Global Markets

Equities chopped their way through the week as thin volumes — thanks to the high August vacation season — created large fluctuations as remaining investors focused on gyrations in the Shanghai Composite (SCI). There was little major economic news to distract investors — except housing news in the U.S. And on Friday, the composite PMI index for Germany climbed above the breakeven point of 50 to show growth for the first time in 15 months.

The underlying mood remains cautious as investors continue to question whether the rally in risk assets over the past five months has gotten ahead of itself. The week began on an ominous note. Equity markets around the world plunged on Monday as waning confidence in the global economic recovery prompted a broad sell-off in risky assets. The deterioration in sentiment reverberated from disappointment in a U.S. consumer confidence reading along with disappointing retail sales data. The data highlighted both the weakness — and the importance of household spending — in the recovery.

For a change, rather than fixating on U.S. equities, Asian/Pacific investors honed in on Chinese shares and in particular, the Shanghai Composite which on Monday suffered its worst one-day decline in nine months amid lingering concerns that the authorities might move to rein in bank lending. At one point on Wednesday, the index was down as much as 20 percent from its high reached only on August 4.

On the week, all Asian/Pacific equity indexes followed here were down while those in Europe had healthy gains. In North America, all but the S&P/TSX Composite were up on the week.

Global Stock Market Recap

Europe and the UK

After a dreadful start on Monday, the FTSE, DAX and CAC righted themselves and chipped away each day at their losses. By week’s end, each had experienced a healthy gain. The FTSE, DAX and CAC were up 2.9 percent, 2.9 percent and 3.4 percent respectively.

Sparse economic data provided a necessary fillip for investors. On Tuesday, the ZEW economic sentiment indicator for Germany showed that sentiment improved after the surprisingly positive second quarter GDP data boosted investors' confidence. The indicator jumped sharply to 56.1 in August — the highest since April 2006 — and above expectations. And on Friday, the Markit German composite PMI index climbed above the breakeven point and showed positive growth for both manufacturing and services combined. Stocks celebrated. And the good news didn’t end there — U.S. existing home sales jumped by 7.5 percent even though prices continued to fall while Fed Chairman Ben Bernanke said the global economy is beginning to emerge from recession.

Friday’s rally saw the FTSE stocks climb the most in more than a month, led by energy and basic-resources companies as signs that the first global recession since World War II is ending mounted. The FTSE has rebounded 38 percent from its March lows and reached the highest level since October.

Bank of England’s MPC minutes

Analysts who assume blithely that central bank policy committees are unanimous in their decisions received a jolt on Wednesday after the minutes revealed that Mervyn King, Bank of England governor, was outvoted on policy for only the third time since he took the helm in 2003. The markets were shaken, the pound plunged and gilts were up as markets digested Mr King’s unsuccessful attempt to press for greater stimulus to the economy through the quantitative easing program. Sterling tumbled more than 1 percent against the dollar and the euro before recovering later in the day. At the same time, government bonds saw one of their biggest moves of the year as expectations rose of looser policy via lower interest rates or further extension of quantitative easing.

Mr King, long known for his caution for fear of triggering inflation, and two other MPC members voted to increase QE by £75 billion to £200 billion while the six other members of the MPC voted for an increase of £50 billion to £175 billion. Analysts said that Mr King’s dissension told the markets that he was prepared to err on the side of risking more inflation rather than courting deflation. It was significant to analysts since Mr King had established himself as a hawk and very quick to crush any signs of inflationary pressures. But now it emerges that the MPC is deeply concerned about whether the nascent recovery is sustainable — particularly since there is little evidence that the £125 billion spent so far has delivered additional lending. However, finding a measure to quantify results is difficult.

It was the third big surprise for investors in the past month. They were taken by surprise when the Bank failed to extend QE at its July policy meeting. They then did not expect the Bank to increase the program at its meeting earlier this month — which they did. Analysts now say the Bank could again increase QE by as much as £50 billion in November when the current program ends.

Asia/Pacific

All Asia/Pacific equity indexes were down last week, with many dating their last decline to the July 9 week. Stocks seesawed through the week on concerns that a tightening of credit in China would reduce growth. The chatter about China’s fiscal stimulus reflects international investors’ concerns. Worries that China will start reining in credit growth have clouded market sentiment during the past few weeks, even though the Shanghai Composite remains 62.1 percent higher on the year — even after three consecutive weeks of losses. Analysts voiced concerns that the rapid credit increase is not being invested in the real economy because of the glut in manufacturing capacity and is instead being invested in riskier higher yielding financial assets.

Japanese stocks ended lower Friday as the strengthened yen hurt exporters. Auto companies were hit hard by concerns that the end of the U.S. government's cash-for-clunkers incentive program — which always was a limited program — may lead to weaker sales.

It should be noted that the latest bout of risk aversion has occurred against the backdrop of low volume. History suggests that trends established during periods of low trading volumes have swiftly petered out once volumes picked up.

Reserve Bank of Australia minutes

The RBA projected that its decision on when it would increase borrowing costs would need to balance inflation risks with the possibility of killing off confidence and demand. The Bank’s current interest rate is at 3 percent — an historic low. The RBA said that it would need to raise its overnight cash rate at some point. The board said that it was uncertain whether the recent household spending increase was due to temporary government handouts and would soon fade or would be more long lasting. Australia’s economy grew 0.4 percent in the first quarter, rebounding from its first contraction in eight years in the previous three months, as lower borrowing costs and government spending stoked domestic demand.

The minutes revealed that the board members were of the view that the cash rate had been reduced to the current low level in anticipation of weak economic outcomes. The minutes further revealed that the board members left open the possibility of further reductions in the rate if need arose. But with the recent improvements in the global and domestic outlook, the members said it appeared unlikely that further cuts would be necessary.

Currencies

The dollar was down on the week against all major currencies except the pound sterling. The dollar lost ground against the euro, yen and the Canadian, Australian and New Zealand dollars as investors, once Monday’s jitters were over, again moved into riskier assets.

The pound sterling was volatile as UK economic and policy releases provided mixed momentum in a holiday thinned market. Sterling was shaken on Wednesday after minutes from the Bank of England’s monetary policy committee revealed that governor Mervyn King had unsuccessfully pressed for expanding the Bank’s asset purchase program by £75 billion to £200 billion. That Mr King had wanted to expand quantitative easing surprised the markets, sending the pound down before recovering later in the day. The sell-off, however, wiped out much of the gains sterling had made on Tuesday when it rallied sharply after July consumer prices held steady.

The euro was buoyed by positive economic data that included a greater-than-forecast jump in German business confidence. Later in the week, data showed that the German manufacturing and service sectors expanded in August. With both the French and German economies growing in the second quarter, the euro has benefited from renewed expectations that the eurozone could emerge from recession faster than was previously thought.

Selected currencies — weekly results

Indicator scoreboard

EMU

June seasonally adjusted merchandise trade surplus was €1.0 billion, slightly below May’s revised surplus of €1.1 billion. Exports were down 0.1 percent while imports were flat. On an unadjusted basis, the trade surplus jumped to €4.6 billion from €2.1 billion in May. Unadjusted exports were up 7.6 percent but remain 22.2 percent below June 2008. Imports were up 5.2 percent but were 25.6 percent below a year ago.

Germany

August ZEW soared to a reading of 56.1 from July's 39.5 and the highest level in more than three years. Current economic conditions climbed to minus 77.2 from July's reading of minus 89.3. The ZEW surveys German financial experts for their opinions on current economic conditions and the economic outlook for major industrial economies each month.

July producer price index sank 1.5 percent and plummeted 7.8 percent when compared with last year for its steepest decline since 1949. Energy costs swooned 4.5 percent on the month and 16.5 percent on the year. Excluding energy, the PPI was down 0.2 percent and 3.6 percent on the year. Basic goods prices were down 0.3 percent on the month and 7.9 percent on the year. Consumer goods prices were flat and declined 1.7 percent on the year while capital goods prices edged down 0.2 percent but were up 0.6 percent on the year. Manufacturing production prices fell 0.4 percent and were down 5.5 percent on the year. Food, feed & beverage prices were down 0.2 percent and 4.7 percent on the year.

United Kingdom

July unadjusted consumer price index was down 0.1 percent on the month and up 1.7 percent when compared with last year. Core CPI, which excludes food, alcohol, energy & tobacco, was unchanged on the month and up 1.8 percent on the year. The largest downward pressure came from food thanks to declining meat and vegetable prices. There was also large downward pressure from restaurants and hotels. Upward pressure came from recreation & culture — mainly from games, toys & hobbies.

July retail sales were up 0.4 percent and 3.3 percent when compared with last year. Household goods sales were up 4.5 percent driven by purchases of furniture and electrical items. “Other” store sales were up 1.1 percent. However, volumes at department stores and clothing & shoe stores were down 0.4 percent on the month after soaring 4.7 percent in June. Non-food sales were up 1.1 percent on the month while food sales declined 1 percent.

Asia/Pacific

Japan

Second quarter preliminary gross domestic product was up 0.9 percent or 3.7 percent at an annualized rate. On the year, GDP dropped 6.5 percent. This was the first positive quarter since the first quarter of 2008. Growth stemmed from a combination of increased exports and private consumption. Private consumption was up 0.8 percent on the quarter while exports were up 6.3 percent. However, the closely watched private nonresidential investment sector was down 4.3 percent – albeit an improvement from the first quarter’s drop of 8.5 percent.

Americas

Canada

July consumer price index dropped 0.3 percent and was down 0.9 percent when compared with last year. The annual decline was due primarily to a drop of 23.4 percent for energy products, particularly gasoline. Excluding energy, the CPI was up 1.8 percent on the year. The Bank of Canada core CPI which excludes eight volatile items was unchanged on the month and up 1.8 percent on the year. Of the eight major components, three were down on the year — transportation, shelter and clothing & footwear. The transportation category included lower prices for both gasoline and passenger vehicles. In the shelter component, prices were down for natural gas, fuel oil & other fuels and homeowner's replacement costs. The primary upward pressure came from food, which increased 5.0 percent on the year.

Bottom line

More green shoots appeared last week as German sentiment jumped as did the August combined PMI. In the U.S., housing data indicated that a bottom was being reached at last. And Fed Chairman Ben Bernanke acknowledged that the global economy looked ready to grow again.

There is no data drought this week even though traders will be on the beach. The heaviest data flow is from Japan where key consumer price data along with unemployment will be released. Household spending and merchandise trade data will also fill out the economic picture mid-quarter.

Japan goes to the polls for a general election on August 30. At this time, it looks as though the election will result in a change in government from the LDP to DPJ. The Bank of Japan will need to develop a new relationship. The BoJ’s independence is guaranteed by law although it has had to fight to maintain its independence from the Ministry of Finance. But to ensure the smooth management of monetary policy, the BoJ must also communicate with the government to understand the latter's policy direction. If the economy fails to take off, the Bank could come under increased pressure to add to its monetary easing measures.

Looking Ahead: August 24 through August 28, 2009

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