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World week ahead: Caution rules the day

Monday 2nd August 2010

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As the pace of growth in the world’s biggest economy moderates, investors are reining in some of their optimism and showing signs of somewhat heightened aversion to risk.

So even with solid profits and some bullish outlooks, equities are finding it hard at the moment to maintain momentum for more than a few weeks at a time. 

On Friday all three major US markets ended little changed during a week in which equities drifted lower. The same was true in Europe where the Stoxx Europe 600 Index slipped 0.2% last week. 

The ‘pause’ in markets though wasn’t unexpected after most major markets posted very solid numbers for the month of July. The Dow Jones industrial average gained 7.1%, the Standard & Poor’s 500 was up 6.9% and the Nasdaq Composite also added 6.9%. 

What’s put equities into a holding pattern this past week is mixed economic data and there’s not likely to be much clarity on that front this week. 

Not unexpectedly, the pace of growth in the US economy eased in the second quarter. On Friday, the government reported growth of 2.4% in the latest quarter, down from a 3.7% annual rate recorded in the three months ending March. 

“The typical pattern is to snap back hard and you just haven’t done that,” Jay Feldman, an economist at Credit Suisse in New York, told Bloomberg News.

“We’re not calling for a double-dip, it’s a moderate recovery. Things will appear to be slowing.” 

Credit Suisse forecasts growth will average 2.75% in the second half of the year, compared with 3.1% for the first six months. 

Over the past 12 months, the US economy grew 3.2%. The first years of recoveries from recessions in the mid 1970s and early 1980s averaged 7%, Feldman said.

For investors, the numbers are a flashing yellow light. The S&P 500, for example, is stuck near its 200-day moving average and it will most likely need a big positive surprise from America’s jobs report on Friday to rally. 

Analysts say a significant break above the S&P 500's 200-day moving average, currently around 1,114, would be a bullish signal. 

"The market has the potential to push higher again if we can get through the 200-day moving average," said Michael Sheldon, chief market strategist, RDM Financial, Westport, Connecticut.

"In order to take out the upside of the trading range, we need to see the majority of economic data next week to be better than expected," Stifel Nicolaus options market strategist Elliot Spar in Shrewsbury, New Jersey, told Reuters. 

In addition to the jobs report, the Institute for Supply Management's manufacturing report, due Monday, is expected to show growth for a 12th straight month. 

On Friday, the Institute for Supply Management-Chicago said its business barometer rose to 62.3 this month, exceeding the median forecast of economists surveyed by Bloomberg. Figures greater than 50 signal expansion and the group’s employment and new orders gauges rose as well. 

The worst US recession since the 1930s was even deeper than previously estimated, reflecting bigger slumps in consumer spending and housing, according to the Commerce Department’s annual revisions also issued on Friday. 

The economy shrank 4.1% from the fourth quarter of 2007 to the second quarter of 2009, compared with the 3.7% drop previously on the books, the report showed. Household spending fell 1.2% in 2009, the biggest decline since 1942. 

Among companies expected to report this week are Procter & Gamble and Clorox whose results could give another glimpse into the strength of consumer spending or its lack. 

Earnings growth for S&P 500 companies in the second quarter is expected at 36%, while revenue growth is seen at about 9.1%, according to Thomson Reuters data. 

Options investors appear to be expecting more volatility in the technology sector, which has heavily weighed on the market this week, to continue. 

Some options market analysts see more range-bound trading ahead, with top end at 1,120 on the S&P 500 and the bottom end at 1,065. 

In interviews and investor letters reviewed by Bloomberg, managers who dodged the financial crisis said they expected the US and European economies to slow and were positioning their holdings accordingly. 

David Gerstenhaber of the Argonaut Macro Partnership fund and Xerion fund’s Daniel Arbess see potential in emerging markets. 

Laurence Benedict of Banyan Equity Management LLC has pared investments because markets were proving too tough to anticipate. 

“Our expectation is that we will continue to see downward revisions to growth forecasts in advanced economies,” Gerstenhaber said in a telephone interview.

The US$1 billion Argonaut Macro returned a cumulative 48% from the start of 2007 through June 2010. 

Gerstenhaber, who founded New York-based Argonaut Capital Management in 1993, said he’s keeping his long position in China’s yuan, an investment he’s had for more than a year that will profit if the currency rises. 

But the US government's non-farm payrolls report represents the key focus, and the outlook is bleak. 

The jobless rate is forecast to rise to 9.6% from 9.5% in June, according to a Bloomberg survey, reflecting the end of the benefit of part-time Census work. 

“Consumers seem to be focused on saving and spending only on necessities, and that’s likely to continue through the rest of the year,” Ryan Sweet, a senior economist at Moody’s in West Chester, Pennsylvania, told Bloomberg. 

Another reason for investors to remain cautious was a warning from former Federal Reserve chairman Alan Greenspan who told a US TV interviewer that the American economy feels like it’s experiencing a “quasi recession”. 

Greenspan said he could see “nothing out there” which would alter the trend level of unemployment. As for the risk of a double-dip recession, Greenspan said it could happen if house prices fell again, but he said prices appeared to be stabilising.

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