RJH writes...

An opinion for his partners:

US Macro Commentary:
Markets are fearful and unsteady after various inflation-scare remarks from Federal Reserve officials. Gold prices have climbed as an inflation hedge; stagflation theorems are appearing; energy prices continue to headline; and the other usual suspects remain at large (deficits, Osama et al).

The key issue appears to be the question: is central bank policy reconciling itself to inflationary pressure in the face of already declared central government spending (particularly on disaster relief if not on the conflicts in Iraq and Afghanistan)? If yes, that seems to imply controlling inflation with higher short-term rates even at the price of economic growth. If no, the inflationary impact does not bear thinking about.

Overall, market sentiment is very poor and markets have been/are selling-off. Our own model data is mixed, but leaning positive. The yield curve flattening continues; risk aversion grows; but the PMI index is expanding and the S&P500 is higher than the 6 months prior period. Moreover, the Philadelphia Fed's Anxious Index is sanguine. Overall, the risks of a GDP contraction in the next 4 quarters look less than 10% based on the Estrella-Mishkin probability table.

The logical approach in this environment is to buy those equities that meet our technical and fundamental criteria. Poor sentiment has historically been a consistent contrary indicator: if the macro picture holds this strengthens the view that we should be looking for purchases.

Stare into the precipice and jump. Or not.

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RJH writes...

(17 October Update: Oh dear.)

Recently instructed politely to stop smoking carpet after suggesting that the bombed-out UK consumer discretionary spending sector had at least two potentially lucrative quoted companies, the scribe decided to take a closer look at the macro-data.

Exhibit 1: Last 24 months retail, GDP (by quarter) & house price data

Exhibit 1 shows the sad trend for retail, housing and GDP over the last two years. And within the slowing retail data lurks the collapse of bigger ticket items such as furniture sales. Thus a company like MFI can suffer 15% like-for-like sales drop and breach its banking covenants. Yet it is in that sub-sector one of the scribe's potential interests lies. On the one hand, short of an accounting fraud, it is hard to deny said firm's attractions; on the other, its numbers are beginning to look too good to be true in the greater context.

But what precisely is the greater context? Over the last decade GDP and retail sales have been about 70% correlated; house prices and retail sales about 69% correlated; and, for the benefit of the Chronicle's resident cynic, GDP and new car registrations about 73% correlated (car retailing being where the other potential investment is parked). Exhibit 2 illustrates.

Exhibit 2: Retail, GDP and housing data 1985-2005 (plus GDP forecasts)

Accepting as valid a 2006 GDP forecast of 2.2% growth alongside these correlations suggests aggregate house prices increase in the single digits; and that a modest pick-up in retail sales occurs. But if either development were other than patchy it would be surprising.

There are risks, of which: the UK is becoming a net importer of oil again; Government borrowing plans are at risk from fewer than forecast corporation tax receipts (to mention but one problem); and housing appears to be at the downward inflexion point in its 7 year cycle (if the existence of this cycle is accepted).

Conclusion: ease up on the carpet. Contrarianism is one thing, but at current equity prices retail investments still carry too much risk. However promising individual companies in the sector may appear, keep a watching brief for now.

Sources: Nationwide's house price index; Her Majesty's Treasury; UK Department of Transport. The 2006 GDP forecast is based on the average of 26 City of London firms and 13 non-City forecasts made in September 2005. HMT's own forecast of 2.5%-3% is excluded; and it is notable that one forecaster is predicting a contraction of -0.2%.

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RJH writes...

7 October 1571 and Don Juan of Austria leads a European Christian alliance to victory against Sultan Selim at the naval battle of Lepanto. Much as the defeat at Stalingrad in 1942/1943 showed the world that the Nazis could lose catastrophically, Lepanto destroyed the myth of Ottoman invincibility and marked the empire's first step onto the slippery slope.

Nearly 435 years to the day and the Austrians - led this time by the less romantically named Foreign Minister Ursula Plassnik - were back at it, opposing Turkey's entry into European Union (EU) accession talks. These negotiations were previously agreed to by all EU members, and were due to begin today.

For this battle, though, Donna Plassnik did not have the backing of a single ally. Or at least none that wanted to stand up officially and be counted. Austria thus backed down for the price (reportedly) of smoothing the passage of her friend Croatia's own EU accession bid.

Capital Chronicle has covered Turkey and the EU before ("Turkeys voting for Christmas"). Our view has not changed: there is a clear gap between the views of EU political leaders and those of their populations regarding the desirability of Turkey's accession. Doubters need only consult the final page of the EU's Eurobarometer's latest survey results here for confirmation. Turkey is dead last in this popularity contest with only Albania as the nearest company.

But with Turkey's accession negotiations estimated to last a decade, this episode, unlike Lepanto, is but a minor skirmish. And prelude.

[Editor: So enjoy the Turkish emerging market gains before battle is rejoined. PS - an Austrian Don Juan?]

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