since 1992 after the British economy contracted in the third quarter, bringing the country to the brink of recession as defined by two negative quarters of GDP. At one point, the pound fell to $1.55, the lowest level since November 2002. The currency also weakened against the euro, its largest trading pair. Analysts think that the euro and pound may continue to weaken because European and UK banks have about five times as much loan exposure to emerging markets as the U.S. or Japan, thanks to lending to Eastern Europe. The euro has lost about 20 percent against the dollar since touching the all-time high of $1.6038 on July 15.

India's rupee dropped for an 11 week, the longest losing streak since December 2005. The currency weakened past 50 per dollar briefly after the Reserve Bank of India cut its economic growth outlook for the year ending March 31 to as little as 7.5 percent from an earlier estimate of 8 percent.

Selected currencies — weekly results

Indicator scoreboard

Germany

September producer price index was up 0.4 percent and 8.3 percent when compared with last year. Energy costs climbed 0.9 percent on the month, reflecting in large part hefty gains in hard coal & briquettes (8.0 percent) and in coal & peat (6.5 percent). Excluding energy, the PPI would have edged up 0.1 percent from August and 3.6 percent on the year. Price pressures outside of energy were very subdued. Basic goods were down 0.1 percent while capital and consumer non-durable goods were flat. Durable goods prices crept 0.1 percent higher.

France

September consumption of manufactured goods was up 0.6 percent and 1.5 percent when compared with last year. Durable goods gained 0.4 percent courtesy of a 0.6 percent bounce in autos and a more modest 0.2 percent advance in household goods. Textiles were especially robust (2.8 percent) following back-to-back declines in July and August. The only decline was registered in the other products category (0.2 percent).

Italy

August retail sales were down 0.5 percent and declined 1.3 percent when compared with last year. Weakness was broad-based and led by the non-food sector where purchases fell 0.7 percent on the month and 2.9 percent on the year. Food sales slipped 0.3 percent but were 0.8 percent higher on the year.

United Kingdom

September retail sales were down 0.4 percent and were up 1.8 percent when compared with last year. Annual growth was the weakest since February 2006. Food sales were up 0.3 percent while non-food demand slumped 1.1 percent. Leading the monthly declines were clothing & footwear (2.3 percent) and household goods (2.0 percent). On the upside, non-store retailing was up 1.7 percent and non-specialized stores gained 0.7 percent. Prices remained soft with the 12-month change in the retail sales deflator up 1.0 percent, well beneath the 2 percent CPI target level.

Third quarter gross domestic product dropped 0.5 percent on the quarter but edged up 0.3 percent when compared with the same quarter a year ago and the slowest pace since the second quarter of 1992. The limited details provided in the preliminary estimate show widespread quarterly contractions in output. Within a 0.4 percent drop in services, distribution, hotels & catering was down 1.7 percent, transport, storage & communication dropped 0.6 percent and business services & finance was down 0.4 percent. Only the government sector saw an increase in output (0.4 percent). Within the goods producing area, manufacturing and electricity, gas & water both slumped 1.0 percent while mining & quarrying dropped 0.7 percent. Construction declined 0.8 percent but agriculture bucked the trend with a 0.5 percent quarterly gain.

Asia/Pacific

Japan

August all industry index sank 1.8 percent and was down 2.5 percent when compared with last year. The tertiary index which is a major component of the all industry index declined 1.4 percent and 1.6 percent on the year. The all industry index takes a reading of activity in the 11 service industries that comprise the tertiary index, 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.

September merchandise trade surplus (unadjusted) was 95.1 billion yen, down 94.1 percent from a year ago. Exports edged up 1.5 percent while imports gained 28.8 percent on the year. Exports to the U.S., down for the 13^th month in a row, dropped 10.9 percent while imports gained 10.3 percent on the year. Exports to the European Union sank 9 percent but imports from the EU gained 5.3 percent. Exports to China, which were expected to rebound after the Olympics, edged up 1.7 percent on the year while imports gained 15.8 percent. On a seasonally adjusted basis, the merchandise trade balance was in deficit for the second month, declining by 33 billion yen. Both imports and exports were down 2.9 percent and 1.3 percent on the month respectively.

Australia

Third quarter producer price index soared 2 percent on the quarter and 5.6 percent when compared with the same quarter a year ago. In the second quarter, the PPI was up 1 percent on the quarter and 4.7 percent on the year. The price index jumped thanks mainly due to price increases in building construction (up 1.8 percent), electricity, gas & water (up 7.4 percent) and dairy product manufacturing (up 5.5 percent). These increases were partially offset by a drop of 2.4 percent in motor vehicle and parts manufacturing. Intermediate or stage 2 commodity prices were up 3.7 percent and 9.7 percent on the year mainly due to price increases in coal mining, iron and steel manufacturing, basic chemical manufacturing and oil & gas extraction. These increases were somewhat offset by declining prices in grain, sheep & beef farming and metal ore mining. Prices in preliminary or stage 1 commodities soared by 5.5 percent and 13.3 percent on the year.

Third quarter consumer price index was up 1.2 percent, about as expected, and an improvement from the second quarter gain of 1.5 percent. The CPI was up 5 percent when compared with last year and the largest annual change since December quarter 1995, excluding the period associated with the introduction of the GST. The most significant price increases were for rents which were up 2.1 percent, water & sewerage which were up 12.3 percent, house purchase which was up 1.3 percent, automotive fuel which was up 2.0 percent and deposit & loan facilities which were up 1.9 percent. Overseas holiday travel & accommodation jumped 4.9 percent while electricity was up 4.6 percent and property rates & charges gained 6.1 percent. Child care prices plummeted 22.9 percent, pharmaceuticals were down 3.9 percent, audio, visual & computing equipment dropped 3.9 percent and motor vehicles declined by 0.7 percent.

China

Third quarter gross domestic product slowed to 9.0 percent — the slowest growth since the second quarter of 2003 — as a combination of slowing export demand and previous policy restraint tempered growth. Auto sales, housing investment, slower rate of inventory accumulation and some temporary disruption in industrial activities during Olympics contributed to slower growth.

September industrial production was up 11.4 percent on the year, down from 12.8 percent in August. On a seasonally adjusted basis, industrial production edged up 0.1 percent as the Olympics' disruption on industrial activities largely faded.

September consumer prices were down 0.1 percent and eased to an increase of 4.6 percent when compared with last year. The prices of foodstuff were up 9.7 percent while non-foodstuff prices were up 2.0 percent. Consumable and services were up 5.7 percent and 1.2 percent respectively. For the nine months January to September, the CPI was up 7.0 percent on the year. Food prices were up 17.3 percent for the first nine months, easing from 7.3 percent during the first eight months.

Taiwan

September seasonally adjusted unemployment rate edged up to 4.12 percent from 3.93 percent in August. The number of unemployed surged by 5.7 percent while the number of employed people declined by 0.06 percent.

September industrial production declined 1.4 percent when compared with last year. Seasonally adjusted, industrial production was down 3.8 percent on the month. Manufacturing output contracted by 4.1 percent on the month while information & electronics dropped 3.3 percent. Non-tech output plummeted 6.9 percent.

Hong Kong

September consumer price index was up 3.0 percent when compared with last year. This was an improvement over August’s hefty 4.6 percent gain. The drop was mostly due to government’s electricity subsidy in September. Other fiscal relief measures including the three months’ waiver of public housing rentals and two years’ suspension of Employees Retaining Levy, both of which started in August, have continued to dampen the headline CPI figure. Excluding these changes, underlying CPI eased modestly to 5.1 percent from 6.3 percent in August.

Americas

Canada

August retail sales were down 0.3 percent but were up 4.1 percent when compared with last year. The monthly decline was mainly due to autos which slumped 1.8 percent. Excluding autos, sales would were up 0.4 percent. New car dealers saw demand fall for the seventh month in a row. Other areas of weakness were restricted to clothing & accessories which declined 0.9 percent and furniture, home furnishings & electronics which edged down 0.1 percent. On the plus side there were respectable increases at food & beverage stores (0.7 percent), general merchandise stores (0.8 percent) and building & outdoor home suppliers (0.5 percent).

September consumer price index was up 0.2 percent and 3.4 percent when compared with last year. Core CPI which excludes food and energy was down 0.1 percent and up a tame 1 percent on the year. The Bank of Canada’s core CPI which excludes eight volatile items was up 0.2 percent on the month for an annual rate of 1.7 percent. Among the major product groups, prices posted monthly declines in shelter (0.6 percent), clothing & footwear (0.3 percent) and transportation (0.6 percent). Most other sectors saw monthly increases including food (0.9 percent), household operations & furnishings (0.9 percent), and alcohol & tobacco (0.2 percent). Prices were unchanged in health & personal care and in recreation, education & reading.

Bottom line

Investors focused on earnings last week as there was little new economic information. A look at third quarter growth — or the lack of it — was on view as China’s GDP growth receded to 9 percent on the year from 10.1 percent in the second quarter while in the UK, GDP contracted by 0.5 percent on the quarter after recording no change in the second.

Next week, both the Federal Reserve and the Bank of Japan meet. The Fed is widely expected to cut rates by 50 basis points to 1.0 percent according to fed funds futures. The Bank of Japan, however, has even less room to maneuver than the Fed with its key interest rate at a mere 0.5 percent. However, futures there also show speculation that it too will cut rates, to 0.25 percent on growing concern that its economy will suffer a prolonged recession. The BoJ did not take part in the October 8^th coordinated rate cut — although it supported the move — saying its borrowing costs are already very low. However, with the yen soaring in value and stocks sinking, concerns about the financial system are growing. Thus far, the BoJ’s efforts toward stemming the market turmoil have focused on unlocking credit markets after banks in the U.S. and Europe stopped lending to each other following last month's collapse of Lehman Brothers. And the plethora of new economic information will more than make up for last week’s lack of it.

Looking Ahead: October 27 through October 31, 2008

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