Global Stock Markets: Torrid October Ends with a Bang

October lived up to its reputation as being a torrid month. The following extraordinary performances tell the story:

• MSCI Word Index: -19.1% (largest monthly decline since the Index started in 1969, beating October 1987’s -17.1%)
• MSCI Emerging Markets Index: -27.1% (worst monthly loss since Russia’s debt default in August 1998)
• Dow Jones Industrial Index: -14.1% (15th worst monthly decline since 1900 and the biggest drop since October 1987)
• S&P 500 Index: -16.9% (8th worst one-month decline since 1930)
• U.S. Dollar Index: +7.8% (4th best one-month improvement since 1967)
• Reuters/Jeffries CRB Index: -22.3% (worst monthly decline since the Index started in 1956)
• Crude-oil futures: -32.6% (worst one-month drop since oil futures started trading on the New York Mercantile Exchange in 1983)
• Reuters/Jeffries CRB Industrials Index: -26.5% (sharpest monthly decline since the series started in 1971)
• Gold futures: -18.5% (biggest monthly loss since 1983)

However, the last week of the month witnessed a strong rebound in global stock markets as investors brushed aside discouraging economic reports and took heart from central banks cutting key lending rates and positive developments in the credit markets. This resulted in investors scooping up beaten-down stocks around the globe, and particularly emerging-market stocks, government bonds and currencies, mending some of the damage done earlier in October.

Further evidence of just how tough October has been was provided by Thursday and Friday’s stock market improvement producing the first back-to-back days of gains for the S&P 500 Index and the Dow Jones Industrial Index since September 25 and 26.

In the spirit of Halloween, one can rightfully ask, trick or treat? (By the way, according to FT Alphaville, suitcases of money do not accompany the masks below.)

The FOMC lowered the Fed funds target rate from 1.5% to 1.0% on Wednesday. This action followed an emergency 50 basis point cut in the benchmark rate on October 8. The committee’s statement said economic activity has “slowed markedly” and cited weakness in consumer spending, business investment and exports. It also noted tight credit. The statement also said that “downside risks to growth remain,” which is an indication that more rate cuts could follow. The target rate was last at 1.0% in 2004 and has not been below this level since 1958.

The Fed followed up its rate-cutting action with an announcement that it was setting up dollar swap lines with Brazil, Mexico, South Korea and Singapore, contributing to the sharp turnaround in emerging-market assets.

Below is a tag cloud of the text of the large number of articles I have devoured during the past week. This is a way of visualizing word frequencies at a glance. Unsurprisingly, the key words included the following: “market,” “bank,” financial,” “fund” and “credit.”

Where do we go from here? One bit of cheer is that the stock market is now entering what has historically been the strongest half of the year. Chart of the Day reported:

… investing in the S&P 500 Index from the last trading day in October (therefore referred to as the Halloween indicator) through the end of April accounted for the vast majority of S&P 500’s gains since 1950. While there are some noteworthy periods in which the Halloween indicator didn’t produce (i.e. 1973-74 and 2000-01), the overall outperformance is compelling.

To which Jeffrey Hirsch (Stock Trader’s Almanac) added:

… November is much better in election years when the incumbent party is ousted – usually because of dissatisfaction with the status quo. Traders and investors often celebrate a change of the guard when the economy and stock market are on the ropes as they are now.

Here is Richard Russell’s (Dow Theory Letters) take on matters:

Things are looking better. After a series of 90% down-days, we had a 90% up-day on Tuesday, October 28. Since then, the market action has been fairly good. With bonds appearing to have topped out, I’m beginning to think that there’s a fairly good chance the market has bottomed. On Thursday’s statistics, Lowry’s Selling Pressure Index (supply) finally dropped substantially, giving evidence of an important drop in supply. At the same time their Buying Power Index surged, finally showing an increased willingness to buy. So far, so good.

I summarized my viewpoint in a post on Friday:

I give the current rally the benefit of the doubt provided the recent lows (8,176 on the Dow Jones Industrial Index and 849 on the S&P 500 Index) are not taken out. However, it remains difficult to say whether a secular low has been reached in an environment of economic and profit recession. At least, the extent to which central banks, governments and the IMF are becoming involved to fend off a total economic meltdown is a sign that we could be in a bottoming-out phase of the bear market.

The last word goes to Laszlo Birinyi (Birinyi Associates) who cautioned as follows:

We believe the markets are in uncharted territory with developments and characteristics that are unique in our experience and we can only guess at what might transpire over the next several months. Frankly, we don’t know, history provides no clues and anyone who claims to have some insight or strategy cannot do so on the basis of fact and historical evidence.

Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements based on economic statistics and a performance round up.

Economic reports

According to the Survey of Business Confidence of the World conducted by Moody’s Economy.com:

Sentiment is extraordinarily negative in North America and Europe and measurably weaker in Asia and South America. The financial panic that began in early September has been a body blow to global business confidence and thus the global economy, which, according to the survey, is now in recession.

Economic reports released in the U.S. during the past week were mostly negative. The most important of these was the announcement that real GDP fell by 0.3% in the third quarter. Weakness was driven by consumer spending, down 3.1% (i.e. subtracting 2.2 percentage points from the GDP calculation), as higher gas prices, housing weakness and job losses created huge headwinds for the consumer. Business equipment spending declined while exports and government spending added strength.

Summarizing the U.S. economic situation, Asha Bangalore (Northern Trust) said:

The National Bureau of Economic Research [NBER] will eventually announce the onset of a recession. Based on the NBER’s methodology, the recession appears to have commenced in the fourth quarter of 2007/first quarter of 2008.

The question now is about the depth and duration of the recession. In the post-war period, the median duration of a recession has been 10 months and median drop in real GDP from the peak to trough is a 1.9% annualized decline.

How will the current recession compare with prior history? In our estimation, the depth and duration will err on the side of being slightly higher than the historical median given the nature of the credit crisis that is under way. Congress is supposedly working on a second stimulus package that could moderate the weakness in economic activity.

Elsewhere in the world, the Bank of Japan cut interest rates on Friday for the first time in seven years, reducing the target overnight call rate by 20 basis points to 0.30%. Earlier last week, South Korea, Hong Kong, China, Taiwan and Norway also cut benchmark rates (in the case of China, the third cut in six weeks). It is expected that the European Central Bank, the Bank of England and the Reserve Bank of Australia will ease monetary policy during the coming week.

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
Oct 27	10:00 AM	New Home Sales	Sep	-	445K	450K	460K
Oct 28	10:00 AM	Consumer Confidence	Oct	38.0	52.0	52.0	59.8
Oct 29	8:30 AM	Durable Orders	Sep	-	-1.0%	-1.0%	-4.5%
Oct 29	10:35 AM	Crude Inventories	10/25	-	NA	NA	NA
Oct 29	2:15 PM	FOMC Policy Statement	-	-	-	-	-
Oct 30	8:30 AM	Chain Deflator-Adv.	Q3	4.2%	4.2%	4.0%	1.1%
Oct 30	8:30 AM	GDP-Adv.	Q3	-0.3%	+0.3%	-0.5%	2.8%
Oct 30	8:30 AM	Initial Claims	10/25	479K	470K	473K	479K
Oct 31	8:30 AM	Employment Cost Index	Q3	0.7%	0.7%	0.7%	0.7%
Oct 31	8:30 AM	Personal Income	Sep	0.2%	0.1%	0.1%	0.5%
Oct 31	8:30 AM	Personal Spending	Sep	-0.3%	-0.3%	-0.2%	0.0%
Oct 31	9:45 AM	Chicago PMI	Oct	37.8	50.0	48.0	56.7
Oct 31	10:00 AM	Mich Sentiment-Rev.	Oct	57.6	52.0	57.5	57.5

Source: Yahoo Finance, October 31, 2008.

In addition to interest rate announcements by the Bank of England and the European Central Bank on Thursday, November 6, next week’s U.S. economic highlights, courtesy of Northern Trust, include the following:

1. ISM Manufacturing Survey (November 3): The consensus for the manufacturing ISM composite index is 41.5 versus 43.5 in September.
2. Employment Situation (November 7): Payroll employment in October is predicted to have dropped by 200,000 following a decline of 159,000 in the prior month. The jobless rate is predicted to have risen to 6.2% from 6.1% in September. Consensus: Payrolls: -200,000 versus -159,000 in September, unemployment rate: 6.3% versus 6.1% in September.
3. Other reports: Construction spending, auto sales (November 3), factory orders (November 4), and ISM non-manufacturing (November 5).

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

A summary of the release dates of economic reports in the U.K., Eurozone, Japan and China is provided here. It is important to keep an eye on growth trends in these economies for clues, among others things, about the direction of the U.S. dollar.

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, October 31, 2008.

Equities

Stock markets throughout the world closed the week with excellent gains, spurred on by a combination of interest rate cuts, an improvement in short-term lending rates, short covering and bottom-picking buying. Even though the MSCI World Index improved by 9.8%, for the year to date, the Index was still down 39.8%. Leading the pack among developed markets were Germany (+16.1%), the U.K. (+12.7%) and Japan (+12.1%).

A dramatic reversal of fortune hit emerging markets on the back of the Fed’s dollar swap lines for a number of key developing economies, resulting in the MSCI Emerging Markets Index surging by 20.4% (YTD -54.2%). The week’s largest increases were recorded by Russia (+40.8%), Mexico (+19.3%), Brazil (+17.4%), South Korea (+18.6%) and Turkey (+15.1%).

The performance of the Dow Jones World Index (green line) and the MSCI Emerging Markets Index (red line) during October is shown by the graph below.

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The table below by Finviz summarizes the past week’s performances (in US dollar terms, whereas all the gains/losses referred to elsewhere in this post are in local currency terms) for various stock markets.

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The U.S. stock markets all improved strongly over the week as shown by the major index movements: Dow Jones Industrial Index +11.3% (YTD -29.7%), S&P 500 Index +10.5% (YTD -34.0%), Nasdaq Composite Index +10.9% (YTD -35.1%) and Russell 2000 Index +14.1% (YTD 29.8%).

The Dow needs to rise to 9,810 – 5.2% higher than its current level of 9,325 – in order to be “officially” classified as being in a bull market again. The Index will be required to increase by 10.2% to reach its 50-day moving average and 25.4% to get to the key 200-day line.

The chart below for is a (delightfully green) market map, obtained from Finviz.com, providing a quick overview of the performance of the various segments of the S&P 500 Index over the week.

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The bar chart below, also from Finviz, shows the U.S. sector performance for last week, and specifically, how defensive sectors such as utilities and healthcare underperformed on a relative basis.

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Putting the stock market outlook in perspective, Eoin Treacy (Fullermoney) said:

… the current environment is extraordinary in terms of how overextended markets have become relative to their long-term averages. Statistically, a reversion to the mean (i.e. 200-day moving average) remains the most likely scenario in the short to medium term. Where markets consolidate subsequent to that move will be an important marker for the shape of any potential recovery.

Fixed-interest instruments

Yields on short-dated government bonds were mostly lower during the past week, whereas yields on long-term paper moved up. Long bonds appear to be topping out, either because investors are switching from bonds to stocks, or because the bond market is starting to discount better economic times in the months ahead.

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U.S. mortgage rates increased, with the 30-year fixed rate jumping by 44 basis points to 6.56% (in line with the 30-year U.S. Treasury Note rising by 29 basis points) and the 5-year ARM increased by 9 basis points to 5.99%.

The cost of buying credit insurance for U.S. and European companies eased as shown by the narrower spreads for both the CDX (North American, investment grade) Index (down from 227 to 200) and the Markit iTraxx Europe Crossover Index (down from 920 to 765).

Money-market rates declined because of rate cuts by a number of central banks and the ongoing provision of liquidity. The three-month dollar Libor rate declined by 49 basis points to 3.03% during the week, but remained 203 basis points above the Fed’s target rate of 1.0%. The spread was 43 basis points at the start of the year.

Currencies

A statement by the G7 warning about the dangers of the excessive gains in the Japanese yen caused investors to fear currency intervention. This concern, together with a rate cut of 20 basis points to 0.30% by the Bank of Japan, helped to cool the yen against all major currencies.

Also on center stage was a strong turnaround in a number of emerging-market currencies as investors were comforted by (1), the Fed establishing dollar swap lines with Brazil, South Korea, Singapore and Mexico, and (2), aid programs from the IMF and other organizations reducing the risk of defaults.

Over the week the U.S. dollar gained against the Japanese yen (+4.2%), but lost ground against the euro (-0.9%), the British pound (-0.9%), the Swiss franc (-0.9%), the Canadian dollar (-5.5%), the Australian dollar (-7.4%), the New Zealand dollar (-4.8%) and a host of emerging-market currencies.

Has the greenback made its high for the current cycle? Paul Kedrosky (Infectious Greed) argued in a recent guest post on my blog site that the U.S. dollar’s surge wouldn’t last.

Kedrosky asked:

Down is up, and up is down? How is it that a growing US economy was bad for the US dollar, but a potentially calamitous collapse in the same US economy has the US dollar up double-digit percentages?

BCA Research outlined its currency strategy as follows:

First, the euro and pound will be ‘trading buys’ against the dollar and yen, but no more than that. The European economies and financial systems will be soggy for some time, and their central banks are still behind the curve. Second, the trade-weighted dollar is close to a three-year high, which will not make economic sense even after the US economy and banking system turn the corner. Most likely, the dollar will lose ground against emerging and commodity currencies with good fundamentals, but will hold its own against the euro. Finally, the yen is a tougher call and we recommend standing aside.

Commodities

Fears that the deteriorating global economic situation was causing demand destruction resulted in strong selling pressure for all commodities during October, resulting in the Reuters/Jeffries CRB Index plunging by 22.3% for the month – its sharpest monthly decline since the Index started in 1956.

However, commodities reversed course during the past week as dollar weakness resulted in an improvement for most commodities (with the exception of gold), as shown by the following chart:

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Let’s hope that after the volatile trading that characterized most of October, conditions will calm down – as always happens after a storm. And if this is part of the change to be brought about by a new U.S. president after Tuesday’s election, nobody will be complaining.

The American consumer – R.I.P.

The great American consumer – much like the Norwegian Blue parrot of Monty Python fame – is dead. A stiff. Bereft of life. He rests in peace.

Source: New York Post, October 26, 2008.

That’s the way it looks from Cape Town.