Global stock markets shrugged off dire news on the US employment front, arguing that the gloomy data would hasten US lawmakers’ passage of a stimulus package. After falling for four straight weeks and recording the worst performance of the major US indices for January on record, Wall Street reversed course on the back of a stimulus-induced rally.

The US government seems on track to announce two new recovery plans next week. Firstly, Senate Democrats reached an agreement with Republican moderates on Friday regarding a fiscal stimulus package. The deal, in essence, entails about $110 billion in cuts to the roughly $900 billion legislation, according to The New York Times. Secondly, a rescue plan to inject billions of dollars into banks and entice investors to purchase toxic assets will be outlined on Monday by Treasury Secretary Timothy Geithner.

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As investors’ risk appetite returned, the MSCI World Index and the MSCI Emerging Markets Index chalked up decent gains of 3.8% (YTD -5.4%) and 5.3% (YTD -1.7%) respectively. Among exchange-traded fund (ETFs), sector leaders were China (see additional comments below), Brazil and South Korea – all recording double-digit gains, according to John Nyaradi (Wall Street Sector Selector).

All the major US indices revved higher, as seen from the week’s movements: Dow Jones Industrial Index + 3.5% (YTD -5.6%), S&P 500 Index + 5.2% (YTD -3.8%), Nasdaq Composite Index +7.8% (YTD +0.9%) and Russell 2000 Index +6.1% (YTD -5.8%). Interestingly, the Nasdaq has been outperforming the Dow and S&P 500 since the beginning of December. Leadership by the technology sector is often good for the market as a whole.

Recent safe-haven trades such as US Treasuries (-0.7% in the case of 30-year bonds), the US dollar (-0.6%) and gold (-1.5%) took a back seat, as investors favored equities and commodities such as copper (+4.9%) and aluminum (+7.7%).

While pundits were speculating about when the Federal Reserve would enter the market as a buyer of US government bonds, Treasuries sold off as a large issuance of sovereign debt looms. However, German bonds gained handsomely on the perception that the European Central Bank was behind the curve with interest rate cuts against the backdrop of poor economic data.

The performance of the major asset classes is summarized by the chart below, courtesy of StockCharts.com.

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Giving a glimmer of hope, the Baltic Dry Index (BDI) – measuring freight rates for iron ore and other bulk goods – jumped by 40% last week due to increased Chinese demand for iron ore. The Index has gained 125% over the past two months after plunging by 94% since its May high. The chart below illustrates the close relationship between the BDI (red line) and Reuters/Jeffries CRB Index (green line). (Not shown, the trends of the BDI and US Treasury yields also follow more or less the same path.)

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As reported in my “Credit Crisis Watch” review of a few days ago, the past few months saw progress on the credit front, with a number of spreads having peaked. The TED spread, LIBOR-OIS spread and GSE mortgage spreads have all narrowed markedly since the record highs. Corporate bonds have also seen a strong improvement, but high-yield spreads remain at distressed levels. The tide seems to be turning, but the thawing of the credit markets still has some way to go before liquidity starts to move freely and confidence returns to the world’s financial system again.

Speaking of confidence, Montek Ahluwalia, deputy chairman of India’s planning commission, made the following remark at the recent Davos Forum: “Confidence grows at the rate a coconut tree grows. It falls at the rate a coconut falls.”

Back to the planned US rescue packages, and specifically Bill King’s comments: “The main problem plaguing the US economy is too much debt has been accumulated on gratuitous spending and the papering over of declining US living standards. Solons espouse a monstrous surge in debt to fund even more consumer spending. The toxin is not the cure. Inducements to save and invest in production are the remedy. But the welfare state and its ruling class are trying a last grandiose socialist [Keynesian] binge in the hope of salvaging their realm.”

Next, a tag cloud of my week’s reading. This is a way of visualizing word frequencies at a glance. Key words such as “bank”, “economy” and “market” dominated the list, whereas “China” seems to be gaining more prominence.

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Stock markets have been in a “holding pattern”, or trading range, since the beginning of December. Key resistance and support levels for the major US indices are shown in the table below. The immediate upside target is the 50-day moving average (the Nasdaq and Russell 2000 are already above this line), followed by the early January highs. On the downside, the December 1 and all-important November 20 lows must hold in order to prevent considerable technical damage.

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Here is Richard Russell’s (Dow Theory Letters) interpretation of the situation: “Frankly, I’m very impressed by the stubborn and continuing resistance of the DJ Industrial Average. I don’t think many analysts realize the extreme importance of the Industrial’s steady refusal to violate its November 20 low. The action of the Dow contains the answer to the trillion-dollar question – ‘Is the bear market in a halting process – or will the stock market signal a continuation of the primary bear market?’

“So here we are – at a crossroads to history. The market will issue its verdict when, and only when, it is ready. But for now – if there’s anything traders love, it’s a market rising in the face of lousy news.

“An optimistic outcome would be a continued refusal by the Industrials to close below 7,552. An obviously more bullish outcome would be the DJ Industrial Average and the DJ Transportation Average continuing to rally and ultimately (both Averages) bettering their early-January peaks.

“Clearly, the most bearish outcome would be the Industrials finally breaking below the November 20 low and thereby confirming that we are still locked in a continuing primary bear market.”

From across the pond in London, David Fuller (Fullermoney) said: “… there is a scenario which few other people are taking about. As part of our often-mentioned forecast for a ranging, reversion to the mean recovery rally first hypothesized in late October, there is a possibility that stock markets will do surprisingly well in the next few weeks. Strong rallies would eventually leave markets susceptible to partial pullbacks, including some right-hand base formation extension.

“How could strong rallies possibly occur when everyone is talking about depression? The answers can be found in sentiment and liquidity. Today, most people are either incredibly bearish or despondent, but extreme forecasts are seldom accurate, as I have mentioned before. However, there is plenty of liquidity in many portfolios and governments have significantly increased money supply in recent months. A rising stock market would force a reappraisal by bears, leading to a reversal of short positions, while long-only investors put more of their cash back into the stock market.”

My view is that stock markets, in general, are still caught between the actions of central banks furiously fending off a total economic meltdown on the one hand, and a grim economic and corporate picture on the other. While we figure out whether we are in a normal bounce or witnessing the start of something bigger, I am not averse to selective stock picking – picking out the choice morsels, so to speak.

As far as specific countries are concerned, I alluded to the Year of the Ox in my “Performance Round-up” of last week and mentioned that this is regarded as a sign of prosperity that has been very rewarding in the history of China. And what a start to the year it has been with the Shanghai Composite Index gaining 9.6% during the past week.

The chart pattern (see graph below) shows arguably one of the best base formations of the major stock market indices, followed by Friday’s breakout. Although the Index is still down by 64.2% since its high of October 16, 2007, it has moved to the top slot among global stock market performances for the year to date with returns of +19.8% (local currency) and +19.4% (US dollar terms).

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For more discussion about the direction of stock markets, also see my post “Video-o-rama: Stimulus ad nauseum“.

Economy
“Global businesses remain very pessimistic. Sentiment is dark across the globe. Those that work in government are most worried, followed by businesses in financial and business services,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “Pricing power has sharply eroded, suggesting that deflation is increasingly likely. The only silver lining is that business confidence has not declined further since hitting bottom in mid-December.”

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The latest US economic reports were less grim in some instances than in previous reports, with a few indicators showing that the pace of decline could be slowing down. This view is shared by Nouriel Roubini (RGE Monitor) who wrote in Forbes: “In the US … the second derivative of growth and of other economic indicators is approaching positive territory (i.e. growth is still negative, but GDP may be falling at a slowing rate).”

A snapshot of the week’s US economic data is provided below. (Click on the dates to see Northern Trust’s assessment of the various reports.)

Friday, February 6
Employment Report: Severity of weakness will stimulate votes for fiscal stimulus under consideration

Thursday, February 5
Initial Claims: Labor market situation is dismal
Productivity: Advanced in fourth quarter
Factory Orders: Inventories/shipments ratio keeps advancing

Tuesday, February 4
ISM Non-Manufacturing Survey: Pace of deceleration is slowing

Monday, February 2
Senior Loan Officer Survey: Includes positive aspects
Consumer Spending: Significant reduction
ISM Manufacturing Survey: Positive news, but more is necessary
Construction Spending: Remains week

BCA Research added: “In nominal terms, consumer spending declined at an annualized pace of 11% in the three months to December – the largest contraction since the 1930s. For most consumers and companies it is the trend in nominal dollars that matters, not the statistical artifact of ‘real’ dollars, measured in the national accounts. The need for dramatic stimulus is obvious: declining nominal activity points to a deepening financial crisis.”

Elsewhere in the world, the Bank of England (BoE) slashed its key repo rate by 50 basis points to 1.0% (the lowest level since the BoE was formed in 1694), whereas the Reserve Bank of Australia (RBA) cut its cash rate by 100 basis points to 3.25% (the lowest level in two decades). As expected, the European Central Bank (ECB) maintained its key policy rate at 2%, but will in all likelihood reduce the rate further in coming months as economic indicators show the Eurozone still contracting and inflationary pressures easing.

Further afield, the International Monetary Fund halved its 2009 growth forecast for Asia from 4.9% to 2.7%. “Clearly the hopes that Asia would experience a mild downturn while the global economy retrenched have now been firmly dismissed,” said Glenn Maguire, Asia chief economist at Société Générale, in the Financial Times.

Japan, according to Roubini, is entering another severe slump, one that looks worse than that of other advanced economies, and the fall is still accelerating, resembling a severe case of stag-deflation.

More dire news came from the Russian economics ministry, forecasting the economy’s slide into recession in 2009. GDP growth is forecast to be -0.2% this year compared with 5.6% in 2008. Meanwhile, the ruble has slumped by 35% against the US dollar since August to its weakest level in 11 years. Concerns about the downgrading of the country’s credit rating and a $200 billion reduction of its currency stockpile weighed on sentiment.

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On a more positive note, strong Chinese bank lending and manufacturing data provided signs that the government’s attempts to spend its way out of the economic slowdown are starting to show results. China may also consider tapping into its $1.95 trillion foreign reserves to help boost demand. With domestic government debt only 16.2% of GDP, the country is in a better position to do so than most major economies, according to US Global Investors.

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Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Date

Time (ET)

Statistic

For

Actual

Briefing Forecast

Market Expects

Prior

Feb 2

8:30 AM

Personal Income

Dec

-0.2%

-0.4%

-0.4%

-0.4%

Feb 2

8:30 AM

Personal Spending

Dec

-1.0%

-0.8%

-0.9%

-0.8%

Feb 2

10:00 AM

Construction Spending

Dec

-1.4%

-1.0%

-1.2%

-1.2%

Feb 2

10:00 AM

ISM Index

Jan

35.6

32.0

32.5

32.9

Feb 3

10:00 AM

Pending Home Sales

Dec

6.3%

-0.5%

0.0%

-3.7%

Feb 3

2:00 PM

Auto Sales

Jan

NA

NA

3.6 m

Feb 3

2:00 PM

Truck Sales

Jan

NA

NA

4.2 m

Feb 4

8:15 AM

ADP Employment Change

Jan

-522K

-525K

-535K

-659K

Feb 4

10:00 AM

ISM Services

Jan

42.9

39.5

39.0

40.1

Feb 4

10:30 AM

Crude Inventories

01/30

7.17 m

NA

NA

6.2 m

Feb 5

8:30 AM

Initial Claims

01/31

626K

585K

580K

591K

Feb 5

8:30 AM

Productivity-Prel

Q4

3.2%

1.0%

1.5%

1.5%

Feb 5

8:30 AM

Unit Labor Costs

Q4

1.8%

3.0%

2.8%

2.6%

Feb 5

10:00 AM

Factory Orders

Dec

-3.9%

-3.5%

-3.1%

-6.5%

Feb 6

8:30 AM

Average Workweek

Jan

33.3

33.3

33.3

33.3

Feb 6

8:30 AM

Hourly Earnings

Jan

0.3%

0.3%

0.2%

0.4%

Feb 6

8:30 AM

Nonfarm Payrolls

Jan

-598

-525K

-540K

-577K

Feb 6

8:30 AM

Unemployment Rate

Jan

7.6%

7.5%

7.5%

7.2%

Feb 6

3:00 PM

Consumer Credit

Dec

-$6.6B

-$3.0

-$3.5B

-$11.0B

Source: Yahoo Finance, February 6, 2009.

In addition to Fed Chairman Bernanke’s testimony on the Central Bank’s lending programs in Washington (Tuesday, February 10), the US economic highlights for the week include the following: Wholesale Inventories on Tuesday, the Trade Balance and Treasury Budget on Wednesday, Initial Jobless Claims, Retail Sales and Business Inventories on Thursday, and Michigan Sentiment on Friday.

Click here for a summary of Wachovia’s weekly economic and financial commentary.

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global markets performed during the past week.

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Source: Wall Street Journal Online, February 6, 2009.

In a world faced with untold uncertainty, my concluding thought today is borrowed from Briefing.com, saying that the situation reminds them of a scene in the Oscar-winning movie Terms of Endearment where Shirley MacLaine’s character is confronted with news from a doctor that her daughter has a malignant tumor. Upon hearing this, she asks what she should do. The doctor responds that she tells family members “to hope for the best, but prepare for the worst”. To this McClain’s character responds, “And they let you get away with that?” Don’t we all feel like the doctor these days?

My bags are packed and I am ready to make my way to the airport for a ten-day visit to Europe (Dublin, London, Geneva and Ljubljana). For those not familiar with Ljubljana, it is the charming capital of Slovenia – a country situated in the heart of Central Europe (see my post “Slovenia – the best-kept secret of Central Europe“). And this country will in future be playing a very special role in my life as I have just been appointed as its Honorary Consul for South Africa. And so begins my career as a part-time diplomat …

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That’s the way it looks from Cape Town.

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