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To: Les H who wrote (2795)	9/12/2002 10:31:16 PM
From: Les H	Read Replies (1) \| Respond to of 29600

Daily insights (Part I) Checklist For A Fed Easing -- Financial markets have priced in a 75% chance of a quarter-point Fed rate cut later this year. What indicators should investors watch as a sign the Fed will ease? Our Fed Monitor flattened off having never reached “tight money required” territory, reflecting weakening pipeline inflation pressures and rising financial stress (see the next Insight). This suggests that we are already in “the zone” for Fed easing. A drop in the ISM manufacturing composite index to below 50% has heralded all of the Fed easing cycles since 1990. A decline in the Leading Economic Indicator below its boom/bust line also has been a good warning sign. Finally, a renewed weakening in employment and capital goods orders would indicate the start of another corporate retrenchment phase, and would quickly get the Fed’s attention. (Part II) Checklist For A Fed Easing -- A financial crisis could also force the Fed to ease. The previous Insight highlighted the economic data that would herald a Fed rate cut. However, financial markets may not give the Fed the luxury of waiting. Our composite index of financial stress reached elevated levels prior to the Fed rate cuts in late 1998 and early 2001, even before some of the economic signals erupted. The economy was not particularly weak in either episode, but stock markets were falling and corporate bond spreads blew out. The stress index is again flashing growing troubles, although it has not yet reached previous peaks. Further increases in the stress index would signal that the Fed may be about to hit the panic button. Checklist For An ECB Rate Cut -- Our checklist suggests mounting pressure on the ECB to reflate. Our ECB Monitor, which has reliably led euro area short-term interest rates, has recently rolled over along with the OECD leading economic indicator, implying that the conditions for an ECB rate cut are developing. The following checklist should help pinpoint the timing of European easing. At the top of the list would be a breach of the July 24th lows in European bellwether equity indexes. Other criteria would include a sharp downturn in retail sales and consumer confidence surveys, rising unemployment, falling inflation expectations and weaker credit growth. Currently, this checklist is flashing yellow, but it would not take much more to signal an imminent easing. BoE Checklist = Financial Crisis -- The most likely trigger for a sudden Bank of England (BoE) rate cut would be a financial crisis. U.K. economic data have been mixed but on balance do not yet warrant easing monetary policy. Manufacturing output bounced back after an atypical holiday shutdown in June. Wage data (released Wednesday) will be important; if wage growth remains strong, the economic rationale for a rate cut will recede. The BoE has much less economic justification to lower rates compared with the ECB and the U.S. However, swooning stock markets represent an ongoing risk to business confidence and investment, which is critical for the U.K. given the country’s large financial sector. The BoE has acknowledged this risk and would cut rates along with the ECB and Fed in the event of a financial crisis. Canada’s Star Is Bright, But Not For Bonds Canada’s employment picture remains bright, particularly compared with the dull U.S. situation. Stay underweight Canadian bonds. -- Canada’s employment surged higher yet again in August, adding 59 thousand jobs, of which 51 thousand were private sector employees. The contrast with the U.S. situation is stark, where only 39,000 jobs were created in August, in an economy almost 15 times larger, and payrolls are still lower than a year ago. The continued divergence between these economies suggests that the Bank of Canada will stay on hold (which is priced in the market), while the Fed is likely to cut by 50 bp before yearend (not fully priced). Thus, Canadian bonds will underperform the U.S. as the spread on Canada/U.S. bonds will widen further. When Will U.S. Technology Stocks Recover? -- The risk/reward trade-off is becoming more attractive for U.S. tech stocks. The top panel of the chart shows a regression of previous asset price bubbles (U.S. equities in the 1920s, gold in the 1970s and the Nikkei in the 1980s) against the U.S. tech stock mania. It suggests that the tech bubble has largely been deflated. However, given that cyclical profit headwinds remain intact (business investment prospects are still sluggish and pricing power is worsening), it is prudent to await a drop in our measure of long-term implied tech sector earnings growth to 12% or less before building positions. Such a development has typically marked a favorable turn in the risk/reward profile. Our U.S. Equity Sector Strategy service is still underweight this sector, but will upgrade if valuation keeps improving.