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While inflation fears grip the UK, over on Wall Street, the mood is brighter – too bright, some would say.
The big news across the Atlantic this week has been the Dow Jones index bursting through the 13,000 mark for the first time in its history.
The key question might seem to be – how long can it stay there? But in fact, a more important question is – does it even matter?
The Dow Jones index has just powered through 13,000 this week – but how indicative is it of the true state of corporate America?
John Authers in the FT points out the Dow’s many flaws as a benchmark, saying: “Ultimately a landmark for the Dow signifies little or nothing.” It is “weighted by share price, not market value, so the biggest companies do not have the biggest impact.” He points out that a full third of the 1,000 points that took the Dow from 12,000 to 13,000 came from gains “in just four companies – Altria, Boeing, Honeywell and ExxonMobil.”
On the other hand, the S&P 500 “by far the most important index” is yet to set a new record – though it is not far off it.
Meanwhile, Alan Abelson of Barron’s warns in The Business that the current optimism on Wall Street is “one of those irrational phenomena… that defies rational analysis.” He goes on: “What’s stoking mounting enthusiasm for stocks among the investment masses has little to do with fundamentals and just about everything to do with the billions of often-borrowed money available to the freewheelers who control private equity and hedge funds.”
Abelson cites David Rosenberg of Merrill Lynch, who points out that what’s happening just now is the opposite of what happened in late 2002, early 2003. Then, the market kept falling even though economic data was improving. Today, the market keeps rising, even though the economic data are getting worse.
“Technicals, sentiment, M&A and liquidity can take you only so far. As we saw four to five years ago in reverse, the economic backdrop very often wins out in the end.”
And that backdrop isn’t looking too healthy. The housing market continues to be a drain on the economy – three builders, Pulte Homes, Beazer Homes and Ryland Group posted quarterly losses this week as they were forced to write down property values and “abandon land purchases”, reports Bloomberg. Two declined to give any forecast for the coming year, while Beazer’s chief executive Ian McCarthy said the housing market was “extremely challenging”, with no recovery in sight.
Pulte, the fourth-largest US homebuilder, saw new orders fall 21%, with average prices down 1.8% during the quarter. Ryland, the biggest builder for first time buyers, saw new orders dive 26% over the same period.
Yet shares in all three picked up. One of the main reasons is that investors, still flush with cash and hunting for the next big gain, are desperate to bottom-fish in a sector they think is bombed out and ripe for a comeback.
But fools rush in, as they say. The US housing slump is far from over – with more than 50 subprime lenders taken out of the market by bankruptcy or fire-sales since the start of last year, getting an entry-level mortgage is becoming harder. Credit conditions have tightened too, amid widespread fraud in home loan applications. Fewer buyers means falling prices – and that will hit consumption, and then profits, and finally share prices.
Wall Street might be ignoring the warning signs just now – but as Abelson says: “all that can be said with certainty is that one fine morning we’ll wake up and reality will be back with a vengeance.”
MoneyWeek regular writer James Ferguson expects a recession in the US. You can read his thoughts on the topic here: Where’s this long-awaited recession?
And if you’d like to hear more from James, you might be interested in his email advisory service, Model Investor.
Turning to the stock markets…
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In London, the FTSE 100 broke through the 6,500 level in intra-day trading yesterday, peaking at 6,511, but had dropped back to 6,469 by the end of the day – a 7-point gain. A strong set of results from Reckitt Benckiser saw the household goods group top the FTSE leaderboard with gains of over 5%. However, Xstrata led miners lower in a lacklustre day for the sector. For a full market report, see: London market close
On the Continent, the Paris CAC-40 was up 35 points to 5,944. In Frankfurt, meanwhile, the DAX-30 added 19 points to end the day at 7,387.
On Wall Street, the Dow Jones hit a fresh record high close yesterday as 3M and Ford Motor led the industrials index 15 points higher to end the session at 13,105. The tech-laden Nasdaq climbed 6 points to 2,554. However, the S&P 500 was 1 point lower, at 1,494.
In Asia, Tokyo investors chose to take profits ahead of the bank holiday weekend, sending the Nikkei 28 points lower to a close of 17,400.
Crude oil futures had climbed to $65.16 today and Brent spot was trading at $67.55 a barrel.
Spot gold had rebounded from an intra-day low of $670.80 to $673.20 today. Silver, meanwhile, had fallen to $13.28.
In the foreign exchange market, the pound was at 1.9941 against the dollar and 1.4647 against the euro, whilst the euro was up to 1.3615 against the dollar. And the dollar had fallen to 119.38 against the Japanese Yen.
And in London this morning, a group consisting of Royal Bank of Scotland, Santander Central Hispano SA and Fortis announced that they would make an unsolicited offer for Dutch bank ABN Amro. The announcement raises the possibility of a hostile bid in what is set to be the world’s largest ever financial services takeover. Rival bidder Barclays saw its shares rise by as much as 0.4% in London today, whilst Royal Bank of Scotland’s stock had fallen by over 1%.
And our two recommended articles for today…
Seven ways to go soft on commodities
– Bird flu in Asia. Hurricanes in Florida. A new Starbucks on your local High Street. What do all of these have in common? They have a huge influence on the prices of certain soft commodities. For more on this year’s biggest soft commodities trends – and how to play them – click here: Seven ways to go soft on commodities
Can Beijing reign in the white-hot Chinese economy?
– A blistering first-quarter GDP report has thrown the threat of an overheating Chinese economy into sharp relief. Stephen Roach analyses how Beijing is likely to act – and what impact their actions could have on commodities. To find out why there’s only one choice for China, read: Can Beijing reign in the white-hot Chinese economy?