Getting, Keeping, Losing! (Saut)

Wednesday, June 30th, 2010

This arti­cle is a guest con­tri­bu­tion from Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James.

“... great for­tunes are not insu­lated from risk: The same tides of eco­nomic change and progress that were cre­at­ing these new for­tunes were also destroy­ing old ones. Since 1982 the eco­nomic and tech­no­log­i­cal progress unleashed by supply-side poli­cies has ousted some 60% of the incum­bent tycoons from the Forbes Four Hundred.

There are, basi­cally, two kinds of wealth: tan­gi­ble and finan­cial. Tan­gi­ble assets already exist: real estate, build­ings, min­eral deposits, farm­land, works of art, stock­piles of com­modi­ties, wares of the past. Finan­cial assets con­sist­ing of stocks, bonds, and other secu­ri­ties rep­re­sent not so much tan­gi­ble wealth as a pledge of future production.

... The cycles between these two forms of wealth respond to pub­lic pol­icy. Times of infla­tion and high taxes favor exist­ing wealth over new wealth, tan­gi­ble assets over finan­cial assets, col­lectible cap­i­tal over pro­duc­tive cap­i­tal. Tan­gi­bles tend to yield a rel­a­tive untax­able flow of ben­e­fits; hous­ing jew­elry, art and leisure mostly untax­able returns. Secu­ri­ties tend to yield a tax­able and inflat­able flow of income on a prin­ci­pal that dis­solves with the decline of currency.

Put it this way: Finan­cial assets do best in times of low infla­tion­ary growth. Hard assets do best in times of high infla­tion and high taxes.”

... The Slip­pery Slope of Wealth, George Gilder

“Get­ting, Keep­ing, Los­ing” is the title of the afore­men­tioned quote and it is cer­tainly con­sis­tent with one of my New Year’s res­o­lu­tions, for as we entered 2010 one of my main mantras has been to try and “keep the prof­its accrued since the March 2009 bot­tom.” As touched on in last week’s let­ter, there are cur­rently two major ques­tions rag­ing on Wall Street – is this a new bull mar­ket; or, is what we have expe­ri­enced over the last 15 months just a rally in an ongo­ing sec­u­lar bear mar­ket? For­tu­nately, sec­u­lar bear mar­kets are rather uncom­mon. More com­mon are broad trading-range mar­kets punc­tu­ated by numer­ous tac­ti­cal bull and tac­ti­cal bear mar­kets. For exam­ple, in 1966 the D-J Indus­trial Aver­age (DJIA) first approached 1000. By 1982 the DJIA was still hov­er­ing near 1000. Yet, over that 16-year time period there were 13 rallies/declines of more than 20% (see the nearby chart).

As often stated, since the Dow The­ory “sell sig­nal” of Sep­tem­ber 1999 I have sug­gested the equity mar­kets were likely going to be in a trad­ing range pat­tern sim­i­lar to the 1966 – 1982 affair. Clearly, that is what has occurred over the last 10 years. Most recently, the 54% slide from The Dow’s Octo­ber 2007 peak into its March 2009 low has been fol­lowed by a 70%+ rally that ended in April of this year. Sub­se­quently, the senior index expe­ri­enced it first double-digit decline since the March 2009 bot­tom, ush­er­ing in cries of “the bear mar­ket rally is over!” To me, how­ever, all that’s tran­spired is another decline within the con­text of the broad trad­ing range the Dow has been in since the turn of the cen­tury. Nev­er­the­less, I must admit I am con­cerned because a Dow The­ory “sell sig­nal” was reg­is­tered dur­ing the recent decline. Accord­ingly, I am back in a cau­tious mode, which is why invest­ment accounts should have some cash, while trad­ing accounts should be rel­a­tively “flat.”

I also have to admit I am wor­ried about the weak­en­ing eco­nomic reports. To be sure, the num­ber of eco­nomic indi­ca­tors sur­pris­ing to the down­side is about equal to those sur­pris­ing on the upside. Accord­ing to the astute Bespoke Invest­ment Group, “Of the eleven eco­nomic indi­ca­tors released last week, only six came in ahead of expec­ta­tions, while five sur­prised to the down­side.” One of those down­side sur­prises was Wednesday’s shock­ingly weak New Home Sales, which inked the weak­est read­ing since the sta­tis­tics began in 1963. That said, I don’t think hous­ing is going to spin the econ­omy into another reces­sion, because going from 1.5 mil­lion hous­ing starts to 400,000 is plainly impact­ful. But, going from 400,000 to 300,000, well who cares? To me par­tic­i­pants should be much more ner­vous about the sharp decline in the Eco­nomic Cycle Research Institute’s (ECRI) weekly lead­ing eco­nomic index (see the atten­dant chart). Read­ers of these mis­sives should recall I often ref­er­enced this index as proof of the eco­nomic recov­ery when the index was ramp­ing at its sharpest rate in his­tory. Regret­tably, it is now declin­ing at one of its sharpest rates (see chart).

While I am indeed con­cerned about the ECRI’s weekly index of lead­ing indi­ca­tors, it should be noted that while the ECRI Index has been an excel­lent pre­dic­tor of the econ­omy, it has NOT been very accu­rate in pre­dict­ing the stock market’s direc­tion. Still, given the Dow The­ory “sell sig­nal,” the inter­me­di­ate “sell sig­nal” reg­is­tered by my pro­pri­etary trad­ing indi­ca­tor, and the “hook down” in the monthly sto­chas­tic indi­ca­tor (all of which can be seen in last week’s let­ter), I have no choice but to be cau­tious until cir­cum­stances change. I am also watch­ing the inter­re­la­tion­ship between the S&P 500’s 50-DMA (@1128) and its 200-day mov­ing aver­age (@1112). If the 50-DMA crosses below the 200-DMA, it would be a fur­ther cau­tion­ary signal.

Tags: Bear Markets, Chief Investment Strategist, Commodities, Economic Change, Financial Assets, George Gilder, jeffrey saut, Jewelry Art, Mantras, Mineral Deposits, New Wealth, Productive Capital, Raymond James, Secular Bear Market, Slippery Slope, Stocks Bonds, Tangible Assets, Tangible Wealth, Tangibles, Technological Progress, Tycoons
Posted in Bonds, Commodities, Markets | Comments Off

ECB Shuts off Liquidity, Spanish Banks Scream Murder; Spain and Greece Will Both Default

Wednesday, June 30th, 2010

This arti­cle is a guest con­tri­bu­tion by Mike Shed­lock, Global Eco­nomic Trends Analy­sis.

For just under a year, the ECB has offered €442 bil­lion to encour­age lend­ing. Instead, and eas­ily pre­dictable, the pro­gram did not increase lend­ing and did noth­ing more than allow weak banks to roll over debts.

The pro­gram is now end­ing and Span­ish banks are scream­ing about the ECB's "oblig­a­tion to sup­ply liquidity".

The Wall Street Jour­nal has part of the story in ECB Walks a Fine Line Siphon­ing Off Its Liq­uid­ity.

The Euro­pean Cen­tral Bank is scram­bling to reas­sure mar­kets that Thursday's expi­ra­tion of a €442 bil­lion ($547.46 bil­lion) bank-lending pro­gram won't desta­bi­lize the finan­cial sys­tem, even as banks across the region remain wary of lend­ing to one another.

The ECB intro­duced the 12-month lend­ing facil­ity last sum­mer to encour­age private-sector lend­ing and ensure ade­quate liq­uid­ity within the 16-member cur­rency bloc. Since then, the pro­gram, which rep­re­sents more than half the ECB's liq­uid­ity oper­a­tions, has become a life­line to banks in Greece, Spain and other coun­tries hit by the region's debt crisis.

The cost of bor­row­ing euros in the inter­bank mar­ket rose to an eight-month high Mon­day, as banks pre­pared for the one-year loan's expi­ra­tion. The euro slid on wor­ries that repay­ment will expose Europe's finan­cial sys­tem to new threats. Yields on Ger­man bunds, seen as a haven, fell.

Some investors worry that vul­ner­a­ble euro-area banks, unable to bor­row in the inter­bank mar­ket, could have dif­fi­culty replac­ing that fund­ing, despite repeated assur­ances from the ECB that it will pro­vide funds on sim­i­lar terms, albeit for only three months, begin­ning Wednesday.

"We are con­fi­dent that this very large finan­cial trans­ac­tion can take place with­out dis­rup­tions," ECB gov­ern­ing coun­cil mem­ber Ewald Nowotny said Friday.

Tags: Adequate Liquidity, Assurances, Banks In Greece, Bunds, Council Member, Debt Crisis, Disruptions, ECB, Ewald, Financial Transaction, Global Economic Trends, Governing Council, Interbank Market, Lifeline, Mike Shedlock, Nowotny, Scream Murder, Spanish Banks, Wall Street Journal, Whine
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James Grant: Recovery's Surprising Strength Will "Jar" People

Wednesday, June 30th, 2010

The fol­low­ing is a tran­script of a Wealth­Track inter­view with James Grant, esteemed edi­tor and pub­lisher of Grant's Inter­est Rate Observer. In this must read/view, Grant argues that today's pes­simism is over­done and believes the econ­omy will recover sur­pris­ingly strongly, and will jar peo­ple. He also dis­cusses his thoughts on gold and invest­ing in gen­eral, and shares a few ideas, mak­ing for a thought pro­vok­ing read.

CONSUELO MACK: This week on Wealth­Track, why bal­loon­ing gov­ern­ment debt, the dimin­ish­ing value of the dol­lar, and the ris­ing trea­sure of gold are all on the mind of con­trar­ian James Grant, the edi­tor of Grant’s Inter­est Rate Observer. This finan­cial thought leader is next on Con­suelo Mack WealthTrack.

Hello and wel­come to this edi­tion of Wealth­Track. I’m Con­suelo Mack. “Those who can­not learn from his­tory are doomed to repeat it.” Eight decades ago, the Dow Jones Indus­trial Aver­age plum­meted over four trad­ing days, dubbed ever since as black: Black Thurs­day, Octo­ber 24th, 1929; Black Fri­day, Octo­ber 25th; Black Mon­day, Octo­ber 28th; and Black Tues­day, Octo­ber 29th. Their cumu­la­tive 25% Dow decline would deepen to 90% by the time the mar­ket hit bot­tom in July of 1932. It then took until 1954, another 25 years, for the Dow to reach its pre-1929 lev­els. What rel­e­vance do these events of eight decades ago have today, con­sid­er­ing the Dow is trad­ing far above its March 2009 low?
This week’s Wealth­Track guest is an excel­lent stu­dent of the past, who pays par­tic­u­lar atten­tion to the forces that peri­od­i­cally buf­fet the world econ­omy and mar­kets: bub­bles and busts, loose and tight credit, expand­ing and con­tract­ing debt, ram­pant spec­u­la­tion, and extreme mood swings from eupho­ria to pes­simism and back.

He is James Grant, edi­tor of the biweekly newslet­ter Grant’s Inter­est Rate Observer, a self-described inde­pen­dent, value-oriented and contrary-minded jour­nal of the finan­cial mar­kets. A finan­cial thought leader, Jim is one of Wall Street’s most astute, eru­dite and artic­u­late observers. He is also the author of six books includ­ing a won­der­ful biog­ra­phy of the nation’s sec­ond pres­i­dent titled John Adams: Party of One and his most recent Mr. Mar­ket Mis­cal­cu­lates: The Bub­ble Years and Beyond . In an inter­view con­ducted last Octo­ber, before GDP sta­tis­tics con­firmed the U.S econ­omy expand­ing well above the pace pre­dicted by most econ­o­mists, I asked Jim why he, a noto­ri­ous glass half-full kind of guy, had recently gone from eco­nomic bear to bull
How zippy is the recovery?

JAMES GRANT: Pretty darn zippy. The finest expres­sion was that of a long deceased econ­o­mist named Pigou, a Brit actu­ally, sounds French, who said that the error of opti­mism dies in the cri­sis; it is fol­lowed by the era of pes­simism, which is born not an the infant but a giant. Which is a won­der­ful expres­sion of the human ten­dency to overdo it. So all of the new era cats find out that they didn’t get the memo. They were all wrong. There was in fact a debt prob­lem. It burst in their faces. What they do now? They are dis­con­so­late, they incon­solable.
Noth­ing like this has been seen in the his­tory of the world, the patient will not live sadly. So it’s like that. And espe­cially they overdo it on the down­side and I think that goes for our esteemed gov­ern­ment, espe­cially the Fed, which not only didn’t see it com­ing but also didn’t com­pre­hend it once it splat­tered all over its face like a cream pie.

CONSUELO MACK: How robust do you think the recov­ery will be?

JAMES GRANT: I think it’s going to sur­prise to the upside and so old am I, Con­suelo, I’m not going to give a num­ber, nor am I going to give a date, but I think that it’s going to be sur­pris­ingly strong. The con­sen­sus is for next year to gen­er­ate growth in our gross domes­tic prod­uct of about 2.5% after adjust­ment for price fluc­tu­a­tions. I expect it will be much bet­ter than that. Cer­tainly for a cou­ple of quar­ters which I think will jar peo­ple– they’ll say, wait, that was an unau­tho­rized, who said they could do that? And you can see some of this in the mak­ing. The earn­ings call recently from Cater­pil­lar fea­tured the infor­ma­tion that the deal­ers had run down their stocks to half of the usual and if they were only to restock to the lit­tle bit of the nor­mal, there would be a big sales boom and CAT was kind of ven­tur­ing that not implau­si­ble out­come next year would be growth of more than 10%. And I could see that through­out the econ­omy, and peo­ple are expect­ing much, much less.

I think that the wis­est course for investors is to heed the advice from the scrip­ture of value invest­ing, the Gra­ham and Dodd idea that we can not know the future, there­fore seek a mar­gin of safety in invest­ments in the present. That is to say, we can’t know really what’s going to hap­pen in 2010, let alone 2017, but we can observe two things. We can observe the oppor­tu­ni­ties that are in front of us, in the secu­ri­ties as they are now priced, and two, impor­tantly, they didn’t say this but I will, you can observe how the world is posi­tion­ing itself for an expected outcome.

Tags: Bill Gross, Biweekly Newsletter, Black Friday, Black Monday, Black Thursday, Black Tuesday, BRIC, BRICs, Canadian Market, China, Consuelo Mack, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Editor And Publisher, ETF, ETFs, Extreme Mood Swings, Gold, Gold Bullion, Independent Value, India, Interest Rate Observer, James Grant, Oil Sands, Rampant Speculation, Thought Leader, Tight Credit, Treasure Of Gold, Wealthtrack, World Economy
Posted in Bonds, Canadian Market, China, Emerging Markets, Energy & Natural Resources, ETFs, Gold, India, Markets, Oil and Gas | Comments Off

The Outlook for Natural Gas (Fred Sturm)

Wednesday, June 30th, 2010

Fred Sturm, Exec­u­tive Vice Pres­i­dent & Chief Invest­ment Strate­gist, Macken­zie Invest­ments dis­cusses the out­look for global nat­ural resources.

Source: ClientInsights.ca

Tags: Chief Investment Strategist, Commodities, energy, Executive Vice, Fred Sturm, Investments, Mackenzie, Natural Gas, Natural Resources, Outlook, Vice President
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Technical Talk: S&P 500 hovering above key support

Wednesday, June 30th, 2010

The com­ments below were pro­vided by Kevin Lane of Fusion IQ.

Stocks closed last week on a mod­est pos­i­tive note as the S&P 500 fin­ished with its first pos­i­tive close after four straight los­ing ses­sions. The S&P 500 Index is now hov­er­ing not far above key near-term sup­port in the 1,041 area (see chart below). In the short run the index may see an over­sold bounce after the four days of sell­ing. How­ever, the inabil­ity of the pre­vi­ous rally to mate­ri­al­ize into any­thing sub­stan­tial and then to so quickly retreat cer­tainly make us skep­ti­cal of the bulls.

That said, the trad­ing range on the S&P 500 is fairly wide and only a vio­la­tion of sup­port near 1,041 would turn the big­ger pic­ture more neg­a­tive. Mar­ket inter­nals were mod­estly pos­i­tive on Fri­day and in line with the mar­ginal advance. How­ever, new lows con­tinue to creep up on a consis­tent basis and bear watch­ing. Mar­ket volatil­ity also popped back into the pic­ture last week as traders played hot potato with stocks. This is in stark con­trast to ear­lier in the year when traders were more likely to buy and be patient.

As seen in the chart above the S&P 500 is range bound between the 1,041 (upper orange line) and 1,142 (lower red line) lev­els. Momen­tum as high­lighted by the 14-week RSI is in a weak­ened state as well. Given the S&P 500 has now tested this 1,041 level on three sep­a­rate occa­sions − Feb­ru­ary 2010, May 2010 and June 2010 − any addi­tional test would increase the like­li­hood of a break.

Only a move back above the 100-day mov­ing aver­age (1,133 level and not seen in the chart above) above which the S&P 500 recently tried to rally, and failed, would turn the short-term trend positive.

Source: Kevin Lane, Fusion IQ, June 28, 2010.

Tags: Bounce, Bulls, Hot Potato, Iq, Likelihood, Lows, Market Volatility, Momentum, Moving Average, Occasions, Orange Line, Rally, Red Line, Rsi, Sessions, Stark Contrast, Stocks, Tent, Term Trend
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Ferguson, Roubini vs. Krugman: Slowdown or Depression for The U.S.?

Wednesday, June 30th, 2010

Paul Krugman, a strong sup­porter of fiat money, is obvi­ously hav­ing a major dis­tress over the G20 push to cut deficits in half by 2013, and sta­bi­lize the soar­ing U.S. debt.  In his lat­est New York Times col­umn, Krug­man not only crit­i­cizes aus­ter­ity mea­sures, but also asserts that we are in the early stages of a third depres­sion as a direct result of the spend­ing cut.

Per­haps because Krug­man beat him to the punch with this ulti­mate Dooms­day op-ed piece, on this very rare occa­sion, Dr. Doom–Nouriel Roubini–is actu­ally a lot more opti­mistic about the econ­omy in the United States when he spoke with CNBC last night. (watch the clip here.)

Roubini — No Reces­sion in The U.S.

In The Kud­low Report, Roubini says he does not see a double-dip reces­sion in the U.S.  Rather, the U.S. will expe­ri­ence a slow­down of around 1.5% GDP in the sec­ond half of this year, after grow­ing 3% in the first half, he says.

At the same time, keeping up with his Dr. Doom rep­u­ta­tion, Roubini does see a reces­sion com­ing in the euro zone and Japan.  There is a risk of a con­ta­gion effect to the U.S., which could lead to fur­ther cor­rec­tion in stock prices with a double-dip in Europe, Japan "falling off the cliff", and evi­dence of a slow­down in China.

Meet­ing Krug­man sort of halfway, Roubini thinks fis­cal aus­ter­ity is needed in Greece, Spain and Por­tu­gal, whereas coun­tries like Ger­many, Japan, China, should be doing fis­cal stimulus.

Fer­gu­son Wor­ries about Europe Banks & U.S. Fiscal

Roubini's view is also shared by Har­vard Uni­ver­sity professor–Niall Ferguson–who told CNBC in a sep­a­rate inter­view that

"Right now the pic­ture is def­i­nitely bleaker in Europe than it is in the US....I agree with Nouriel on this, it's not as if the US econ­omy will con­tract, it will grow at a slower rate."

In addi­tion to the debt woes in Europe, Fer­gu­son is "nervous" about Euro­pean banks, which were more lever­aged than US banks.  He noted the Euro­pean gov­ern­ments do not have "very deep pock­ets" as most peo­ple have assumed, and Greek cri­sis revealed the limit of this largesse.

Even though com­pared with the euro zone, the eco­nomic pic­ture in the U.S. does look rel­a­tively better; Ferguson said the hor­ren­dous fis­cal sit­u­a­tion means the US is likely to be faced with tough mea­sures to cut the deficit over the longer term.

My Take - Dif­fi­cult Bal­anc­ing Act

Based on my bifla­tion analy­sis, I believe the risk of defla­tion, not to men­tion depres­sion, is highly overstated.  As such, I don't see the U.S. going into another reces­sion either, albeit slow and ane­mic growth into 2011 or 2012.

On the other hand, the U.S. deficit sit­u­a­tion; how­ever, is not some­thing that may be rec­ti­fied by more  spend­ing as sug­gested by Krugman.

Bloomberg's chart pub­lished on June 4 (below) shows the U.S. government’s total debt, which rose past $13 tril­lion for the first time this month, will sur­pass GDP in 2012, based on fore­casts by the Inter­na­tional Mon­e­tary Fund (IMF).

In a report for the Toronto sum­mit, the IMF sug­gests "growth-friendly" poli­cies such as shift­ing from income and pay­roll taxes to con­sump­tion taxes. In the United States, that might mean adopt­ing a value-added tax (VAT) of up to 8% on all goods and services.

Tags: Austerity Measures, China, Cnbc, Contagion Effect, Debt Woes, Double Dip Recession, Dr Doom, Euro Zone, European Banks, Fiat Money, Fiscal Austerity, Fiscal Stimulus, Germany Japan, Harvard University Professor, Japan China, Kudlow, Niall Ferguson, Nouriel Roubini, Rare Occasion, S Paul, Stock Prices
Posted in Bonds, China, Markets | Comments Off

Will We Have Inflation, Deflation, or Hyperinflation? Part 4 (Final)

Tuesday, June 29th, 2010

By Jeff Hard­ing, Daily Cap­i­tal­ist, on June 29th, 2010

The First three parts are avail­able here:

Part 1 | Part 2 | Part 3

This is is the final part of my four part arti­cle that deals with what I feel is the pri­mary ques­tion investors must now answer: is our future to be infla­tion or defla­tion? The answer has vast impli­ca­tions to our invest­ment plan­ning and deci­sions for the near term, and pos­si­bly for our long term. It is a very com­plex ques­tion with a lot of mov­ing parts involv­ing eco­nom­ics and politics.

Like it or not, it is eco­nomic the­ory that is dri­ving macro­eco­nomic poli­cies and polit­i­cal deci­sions that deter­mine whether we will have infla­tion or defla­tion. Since not all of my read­ers are sophis­ti­cated traders I have tried to present the issues in a direct and hope­fully under­stand­able way. To those sophis­ti­cated read­ers, please bear with me.

Part 4 of 4

What is Money Sup­ply Doing Now?

Money sup­ply will tell you if we are headed for infla­tion or defla­tion. If we look at the rates of change of M1 or Aus­trian True Money Sup­ply (TMS), they are declin­ing. In fact, M1 and TMS appears to have peaked in 2009 and have been declin­ing on a year-over-year basis ever since. On an absolute basis, as shown pre­vi­ously, M1 growth is flat­ten­ing. These two charts below show the year-over-year per­cent­age change in money supply.

What Will the Fed’s Options be in a Double-Dip Eco­nomic Decline?

This is the main point. If, as I have been say­ing, the econ­omy declines in the sec­ond half of 2010, what will the Fed do?

Let me paint a sce­nario. In any sce­nario with declin­ing eco­nomic growth, unem­ploy­ment will rise. If unem­ploy­ment at the nar­row­est mea­sure is now 9.7% and at the broad­est mea­sures (U-6) is 16.9%, ris­ing unem­ploy­ment will become polit­i­cally unac­cept­able to the Obama Administration.

Tags: Absolute Basis, Capitalist, Double Dip, Economic Decline, Economic Growth, Economic Theory, Gold, Hyperinflation, Inflation Deflation, Investment Planning, Jeff Harding, M1, Macroeconomic Policies, Money Supply, Moving Parts, Paul Krugman, Percentage Change, Political Decisions, Sophisticated Readers, Sophisticated Traders, Stimulus, True Money
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Is Gold in a Bubble?

Tuesday, June 29th, 2010

Many “experts” remain skep­ti­cal about the per­for­mance of gold bul­lion and often con­tend gold is in a bub­ble. The chart below, cour­tesy of Casey’s Daily Dis­patch, casts some light on whether the bar­barous relic is dis­play­ing bub­ble char­ac­ter­is­tics. You be the judge …

Source: Casey’s Daily Dis­patch, June 23, 2010.

Mean­while, from across the pond, David Fuller (Fuller­money) com­mented as fol­lows: “… my guess is that we may be no more than approx­i­mately halfway through gold bullion’s sec­u­lar bull mar­ket. I remain some­what cau­tious about gold’s short-term out­look but I am a long-term bull.”

Stick around – there is no fever like gold fever!

Tags: Barbarous Relic, Casey, Daily Dispatch, David Fuller, Fullermoney, Gold, Gold Bullion, Gold Chart, Gold Fever, Guess, June 23, Secular Bull Market, Term Outlook
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Not Much Out of the G20 (Rosenberg)

Tuesday, June 29th, 2010

This arti­cle is a guest con­tri­bu­tion by David Rosen­berg, Gluskin Sheff.

Much of the pledges made are stan­dard fare. The key take­away is the acknowl­edg­ment of fis­cal restraint, which will be the dom­i­nant macro theme for at least the next three years. This con­fab was in stark con­trast to the pro-growth stim­u­lus theme of a year ago. No men­tion of cur­ren­cies in the after­math of the Chi­nese announce­ment to revalue; at least moderately.

All in, the stress on fis­cal con­sol­i­da­tion implies the need for pol­icy rates to remain at ultra-low lev­els for a pro­longed period of time. This in turn lim­its the chance of any sus­tained rise in gov­ern­ment bond yields.

In terms of any goals estab­lished, there is an objec­tive to shave fis­cal deficits in half by 2013, and to sta­bi­lize debt-to-GDP ratios with a 2016 dead­line. But spe­cific time­lines are at the dis­cre­tion of each gov­ern­ment. Ditto on the issue of bank taxes and global finan­cial regulations.

“THE THIRD DEPRESSION”

That is the title of today’s spir­ited col­umn by Paul Krug­man in the NYT’s edi­to­r­ial sec­tion. His argu­ments can be debated as we are sure the entire Aus­trian school (along with Robert Barro) would take him to task on the effi­cacy of even more gov­ern­ment intru­sion at this point. How­ever, Krugman’s view on what this cycle is all about is right on the mark: a defla­tion­ary depres­sion. In our view, the best med­i­cine from gov­ern­ments is to pre­vent credit bub­bles from occur­ring in the first place – it’s not as if the U.S. didn’t have warn­ing signs once Fan­nie and Fred­die mor­phed into de facto hedge funds. In any event, here are some snip­pets from the Krug­man piece that the perma-bulls should con­sider (espe­cially with the con­sen­sus still north of $96 on 2011 EPS projections):

“Reces­sions are com­mon; depres­sions are rare. As far as I can tell, there were only two eras in eco­nomic his­tory that were widely described as “depres­sions” at the time: the years of defla­tion and insta­bil­ity that fol­lowed the Panic of 1873 and the years of mass unem­ploy­ment that fol­lowed the finan­cial cri­sis of 1929–31.”

“We are now, I fear, in the early stages of a third depres­sion ... pri­mar­ily by a fail­ure of policy.”

“There is no evi­dence that short-run fis­cal aus­ter­ity in the face of a depressed econ­omy reas­sures investors. On the con­trary: Greece has agreed to harsh aus­ter­ity, only to find its risk spreads grow­ing ever wider; Ire­land has imposed sav­age cuts in pub­lic spend­ing, only to be treated by the mar­kets as a worse risk than Spain, which has been far more reluc­tant to take the hard-liners’ medicine.”

“The Fed seems aware of the defla­tion­ary risks — but what it pro­poses to do about these risks is, well, noth­ing. The Obama admin­is­tra­tion under­stands the dan­gers of pre­ma­ture fis­cal aus­ter­ity — but because Repub­li­cans and con­ser­v­a­tive Democ­rats in Con­gress won’t autho­rize addi­tional aid to state gov­ern­ments, that aus­ter­ity is com­ing any­way, in the form of bud­get cuts at the state and local levels.”

“In the face of this grim pic­ture, you might have expected pol­icy mak­ers to real­ize that they haven’t yet done enough to pro­mote recov­ery. But no: over the last few months there has been a stun­ning resur­gence of hard-money and balanced-budget orthodoxy.”

“... both the United States and Europe are well on their way toward Japan-style defla­tion­ary traps.”

As we said before, this is a pow­er­ful indict­ment against the cur­rent pol­icy stance. But many other enti­ties do not share Mr. Krugman’s view, or that more gov­ern­ment inter­ven­tion will do much good. The BIS (Bank for Inter­na­tional Set­tle­ments) just pub­lished a report that came to dif­fer­ent pol­icy con­clu­sions (cited in today’s FT):

“A pro­gramme of fis­cal con­sol­i­da­tion – cut­ting deficits by sev­eral per­cent­age points of GDP over a num­ber of years – would offer sig­nif­i­cant ben­e­fits of low and sta­ble long-term inter­est rates, a less frag­ile finan­cial sys­tem and, ulti­mately, bet­ter prospects for invest­ment and long-term growth.

Tags: Austrian School, Best Medicine, Bond Yields, BRIC, BRICs, Canadian Market, Confab, David Rosenberg, Deflationary Depression, Economic History, Editorial Section, Fiscal Consolidation, Fiscal Deficits, Fiscal Restraint, G20, Government Bond, Government Intrusion, Nyt, Paul Krugman, Prolonged Period, Recessions, Robert Barro, Warning Signs
Posted in Bonds, Canadian Market, Emerging Markets, Markets, US Stocks | Comments Off

The Great Divergence

Tuesday, June 29th, 2010

This arti­cle is guest con­tri­bu­tion by Bill Hes­ter, CFA, Huss­man Funds.

For a brief period dur­ing the last decade the devel­oped economies around the world became one. Coun­tries shared sim­i­lar fis­cal poli­cies, inter­est rate poli­cies, and spend­ing pat­terns which resulted in unchar­ac­ter­is­ti­cally sim­i­lar eco­nomic per­for­mances. Investors took their cues from these trends and sent finan­cial mar­ket secu­ri­ties con­verg­ing in price and yield. The range of bond yields tight­ened, the level of val­u­a­tions became closely aligned, and trail­ing stock returns were remark­ably sim­i­lar. As the devel­oped economies con­tinue to recover from the world-wide credit cri­sis, and now face new pres­sures of over-levered sov­er­eign bal­ance sheets and the prospects for below-average eco­nomic growth, investors should expect finan­cial mar­ket per­for­mance among coun­tries to con­tinue to diverge.

The con­ver­gence of finan­cial mar­ket per­for­mance that began in the sec­ond half of the 1990's – both in the bond and equity mar­kets – was helped by three major forces. The first was the trail­ing effects of the period of The Great Mod­er­a­tion. Eco­nomic cycles stretched out and mod­er­ated dur­ing the 1990's and early 2000's, not only in the US but in most of the major Euro­pean economies as well. Eco­nomic growth sta­bi­lized, infla­tion sub­sided, and exoge­nous shocks were fewer and came with less impact so investors pushed bond yields lower and stock prices higher on an expec­ta­tion that the mod­er­a­tion would con­tinue. The sec­ond trend fuel­ing the con­ver­gence in finan­cial mar­ket per­for­mance was very strong world-wide growth. World GDP grew at an aver­age rate of nearly 5 per­cent in the three years through 2007, ver­sus a longer-term aver­age of 3.2 per­cent. More mod­er­ate eco­nomic cycles and investors' per­cep­tions that world growth would remain strong helped coun­tries with weaker struc­tural char­ac­ter­is­tics con­verge in val­u­a­tion with those with bet­ter characteristics.

The third event that sup­ported the con­ver­gence was the adop­tion of the Euro by the coun­tries in the Euro­pean Union. The hope of the sin­gle cur­rency was to intro­duce a viable alter­na­tive to the US Dol­lar as a world cur­rency and to make trade and the economies of Europe more effi­cient by low­er­ing finan­cial trans­ac­tion costs. As soon as the Maas­tricht Treaty was agreed upon, Euro­pean coun­tries began to focus on the hur­dles to enter the union, includ­ing low­er­ing deficits and debt lev­els. This brought an align­ment among Euro mem­bers in lever­age char­ac­ter­is­tics, which over time mis­led investors into think­ing that a mon­e­tary union meant sin­gu­lar eco­nomic outcomes.

These three forces proved potent in dimin­ish­ing investors' assess­ment in the dif­fer­ences in the char­ac­ter­is­tics of indi­vid­ual coun­tries. The graph below shows the spread between the high­est and low­est 6-month returns of the mem­bers of Mor­gan Stanley's index of devel­oped coun­tries (the spread is smoothed to high­light the medium-term cycli­cal fluc­tu­a­tions of the series).

The large spread around 1990 high­lights the weak­ness in the Nordic coun­tries dur­ing this period as their stock mar­kets col­lapsed as they bat­tled their domes­tic bank­ing crises. The peak around 2000 coin­cides with the peak in the world-wide stock mar­ket bub­ble where a few indexes that were over-weighted in telecom­mu­ni­ca­tion and tech­nol­ogy stocks fueled strong rel­a­tive out­per­for­mance. But even out­side of those peaks, the graph shows that dur­ing the 1970's and 1980's it was typ­i­cal for there to be large diver­gences between the best and worst per­form­ing coun­tries – 40 to 50 per­cent­age points dif­fer­ence was typ­i­cal. More recently through 2007 the diver­gence in stock mar­ket returns among devel­oped coun­tries col­lapsed. There was very lit­tle value in mak­ing dis­tinc­tions at the coun­try level when indi­vid­ual coun­try returns were so tightly cen­tered about broad bench­mark return levels.

These trends have shifted the last cou­ple of years and the recent spread between rel­a­tive per­for­mances con­tin­ues to widen. Year to date, Denmark's bench­mark index is up 20 per­cent, while the Athens Stock Exchange index has dropped 33 per­cent. Coun­try selec­tion is begin­ning to mat­ter again.

Bond Yield Divergences

One of the strongest ben­e­fits of the shared cur­rency was that investors began to price gov­ern­ment debt sim­i­larly across the Euro area. The coun­tries of south­ern Europe and coun­tries with smaller economies felt the great­est amount of ben­e­fit. Yields on Greek debt fell by more than half in less than 10 years. Ire­land and Spain also directly ben­e­fited from a col­lapse in bor­row­ing rates. This helped their economies pros­per, fueled partly by lower bond yields and boom­ing hous­ing markets.

As the bot­tom right sec­tion of the graph above shows investors have returned to assess­ing indi­vid­ual coun­try risk, and they are quickly re-pricing that risk. These trends are worth watch­ing because they've mostly con­tin­ued to dete­ri­o­rate in the time since the ECB announced its $1 tril­lion res­cue plan in May. Spreads between Ger­man bond yields and the debt of periph­eral Euro­pean coun­tries have blown out to lev­els nearly as wide as imme­di­ately prior to the res­cue. The spread between bonds issued by Por­tu­gal and Bunds are 8 times the longer-term aver­age of the spread. Span­ish bond spreads are trad­ing at 13 times their longer-term average.

The widen­ing spreads between the bonds of periph­eral Europe and Ger­many are, of course, pick­ing up both aspects of investors' reac­tions. Bond investors are demand­ing higher yields from the debt of coun­tries with less attrac­tive lever­age pro­files and seek­ing out the safer debt of coun­tries like Ger­many, widen­ing spreads.

The risk is that the cost of bor­row­ing money from bond investors for the highly indebted coun­tries will rise sub­stan­tially, off­set­ting any improve­ments they can make in their bud­get out­look by way of higher taxes or push­ing through aus­ter­ity plans. One impor­tant thresh­old has already been sur­passed. Over the last cou­ple of years the cost of bor­row­ing money for longer-periods for the periph­eral Euro­pean coun­tries has been below the aver­age coupon rate of their exist­ing debt. This was a result of low infla­tion and low pol­icy rates world­wide. Recently though, the 10-year note yield for many of these coun­tries has risen above their his­tor­i­cal aver­age cost of issu­ing debt. The yields on Por­tu­gal debt are now more than full per­cent­age point above the aver­age cost of its debt cur­rently out­stand­ing. The yield on the debt of Ire­land and Spain are now also trad­ing at yields above their own his­tor­i­cal cost of borrowing.

Diverg­ing bond yields might be one of the more impor­tant risks to the rel­a­tive val­u­a­tion between coun­tries. The con­ver­gence of bond yields was dra­matic near the mid­dle of this decade and fueled a con­ver­gence in stock mar­ket val­u­a­tions. Investors have likely already begun to fac­tor in new lev­els of long-term dis­count rates in valu­ing world­wide benchmarks.

Eco­nomic Growth Divergences

The diver­gence in dis­count rates will likely be only part of the val­u­a­tion read­just­ment process. The other part that investors will be fac­tor­ing into their analy­sis is the expec­ta­tions of future cash flows. These expec­ta­tions are also diverg­ing. Return­ing to the Euro area, dur­ing the first decade of the mon­e­tary union eco­nomic growth was mostly aligned among mem­ber coun­tries. Eco­nomic growth was faster in the smaller, periph­eral coun­tries. But as a group, growth was wide­spread and sta­ble among Euro-area countries.

Coun­tries within the union used these years of favor­able tail winds in dif­fer­ent ways, points out David Marsh in his new book The Euro . Mea­sures put into place dur­ing this period – like a con­tain­ment of worker incomes and domes­tic invest­ment — has helped Ger­many become the best-managed of the larger Euro coun­tries in his view. And Ger­man com­pa­nies have emerged with increased com­pet­i­tive­ness. Accord­ing to the Orga­ni­za­tion of Eco­nomic Coöper­a­tion and Devel­op­ment, Ger­many improved its com­pet­i­tive­ness against all other coun­tries by more than 10 per­cent in the decade through 2007, based on labor costs per unit of out­put in indus­try. Over the same period, Italy's com­pet­i­tive­ness posi­tion wors­ened by 34 percent.

It's also clear that the lead­ers of Euro­pean coun­tries plan on pur­su­ing dif­fer­ent strate­gies in tend­ing to their vio­la­tions of the Maas­tricht Treaty (which included lim­i­ta­tions on deficits and debt loads when mea­sured in rela­tion to GDP). For one brief moment in May, Euro­pean lead­ers came together with one voice to announce their bailout plan. Since that time, the rhetoric has reverted back to the more typ­i­cal dis­parate tone. Coun­tries like Greece, Por­tu­gal, and Ger­many have announced that they are pur­su­ing mostly strate­gies of aus­ter­ity (send­ing the US-based Key­ne­sians who archi­tected the Amer­i­can bailout plan into a frenzy). The French lead­ers have mostly balked at this strat­egy. France's Prime Min­is­ter Fran­cois Fil­lon was quoted this week say­ing that “for the moment, we are try­ing to avoid austerity”.

The vastly dif­fer­ent approaches to solv­ing the sov­er­eign debt prob­lem in Europe are likely to pro­duce a wide array of out­comes. And con­sid­er­ing the amount of debt that has to be reigned in, across so many coun­tries, leaves this as more of a hope­ful exper­i­ment than a sim­ple follow-through of a text­book eco­nomic the­ory. It's becom­ing clear that investors are mov­ing from a period where they were mostly focused on the strengths of a sin­gle cur­rency to a period where they are con­cerned about the inher­ent weak­nesses of the union. As they do, the growth fore­casts for indi­vid­ual coun­tries will come into greater focus. Over the last decade there has typ­i­cally been about a 2 per­cent­age point spread between the rates at which the fastest grow­ing coun­tries expanded at ver­sus the slow­est coun­tries. This spread will likely widen. The expec­ta­tions for eco­nomic growth over the next cou­ple of years are cur­rently much wider. The graph below shows the expected GDP growth in 2010 across a range of countries.

There's almost 8 per­cent­age points dif­fer­ence between the expec­ta­tions for growth in Canada ver­sus the expected con­trac­tion in Greece. And more than 3 per­cent­age points dif­fer­ence in expected growth among Euro-area coun­tries. The table also shows that the com­pa­nies with the most chal­leng­ing near-term debt loads – Italy, Por­tu­gal, Ire­land, Spain, and Greece – also have the worst prospects for eco­nomic growth.

Bench­mark Bank Weight­ing Divergences

The tremors that have been felt in US and Euro­pean stock mar­kets this year are less about sov­er­eign debt risks then they are about the con­cen­tra­tion of risks on Euro­pean bank bal­ance sheets. If Greece's debt – along with the debt of Spain and Por­tu­gal – was more diver­si­fied among gov­ern­ments and insti­tu­tions, then a default of the debt might cause fewer prob­lems as the pain of a write-down would be more widely dis­trib­uted. Instead, Euro­pean banks hold a big slug of this debt. The Econ­o­mist mag­a­zine recently esti­mated that for­eign banks' expo­sures to Greece, Por­tu­gal, and Spain com­bined comes to Euro 1.2 tril­lion and that most of this debt is being held by Euro­pean Banks. Ger­man bank hold­ings alone account for almost a fifth of the total debt.

So investors are show­ing sen­si­tiv­ity to Euro­pean bank stocks and indexes that have a large weight­ing of finan­cials in their bench­mark index. The graph below shows that there's been a rough cor­re­la­tion between the per­for­mance of coun­try bench­marks and their weight­ings of finan­cial stocks.

The risk­i­ness of Euro­pean bank bal­ance sheets may not be an issue that is qui­etly swept under the rug. That's because the debt repay­ment sched­ules of the coun­tries with the great­est amount of stress on their sov­er­eign bal­ance sheets are very much front-loaded. For the coun­tries that are most often grouped together — Greece, Por­tu­gal, Italy, and Ire­land, and Spain – about two-thirds of their total debt is due over the next three years. These aren't risks that sit far out on the hori­zon. These are risks that come due in the next few years.

In addi­tion to mon­i­tor­ing coun­try risk, investors will likely be assess­ing broad bench­mark risk by mea­sur­ing the weight of each index that is ded­i­cated to finan­cial com­pa­nies and which banks hold the great­est amount of debt from the coun­tries with the high­est lever­age ratios. These dif­fer­ences will also likely fuel future diver­gences in bench­mark returns.

Inter­na­tional stock mar­kets are under­go­ing a new level of analy­sis at the coun­try level. It's likely that investors are begin­ning to price in changes in their assump­tions of futures cash flows and dis­count rates, informed by each country's growth prospects, debt lev­els, infla­tion risks, and fis­cal bat­tle plans. If the first decade of this cen­tury was about the con­ver­gence of eco­nomic per­for­mance, bond yields, and stock per­for­mance in devel­oped coun­tries, the next few years may be about the grow­ing diver­gences in these char­ac­ter­is­tics. If so, coun­try selec­tion will begin to mat­ter again.

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Tags: Balance Sheets, Bond Yields, Canadian Market, Cfa, Credit Crisis, Economic Cycles, Economic Performances, European Economies, Exogenous Shocks, Fiscal Policies, Great Divergence, Growth Investors, Hester, Hussman Funds, Last Decade, Market Performance, Rate Policies, Stock Prices, Stock Returns, Strong World, World Gdp
Posted in Bonds, Canadian Market, Markets, Outlook | Comments Off

Will We Have Inflation, Deflation, or Hyperinflation? Part 3

Tuesday, June 29th, 2010

This is Part 3 of a four part arti­cle that deals with what I feel is the pri­mary ques­tion investors must now answer: is our future to be infla­tion or defla­tion? The answer has vast impli­ca­tions to our invest­ment plan­ning and deci­sions for the near term, and pos­si­bly for our long term. It is a very com­plex ques­tion with a lot of mov­ing parts involv­ing eco­nom­ics and politics.

Like it or not, it is eco­nomic the­ory that is dri­ving macro­eco­nomic poli­cies and polit­i­cal deci­sions that deter­mine whether we will have infla­tion or defla­tion. Since not all of my read­ers are sophis­ti­cated traders I have tried to present the issues in a direct and hope­fully under­stand­able way. To those sophis­ti­cated read­ers, please bear with me.

Part 3

What Fac­tors Will Drive the Economy?

This is the point where we need to look at some long-term trends in the econ­omy to see how they will impact a recovery.

If our econ­omy is based on con­sumer spend­ing (70% of GDP) then GDP will see a decline in the sec­ond half of 2010.

In my arti­cle, Eco­nomic Mega­trends That Will Drive Our Future, I point our seven mega­trends that will impact our econ­omy for the long term:

1. The cul­ture of con­sump­tion is bro­ken and won’t return to for­mer lev­els. This is the key to everything.
2. Con­sumers will con­tinue to increase sav­ings to pre­pare for retirement.
3. Declin­ing U.S. con­sumer demand will con­tinue to neg­a­tively impact the world economy.
4. Defla­tion (delever­ag­ing) will con­tinue for some time.
5. Home own­er­ship rates will decline to more his­tor­i­cal lev­els of, say, around 66%, down from the high of 69% dur­ing the boom, which will keep a lid on home prices.
6. Gov­ern­ment stim­u­lus and recov­ery pro­grams only delay recov­ery and deepen the pain for workers.
7. Mas­sive fed­eral deficits will dou­ble the national debt, result in higher taxes, and will act as a per­ma­nent drag on the economy.

I wrote this arti­cle in Sep­tem­ber, 2009, and it still stands. The sig­nif­i­cant things to note are No. 1 and No.2. Con­sumers are over-indebted and are doing their best to pay down debt. This arti­cle from the Wall Street Jour­nal defines the issue:

After years of binge­ing on debt, U.S. house­holds are par­ing back. Those not doing so by choice are often being forced, because lend­ing stan­dards remain tight.

[T]he house­hold sector’s debt level, which includes both con­sumer credit and mort­gage loans, remained at about 20% of total assets in the first quarter.

In the mid-1990s that ratio was around 15%, com­pared with a peak in the first quar­ter of 2009 of about 22.5%.

Just get­ting debt down to 18% would require house­holds to shed an addi­tional $1.4 tril­lion of debt.

The way to pay down debt is to decrease spend­ing and increase sav­ings, espe­cially when unem­ploy­ment is at 9.7% and when real wages  (infla­tion adjusted) have been essen­tially flat:

J. M. Keynes referred to the phe­nom­e­non of increased sav­ings and reduced spend­ing as “hoard­ing” by con­sumers and believed it harmed the econ­omy, which is why, he said, the gov­ern­ment needs to spend in their stead. In fact, what con­sumers are doing is very ratio­nal eco­nomic behav­ior in light of uncer­tainty. Sav­ings will actu­ally lead the econ­omy out of the reces­sion by cre­at­ing new cap­i­tal to fund an eco­nomic expansion.

The main point here is that the con­sump­tion cycle for the major­ity of big spenders, the Baby Boomers, has changed, in my opin­ion, per­ma­nently. Boomers now real­ize that they need to save for retire­ment because Social Secu­rity won’t be enough, they don’t have enough finan­cial assets, their home val­ues will not regain their for­mer highs, and they won’t inherit enough from their par­ents to help them in their old age.

This has sig­nif­i­cant impacts on the recov­ery and the inflation/deflation issue. That is because the politi­cians mak­ing pol­icy deci­sions believe that Keynes is right. I’ll dis­cuss this later.

Is Credit Unfreezing?

Recently lend­ing has increased and excess reserves have decreased. Some have sug­gested that this is the begin­ning of the end of the credit freeze but I disagree.

This chart (TOTLL, YoY) reveals an increase in lend­ing by com­mer­cial banks in Q1 2010:

This cor­re­sponds to a like decrease in excess reserves (EXCRESNS) dur­ing the same period:

This lend­ing is evi­denced by an increase in con­sumer loans in Q1 2010 (CONSUMER):

What hap­pened was that con­sumers went on a mild spend­ing spree. I believe that almost all of the increase in con­sumer spend­ing had to do with gov­ern­ment fis­cal stim­u­lus: Cash for Clunk­ers, Cash for Appli­ances, and the home buyer credit which has spurred sales in home improve­ment goods.

New car sales have been doing bet­ter as a result of dealer incen­tives. The data show that non­re­volv­ing loans (NREVNCB), the mea­sure for (mainly) auto loans (up 7.1% in April), went up dra­mat­i­cally in Q1 2010:

Retail sales increased dur­ing that period, but now it is declin­ing, much to the con­cern of the Fed.

The lat­est Fed Flow of Funds report showed renewed declines in total credit as well as con­sumer credit. For Q1 over­all house­hold debt decreased for the sev­enth con­sec­u­tive month (-2.4%). Con­sumer credit con­tracted 1.5%. Non­fi­nan­cial busi­ness debt was flat after four months of declines.

The Report said revolv­ing credit, or credit-card use, fell a 19th straight time in April, down 12.0%. Fur­ther, per­sonal sav­ings are increas­ing again after the drawdown.

It appears that the tem­po­rary increase in con­sumer spend­ing was not related entirely to money sup­ply increases. Non­re­volv­ing loans for autos increased, but a sig­nif­i­cant por­tion of gen­eral spend­ing was fueled by per­sonal sav­ings of con­sumers. The fol­low­ing chart reveals that the rate of con­sumer sav­ings (PSAVERT) declined in response to gov­ern­ment incen­tives which favored cer­tain indus­tries (mid-2009 to Q1 2010). It appears that per­sonal sav­ings is start­ing to rise again, but we will need to watch the data to con­firm such a trend.

The Fed’s Problem

The Fed has a dilemma.

On the one hand, if they believe we are in a strong recov­ery, then they are wor­ried about inflation.

There was a lot of talk about recov­ery and the prob­lem of what will hap­pen when banks start lend­ing again: banks will use their huge excess reserves which would cause money sup­ply to explode, thus fuel­ing “infla­tion” which they define as ris­ing prices. This is what has been pop­u­larly referred to as the “drain­ing the pond” or the “exit strat­egy” prob­lem: how can the Fed sop up excess reserves before they hit the econ­omy and cause ris­ing prices? It is a very seri­ous issue.

The Fed closely mon­i­tors CPI and, as shown before, prices are grow­ing at the rate of 2% YoY. (I’ll dis­cuss signs of a decreas­ing CPI rate below.) If they decide to decrease the money sup­ply by rais­ing the Fed Funds rate from nearly zero per­cent, they believe they run the risk of jeop­ar­diz­ing the nascent recovery.

For many months now most of the dis­cus­sion by the Fed and most econ­o­mists con­cerned exit strat­egy. Now the dis­cus­sion has changed almost 180°: the buzz is now all about the pos­si­bil­ity of defla­tion and eco­nomic decline. (See dis­cus­sion below.)

For these rea­sons, I don’t think they are that con­cerned with infla­tion for the near term.

The Impli­ca­tions of a Double-Dip Decline

Tem­po­rary Effects of Stimulus

I think the econ­omy is headed for a decline com­menc­ing at some point in the sec­ond half of 2010. I believe the Fed is con­cerned about this as well. Evi­dence of this is start­ing to show up in the num­bers. The rea­sons for this are com­plex, but:

1. Most of the eco­nomic gains have been the result of fis­cal stim­u­lus which is run­ning out of steam.
2. There has not been suf­fi­cient delever­ag­ing in the econ­omy by which banks have repaired their bal­ance sheets.
3. The remain­ing huge real estate debt hang­ing over banks, espe­cially com­mer­cial real estate, has not been dealt with because of var­i­ous gov­ern­ment poli­cies that post­pone the inevitable write-downs (mark-to-make believe, extend and pre­tend, hous­ing cred­its, and delay and pray) and will restrict lending.
4. Mon­e­tary stim­u­lus has failed to cre­ate viable eco­nomic growth.
5. These facts inhibit the cre­ation of credit and will act like an anchor on the economy.
6. The long-term mega­trends men­tioned before will reduce eco­nomic activ­ity and cause major shifts in the economy.

There is no ques­tion that con­sumer spend­ing has been stim­u­lated by gov­ern­ment pro­grams. Those pro­grams are now com­ing to an end. Recent data show­ing a decline in retail sales sur­prised most economists.

The Wealth Effect

Another fac­tor is that the stock mar­kets have had a pos­i­tive impact on fam­i­lies’ per­ceived wealth which has helped con­sumer spend­ing. But, it appears that most of such spend­ing has been from the wealth­ier seg­ment of the econ­omy. A recent Gallup poll showed that con­sumers earn­ing more than $90,000 accounted for the bulk of that spend­ing increase. A mar­ket stock decline will reduce this wealth effect.

Man­u­fac­tur­ing Recovery

I believe our man­u­fac­tur­ing recov­ery has been a result of cycli­cal fac­tors unre­lated to stim­u­lus pro­grams. As ner­vous retail­ers and whole­salers cleared out inven­to­ries in the early stages of the reces­sion, at some point they had to restock. While unem­ploy­ment is high, the fact is that at least 80% of the work force have jobs and, even though they may feel inse­cure, they still spend on what is nec­es­sary. That boosted man­u­fac­tur­ing. But man­u­fac­tur­ing with­out renewed con­sumer demand and a revival of credit will not lead us out of the recession.

Also, man­u­fac­tur­ing has been ben­e­fited by the cheap dol­lar which has boosted exports. Other coun­tries, espe­cially devel­op­ing coun­tries, have been buy­ers of US prod­ucts. But I think this is chang­ing because of:

1. The dollar’s rise caused by Europe’s deep eco­nomic prob­lems will reduce our cheap dol­lar advan­tage; and
2. China’s econ­omy is based on exports and declin­ing US and EU economies will impact its growth. Fur­ther they are fac­ing a seri­ous hous­ing bub­ble that will burst the hard way. China needs an Amer­i­can eco­nomic recov­ery to save them, not vice versa.

It is clear that the Amer­i­can econ­omy headed for a dou­ble dip decline, which I believe will occur in the sec­ond half of 2010.

Defla­tion Fears

I have noticed in the main­stream media that with increas­ingly weak num­bers com­ing out recently there is a lot of talk about defla­tion. This is impor­tant because it is a reflec­tion of main­stream eco­nomic think­ing, which includes the Fed. Ben Bernanke reads the same head­lines as you and I do.

Here are some recent head­lines and the issues they raise:

CPI Declines

The con­sumer price index dropped 0.2% last month, the Labor Depart­ment said. The “core” rate of inflation–underlying con­sumer prices, which strip out volatile energy and food items and are closely watched by the Fed–rose 0.1% in May. …

This con­cerns shows up in Core CPI YoY (CPI less energy and food):

Defla­tion Fears Stir in Devel­oped Economies

Defla­tion makes it harder for con­sumers, busi­nesses and gov­ern­ments to pay off debts. Prin­ci­pal repay­ments on debt are fixed but defla­tion is marked by falling incomes, so as defla­tion sets in the bur­den of pay­ing off old debts gets greater. …

That’s an acute worry today. In addi­tion to gov­ern­ment debt, U.S. house­holds are still try­ing to work off large debt bur­dens built up in the last two decades. A Fed­eral Reserve report Thurs­day [Flow of Funds report] showed house­holds cut their bor­row­ings in the first quar­ter to $13.5 tril­lion, down from a peak of $13.9 tril­lion in 2008.

Bernanke Warns on Deficits

Defla­tion isn’t a con­cern at moment

Bernanke Calls for Deficit Plan

Advanc­ing a theme he has empha­sized in the last few months, Mr. Bernanke said that if Con­gress pur­sued more fis­cal stim­u­lus to sus­tain the recov­ery, it should be accom­pa­nied by a con­crete plan to bring the deficit back into line in the long run. With­out a fis­cal “exit strat­egy,” he said, the U.S. could, “in the worst case,” see finan­cial insta­bil­ity like in Greece.

The Con­gres­sional Bud­get Office projects the U.S. deficit will hit $1.4 tril­lion this year, or 9.4% of gross domes­tic prod­uct. Even as the econ­omy recov­ers, it projects deficits in excess of $400 bil­lion a year later this decade.

Bernanke Urges Deficit Cuts

At a moment when many econ­o­mists warn that the Amer­i­can eco­nomic recov­ery is likely to be imper­iled by pro­longed high unem­ploy­ment and slow growth, Pres­i­dent Obama is dis­cov­er­ing that the tools avail­able to him last year — a big eco­nomic stim­u­lus and action by the Fed­eral Reserve — are both now polit­i­cally untenable.

Fed Weighs Growth Risks

But fis­cal woes in Europe, stock-market declines at home and stub­bornly high U.S. unem­ploy­ment have alerted some offi­cials to risks that the econ­omy could lose momen­tum and that infla­tion, already run­ning below the Fed’s infor­mal tar­get of 1.5% to 2%, could fall fur­ther, rais­ing a risk of price deflation.

Mar­tin Wolf on the Dan­ger of Deflation

There is no world econ­omy big enough to off­set renewed con­trac­tion in Europe and the US. Con­certed fis­cal tight­en­ing could, in cur­rent cir­cum­stances, fail: larger cycli­cal deficits, as economies weaken, could off­set attempts at struc­tural fis­cal tightening. …

Pol­i­cy­mak­ers must recog­nise that defla­tion is a risk, too, and that tighter fis­cal pol­icy requires effec­tive mon­e­tary pol­icy off­sets, which may be hard to deliver today, above all in the eurozone.

Pre­ma­ture fis­cal tight­en­ing is, warns expe­ri­ence, as big a dan­ger as delayed tight­en­ing would be. There are no cer­tain­ties here.

S&P Warns of Ris­ing Cor­po­rate Defaults

Small banks are big prob­lem in gov­ern­ment bailout program

Busi­ness Hold Record Amounts of Cash

The Fed­eral Reserve reported Thurs­day that non-financial com­pa­nies had socked away $1.84 tril­lion in cash and other liq­uid assets as of the end of March, up 26% from a year ear­lier and the largest increase on records going back to 1952. Cash made up about 7% of all com­pany assets includ­ing fac­to­ries and finan­cial invest­ments, the high­est level since 1963.

You get the drift: the econ­omy is not going as the Fed and most econ­o­mists have pre­dicted so nat­u­rally they talk about defla­tion. They are wor­ried about the pos­si­bil­ity of expe­ri­enc­ing defla­tion sim­i­lar to what occurred in the Great Depression.

Why Most Econ­o­mists Have it Wrong

Most econ­o­mists believe that more fis­cal stim­u­lus is needed now and that Bernanke’s cries for fis­cal san­ity must not be heeded or we will sink into a depres­sion. This is a nor­mal Key­ne­sian reac­tion to the world. In fact the arch knee-jerk Key­ne­sian of our time, Paul Krugman’s last three edi­to­ri­als have spo­ken to this issue. Across the pond Mar­tin Wolf of the Finan­cial Times has been beat­ing the same drum.

I wish they would explain why all the fis­cal and mon­e­tary stim­u­lus the gov­ern­ment has done since Octo­ber, 2008 hasn’t worked yet. Krug­man would just say gov­ern­ment hasn’t spent enough. But then he always says that. Per­haps he should read some of Romer and Reinhart’s research on what gov­ern­ment debt does to a country’s abil­ity to recover. The fact is fis­cal stim­u­lus never works and never has. But it will leave us sad­dled with huge debt.

It would be a mis­take to credit gov­ern­ment spend­ing on fis­cal stim­u­lus projects for any last­ing eco­nomic gains. Since the gov­ern­ment can ulti­mately only obtain money from tax­pay­ers, it is only a shift of cap­i­tal from indi­vid­u­als (i.e., the folks that make the econ­omy func­tion) to the gov­ern­ment to fund projects it deems polit­i­cally beneficial.

Gov­ern­ment fis­cal stim­u­lus projects do not cre­ate any last­ing eco­nomic ben­e­fit. While it is true that new roads and safe bridges ben­e­fit the econ­omy, that is not the pur­pose of fis­cal stim­u­lus. The pur­pose of fis­cal stim­u­lus is to cre­ate “jobs” and stim­u­late con­sumer spend­ing. Such stim­u­lus is waste­ful and never cre­ates a viable eco­nomic enter­prise which would con­tinue after the money dries up.

One must ask what the pri­vate econ­omy would do with the $62 bil­lion already spent through the Amer­i­can Recov­ery and Rein­vest­ment Act ($202 bil­lion con­tracts, grants and loans awarded to date). I urge any­one who believes the spend­ing through ARRA would stim­u­late the econ­omy to check out the var­i­ous con­tracts and grants that are being awarded. The main web site is Recovery.gov. You will see that most are repairs to fed­eral facil­i­ties or grants for fed­eral pro­grams. I rec­om­mend you hold your nose while doing this. They are out­ra­geous wastes of your tax money and they will dam­age the abil­ity of the econ­omy to recover and will place a great bur­den on future gen­er­a­tions to pay them.

If gov­ern­ment spend­ing were the key to eco­nomic wealth then we should all be rich.

Tomor­row, Part 4. The Fed’s response to a decline, money sup­ply, and the likely outcome.

After Part 4, I will pub­lish the entire arti­cle as one down­load­able PDF.

Source: Daily Cap­i­tal­ist

Tags: Bill Gross, Capitalist, China, Consumer Spending, Drag On, Economic Theory, Federal Deficits, Home Ownership Rates, Hyperinflation, Inflation Deflation, Investment Planning, Jeff Harding, Macroeconomic Policies, Megatrends, Moving Parts, National Debt, Political Decisions, Sophisticated Readers, Sophisticated Traders, Stimulus, Term Trends, World Economy
Posted in China, Markets | Comments Off

The Future Market for Alternative Cars

Tuesday, June 29th, 2010

Tesla became the first Amer­i­can automaker to go pub­lic since 1956 today as shares began trad­ing under the ticker TSLA on the Nas­daq. With its most expen­sive car sell­ing for more than $100k, Tesla is look­ing to strike a chord with wealthy yet envi­ron­men­tally con­scious car buy­ers. Later this year, Chevro­let hopes its Volt (a price tag about half the size of the Tesla Road­ster) will become the first elec­tric car for the masses.

Build­ing this indus­try from the ground up isn’t an easy task. There were more than 260 mil­lion reg­is­tered vehi­cles in the United States last year and only a small per­cent­age of those are fueled by alter­na­tive energies.

The trans­porta­tion sec­tor con­sumed 27.92 quadrillion British ther­mal units (Btus) of energy in 2008, roughly 28 per­cent of all energy con­sumed in the U.S. Of that, petro­leum prod­ucts accounted for nearly 95 per­cent. Elec­tric­ity and nat­ural gas com­bined accounted for less than 3 percent.

This story isn’t new. Petro­leum prod­ucts accounted for 95 per­cent, 97 per­cent and 96 per­cent of energy usage by the trans­porta­tion sec­tor in 1965, 1985 and 2005, respectively.

While Tesla, Chevro­let and oth­ers bat­tle it out in the elec­tric car mar­ket, tycoons like T. Boone Pick­ens have been out­spo­ken pro­po­nents of nat­ural gas vehi­cles (NGVs).

Cur­rently the U.S. only rep­re­sents a smidgen of the global NGV mar­ket. Of the more than 10 mil­lion NGVs around the world, only 110,000 drive on America’s road­ways. Many of these are in cities that have con­verted their munic­i­pal fleets of buses and trucks to liq­ue­fied nat­ural gas (LNG).

As you can see from the chart, the U.S. trails China, Colom­bia and Argentina in the NGV mar­ket. More than half of the total vehi­cle pop­u­la­tion of Pak­istan (52 per­cent) is NGVs, mak­ing it the world’s largest market.

Over­all, the global NGV mar­ket has grown by more than 20 per­cent a year since 2000, accord­ing to the Inter­na­tional Asso­ci­a­tion for Nat­ural Gas Vehi­cles (IANGV). In the past four years alone, the Asia-Pacific Region has increased its num­ber of NGVs from just over 1 mil­lion to almost 6 million.

Some have argued that in order to increase the usage of NGVs in the U.S., there needs to be mas­sive invest­ment in fuel­ing sta­tions and infra­struc­ture but that’s not nec­es­sar­ily true. There were 1,300 refu­el­ing sta­tions ser­vic­ing the 110,000 NGV vehi­cles as of 2007—roughly one sta­tion for every 85 vehi­cles, accord­ing to IANGV statistics.

That’s a sub­stan­tially bet­ter ratio than the world’s lead­ing NGV mar­kets. In Pak­istan, there is one fuel­ing sta­tion for every 750 NGVs. In Iran it’s one for every 1631 vehi­cles. In India it’s one for every 1670.

In the near term, it’s unlikely either elec­tric cars or NGVs will grab sub­stan­tial mar­ket share in the U.S. auto busi­ness but after 2008’s sky-high gas prices and BP’s Gulf dis­as­ter, the Amer­i­can pub­lic may finally be ready for an alternative.

None of U.S. Global Investors fam­ily of funds held any of the secu­ri­ties men­tioned in this arti­cle as of March 31, 2010.

Tags: Alternative Cars, Alternative Energies, Car For The Masses, Electric Car, Expensive Car, Gas Lng, India, Liquefied Natural Gas, Municipal Fleets, Natural Gas, Natural Gas Vehicles, Outspoken Proponents, Petroleum Products, Population Of Pakistan, Quadrillion, Rsquo, Smidgen, T Boone Pickens, Tesla Roadster, Transportation Sector, Tsla, Vehicle Population
Posted in China, Energy & Natural Resources, India, Infrastructure | Comments Off

Recession Warning (Hussman)

Monday, June 28th, 2010

This arti­cle is a guest con­tri­bu­tion by John Huss­man, Huss­man Funds.

Based on evi­dence that has always and only been observed dur­ing or imme­di­ately prior to U.S. reces­sions, the U.S. econ­omy appears headed into a sec­ond leg of an unusu­ally chal­leng­ing downturn.

A few weeks ago, I noted that our reces­sion warn­ing com­pos­ite was on the brink of a sig­nal that has always and only occurred dur­ing or imme­di­ately prior to U.S. reces­sions, the last sig­nal being the warn­ing I reported in the Novem­ber 12, 2007 weekly com­ment Expect­ing A Reces­sion. While the set of cri­te­ria I noted then would still require a decline in the ISM Pur­chas­ing Man­agers Index to 54 or less to com­plete a reces­sion warn­ing, what prompts my imme­di­ate con­cern is that the growth rate of the ECRI Weekly Lead­ing Index has now declined to –6.9%. The WLI growth rate has his­tor­i­cally demon­strated a strong cor­re­la­tion with the ISM Pur­chas­ing Man­agers Index, with the cor­re­la­tion being high­est at a lead time of 13 weeks.

Tak­ing the growth rate of the WLI as a sin­gle indi­ca­tor, the only instance when a level of –6.9% was not asso­ci­ated with an actual reces­sion was a sin­gle obser­va­tion in 1988. But as I've long noted, reces­sion evi­dence is best taken as a syn­drome of mul­ti­ple con­di­tions, includ­ing the behav­ior of the yield curve, credit spreads, stock prices, and employ­ment growth. Given that the WLI growth rate leads the PMI by about 13 weeks, I sub­sti­tuted the WLI growth rate for the PMI cri­te­rion in con­di­tion 4 of our reces­sion warn­ing com­pos­ite. As you can see, the results are nearly iden­ti­cal, and not sur­pris­ingly, are slightly more timely than using the PMI. The blue line indi­cates reces­sion warn­ing sig­nals from the com­pos­ite of indi­ca­tors, while the red blocks indi­cate offi­cial U.S. reces­sions as iden­ti­fied by the National Bureau of Eco­nomic Research.

The blue spike at the right of the graph indi­cates that the U.S. econ­omy is most prob­a­bly either in, or imme­di­ately enter­ing a sec­ond phase of con­trac­tion. Of course, the evi­dence could be incor­rect in this instance, but the broader eco­nomic con­text pro­vides no strong basis for ignor­ing the present warn­ing in the hope of a con­trary out­come. Indeed, if any­thing, credit con­di­tions sug­gest that we should allow for out­comes that are more chal­leng­ing than we have typ­i­cally observed in the post-war period.

Unthink­a­bil­ity is Not Evidence

One of the great­est risks to investors here is the temp­ta­tion to form invest­ment expec­ta­tions based on the behav­ior of the U.S. stock mar­ket and econ­omy over the past three or four decades. The credit strains and delever­ag­ing risks we cur­rently observe are, from that con­text, wildly "out of sam­ple." To form valid expec­ta­tions of how the eco­nomic and finan­cial sit­u­a­tion is likely to resolve, it's nec­es­sary to con­sider data sets that share sim­i­lar char­ac­ter­is­tics. For­tu­nately, the U.S. has not observed a sys­temic bank­ing cri­sis of the recent mag­ni­tude since the Great Depres­sion. Unfor­tu­nately, that also means that we have to broaden our data set in ways that investors cur­rently don't seem to be contemplating.

Tags: Brink, China, Commodities, Contraction, Correlation, Criterion, David Rosenberg, Downturn, Employment Growth, energy, Gold, Hussman Funds, Ism, John Hussman, Lead Time, National Bureau Of Economic Research, Natural Resources, Pmi, Purchasing Managers Index, Recession, Recessions, Red Blocks, Second Phase, Stock Prices, Wli, Yield Curve
Posted in Bonds, China, Commodities, Gold, Markets, US Stocks | Comments Off

Hugh Hendry: "German and French Bureaucrats are Determined to Destroy Wealth and Hard Working Entrepreneurs in Europe"

Monday, June 28th, 2010

HUGH HENDRY, CEO OF ECLECTICA ASSET MANAGEMENT, TALKS ABOUT THE EURO AND ASIAN CURRENCIES ON BLOOMBERG WITH BLOOMBERG'S ERIC SCHATZKER.

(This is not a legal tran­script. Bloomberg LP can­not guar­an­tee its accuracy.)

JUNE 23, 2010

7:48 A.M.

ERIK SCHATZKER, BLOOMBERG NEWS: Well, John, speak­ing of hedge funds, his macro hedge fund is up 10 per­cent year-to-date and he says the euro is "fin­ished." How is that for a call­ing card? Hugh Henry is CEO and Chief Invest­ment Offi­cer at Eclec­tica Asset Man­age­ment, a $450 mil­lion hedge fund.

Hugh has 18 years of expe­ri­ence in money man­age­ment and he is par­tic­i­pat­ing in Bloomberg's sov­er­eign debt sum­mit here in Lon­don today, Hugh, very good to have you. Let's start off with that provoca­tive state­ment, the euro is fin­ished. What do you mean? The euro is going to par­ity or less, or the Euro­zone is going to self-destruct?

HUGH HENDRY, CEO, ECLECTICA ASSET MANAGEMENT: I can't believe I quoted Tol­stoy, I quoted John Buchanan, I quoted T. S. Elliott and I heav­ily nuanced the com­ment about the euro. I gave big qual­i­fi­ca­tions for the notion of the euro being fin­ished, but the euro does strike me as being anal­o­gous to the gold stan­dard in the 1920s, and of course we are now see­ing a con­flict between domes­tic sta­bil­ity, domes­tic pros­per­ity and the need for exter­nal bal­ance. And that typ­i­cally rings the bell for such a system.

SCHATZKER: Well, a sub­ject of much debate, clearly, between Pres­i­dent Obama and Chan­cel­lor Angela Merkel and it was the sub­ject of an op-ed by George Soros as you might have seen in today's Finan­cial Times. Do you side with Soros? Is Ger­many the pro­tag­o­nist and pos­si­bly the antag­o­nist here? Is it all going to come down to what Ger­many does or doesn't do?

HENDRY: George is some­one that we all have aspired to match his bril­liance, but I have to tell you, you have to remem­ber some­thing that the rich­est peo­ple on the planet become social­ists. Social­ism is a great thing for George. I want to bring George down. I want George's rep­u­ta­tion, but George is now embrac­ing socialism.

What is social­ism? Social­ism is when you build a moat around the cas­tle. I am spend­ing all of my time try­ing to decide where I am going to live, because taxes are so high in this coun­try, and less of my time try­ing to work out how I sur­pass Soros and his reputation.

SCHATZKER: Well, let's talk about how you are invest­ing. We talked about the nuance com­ments refer­ring to the euro. How about what else you are look­ing at? Let's talk about where you are short? Where do you see calamity and how do you profit from it right now?

HENDRY: Well, short­ing is a pre­car­i­ous busi­ness, and we would rather enter­tain the more cer­tain world of fixed income and credit, okay? But what I would say to you is whilst Europe is the epi­cen­ter, the ball has become very large. It is obvi­ous the prob­lems are very apparent.

I would say to you what are the impli­ca­tions of those prob­lems? And the impli­ca­tions could be felt more prof­itably for a spec­u­la­tor in Asia because Asian cur­ren­cies of course now have been reval­ued 20 per­cent vis-a-vis the euro. And wages in Europe are falling and wages in China are now going up. So the noose is get­ting tighter and tighter not in Europe, but I would argue, in Asia.

SCHATZKER: All right. I need to find out how you are express­ing that view. Hugh, I want you to sit tight for two min­utes. We are tak­ing a quick com­mer­cial break. And then we are com­ing back with Hugh Hendry. He is the CEO and CIO of Eclec­tica Asset Man­age­ment, a hedge fund man­ager with 18 years of expe­ri­ence. He says there is oppor­tu­nity in Asia, but it is not the kind of oppor­tu­nity that may make you feel com­fort­able. Stay tuned for more with Hugh Hendry in two minutes.

(BREAK)

Tags: Angela Merkel, Asian Currencies, Bloomberg News, Chancellor Angela Merkel, Chief Investment Officer, China, Commodities, Domestic Stability, Eclectica Asset Management, Eurozone, External Balance, Financial Times, French Bureaucrats, George Soros, Gold, Hedge Fund, Hugh Hendry, Hugh Henry, John Buchanan, Obama, Provocative Statement, Richest People On The Planet, Self Destruct, Sovereign Debt
Posted in China, Commodities, Gold, Markets | Comments Off

The Oil Industry in a Post-BP World (Fred Sturm)

Monday, June 28th, 2010

Fred Sturm, Exec­u­tive Vice Pres­i­dent & Chief Invest­ment Strate­gist, Macken­zie Invest­ments dis­cusses impli­ca­tions of the Gulf oil spill.

Source: ClientInsights.ca

Tran­script

Inter­view with Fred Sturm, Chief Invest­ment Strate­gist, and port­fo­lio man­ager of $9-billion in Resources Funds at Macken­zie Finan­cial, among the largest man­dates of this kind in the world.

DR: Fred, We're going to talk today about the impact of the dif­fi­cul­ties that BP has run into in the Gulf of Mex­ico; Prior to this inci­dent, the Obama admin­is­tra­tion had approved the expan­sion of off­shore drilling in the Gulf of Mex­ico, and of course that's now been suspended.

In your view how big an impact is the sus­pen­sion of drilling in terms of the sup­ply demand bal­ance for oil?

FS: In our view, not that mate­r­ial in the short instance. The US con­sumes 20% of the world's oil, it has only a hand­ful of per­cent of the world's reserves, so the pro­duc­tion base in Amer­ica at 5.5 mil­lion bar­rels out of 85-million bar­rels is not that large.

The impact is more the ongo­ing spillover of chal­lenge to develop the off­shore. The world sim­ply needs more off­shore devel­op­ment. There is insuf­fi­cient oil in our time hori­zon already, com­ing for­ward, to sat­isfy what the world would want to and need to consume.

DR: And, when­ever some­thing like BP hap­pens there are inevitably going to be win­ners and losers; Aside from BP, who would you pin­point as the losers as of this event?

FS: Losers will be the smaller com­pa­nies that were hop­ing to develop one well here or there, because the big com­pa­nies like BP and Exxon, have been self insur­ing in a sense of tak­ing on this risk unin­sured. If you are a smaller com­pany, its very dif­fi­cult to jus­tify risk­ing your entire com­pany on one prospec­tive well. It will pro­gres­sively become a big boys game, rather than for smaller companies.

We expect this trend to big­ger broader base to continue.

DR: So smaller explo­ration com­pa­nies (will lose), and on the winner's side, larger com­pa­nies. What about the oil sands sec­tor? Is that going to be a win­ner com­ing out of this. Onshore oil pro­duc­tion growth, reli­able growth, con­tain­able iden­ti­fi­able envi­ron­men­tal foot­print and impact; those are all clear win­ners for us.

I think it does cast the Cana­dian tar sands in a much more favourable light. The other, per­haps less obvi­ous, is the ser­vice com­pa­nies because what is clear is that the inte­grated com­pa­nies will want the best equip­ment. Too much expo­sure to risk using older equipment.

We think that com­ing out of this total expen­di­ture on ser­vic­ing will go up, not down.

DR: I want to close by talk­ing briefly about BP. Can we start by quickly talk­ing about what's hap­pened to the total value of BP's shares since this incident?

FS: Yeah, amaz­ingly this com­pany has been cut into half — here we're talk­ing about a hundred-billion dol­lars of mar­ket cap — far in excess of what any per­ceived envi­ron­men­tal dis­as­ter might be.

DR: Fred, BPs off 50%; is there a price at which you'd find BP attractive?

FS: Its awfully tempt­ing from a val­u­a­tion per­spec­tive, to become an investor in the BP shares at cur­rent lev­els. Our val­u­a­tion sug­gests that they are under­priced at cur­rent junc­ture. As an investor in the equity mar­kets we have to bal­ance the real­iza­tion of value, and the tim­ing of that real­iza­tion against a dynamic.

We sus­pect that every per­son that thought they were going to rent a house out any­where near the beach is going to claim this envi­ron­men­tal dis­as­ter has impacted their busi­ness. So there will be some very hon­ourable claims. There will be some that will be less clear, which are not going to be argued out for another decade.

DR: Last ques­tion; Are there any longer term lessons that you would draw from the BP expe­ri­ence here for money man­agers and investors?

I think it comes back to the dis­cus­sion around diver­si­fi­ca­tion. In all the best research that we can do, in all the best val­u­a­tion work that we can do ran­dom things hap­pen, acci­dents hap­pen, and the whole process of diver­si­fi­ca­tion tries to address that. Diver­si­fi­ca­tion by indus­try sub­sec­tor, diver­si­fi­ca­tion by geog­ra­phy, com­pany pro­file I think is very impor­tant. That's prob­a­bly the sin­gle most impor­tant message.

DR: Fred, thank you very much.

Tags: Big Boys, Bp, Canadian Market, Chief Investment Strategist, Demand Balance, Dr Fred, Entire Company, Executive Vice, Exploration Companies, Fred Sturm, Gulf Of Mexico, Gulf Oil, Investments, Mackenzie, Mackenzie Financial, Offshore Development, Offshore Drilling, Oil Industry, Oil Sands, Oil Spill, Portfolio Manager, Smaller Companies, Smaller Company, Spillover, Time Horizon, Vice President, Winners And Losers
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

G-20 Dodges Deflation

Monday, June 28th, 2010

While I didn’t like the sense­less destruc­tive behav­ior out­side the weekend’s G-20 gath­er­ing in my native Toronto, I did like some of the con­struc­tive results that emerged from the meeting.

The risk of dan­ger­ous defla­tion in the devel­oped mar­kets is still very real, so it’s a good move by the debt-loaded mem­bers of the G-20 to take a bal­anced approach to cut­ting their deficits by half by 2013, grad­u­ally reduc­ing their stim­u­lus spend­ing and sta­bi­liz­ing debt bur­dens by 2016.

At the same time, the coun­tries also com­mit­ted to growth as a top pri­or­ity – had they imposed harsher fis­cal and mon­e­tary terms, cap­i­tal could have been choked off and the poten­tial for growth gravely threatened.

While infla­tion remains a sig­nif­i­cant risk in the long term, given all of the eco­nomic stim­u­lus money in the sys­tem, right now the big­ger haz­ard is defla­tion.
The big prob­lem with defla­tion is that once that cycle is under way, it is very dif­fi­cult to get out of. Just look at Japan – con­sumer prices there have fallen for 15 straight months and pes­simism is run­ning high.

Falling prices may sound like a good thing, but when peo­ple see falling prices, they delay their spend­ing because they want to see if prices will fall even more. This wait­ing game fur­ther slows eco­nomic activ­ity and raises unem­ploy­ment in a crip­pling circle.

Stub­bornly high job­less­ness is plagu­ing the U.S., and it may worsen now that the boost from Cen­sus Bureau work is wind­ing down – nearly a quarter-million tem­po­rary Cen­sus jobs have ended this month. On top of that, more than 1 mil­lion Amer­i­cans are at risk of los­ing their unem­ploy­ment insur­ance and health ben­e­fits as of July 1.

We believe strongly in gov­ern­ment poli­cies as a pre­cur­sor for change.

Every mem­ber nation of the G-20 acts in its own eco­nomic self-interest; how­ever, they also rec­og­nize a broader inter­est. Had they as a group opted to be more aus­tere, the mul­ti­plier effect (the G-20 rep­re­sents 85 per­cent of the global econ­omy) would likely have been severe.

Tags: Balanced Approach, Census Bureau, Constructive Results, Debt Burdens, Deflation, Destructive Behavior, Dodges, Economic Stimulus, Global Economy, Government Policies, Joblessness, Member Nation, Monetary Terms, Multiplier Effect, Native Toronto, Pessimism, Self Interest, Top Priority, Unemployment Insurance, Waiting Game
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Curious Move in United States Oil Fund (USO)

Sunday, June 27th, 2010

By Dian L. Chu, Eco­nomic Fore­casts & Opinions

United States Oil Fund (USO) was a big mover on Fri­day jump­ing 3.69% to $35.65, out­per­form­ing other ETFs. The fund was trad­ing in the neg­a­tive ter­ri­tory for the most part in the morn­ing, but spiked up around 11:45 EST, and kept the momen­tum through clos­ing. (Chart 1)

Some of the sharp move could be attrib­uted to crude oil and the Dollar.

Crude oil moved higher as well on Fri­day, up 3.07% to $78.86, partly on con­cerns over a pos­si­ble trop­i­cal storm hit­ting the Gulf of Mexico.

Mean­while, dol­lar was mov­ing lower on weaker U.S. GDP release, cou­pled with the recent slew of softer data on jobs and housing.

Typ­i­cally, a declin­ing dol­lar would prompt a flight to gold as the ulti­mate dol­lar hedge. But USO man­aged to out­per­form the SPDR Gold Trust (GLD), which was up 1.2%, as well as the United Nat­ural Gas Fund (UNG), up 2.97%. (Chart 1)

Fri­day is usu­ally a light trad­ing day as traders take prof­its off the table unwill­ing to risk long posi­tions into the week­end. So, this move on crude, the dol­lar and USO caught some traders off guard.

Dol­lar Unwind

Of course, one could very well argue that one day does not make it a trend. Nev­er­the­less, it seems to sug­gest some dol­lar unwind­ing, as mar­kets are begin­ning to reassess the dol­lar risk ahead of the G8 and G20 meet­ings — the still loose deficit spend­ing of the U.S. vs. aus­ter­ity mea­sures in Europe and the mon­e­tary tight­en­ing in China.

This trend is evi­dent in the dol­lar chart.  For the week, the dol­lar index has slipped for a third week, par­tic­u­larly against the euro, while com­modi­ties and equi­ties seem to have reac­quainted the his­tor­i­cal inverse rela­tion­ship with the dol­lar.  (Chart 2)

Bet­ter Prospect in Crude

Another sug­ges­tion is that since gold has had a nice run-up, while nat­ural gas has rel­a­tively poor medium-term fun­da­men­tals, cer­tain play­ers could view crude oil, along with USO fund, as bet­ter invest­ments, rel­a­tive to gold and nat­ural gas, at the moment.

Sov­er­eign Funds Diversification

Mar­ket move­ments aside, two recent events also sig­nal longer-term bull­ish for com­mod­ity and commodity-related ETFs in general.

Back in Feb­ru­ary, Bloomberg reported that China’s sov­er­eign wealth fund–China Invest­ment Corp.–invested for the first time in the U.S. Oil Fund (USO) and became the fourth-largest holder with a value of $78.6 million.

Chesa­peake Energy (CHK) also announced this week it has sold US$900 mil­lion in pre­ferred stock to sov­er­eign wealth funds from China, Sin­ga­pore, South Korea, Abu Dhabi, as well as two private-equity firms, as reported by The Wall Street Jour­nal.

The BP Gulf dis­as­ter most likely will increase investor inter­est in onshore energy and nat­ural gas. So, con­ceiv­ably, sov­er­eign funds would con­tinue to look at com­mod­ity invest­ment vehi­cles such as UNG and USO for diver­si­fi­ca­tion, as well as a hedge against their mas­sive dol­lar holdings.

USO – A Tech­ni­cal Look

While I don’t typ­i­cally rec­om­mend futures-based ETFs due to the rolling effect, for investors who are still inter­ested, the fol­low­ing is a tech­ni­cal take on U.S. Oil Fund (USO). (Chart 3)

USO shares were trad­ing in the bear­ish ter­ri­tory for quite a while. The next few trad­ing ses­sions should decide if the momen­tum from Fri­day would hold to a defin­i­tive breakout.

Mean­while, the shares should find the next resis­tance at the 50-day mov­ing aver­age of around $36, sup­port at $33– $34. If it breaks above the $36, the next resis­tance level should be around $38.

Near Term Indi­ca­tor – The U.S. Dollar

In the near term, markets—commodity and equity—most likely will look to the dol­lar and macro indi­ca­tors for direc­tion, which is some­thing investors should also keep a close watch on.

Eco­nomic Fore­casts & Opinions

Tags: Austerity Measures, China, Commodities, Crude Oil, Declining Dollar, Deficit Spending, Dian, Dollar Chart, Dollar Index, Economic Forecasts, ETF, ETFs, G20 Meetings, G8, GDP, Gdp Release, GLD, Gold, Gulf Of Mexico, Inverse Relationship, Natural Gas, Negative Territory, Slew, Tropical Storm
Posted in China, Commodities, Energy & Natural Resources, ETFs, Gold, Markets, Oil and Gas, US Stocks | Comments Off

Steel Supports Recovery

Saturday, June 26th, 2010

This note is a guest con­tri­bu­tion by Frank Holmes, CEO and Chief Invest­ment Offi­cer, U.S. Global Investors.

One good way to mea­sure the strength of the global recov­ery is with a steel yardstick.

At 124 mil­lion met­ric tons, global crude steel out­put last month was up 29 per­cent year over year due to grow­ing demand, and it was nearly 10 per­cent above pre-recession lev­els in May 2007.

For the first five months of the year, world­wide pro­duc­tion exceeded 580 mil­lion met­ric tons, accord­ing to World Steel Asso­ci­a­tion fig­ures. Mills have been run­ning at above 80 per­cent capac­ity since Feb­ru­ary – com­pare that to the mid-60s in the same months of 2009.

China accounts for close to half of global pro­duc­tion – 265 mil­lion met­ric tons so far this year, up more than 20 per­cent from the first five months of 2009. China is now on track to con­sume 600 mil­lion met­ric tons this year, but ana­lysts expect demand to slow in the sec­ond half of this year in response to Bei­jing efforts to put the brakes on run­away growth.

But that’s a short-term side­bar to the long-term growth story, which is being dri­ven in large part by the rapid middle-class expan­sion in China, India, Brazil and other key emerg­ing markets.

Infra­struc­ture spe­cial­ists at Mac­quarie expect global steel pro­duc­tion to increase by 339 mil­lion met­ric tons per year by 2014, and it says China will account for 59 per­cent of that growth.

Tags: Brazil, Chief Investment Officer, China, Crude Steel, Emerging Markets, Five Months, Frank Holmes, Global Production, Global Recovery, Global Steel, India, Infrastructure Specialists, Macquarie, Mid 60s, Million Metric Tons, Runaway Growth, Steel Association, Steel Output, Steel Production, U S Global Investors, World Steel, Worldwide Production, Yardstick
Posted in Brazil, China, India, Infrastructure, Markets | Comments Off

U.S. Equity Market Diary (June 28, 2010)

Saturday, June 26th, 2010

U.S. Equity Mar­ket Diary (June 28, 2010)

All 10 sec­tors of the S&P 500 index declined this week (chart below). The best-performing sec­tor was finan­cials, down 1.5 per­cent. Other better-performing sec­tors included health care and tele­com ser­vices. The three worst-performing sec­tors were energy, con­sumer dis­cre­tion and technology.

Within the finan­cials sec­tor, the best-performing stock was Moody’s Corp, up 4.3 per­cent. Other top per­form­ers in the sec­tor were First Hori­zon National Corp., Dis­cover Finan­cial Ser­vices, Berk­shire Hath­away Inc. and Cap­i­tal One Finan­cial Corp.

Strengths

• The oil & gas refin­ing & mar­ket­ing group was the top-performing group for the week, up 4 per­cent. Gov­ern­ment data this week showed a drop in gaso­line inven­to­ries, and the travel group AAA fore­cast that U.S. auto travel over the July 4 hol­i­day week­end will likely rise 18 per­cent. Both fac­tors helped lift expec­ta­tions that demand for gaso­line will keep prices up.
• The human resources & employ­ment ser­vices group rose 2 per­cent. A major bro­ker­age firm upgraded Robert Half Inter­na­tional Inc. to “out­per­form” and raised its tar­get price on the stock.
• The biotech­nol­ogy group gained 1 per­cent. Gen­zyme Corp. entered into an agree­ment to repur­chase $1 bil­lion of its com­mon stock.

Weak­nesses

• The motor­cy­cle man­u­fac­tur­ing group was the worst per­former, los­ing 9 per­cent, led down by its sin­gle mem­ber, Harley-Davidson Inc. A major bro­ker­age firm reit­er­ated its “sell” rat­ing on the stock, say­ing its research showed that new bike demand appeared to have decel­er­ated in May.
• Seven of the 10 worst-performing groups were in the con­sumer dis­cre­tion sec­tor (motor­cy­cle man­u­fac­tur­ing, spe­cialty stores, pho­to­graphic prod­ucts, depart­ment stores, home fur­nish­ings, edu­ca­tion ser­vices and hotels). It appears that investors have become more con­cerned about a slow­down in the pace of eco­nomic growth and con­sumer spending.
• The retail drug group under­per­formed, drop­ping 8 per­cent. Wal­green Corp. reported earn­ings below the con­sen­sus esti­mate, in part due to higher-than-expected expenses.

Oppor­tu­ni­ties

• There may be an oppor­tu­nity for gain in M&A (merger & acqui­si­tion) trans­ac­tions in 2010. Cor­po­rate liq­uid­ity is high, thereby pro­vid­ing the means to pur­sue acquisitions.

Threats

• Should investors’ expec­ta­tions for an improv­ing econ­omy not come to fruition on a rea­son­able time frame, it could be a threat to stock prices.
• As gov­ern­ments around the world begin to wind down the mon­e­tary and fis­cal stim­u­lus pro­grams put in place dur­ing the eco­nomic cri­sis, a head­wind for stocks will likely be created.

Tags: Berkshire Hathaway, Berkshire Hathaway Inc, Biotechnology Group, Brokerage Firm, Capital One Financial, Capital One Financial Corp, Discover Financial Services, Drug Group, First Horizon, First Horizon National Corp, Gasoline Inventories, Genzyme Corp, Harley Davidson Inc, Market Diary, Photographic Products, Retail Drug, Robert Half International, Robert Half International Inc, Target Price, U S Auto
Posted in Energy & Natural Resources, Markets, Oil and Gas, US Stocks | Comments Off

The Economy and Bond Market Diary (June 28, 2010)

Saturday, June 26th, 2010

The Econ­omy and Bond Mar­ket Diary (June 28, 2010)

Trea­sury bonds ral­lied this week, send­ing yields lower by about 10 basis points across much of the Trea­sury yield curve. Weak hous­ing data and grow­ing con­cerns over the global eco­nomic impact of aus­ter­ity mea­sures were the pri­mary dri­vers. The Fed­eral Reserve met this week and met expec­ta­tions by sig­nal­ing no change in mon­e­tary policy.

New homes sales dropped nearly 33 per­cent in May to 300,000 units, less than a quar­ter of their level in May 2005 and the low­est level since records began in 1963. Expi­ra­tion of the home­buyer tax credit appar­ently pulled demand for­ward and the mar­ket is suf­fer­ing with­out that support.

Strengths

• China relaxed the yuan’s peg to the dol­lar, essen­tially allow­ing it to appre­ci­ate. While this is effec­tively a tight­en­ing step for China, it is viewed as a bet­ter alter­na­tive than rais­ing inter­est rates. The tim­ing was also favor­able from a polit­i­cal stand­point, as the G-20 meet­ing of large economies is being held this week­end in Toronto. Many nations par­tic­i­pat­ing in the meet­ing have urged China to allow appreciation.
• Global steel out­put rose 29 per­cent in May and now stands 10 per­cent higher than May 2007, before the global eco­nomic crisis.
• The Uni­ver­sity of Michi­gan Con­sumer Con­fi­dence Index rose to the high­est level since Jan­u­ary 2008.

Weak­nesses

• May new home sales hit a record low and exist­ing home sales also dis­ap­pointed, falling 2.2 per­cent in the month. Hous­ing is not pro­vid­ing any basis for the eco­nomic rebound.
• Aus­ter­ity mea­sures are all the rage around the world, includ­ing the United King­dom, Ger­many and Japan. The mea­sures pro­posed are often aggres­sive cost cut­ting or tax increases that threaten the near-term eco­nomic recovery.
• Durable goods in May declined 1.1 per­cent, bet­ter than expected but still down sharply.

Oppor­tu­ni­ties

• Infla­tion is unlikely to be a prob­lem for some time and this gives cen­tral bankers and other pol­i­cy­mak­ers around the world room for expan­sive policies.

Threats

• The risk of aus­ter­ity mea­sures going too far and sig­nif­i­cantly dimin­ish­ing eco­nomic growth is real.
• Con­cerns about a full-blown credit cri­sis have prob­a­bly dimin­ished, but still can­not be ruled out.

Tags: All The Rage, Austerity Measures, Basis Points, Bond Market, China, Consumer Confidence Index, Economic Rebound, Existing Home Sales, Global Economic Crisis, Global Economic Impact, Global Steel, Homebuyer Tax Credit, Market Diary, Michigan Consumer Confidence, New Homes Sales, Political Standpoint, Steel Output, Treasury Bonds, Treasury Yield Curve, University Of Michigan Consumer Confidence, University Of Michigan Consumer Confidence Index
Posted in Bonds, China, Markets | Comments Off