US INTEREST RATES

The S&P 500 index corrected further down to a 1-month low from last month’s 1-year high. That 1-year high represents a 48% correction of the 2-year plunge from the record high in Oct 2007 to March’s 13-year low. Bearish factors for stocks include (1) concerns in the banking sector after comments from Jon Greenlee, associate director of the Fed division that regulates banks, that the banking system is “far from robust” as lenders still face threats from defaults on commercial real estate loans, and (2) the prediction from Pacific Investment Management that the slump in US housing prices is unlikely to end before the middle of next year as recent statistics that show a rise in home prices is being distorted by government efforts to reduce foreclosures. Bullish factors include (1) the greater-than-expected surge in the Oct ISM manufacturing index to a 3-1/2 yr high, (2) the unexpected +0.8% increase in Sep construction spending, the largest gain in a year, and (3) Deutsche Bank’s hike in its GDP estimates for US economic growth in the second half of this year and next year, citing a “noticeable pickup in demand” from the most recent Q3 GDP report. 

Earnings expectations for the S&P 500 are as follows, according to Thomson Financial: Q3-2009 (-17.5%), Q4-2009 (+214.9%), Q1-2010 (+37.6%), Q2-2010 (+20.9%). S&P 500 annual earnings are expected at –7.9% in 2009 and +26.9% in 2010 (2008 -23.9%, 2007 -3.7%, 2006 +16.1%, 2005 +13.7%, 2004 +20.2%, 2003 +18.4%, vs 25-year average of +8.6%). The S&P 500 forward P/E (based on forward-looking earnings) is at 16.9, well above the 5- year average of 15.3.

US STOCK INDEXES

The dollar index corrected further up to a 1-month high from its recent 15-month low. The euro corrected down to a 1-month low from its recent 15-month high, while the dollar/yen is consolidating on either side of 90 yen, modestly above its recent 9-month low. Bullish factors for the dollar include (1) euro weakness after the EU Commission predicted that further losses at European financial institutions may total 400 billion euros ($586 billion) through next year, and (2) short covering in the dollar ahead of the upcoming G- 20 summit in Scotland. Bearish factors include (1) the post-FOMC statement that stated the Fed intends to keep interest rates low for an "extended period," which will continue to weaken the dollar's interest-rate differentials, and (2) the prediction from BNP Paribas SA that the dollar will slide further as nations that hold the biggest currency reserves seek “safer” assets including gold.

The recent purchase by India’s central bank of 200 metric tons of gold from the IMF may be a sign that global central banks are looking to diversify their assets to protect against further dollar declines. India’s purchase was the biggest central bank purchase of gold in at least 30 years and lifted India to the world’s tenth-largest government holder of gold with 557.7 tons in reserves, according to the World Gold Council. In April, China’s central bank announced that it had increased its gold reserves to 1,054 tons, up +76% from 454 tons in 2003. With gold prices up 24% this year and the dollar index down over 6%, more central banks may be prompted to shy away from the dollar and turn toward the yellow metal.

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