Growing signs of an economic slowdown

The world economy may still be growing, but signs of an economic slowdown appear to be growing even faster.

Last week, Federal Reserve chairman Alan Greenspan gave a relatively upbeat assessment of the economy to the US Congress, saying: "There is no real underlying evidence of any cumulative weakness here."

In similar vein, International Monetary Fund (IMF) chief economist Dr Raghuram Rajan told The Straits Times after giving a lecture in Singapore that the IMF may upgrade its forecast for global growth of 4.6 percent this year.

Investors, however, appear to have other ideas, with stocks around the world continuing their recent run of poor performances last week.

In the US, the Nasdaq Composite Index closed the week at 1,849.28, a 1.8 percent weekly fall and a new low for the year. The Dow Jones Industrial Average also closed 1.8 percent lower at 9,962.36 for its fifth consecutive weekly loss, while the Standard & Poor's 500 fell 1.4 percent to 1,086.20, its sixth consecutive weekly loss.

US markets were hit by disappointing results from Microsoft and Coca-Cola last week. Microsoft reported an earnings increase of more than 80 percent for the last quarter, but warned of slowing sales. Coca-Cola's second-quarter sales were $5.97 billion, less than the consensus estimate of $6.13 billion and the smallest quarterly gain in more than two years.

European stocks dropped for a fifth straight week, the Dow Jones Stoxx 50 Index edging 0.3 percent lower to 2,600.42 and the Dow Jones Stoxx 600 Index falling 0.7 percent to 232.80.

Corporate news in Europe last week were discouraging. On Tuesday, Swiss reinsurer Converium reported an unexpected second-quarter loss and said it may ask shareholders for more money to boost capital eroded by US casualty claims. On Thursday, STMicroelectronics, Europe's biggest semiconductor maker, said profitability this quarter may be lower than in the previous period, hurt by the dollar's drop against the euro, price competition and accidents at some of its plants.

In Asia, the Nikkei 225 fell 2.2 percent to 11,187.33 last week, its third weekly drop in four. Most other Asian markets also fell, with Morgan Stanley Capital International's Asia-Pacific Index, which tracks more than 900 stocks, dropping 2.5 percent to 87.86 last week. China's Shanghai Composite Index was the biggest decliner among the region's markets, falling 3.4 percent.

Samsung Electronics saw its earnings outlook cut by HSBC Securities Asia and CLSA while Chartered Semiconductor, the world's third-biggest provider of made-to-order chips, cut its own sales forecast for the current quarter.

Recent economic news are also indicating a slowdown.

Inflation appears to be moderating. The US consumer price index increased 0.3 percent in June, but the core CPI -- which excludes food and energy costs -- rose just 0.1 percent. Inflation in the 12 euro nations slowed to 2.4 percent in June from 2.5 percent the month before.

China's consumer price index in June was up 5 percent from a year earlier. However, Guotai Junan Securities economist Zhou Keyu noted that that implied that the CPI fell by 0.7 percent from the month before.

Similarly, in Singapore, consumer prices rose 2.3 percent last month from a year ago, when the country was still suffering from the after-effects of Severe Acute Respiratory Syndrome (SARS). However, compared with May 2004, prices slipped 0.1 percent in June.

Privately owned housing starts in the US fell 8.5 percent in June to a seasonally adjusted rate of 1.802 million, the biggest decline since February last year. Building permits, an indicator of future housing activity, fell 8.2 percent to a seasonally adjusted annual rate of 1.924 million.

Forward indicators also portend a slowdown.

In the US, the Conference Board reported that its index of leading economic indicators for June fell 0.2 percent, the first decline since March 2003, although the trend may have been distorted by the closure of businesses for former-president Ronald Reagan's funeral.

In Singapore, the latest business activity survey by the Business Times and the National University of Singapore found companies less optimistic about business conditions for the next six months, with the net balance of optimistic companies falling 17 points to 37 percent.

US-based iSuppli Corp reported last week that chip inventories hit US$827 million at the end of the second quarter, way up from US$12 million three months earlier. Indeed, the rise in chip inventories has been known for some time already and has been weighing down the technology sector in particular and stocks in general (see "Terrible week for tech stocks").

Not that a slowdown at this juncture would be unexpected. Back at the beginning of the year, based on forecasts by many economists, I had expected "the US economy to slow, probably in the second half of 2004" (see "What's in store for 2004").

Rather, the question to ask is: Does the economy decelerate to its long-term growth rate and stabilise there, or is this the start of the next recession?

Terrible week for tech stocks

Technology stocks took a beating last week as analysts downgraded the outlook for the sector, citing excess supply and inadequate demand.

Last week, Merrill Lynch advised investors to sell semiconductor shares. It said that orders may slow, and cut its recommendation for the chip industry to "underweight" from "overweight".

"We think semiconductor equities offer no upside from current levels," the brokerage said in a note to clients. "Stock prices have declined, but we believe they have the potential to decline further." The brokerage also cut its recommendation for chip-equipment makers to "neutral" from "overweight".

Last week, Citigroup Smith Barney reduced its recommendation on the shares of three major Asian chip manufacturers to "sell" from "buy". It said that the three -- Taiwan Semiconductor Manufacturing, United Microelectronics and Chartered Semiconductor Manufacturing -- faced the risk of an "inventory correction".

Citigroup analyst Andrew Lu said in the report that semiconductor inventory correction may take place early next year, resulting in a price war among industry players. "We recommend avoiding the sector for the next 12 months; sell on any rebound over mixed news," he said.

Advance indications from Intel may have influenced these recommendations.

Last week, the chip giant reported profits of US$1.76 billion or 27 US cents a share for the second quarter, in line with Wall Street forecasts, and nearly double that of US$896 million or 14 US cents a share from the year-ago period.

However, sales came in a bit lower than Wall Street forecasts. Gross margin was 59.4 percent, below the guidance of 60 to 61 percent that Intel indicated in June. Significantly, inventories rose 15 percent to end the quarter at US$3.2 billion.

In the face of these concerns, as well as the resumption in the rise of oil prices, US stocks fell last week, led by the tech-heavy Nasdaq, which lost 3.3 percent, to 1883.15, its biggest weekly slide since April. The Standard & Poor's 500 Index lost one percent to 1101.39, its fifth straight weekly drop. The Dow Jones Industrial Average fell 0.7 percent to 10,139.78, its fourth consecutive weekly decline. The indices are at their lowest in about two months.

European stocks also fell last week, led by technology stocks. The Dow Jones Stoxx 50 Index lost 1.8 percent. The Stoxx 600 Index shed 1.3 percent, with its technology sub-index falling the most. Both indices slid for the fourth consecutive week.

Nokia, the phone equipment maker, was one of the big losers last week, falling 16 percent. On Thursday, it had predicted a decline in third-quarter profit and sales. STMicroelectronics, Europe's largest chipmaker, slid 5 percent. Infineon Technologies AG, the region's second-biggest chipmaker, fell 4.9 percent. Royal Philips Electronics, the region's No. 3 semiconductor maker, shed 5.7 percent.

It was the same story in Asia, with semiconductor-related stocks leading the falls last week. The Morgan Stanley Capital International Asia-Pacific Index, which tracks more than 900 stocks in the region, slipped 0.3 percent to 90.14 this week, its third weekly decline. The MSCI Asia-Pacific Information Technology Index fell 3.1 percent.

South Korea's Kospi index fell 1.1 percent last week, its sixth weekly drop in seven. Taiwan's Taiex index fell 4.8 percent, the biggest weekly decline since the week ended June 4.

Japan's Nikkei 225 Stock Average managed a 0.1 percent gain with the help of a merger between Mitsubishi Tokyo Financial Group, the nation's largest bank by market value, and UFJ Holdings, the fourth biggest by assets. However, Tokyo Electron, the world's second-largest maker of semiconductor production equipment, fell 4.6 percent, its biggest weekly loss in a month.

Predictably after the Citigroup Smith Barney report, Chartered Semiconductor Manufacturing, Taiwan Semiconductor Manufacturing and United Microelectronics all fell, by 9.5 percent, 7.6 percent and 4 percent respectively.

It was not all gloom in technology, though.

According to market research firms Gartner Inc. and IDC, worldwide shipments of personal computers rose strongly in the second quarter. Adding to their optimism, Dell, the world's largest personal computer maker, raised its fiscal second-quarter earnings guidance by 2 US cents a share -- to 31 cents -- on Friday, citing strong growth in business outside the US.

Philips Electronics beat analysts' expectations on Tuesday with net income in the second quarter surging to E616 million, or US$758 million, compared with just E42 million a year earlier. Sales were up 11 percent to E7.28 billion.

Samsung Electronics, the world's No. 2 semiconductor maker, lost only 0.2 percent last week. On Friday, the company reported that second-quarter earnings more than tripled and that it would pay an interim dividend that is 10 times more than a year ago.

Nevertheless, investors have been warned. The easy comparisons in earnings and sales may be coming to an end, especially in technology.

UOL divesting stake in UOB

The stable of companies belonging to Singapore's richest banker, Wee Cho Yaw, has been making headlines over the past few months. The latest news is that United Overseas Land (UOL) will be divesting its stake in United Overseas Bank (UOB).

Last Friday, UOL announced that it was selling its 4.2 percent stake in UOB at a minimum price of S$13.56. The minimum sale price for the UOB stake divestment is based on the average of the closing prices of UOB shares on the past five trading days.

The hotel and property group expects a net gain of about S$542 million from the divestment. It hopes to complete the sale within one year and distribute the proceeds in cash to its shareholders, who will get about 68 cents per share.

Trading in shares of UOL and OUB were both suspended on Friday at the request of the companies. UOB's shares were last traded at S$13.40, while UOL's were last traded at S$2.34.

UOL made the decision to divest after it accepted the recommendation of its financial adviser ING Bank to sell the stake in UOB.

As part of the selective rationalisation of UOL's assets -- which includes the sale of the UOB stake -- ING also recommended that UOL sell its other passive non-property investments.

For passive property investments -- specifically its stake in United Industrial Corp -- ING recommended that UOL either divest itself of the stake or lift its take to the level that would make it an associated firm.

The divestment of UOB by UOL will help to unravel Wee’s cross shareholding. While UOL holds 4.2 percent of UOB’s shares, UOB holds 49 percent of UOL’s. Analysts are already asking what Wee intends to do about the latter.

In April, UOB had announced a plan to sell a substantial part of its stake in UOL to its own shareholders at a price of S$1.58 per UOL share. The price had been 15 percent lower than UOL's last-traded price at the time of the announcement.

However, some of UOB’s shareholders had been unhappy with the plan, complaining that the price was too low, and would have resulted in an exceptional loss for the bank.

The situation became more complicated when the Singapore government’s investment holding firm Temasek Holdings subsequently put up a higher bid for UOL at S$2.06 per share, and then followed up with another even higher bid at S$2.26 per share.

Under the circumstances, UOB’s own plan fell through, while UOB itself rejected both of Temasek’s bids.

UOB needs to bring down its stake in UOL, along with the bank's other non-core businesses, to 10 percent by 2006 to comply with the regulatory requirements of the Monetary Authority of Singapore.

Wee is a shrewd businessman and he is naturally averse to selling any of his assets at less-than-fair value. This reluctance, however, has resulted in UOB being the slowest of the big three banks in bringing its non-core assets down to the required level.

With the economy and stock market in relatively good health, this may be a good time for UOB to pick up the pace in its divestment plan. Otherwise, should the economy and stock market turn down again, it might find itself forced to sell out at bargain prices.

Stocks fall as Fed raises rates and jobs data disappoint

Stock markets around the world fell last week after the Fed raised interest rates by 25 basis points on Wednesday and a US Labor Department report showed that American companies created 112,000 jobs last month, less than half what economists had expected, raising fears that the US economy may be slowing down.

In US markets, the Standard & Poor's 500 Index dropped 0.8 percent to 1125.38 for the week, its third consecutive decline. The Dow Jones Industrial Average fell 0.9 percent to 10,282.83, its second weekly fall. The Nasdaq Composite Index declined 0.9 percent to 2006.66, its second weekly fall in three.

In Asia, the Morgan Stanley Capital International Asia-Pacific Index declined 0.5 percent, its second weekly loss in three. South Korea's Kospi fell 3 percent while Japan's Nikkei 225 Stock Average slid 0.5 percent.

In Europe, the Dow Jones Stoxx 50 Index shed 2.2 percent last week. Energy stocks led the way down, followed by non-cyclicals.

So much for the much-anticipated summer rally. Instead, it looks to me like stock markets may be resuming their correction.

For the second half of 2004 as a whole, however, I still think there is a good chance that we will see a gain for most markets.

The US labour market notwithstanding, the global economy remains strong. In the US, the Institute for Supply Management (ISM) index, a compilation of responses from purchasing managers that provides an indication of manufacturing activity, stayed strong at 61.1 in June, near a 20-year high.

In Singapore, the purchasing managers index (PMI), a similar index compiled by the Singapore Institute of Purchasing and Materials Management, rose to a 44- month high of 56.8 in June.

In Japan, the tankan survey showed Japanese companies to be increasingly confident about business conditions. The diffusion index (DI) for large manufacturers hit plus 22 last month, its highest reading since August 1991. The DI for small manufacturers rose to plus two, its first positive reading since November 1991.

Non-manufacturers also reported improvements. The DI for large non- manufacturers rose to plus nine from plus five in the previous quarter, while small non-manufacturers rose to minus 18 from minus 20.

Even Europe is seeing some economic resilience. Although European manufacturing slowed last month, with the purchasing managers' index in the Eurozone falling to 54.4 in June, it is still near its three-and-a-half year high in May of 54.7. And although Germany's Ifo index of business sentiment fell to 94.6 in June from 96.0 in May, Ifo Institute head Hans-Werner Sinn said that he still expected Germany to experience a moderate recovery later this year.

On 1 July, the European Central Bank decided to leave its main lending rate unchanged.

Stock markets are also likely to be supported by robust corporate earnings going forward. In the US, forecasts compiled by Thomson First Call indicate that second quarter profits for the 500 companies in the Standard & Poor's stock index rose 20.5 percent compared with the corresponding quarter last year.

Edward Yardeni, chief investment strategist for Prudential Equity, thinks investors have not paid sufficient attention to the strong corporate fundamentals.

"I believe that short-term concerns about interest rates, inflation, oil prices and Iraq have distracted investors from appreciating the amazing rebound in profits and cash flow," Yardeni wrote in a research note on 22 June. "They should also be very impressed by the health of corporate balance sheets. The market's P/E should rebound later this year, once investors see the light and stop staring into the dark."

However, a strong stock market rally -- if and when it does come -- is likely to be the last for quite a while. As I have mentioned before, the current bull market -- assuming it is still alive -- is probably just a rally in a secular bear market. It is a rally that has been made possible by loose fiscal and monetary policies in the US, policies which, as Stephen Roach, chief economist for Morgan Stanley, keeps reminding us, are exacerbating the twin deficits in the US and causing global imbalances that must eventually be corrected.

"There are no assurances that this transition [to a condition of balance] will be smooth or trouble-free," Roach wrote on 28 June in the Global Economic Forum. "At the same time, there are no guarantees that such rebalancing will end in crisis either. But on a risk-reward basis, the odds appear to be skewed more toward a hard- than a soft-landing, in my view."

So some time toward the end of this year or in the first half of next year, we are likely to see stock markets resume their longer-term decline in anticipation of a global economic slowdown,.

Felix Zulauf, president of Zulauf Asset Management, appears to think so too, based on what he said at Barron's 2004 Midyear Roundtable discussion.

"In the second half, growth will continue, but at a decelerating rate," he said. "Inflation rates will rise, but by less than expected. Short term interest rates will rise, also by less than expected. Monetary policy will remain expansive and stock markets will rally. But investors should sell into the rally because it will mark the cyclical top of the first bull market within a secular bear market."