In the tug-o-war between the bears and the bulls, the bulls gained ground last week. It is all very confusing, so to help clarify our thoughts, let us consider the forces acting on investor sentiment:

• In technical terms the markets were oversold, whereas in fundamental terms they are now in no-man's land (neither gung-ho "new economy" valuations of three years ago, nor near historical averages of PE)
• Initial jobless claims are declining, but unemployment is high and financial unrest on Wall Street is minimising corporate hiring plans
• US spending is still strong, but durable goods orders are down
• New home sales are booming, but existing home sales have fallen sharply
• "Get tough" laws on corporate fraud have been passed, but new scandals are emerging so often that they are scarcely noticed anymore (e.g. Qwest this week)
• Major banks are protesting their innocence in financial scandals, but individual executives are "claiming the Fifth" (the right not to self-incriminate)
• Bush and Greenspan are being aggressive in condemning greed and deceptive financial reporting, while their very own Administration is playing its own reporting games in claiming a deficit of $ 165 billion for the fiscal year to end September, vs. the true deficit of $ 412 billion if Social Security is included.

Within such contradictory news, we can find support for almost any view. Economists tend to argue that the losses in share prices are having a negative impact on the real economy, whilst most traders are much more optimistic. Our own view? Let us say "less pessimistic", but still conscious of the large downside risk on all fronts.

Certainly the bond markets remain very cautious. Competitive bids for corporate bonds are increasingly difficult to obtain. Emerging market spreads keep growing. Brazil could go either way, but we now expect the worst. The current sovereign bond price level is unsustainable: prices have to go back up or collapse. Unfortunately, only US or IMF intervention on a grand scale can prevent default on Brazil external debt, as refinancing at a 25% interest rate is inconceivable. In emerging markets, Russia remains strong, but we allow ourselves again to mention the appropriateness of profit taking.

Our view remains in favour of slow economic growth (current rate announced at 1.1%), subject to a chance of such growth being even slower owing to the bear market. Inflationary pressures look subdued. This view has received quiet support from the authoritative Chicago Fed National Activity Index, which is defined as being in a "neutral position".

The picture in Europe is scarcely better in terms of the economy, except for the UK. Even there, consumers appear to be running out of steam, and the threat remains of the housing bubble bursting. Regular readers will know that we fret about high PEs. Using "BigCharts", we have taken a closer look at the SP 500 index. It peaked at over 1,500 in March 2000 and is currently at 900, having bounced off the 800 low. Over that time the average rolling EPS has fallen by half (from $ 50 to $ 25), a percentage fall greater than that of the index. The implication that PEs have gone up is confirmed: from 30 in 2000 to 36 today, all versus a long-term average of only 12. With profit growth looking modest by even the most optimistic pundits, it is really difficult to see opportunity in these valuations. It is like saying that the environment today justifies higher valuations than at the height of the dot.com boom .

There is a major threat to our benign scenario of gentle recovery and low inflation, viz., the proposed war on Iraq. If America acts alone against Iraq, as seems most likely, the sense will be overwhelming of the superpower going its own way despite world opinion. The new war will be very expensive and utterly divisive in terms of "West vs. Islam", although the West itself will be split. Saudi Arabia will be very vulnerable to internal uprising. Peace between Palestine and Israel will disappear from the radar scene. Bin Laden will be delighted. This scenario is only a threat, but the world already has problems enough in recovering from the excesses of the late 1990s.

We promise readers who find us perennially pessimistic that we shall keep a sharp eye open for good news! In fact, there is quite a bit above, sorry we had to qualify it!

Recommended average maturity for bonds in each currency
Stay long across the board, except in Sterling.

The recovery of the stock market helped the USD to stop its slide. Yesterday, the US consumer confidence for July fell 9 points to 97.1. This is the largest fall since October. The Brazilian Real made new lows (3.35 to the dollar). Comments by US Treasury Secretary Paul O'Neill, suggesting foreign aid to Latin America would just end up in Swiss Bank accounts, infuriated Brazil. There are concerns also about Uruguay, where the Government temporarily halted activity in all banks on Tuesday this week.

EUR/USD: As expected, a consolidation range has been established between 1.0050 and 0.9750. An exaggeration as far as 0.9675 is possible, but we do not think the euro will go lower. On the upside, a break of 0.9890 should announce a return to 1.0050.

USD/CHF: The Swiss Franc is also in a consolidation range, of 1.4650-1.4900. On the upside, only a break of 1.4950 would announce 1.5100, but, rather than this scenario, we favour a return to the down side, with 1.4650 as first target, followed by 1.4480.

USD/JPY: The dollar broke the 120 psychological level, but is struggling to stay there. A break of 120.80 would be significant, and herald 122.00. 118.30 is the key support level.

EUR/JPY: So far this pair has been well supported at 117.00. The rate needs to close above 118.50 to set a further target. The key resistance is at 119.75.

USD/CAD: We are keeping our short position at 1.5950, with the same target at 1.5550. The stop loss can be moved down to 1.5900.

AUD/USD: After the rally of the last three days, the important resistance at 0.5500 is being encountered. A break there should bring the rate to 0.5580, followed by 0.5650.