The Dow Jones Industrial Average hit a new low for the year on Friday at the end of a nervous week for global markets.
Fears of slower economic growth, record high oil prices, disappointing earnings figures and a sharp drop in the dollar pushed the main markets down for a second week running. The widening investigation into the insurance industry by Eliot Spitzer, New York attorney-general, also overshadowed sentiment.
Traders increasingly fear that global growth will be slower than expected next year as the impact of high oil prices takes its toll and debt-burdened US consumers cut spending, leading to slower earnings growth. Global fund managers are more pessimistic about the outlook for growth and corporate profits than they have been for 3½ years, according to Merrill Lynch’s monthly poll.
The picture of slowing global growth is supported by the Goldman Sachs Global Leading Indicator, which fell to 3.9 per cent in October from 4.1 per cent a month earlier. This continues the slide in the headline reading since its peak of 6 per cent in April and confirms that the global industrial cycle is past its peak. Goldman expects global economic growth to slow to 3.9 per cent next year from 4.8 per cent in 2004.
For once oil was rivalled as the big story of the week by the sudden weakening of the dollar. Nervousness about the outcome of the US presidential election and the country’s giant current account deficit were key factors. But there was also a sense that cyclical support for the dollar was falling, with expectations of less aggressive monetary tightening by the Federal Reserve.
After trading in a range of $1.18-$1.25 against the euro for the past six months, the dollar hit $1.2683 late in New York trade on Friday. It fell to a four-month low of Y107.21 against the yen.
Arun Motianey, director of investment research at Citigroup Private Bank in New York, said: “Markets have suddenly begun to focus on the unsustainability of the US current account deficit and how it’s being financed. The fact that it’s being financed entirely by debt inflows is worrying.”
Mr Motianey believes the dollar needs to fall 20-25 per cent over the next two to three years - mainly against Asian currencies. “The Asian countries need to become sources of demand rather than supply,” he says.
Oil prices reached new record highs on Friday. Nymex crude futures hit $55.45 per barrel and Brent crude hit a new intraday peak of $51.55, before closing at $55.17 and $51.22, respectively, driven by worries that the US had insufficient stocks of heating oil to get through the coming winter. Traders still feel that, with the world facing slower economic growth next year, demand for oil will drop and prices fall.
That is how the bond market is reading the situation, helping to drive the yield on the US 10-year Treasury back below 4 per cent. “This highlights the bond market’s concern with the negative impact of oil on consumer demand and the overall economy, rather than with oil’s inflationary impact,“ said Ashraf Laidi, chief currency analyst at MG Financial Group in New York.
The problem for Wall Street was that too few companies were beating expectations with their third-quarter figures, and they were not bullish enough about prospects next year. In spite of some positive surprises from two leading tech groups, Ebay and Google, there was a disappointing outlook from Microsoft.
By Friday’s close the Dow was down 1.8 per cent on the week but the tech-heavy Nasdaq Composite was 0.2 per cent higher.
Japan’s Nikkei 225 Average ended Friday higher, but it has only risen twice in the past 11 sessions and fell 1.2 per cent over the week to 10,857.1. Europe was more resilient, with the FTSE Eurofirst 300 index up 0.2 per cent at 996.61 on the week, helped by some better-than-expected corporate results.
So what will happen now? The bears are led, as usual, by Dresdner Kleinwort Wasserstein. “The immediate challenge will be what will happen as earnings growth inevitably stalls out. For the bulls equities are cheap enough to withstand this. For us, the secular de-rating will force equities below this year’s comfortable trading ranges,” says DKW’s Albert Edwards.
The bulls point out that even if global growth slows to between 3.5 per cent and 4.0 per cent next year, that still represents decent momentum and provides a solid underpinning for equities in the months ahead.