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Sheraz Mian

Uncertainty Driving Market Volatility

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Friday, August 19, 2011

Uncertainty has gripped the market. This is pushing gold prices to new highs and yields on treasury bonds to new lows. While there is no shortage of issues, the biggest driver of this glum mood is the uncertain outlook for the U.S. economy. Europe's inability to get a handle on its problems is another key issue that refuses to go away.

The market is trying to handicap the odds of a fresh recession in the U.S. on a day-to-day basis. These odds increase on a day like Thursday when the overall thrust of economic reports was clearly on the negative side. The resulting head-spinning moves in stocks, bonds and commodities reflect the pricing of such increasing odds. With nothing major on the economic docket today, we will likely see a continuation of Thursday's negative momentum.

So, is the U.S. economy heading towards a recession?

I don't think a recession is on the cards, but there is no doubt that the economic picture remains fragile and mixed. Some measures of economic health, such as regional manufacturing and consumer confidence, appear to be in recessionary territory already. But other metrics that capture trends in consumer spending, corporate investments and the labor market are pointing towards positive, though sub-par, economic growth.

So the best that can be said at this stage is that the economic picture is uncertain and mixed. I am reasonably confident that the underlying momentum in the economy will keep it in the positive territory. But it will take us at least another few weeks to get a better handle on the situation. Till then, brace yourself for a bumpy ride.

In corporate news, we don't have anything significant on the earnings front this morning. But we did have a couple of major earnings reports after the close on Thursday. Hewlett-Packard (HPQ - Analyst Report) came out with a positive EPS surprise on inline revenue. But the computer giant guided lower, confirming the consumer weakness that we saw in Dell's (DELL) results a couple of days back.

But the earnings report was not the most important news out of Hewlett-Packard on Thursday; it was the announcement that they are going the IBM (IBM - Analyst Report) way in their business model. They want to get out of the PC business and bulk up on services. So, they plan to sell the computer business and acquire a British software firm.

Exiting from the low-margin commoditized PC business will be a net long-term positive for the company's margins and returns. But executing such major strategic moves is never easy or smooth. We will have to wait and see how Hewlett-Packard's 'newish' management team comes through on this plan.

Sheraz Mian
Director of Research

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