Equity markets, how low can you go?

The world’s major markets were off again last week and continued the trend into this week, leaving international investors to wonder how low can they go.

The US markets lost around 2% for the week and the European markets more in the 5% range. Japanese equities fell to a 20-year low when the Nikkei 225 fell more than 4.0% to close at 8,042.26. To give the decline some perspective, we have included a year to date graph of the Dow Jones Industrial Average, which is now off some 15% from its peak in mid January. Four of the DOW 30, Boeing, Coke, DuPont, and McDonalds have now broken their 52 week lows. Walt Disney didn’t hit a 52-week low, but fell when Merrill Lynch lowered its estimate for the company’s second quarter performance and the full fiscal year but left its rating at “neutral”.

Interestingly, US Treasury Secretary John Snow insisted last week that the US favors a strong dollar. However, the USD fell to 1.1041 on the Euro (its lowest exchange rate since the Euro started trading four years ago) as the European Central Bank cut rates a quarter point to 2.5% for the overnight number. The ECB decision follows a reduction in the forecast for 2003 GDP to 1.0% from 1.6%. EU trend growth is closer to 2.0% to 2.5%. The rate decision was also endorsed with news that German unemployment had increased to a five-year high of 4.7 million.

Even though the Bank of England kept rates the same at 3.75%, the USD lost more than 1% against the Pound and other major currencies as well. We have addressed in past articles theories on why the US would allow a weaker Dollar for benefits in the longer term to its economy and we still hold to the Euro moving to a 1.20 exchange rate by the end of 2004. Last Friday saw the release of some disappointing US employment data. Non-farm payrolls fell sharply by 308,000 and unemployment rose from 5.7% to 5.8%, just below the 6-year high of 6% recorded last December. Data for January was revised to 185,000 from 143,000. Also in the US, manufacturing expansion slowed in February with the Institute of Supply Management index falling to 50.5 from 53.9 in January.

December’s index reading was 55.2. Analysts suggested stronger economic growth would be unlikely to materialise until demand picked up, probably after the Iraqi situation was resolved. The Iraqi War remained the dominant influence over the oil market as well, with Brent Crude futures reaching their highest levels since hitting the last peak in September 2000. Consumer spending continues to be the major player on economic recovery. Should layoffs continue and individuals move to pay down debt and reduce discretionary spending, then economic recovery will be difficult to achieve.

For the pessimists, concerns over the recent weak economic numbers and fear of a double dip recession have them believing that the markets are too rich and will fall further. Even Bill Gates sold yet another million shares of Microsoft, showing that even the very rich are getting short on cash. For the optimists, there remains close to three trillion in cash instruments in the US alone, hunting for returns and supporting equity prices. Once the Iraqi situation is settled one way or another, perhaps confidence will return, both to consumer spending and the global equity markets.
Email: darcy@investments-intl.com