Further Evidence of a U.S. Slowdown?

 |  Includes: DIA, EWU, QQQ, SPY
by: Mike Wright

Following the previous week’s heavy buying, global markets again finished the week positively. However, gains were limited to around half a percent for the week, with the Nasdaq and S&P 500 rising the most. With many cross winds in the form of bank write downs, and some positive earnings surprises from the U.S., it was hard for markets to make significant progress in either direction.

Volatility continued in the UK financial sector with RBS releasing the full details of its required cash injection. Gordon Brown called for banks to be honest in declaring their subprime losses, but the truth may be harder to stomach than the rumors. At least now we might get closer to finding out the real reasons why British banks were refusing to lend to each other. The fact that Barclays was down nearly as much as RBS last week tells its own story. Investors are voting with their feet and the prospect of further bad news from British banks is hard to rule out.

UK Bankers and home buyers alike will also have read the latest U.S. new home sales figures and gulped. Purchases of new homes dropped to their lowest level in 17 years in the states. Stricter loan rules and falling prices have been causing buyers to hold off. The UK housing market may only just be starting to fall, but there is no denying its descent, and combined with the dearth of new loans available, it may not be long before UK market also collapses. Markets will continue spasm until we have more clarity over the success of Monday’s BOE mortgage market intervention, and definitive answers from UK banks regarding their capital adequacy.

Energy ruled the roost again last week and oil kissed the underside of $120 per barrel at one point. Oil and Natural Gas prices were two standard deviations from their moving average at one stage, indicating they were too hot and in dire need of a cooling off, but there was little significant selling to be had. While energy prices continue to power at full speed, American consumers appear to be running on vapors.

Further evidence of a U.S. slowdown could be presented in the numerous top tier economic announcements next week. Today (Wednesday) brings ADP Nonfarm Employment changed and GDP figures. Thursday sees the release of the ISM manufacturing Index and Friday the all important Nonfarm Employment change and unemployment rate.

The week’s most important announcement is the FOMC interest rate and discount rate statement this evening. Expectations are for the U.S. central bank to cut rates to by a quarter point to 2%, however there is increasing speculation that this may be the low point of the cycle. Inflation remains a problem and according to research highlighted by Barry Rithholtz, if inflation were to be measured in the same way that it was in the 1980s, U.S. inflation would currently be running at 11.6%.

We believe that it is possible that markets were holding back last week in anticipation of this week’s U.S. interest rate decision. After making little significant progress last week, this week could be an entirely different proposition. An expiry miss pays out if the market is outside of the predicted trading range at the time of expiry. An expiry miss with the levels set to 1375 and 1407 could return 10% over the next 10 days on the S&P 500. As long as the market doesn’t finish between these levels, the trade will win.