A Reversal in CAD in Synch with Reversal in Markets

Thursday, October 29th, 2009

Canadian central banker, Mark Carney’s concerns about the strong Loonie are well known. It threatens Canada’s economic recovery. Some currency analysts believe the Canadian dollar could test its $1.10 highs again. But what is Carney doing about it?

David Rosenberg says we should embrace this period in Canada’s economic history. “For its part, the Bank of Canada has said that “persistent strength in the Canadian dollar” is going to “slow growth and subdue inflation pressures.” So, in return for softer growth, what we get back is lower “inflation pressures.” The winner here is anyone who needs to borrow money – a strong loonie will prevent the Band of Canada from taking the interest-rate punchbowl away any time soon.”

But, last week, the Bank of Canada interrupted the Canadian dollar’s ascent when it left rates at 0.25%, and downgraded economic growth prospects for 2010 and 2011. The dollar lost 2 cents. There is pressure though for the BoC to ease further.

Carney’s wait-and-see stance on quantitative intervention, indicates he may not have to. Instead, he may be talking through this, while waiting for the G20 to sort out the US dollar; in effect, a policy of benign neglect.

At the G-20 meeting in Pittsburgh in late September, leaders made commitments to pursue policies to bring the world into greater economic balance. Following that meeting, the ECB’s Trichet said it is “extremely important” that U.S. authorities pursue policies supporting a strong dollar, and that excessive foreign-exchange volatility is an “enemy.”

There’s another G20 meeting scheduled for Nov. 6-7 in Scotland, and it’s most likely to serve as a forum where all concerns over the dollar’s weakness will be aired. “I think there will be fireworks at the G20,” said Stephen Jen, a well-respected currencies investor at hedge fund BlueGold Capital Management in London.

The US is wallowing in the advantage of a weaker dollar. Neil Mellor, Bank of New York currency analyst, says, “You can’t continue down this road without something giving way, and it’s clear that the U.S. is not going to do anything to put meat on the bones of its strong-dollar policy.”

US$450-billion has been sucked from money market funds (the dollar) into risky assets since March. Zero-percent-interest-rate policy (ZIRP) crowded investors out of the money market and into risky assets. In the simplest of terms, the global equity markets’ slingshot recovery has led to conversely rapid devaluation of the dollar.

Now, a “strong US dollar policy,” for which there is great political will globally, appears to hinge upon a reversal of fortune in markets or concerted monetary intervention via the IMF, or both.

Therefore, the price of relief from the Loonie’s climb could be a synchronized decline in commodity prices and equity markets, in the near term. The repatriation of cash to US money markets means a stronger US dollar, and thus a weaker Canadian dollar, hence the synchronization with the reversal in equity markets and commodities prices. Perhaps Carney is right to let the big players sort out and tighten the US Dollar.

In newer developments earlier this week, the US government, perhaps under some pressure, showed signs that it is willing to withdraw stimulus, thus tightening the Greenback, by closing down the housing tax credit, and calling on Bank of America to repay its bailout by selling shares. The market is reacting poorly.

It begs the question - Is the tail wagging the dog?

If the stimulus and zero interest rate policy is responsible for the markets’ huge recovery, then what effect will indications now, of the US government’s willingness to withdraw stimulus, have?

Either way, it would be prudent, at this point, to take the political pressure from the world’s other large economies to re-establish balance without jeopardizing their own recoveries, seriously.

Tags: Ascent, Bank Of Canada, Bank Of New York, Benign Neglect, Boc, Buybacks, Canada, Canadian Dollar, Capital Management, Commodities, Currency Analysts, David Rosenberg, Dollar Policy, ECB, Economic Balance, Economic History, Economic Recovery, Finance Minister, G20 Meeting, Global Equity Markets, Gold, Growth Prospects, Hedge Fund, Inflation Pressures, Interest Rate Policy, Late September, Loonie, Mark Carney, Money Market Funds, Neil Mellor, Punchbowl, Resumption, Risky Assets, Strong Dollar, Trichet, Volatility
Posted in Emerging Markets, Gold, Markets | No Comments »

Technical Talk: Fatigue sets in on stock markets

Thursday, October 29th, 2009

The comments regarding the Dow Jones Transportation Average were provided by Kevin Lane of Fusion IQ.

“As seen below, the Dow Jones Transportation Average (TRAN) has stalled and turned down from resistance at the 4,075 level (red lines) twice in the past few months. This inability of the transports to get above this level suggests at the very minimum the economy’s recovery path is being called into question.

“Technically the index is currently testing the lower end of its upward sloping channel (green line). While in the short run the index may find a shallow bounce from this level, the failure twice now at a key resistance level is the greater trump card.

“The burden of proof now rests on the transport bulls and the index is an underweight sector that we expect to continue to underperform until it can work above resistance.”

Regarding the S&P 500 Index, Adam Hewison (INO.com) sounded a cautious note as explained in one of his popular technical analysis presentations. Click here to access the presentation.

Source: Kevin Lane, Fusion IQ, October 27, 2009.

Tags: Amp, Bounce, Bulls, Burden Of Proof, Cautious Note, Dow Jones, Dow Jones Transportation, Failure, Fatigue, Fusion, Ino, Iq, October 27, Presentation Source, Recovery Path, Resistance Level, Stock Markets, Transportation Average, Transports, Trump Card
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David Rosenberg: Stocks Overvalued by at Least 20%

Thursday, October 29th, 2009

The stock market has become overheated since exploding off its March lows and could be in for a strong correction, economist David Rosenberg told CNBC.

“It is overvalued by at least 20%,” Rosenberg, formerly chief economist at Merrill Lynch and now with Gluskin Sheff & Associates, said in an interview. “But it comes down to what your view in corporate earnings (is) going to be. By the time you’re up 60% from any egregiously oversold low, you’ve already got the earnings recovery.”

Source: CNBC, October 27, 2009.

Tags: Amp, Chief Economist, Cnbc, Corporate Earnings, David Rosenberg, Gluskin Sheff, Lows, Merrill Lynch, October 27, Stock Market, Stocks
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Bill Gross: Investment Outlook (October 2009)

Thursday, October 29th, 2009

Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the shrewdest money men around. His monthly newsletter, this month entitled “Midnight Candles”, therefore always makes for thought-provoking reading.

He concludes the newsletter as follows:

“Asset appreciation in US and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates.

“But while this may support asset prices - including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get.

“Broadening the concept to the US bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and ‘old normal’ market standards. Not likely, and the risks outweigh the rewards at this point.

“Investors must recognize that if assets appreciate with nominal GDP, a 4-5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets - while still continuously supported by Fed and Treasury policymakers - is likely at its pinnacle. Out, out, brief candle.”

Click here for the full article.

Source: Bill Gross, PIMCO - Investment Outlook, November 2009.

Tags: Asset Appreciation, Asset Prices, Bill Gross, Bond Investors, Central Banks, Chinese Currency, Commercial Real Estate, Gross Co, Gross Investment, High Yield Bonds, Inevitable Conclusion, Investment Grade, Investment Outlook, Maturities, Money Men, Nominal Gdp, PIMCO, Rage Rage, Treasury Bills, Us Bond Market
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Weak dollar is protectionist barrier, says Bill Gross

Thursday, October 29th, 2009

The dollar is likely to continue depreciating and the “new normal” will see consumers shedding debt in an attempt to balance their books, Bill Gross, the influential manager who runs top bond fund Pimco, told CNBC Wednesday.

“I think the dollar is an over-owned currency. The Chinese, the Asians have basically owned too many dollars for too long,” Gross told “Squawk Box”.

The government has increased borrowing and this will make the dollar “more and more owned and less and less desirable” but this is necessary for balancing the world economy, as it may result in higher production in the US and lower production in China.

Source: CNBC, October 28, 2009.

Tags: Asians, Bill Gross, Bond Fund, Books, China, Cnbc, Consumers, Currency, Dollar Bill, Emerging Markets, PIMCO, Squawk Box, Weak Dollar, World Economy
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Stocks and risky assets stumble

Thursday, October 29th, 2009

I concluded a post on stock markets over the weekend saying: “After equities’ seven-month climb, stock markets certainly look vulnerable for a decline. Two downside reversal days - on Wednesday and Friday - would seem to indicate that stocks could commence a pullback to work off the overbought condition, allowing fundamentals to reassert themselves.”

Global stock markets, as well as other risky assets, closed sharply lower over the past few days as concerns mounted over the sustainability of the global economic recovery and the outlook for central bank policy.

The performance of the major asset classes is summarized by the charts below, with the top one showing the period from the March 9 stock market lows until October 19 peak and the second one the subsequent period. The numbers indicate an all-change pattern in the performances as risk aversion re-entered financial markets and government bonds and the US dollar regained some favor.

Source: StockCharts.com

Source: StockCharts.com

A summary of the movements of major global stock markets since the March 19 peak, as well as various other measurement periods, is given in the table below.

The MSCI World Index and the MSCI Emerging Markets Index have declined by 5.3% and 6.2% respectively since the highs of October 19, with markets like Ireland (‑13.2%), Brazil (-10.5%), Austria (-10.8%) and Belgium (-9.0%) falling by significantly more. Also, higher risk indices such as small caps have borne the brunt of the selling, with the Russell 2000 Index down by 9.0%. This is a pattern that one would expect as investors shift the emphasis to higher quality.

Click here or on the table below for a larger image.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based) are given in the table below. A number of indices, including the S&P 500 Index, have fallen below their 50-day moving averages over the past few days, but all the indices are still holding above their respective 200-day moving averages. The 50-day lines are also above the 200-day lines in all instances.

The October lows are also given in the table as a break below these levels would indicate a reversal of the uptrend since March, i.e. reversing the progression of higher reaction lows.

Click here or on the table below for a larger image.

Over the past few days a number of commentators have made pronouncements about the extent of a possible decline. For example, Jeremy Grantham (GMO) expects the S&P 500 to drop by 15% to 25%, David Rosenberg (Gluskin Sheff & Associates) sees markets falling by 20% and Doug Kass is looking at -5% to -12%.

This brings me to the topic of valuations. Based on operating earnings (i.e. stripping out everything that is bad), the historical price/earnings (PE) multiple of the S&P 500 is 27.0; using “as reported” (GAAP) earnings the figure shoots up to a giddy 95.7! Getting past the loss-making fourth quarter of 2008 and calculating prospective multiples through December 31, 2009 reduce the valuations to 19.0 and 24.4 respectively. Looking further out to the end of 2010, the prospective PEs are 14.1 and 22.9 respectively - still hardly the type of valuations that will inspire one to be a buyer across the board. (The earnings estimates are courtesy of Standard & Poor’s.)

Another way of looking at valuation levels, and cutting through the uncertainty of having to forecast earnings, is by means of Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE), effectively muting the impact of the business cycle by averaging ten years of earnings. Using rolling ten-year reported earnings, my research (based on Shiller’s methodology, but including some refinements) shows that the “normalized” price-earnings ratio of the S&P 500 Index is currently 18.7. This compares with a long-term average of just more than 16.3 and implies an overvaluation of 15%. Considering a geometric rather than an arithmetic average of earnings, the overvaluation increases to 25%. The graphs below show data since 1950, but the actual calculations date back to 1871

Meanwhile, David Rosenberg highlights that this is not the onset of a sustainable secular bull market as we had coming off the fundamental lows of prior bear phases, such as August 1982, when:

• Dividend yields were 6%, not sub-2%.

• Price-to-earnings multiples were 8x, not 27x.

• The market traded at book value, not more than twice book.

• Inflation and bond yields were in double digits and headed down in the future, not near-zero and only headed higher.

• The stock market competed with 18% cash rates, not zero, and as such had a much higher hurdle to clear.

• Sentiment was universally bearish; hardly the case today.

• Global trade flows were in the process of accelerating as barriers were taken down; today, we are seeing trade flows recede as frictions, disputes and tariffs become the order of the day.

• A Reagan-led movement was afoot to reduce the role of government with attendant productivity gains in the future, as opposed to the infiltration by the public sector into the capital markets, union sector, economy and of course, the realm of CEO compensation.

Back to charting, Adam Hewison (INO.com) also sounded a cautious note on the outlook for the S&P 500 as explained in one of his popular technical analysis presentations. Click here to access the presentation.

I conclude with a comment from David Fuller (Fullermoney) who said: “At this stage of the bull cycle, I think a correction of approximately 10-15% for developed country stock markets and somewhat more for emerging markets would be good news for investors with cash to invest. Such a mean reversion towards rising 200-day moving averages would blow the recent froth off valuations and stem talk of an early change in monetary policy.”

I will bide my time while the fundamentals play catch-up. Meanwhile, caution remains the operative word.

Tags: Asset Classes, BRIC, Bric Countries, Brunt, Downside, Economic Recovery, Emerging Markets, Financial Markets, Global Stock Markets, Government Bonds, Lows, Moving Averages, Msci Emerging Markets, Msci Emerging Markets Index, Msci World Index, October 19, Pullback, Risk Aversion, Risky Assets, Russell 2000 Index, Small Caps, Stock Market
Posted in Emerging Markets, Markets | No Comments »