I early July some predicted that the markets would go up, but the trend is clear – down. Will it ever end? Yes, one day, but not yet. It’s difficult times, but the worst is that it is pretty late many realizes how bad the situation is, meaning there are still some stops to be taken out.

Read more about all the interesting happenings in the financial markets in the outlook here below. I hope you find it interesting to read my private view about the consequences for the stock markets, currencies, China and what to expect from the central banks.

Hot Topic – what’s going on and where will it all end ?

The Hot Topic was thought to cover a single issue that is in focus, but this week I try to highlight the

developments that I suggest are important to include in the risk considerations. As everybody try just to get the

overall picture, this is meant as the long term view I have right now. The detailed market comments I have made

shorter this week (makes little sense to discuss, normal interesting data, that moves the market 1 – 2% when the

world moves 5 -10% within 24 hours).

No doubt that investors escape almost everything and are rushing into very few safe heavens like US T-Bills, but

also back to Japan as mentioned the past weeks.

In equities the trading pattern indicates that professionals unload stocks at any uptrend and the down trend

accelerates due to stop loss selling (like short Yen / long stock positions). If this anticipation is correct, then it

underlines the growing uncertainty about future income among corporate companies. The consequence is

further repricing of assets (a nicer way to say that more losses are expected in the global stock markets).

Each country worldwide gives immediate aid to their domestic financial systems, though in different ways. The

banking bailouts have become well known, but important investors like the governments in China and some

Middle East oil producers now intervene directly in the domestic stock markets. Particularly the Middle East

governments was until recently steady buyers of US stocks but this source is gone for the moment, partly

caused by the domestic support.

The European banking crisis grows so fast, that it has overtaken the US financial crisis in terms of market focus.

The problems in US are still growing, but the developments in Europe show how steep the negative

development is. Saturday’s coffee get together in Paris between France, Germany, Italy and UK, as expected,

didn’t bring anything, but at least, all European nations probably establish their own guarantee programmes for

the banking sector.

Fine, because it avoids the risk of panic among private clients that could lead to extensive run on banks. Very

unfortunate it doesn’t fix the fundamental problems for the European banking sector, high leverage, growing

losses and lower earnings. It might be a surprise to many that European banks are much more leveraged than

US banks. It has been well known, that the increase in profitability among European banks during the past

decade solely came from more leveraged balance sheets. In US, the banks outside Wall Street, have lent 96

cents for each USD 1 of deposits where continental European banks have lent 1,40 EUR per EUR 1 of deposits.

One could argue, that the credit quality is better in Europe due to higher saving ratios among European private

households, but it’s a difficult call in these markets.

As the global downturn is spreading forceful we must expect higher write off’s in Europe on top of the hits from

the US sup prime loans. This, combined with a pressure to lower the leverage, naturally results in much lower

earnings in the European banking sector. Which again causes further delays in restoring a healthy capital base.

With a global growth slump combined with a battered banking sector in US and Europe, an economic Ice Age is

inevitable – the golden questions are how long time it will take, what measures will governments take to prevent

a prolonged economic crisis and when will investors start to believe in the end of the Ice Age ?

The Ice Age will be very visible next year, where I am worried about some of the refinancing needs within the

banking sector and among stressed corporations. When we are through this bulk of refinancing, we have an idea

about the financing costs for a period. During the same period sales and corporate earnings will adjust lower, but

as a result we get a better feeling for the new P/E values and the related stock prices.

The governments who still have fiscal policy ammunition left over will use it, so good old Keynes is back on

stage. A new round of checks from the US government is not unlikely (despite it will remind about the Bush

administration), in Europe more public spending in some countries is to expect (the constrain is the high level of

public spending we have already), China is clearly doing a lot to move the domestic demand and Japan most

likely joins the public spending spree.

We are still on the way down but when investors get a feeling for where the new corporate earnings will be, the

liquidity squeeze is manageable and public spending starts to work, then some risk appetite will return to the

market.

An additional asset class that needs to stabilise before the world recovers is where all the troubles started – real

estate. Even in USA where the downturn in housing prices has been going for long, the data last week showed

that it was another month with new lows. When the real estate market will stabilise is too early to judge, as it just

points lower. Particular in some areas in Europe, but Japan is getting deeper in minus and in China is a negative

price development a risk.

The good news in this depressing repricing world are the lower commodity prices. Combined with the expected

public spending initiatives, this will build the base for the recovery. When investors can see the signs helping,

then we have had the lows in equities.

As always, it’s not time to buy yet, but so far I keep the view that there is a chance for lows before end of Q1

2009. I also keep the view that Far East has the best preconditions for the recovery. When USA and Europe will

recover is still unclear for me, USA is still on the steep way down.

So much on my fundamental long term view. Below are few thoughts for the coming days.

Equities

USA:

Dow Jones (10325)  S&P 500 (1099)  Nasdaq Comp (1947)

Even the10.400 target in Dow Jones – at least nice that I have some luck in equities when I misjudge the currency marketso much.

What is to be said about equities in addition to the Hot Topic view? Some interesting information bits and pieces

are always to be found. Pretty important are the many US corporate results that start to be released in October,

as we all will study the earnings reports closely.

The steep Friday evening New York sell off with 5% within 2 hours is worrisome and points towards lower levels.

Targets: Jones 9.800  S&P 500 1.045  Nasdaq Comp 1.850

Japan:

Nikkei 225 (10473)  Topix (999)

So the Japanese Topix closed below 1000, who would have believed that?

I can’t find anything upbeat about  Japan – apologise.

Targets: Nikkei 225 9.950  Topix 9.500 

Europe:

Dax (5500)  FTSE 100 (4745) 

Some might also have noticed the very sluggish views from the European car producers last Thursday and

Friday. No relief there and it will hurt the automotive sector, where many German companies are exposed. It

should give negative readings in the German industrial production, and most likely the automotive sector will

underperform the next 6 – 9 months.

I can’t find anything upbeat about UK either.

All targets have been reached, and the new target will be lower, but with stocks swinging 5% a day it feels wrong

just to forecast another 5% down. The message is that I see shares trading lower and then we need to take from

week to week.

Targets: DAX 5.225  FTSE 100 4.500 

China:

Hang Seng (16800)  Shanghai B (126)  USD/CNY (6,8425)

With China on holiday most of last week it was very interesting how the Chinese mainland stock market reacted

this Monday morning. The drop was “only” 5% which is pretty ok when you take last weeks happenings into

account.

It actually seems that China had a national holiday as not many new signs and discussions came from China,

despite the challenging times. No doubt that the global slowdown will have a negative impact on China, so worth

to follow are news about how to increase domestic demand and the price development in the housing market.

Earlier today I noticed that a leading bank lowered their GDP forecast for China, down to 9,6% this year and

8,0% next year. It might still seem high, but the official target is 8,5% so I am sure that the Communist Party

feels themselves forced into action regarding the domestic demand.

Hang Seng once more hit the target. I set a new target 5% below today*s close like the other markets following

the view that we are set to follow the trend down

Targets: Hang Seng 15.950     Shanghai B 115

Foreign Exchange

EUR/USD (1,3575)

Last Monday EUR/USD was 4½ big figure lower than the prior week and today EUR/USD is

7 big figures lower than last week……The two big capital flows mentioned above (T-Bill purchase and EUR/JPY

selling) is so extreme bearish for EUR/USD. The “sell on rally” view last week was wrong in the sense that it

should just have been an outright sell recommendation.

Fridays US unemployment data for the first time showed true recession numbers with non farm payrolls at -149k

(levels around -150k per month are typical for recessions). The unemployment rate also went up from 6,055% to

6,125%, but rounded it’s 6,1% both months – the trend is up.

As lately, the greenback only reacts on capital flows and not on economic fundamentals, but to ignore the

fundamentals means a rebound later. I know that investors are selling Euro based on all the bad news, but the

move in EUR/USD seems overdone. I change my target to 1,4250, as a recovery from the current level.

There is a real lack of economic data this week, so capital flows, news from the financial sector and impulses

from equities will be important for EUR/USD this week

Targets:  1,4250 with stop loss at 1,3425.

EUR/JPY (140,40) – USD/JPY (103,40)

EUR/JPY is 12 big figures lower than last week, so it shows everything.

As mentioned several times is Japan suddenly safe heaven. I had expected some outflow of Japan in early

October, but it seems that flight back home to Japanese accounts still dominates. On Thursday Japan releases

the normally very important machine orders (expected -2,7% m/m) which I keep an eye on.

I need to lower the EUR/JPY target, though higher than the current rate.

Targets: EUR/JPY 146,50 – USD/JPY 105,00

EUR/GBP (0,7735) – GBP (1,7575)

Serious capital moves from UK towards US and the greenback. With the

pressure on Euro I am deeply wrong in EUR/GBP as well. I lower the EUR/GBP target, but still higher from here

and adjust the GBP/USD target lower as well.

Targets: EUR/GBP 0,8150 – GBP/USD 1,7900

Central bank rates

US Federal Reserve Bank: The next step has changed from being a hike to a cut. Not that I think it is the right thing to do, but Fed needs to send all the relief signals they can. You could also say that during a crisis assures the central bank normally a loose monetary policy. Fed is already doing that, but to avoid criticism they most likely cut with 50 basis points in October.

Bank of England: The current 5,00% is high compared to rest of the world, so it’s very unpleasant with rising inflation as I don’t think the BoE people have the guts to hike with growth deteriorating. Unchanged for a long time ahead.

European Central Bank: Mr. Trichet is hinting a rate cut now, so it looks like November with 25 basis points.

Bank of Japan: They should hike with the Japanese inflation rising but another example of the central bankers being afraid of the political and public opinion. As a consequence BOJ will stay at 0,50% rest of this year.

I am looking forward to your comments and wish everybody a profitable week.

Peter

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