Greenspan treads carefully

Most of the major markets were off in the middle of last week but ended the week up, moving indices forward once again. This past Monday turned into a very strong trading day for equities, even though there was a lot of profit-taking late in the day, ending with the S&P, NASDAQ and Russell 2000 indices all hitting 52 week highs. Activity and interest were high with advances out pacing declines by 3 to 1 on the NASDAQ as the index marched forward 20.91 points to gain 1.21% on the day, closing at 1754.84. Banks, techs and cyclicals were the leaders. More important in terms of analysing the market was to review the volume on advancing shares against volume of declining shares. The US Dow index traded 1.4 billion shares on Monday, a good day but not really outside the 10 day moving average trading range of late. But the volume on the advancing shares outpaced decliners by two to one. Clearly the bulls are running away with the market and as long as earnings come in to support investor confidence, we may well be moving forward with economic recovery. Please be reminded that an efficient market will anticipate economic conditions two to six months in advance. We also note that the US treasuries pulled back, taking note of the bullish equity markets.

Centre stage this week is Allan Greenspan, who will provide two days of testimony on the US economy to the House of Congress on Tuesday and Wednesday. In his semi annual report to the US Congress, analysts are expecting Greenspan to revise some critical numbers including GDP, which in February was forecast at 3.25% to 3.5%, but are now expected to be 2.5% to 3.0%. Unemployment is also a key figure which was set at 5.7% to 6.0% but which is expected to be 6.4%. Important to watch would be when Greenspan forecasts employment start to fall. This would be a signal that interest rates will start to rise, accompanying economic growth that he is forecasting. We are also interested to hear what Greenspan has to say about the output gap, the difference in production vs consumption which has become quite pronounced over the past several years of slow economic activity. It may take some time to work this out of the system, resulting in many quarters or even years of sideways movement in interest rates. Whatever he says, Greenspan will try not to spook the bond market, and focus towards keeping a lid on higher bond yields. As we are entering the height of the earnings season for typically the slowest quarter of the year, you can bet a lot of interest will be placed on what Greenspan has to say.

In economic news for the week, US trade deficit expanded in May to 41.8 Billion, up from 41.65 Billion in April. Both imports and exports increased, but with weak numbers, indicate a measure of uncertainty in global demand. We had discussed in earlier articles that the deficit should be reduced in part by a weaker dollar but recent trading has seen the USD gain on other major currencies working against the poor deficit situation. Pressure was high in the Euro Zone last week with public comments from Germany’s Gerhard Schroeder suggesting the European Central Bank should do more to help stimulate the European economies. ECB Chief Economist Issing responded stating the Bank had done enough in lowering rates to 2.0% and that it was up to individual Eurozone governments to introduce economic reforms and prudent fiscal strategies. This view was more or less supported by a survey of analysts and economists which showed they believed the German economy was improving. Meanwhile, the Bank of England surprised markets by lowering rates 25 basis points. The overnight bank rate is now at 3.5%, the lowest rate it has been at since 1955. Although the rate change should have bolstered equities, the accompanying announcement from new BoE Governor, Mervyn King, was somewhat down beat about the economy over the near term. The UK’s trade deficit also widened in May along with the US, rising to 4.1 billion GBP from 3.4 billion GBP in April. Imports from countries outside of Europe increased and value of exports to other European countries fell to its lowest level in four years. In closing, there has been a measure of good news economically and in corporate earnings. Confidence from Greenspan and solid corporate earnings reports this quarter should stabilise investors confidence in the economic growth we are all looking for. e-mail:     darcy@investments-intl.com