• US GDP dropped 5.7% in the first quarter of 2009
• US durable goods orders rose 1.9% in April
• US initial jobless claims fell by 13,000 to 623,000
• US existing-home sales increased 2.9% in April-09
• German GDP down by 3.8% in Q1
• Russia’s Digital Sky Technologies invests $200m in Facebook giving the site a $10 bn (hypothetical) value
• US Consumer Confidence for May increased to 54.9 (40.8 in April), highest level since last September
• US Home Price index dropped a record 19.1% during Q1 compared with Q1 2008
• In March, China added $23.7bn to its US Treasury holdings to reach a new record of $768bn
Where are the markets heading?
This week's commentary will focus on charts and graphs a little more than usual. We have looked at a number of comparison charts with the aim of giving you a different perspective in terms of possible impacts in the economy and market developments. As always, the past is no perfect indication of where the future might be, but certain patterns repeat throughout history. In addition to the recognized patterns (e.g. the strong tendency for prices to revert to the mean) I find charts extremely illuminating. For instance, the chart below depicting the price/rent ratios of various countries is fascinating. In hindsight, how could one not have concluded that the housing bubble was unsustainable? The speed of increase of these ratios particularly in Ireland, Spain and the UK appear mind-boggling. By contrast the US housing market was relatively tame. We can also assume that at some point in 2009 or more likely in 2010, the ratios will revert closer to the anemic levels seen in Germany's housing market. At that inflection point, granted history repeats itself, it may then be a sign of a market bottom once again.
The yield curve is often scrutinized to help predict future interest rate changes and to forecast economic activity. A normal yield curve is defined as a gradually rising curved line wherein longer maturity bonds (e.g. 30 year Treasury Bonds) have a higher yield than shorter-term bonds (e.g. T-Bills). An inverted yield curve hence is downward sloping with short term bonds showing higher yields than long term bonds. Historically, inversions of the yield curve have preceded many of the U.S. recessions and the yield curve is often seen as an accurate forecast of the turning points in the business cycle.
The graph below shows the yield curve from November 2006, clearly inverted and in hindsight a stark reminder of the immense failure of much of the financial services, investment and banking industry not heeding these important signs.
Inverted Yield Curve
During the following 2 years, we experienced various combinations of flat and near normal yield curves but particularly since the beginning of May, the yield curve is nearly perfect. Reverting back to the almost ideal curve happened just one month after the stock market bottom in early March. Could this be another indicator of green shots rising up?
Normal Yield Curve
US equity markets and the US$ don't have an exact historic correlation but in simplified terms, what's good for the US economy and US equity markets should be good for the US$ as well; and vice versa, bad economic figures should be bad for US stocks as well as the US$ (all other things being equal). In response to the global financial crisis, the US$ saw an unprecedented increase in value against most major global currencies. While world stock markets fell off a cliff, it seemed as if everyone wanted to sell off their investments and stay in cash to weather the financial storm for as long as it went on. The preferred cash as a safe haven turned out to be the US$ despite the fact that the epicenter of the financial crisis was in the US. Hence, an almost perfect negative correlation started to evolve wherein US stock markets fell while the US$ appreciated. This somewhat unusual relationship is clearly seen in the comparative chart of S&P500 Index versus US$ Index.
Since March, stocks have been on the rise again while the US$ fell in value against the major currencies. We were at an inflection point during April and since then, the relative performance of the US market versus US$ has changed. It is hard to determine how long this negative correlation may last; however, if I had to make a choice, I would rather sell the US$ than sell US stocks. As a US investor I would also rather buy US stocks than buying US$. As an international investor, I might only buy US stocks while selling the US$.
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