Weekly
Market Commentary of July 28th 2008
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A pullback in the outlook for inflation would likely
propel a powerful stock market rally in the U.S. With
the primary driver of overall inflation stemming from
global food and energy commodity price pressures, the
key to falling inflation may be a slower pace of emerging
market growth. This slowdown appears to be unfolding.
China has been an engine of growth for a long time.
However, the Chinese economy faces many challenges in
the quarters ahead that may lead to a slowdown in growth:
- Instead, high yield bond credit spreads are narrower
than they were back in mid-March when Bear Stearns
failed.
- In addition, the credit market is pricing in a lower
risk of failure by major U.S. banks than back in mid-March,
based on the pricing of credit default swaps.
- In short-term money markets, firms are becoming
less reluctant to part with their cash. The spread
between three-month London interbank offered rate
(LIBOR), and the expected federal-funds rate over
the next three months remains elevated, but is narrower
than back in mid-March. This spread shows the difference
between what firms charge each other for short-term
cash and what they expect to pay in the relatively
risk-free overnight fed funds market. The current
spread, 73bps, is down from the March high of 104bps.
Indeed, China’s
GDP growth has started to slow, posting second quarter
GDP of 10.2%, down 2.4% from 12.6% a year ago, and the
index of leading indicators, from the Chinese National
Bureau of Statistics and Goldman Sachs, reflects a slowing
trend. Other so-called, BRIC (Brazil, Russia, India,
and China) countries are also seeing signs of slowdown—Brazil
and India have seen sharp downturns in their leading
indicators of economic growth. One of the countries
that has been hit the hardest is Vietnam; the country’s
Ho Chi Minh stock index fell last week by the largest
amount in four months and has declined by -63% from
the peak with inflation rising at a 27% pace over the
past year, pressuring five year government bonds to
yield 20%.
In recent months, many emerging market nations are
hiking interest rates and passing on higher energy prices:
- Rate hikes have been implemented in Brazil, Chile,
Indonesia, Philippines, South Africa, and Vietnam.
- China has raised gasoline prices 17% and diesel
by 18%.
- India raised fuel prices by 13%.
- South Korea announced an increase of 50% to natural
gas prices.
- Malaysia announced a 40% increase in gas prices.
- Thailand raised gasoline prices by 41%.
- Taiwan raised gasoline and electricity prices by
13%.
- Indonesia raised fuel prices by 29%.
- Nepal raised fuel prices by 25%.
- Bhutan announced roughly 10% hike in gasoline prices.
- Sri Lanka raised prices on gasoline, diesel and
kerosene by 14–47%.
The last time Southeast Asian economies were under
this much stress was in August of 1997, when fleeing
capital triggered a cascade of financial collapse among
emerging nations. Within days of Thailand’s collapse,
many of its neighbors were brought down, and within
month
s financial crashes were seen in Japan and South Korea
and reached as far as Russia and Brazil. In the aftermath
of 1997–1998 emerging market led slowdown, oil prices
fell by 60% to about $10 per barrel and other non-energy
commodities experienced similarly large declines. While
we are not predicting the Asian Contagion part II, as
the global growth engines shift into a lower gear commodity
prices may continue to slide.
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In the U.S., inflation pressure is largely contained
within commodities. If global commodities prices continue
to come down and ease inflation pressures in the U.S.,
the stock market could post a powerful rally. On the
other hand, many emerging market countries are experiencing
a huge surge in inflation, which has become embedded
in wage growth and may make inflation pressures slower
to dissipate as commodity prices fall. The potential
combination of slowing growth and stubborn inflation
in the emerging markets leaves us negative on the prospects
for emerging market stock performance and in favor of
developed markets, especially the U.S.
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IMPORTANT DISCLOSURES Investing in international and emerging markets may entail additional risks such as currency fl uctuation and political instability. Investing in small-cap stocks includes specifi c risks such as greater volatility and potentially less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise and are subject to availability and change in price.
The opinions voiced in this material are for general information only and are not intended to provide specifi c advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your fi nancial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
© LPL Financial
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