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Markets: A sucker punch?
New York: November 26, 2003
By John R. Stephenson

Yesterday, saw some lackluster trading after the markets posted some strong gains on Monday. The major indices decided to take a break and to digest the stronger than anticipated economic growth numbers (revised GDP in the third quarter of 8.2%). The Conference Board, a private research group, released some positive numbers showing that consumer confidence had surged to year-high in November. But in spite of the good news there remains cause for concern.

First of these concerns is the fact that the sales of existing homes dropped sharply last month. As we have mentioned before in this column, over the last three years, gains in tangible assets (homes) have been offset by losses in intangible assets (stocks and bonds). Because there are more people who are homebuyers than there are people who are shareholders, the wealth effect (the perception of one's overall net worth) has been maintained or modestly improved over the last few years because of surging house prices. A continued slowdown in the housing sector, one of the few bright spots in the economy, could be a bad sign for an economy that has been wheezing along for the last little while.

Another area of concern is the growing protectionist sentiment out of Washington. The first protectionist measure was the imposition of a tariff on imported steel and recently, a tariff has been slapped on Chinese textiles. The increasing protectionist stance out of Washington further exacerbates the downward pressure on the US dollar. In essence, protectionism is nothing short of a currency devaluation by other means. By imposing tariffs on foreign producers, US consumers will end up paying more for bathrobes and other apparel made in China. The net effect - a reduction in purchasing power. It is likely that the protectionist sentiment out of Washington will only increase as the US election cycle approaches. This comes at a time when there has been a dramatic decline in the net inflows into the US capital markets over the last few months (see figure 1). The net capital inflows, into U.S. Stocks and Bonds was approximately $11 billion in September, down from over $700 billion in June of this year.

With foreign investors beginning to shun the US bond and equity markets and a ballooning current account deficit (see figure 2), the consequence is a weaker US dollar as investment capital is diverted towards the Yen, Euro and Canadian dollar. This comes at a time of reasonably strong economic data out of the US. With smaller capital inflows into US markets by foreigner and a reduction in liquidity (money supply), the US dollar should continue to fall and US equity markets should weaken in the months ahead. Investors might consider reducing their holdings of US stocks, particularly the stocks of homebuilders, which have enjoyed a strong run of late and appear to be over owned and under sold.

Figure 1: Net Capital Inflows

Source: US Department of Commerce

Figure 2: Current Account Balance

Source: US Department of Commerce

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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