Words from the (Investment) Wise (November 29, 2009)

Sunday, November 29th, 2009

As shoppers were emptying their purses on Black Friday bargains, Dubai’s attempt to reschedule its debt roiled financial markets, plunging risky assets into the red. The government of Dubai requested a six-month payment freeze on the $59 billion debt issued by Dubai World - a state-owned conglomerate that has become known for its extravagant real estate projects.

Worries about Dubai’s debt woes rattled investors’ confidence, precipitating a sell-off in equities, high-yielding corporate bonds, commodities and the Baltic Dry Index, while mature-market government debt, the US dollar and the Japanese yen attracted safe-haven buyers. On Thursday and Friday, many emerging-market and high-yielding currencies declined sharply.

A fact not widely known is that Dubai has the worst debt per capita in the world. Ah well …

Source: Peter Brookes, Times Online

The credit-rating agencies promptly downgraded Dubai’s government-related debt and the cost of insuring against default jumped across the United Arab Emirates (UAE) region. As shown in the Bloomberg screenshot below, courtesy of Bespoke, the price of Dubai’s sovereign debt credit default swap (CDS) last week spiked up to 541 basis points. “Now that global markets have stabilized and exited crisis mode, an isolated event in Dubai where default risk doesn’t even spike to its 2009 highs [of almost 1,000 basis points] has caused a global market selloff,” remarked Bespoke.

Source: Bespoke, November 27, 2009.

Geoffrey Yu, strategist at UBS, said (via the Financial Times): “Although the majority of market observers believe the problems in Dubai are not insurmountable, the wider fallout has simply revealed how fragile markets are - and risk appetite may not be as strong as previously assumed, regardless of how profligate central banks globally have been in providing liquidity.”

Also as reported by the Financial Times, Julian Jessop of Capital Economics argued that Dubai’s move was unlikely to affect the positive outlook for emerging markets in the longer term: “We do not believe the events in Dubai mark a new phase in the global crisis. But if they are the catalyst for a more selective approach to investment, that might be no bad thing.”

In terms of banks’ exposure to Dubai, JPMorgan Chase comments (via The Big Picture) that the Royal Bank of Scotland underwrote more Dubai World loans than any other institution. In terms of capital at risk, HSBC has the largest exposure to the UAE.

The past week’s performance of the major asset classes is summarized by the chart below. Gold bullion (not shown on the graph) touched a record high of $1,194.90 on Thursday before tumbling to $1,136.80, but subsequently recovered to close 2.4% up for the week at $1,177.63. Similar volatility was seen in the oil price, with West Texas Intermediate Crude declining by more than $5 at one point on Friday, but later regaining some ground to end the week 1.8% down at $76.05.

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The MSCI World Index (-0.1%) last week marked time, whereas the MSCI Emerging Markets Index (-2.5%) experienced more selling from risk-averse investors. However, the aggregate indices mask greatly varying performances. For example, among mature markets the Japanese Nikkei 225 Index (-4.4%) recorded a fifth consecutive down-week, suffering from the strong Japanese yen that recorded a 14-year low versus the US greenback. On the other hand, the Brazillian Bovespa Index (+1.1%) and the Russian Trading System Index (+1.8%) bucked the broader downtrend among emerging markets.

As far as the US indices are concerned, Friday’s losses wiped out the gains from earlier in the week, reversing a new recovery high of 10,464 made by the Dow Jones Industrial Index on Wednesday. By the close of the Thanksgiving-shortened week on Friday, the S&P 500 Index remained unchanged on the week, whereas the other major indices experienced a second down-week. Five of the ten economic sectors (as measured by the SPDR exchange-traded funds) closed higher for the week, with Telecoms (+1.8%), Health Care (+1.3%) and Utilities (+0.9%) outperforming, and Financials (-2.2%) in the red.

The year-to-date gains in the US remain firmly in positive territory and are as follows: Dow Jones Industrial Index 17.5%, S&P 500 Index 20.8%, Nasdaq Composite Index 35.6% and Russell 2000 Index 15.6%.

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

Top performers among stock markets this week were Bangladesh (+5.7%), Ecuador (+4.3%), Kuwait (+3.4%), Kenya (+2.1%) and Estonia (+1.9%). At the bottom end of the performance rankings, countries included Cyprus (‑15.6%), Vietnam (-11.7%), Serbia (-8.8%), China (-6.4%) and Greece (‑6.2%). The declines in the Shanghai Composite Index came in the wake of a warning by China’s banking regulator that it would refuse approvals for expansion and limit banking operations if lenders did not meet new capital adequacy requirements.

Of the 98 stock markets I keep on my radar screen, 30% recorded gains (last week 39%), 65% (58%) showed losses and 5% (3%) remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that, as far as exchange-traded funds (ETFs) are concerned, the winners for the week included United States Natural Gas Fund (UNG) (+10.0%), Rydex S&P Equal Weight Utilities (RYU) (+3.0%), Currency Shares Japanese Yen (FXY) (+2.6%), PowerShares DB Gold (DGL) (+2.5%) and Vanguard Extended Duration Treasury (EDV) (+2.5%).

At the bottom end of the performance rankings, ETFs included iShares MSCI Turkey Investible Market (TUR) (-5.6%), SPDR S&P Emerging Europe (GUR) (-5.4%) and Market Vectors Russia (RSX) (-4.9%).

Referring to the bull market in gold, the quote du jour this week comes from Richard Russell, 85-year-old author of the Dow Theory Letters. He said: “There’s still loads of scepticism about the rising price of gold and the bull market in gold. It’s been so long since the US public (since 1971) realized gold was real Constitutional money that they don’t know what to make of the gold action. They think gold near $1,200 an ounce is expensive and they’d rather have dollar bills.

“I’ve coined the phrase, ‘dollar-bugs’ for these ignorant Americans. I guess they’ll have to get educated the hard way, which means holding on to their fading Federal Reserve Notes, no matter what. As far as I’m concerned, it’s an amazing example of mass brainwashing. ‘Hey, I’d rather have junk paper turned out by the Fed than the real thing - gold.’ Pathetic. And the happy thought is that you can (legally) still swap your junk fiat paper for gold.”

Still on the topic of gold, Ian McAvity (Ian McAvity’s Deliberations) said: “Gold bubble? I regard such talk as nonsense … Gold is about 52% higher than the peak weekly average price of January 1980. The US CPI is 177% higher, US M-2 Money Supply is 464% higher, and the S&P is 892% higher. I don’t think it untoward to suggest gold is badly lagging a number of important yardsticks and at these levels has some catching up to do.”

In other news, MarketWatch reported that the number of distressed banks in the US rose to the highest level in 16 years in the third quarter. The Federal Deposit Insurance Corporation’s (FDIC) Deposit Insurance Fund, which is used to protect depositors, swung to an $8.2 billion loss in the third quarter, the largest drop since the savings-and-loan crisis of the 1990s.

Separately, according to MarketWatch, rates on 30-year fixed-rate mortgages averaged 4.78% last week, matching April’s all-time low of in Freddie Mac’s weekly survey of conforming mortgage rates. The mortgage rate averaged 5.97% a year ago.

Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. There is nothing specific to report here, other than that “gold” and “banks” are still prominent and “Dubai” is making an appearance.

Back to the stock markets: The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town) are given in the table below. With the exception of the Russell 2000 Index and the Bombay Sensex Index, the indices in the table are all trading above their 50-day moving averages, with all the indices also above their respective 200-day moving averages.

However, many stock markets have already fallen to below their 50-day lines (not shown on this table, but indicated on the performance table higher up), pointing to possible further weakness. Also, the Japanese Nikkei 225 Index last week became the first major market to breach its key 200-day moving average, pointing to a very weak technical picture.

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

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

In addition to having retraced 50% of their bear market declines, the Dow Industrial and S&P 500 are up against significant medium-term downward trend lines. Also, negative divergences have been showing up in a number of breadth indicators, financial stocks and small caps, suggesting a more cautious tone.

According to Bespoke, last week’s sentiment survey from Investors Intelligence showed bullish sentiment among newsletter writers was near its highest levels since the March lows (50.6%), while bearish sentiment is at a five-year low (17.6%). This puts the spread between bulls and bears at 33, which is the highest level since December 2007. “High levels of bullish sentiment are typically considered contrarian, but we would note that sentiment can remain bullish for extended periods of time with little impact on the market. While it is true that markets typically peak when bullish sentiment is high, however, high levels of bullish sentiment don’t necessarily mean an imminent decline,” said Bespoke.

Source: Bespoke, November 25, 2009.

Casting his eye on 2010, Eoin Treacy (Fullermoney) said: “Most markets rallied from deeply oversold levels this year and have posted impressive advances since March. It is unreasonable to expect the same type of performance to be repeated next year. Nevertheless, monetary conditions are unlikely to pose a headwind and the environment is likely to remain largely bullish despite the potential for swift mean reversion in markets somewhat overextended relative to their 200-day moving averages.”

In my opinion, stock markets have run too far too fast - driven by an avalanche of liquidity - and they have moved out of alignment with economic and earnings growth that may not live up to the expectations being priced into equity valuations. I will bide my time while the fundamentals play catch-up.

For more discussion on the economy and financial markets, see my recent posts “Dubai’s latest mega-project - a massive default?“, “Japanese Nikkei 225 nosedives“, “Gold ETF makes it 9 up-days in a row“, “Gold bullion - overdue for a pullback?“, “Ritholtz: “Buy and hold” is a disaster“, “Charlie Rose in conversation with Barton Biggs“, “Picture du Jour: Will emerging-market outperformance last?” and “WealthTrack: Robert Kleinschmidt - reveling in contrarian investment philosophy“.

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Economy
“There has been no meaningful change in global business sentiment during the past three months. Since mid-August, business confidence has been consistent with a tentative global economic recovery,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. “Businesses have remained consistently more upbeat about the outlook than their assessment of current conditions. Sales and hiring are soft, as are pricing and inventories. South American businesses and professional service firms are the most positive and North Americans and those working in government generally the most negative.”

Source: Moody’s Economy.com

Purchasing managers indices for the 16-country Eurozone region showed private sector activity expanding this month at the fastest pace in two years, led by France and Germany, reported the Financial Times. The composite index, covering Eurozone services and manufacturing, reached 53.7 in November, up from 53.0 in October, making it the fourth consecutive month of expansion.

As far as hard data are concerned, Germany’s economy expanded again in the third quarter of 2009. GDP rose by 0.7% on a seasonally adjusted basis from the previous quarter, when it expanded by a revised 0.4%. Economic activity was boosted by inventory restocking and spending on machinery and equipment.

Concerns remain about the pace of the global economic recovery, and therefore how quickly governments and central banks should withdraw emergency support measures. According to the Financial Times, Mr Strauss-Kahn, managing director of the International Monetary Fund, said the global economy stood at the cusp of recovery but remained vulnerable to shocks and policy missteps. Fiscal and monetary stimulus programs should not be stopped too soon, he said.

A snapshot of the week’s US economic reports is provided below. (Click on the dates to see Northern Trust’s assessment of the various data releases.)

Tuesday, November 24
• Minutes of November 3-4 FOMC Meeting - spots of optimism are visible, concerns about dollar, commercial real estate loans, and low interest rates are noticeable
• Widespread revisions of Q3 GDP
• Home prices - signs of stability remain in place
• Consumer Confidence Index moves up slightly

Monday, November 23
• Low mortgage rates and tax credit lift sales of existing homes

A very handy graph to assess the current state of the US economy comes courtesy of Russell Investments. Click here to link to the interactive version.

Source: Russell Investments, November 22, 2009.

The minutes of the Federal Open Market Committee’s (FOMC) November 3-4 meeting point to continued aggressive monetary policy in the near term. Although participants agreed that the recession was over, they expected the unemployment rate to remain elevated and the inflation rate to remain below the central bank’s optimal level. Participants expected economic growth to slow a bit in 2010 and then pick up again after that.

On the topic of the magnitude of the US economic recovery, David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, provided the following interesting snippet:

“The recession in the US may be over, but what sort of recovery lies ahead remains in question. All we can say is that when looking at what is normal in the context of a post-recession rebound during the post-WWII era, the first quarter of growth is closer to 7.3% at an annual rate, not 2.8% as we just saw in the latest real GDP estimate - the median was 6.3%. The fact that with the massive amount of stimulus - without it, growth would have flirted with 0% - this first quarter of positive growth was basically one-third of what is typical, really says something.”

Food for thought indeed.

Source: Gluskin, Sheff & Associates - Breakfast with Dave, November 26, 2009.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, November 27, 2009.

The European Central Bank (ECB) will make an interest rate announcement on Thursday (December 3). US economic data reports for the week include the following:

Monday, November 30
• Chicago PMI

Tuesday, December 1
• Construction spending
• ISM Index
• Pending home sales
• Auto and truck sales

Wednesday, December 2
• ADP employment report
• Fed Beige Book

Thursday, December 3
• Jobless claims
• Productivity
• ISM Services

Friday, December 4
• Nonfarm payrolls
• Factory orders

Markets
The performance chart from the Wall Street Journal Online shows how different global financial markets performed during the past week.

Source: Wall Street Journal Online, November 27, 2009.

“Regardless of the dollar price involved, one ounce of gold would purchase a good-quality men’s suit at the conclusion of the Revolutionary War, the Civil War, the presidency of Franklin Roosevelt, and today,” said Peter Burshre (hat tip: Chart of the Day). Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist the readers of Investment Postcards to not only don decent suits, but also build considerable wealth with their investment portfolios.

That’s the way it looks from Cape Town (where I will be spending my time over the next few weeks, because my visit to New York had to be cancelled to attend to local business responsibilities).

Source: Wayne Stayskal, November 11, 2009.

Financial Times: Bets rise on rich country bond defaults
“The mounting level of debt in the industrialised world is prompting a growing number of investors to use the derivatives market to bet on the chance of rich governments defaulting on bonds.

“The volume of activity in sovereign credit default swaps - which measure the cost to insure against bond defaults - linked to the US, UK and Japan have doubled in the past year because of concerns about their public finances.

“CDS volumes for Italy, which has one of the highest debt burdens of the developed economies, are now the highest for an individual country, according to the Depository Trust & Clearing Corporation.

“In contrast, the outstanding volume of CDS linked to emerging nations such as Russia, Brazil, Ukraine and Indonesia have been flat or fallen in the past 12 months as investors have become less interested in trading the risks of those countries.

“In the past, the CDS market for developed countries was sluggish, because few investors saw the need to buy or sell protection against a risk of default that seemed exceedingly remote.

“However, rising debt levels and growing political and economic uncertainty have created a more active market, with more investors now seeking insurance. Meanwhile, many banks are prepared to offer protection in exchange for a fee.

“This fee has recently jumped, since the cost to insure the debt of developed countries has increased since the summer of last year, while the cost of insuring emerging market debt has fallen.

“Gary Jenkins, head of fixed income research at Evolution, said: ‘The biggest single risk hanging over the bond markets is the rapid rise in public debt in the industrialised world.

“‘If we get to a point where the market thinks the levels of debt are unsustainable, then we will see an almighty sell-off in the government bond markets, with yields soaring. Governments need to take action to cut deficits and debt.’

“Nigel Rendell, senior emerging markets strategist at RBC Capital Markets, said: ‘It is not surprising that investors are increasingly worried about debt in the industrialised world. Debt to GDP of more than 100 per cent is difficult to sustain.’”

Source: David Oakley, Financial Times, November 22, 2009.

Financial Times: Dubai World
“Dubai has shocked investors by asking for a debt standstill at Dubai World, the government’s flagship holding company that has developed some of the world’s most extravagant real estate projects. The move raised the spectre of default in the Middle East’s trading hub just as early signs of economic recovery have emerged. John Paul Rathbone analyses recent developments in Dubai.”

Source: John Paul Rathbone, Financial Times, November 24, 2009.

Financial Times: Dubai shock after debt standstill call
“Dubai has shocked investors by asking for a debt standstill at Dubai World, the government’s flagship holding company that has developed some of the world’s most extravagant real estate projects.

“The move raised the spectre of default in the Middle East’s trading hub just as early signs of economic recovery have emerged. During the boom, Dubai rode the wave of easy credit generating phenomenal economic growth but was badly hit by the global credit crisis.

“Dubai’s surprise move angered some investors who had been reassured by local officials for months that the city would meet all obligations on its $80bn of gross debt in spite of recession and a real estate crash.

“‘Investors view this as shockingly bad news,’ said Rob Whichello of BNP Paribas. Two hours after announcing it had raised $5bn from two Abu Dhabi banks, the department of finance asked for a standstill until May 30 on all financing to the heavily indebted Dubai World and its troubled property unit Nakheel, which is due to pay back $4bn on an Islamic bond on December 14.

“Dubai also launched a restructuring of the government holding company, which oversees ports operator DP World, the UK-based P&O Ferries and troubled investment company Istithmar. Nakheel, the developer behind the city’s Palm Islands that boast celebrity owners such as David Beckham, has had to shed thousands of staff and left contractors out of pocket as local property prices halved and credit dried up.

“A symbol of Dubai’s pre-crunch excess, the government company has had to cancel plans for the world’s tallest tower and a constellation of reclaimed islands, as collapsing cash flow left the developer on the brink.

“‘This will destroy confidence in Dubai, the whole process has been so opaque and unfair to investors,’ said Eckart Woertz, economist with Dubai’s Gulf Research Centre.

“The gaping size of Dubai World’s $22bn debt problem has been apparent for a year. But the government’s level of support has been clouded by politics and a lack of clarity on how much it could raise from international markets and the oil-rich capital of the United Arab Emirates, Abu Dhabi.

“Bond markets reacted sharply to the news with investors demanding higher premiums to hold debt from the region. In London trade it cost about $460,000 annually over five years to insure $10m worth of Dubai government debt against default, compared with $360,000 on Tuesday. Prices rose for its neighbours with Abu Dhabi protection $100,000 more than on Tuesday.

“Standard & Poor’s and Moody’s Investors Service immediately downgraded the ratings of all six government-related issuers in Dubai following news of the repayment delay and left them on review for possible further downgrade.

“Moody’s cut ratings on some government-related entities to junk status, while S&P cut ratings on some entities to one level above junk.

“S&P said the restructuring ‘may be considered a default under our default criteria, and represents the failure of the Dubai government (not rated) to provide timely financial support to a core government-related entity’.”

Source: Simeon Kerr and Jennifer Hughes, Financial Times, November 25, 2009.

Eoin Treacy (Fullermoney): Dubai could trigger corrective phase
“Middle Eastern stock markets have been laggards over the last year despite the advance in oil prices. Laggards usually lag for a reason and these are now becoming apparent with yesterday’s announcement. This news has had little effect on the region’s stock markets which suggests either some expectations of credit problems are already in the price or the focus of these problems lies with the Dubai government and foreign creditors.

“Dubai took full advantage of loose credit conditions earlier this decade to build on a massive scale. A huge percentage of the world’s cranes were domiciled in the country and the ‘before and after’ pictures of the city were commonly used to illustrate the extent of the development. The aim of building a financial and tourist hub and becoming a gateway between Europe and Asia as a solution to the Emirate’s lack of oil and gas reserves is laudable, but as with any mania, the good idea was taken to excess. The contraction of global liquidity has put pressure on Dubai’s ability to attract investment and has contributed to the current problems.

“Countries that experienced the biggest building booms on credit alone are experiencing some of the deepest recessions. The US, UK, Ireland, Spain and a number of Eastern European and Middle Eastern countries share this characteristic. However, the stock market action of the last year demonstrates that not all countries have been affected the same way and those which avoided building to excess have largely avoided recessions and posted the best stock market performances.

“The extent to which British banks are exposed to Dubai World has begun to rekindle worries about contagion but I wonder how justified this is? Dubai’s big brother, Abu Dhabi, is on a sounder financial footing and remains likely to provide assistance. Creditors may have to endure a delay in getting their capital returned but massive writedowns akin to those experienced following Lehman Brothers’ bankruptcy are probably unlikely. However, the perception of these problems is more important in the short-term. Stock and commodity markets have had an exceptional run since March. The Dubai default could be a catalyst for a deeper corrective phase unfolding generally.”

Source: Eoin Treacy, Fullermoney, November 26, 2009.

Nouriel Roubini (Forbes): Will the world go shopping?
“Roughly one year ago, around the Thanksgiving festivities, the National Bureau of Economic Research announced that the US recession started in December 2007. One year later, though the US economy is in recovery mode, retailers are approaching the holiday season - which accounts for slightly less than one-fifth of yearly US retail sales - with some concern.

“A sharp collapse in US consumer spending since mid-2008 led to a particularly dismal 2008 holiday retail season. As per US Census Bureau estimates, core retail sales (which exclude autos, gasoline and building supplies) fell by 1.1% year on year during November and December 2008, compared to an average 4.6% year-on-year increase in holiday season sales over the past decade. Total retail sales suffered a larger collapse, falling 9.5% year on year.

“After collapsing in 2008, retail sales showed signs of stabilizing over the summer of 2009. While auto sales have fluctuated sharply during recent months due to the government’s ‘cash for clunkers’ initiative, core retail sales have risen for three consecutive months as of October 2009, creeping up at a pace of about 0.5% month on month. Entering the 2009 holiday season, the recent uptick in core sales offers hope for better than anticipated holiday retail sales.

“Economic indicators, however, suggest a note of caution. The renewal in US consumer confidence over the first half of 2009 faded. Successive grim reports on the employment situation revealed no quick end to labor market woes, lowering consumers’ income expectations. According to the October Reuters/University of Michigan Survey of Consumer Sentiment, in October 2009, consumers reported worsening personal finances for the 13^th consecutive month, the ‘longest and deepest decline in the 60-year history of the surveys’.

“The poor state of personal finances has driven consumers to reduce debt at an accelerated pace. In September, consumer credit fell for the eighth consecutive month at an annualized pace of 7.2%. The poor health of personal finances, labor market uncertainty and the ongoing household balance- sheet repair will continue to promote frugal behavior by US consumers. The Conference Board consumer confidence surveys tell a revealing story: Consumers’ plans to purchase big-ticket appliances have declined in the run-up to the 2009 holiday season. This is a bit unusual as plans to buy big-ticket appliances usually display a sinusoidal pattern, with a trough in the month of October and a peak sometime the following spring.

“A measure of weekly retail sales released by the International Council of Shopping Centers and Goldman Sachs indicates that same-store sales flattened over the first three weeks of November, though compared to 2008, sales are up by a promising average pace of 2.9%. The National Retail Federation projects retail sales will fall 1% during this holiday season, compared to an average 3.4% annual gain in holiday sales over the past decade. After the sharp slide in 2008, a decline of ‘only’ 1% or even a small positive gain in 2009 holiday sales may seem like a welcome number; however, accounting for the base effects of a dismal 2008 season, the underlying reality for retailers remains grim for this holiday season.”

Click here for the full article.

Source: Nouriel Roubini, Forbes, November 26, 2009.

Financial Times: Divisions emerge on stimulus strategy
“Stark divisions are emerging among economic policymakers about how quickly governments and central banks should withdraw emergency support measures, with Dominique Strauss-Kahn, the managing director of the International Monetary Fund, warning on Monday about the risks of early exit.

to shocks and policy mis-steps. Fiscal and monetary stimulus programmes should not be stopped too soon, he said.

“He added: ‘It is too early for a general exit. We recommend erring on the side of caution, as exiting too early is costlier than exiting too late.’

“His words may be of some use to the Obama administration, which is boxed in by increasingly shrill calls to reduce the budget deficit and by appeals from some liberal Democrats and economists to spur job creation with more public money.

“On the monetary policy side, Ben Bernanke, US Federal Reserve chairman, last week said ‘inflation seems likely to remain subdued for some time’ and reiterated that interest rates were likely to remain exceptionally low for ‘an extended period’, although he also said he was ‘attentive’ to the value of the dollar.

“Mr Strauss-Kahn’s stance contrasted with warnings by the European Central Bank that delays in unwinding exceptional measures taken to combat the economic crisis could backfire. Last Friday, Lorenzo Bini Smaghi, an ECB executive board member, said history showed that the late implementation of ‘exit strategies’ could cause future crises.

“Speaking in Madrid on Monday, Jean-Claude Trichet, ECB president, said the threats to public finances posed by government stimulus packages meant ‘there is an increasingly pressing need for ambitious and realistic fiscal exit strategies and for fiscal consolidation’. He said it was ’still premature to declare the financial crisis over. But when the appropriate time comes, there should be no concern about the ECB’s determination and ability to exit.’

“Mr Strauss-Kahn said the worst of the financial storm had passed but the global economy remained in a holding pattern - ’stable, and getting better, but still highly vulnerable’.”

Source: Brian Groom, Ralph Atkins and Tom Braithwaite, Financial Times, November 23, 2009.

Financial Times: Fed sees risks in low rates policy
“Federal Reserve officials have expressed concerns that near-zero interest rates could fuel ‘excessive risk-taking in financial markets’ but believe the possibility of such an outcome is ‘relatively low’ minutes from its November meeting show.

“Both China and Germany warned this month that the weak dollar and the Fed’s policy to keep US interest rates ‘exceptionally low’ for an ‘extended period’ could be laying the groundwork for a new speculative bubble.

“The central bank’s Federal Open Market Committee already had discussed this risk, according to the minutes released on Tuesday. In their meeting on November 3-4, the officials ‘noted the possibility that some negative side-effects might result from the maintenance of very low short-term interest rates for an extended period’.

“The minutes said: ‘While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks.’

“The committee members took a fairly sanguine view of the dollar’s recent decline, which they described as ‘orderly’ and linked to improved risk appetite. However, the minutes note that ‘any tendency for dollar depreciation to intensify or to put significant upward pressure on inflation would bear close watching’.

“In the meeting, the committee decided to stick to its interest-rate policy, saying the US economy was continuing to improve but that inflation risks were low. The committee members upgraded their forecasts for US growth in 2009 and 2010, but reduced their forecast slightly for 2011. They also lowered their unemployment expecations, forecasting a rate between 9.3 and 9.7 per cent next year, down from a previous forecast of between 9.5 and 9.8 per cent.

“The minutes were released after the commerce department said gross domestic product grew at an annual rate of 2.8 per cent in the third quarter, below its first estimate of 3.5 per cent.”

Source:  Sarah O’Connor, Financial Times, November 24, 2009.

CNBC: FOMC minutes - reaction
“Dissecting the FOMC minutes with James Bianco of Bianco Research, Zane Brown of Lorb Abbett and CNBC’s Steve Liesman.”

Source: CNBC, November 24, 2009.

MoneyNews: Interest alone on Federal debt - $4.8 trillion
“When you think about the government’s exploding debt burden, you probably don’t focus on interest payments.

“But those payments will likely total $4.8 trillion over the next 10 years, amounting to more than half the government’s $9 trillion in debt.

“Interest rates are near zero now, thanks to the Federal Reserve’s massive monetary stimulus. But at some point the Fed will have to reverse that easing.

“‘When interest rates rise, even a small amount, the interest payments go up a lot because of the size of the debt,’ Charles Konigsberg, chief budget counsel of the Concord Coalition, told CNNMoney.com.

“The $4.8 trillion interest-payment estimate made by the Congressional Budget Office assumes some interest rate appreciation. But if rates rise higher than its estimates, the dollar total will be higher.

“The Obama administration has pledged to cut the budget deficit to 3 percent of GDP, down from 10 percent last year. But that goal may be more fantasy than reality.

“‘Even under the president’s (2010) budget as evaluated by the CBO, we do not get anywhere close to that,’ William Gale, a senior fellow at the Brookings Institution, told CNNMoney.com.”

Source: Dan Weil, MoneyNews, November 23, 2009.

Asha Bangalore (Northern Trust): Widespread revisions of Q3 GDP
“Real GDP grew at an annual rate of 2.8% in the third quarter, previously estimated as a 3.5% increase. Lower estimates of consumer spending (+2.9% vs. +3.4% in the advance report), outlays on structures ((-15.1% vs. -9.0% in the advance report), residential investment expenditures and (+19.5% vs. +23.4% in advance report), including a smaller contribution from inventories and a wider trade gap more than offset the upward revisions of government spending and equipment and software spending.

“Going forward, real GDP is projected to show a slightly slower pace of growth in the fourth quarter of 2009 and first quarter of 2010, partly because car sales of the future have been borrowed to take advantage of the ‘clash for clunkers’ program.

“Corporate profits from current production rose 10.6% in the third quarter, following a revised 3.7% gain in the second quarter. From a year ago, corporate profits fell 6.7%, the first single-digit decline after three straight quarters of significantly weaker profits. Corporate profits of the financial sector advanced 36.4% in the third quarter and made up the larger share of corporate profits. Corporate profits of the non-financial sector increased only 2.0%. The financial sector’s performance is artificially boosted by the support programs in place.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 24, 2009.

Clusterstock: The bloodbath in American manufacturing is over
“Manufacturing has been one of the hardest hit sectors around, but the pain is going away.

“Today’s chart shows the number of mass layoff events (at least 50 people whacked in one blow) per month in manufacturing, and as you can see, it’s way down from its peak, and now below the peak of the 2001-2002 recession.

“Still, we’ve got to see a lot of improvement before we’re at pre-crisis levels.”

Source: Joe Weisenthal and Kamelia Angelova, Clusterstock - The Business Insider, November 20, 2009.

Standard and Poors: S&P/Case-Shiller - Home prices show sustained improvement
“Data through September 2009, released today [Tuesday] by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, show that the US National Home Price Index improved in the third quarter of 2009, posting its second consecutive quarterly increase and further improvement in its annual rate of return.

“The chart above depicts the annual returns of the US National, the 10-City Composite and the 20-City Composite Home Price Indices. The S&P/Case-Shiller US National Home Price Index, which covers all nine US census divisions, recorded an 8.9% decline in the third quarter of 2009 versus the third quarter of 2008. This is a marked improvement over the 14.7% decline in the annual rate of return reported in the second quarter of 2009, and the 19.0% drop in the first quarter. The 10-City and 20-City Composites recorded annual declines of 8.5% and 9.4%, respectively. These two indices, which are reported at a monthly frequency, have generally seen improvements in their annual rates of return every month since the beginning of the year.

“‘We have seen broad improvement in home prices for most of the past six months,’ says David Blitzer, Chairman of the Index Committee at Standard & Poor’s. ‘However, the gains in the most recent month are more modest than during the seasonally strong summer months.’”

Source: Standard and Poors, November 24, 2009.

Asha Bangalore (Northern Trust): Low mortgage rates and tax credit lift sales of existing homes
“Sales of all existing homes rose 10.1% to an annual rate of 6.1 million units in October. Attractive mortgage rates and the first-time home buyer tax credit of $8,000 helped to boost sales of existing homes. The tax credit program has been expanded and extended to April 30, 2010.

“Sales of single-family existing homes advanced 9.7% to an annual rate of 5.33 million units in October. Sales of single-family existing homes have moved up nearly 32% from the cycle low of 4.05 million homes in January 2009. The peak of single-family existing home sales was in September 2005 (6.34 million units).

“The median price of an existing single-family home declined 1.6% to $173,100 in October from the prior month and it is down 6.8% from a year ago. The year-to-year decline of the median price shows a significant moderation, with the October reading the smallest since June 2008.

“As a result of the low mortgage rates and the first-time home buyer tax credit of $8,000, the supply of unsold single-family existing homes in October dropped to nearly 7-month supply, which is slightly below the historical median of 7.2-month supply.

“The important implication is that the declining trend of the number of unsold existing homes should establish price stability. Additional home sales will be possible as the economy recovers and hiring recovers.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 23, 2009.

Clusterstock: The “distressing” gap between new and existing home sales
“This morning’s existing home sales number showed that sales surged in October by a surprising 10.1%. But new home sales continue to remain quite weak.

“Today’s chart, showing the ‘distressing’ gap between the two measures, comes courtesy of Calculated Risk, which explains:

“‘The initial gap was caused by the flood of distressed sales. This kept existing home sales elevated, and depressed new home sales since builders couldn’t compete with the low prices of all the foreclosed properties.

“‘The recent spike in existing home sales was due primarily to the first time homebuyer tax credit.

“‘But what matters for the economy - and jobs is new home sales, and new home sales are still very low because of the huge overhang of existing home inventory and rental properties.’”

Source: Joe Weisenthal and Kamelia Angelova, Clusterstock - The Business Insider, November 23, 2009.

MoneyNews: Nearly 11 million US homes underwater
“Some experts say the housing market has bottomed, but one statistic indicates otherwise.

“The portion of US homeowners who are ‘underwater’ on their loans - that is, they owe more on the mortgage than the home is worth - surged to 23 percent in the third quarter, or almost 10.7 million households, according to First American CoreLogic, a real estate research firm.

“Many of the underwater homes will end up in foreclosure or on the already bulging market of homes for sale.

“Of the 10.7 million homes underwater, nearly half have a mortgage that is at least 20% percent higher than the home’s value, according to First American.

“More than 520,000 of these homeowners are in default on their mortgages.

“This ‘is an outstanding risk hanging over the mortgage market’, Mark Fleming, chief economist of First American, told The Wall Street Journal.

“‘It lowers homeowners’ mobility because they can’t sell, even if they want to move to get a new job.’

“Some homeowners who are underwater are fully capable of paying their mortgages, but are ditching their homes anyway - to the tune of 588,000.”

Source: Dan Weil, MoneyNews, November 24, 2009.

Clusterstock: We’re still generating too many negative equity mortgages
“In Washington, DC, the prevailing view these days is that unemployment is now the leading driver of mortgage defaults. This is one reason you can expect to see the next stage of the government’s attempt to rescue the housing market focus on saving jobs.

“But a new study out of Amherst Securities indicates that negative equity is by far the best default predictor of defaults. If that view is correct, the fact that we are still producing mortgages that quickly slip into negative equity should be terrifying. And, in fact, much of the recovery in the housing market appears to be built on thinly capitalized mortgages subsidized by low loan-to-value FHA guaranteed mortgages and the home-buyer tax credit.

“As the chart below shows, even home buyers who took out mortgages as late as this year are finding themselves with negative equity at historically high rates. We’ve come down from the worst levels of the housing boom but we are still well above healthy levels.

“In short, we may be witnessing a policy mistake of stunning proportions as lawmakers and regulators focus on job creation while ignoring the still problematic loan-to-value ratios in the housing market.”

Source: John Carney and Kamelia Angelova, Clusterstock - The Business Insider, November 24, 2009.

Yahoo Finance - Tech Ticker: Housing bottom? “Not even close,” Barry Ritholtz says
“A fifth-straight monthly gain for the Case-Shiller Index Tuesday and Monday’s stronger-than-expected existing home sales report is giving renewed hope to the housing bulls.

“‘Disregard them,’ says Barry Ritholtz, CEO of Fusion IQ, who notes the existing home sales number was juiced by sales of cheap condos and various government programs. Meanwhile, the Case-Shiller results were below expectations.

“We are ‘not even close’ to a bottom in housing, says Ritholtz, who estimates national house prices remain 15-20% overvalued, based on the traditional metrics of: median income-to-median sales price, the cost of owning vs. renting, and housing stock as a percent of GDP.

“‘Until we start seeing a healthy housing market that can stand on its own, without government props, without distressed properties selling 60% off peak levels - that’s how you know the bottom is in,’ says the blogger and Bailout Nation author.

“The likely best-case-scenario for housing is several years of sideways action for prices, wherein population growth and a firmer economy combine to sop up the still huge inventory of homes on the market.

“‘And that’s if we’re lucky,’ Ritholtz says, citing the lackluster environment for jobs and wages, as well as CoreLogic’s analysis that 23% of all US mortgage holders are under water. With so many Americans owing more money than their homes are worth, the recent rise in foreclosures and so-called jingle mail is ‘not nearly done’, he warns.

“In sum, expect more homes for sale at distressed prices and more downward pressure on prices overall - unless the ‘real’ economy shows dramatic improvement, which Ritholtz doesn’t see anytime soon.”

Source: Aaron Task, Yahoo Finance - Tech Ticker, November 24, 2009.

Clusterstock: US weekly jobless claims the lowest since September 2008
“The Department of Labor reported today [Wednesday] that initial jobless claims for the week ending November 21 fell 35,000 on a seasonally-adjusted basis from the previous week.

“They rose 68,080 on a not-seasonally-adjusted basis, but this basically means that jobless claims rose less than normal for this time of year. Seasonal adjustments are widely used to spot overall unemployment trends since the employment market is indeed seasonal.

“As shown below, at 466,000, this most recent seasonally-adjusted claims number represents the best data point we’ve had since the week of September 13, 2008.

“Regardless of the potential for static in the weekly numbers, or errors due to seasonal adjustments, it’s now pretty clear that the overall rate of new jobless claims has indeed slowed substantially.”

Source: Vincent Fernando and Kamelia Angelova, Clusterstock - The Business Insider, November 25, 2009.

Angry Bear: Unemployment claims - 1975, 1982-83 and 2009
“The weekly initial unemployment claims are widely reported and various charts show how they have been falling since the peak. But it is hard to compare the drop in claims this cycle compared to after other severe recessions in the standard charts showing claims over time.

“So to make such comparisons easier I though readers might find a chart showing claims after the 1974 and 1982 recessions and this recession on the same scale.”

Source: Spencer, Angry Bear, November 25, 2009.

Asha Bangalore (Northern Trust): Consumer Confidence Index moves up slightly
“The Conference Board’s Index moved up to 49.5 during November from 48.7 in the previous month. The Present Situation Index (21.0 vs. 21.1 in October) fell, while the Expectations Index rose to 68.5 in November from 67.0 in the prior month. The number of respondents indicating that ‘jobs are hard to get’ rose to 49.8 from 49.4 in the prior month, while those noting that ‘jobs are plenty’ fell to 3.2 from 3.5 in September. The main message is that hiring remains weak.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 24,2009.

MoneyNews: Dreman - brace for 10 percent inflation
“David Dreman says investors should be prepared for high inflation rates - as high as 10 percent - to start within the next three years, and that the Obama administration is powerless to stop it.

“Dreman, the well-known contrarian investor and CEO of Dreman Value Management, told Fox Business that the stock market will see a correction, although ‘it’s anybody’s guess’ when that correction will occur.

“He said inflation could rise to be as high as 8 percent to 10 percent within the next three years.

“Dreman advises investors to hold onto their current stocks and ‘ride through’ the correction. He also advises investors to stay out of long-term bonds because they will take a hit.

“Instead, investors should go for very short-term bonds, equities, and real estate, he said.

“Dreman predicts that interest rates will remain low since ‘no administration’ will attempt to raise them with high unemployment rates. He said the current administration is both trapped and powerless.

“Dreman also said that gold is currently undervalued, despite breaking records daily.”

Source: MoneyNews, November 25, 2009.

Bloomberg: Late card payments rose in October, Moody’s reports
“US credit-card delinquencies climbed last month to the highest level since February as five of the six biggest card lenders posted increases, Moody’s Investors Service said.

“Loans at least 30 days overdue, a signal of future defaults, rose to 6.12 percent in October from 5.97 percent in September, Moody’s said in a report dated Nov. 20 and distributed today. So-called early-stage delinquencies, payments 30 to 59 days late, were unchanged at 1.66 percent.

“Banks typically write off card loans after 180 days, and defaults fell last month to 10.04 percent from 10.72 percent in September, reflecting lower delinquency rates earlier in the year. Credit-card defaults and delinquencies tend to track US unemployment, which climbed to 10.2 percent in October, the highest since 1983.

“‘Weak job creation, elevated bankruptcies and rising unemployment continue to weigh on results,’ John McDonald, an analyst with Sanford C. Bernstein & Co., said in a November 17 research note. ‘It still feels too early to declare victory.’

“Write-offs may peak at 12 percent to 13 percent in 2010, Moody’s analysts Will Black and Jeffrey Hibbs said in the report.”

Source: Peter Eichenbaum, Bloomberg, November 23, 2009.

Bloomberg: Strauss-Kahn says half of bank losses are undisclosed
“Dominique Strauss-Kahn, managing director of the International Monetary Fund, talks about bank losses and the outlook for a global economic recovery. Strauss-Kahn answers questions from delegates at the Confederation of British Industry’s annual conference in London.”

Click here for the article.

Source: Bloomberg, November 23, 2009.

Financial Times: S&P raises fears over health of some banks
“A study by Standard & Poor’s has raised questions over the financial strength of some of the biggest banks ahead of new rules that could require them to raise more funds.

“The analysis by S&P showed that HSBC is the best capitalised bank in the world, while Switzerland’s UBS, Citigroup of the US and several of Japan’s biggest banks are among the weakest.

“The ranking of 45 of the world’s leading banks will unnerve investors, highlighting once again the capital shortfall that institutions still need to make up over the coming years.

“Although some banks will be able to top-up capital through retained profits, analysts expect a string of rights issues from weaker banking groups as they try to raise tens of billions of dollars.

“S&P’s risk-adjusted capital (RAC) ratios - a measure of balance sheet strength - foreshadow the new capital ratio regime expected to be set by the Basel committee on banking supervision early next year.

“Its report, published on Monday, gave HSBC a 9.2 per cent ratio, compared with barely 2 per cent for the likes of UBS, Citigroup and Mizuho.”

Source: Patrick Jenkins, Financial Times, November 23, 2009.

The Wall Street Journal: Banks scramble as debt comes due
“Banks have spent the past year dealing with a mountain of bad assets. Now attention is turning to trillions of dollars of debt they have maturing over the next few years.

“Banks unable to maneuver around the challenge could be forced to refinance their debt at sharply higher costs.

“The situation was caused by banks engaging in cheap borrowing during the credit-market boom that began in the middle of the decade and lasted through 2007. As financial markets hit crisis mode, banks were propped up by government guarantees that enabled them to keep selling debt - but with much shorter maturities.

“About $10 trillion of debt comes due by the end of 2015, including $7 trillion by 2012, according to Moody’s Investors Service, which highlighted growing concerns about the banks’ looming liabilities in a report this month.

“The life span of bank debt has shrunk to historically low levels, forcing banks to deal with the problem sooner rather than later. Globally, the average maturity of new debt rated by Moody’s fell from 7.2 years to 4.7 years in the past five years.

“‘We thought that we should send a signal’ of warning, said Jean-Francois Tremblay, a Moody’s analyst and one of the report’s authors.

“The problem is especially acute for US and UK banks, which have been among the hardest hit by the financial crisis. In the US, banks have seen maturities drop to 3.2 years from 7.8 years in the past five years. In the UK, the average maturity for new debt fell to 4.3 years from 8.2 years, Moody’s said.”

Source: Carrick Mollenkamp and Serena NG, The Wall Street Journal, November 25, 2009.

Financial Times: Better climate for hedge funds
“The hedge fund sector looks to be going through the early stages of recovery, with industry flows turning positive and redemptions largely normalising to historical levels, says Huw van Steenis, head of banks and financials research at Morgan Stanley.

“‘Next year is likely to be a pivotal year for hedge funds, with the sector set to benefit from the rise in demand for better risk adjusted returns, the migration of talent from investment banks and trading off the back of a successful 2009,’ he says.

“Mr van Steenis believes sovereign wealth funds, foundations and pension funds have overtaken endowments and high net worth hedge fund of funds as the largest source of inflows - and thinks the market is underestimating the potential upsurge in demand for absolute return funds from private clients and smaller institutions.

“‘In the UK, in the third quarter alone, there were $2.1bn of inflows into absolute return funds - three times that in the first quarter. Our base case estimates that global assets under management in the sector will reach $1,750bn by the end of 2010 - where we were in the first half of 2007 - although we see risks posed by performance, regulation and reputational issues.

“‘The outcome of US/EU regulatory changes remains uncertain, but growing pragmatism should be the order of the day; we estimate that hedge funds funded 30-40 per cent of capital raised by US and European banks this year.’”

Source: Huw van Steenis, Financial Times, November 24, 2009.

Bespoke: Sovereign default risk
“Below we highlight current credit default swap prices and the year-to-date change for the sovereign debt of 39 countries. As shown, default risk has declined for every country except Japan in 2009, including Dubai.”

Source: Bespoke, November 27, 2009.

Yahoo Finance - Tech Ticker: A bad economy could spell good news on Wall Street for years to come
“The economic recovery isn’t as strong as first thought. Revised GDP figures released this morning [Tuesday] show the economy grew at a 2.8% annualized pace in the third quarter, less than the 3.5% initially reported. The revision was in line with expectations but shows the economy didn’t have as much momentum heading into the fourth quarter as previously believed.

“Unlike Wall Street traders, consumers seem to know the recovery is ‘anemic’, as Barry Ritholtz, CEO of Fusion IQ, describes it. The Conference Board’s latest confidence survey shows Americans feel worse about the current economic situation than they did in March, when the stock market was making new lows.

“What’s driving the disconnect between Wall Street and Main Street?

“Ritholtz says it’s a classic example of bad news being good news on Wall Street. ‘We’re in a cycle that’s not based on profitability, not based on expanding economy but based on all sorts of government supports,’ he says. ‘Bad news is going to be good news for the next couple of quarters probably.’

“That’s because low interest rates and liquidity provided by the Federal Reserve, coupled with government stimulus are enticing traders to buy into the market. ‘Cash is trash,’ says Rithotlz, who remains bullish on stocks.

“Ritholtz is confident that eventually fundamentals will prevail and thinks the market will take a hit once the economy shows signs of improvement, meaning the ‘extraordinary’ stimuli can be removed.

“But predicting the timing is anyone’s guess. ‘You could have this disconnect that goes on for not days, weeks or months but years and years,’ he says.

“So, in the meantime, Ritholtz - who correctly predicted the 2008 crash and told Tech Ticker’s audience ‘the mother of all bear market rallies’, was upon us in March - is still long stocks and likes commodities (thanks to a weak dollar) and emerging markets.”

Source: Peter Gorenstein, Yahoo Finance - Tech Ticker, November 24, 2009.

Financial Times: Getting technical
“There is one group of investors that has few doubts about the direction of the US stock market. Technical analysts - who scour price moves in charts for patterns of behaviour that they think will be repeated and drive future action - see plenty of signals that justify a continued move higher in the S&P 500 index of US stocks.

“Although there are many reasons to doubt the relevance of technical analysis, there are many investors who do trade on these signs. Indeed, much of the computer-driven, high-speed trading that has become a feature of stock trading uses such analysis to programme trades. At the very least, it is important to be aware of the key price levels that technical analysts are targeting.

“At its simplest in terms of technical signals, a rising support line connects the dips seen in the S&P 500 since it started its rally in March. This backs the idea that such a support will continue to prop up prices after any dips.

“In terms of specific levels, the most widely watched ones are those that cluster round key ratios identified by the mathematician Fibonacci in the 13th century. Under these ratios, technical analysts believe that once markets have rallied 50 per cent from a low, they tend to progress to a level marking a 61.8 per cent retracement.

“Taking the 2007 S&P 500 high of 1,576 as the top and the March 2009 low of 667 as a bottom, the eyes of these analysts are on the S&P reaching 1,121 - a level that would mark a 50 per cent retracement of the decline from the peak. The subsequent 61.8 per cent retracement level would be 1,229.

“Technical analysts similarly argue that charts signal continued dollar declines and rises in gold, silver and oil prices. With fundamental factors sending mixed pictures, more traders may grasp for the cryptic clues on short-term market moves provided by technical analysis.”

Source: Aline van Duyn, Financial Times, November 24, 2009.

Bespoke: Where are the Financials?
“Probably the main reason why the S&P 500 has struggled to take out old highs in recent weeks is the performance of the Financial sector. It’s actually surprising that the market is where it is given how poorly the Financials have done. As shown in the first chart below, the S&P 500 Financial sector can’t even get above its 50-day moving average, much less test its bull market highs from a month or so ago.

“The Financials led us into and out of the bear, and it’s hard to imagine the overall market continuing its bullish pace over the next few months without a resurgence in the Financials. The question right now is whether to treat the stagnation as a bullish signal to gain exposure to the sector or a bearish signal to sell the broad market.”

Source: Bespoke, November 23, 2009.

Bespoke: Goldman can’t get out of its own way
“While there probably aren’t a lot of people shedding tears over it, the stock of Goldman Sachs (GS) can’t seem to get out of its own way. We’ve highlighted the relative weakness in this stock several times over the last few weeks, so this shouldn’t come as any surprise, but GS is now on pace to close at its lowest levels since early November.

“Politicians in Washington and conspiracy theorists may be rejoicing in Goldman’s misery, but if there’s one thing Goldman employees can be thankful for it is that with the stock lagging the overall market, the intensity of public backlash directed towards the company seems to have abated. Next thing you know, the conspiracy theorists will claim that ‘evil’ Goldman is purposely making their stock weak just so they can buy back the stock at lower prices.”

Source: Bespoke, November 25, 2009.

Financial Times: Asian asset bubble fears overblown
“Fears that asset bubbles are being created in Asia by foreign capital inflows look overdone at this point, says Michael Spencer, Deutsche Bank chief Asia economist.

“He says that while a few narrow real estate markets may be starting to look pricey, equity markets for the most part appear to be at or near fair value.

“‘The bigger problem facing a number of key Asian economies is the extent to which their currencies are pegged to the dollar, and the Federal Reserve’s very stimulative policy stance.

“‘The monetary stimulus and capital flows these pegs are engendering are forcing [Asian] authorities to adopt more restrictive prudential regulations in an effort to avoid the inevitable inflation pressures and asset bubbles this arrangement will bring.’

“Mr Spencer says the possibility that this extends to capital controls cannot be ruled out - but argues that they would be used only as a last resort if monetary control could not be established through currency appreciation, rate hikes and sterilisation.

“‘We would anyway dispute the argument that capital flows or asset prices are at extremes. Asian equity prices may have risen sharply since the beginning of the year, but the regional index is only about 5 per cent higher than it was last summer. In a similar vein, while property prices in general are going up, it is only the luxury end that is ‘frothy’.’”

Source: Michael Spencer, Financial Times, November 25, 2009.

Reuters: Templeton’s Mobius eyes Libyan market
“Templeton Asset Management fund manager Mark Mobius said he was eyeing private equity and other investments in Libya and said the stock market had enormous potential for growth.

“Mobius, a prominent emerging market investor, told Reuters at the launch of a new Egyptian brokerage office in Tripoli he saw potential for tourism, infrastructure and telecoms investments.

“Libya, holder of Africa’s largest oil reserves, has attracted a wave of interest from Arab and international companies, operating mainly in energy and construction, since most international sanctions were lifted in 2004.

“‘This market is very exciting now because the government is embarking on a privatisation programme to list many of the state enterprises. Although the market is small now, the potential for growth is enormous,’ Mobius said, speaking late on Sunday.

“Libya has said it plans to sell shares in four state firms via initial public offerings (IPOs) in 2010 and will enact a law next year offering tax breaks to companies listing on the stock exchange in an attempt to get more Libyans to invest.

“The Libyan exchange now has 10 listed firms, mostly banks and insurance companies. Shares worth about 2.1 million dinars ($1.75 million) traded in October, a stock market report said.

“Foreign firms have been lining up for oil deals and infrastructure contracts in a country which boasts a long Mediterranean coastline but few top class hotels.

“‘The potential here for hospitality and tourism is tremendous. That’s one area. The other area is infrastructure, roads, bridges, whatever, if that’s privatised,’ Mobius said.”

Source: Shaimaa Fayed, Reuters, November 23, 2009.

MoneyNews: Forecasters see dollar decline next year
“The top performing forecasters in Bloomberg’s survey of 46 firms predict the dollar will continue falling next year.

“The sluggish economic recovery and exploding government debt burden will weigh on the currency, they say.

“Standard Chartered bank, which placed first in estimating the dollar-euro rate over the 18 months ended June 30, sees the euro rising 5.5 percent against the dollar next year, to $1.58.

“‘History tells us the dollar shouldn’t start rising on a sustained basis until 12 months after the Fed starts to lift rates,’ Callum Henderson, the bank’s head of foreign exchange strategy told Bloomberg.

“‘It’ll take time to drain the oversupply of dollars from the market. The dollar will remain weak until the Fed’s rates rise above the competitors.’

“All three of the top performers in Bloomberg’s survey see the dollar falling against the euro next year.

“That includes Aletti Gestielle (an Italian money management firm) and HSBC in addition to Standard Chartered.

“The dollar bears are contrarians, as 24 of the 37 predictions on dollar-euro have the greenback rising next year.

“But some of the most renowned currency experts anticipate the dollar will depreciate further.

“‘I think the dollar is an over-owned currency,’ Pimco managing director Bill Gross told CNBC. ‘The Chinese, the Asians have basically owned too many dollars for too long.’”

Source: Dan Weil, MoneyNews, November 23, 2009.

Richard Russell (Dow Theory Letters): Why gold?
“Let’s say you’re a multimillionaire. You’re seriously worried about what to do with your millions in savings. You don’t want to keep your money under your mattress or in your Frigidaire, so where should you keep it? US T-bills are now in a state of zero or even negative interest - you pay the government to hold your money, but you’re SAFE. T-bills have behind them the full faith and credit of the United States. Great, but, now you’re thinking the unthinkable - How good is the full faith and credit of the US? There are rumors that the credit rating of the US could actually be lowered. And with the massive unfunded debt of the US, that could happen, and worse - the dollar could cave in. What to do?

“And you ask yourself, ‘What’s safer than T-bills or even top-grade foreign short-term debt?’ The answer is that there is one item that’s safer - gold. Gold represents intrinsic value in and of itself and by itself. Gold needs no nation to back or guarantee its value. Gold is no single nation’s liability. Furthermore, gold has no maturity date and gold is so safe that it doesn’t need to pay interest to those who hold it. You decide to put your savings into gold rather than T-bills. And unlike T-bills today, gold doesn’t depend on anyone’s ‘full faith and credit’.

“The fact is that the so-called ‘opportunity cost’ of buying or holding gold is zero today. T-bills pay you nothing. The fact is that it’s cheaper, safer, and it makes more sense to hold gold at this time than at almost any time in my memory. And a lot of knowledgeable, big money investors are doing just that - buying and holding gold for safety and as a store of value.”

Source: Richard Russell, Dow Theory Letters, November 24, 2009.

TheStreet.com: $8,000 gold
“James Turk, author and founder of GoldMoney, argues that gold will hit $8K in 6 years’ time.”

Source: TheStreet.com, November 25, 2009.

International Monetary Fund: IMF announces sale of 10 metric tons of gold to the Central Bank of Sri Lanka
“The International Monetary Fund (IMF) announced today the sale of 10 metric tons of gold to the Central Bank of Sri Lanka. The sale was conducted on the basis of market prices prevailing on November 23, 2009 with proceeds equivalent to US$375 million. This transaction is part of the total sales of 403.3 metric tons approved by the Executive Board in September 2009, and it adds to the total of 202 metric tons already sold to the Reserve Bank of India and the Bank of Mauritius.”

Source: International Monetary Fund, November 25, 2009.

Financial Times: Gold rush forces US to clip Eagle sales
“The rush by retail investors into gold has forced the US government to suspend sales of the world’s most popular bullion coin, the American Eagle, after running out of inventories.

“The shortage, the second since the start of the financial crisis in August 2008, is the latest sign of investors seeking a safe haven into bullion amid the US dollar woes. Safe-haven buying spurred by concerns about the health of Wall Street and a spike in inflation due to a lax monetary policy have also benefited gold sales.

“‘The US Mint has depleted its current inventory of 2009 American Eagles one-ounce bullion coins due to the continued strong demand,’ the mint said in a statement late on Wednesday. It added that selling will resume ‘once sufficient inventories … can be acquired to meet market demand’.

“The US Mint has sold about 1.19m ounces of American Eagles so far this year, up almost 75 per cent from the same period last year and on track to be the highest annual volume in ten years, according to official data. Sales of American Eagle’s silver coins have hit 26m ounces, the highest level in at least 23 years.”

Source: Javier Blas, Financial Times, November 26, 2009.

MoneyNews: Banks say too much gold to store
“Gold prices have been soaring this year thanks to a weak dollar, and everyone wants in on the investment.

“For some banks, though, it is becoming clear that only the big institutional investors are welcome to store the precious metal in their vaults.

“So they’re telling smaller investors to get their gold out and store it elsewhere.

“HSBC has told retail clients to remove their small gold holdings from its vault in New York City, The Wall Street Journal reported.

“Small retail investors don’t turn enough profits for the bank like the big institutional investors do, the newspaper reported.”

Source: Forrest Jones, MoneyNews, November 24, 2009.

David Fuller (Fullermoney): Gold’s advance is not a bubble
“Intrinsic or not, I think value is in the eye of the beholder. The Fullermoney view for the last nine years is that gold is being gradually remonetised in the eyes of investors. That process has accelerated over the last year because we have witnessed nothing less than the greatest monetary reflation in history.

“What might we expect from gold over the short to medium term?

“Technically, gold looks temporarily overstretched and $1,200 is a minor psychological level. Consequently, we could easily see a short-term reaction and consolidation of perhaps $30 to $50 before this secular bull market powers on into 1Q 2010. If the consistency of the two earlier cycles commencing in September 2005 and September 2007 is maintained, gold should reach at least $1,300 between March and May of next year.

“I do not think that gold’s current advance is a bubble, although it is likely to become one eventually. A genuine bubble, as opposed to a market that happens to be rising at a time when most people are underinvested and therefore envious observers, will include gold fever of the sort we have not seen since 1979-1970.

“To put recent events in perspective, bullion consolidated for eighteen months prior to the last three month’s gains. It has rallied about $200 since the September breakout, which is approximately $100 less than the two earlier advances referred to above. Comparing those three moves, gold’s recent percentage move is clearly less to date than we saw on the two earlier advances. Lastly, the Amex Gold Bugs Index has yet to clear its 2008 high. This does not suggest a bubble to me.”

Source: David Fuller, Fullermoney, November 26, 2009.

Financial Times: Oil prices are too high
“An oil price at $80 a barrel is inconsistent with supply and demand dynamics, inventory levels and the current macroeconomic environment, says Alexander Redman, strategist at Credit Suisse.

“‘US gasoline demand is at lower levels than this time a year ago, while distillate demand remains well below the five-year range and jet plane storage continues to climb. Overall, US oil demand is still down by 3 per cent year-on-year.’

“At the same time, he says, US petroleum inventories are among the highest levels of this decade and a further 100m barrels of oil is being held globally offshore in tankers.

“Mr Redman says an examination of the longer-term association between the real oil price and global spare oil capacity indicates two important factors.

“‘First, the oil price only tends to spike up once spare capacity falls below the critical 2-3 per cent level - the International Energy Agency does not project this occurring again until 2014. Second, using the IEA’s estimate of 2010 spare capacity of about 8 per cent, the oil price would typically be closer to $40 a barrel.

“‘For now, the market appears to be pricing in the return to a tighter supply environment well into the next decade and disregarding the current glut in supply.

“‘Going forward, the Credit Suisse oil team is targeting $70 a barrel for WTI - and $68 a barrel for Brent Crude.’”

Source: Alexander Redman, Financial Times, November 26, 2009.

Financial Times: Eurozone PMI growth reaches two-year high
“The eurozone recovery is gathering pace in the final months of 2009, but warning signs of weaker growth next year have appeared.

“Purchasing managers’ indices for the 16-country region on Monday showed private sector activity expanding this month at the fastest rate in two years, with France and Germany powering the revival. However, the survey also pointed to a loss of momentum in coming months.

“The results add to evidence that the eurozone has returned to expansion, but that it risks seeing growth fade once government and central bank support measures are ended. The results are likely to add to policymakers’ wariness about the outlook for 2010.

“In a speech in Madrid, Jean-Claude Trichet, European Central Bank president, said: ‘We can spot a number of signs of stabilisation. But the crisis has debilitated the real economy … [and has] proved so deep because it has deprived our citizens of confidence.’”

“The eurozone recession ended in the third quarter, when gross domestic product rose by 0.4 per cent.

“November’s purchasing managers’ indices suggest the fourth quarter will see growth of a similar pace or faster. The composite index, covering eurozone services and manufacturing, reached 53.7 in November, up from 53.0 in October, making it the fourth consecutive month of expansion.

“However, Chris Williamson, chief economist at Markit, which produces the survey, said November ‘also saw the first signs of growth peaking’. New orders grew at a slower rate than in October, especially in the service sector. Job losses remained high and ‘highlighted the fragility of the recovery’, he added.”

Source: Ralph Atkins, Financial Times, November 23, 2009.

Financial Times: Japan says economy back in deflation
“The Bank of Japan moved towards a neutral stance on the risk of inflation on Friday even as the government formally declared that the world’s second-largest economy has entered deflation for the first time since 2006.

“The government’s declaration sets the scene for heightened tension with the bank, which has been resisting public calls by politicians for greater aggression in the fight against deflation.

“‘We want the BoJ to extend support on the monetary policy front in overcoming deflation,’ said Naoto Kan, deputy prime minister. Hirohisa Fujii, finance minister, and Shizuka Kamei, financial services minister, have also called on the central bank to do more.

“The bank’s policy board kept interest rates on hold at 0.1 per cent on Friday, but said ‘there is a possibility that inflation will rise more than expected’ due to higher commodity prices, offset by a risk it could fall due to lower public expectations for medium- to long-term inflation. In previous statements it only mentioned the risk of inflation declines.

“Consumer prices were down by 2.2 per cent on the previous year in September, or by 1.0 per cent excluding fresh food and energy. Although year-on-year inflation first turned negative in February, the government only now declared that ‘the Japanese economy is in a mild deflationary phase’.”

Source: Robin Harding, Financial Times, November 20, 2009.

Financial Times: Japanese export growth eases recession fears
“Strong demand from China and other Asian economies lifted Japanese exports, which last month fell at their slowest rate for a year, boosting hopes that the economy will continue to report healthy growth.

“In October, exports fell 23.2 per cent from a year earlier, compared with a 30.6 per cent decline in September, according to data released by the Ministry of Finance on Wednesday. The figure represented the smallest drop since October 2008, when exports fell 7.9 per cent.

“On a seasonally adjusted basis, the value of shipments rose for the third straight month by 2.5 per cent from September.

“Junko Nishioka, economist at RBS in Tokyo, said the fall in exports last month was smaller than expected and marked a ‘clear improvement’.

“‘It shows how rapidly the growth rate is improving. Overall, we can safely say that the worst is over and downside risk is limited,’ said Ms Nishioka.

“Japan’s economy grew at an annualised rate of 4.8 per cent in the third quarter, fuelled by a mix of stimulus-induced domestic demand, a bounceback in exports and rebuilding of inventories.”

Source: Justine Lau, Financial Times, November 25, 2009.

Financial Times: China banks prepare to raise capital
“China’s banks are preparing to raise tens of billions of dollars in additional capital to meet regulatory requirements following an unprecedented expansion of new loans this year, according to people familiar with the matter.

“China’s 11 largest listed banks will have to raise at least Rmb300bn ($43bn) to meet more stringent capital adequacy requirements and maintain loan growth and business expansion, according to estimates from BNP Paribas.

“China’s banking regulator has warned it would refuse approvals for expansion and limit banking operations if lenders did not meet new capital adequacy requirements, a move that has prompted the country’s largest state-owned banks to prepare capital-raising plans for next year and beyond.

“Expectations of giant cash calls from the listed Chinese banks spooked investors on Tuesday, helping to send the benchmark Shanghai Composite Index down 3.45 per cent on a day of record turnover on the Shanghai and Shenzhen markets.

“China’s banking regulator ‘is definitely aware of potential asset quality issues and is pushing for higher capital adequacy requirements to offset deterioration in asset quality’, according to Dorris Chen, an analyst with BNP Paribas.

“Following government orders to prop up the domestic economy in the face of the global crisis, Chinese banks extended a record Rmb8,920bn in loans in the first 10 months of the year, up by Rmb5,260bn from the same period a year earlier.

“This unprecedented loan expansion resulted in a record fall in their core capital adequacy rates from just over 10 per cent at the end of last year to 8.89 per cent by the end of September, a drop that worries regulators.”

Source: Jamil Anderlini, Financial Times, November 24, 2009.

Infectious Greed: China leaps to second spot in global science
“The latest Thomson ISI science data shows that China has leaped to second-spot worldwide in academic science, as measured by papers produced. The US still leads the way, at 340,000 publications per year (not shown), but China could surpass US production within five years at current rates of relative growth.

“Of course, paper production is only one measure. Citations matter at least as much, and that isn’t captured here. Nevertheless, it is striking stuff.”

Source: Paul Kedrosky, Infectious Greed, November 21, 2009.

MoneyNews: Roach - buy China after collapse
“Buy China, advises Morgan Stanley Asia chairman Stephen Roach - but only after it tanks following a market correction Roach says is long overdue.

“‘I think right now the markets have run too fast too far, liquidity-driven and they have moved out of alignment with what I think is a very sluggish underlying recovery in the global economy,’ Roach told CNBC.

“Roach says the Chinese have focused too much on its investment growths and depended too much on export sales.

“‘The crisis is a wake-up call that the external demand from the West won’t be there for a long time,’ Roach says, pushing China to find new sources of demand.

“‘Korea has shifted its major external market from America to China, as has Japan … so there’s a lot riding on the ability of the Chinese to stimulate this new source of internal demand that could benefit not just the Chinese, but the Koreans and the Singapore too,’ Roach notes.

“Overall, however, Roach remains bullish on China, seeing an upside in its services sector over the next 5 to 7 years.”

Source: Julie Crawshaw, MoneyNews, November 23, 2009.

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Dubai’s latest mega-project – a massive default?

Saturday, November 28th, 2009

This post is a guest contribution by James Pressler* of The Northern Trust Company.

Over the past few years, Dubai has built a reputation not just locally but worldwide. As the fastest growing of the seven emirates making up the United Arab Emirates, it has become known for its astonishing creations - the largest manmade islands (three at latest count), one of the world’s largest ports, and the Burj Dubai - the tallest manmade structure in the world. Unfortunately, its latest creation is not receiving the same kind of oohs and ahhs. The announcement on Wednesday requesting a six-month payment freeze on the $59 billion in debt issued by Dubai World, a state-run conglomerate behind all this grand development, made markets shudder at another prospect - the largest sovereign default since Argentina in 2001.

While technically this week’s announcement does not yet constitute a formal default, international markets are treating it like one. Credit default spreads have broadened to what one analyst called “Icelandic” levels, investors have cut back positions and headed for the safety of the US$(?), and everyone is reconsidering just how safe some safe bets are. If a shamelessly-wealthy Gulf country could potentially default, what about countries with rising debts, huge deficits and shaky recoveries?

The complexities of the UAE’s governmental structure make the situation difficult to grasp at first glance, but the problem can be captured by a few basic points. First, Dubai is the second-largest emirate in the UAE next to Abu Dhabi, but Abu Dhabi is also the power of the national government and has been challenged by Dubai’s meteoric rise. Next, the UAE has a sovereign wealth fund estimated at one half-trillion dollars in case of emergency, so money is clearly available at the national level to bail out Dubai if that route is chosen. Lastly, the national government wants to emerge from this situation with international markets assured that a state-run entity has the backing of the government and will be subsequently subject to reform and accountability. Taken together, these points plus an appreciation of the politicial undercurrents suggest a scenario that avoids outright default.

In our base case, Abu Dhabi offers support from a national level so Dubai World can meet its financial obligations and implement some debt restructuring, all in exchange for ownership of significant Dubai-owned assets - Emirates airlines has been suggested in recent reports. In addition, Abu Dhabi forces Dubai World to restructure its business model from the dysfunctional “build it and they will come” ideal. These conditions would satisfy Abu Dhabi’s emirate-level interest in retaining dominance while also securing the national interest of retaining some international market confidence, all while avoiding a formal default. We will be monitoring events for key markers suggesting this scenario is playing out - replacement of Dubai World board members by more technocratic people favored by Abu Dhabi, the transfer of Dubai’s assets, and a general humbling of the indebted emirate in a way that places Abu Dhabi firmly in charge.

However, it would be irresponsible to not also mention what worries us looking forward. Aside from the off-chance that Dubai and Abu Dhabi are unable to converge on a cohesive recovery, what are the chances that Dubai World is just the first of more possible defaults to come? Since the UAE does not release public debt figures and estimates are sketchy at best, there is a chance that another public company could announce an excessive financial burden and a need for bailing out. This applies not just for the UAE but for any of the fast-developing Gulf countries experiencing an asset bubble collapse. With widening credit default spreads throughout the region and even into emerging Asia, any entity dependent on the recent flood of cheap money to roll over its debts could easily find itself out of options. Few would be as singularly vulnerable as Dubai World, but a significant default could set forth a vicious cycle of contraction and collapse that could take a number of victims.

The first sign of things to come could be as early as the first week in December, when Gulf markets re-open from the Eid al-Adha holiday (Dubai World announcing its debt postponement plans just before Eid celebrations was in all likelihood not a coincidence). This will mark the first chance for officials to state positions and make confidence-building claims, with the further interest of calming international markets. Between that time and the December 14 due date for Dubai World’s next debt payment, we expect to see a concrete plan laid out for bailing out the conglomerate and some pressure taken off the credit markets. However, if no settlement can be reached, it would not surprise us if another major entity started talking about restructuring or a debt freeze before year-end – and not necessarily a company in the UAE.

* James Pressler is an associate international economist at The Northern Trust Company, Chicago.

Source: Northern Trust - Daily Global Commentary, November 27, 2009.

Tags: Abu Dhabi, Bets, Burj Dubai, Complexities, Conglomerate, Credit Default, Debts, Emirate, First Glance, Governmental Structure, International Markets, James Pressler, Manmade Islands, Meteoric Rise, National Government, Northern Trust Company, Tallest Manmade Structure, Trillion, Uae, United Arab Emirates
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Advisor Alert - November 27, 2009

Friday, November 27th, 2009

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Tags: asset class, Canada, Census Bureau, Chief Investment Officer, China, Commodities, Congressional Budget Office, Economic Trend, Emerging Markets, Federal Budget Deficit, Federal Budget Outlays, Federal Deficits, Frank Holmes, Global Investors, Gold, Gold Equities, India, Market Groups, Medicare Medicaid, National Debt Clock, oil, Reputable Sources, Social Security Benefits, Treasury Department, Trend Data, Unfunded Liabilities, War Efforts
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Richard Karn: Nobody’s Right When Everybody’s Wrong (Chapter 2)

Thursday, November 26th, 2009

On Tuesday of this week we featured chapter 1 of Richard Karn’s fascinating e-book, Credit and Credibility, about the future of  markets, the global economy, global credit markets, and the 5 most pressing issues in the midst at this ‘hinge of history’ we have arrived at.

Karn has been described as one of the finest analysts and writers in the financial industry. Karn happens to be the featured guest speaker in an upcoming webinar (1 CE credit), on December 2, on the subject of currency debasement, sponsored by BMG Inc.

Chapter Summary: Credit and Credibility

Chapter 1: Pay no attention to the man behind the curtain! discusses fiat currency, the financial excesses and abuse it engenders, interventionist policy response to perpetuate it, and the role of the US dollar going forward;

Chapter 2: Nobody’s right when everybody’s wrong develops our contention that all fiat currencies today have become derivatives of the US dollar;

Chapter 3: May you live in interesting times explores the extent to which emerging markets can decouple from “consumer” economies and the role of China as the litmus test for the thesis;

Chapter 4: The report of my death was an exaggeration details our contention the world has had its fill of “financial innovation”, and the only way the US economy will recover will be through its traditional strengths in agriculture, manufacturing, invention, and hard work; and

Chapter 5: Passing laws, just because offers our assessment of the anthropogenic global warming debate and pending legislation.

Below we are very pleased to feature once again, for its relevance, the full Second chapter. Karn offers us a hype-less, lucid, insightful, look at the “macro” picture and begins to answer leading questions, proffered from his profound research. Yesterday, we featured some of Richard Karn’s latest thoughts. Very interesting reading. Enjoy!

Credit and Credibility

Chapter 2: Nobody’s right when everybody’s wrong

Arguably more effective than the military adventurism that dominates the headlines, what amounts to American cultural imperialism has subtly seduced large swathes of the world, and it has not been limited simply to a taste for fast food, film, and fashion.  The far more addictive aspect has been the successful overseas marketing of the “debt culture” via the financial innovation associated with the securitization (derivative) markets, which at $27 trillion has constituted the US’ largest export of the 21^st century.[1] This is the realm of the money center banks.

Enticed by various forms of off-balance sheet ‘accounting’ skullduggery, very few large banks globally managed to resist the siren song of easy profits and big bonuses offered by these financial innovations simply because it appears the only restriction on ‘profits’ was how far a bank dared to push its exposure.  That these vehicles were purposefully unregulated only increased their allure: calls for regulation as far back as 1998,[2] and again in the aftermath of the Enron scandal when these vehicles’ deceptive capabilities were fully exposed, were shouted down at every turn by none other than Alan Greenspan, Larry Summers and Robert Rubin and their cohorts in the SEC,[3] ostensibly not to stifle innovation or to drive markets offshore. But the behavior at Enron, far from being viewed as a cautionary tale prompting stricter agency enforcement, was adopted as the exemplar by money center banks-the very same banks, incidentally, that had made the ongoing fraud at Enron possible through a host of derivatives and special investment vehicles[4] the likes of JPMorgan, Citibank et al[5] actively marketed to Enron; instead, derivatives were the mechanism use to transmit the cancer globally.

This tacit government sanction suggests to us then that in effect the whole financial crisis only came to light because of what amounts to a falling out amongst thieves. No investigative reporter or oversight committee or regulatory watchdog safeguarding the interests of the public discovered and exposed any wrong-doing: major international banks’ books just became so overloaded with god-awful paper they knew may well be worthless that they grew terrified of loaning money to each other even over night for fear of not being repaid.[6] Once inter-bank lending stopped, credit creation froze, and the Ponzi-scheme parallel in the fiat currency mechanism began to breakdown.

The securitization and derivatives markets were so thoroughly corrupted by ‘innovation’ that if a bank shuffled paper, adjusted notional values and tweaked their infallible computer models furiously enough, they could arrive at the happy position of not requiring any capital reserves whatsoever to make loans. In other words, major banks worldwide indulged in what amounts to rampant uncollateralized lending-literally creating and distributing unfathomable amounts of money in the form of debt issuance from nothing, secured by nothing.  And quite possibly worth nothing.  It is widely assumed the still undisclosed expenditure of $2 trillion of taxpayer money referred to in the previous chapter was used to purchase boatloads of this stuff in order to stave off the recognition by the public that this behavior had rendered many of these ‘too big to fail’ money center banks literally insolvent; similar bailouts have been undertaken by governments worldwide.

Concurrent with the runaway lending, central banks throughout the world were channeling trade surpluses with the US as well as with each other into US Treasury bonds while simultaneously creating equal amounts of domestic currency to weaken it in order to maintain export competitiveness. This got so out of hand that today two-thirds of the world’s assets are denominated in US dollars.[7] The most controversial of these arrangements has been the de facto vendor financing agreement China has extended to the US: China suppressed the yuan, exports exploded, and it accumulated surpluses; the US let the dollar fall, consumption exploded, and it accumulated debts.[8] Both actions were irresponsible and highly inflationary.  Combined with similar behavior from much of the world, it produced a flood of liquidity that was if not misinterpreted as emerging market prosperity, certainly overstated it.  At the time it was noted primarily for contributing to the low interest rate environment enjoyed in the US that enabled the American consumption binge accompanying the housing bubble.  Few realized housing bubbles were pandemic.[9]

Our analysis concludes it was never a case of a “global savings glut” as proclaimed by Mr. Bernanke and the Fed in 2005[10] and reiterated by ex-Treasury Secretary Paulson[11]earlier this year  to deflect blame for the global financial crisis but a global fiat currency glut-a case of rampant global monetary inflation. Too much money could be leveraged too many times and transferred between too many international markets too quickly.  In addition to masking the extent of fiat currency creation, it produced, by historic standards, rapid-fire sequential bubbles in a range of real assets and commodities supported by credible explanations like ‘the emerging market infrastructure build-out,’ or ‘they’re not making any more real estate’ or ‘emerging middle classes will want to improve their diets’ or ‘Peak Oil,’ and was reinforced by price action.  These bubbles, as they must be, were largely based on the sound reasoning, analysis and extrapolations of economic data, as was the price action that supported it on charts; however, positive technical chart patterns cannot readily distinguish between breakouts driven by a glut of fiat currency looking for a speculative return and the supply and demand imbalances in this instance attributed to emerging market growth. Momentum produced the self-reinforcing hype of being right-something the ETR fell victim to itself-and as markets have discovered, it works in both directions. 

Download a PDF of the complete chapter here.

[2] O’Brien, Timothy L.: “A Federal Turf War Over Derivative Control”; The New York Times: 08.05.1998. http://query.nytimes.com/gst/fullpage.html?res=9B0DEFD81231F93BA35756C0A96E958260&n=Top%2FReference%2FTimes%20Topics%2FOrganizations%2FT%2FTreasury%20Department%20&scp=1&sq=Brooksley%20Born%20warns%20about%20derivatives&st=cse

[3] Whalen, Christopher:  “Statement to the Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Securities, Insurance, and Investment”: June 22, 2009, http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=1f354557-7b1f-4ffd-9014-e80435bc55b8

[4] McLean, B., Elkind, P. & Gibney, A.: Enron: The Smartest Guys in the Room; Magnolia Pictures: 2005.

[5] Thornton, Emily & France, Mike: “For Enron’s Bankers, a ‘Get out of Jail Free’ card”; BusinessWeek: 11.08.2008. http://www.businessweek.com/magazine/content/03_32/b3845036.htm

[6] Carney, Brian M.: “Bernanke is Fighting the Last War”; Wall Street Journal: 18.10.2008. http://online.wsj.com/article/SB122428279231046053.html

[7] Tett, Gillian: “In uncertain times, all that glitters is the gold standard”; The Financial Times: 09.04.2009.

http://www.ft.com/cms/s/0/d29f2728-249e-11de-9a01-00144feabdc0.html

[8] Grant, James: “For a better fuse box”; Grant’s Interest Rate Observer: Vol. 27, No. 6, 20.03.2009. http://www.grantspub.com

[9] Tomlinson, Richard & Doyle, Dara: “Ireland Loses Iceland Stigma as Euro Ensures No Return to Past”; Bloomberg: 04.06.2009.  http://www.bloomberg.com/apps/news?pid=20601109&sid=aBWMuYMHhfXw

[10] Cassidy, John: “Anatomy Of A Meltdown”; the New Yorker: 01.12.2008. http://www.newyorker.com/reporting/2008/12/01/081201fa_fact_cassidy?currentPage=all

[11] Yanping, Li: “China Central Bank Attacks Paulson’s ‘Gangster Logic’”; Bloomberg: 16.01.2009. http://www.bloomberg.com/apps/news?pid=20601087&sid=an1lSsWKeDs0&refer=home

Tags: Anthropogenic Global Warming, BMG Inc., Chapter Summary, China, Commodities, Credit Markets, Debasement, E Book, Emerging Markets, Exaggeration, Excesses, Fiat Currencies, Fiat Currency, Financial Innovation, Global Credit, Global Economy, Gold, Litmus Test, Man Behind The Curtain, May You Live In Interesting Times, oil, Policy Response, Richard Karn, Thesis Chapter, Traditional Strengths
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Richard Karn: Credit and Credibility - Chapter 1

Tuesday, November 24th, 2009

5 months ago we featured a fascinating e-book by Emerging Trend Report’s, Richard Karn, Credit and Credibility, about the future of  markets, the global economy, global credit markets, and the 5 most pressing issues in the midst of this ‘hinge of history’ we find ourselves in.

Karn has been described as one of the finest analysts and writers in the financial industry. Karn happens to be the featured guest speaker in an upcoming webinar (1 CE credit), on December 2, on the subject of currency debasement, sponsored by BMG Inc.

Chapter Summary: Credit and Credibility

Chapter 1: Pay no attention to the man behind the curtain! discusses fiat currency, the financial excesses and abuse it engenders, interventionist policy response to perpetuate it, and the role of the US dollar going forward;

Chapter 2: Nobody’s right when everybody’s wrong develops our contention that all fiat currencies today have become derivatives of the US dollar;

Chapter 3: May you live in interesting times explores the extent to which emerging markets can decouple from “consumer” economies and the role of China as the litmus test for the thesis;

Chapter 4: The report of my death was an exaggeration details our contention the world has had its fill of “financial innovation”, and the only way the US economy will recover will be through its traditional strengths in agriculture, manufacturing, invention, and hard work; and

Chapter 5: Passing laws, just because offers our assessment of the anthropogenic global warming debate and pending legislation.

Below we are very pleased to feature once again, for its relevance, the first full chapter. Karn offers us a hype-less, lucid, insightful, look at the “macro” picture and begins to answer leading questions, proffered from his profound research. Tomorrow we will feature some of Richard Karn’s latest thoughts, and on Thursday, we will share Chapter 2 with you. Very interesting reading. Enjoy!

Credit and Credibility

Chapter 1: Pay No Attention to the Man Behind the Curtain

Americans’ willful ignorance of all things economic combined with a blind faith in our elected officials has made us all complicit to one extent or another, even if by omission, in the financial crisis rocking our country.  Most of us have been viscerally aware of the economic problems our country faces, but as with health check-ups after a certain age we’ve become loathe to visit the doctor for fear of what all those warnings we’ve been studiously ignoring really mean.  And the truth is that you do not need a doctorate to know that our economy is displaying the pathology of a critically ill patient that has been so badly, and we would argue purposefully, misdiagnosed that the disease itself has escaped real treatment while those treatments administered to the symptoms have only served to accelerate the progress of the disease.

We all want to believe that our government is acting in our best interests, that its shortcomings and failures are a matter of well-intentioned incompetence and not something more sinister.  But political pandering to special interest groups routinely takes precedence over the common good and is largely responsible for bringing us to the brink of economic collapse today.  In what has become an all too familiar scenario, successful lobbying resulted in the de- or self-regulation of another segment of the financial industry, which was accompanied by the concurrent elimination, subversion, or de-fanging of agency enforcement, and has culminated in another financial crisis rife with corruption, the cost of which is once again being borne by American taxpayers.  It strikes most of us as perfectly obvious that politicians cannot serve two masters, especially when one pays better and arguably preys on the other, but the practice continues unabated-as is witnessed by the financials sector’s continuing influence in Washington despite the revelations of the last 18 months.

The sheer scale of the debacle guarantees it will be the subject of myriad forensic dissections regarding what went wrong in the US and why, but the ETR submits historians will eventually point to the root of the problem being the very nature of the US dollar itself.  The dollar has been a purely fiat currency since August of 1971 when President Richard Nixon ended its convertibility to gold.  We support the contention that it is the inherent lack of fiscal restraint attendant to the subjective administration of a fiat currency regime rather than a rules-based currency accessible to all, such as a gold standard, that has by design or default culminated in the problems extant in the US economy today; that the dollar is the world’s reserve currency has startling implications for the global economy well beyond the heated rhetoric its mismanagement has provoked amongst our allies, trading partners and rivals alike.

Let us not equivocate here: the economic failure we are witnessing today is not with capitalism as many would have us believe but with the abuse engendered by the interventionist policies that have been put into practice since the US dollar became a purely fiat currency. It is not a coincidence that since ending the dollar’s convertibility to gold America has been transformed from the largest creditor nation on earth to the largest debtor nation, nor that it has fallen from one of the most admired nations on earth to one of the most reviled.  Any economic system whose foundation rests on the shifting sands of a fiat currency is destined to collapse: this has been the case with every single fiat currency in history, twenty failing during the 20^th century alone,[1] and the reasons are not difficult to fathom.  When a government holds its currency-literally its stock in trade-in low regard, which history tells us a fiat currency regime invariably does when it can conjure money at will to spend as frivolously as it dares, inevitably certain of  its citizens will too, giving rise to a Culture of Cheating. No longer restrained by such quaint notions as sound money of tangible lasting value or living within our means, the unbridled expansion of credit has witnessed a corresponding increase in the frequency of financial crisis, each of escalating magnitude and attended by ever more pervasive corruption.

Interventionist policy responses implemented ostensibly to resolve one crisis serve as well to foster the development of the next because the ’solution’ never addresses the root of the problem, only its latest chaotic manifestation.  Despite demonstrating time and again that low interest rates combined with massive liquidity injections invariably lead to asset bubbles that also invariably collapse,[2] that accurately summarizes the Fed and Treasury’s uniform response to crisis: promote the assumption of more debt as the means to restore economic growth.  But artificially stimulating growth through the creation of debt has been proven over the years to diminish the effect of each effort due to the increasingly debilitating economic drain attendant to servicing the accumulated debt, the misallocation of easy credit toward consumption rather than production, and the specious growth attendant to siphoning off ‘profits’ from transactions that merely shuffle the new paper hither and yon.  The growing imbalance between the service and manufacturing industries is reflected in the persistent deterioration in results: in 1966, each dollar borrowed produced ninety-three cents of GDP growth; by 2007, a borrowed dollar produced less than twenty cents of GDP growth.[3] (Please refer to the charts on page 5.)  In other words, each new effort requires more ’stimulus’ than its predecessor in order to produce a similar result: we term this policy rut, which we believe has spilled over into many aspects of American society, the doctrine of ‘more of the same, only harder’ because the desired outcome is not to cure the problem but to perpetuate it by deflecting it in a new direction.

Nearly four decades of experience with the fiat dollar is plainly telling us that this doctrine has failed, and until the fiat dollar is rejected, the progression of financial crises will continue to accelerate until our economy, and indeed quite probably large swathes of the global economy, is hopelessly gutted and lay in ruins.  We see this reflected in our vulnerable household finances which have deteriorated to the point we increasingly rely on revolving credit instead of savings as the most important source of liquidity after our jobs.[4] We see it in the uncontrolled growth of US trade imbalances, military adventurism, deficit spending, un- or underfunded entitlement programs, and ever more debt issuance and monetary expansion that have culminated in American taxpayers ultimately being responsible for more than $70 trillion dollars of debt,[5] not including that which we are currently assuming ostensibly to stave off financial collapse- a debt so large in fact it is literally only possible under a fiat currency regime.

Download Chapter 1 as a PDF.

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Will Emerging Market Outperformance Last?

Tuesday, November 24th, 2009

The MSCI Emerging Markets Index has notched up a massive 72.3% gain for the year to date, and an even more impressive 101.4% since the March 9 lows. Although emerging markets were the clear leaders during the initial months of the recovery, the MSCI World Index has subsequently done some catching up but still lags with gains of 26.7% and 69.3% for the two measurement periods.

The chart below shows the performance of the MSCI Emerging Markets Index relative to the Dow Jones World Index. Needless to say, an upwardly sloping line means outperformance by developing stock markets.

Source: StockCharts.com

Should emerging markets be renamed “emerged” markets? Let’s consider two graphs to gain a better understanding of one of the key drivers of emerging stock markets.

As shown below, the Emerging Markets Index is primarily driven by commodity prices and in particular by metal prices as measured by the Economist Metals Price Index. Considering the historical relationship, emerging-market equities seem to be fairly priced given the level of metal prices.

Source: Plexus Asset Management (based on data from I-Net Bridge).

All other things being equal, the outlook for emerging markets, or at least the resource-related ones, appears positive given the favorable prospects for metal prices on the back of improving global industrial production and stronger global economic growth.

What is important is that the ratio of the Emerging Markets Index and World Index is also driven by commodity prices and specifically metal prices. As shown below, the relative risk of investing in emerging-market equities has increased as the ratio has outrun metal prices.

Source: Plexus Asset Management (based on data from I-Net Bridge).

Longer term I have little doubt that emerging markets will outperform their mature peers. However, over the next few months metal prices would need to rise quite substantially to ensure further outperformance by the Emerging Markets Index. At best, I would expect emerging markets to maintain the current relative levels against the MSCI Global Index should metal prices move sideways.

Tags: Commodities, Commodity Prices, Dow Jones, Economist, Emerging Market, Emerging Markets, Emerging Stock Markets, Favorable Prospects, Global Economic Growth, Graphs, Lows, Measurement, Metals, Msci Emerging Markets, Msci Emerging Markets Index, Msci World Index, Peers, Plexus Asset Management, Price Index, Relative Risk, Stockcharts, Year To Date
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Words from the (Investment) Wise (November 22, 2009)

Sunday, November 22nd, 2009

Stock markets succumbed to a bout of profit-taking last week, sparked by concerns that the rally has overshot the pace of economic recovery. Riskier assets were showing signs of fatigue as the US dollar - the catalyst of many recent moves - stabilized and was perceived to be near its trough (if only short-term in the books of ardent dollar bears).

The greenback, usually the remit of the US Treasury, received support from Fed Chairman Ben Bernanke in a speech. He noted that the Fed was “attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the US economy, will help ensure that the dollar is strong and a source of global financial stability.” These comments spurred some buying interest.

Bill King (The King Report) summarized the situation as follows: “For the past few months, bad economic news was perceived to be good news for stocks on the rationale that it ensured more juice. Dollar down, stocks and gold up has been the routine. Are we at an inflection point, where bad economic news is becoming bad news for stocks?”

Source: Ed Stein, Comics.com, November 20, 2009.

The past week’s performance of the major asset classes is summarized by the chart below. With the exception of equities and investment-grade corporate bonds, most asset classes closed higher on the week despite nervousness creeping in before the weekend. Gold bullion touched a record high of $1,152.74 on Thursday and helped platinum, silver, palladium and copper reach fresh peaks for the year.

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The MSCI World Index (-1.1%) and the MSCI Emerging Markets Index (+0.3%) followed different paths last week, resulting in year-to-date gains of 24.5% and an impressive 70.2% respectively. Notwithstanding solid gains since the March lows, no major index has yet been able to reclaim the 2007 pre-crisis peaks.

As far as the US indices are concerned, the Dow Jones Industrial Index eked out a small gain for the week as investors emphasized high quality, but the other major indices all reversed a two-week up-patch. Six of the ten economic sectors closed lower for the week, with Technology (-1.4%) and Consumer Discretionary (-1.1%) underperforming,

The year-to-date gains in the US remain firmly in positive territory and are as follows: Dow Jones Industrial Index 17.6%, S&P 500 Index 20.8%, Nasdaq Composite Index 36.1% and Russell 2000 Index 17.1%.

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

Top performers among stock markets this week were Bangladesh (+21.3%), Latvia (+4.5%), Kazakhstan (+4.3%), Qatar (+4.1%) and China (+3.8%. At the bottom end of the performance rankings, countries included Ecuador (‑9.3%), Egypt (-7.6%), Greece (-7.1%), Turkey (-7.0%) and Macedonia (‑6.3%).

Of the 98 stock markets I keep on my radar screen, 39% recorded gains (last week 66%), 58% (31%) showed losses and 3% (3%) remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

While other benchmark indices have been going from strength to strength, the Japanese Nikkei Dow has been in a downtrend since August and last week recorded a fourth consecutive down-week. The weakness in Japanese stocks coincided with a surge in the price of credit default swaps (CDSs) on Japanese government bonds (JGBs) - under stress of sovereign solvency fears. The chart below shows the significant underperformance of the Nikkei (red line) versus the S&P 500 (green line) - in absolute terms in the top section and on a relative basis (blue line) in the bottom part.

Source: StockCharts.com

John Nyaradi (Wall Street Sector Selector) reports that, as far as exchange-traded funds (ETFs) are concerned, the winners for the week included iShares Silver Trust (SLV) (+6.2%), PowerShares DB Silver (DBS) (+6.2%), PowerShares DB Base Metals (DBB) (+4.6%), SPDR S&P Metals and Mining (XME) (+3.8%) and Market Vectors Agribusiness (MOO) (+3.8%).

At the bottom end of the performance rankings, ETFs included iShares MSCI Turkey Investible Market (TUR) (-8.1%), HOLDRS Merrill Lynch Market Oil Service (OIH) (-4.3%), First Trust ISE-Revere Natural Gas (FCG) (-3.9%), SPDR S&P International Financial Sector (IPF) (-3.9%) and iShares Dow Jones US Home Construction (ITB) (-3.7%).

“Short-term US interest rates turned negative on Thursday as banks frantically stockpiled government securities in order to polish their balance sheets for the end of the year,” reported the Financial Times. Three-month T-Bills traded at a yield of -0.03% and six-month Bills fell to 0.12% - the lowest six-month yield since 1985. “Conventional wisdom says it’s year-end window dressing … But why Bills? If you want to park cash, why not place it in some short-term paper with a positive yield? … those pundits that exclaim there is no problem are not correct. If there were no concerns, the cash would not eagerly run to a negative yield vehicle,” observed Bill King.

Signs of heightened risk aversion also came from a widening of the spread of emerging-market bond yields over Treasuries and an increase in credit default swap spreads on corporate bonds and sovereign debt (notably the US and the UK). Risk aversion also resulted in the selling of some commodity-linked currencies.

In other news, a US congressional panel on Thursday approved the Ron Paul-Alan Grayson initiative to open the Federal Reserve’s monetary policy decisions to government audits. The panel approved the amendment to broader legislation to revamp financial rules, but put off a vote on the broader measure.

Also, the Fed announced a reduction in the term of discount window loans from 90 to 28 days, effective January 14, 2010. Asha Bangalore (Northern Trust) argued that the need for discount window loans had decreased significantly from the period following the collapse of Lehman Brothers. “This [Fed's announcement] marks the beginning of a gradual withdrawal of the extraordinary support the Fed has extended to the global financial system as signs of stability have emerged,” she said.

Next, a tag cloud of all the articles I read during the week. This is a way of visualizing word frequencies at a glance. “Gold” has been rising in prominence for a while, and now occupies the top slot in the media. Words such as “rates”, “dollar”, “prices” and “China” are not far behind.

Back to the stock markets: The S&P 500 Index broke above 1,100 on Monday, but reversed course later in the week and again closed below what was seen as an important resistance level.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town) are given in the table below. With the exception of the Russell 2000 Index, the indices in the table are all trading above their 50-day moving averages, with all the indices also above their respective 200-day moving averages. However, many European markets have already fallen to below their 50-day lines (not shown on this table, but indicated on the performance table higher up), pointing to possible further weakness.

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

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

In addition to having retraced 50% of their bear market declines and up-volume recently having been mediocre, the Dow Industrial and S&P 500 are up against significant medium-term downward trendlines. Also, negative divergences are showing up in a number of breadth indicators, often good leading indicators at tops, as discussed below.

The number of S&P 500 stocks trading above their respective 50-day moving averages has declined from 92.6% in September to 56.8%, having made a series of declining tops while the underlying index was making new highs for the move. “This means that less and less stocks have been helping the index move higher, and it’s definitely something that favors the bearish argument,” said Bespoke.

Source: StockCharts.com

The Bullish Percent Index shows the percentage of stocks that are currently in bullish mode as a result of point-and-figure buy signals. The figure is still relatively high at 77.0%, but the indicator appears to be topping out.

Source: StockCharts.com

Richard Russell, 85-year-old writer of the Dow Theory Letters newsletter, said: “I keep thinking that the stock market is on thin ice … I’m still bothered by the fact that this ‘bull market’ never started from an area where stocks were selling below ‘known values’. Every bear market I’ve ever seen has ended with stocks selling below ‘known values’. We never saw anything like that at the October 2008 lows or at the March 2009 lows. For this reason, I continue to think that maybe the final bear market bottom lies ahead. Suspicion, thy name is Russell.”

In case you have missed Adam Hewison’s (INO.com) short technical analysis videos during the past week, click on the following links to access these excellent presentations: S&P 500, Dow and Nasdaq, the US dollar, gold and crude oil.

As stated before, share prices have moved too far ahead of economic reality. This calls for a cautious approach in anticipation of the market working off its overbought condition and fundamentals reasserting themselves. I will bide my time while the fundamentals play catch-up.

For more discussion on the economy and financial markets, see my recent posts “Velocity of US money supply at long last edging up“, “2009 Rally vs. 1982 Bull Market“, “Picture du Jour: Plunging dollar erodes non-US investors’ returns“, “WealthTrack: Bruce Berkowitz - golden rules of investing“, and “Donald Coxe - Investment Recommendations (November 2009)“. (And do make a point of listening to Donald Coxe’s webcast of November 20, which can be accessed from the sidebar of the Investment Postcards site.)

Twitter and Facebook
I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those not doing so already, you can follow my “tweets” by clicking here. You may also consider joining me as a friend on Facebook.

Economy
“Global business confidence is slowly improving. Businesses remain cautious, but sentiment is much better than at the beginning of the year and is consistent with a tentative global economic recovery,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. “Businesses were much more upbeat … notably optimistic about the economy’s prospects next spring. South American businesses are the most positive, and North Americans generally the most negative.”

Source: Moody’s Economy.com

The Ifo World Economic Climate Indicator rose in the fourth quarter of 2009 for the third time in succession, with the economic climate improving in all major economic regions. The improvement was particularly marked in Asia, where the indicator even surpassed its long-term average, but the climate indicator also rose clearly in Western Europe and North America in the fourth quarter. While the recovery of the world economy is driven especially by Brazil as well as India, China and other Asian countries, the economic expectations are now optimistic almost everywhere, with the exception of several countries in Central and Eastern Europe.

Source: Ifo, November 19, 2009.

As far as hard data are concerned, the Japanese gross domestic product grew by 1.2% quarter on quarter between July and September - the biggest quarterly expansion since the first quarter of 2007. A growing trade surplus and stimulus-fuelled private consumption combined to help the world’s second-largest economy recover from its worst postwar recession.

The latest acronym used in the context of economic recovery is “LUV”, indicating an L-shaped economic recovery in Western Europe, a U-shaped improvement in the US and a V-shaped reversal in the BRIC and other emerging countries.

A snapshot of the week’s US economic reports is provided below. (Click on the dates to see Northern Trust’s assessment of the various data releases.)

Thursday, November 19
• Index of Leading Economic Indicators underscores US economy will continue to grow
• Labor market data point to stabilizing conditions

Wednesday, November 18
• Higher prices for cars and energy lifted CPI in October
• Housing starts - permits show a more stable trend

Tuesday, November 17
• Fed reduces term of discount window loans
• Factory production slips in October
• Higher prices for food and energy lift wholesale prices, core price index declines

Monday, November 16
• Chairman Bernanke stresses job market and credit conditions; the dollar receives special mention
• October retail sales - noteworthy gains of several components

Bespoke’s “Economic Indicator Diffusion Index” measures the pace at which US indicators are coming in ahead of (or below) expectations over a 50-day period. Interestingly, the Index last week fell into negative territory as data reports failed to live up to (higher) expectations.

Still bearish, Nouriel Roubini (RGE), according to The Money Game - The Business Insider, predicts a slow recovery, quoting the following ten reasons why we will see a U-shaped US recovery:

1. A U-shaped US consumer. Roubini argues against a “V-shaped” recovery, which he says puts too much confidence in this year’s strong equity rally. Eighty percent of the population reacts to home prices, not equity prices, and he forecasts that home prices will fall further.

2. Difficult labor market conditions. Expect a strong second half of 2009 and a sluggish 2010, with growth below potential and continued job losses.

3. Balance sheet recession caused by over-leverage and debt accumulation. There are signs of a massive re-leveraging in the public sector. The cost of maintaining this level of debt will be very high and a drag on the economy.

4. Investment usually is a strong recovery component. But investment will not recover while one third of current capacity is not utilized.

5. A damaged financial system and the related credit crunch. Only half of the estimated $3 trillion global credit losses (IMF recently lowered their estimates) have been recognized so far. Expect more to come, especially in Europe.

6. Home prices said to fall further and commercial real estate bust continuing.

7. Exit strategy: Damned if you do and damned if you don’t. Removing fiscal accommodation will constrain a recovery that still appears weak. It has already been determined that it is too early to remove fiscal accommodation, but if it continues it will fuel persistent large budget deficits and lead to inflation.

8. Fall in potential GDP levels and possibly in potential growth.

9. Global imbalances: Over-spenders retrench while over-savers don’t compensate. Fall in demand from countries that tend to be over-spenders (US, UK) has not been neutralized by countries that tend to be over-savers (Japan, Germany).

10. Emerging markets (EMs) fared better, but can’t close the consumption gap. Can China/India be the engine of global growth? No. Can EMs decouple from anemic growth in G3? No. Is the policy response of China/Asia appropriate and sustainable? No. There are not the necessary social safety nets in EM countries, so the motive to save is high. Private demand has to take over and drive growth.

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, November 20, 2009.

Click here for a summary of Wells Fargo Securities’ weekly economic and financial commentary.

US economic data reports for the week include the following:

Monday, November 23
• Existing home sales

Tuesday, November 24
• GDP
• Case Shiller 20 City Index
• Consumer confidence
• FHFA Home Price Index

Wednesday, November 25
• Personal income and spending
• PCE prices
• Initial jobless claims
• Durable goods orders
• Michigan Sentiment Index
• New home sales

Thursday, November 19
• Thanksgiving Day

The performance chart for various financial markets usually obtained from the Wall Street Journal Online is unfortunately not available this week.

“The recipe for perpetual ignorance is to be satisfied with your opinions and
content with your knowledge,” said Elbert Hubbard, American writer (hat tip: The Kirk Report). Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will make a contribution towards continuously shaping new opinions and increasing the knowledge of the readers of Investment Postcards to enable them to make the appropriate investment decisions.

This week, the markets will be closed on Thursday, Thanksgiving Day, and on Friday from 13:00 EST.

That’s the way it looks from Cape Town (where I am enjoying beautiful summer days before making my annual early-December trip to New York City).

Source: Tom Toles, The Washington Post, November 17, 2009.

Clusterstock: The Journal has the richest readership among print publications
“The Wall Street Journal has the wealthiest readership among print readers according to a new survey from Mediamark Research & Intelligence, by way of BtoB Online.

“This is why Rupert Murdoch is trying to build stronger pay walls around his sites. He wants to protect his premium readership so he can keep charging high ad rates.”

Source: Jay Yarow and Kamelia Angelova, Clusterstock - The Business Insider, November 19, 2009.

Financial Times: Goldman’s PR problem
“Although the $500 million Goldman Sachs has pledged to help small businesses is the largest donation the company has ever made, the firm remains the whipping boy for Wall Street excess, says Francesco Guerrera.”

Click here for the full article.

Source: Financial Times, November 18, 2009.

Ifo: Clear improvement in the Ifo World Economic Climate Indicator
“The Ifo World Economic Climate Indicator rose in the fourth quarter of 2009 for the third time in succession. The rise in the indicator is the result of both more favourable expectations for the coming six months as well as less negative assessments of the current economic situation. The recovery of the world economy is driven especially by the dynamic development in Brazil as well as in India, China and other Asian countries.

“The economic climate improved in all major economic regions. The improvement was particularly marked in Asia, where the indicator even surpassed its long-term average. Also in Western Europe and North America the climate indicator rose clearly in the fourth quarter of 2009. The economic expectations are now very optimistic almost everywhere, with the exception of several countries of Central and Eastern Europe.

“In contrast, the current economic situation is still assessed as decidedly unfavourable in all major regions, although these assessments clearly improved over the previous quarter. The appraisals of the current economic situation are particularly negative in the euro area, North America, Central and Eastern Europe and Russia.

“The inflation expectations for 2009, on a worldwide average, are clearly lower than the inflation estimate for the previous year (2.5% compared to 5.4%). According to the expectations of the World Economic Survey (WES) participants, prices will increase only slightly in the course of the coming six months.

“The short-term interest rates will increase again in the coming six months for the first time in more than a year, in the opinion of the WES experts. In accord with the more favourable economic outlook, the WES experts anticipate that the long-term interest rates are also likely to increase in the coming six months in most countries.

“An increasing number of WES experts regard the euro as overvalued. The other major world currencies, the US dollar, the Japanese yen and the British pound, are now seen as properly valued, on average.”

Source: Ifo, November 19, 2009.

Bill King (The King Report): Sovereign solvency fears
“Over the past several weeks, credit default swaps (CDS) on sovereign debt have rallied sharply. Investors increasingly fear that the massive amounts of sovereign debt will not be repaid. The following CDS chart on JGBs is alarming.

“While the surge in CDS on Japanese debt has retrenched over the past week, the CDS on US and UK debt have rallied … Our guess is the market fears another downturn will lead to more stimulus and more governments absorbing crappy paper and risk from the private sector … The last crisis flamed on fears of bank and major corporate solvency. The next crisis could be characterized by sovereign solvency fears.”

Source: Bill King, The King Report, November 18, 2009.

The Wall Street Journal: China’s blunt talk for Obama
“China’s top banking regulator issued a sharp critique of US financial management only hours before President Barack Obama commenced his first visit to the Asian giant, highlighting economic and trade tensions that threaten to overshadow the trip.

“Liu Mingkang, chairman of the China Banking Regulatory Commission, said that a weak US dollar and low US interest rates had led to ‘massive speculation’ that was inflating asset bubbles around the world. It has created ‘unavoidable risks for the recovery of the global economy, especially emerging economies’, Mr. Liu said. The situation is ’seriously impacting global asset prices and encouraging speculation in stock and property markets’.

“Early Monday, a spokesman for China’s Ministry of Commerce added further criticism of the Obama administration, targeting recent measures by Washington against Chinese exports. ‘We’ve always known the US and the West as free market economies. But now we’re seeing a protectionist side,’ the spokesman, Yao Jian, told a monthly press briefing. Mr. Yao also rejected criticism of China’s currency policy, saying the yuan’s exchange rate has little to do with trade imbalances with the US and that China should keep the exchange rate stable.

“The Chinese comments signaled that Mr. Obama - on the third leg of a four-country Asian tour - can expect blunt talk from Chinese leaders on the economy. The issue could complicate his broad agenda in China that also includes efforts to extract new commitments on climate change and to encourage them to take a more active role to defuse nuclear threats in Iran and North Korea.”

Click here for the full article.

Source: Jonathan Weisman, Aaron Back and Andrew Browne, The Wall Street Journal, November 16, 2009.

Financial Times: Obama in China
“Barack Obama and Hu Jintao pledge to work together on a long list of pressing international issues during talks in the Chinese capital Beijing.”

Click here for the full article.

Source: Financial Times, November 17, 2009.

Reuters: China, US eye pact to help troubled banks
“Chinese and US regulators are negotiating a pact aimed at encouraging Chinese financial institutions to buy into small and medium-sized banks in the United States, bankers briefed on the plan said on Tuesday.

“Chinese bankers have complained that it’s been difficult for them to set up branches or invest in banks in the world’s leading economy, due partly to US regulators’ tough supervision and strict approval process for financial deals.

“But the global financial landscape has been revamped by the credit crisis, and cash-rich Chinese banks are now bigger players on the world scene and are scouting around for investment targets.

“To illustrate the global shake-down, Industrial and Commercial Bank of China is now the world’s biggest bank by market value, while Citigroup, once the world’s No.1 bank, is worth the same as a second-tier commercial bank in China.

“Two senior Chinese bankers said they had been invited this year by US officials, investment bankers and financial advisers to look at several potential investments in US banks, mostly in financial trouble.

“‘The trend is already there,’ said one Chinese banker. ‘Now they’re going to make this into an agreement to show there’s a change in official attitude toward Chinese investments in the US banking system,’ said the banker, who declined to be identified due to the sensitive nature of the matter.”

Source: George Chen, Reuters, November 17, 2009.

Financial Times: Geithner defends record to Congress
“Tim Geithner launched a fierce defence of his record as US Treasury secretary on Thursday as Republicans said his policies had failed and he should resign.

“In an unusually testy Congressional hearing, Mr Geithner told his Republican critics that he refused to take responsibility for ‘the legacy of crises you’ve bequeathed this country’.

“Kevin Brady, senior House Republican on the joint economic committee, told Mr Geithner he was a failure. ‘Unemployment skyrocketed … The deficit is becoming frightening … We are reduced to begging China to buy our debt and getting lectures from other nations on our financial disarray,’ he said. ‘The public has lost all confidence in your ability to do the job.’

“Mr Geithner shot back: ‘I agree with almost nothing in what you’ve said.’

“Although the US economy has started growing again, last month the unemployment rate breached 10% and is expected to stay high. With investment banks returning to profit but ordinary people still suffering, Republicans are increasing their attacks on the Obama administration over the economy.

“The Treasury secretary faced an array of questions and criticism during the hearing, which was ostensibly about plans to reform financial regulation. On that topic, Mr Geithner urged Congress to press ahead with legislation to reform the US regulatory system.

“He said reform would help to avoid a situation such as the government bail-out of insurance behemoth AIG in the future. He was criticised for his role in that rescue as then-president of the New York Federal Reserve.

“‘The United States of America … came into this crisis without anything like the basic tools countries need to contain financial panics,’ he said. ‘Coming into AIG, we had basically duct tape and string.’

“Mr Geithner also faced complaints that China was unfairly undervaluing its currency, the renminbi.

“He replied that he was confident Beijing would soon move to flexible rates. ‘They understand they need to do it, I think they want to do it, and I’m quite confident they will do it,’ he said.

“He also defended the ‘extraordinary’ actions taken to stabilise the economy and said the troubled asset relief programme was bringing good returns to US taxpayers.”

Source: Sarah O’Connor and Alan Rappeport, Financial Times, November 19, 2009.

Mark Felsenthal (Reuters): House panel OKs plan to open Fed policy to audits
“A US congressional panel on Thursday approved a measure to open the Federal Reserve’s monetary policy decisions to government audits, a surprise blow to the central bank’s efforts to shield its independence and a signal of frustration with the central bank.

“The provision, co-sponsored by Republican Representative Ron Paul and Democrat Alan Grayson, would allow a congressional watchdog agency to conduct a broad review of the US central bank’s policy and lending. Fed officials have strongly opposed it, saying it would cast doubt on the central bank’s independence from political pressure.

“The House of Representatives Financial Services Committee approved the amendment to broader legislation to revamp financial rules. The panel put off a vote on the broader measure.

“House Financial Services Committee Chairman Barney Frank, who opposed the Paul-Grayson measure, predicted it would be revisited when financial reform legislation is debated by the House.

“‘I think it’s going to be seen as weakening the independence of monetary policy with consequent negative implications,’ he told reporters after the vote. ‘I think people will be worried about the impact on the dollar and on interest rates, and I think that one may be revisited when we get to the floor.’

“However, Paul’s measure has earned support from more than half of the members of the House.

“The amendment is a further congressional slap at the US central bank after a Senate regulatory overhaul proposed stripping the Fed of its regulatory authority. Some lawmakers fault the Fed for failing to anticipate or prevent the financial crisis that pitched the economy into deep recession, while others are angry at its extensive emergency support for financial institutions.

“The Fed objected to the provision, saying it could raise financial market questions about its independence and could result in higher long-term interest rates as investors worry about inflation risks.”

Source: Mark Felsenthal, Reuters, November 20, 2009.

Bespoke: Government spending - where does it end?
“On Thursday, the Treasury Department released its monthly budget statement which summarizes revenues and spending for the month of October. After one looks at these figures, it’s hard to believe that they are accurate, but unfortunately they are. Unless you have been living under a rock for the last several years, you know that our Federal Government has been spending money at rates that would make even a sub-prime borrower blush. But even taking this into account, these numbers are still startling, if not scary.

“During the month of October, the Federal Government spent $2.30 for every dollar of revenue it took in. Given the fact that this is the fifth time this year that the ratio has exceeded two, one might think that this type of deficit spending is commonplace. However, going back to 1970, October was only the 13th month that the ratio ever exceeded two. Prior to 2008, the ratio exceeded two on average once every 6.5 years. In the last two years, the ratio has exceeded two on average once every three months!

“The charts below highlight the twelve-month rolling totals of government revenues and outlays. It doesn’t take an accountant to see that these two lines are moving in the wrong direction. Given the fact that nobody thinks Washington is going to reign in spending, the only way to solve the gap is through higher revenues (raising taxes) or increasing the money supply. Is it any surprise that barely a day goes by where the dollar doesn’t trade down in value?”

Source: Bespoke, November 16, 2009.

MoneyNews: Obama admits spending binge risks plunge into second recession
“President Barack Obama gave his sternest warning yet about the need to contain rising US deficits, saying on Wednesday that if government debt were to pile up too much, it could lead to a double-dip recession.

“With the US unemployment rate at 10.2%, Obama told Fox News his administration faces a delicate balance of trying to boost the economy and spur job creation while putting the economy on a path toward long-term deficit reduction.

“His administration was considering ways to accelerate economic growth, with tax measures among the options to give companies incentives to hire, Obama said in the interview with Fox conducted in Beijing during his nine-day trip to Asia.

“‘It is important though to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the US economy in a way that could actually lead to a double-dip recession,’ he said.”

Source: MoneyNews, November 18, 2009.

The Washington Post: Bailout program could be extended
“The Obama administration is poised to extend the life of the highly unpopular $700 billion financial bailout and, to display a commitment to fiscal responsibility, is planning to use much of the leftover funds to reduce the national debt, government sources said.

“Administration officials are grappling with how best to announce the extension of the Troubled Assets Relief Program at a time when the economy is struggling and the unemployment rate is at its highest point in 26 years. The officials are hoping that by putting roughly $200 billion toward paying down the $12 trillion national debt, they could mitigate the political fallout, the sources said.

“No final decision about the fate of the bailout has been made, and officials are keenly aware that their preferred course contains risks. Officials worry that lawmakers, seeking to fund their own projects, may try to tap any large sum of unused money set aside for debt reduction, the sources said, speaking on condition of anonymity because the internal deliberations were private.

“Congressional Democrats are already eyeing the unexpended bailout cash as a source of funding for new efforts to combat soaring unemployment. Rep. John B. Larson (D-Conn.), chairman of the House Democratic Caucus, said lawmakers could send an important message about their priorities by taking money from the financial bailout program and redirecting it to pay for road and bridge projects and other measures meant to create jobs.”

Source: David Cho, Michael Shear and Lori Montgomery, The Washington Post, November 19, 2009.

Asha Bangalore (Northern Trust): Chairman Bernanke stresses job market, credit conditions and dollar
“The Chairman spoke at length about credit conditions and the labor market. In his opinion, impaired financial market conditions have led to banks holding larger buffers compared to the situation prior to the onset of the current crisis. In addition, a shaky economic environment marked with high loan losses and uncertainty about regulatory capital standards are factors restraining the growth of credit. The impaired market for securitization is another aspect that is contributing to the reduction of credit availability.

“The main message is that the credit machine needs to function for self-sustained economic activity. There is a minor improvement to note on this front. Loan extensions remain noticeably weak but for the week ended November 4, the decline was smaller (6.5%) compared with recent weeks. It appears that a trough has been established. Additional improvements with positive readings will be necessary to declare the coast is clear.

“Bernanke also spoke extensively about the labor market and more or less reiterated the well known aspects of the current labor market conditions. He raised the issue of a ‘jobless recovery’ and highlighted the reasons for the likelihood of this situation.

“The explicit mention of the dollar was the most important departure from earlier speeches. He noted that the Fed is ‘attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the US economy, will help ensure that the dollar is strong and a source of global financial stability.’ Historically, the dollar is the domain of the Treasury Department.

“The inflationary implications of the weak dollar are restrained partly by the enormous slack in the economy. However, prices of imported goods excluding fuel have risen for three straight months and commodity prices have also risen. Although inflation expectations have risen in recent days, the overall picture is that of a contained situation. Inflation expectations will be watched closely in the months ahead.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 16, 2009.

Asha Bangalore (Northern Trust): Fed reduces term of discount window loans
“The Fed announced a reduction in the term of discount window loans to 28 days from 90 days as of January 14, 2010. The Fed lengthened the maturity of discount window loans on August 17, 2007 to 30 days from a maximum term of overnight and extended it further to 90 days on March 16, 2008.

“As seen in the chart below, the need for discount window loans has reduced significantly from the period following the collapse of Lehman Brothers. This marks the beginning of a gradual withdrawal of the extraordinary support the Fed has extended to the global financial system as signs of stability have emerged.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 17, 2009.

Financial Times: Short-term US interest rates turn negative
“Short-term US interest rates turned negative on Thursday as banks frantically stockpiled government securities in order to polish their balance sheets for the end of the year.

“The development highlighted the continuing distortions in the financial system more than a year after Lehman Brothers’ failure triggered a global crisis.

“The growing appetite for short-term government debt reflects an effort by banks to present pristine year-end balance sheets to regulators and investors - an effort known as ‘window dressing’ on Wall Street, analysts said.

“With the Federal Reserve maintaining an overnight target rate of zero to 0.25 per cent, investors are demonstrating a willingness to completely forgo interest income - or even to take a small loss - to own securities that are seen as safe.

“Ted Wieseman, economist at Morgan Stanley, said there was a ’squeeze in the [Treasury] bill sector’ that was ‘intensifying as investors stash money over year-end’.

“The scramble has been exacerbated by the fact that all leading US banks, many sitting on big trading profits, will this year close their books at the same time - at the end of December. In past years, investment banks such as Goldman Sachs and Morgan Stanley reported annual results in November.

“‘People are setting up for year-end early, and once you see bill rates going down quickly, it pulls in more buying,’ said Gerald Lucas, senior investment adviser at Deutsche Bank.

“On Thursday, Treasury bills maturing in January traded below zero per cent, traders said. Three-month bills traded at 1 basis point and six-month bills fell to a record low of 13 basis points - compared with 14 basis points at the height of the crisis last year.”

Source: Michael Mackenzie, Financial Times, November 20, 2009.

MoneyNews: Bullard - shrinking reserves key to exit plan
“A senior Federal Reserve official said on Wednesday the US central bank may start tightening financial conditions by adjusting its extensive asset purchase programs rather than raising interest rates.

“‘The market’s focus on interest rates is disappointing, given quantitative easing,’ St. Louis Federal Reserve Bank President James Bullard said in a presentation to a group of bankers. “Markets should be focusing on quantitative monetary policy rather than interest rate policy,” he said.

“‘The main challenge for monetary policy going forward will be how to adjust the asset purchase program without generating inflation while interest rates are near zero,’ Bullard said.

“Medium-term inflation hinges on what the Fed will do with this program, he said.

“Bullard said financial market focus on interest rates may in part be misplaced because the Fed has in the past waited two and a half to three years after the end of a recession before raising rates.

“‘Assuming that the (Fed) would behave the same way that it’s behaved in the past, this could mean that the (Fed) would not start increasing rates until early 2012,’ he said.

“However, the Fed will take into account the criticism that it fueled a housing bubble that contributed to the crisis by holding interest rates too low for too long in the early part of the decade, he said.”

Source: MoneyNews, November 18, 2009.

Bill King (The King Report): Getting more bearish on US economy
“Goldie’s Jan Hatzius is getting more bearish on the economy by the day.

“‘Despite the sharp pickup in real GDP growth since the dark days of early 2009, we estimate that real final demand - net of the boost from fiscal policy - is still contracting at an annual rate of around 1% in the second half of 2009. Although we expect a moderate recovery of around 2% by the second half of 2010, such a 3-percentage-point improvement would be insufficient to offset the loss of 4-5 percentage points of stimulus from fiscal policy and the inventory cycle. Hence, real GDP growth is likely to slow anew to a below-trend pace.

“‘The significantly stronger recovery that is now anticipated by a number of forecasters would require a much sharper acceleration in underlying final demand, along the lines of prior recoveries from deep recessions. But this ignores some key differences between the current situation and the aftermath of prior slumps. In particular, bank credit is tighter, the personal saving rate is much lower, the labor market is less cyclical, there is much more excess housing supply, and state and local budget gaps are deeper.’”

Source: Bill King, The King Report, November 17, 2009.

Asha Bangalore (Northern Trust): Leading Economic Index underscores US economy will continue to grow
“The Conference Board’s Index of Leading Economic Indicators rose 0.3% in October, after a 1.0% increase in the prior month. On a year-to-year basis, the leading index moved up 4.7% in the fourth quarter of 2009 (based on October data). The year-to-year change in the leading index has held in the positive territory for two consecutive quarters. The historical record of the leading index supports expectations of continued growth of real GDP in the near term.

“In October, six of the ten components of the leading index advanced - average manufacturing workweek, stock prices, interest rate spread, jobless claims, real money supply and orders of durable consumer goods. The remaining four components - orders on non-defense capital goods, vendor deliveries, building permits and consumer expectations - fell in October.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 19, 2009.

Asha Bangalore (Northern Trust): Factory production slips in October
“Industrial production inched up 0.1% in October mainly due to a 1.6% increase in production at the nation’s utilities. Utilities and mining (-0.2%) components make up a small part of the total industrial production. Excluding these components, factory production slipped 0.1% in October after posting strong gains for three consecutive months.

“The weakness was in the durable goods component (-0.4%), while production of non-durable posted a small increase. Within durables, the gain in primary metals (+3.6%) was more than offset by declines in autos (-1.6%), furniture (-1.9%), electrical equipment (-0.9%) and computer and electronic products (-0.3%). Stepping back from these details, the small decline in factory production is not a severe setback. The process of recovery will be marked with some monthly readings showing declines. More importantly, the projected trajectory of factory activity in the coming months is positive.

“The operating rate of the nation’s industries moved up to 70.7% in October from 70.5% in the prior month. The capacity utilization rate of the factory sector held steady at 67.6% in October, which is noticeably higher than the 65.1% record low mark of June 2009.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 17, 2009.

Asha Bangalore (Northern Trust): Labor market data point to stabilizing conditions
“Initial jobless claims held steady at 505,000 during the week ended November 14. Continuing claims, which lag initial claims by one week, declined 39,000 to 5.611 million. The insured unemployment rate held steady at 4.3%.

“Total claims which include recipients under the special programs, Extended Benefits Program and Emergency Unemployment Compensation Program, were 9.81 million during the week ended October 31, down from 10 million during the week ended October 3. Total continuing claims have held below 10 million for four straight weeks implying that although hiring is not advancing, job losses have stabilized.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 19, 2009.

Clusterstock: The hires-and-fires gap brings good news for job seekers
“The unemployment rate is still miserable, but it’s not entirely bad news - at least if you find clever ways of slicing and dicing the data.

“Today’s chart measures the percentage difference between new hires and separations (people leaving a job). As you can see, the gap yawned late last year, as way more people left the workforce than were hired. But it’s coming back, getting closer to the 0% mark (even). And then of course, we just need to create a lot of jobs.”

Source: Vince Veneziani and Kamelia Angelova, Clusterstock - The Business Insider, November 16, 2009.

Asha Bangalore (Northern Trust): Housing starts - permits show a more stable trend
“Total housing starts fell 10.6% to an annual rate of 529,000, the lowest since April. The 35% plunge in construction of apartment building to a new record low of 53,000 units brought down the overall reading. The 6.9% drop in single-family starts to 476,000 is the lowest since May. Uncertainty about the extension of the $8,000 tax credit for first-time home buyers is seen as one of the reasons for the weakness in home construction. If this is accurate, a rebound is likely in November because the tax credit program has been extended to April 2010.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 19, 2009

Asha Bangalore (Northern Trust): October retail sales - noteworthy gains of several components
“Retail sales rose 1.4% in October, after downward revisions of retail sales in September (-2.3% vs. earlier estimate of -1.5%). The downward revision of retail sales in September combined with the widening of the trade deficit in September implies a lower estimate of third quarter real GDP (+3.5%).

“In October, retail sales excluding building materials (part of residential investment expenditure in GDP), autos (unit sales are consistent with auto spending component of consumer spending in GDP) and gasoline (excluded due to volatility of prices) advanced 0.5% after strong readings in August and September. In addition, retail sales excluding, building materials, autos, and gasoline rose 1.4% in October, the first year-to-year gain since October 2008. The main point is that consumer spending is recovering gradually.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 16, 2009.

Bill King (The King Report): Sharp contraction in consumer credit
“John Williams: ‘As shown in the following graph, consumer credit outstanding fell at a 4.8% annualized rate, the deepest annual decline of the post-World War II era:

“‘The year-to-year contraction in September commercial and industrial (C&I) loans also set a post-World War II record decline, and October’s drop will be even worse. Based on 28 days of reporting, October C&I loans fell by about 16.2% year-to-year, following annual contractions of 10.6% in September and 7.1% in August.’”

Source: Bill King, The King Report, November 16, 2009.

Asha Bangalore (Northern Trust): Higher prices for cars and energy lifted CPI in October
“The Consumer Price Index (CPI) rose 0.3% in October after a 0.2% increase in the prior month. The details of the October CPI report indicate that higher prices for cars and energy were the predominant gains. The energy price index moved up 1.5% in October, with higher gasoline prices accounting for a large part of the increase. Food prices inched up only 0.1% following a 0.1% decline in the prior month. Year-to-date the CPI has risen at annual rate of 2.7% and from a year ago it fell 0.2%.

“The core CPI, which excludes food and energy, increased 0.2% in October. According to the BLS, higher prices for used and new cars and light trucks were responsible for 90% of the increase in the core CPI. Given the soft demand for cars and shaky balance sheets of households, it is unlikely that higher prices will stick in the months ahead.

“From a year ago, the core CPI increased 1.7% and is inching closer to the Fed’s threshold of tolerance (2.0%). However, the concentration of the gains in prices among two components - energy and autos - suggests that we need to wait for more evidence before we can confirm that inflation is problematic. Inflation will continue to rank low among the Fed’s priorities compared with economic growth and financial stability in the near term.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, November 19, 2009.

MoneyNews: Sprott - hyperinflation on the way
“Eric Sprott, CEO of Sprott Asset Management, says quantitative easing is ‘just debasing the currency, which will eventually lead to hyperinflation’.

“The recent extension of the homeowner credit and giving corporations loss carry-backs while paying unemployment benefits for an additional 20 weeks, augur an inflationary if not a hyperinflationary scenario, Sprott notes.

“‘I really think that once the Fed has spent the $1.25 trillion buying the GSE paper that we might yet see another level of quantitative easing in the States,’ he says.

“Sprott does see one upside for investors, though: ‘You can just feel the momentum in gold - it’s picking up dramatically’ and so too are prospects for a plethora of little-known small and mid-cap gold stocks.

“‘There aren’t too many choices when you’re in debt to the level that the US government is,’ Sprott told The Gold Report.

“‘One way of calculating it says there’s $72 trillion of debt and another way suggests it is $100 trillion. It’s almost academic which calculation you use; it’s just an overwhelmingly serious problem … it certainly seems that (the Obama administration) is going to try to spend their way out of it,’ Sprott says.”

Source: Julie Crawshaw, MoneyNews, November 19, 2009.

Clusterstock: An inflation warning sign
“In a speech on Monday, Federal Reserve chairman Ben Bernanke said he did not see inflationary threats on the horizon.

“Perhaps that is because he’s looking in the wrong place. The prices of crude goods, those in the earliest stages of production, have been inflating for most of the year. The willingness to pay more for crude goods probably indicates that businesses are predicting selling finished goods at higher prices. In other words, this is a strong indicator of inflationary expectations.”

Source: John Carney and Kamelia Angelova, Clusterstock - The Business Insider, November 17, 2009.

Financial Times: “Sweet spot” of low interest rates
“Treasury bonds look to be pricing in a ’sweet spot’ of exceptionally low interest rates and benign inflation - but yields are likely to rise sharply next year, says Manoj Pradhan, global fixed income economist at Morgan Stanley.

“‘Our proprietary model puts the current fair value for 10-year Treasury bond yields at 3.3% - bang in line with actual yields,’ he says.

“But Mr Pradhan warns that significant uncertainty still surrounds inflation expectations. ‘It is hard to find investors who believe inflation over the medium to long run will be precisely in line with central bank targets.

“‘And even if you believe that inflation will play fair, investors seem to be receiving no compensation for the macroeconomic risks that have surely made an indelible impression over the past two years, or for the fiscal risks that abound.’

“Furthermore, Mr Pradhan says, the sanguine expectations in the US Treasury market have put pressure on yields elsewhere, making it difficult for early-hiking central banks to find policy traction through higher bond yields.

“‘We expect US 10-year yields to rise to 5.5% by the end of 2010 - an increase of 220 basis points that outstrips the 137 basis-point increase in the Fed funds rate expected over the same horizon. This bear steepening of the curve in 2010 may well be preceded by slightly lower 10-year yields in 2009.’”

Source: Manoj Pradhan, Financial Times, November 19, 2009.

BCA Research: Regional fixed income - allocation in a changing policy environment
“In some developed countries, a new interest rate cycle is underway. This development will be the main factor driving relative bond yields for the foreseeable future.

“In countries where the effects of the credit crunch were less severe, central bankers are becoming more confident that their economies are on solid footing. In some instances, policymakers have opted to begin renormalizing interest rates, while others are openly discussing ‘exit’ strategies. Correspondingly, the opportunities that will present in the government bond market in the coming months will take advantage of the relative timing and speed of this process. Monetary policy will tighten fastest in those countries where the recession was mildest (like in Australia) or where the boost to growth from resource-related prices is highest (as is the case in Norway).

“Our global fixed income strategists expect commodity-country bonds to continue to underperform. In contrast, the euro area and Japanese bond markets will outperform as their respective central banks have the most flexibility to stay on hold for the foreseeable future. The Fed will also remain on hold for an extended period, although a poor valuation starting point and increased debt issuance will act as a weight on Treasurys.”

Source: BCA Research, November 20, 2009.

Financial Times: Corporate bonds - all good things come to an end
“Credit markets are likely to offer lower returns in 2010 - although heightened volatility and increased supply should ensure an interesting year, says Stephen Dulake, head of credit research at JPMorgan.

“He notes that 2009 was a year when you could buy high-quality corporate debt and achieve equity-like returns. ‘However, all good things come to an end and next year we forecast high grade returns of around 3%, and coupon-like 7-8% returns for high yield.’

“But Mr Dulake says that low return does not necessarily equate to low volatility. ‘For example, we see the potential for risk markets to swing from pillar to post as investors oscillate from fearing deflation to fearing inflation,’ he says.

“He also argues that supply is likely to be greater than many expect.

“‘Our analysis suggests we could see investment grade companies issue €200 billion of bonds in 2010. This is double the average of the past decade and is a direct consequence of the sea-change in corporate liability management of the past 12-18 months. We expect this shift away from loans and toward bonds to be a multi-year process.

“‘Furthermore, a meaningful pick-up in merger and acquisition activity could also lead to an increase in supply.

“‘In high yield, we expect issuance of €35 billion in 2010, which would represent a record year and would in part be driven by leveraged corporates refinancing loans.’”

Source: Stephen Dulake, Financial Times, November 17, 2009.

Bespoke: YTD sector performance
“One would think that in a year where the average stock in the S&P 500 is outperforming the index by a wide margin (40.3% vs 22.9%), that most sectors would also be outperforming the overall index. Yet with the S&P 500 trading to a new high for the year, only three out of ten sectors are actually outperforming the index in 2009. Through this morning, Technology (55.1%), Materials (43.5%), and Consumer Discretionary (36.5%) are the three best performing sectors this year, while Telecom Services (-4.1%), Utilities (1.6%), and Consumer Staples (12.7%) have lagged the most.”

Source: Bespoke, November 16, 2009.

MoneyNews: Whitney - more bearish now than in a year
“Meredith Whitney says she hasn’t been as bearish as she is now in a year.

“‘I look at the board, and every stock from Tiffany to Bank of America to Caterpillar is up,’ Whitney told CNBC.

“‘But there’s no fundamental rooting for why these names are up, particularly in the consumer space.’

“Moreover, Whitney says she has never seen so much consumer credit contraction.

“‘You didn’t see this much even in the Great Depression,’ she says.

“‘$1.5 trillion in credit cards has been pulled from the system.’

“‘There’s nowhere to hide at this point.’

“Whitney expects banks will do another round of capital raising because the sector is inadequately capitalized at present and foresees ‘another leg down’ in the residential real estate market when mortgage rates and prices begin moving lower.

“Whitney still sees a much bigger risk related to residential mortgage exposure, rather than commercial, and advises investors to sit on their cash for a while because everything’s too expensive right now.

“However, though she expects a double-dip recession, Whitney says the second half of the ‘W’ will not be as severe.”

Source: Julie Crawshaw, MoneyNews, November 18, 2009.

Bloomberg: Mobius expects 40% BRIC stocks gain, says buy on dips
“Mark Mobius said stocks in Brazil, Russia, India and China are likely to rise by 30 to 40 percent within three to four years as higher economic growth and lower government debt spurs corporate earnings.

“Mobius, chairman of Templeton Asset Management Ltd., said he’s increasing holdings in all emerging markets, with particular focus on the four biggest developing-nation economies collectively known as the BRICs.

“‘BRIC countries are really at the top’ of our favorite holdings, Mobius, who oversees about $25 billion of emerging-market assets, said in an interview at the sidelines of a press conference in Istanbul today. ‘You can see BRIC countries have been best performing.’

“Russia’s RTS Index has surged 135 percent this year, the biggest gainer among 89 equity gauges worldwide, and Brazil, China and India rallied more than 75 percent as the global economic recovery spurred demand for commodity exports. While developed countries may shrink 4 percent this year, emerging markets as a whole may avoid a contraction with zero change in gross domestic product, Mobius said.

“While a ’sudden violent correction’ is likely in a bull market, investors should be ‘ready to buy’, Mobius told reporters.

“The biggest growth areas in emerging markets are in the consumer and commodity industries, with China and Brazil offering among the cheapest stocks worldwide, Mobius said.”

“The MSCI gauge of 22 developing countries is valued at 20 times reported earnings, according to data compiled by Bloomberg. The MSCI China Index trades at 17.7 times profit, while the MSCI Brazil Index is valued at 18.2 times earnings. That compares with a price-earnings multiple of about 30 for the MSCI All Country gauge of developed and emerging economies. The S&P 500 is valued at 22 times profit of the companies in the index.”

Source: Seda Sezer and Tian Huang, Bloomberg, November 18, 2009.

Bespoke: Checkup on China and the Baltic Dry
“China’s Shanghai Composite stumbled significantly during the late summer, but it has come back nicely with a gain of 24.5% off of its lows at the end of September. While its rally has been impressive, Shanghai has yet to take out its 2009 highs made in early August. At the same time, the cost to ship goods as measured by the Baltic Dry Index has increased 115% since its lows in September and has made a new 2009 high. Traders like to relate the Baltic Dry Index to how things are going in China, so with the Baltic Dry charging to new highs, will the Shanghai Composite follow?”

Source: Bespoke, November 19, 2009.

Times Online: Dollar carry trade could herald the next global crisis, analysts warn
“The global economy could be poised for the creation of a potentially explosive dollar carry trade, analysts said yesterday.

“The trade allows investors to borrow dollars at near-zero interest rates, which they use to fund asset-buying sprees around the world, and has been possible since the collapse of Lehman Brothers last year and the extreme monetary response to its aftermath.

“The warning was issued at the Apec summit of Asia Pacific leaders in Singapore and came after a variety of assets started to display bubble-like patterns of inflation: everything from gold and copper to fine wine and Hong Kong penthouses.

“As the carry trade grows more popular it could add more downward pressure to the already falling dollar, particularly if the ‘carried’ - borrowed - dollars are immediately sold to buy non-dollar denominated assets in China or Singapore.

“Analysts believe that it was the sudden unwinding of the yen carry trade - immense pockets of investment funded by cheaply borrowed yen - that sent the destructive ripples of the Wall Street crisis around the world last autumn.

“Carry trades, which essentially mean borrowing at low rates to fund higher return assets, make sense until markets turn sour and exchange rates shift too violently. At that point, the rush for the exit wildly exacerbates any crash. A collapse of the dollar carry trade has the potential to be particularly harmful because of its scale.

“While a few prominent financial figures have already warned of the threat of an emerging dollar carry trade, governments have steered clear of commenting on the issue until now.

“But talking on the sidelines of the Asia Pacific summit, Donald Tsang, chief executive of Hong Kong, admitted openly that the dollar carry trade had started to spread and that the prospect ’scared’ him.”

Source: Leo Lewis, Timesonline.co.uk, November 14, 2009.

The Wall Street Journal: It’s time to get dollar bullish
“After a dramatic decline in the USbcurrency, investors should consider going long the dollar via an ETF, says Barrons.com’s Bob O’Brien.”

Source: The Wall Street Journal, November 18, 2009.

Financial Times: IMF chief urges stronger renminbi for global balance
“A stronger Chinese renminbi is part of the reforms that Beijing needs to implement to increase domestic consumption and help ease global imbalances, the head of the International Monetary Fund said on Monday.

“Dominique Strauss-Kahn, managing director of the IMF, said the countries at the heart of global imbalances needed to take various measures to ease them.

“In the case of China, that means an increasing emphasis on domestic demand, especially private consumption, Mr Strauss-Kahn said in remarks prepared for a financial conference in Beijing.

“‘A stronger currency is part of the package of necessary reforms,’ he said. ‘Allowing the renminbi and other Asian currencies to rise would help increase the purchasing power of households, raise the labour share of income, and provide the right incentives to reorient investment.’

“Mr Strauss-Kahn noted that Chinese authorities were already taking steps to boost household consumption, including health care reforms.

“‘But more can be done to secure a lasting, structural shift towards consumption, by expanding the scope of social policies, moving ahead on financial sector reform, and undertaking corporate governance reforms,’ he said.

“Conversely, countries with large current account deficits need to increase savings, and for many of them, including the United States, fiscal consolidation must take priority, he said.

“Overall, the global economy appears to have turned a corner, Mr Strauss-Kahn said, but the biggest risk to the outlook is a premature withdrawal of policy stimulus.”

Source: Financial Times, November 16, 2009.

BCA Research: Asian currencies - near-term risks, but structurally sound
“There are strong long-term trends supporting further appreciation in Asian currencies, although a near-term pullback is likely if Chinese authorities do not allow the renminbi to appreciate. Valuations vary, but these currencies tend to be inexpensive.

“The real effective exchange rates of many Asian currencies have been quite subdued. Similarly, in nominal trade-weighted terms, many Asian currencies have not yet appreciated much over the past decade. As a result, from a ‘fair value’ perspective the Chinese RMB, the Korean won and the Taiwanese dollar currently look cheap, while the Singapore dollar is slightly expensive.

“Meanwhile, from a structural viewpoint, Asian currencies are being supported by the following trends: robust productivity gains, firming domestic demand, rising relative returns on capital, solid fiscal positions and widening trade surpluses with China. However, a major concern is that weak export prices will cause a pullback in EM currencies in the near-term. A large divergence has emerged between Asian export prices and appreciating regional currencies. This divergence will cap currency rallies in Asia, if China keeps the RMB at current levels.

“Our EM team concludes that on a long-term perspective, Asian currencies will benefit from decent valuations and structural backdrops but are at risk in the near-term. Stay tuned.”

Source: BCA Research, November 17, 2009.

Bespoke: Gold closing in on 20% above 200-day moving average
“Gold’s move over the past couple of months has been pretty incredible but not without precedent. As shown in the first chart below, the most recent leg up for gold has put it at 19% above its 200-day moving average. In the second chart, we highlight the historical 200-day moving average spread for gold. As recently as 2006 and 2008, the 200-day spread moved well above 25%, and back in 1980, the spread briefly got up to 136%! Gold is definitely overbought right now, enough so that the risk/reward tradeoff in the short-term is probably favoring the risk side. However, it has gotten much more overbought in the past than it is now, so it could still go higher before correcting.”

Source: Bespoke, November 18, 2009.

Richard Russell (Dow Theory Letters): Gold bull market - great persistency
“I think the most interesting action in the current picture is the action of gold. I get the feeling of a ground swell, some irresistible force that is driving gold higher. What’s interesting is that there are no wild spikes in gold, no fireworks, but a steady, persistent climb. This is powerful bull market action, and where it comes from nobody really knows. Is this the buying of millions of Chinese? Or is it the late-entrance of US hedge funds? Or is it short-covering on the part of squeezed COMEX speculators.

“In the end, does it matter who’s doing the buying? I know this - most Americans have been brain-washed after may years of anti-gold propaganda. Most Americans don’t know anything about gold. Most Americans have not been buying gold. Most Americans don’t realize that gold is the time-honored ultimate form of money. So the buying is probably coming from some place other than the US populace.

“So far the gold action is coming in via almost measured increases of 3 to 10 dollars a day. It’s as if the buyers are waiting for a correction, and when no correction arrives, they say ‘What the heck’ and they buy a quantity of gold, maybe not as much as they’d like, because they keep waiting for that elusive correction.”

Source: Richard Russell, Dow Theory Letters, November 18, 2009.

Richard Russell (Dow Theory Letters): The case for gold
“I like to keep it simple, and I like to understand the fundamentals. So here goes. The Fed and the other central banks can create ‘money’ out of thin air. By now, everybody on earth knows that. People also figure that if it’s an item that can be created without work and through an accounting entry, it can’t be real money, rather it’s simply a brand of ‘Monopoly money’.

“OK, then how about this? You can take the phoney money that the Fed creates and you can actually buy something real with it. That ‘real something’ can be gold or it can be a foreclosed home or it can be top-grade stocks like the thirty stocks that make up the Dow. Trade Fed-created junk for something real? Why not, it certainly makes a lot of sense.

“But there’s something else. Sophisticated investors are beginning to distrust ALL fiat or central bank-created ‘money’. Moreover, they distrust a situation where central banks all over the world are creating huge additional amounts of their phoney money. Knowledgeable investors are starting to place all fiat money into a single class. And they distrust that class. They distrust it because they think of it as ‘junk money gone wild’. Their reaction - turn in your junk money for the one type of intrinsic money that has represented wealth for 6000 years - gold.

“I’ve written many times that gold seems to be imbedded into the DNA of mankind. Today, with the world in turmoil, rich men may be saying to themselves, ‘I don’t know what’s going on any more, and frankly, I don’t know where I’ll be in ten years. But if I own a thousand ounces of gold, I’ll know I’m rich. I don’t know what the price of gold will be when this whole mess is over, but I know I’ll still be wealthy if I own a thousand ounces of gold.’ And that, to my mind, is some of the thinking behind the rising price of gold and maybe even of stocks.”

Source: Richard Russell, Dow Theory Letters, November 17, 2009.

The Wall Street Journal: John Paulson making big new bet on gold
“One of the biggest investors is placing a huge new bet on gold.

“John Paulson, who scored about $20 billion of profits between 2007 and early 2009 wagering against the housing market and financial companies, is launching a hedge fund dedicated to buying up shares of gold miners and other bullion-related investments, according to investors.

“Mr. Paulson told his investors he personally would invest between $200 million and $250 million in the new fund, which he said will begin on January 1, according to an investor at the meeting.

“Paulson & Co. already is a major holder of gold shares including AngloGold Ashanti and Kinross Gold, doing most of its buying early this year. Mr. Paulson currently has more than 10% of his $30 billion or so under management in gold-related investments, according to his investors. The moves have benefited from the recent surge in gold prices to nearly $1,150 an ounce.

“The gold fund will invest in gold-related shares and gold derivatives and will aim to outperform gold prices.

“Mr. Paulson noted that central banks around the globe have gone from sellers of gold to buyers, and that the global supply of gold is constrained.

“While harmful inflation isn’t on the horizon, he said, Mr. Paulson argued that there is a risk of a burst of inflation down the road. That’s because in the past there’s been a lag between a surge in money supply and higher inflation. Gold often does well when inflation rises.”

Source: Gregory Zuckerman, The Wall Street Journal, November 19, 2009.

Clusterstock: How the old gold bugs lost control of gold
“Latest data from the World Gold Council shows just how much the gold market has changed in just under two years. Essentially, the more traditional sources of demand for gold, i.e. jewelry, industry, gold bar hoarders, and coins have been falling.

“Meanwhile, gold demand from new retail investment products has skyrocketed from just 7% of total gold demand in 2007 to a whopping 27% most recently. That’s almost a 4x increase in their share of demand in under two years. Given that market prices are generally driven by incremental changes in supply and demand, clearly the new retail style gold players are now driving the market.

“The true gold bugs of yesteryear are no longer in charge. Though they’re probably not complaining given that retail demand is making them rich. Just realize that retail demand can be a fickle friend.”

Source: Vincent Fernando and Kamelia Angelova, Clusterstock - The Business Insider, November 19, 2009.

Financial Times: Global recovery threatens food price surge
“Conditions are ripe for a fresh surge in food prices as the global economy recovers, says the senior United Nations agriculture official.

“Jacques Diouf, director-general of the UN’s Food and Agriculture Organisation (FAO), believes that the world is not doing enough to avert another food crisis. His warning comes as leaders are expected to gather in Rome on Monday for the World Food Summit .

“‘When the recovery picks up, we will be back to square one,’ Mr Diouf told the Financial Times in an interview.

“He said the same structural problems behind last year’s spike in food prices were still affecting the market. These included lack of investment, surging demand in Asia and diversion of food commodities into biofuels.

“‘We have all the elements of the crisis,’ he said, adding that a weakening US dollar could exacerbate the upward price pressure in food commodities.

“Although the prices of some commodities, such as wheat and rice, have halved since their peak in mid-2008 because farmers in rich countries have expanded their output, they remain well above the pre-crisis level and near record levels in poor countries.

“Other food raw materials - particularly the so-called breakfast commodities such as cocoa, sugar and tea - are now trading at their highest level for about 30 years.

“Mr Diouf’s warning came as global food companies urged policymakers to strive for regulatory transparency and a boost in infrastructure spending to tackle the food crisis.”

Source: Javier Blas and Vincent Boland, Financial Times, November 15, 2009.

Financial Times: Fears of China property bubble
“A large bubble is forming in China’s property market as a result of Beijing’s credit-driven stimulus programme, one of the country’s most prominent real estate developers warned.

“Zhang Xin, chief executive of Soho China, one of the country’s most successful privately owned property developers, told the Financial Times the asset bubble was leading to rampant wasteful investment in the sector, undermining the country’s long-term growth prospects.

“‘Real estate prices should only go up because people want to actually use the space, but at the moment we can see more and more empty buildings across the whole country and in every real estate segment,’ Ms Zhang said. ‘The rising prices are a direct result of so much money coming from the banks and the Chinese banks should be very worried.’

“Ms Zhang’s assessment was echoed by Fan Gang, a member of the central bank’s monetary policy committee, who warned on Wednesday that real estate in cities such as Beijing, Shanghai and Shenzhen was expensive and there was a growing risk of asset price bubbles.

“Urban property prices in 70 big and medium-sized Chinese cities rose 3.9% in October from a year earlier, accelerating from September’s 2.8% rise, according to government figures.

“Price rises in top-tier markets such as Beijing and Shanghai have been much faster. Analysts say the rebound has largely been driven by an unprecedented government-led expansion of bank lending. It is also being driven by government policies, including tax breaks, low interest rates and smaller down-payment requirements.

“‘In Manhattan, they have vacancy rates of 10-15 per cent and they feel like the sky is falling, but in Pudong [the central business district in Shanghai] vacancy rates are as high as 50 per cent and they are still building new skyscrapers,’ Ms Zhang said.

“‘If you look at GDP growth, then China looks like a new engine driving the global economy, but if you look at how growth is being created here by so much wasteful investment you wouldn’t be so optimistic.’”

Source: Jamil Anderlini, Financial Times, November 18, 2009.

Financial Times: Pace of growth picks up in Japan
“Japanese gross domestic product grew 1.2 per cent quarter-on-quarter between July and September, as stimulus-fuelled consumer spending joined a growing trade surplus to help the world’s second-largest economy continue its climb out of its sharpest postwar recession.

“Monday’s preliminary data showed growth at its fastest in over two years and left little doubt the worst is over for an economy battered by collapsing external demand after last year’s financial crisis.

“The pace of third-quarter growth was equivalent to 4.8 per cent on an annualised basis, compared with the 2.6 per cent forecast by economists in a Kyodo News survey. However, Japan’s economy was still 4.4 per cent smaller than in the same quarter of 2008, showing how far it still has to go to make up the damage inflicted by global woes last winter.

“With stimulus programmes such as car subsidies due to expire and the temporary process of inventory restocking also a big contributor to GDP growth, many economists remain downbeat on prospects for the first half of 2010.

“‘It is difficult to interpret the Q3 inventory build-up as supportive of further strong growth in production,’ wrote Chiwoong Lee, economist at Goldman Sachs in a research note.

“Economists said worries about fragility in consumer sentiment meant Japan was likely to remain dependent in the near-term on the strength of export markets such as China.”

Source: Mure Dickie and Robin Harding, Financial Times, November 16, 2009.

Tags: Asset Classes, Ben Bernanke, Bill King, BRIC, China, Commodities, Corporate Bonds, Dollar Down, Dual Mandate, Dual Objectives, Ed Stein, Emerging Markets, ETF, Global Financial Stability, Global Stock Markets, Gold, Gold Bullion, India, Inflection Point, Interest Bill, Investment Stock, Maximum Employment, Msci Emerging Markets, Msci Emerging Markets Index, Msci World Index, oil, Platinum Silver, Signs Of Fatigue, Us Treasury
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Advisor Alert - November 20, 2009

Saturday, November 21st, 2009

The following report is the advisor alert produced by US Global Investors, a comprehensive weekly alert providing SWOT analysis for all major market groups.

You may listen to it in its entirety here while you work:

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Advisor Alert - November 20, 2009

Tags: Brazilians, Brian Hicks, BRIC, Canada, Chief Investment Officer, China, Commodities, Domestic Flight, Economic Data, Emerging Markets, Frank Holmes, Full Flavor, Global Investors, Global Resources, Global Strategist, Gold, Guarulhos International Airport, India, Infrastructure Development, Infrastructure Markets, Infrastructure Opportunities, Investment Managers, Market Groups, oil, Pspfx, Resources Fund, Rio De Janeiro, Tacit Knowledge
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The Secret To Happiness According To Kids | Seven Ways to Create More Time In Your Day | Secrets to Long Life | How to Get Rid of Cold Sores

Friday, November 20th, 2009

For this weekend here are four articles you might find interesting. Enjoy and Have a Great Weekend!

Melina Bellows: The Secret To Happiness According To Kids
November-19-09, 11:29 AM

As the New York Times recently pointed out, many parents have found themselves out of work and at home–and it ain’t good. “For many families across the country, the greatest damage inflicted by this recession has not necessarily been financial, but emotional and psychological,” reports Michael Luo. “Children, especially, have become hidden casualties, often absorbing more than their parents are fully aware of.”

Seven Ways to Create More Time In Your Day
November-19-09, 11:41 AM

Do you ever feel like you have way too much time on your hands, and far too little work and life to fit into it? Unless you’re a teen on summer break, I reckon it’s unlikely! Most of us would love to have an extra couple of hours in each day. With two more hours, we could find time to exercise, to read some of the books that are gathering dust on our shelves, to spend time with the kids…

Don’t Overeat - Secrets to Long Life
November-20-099:36 AM

Ask Walter Breuning his secret for living as long as he has, and he’ll reply modestly, “There is no secret about it.” Breuning, who became the world’s oldest living man on his 113th birthday September 21, adds that kindness and common sense have played a crucial part to his longevity. Learn the six things that have allowed him to lead a long and happy life.

How to Get Rid of Cold Sores - Nutrition
November-20-0910:13 AM

Q: Are there any foods I can eat-or avoid-to help prevent cold sores?

Tags: Bellows, Common Sense, Gathering Dust, Happiness, Hidden Casualties, How To Get Rid Of Cold Sores, Kindness, Long And Happy Life, Longevity, Michael Luo, New York Times, Nutrition, Oldest Living Man, Parents, Psychological Reports, Read Books, Recession, Seven Ways, Shelves, Summer Break
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Hugh Hendry: Investment Outlook (November 2009)

Thursday, November 19th, 2009

As usual, Hugh Hendry provides a profoundly insightful view of the global economy and markets, and this month’s letter is a must read:

Eclectica Asset Management -Letter to Investors - November 2009

by Hugh Hendry
Portfolio Manager, Eclectica Fund

“The power to become habituated to his surroundings is a marked characteristic of mankind.”

John Maynard Keynes
The Economic Consequences of the Peace, 1921

This month I will attempt to answer the entrance examination for the Chinese civil service. That is to say, I will attempt to tell you everything that I know. In doing so, I will argue that this year’s rally in inflationary assets, from emerging stock markets to industrial commodities to the fall in the US dollar, could be a FAKE. Let me explain why.

But first, I am indebted to Scott Sumner, professor of economics at the University of Bentley, and his essay on the economic lessons that can be drawn from timelessness in art (see http://blogsandwikis.bentley.edu/themoneyillusion/?p=2542). It is a theme that I will constantly revisit in my arguments below.

Sumner is able to take us from the Flemish forger, Van Meegeren, and his horrendous reproductions of the Dutch painter, Vermeer, to the notion that every recession seems unique and special to its protagonists. So just how did Van Meegeren fool the Nazis with paintings that today look so awful, so un-Vermeer? Jonathan Lopez, the noted art historian, argues that a FAKE succeeds owing to its power to sway the contemporary mind. Or in other words, the best forgeries tend to pay homage to the tastes and prejudices of their time. The present is so seductive.

However, forget the art world. Controlling the psyche of this generation of investor is the indelible mark of the falling dollar and the associated fear of inflation. Monetary inflation has been the distinguishing feature of the last ten years, and it is now firmly embedded in the contemporary mind. I am sure I need not remind you that gold, along with just about every other commodity, has at least quadrupled in price since 1999. You already know my explanation for why this has happened.

The spectacular rise in the Chinese trade surplus, predominantly with America, to $320bn per annum at its peak in 2007, and the mercantilist desire to prevent currency appreciation drove the Asians and the sheiks to buy Treasuries and print their own currencies. The ability of fractional reserve banking to leverage this liquidity many times over provided the monetary mo-jo to instigate ever higher commodity prices. In other words, quantitative easing, masquerading as a cheap but fixed currency regime, has succeeded where Japan’s orthodox version has failed. The QE succeeded because, amongst other features, it raised the velocity of monetary circulation.

However, it was not always like this. As an example, ten years ago it was unthinkable that the dollar would prove so fragile. Recall that back then, when the euro was first launched in 1999, it promptly lost 31% of its value against the greenback. The subsequent reconstruction of modern China, though, intervened. In order to finance the emergence of a new economic superpower, an abundance of dollars was needed. Have no doubt that had we not had the dollar as a reserve currency, the rise of China would not have been as swift nor as decisive.

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The Yellow Brick Road
Consider another economy needing to be rebuilt: that of the United States in 1865, the post Civil War era. The rebirth of the American economy was funded from the monetary rectitude of the gold standard, not from the generosity of a foreign and infinitely expandable paper currency. However, all of this occurred before the discovery of cyanide for heap-leaching and the opening up of the huge South African gold fields. In other words, hard money was in tight supply and the recovery was neither swift nor decisive. Indeed, 30 years later, during the presidential election campaign of 1896, Williams Jennings Bryan was still hotly contesting its merits. He railed against the persistent price deflation and argued that the economy was burdened by a “cross of gold” (see The Eclectica Fund Report, December 2005).
Perhaps I Should Stick to the Twenty-First Century?
My previous investment letter attempted to explain the subtleties of the Triffen dilemma and the dollar’s pre-eminent role in regenerating modern day economies. Let me repeat once more: lots of dollars were required, and duly delivered, to build modern China. They did not have to wait on the vagaries of a gold discovery to promote and sustain their economic engine. Instead, they required the willingness of their trade partners to run trade deficits. The US delivered and, partly as a consequence, the Fed’s broader trade weighted dollar index has now fallen 20% since its peak in 2002 (the narrower DXY index compiled by the Intercontinental Exchange has fallen more, but excludes the renminbi and overstates the role of the euro). In return, the world has a new $4trn trading partner: China.

Heady stuff, but not without precedent: recall the Marshall Plan, a watershed American aid program that assisted the reconstruction of the Western European economy during the 1950s and 60s. This was further augmented by America’s willingness to run trade deficits, the modern day equivalent to a gold discovery, which became necessary to sustain the emergence of the new economic trading bloc. This resulted in the dollar’s huge devaluation versus gold in the 1970s. However, back then, the broad trade weighted index kept rising. This time it has fallen sharply.
What an Ungrateful Lot We Are?
The dollar’s role as the world’s sole reserve currency has both assisted and accelerated the development of world trade. America’s trading partners have come to rely upon the bounty of dollars necessary to recycle their trade surpluses and thus finance their growing prosperity. This was done even at the expense of domestic American job losses. Replace the dollar with IMF special drawing rights; I hear your retort. Sure, but have you ever bought a cup of coffee with an accounting identity? And, fundamentally that argument still suffers from the dearth of any other major economy showing any willingness to sacrifice its short term economic standing for the longer-term mutual benefit of having enriched trading partners.

Do not forget that the Chinese could replicate equivalent currency baskets to SDRs at any moment. Instead, they continue to recycle almost three quarters of their trade surplus back into dollars. This is not coercion but simple commercial pragmatism. They know full well that neither Europe nor Japan nor Britain nor Switzerland nor the rest of Asia are willing to sacrifice the implicit loss of manufacturing jobs. They understand that it is only the US that is willing to embrace the benefits of comparative advantage that arise from international trade. Have you ever asked yourself why car prices in America are so low compared with those in Europe? This is my point.

I keep hearing that a dollar devaluation would help matters. I agree; it has. Let me say it again; we have already had the devaluation. That is what the last five years were all about. Now with China rebuilt, and the trade deficit in full retreat (note the -47% contribution from net exports to China’s GDP growth in the first 9 months of this year), there are less dollar bills being exported overseas to ungrateful recipients. Is it not time we drop our fascination with the present and consider the future? Is it really inconceivable that the dollar could now strengthen?
Women in Love, Investors in Love. What’s the Difference?
Of course this is a minority view. Investors have reacted to last year’s deflationary traumas by insisting that it is business as usual. They behave like D.H. Lawrence’s coal miner Gerald from the novel Women in Love, who, just days after his father’s funeral, steals into his former lover’s bedroom and, “…into her he poured all his pent-up darkness and corrosive heat, and he was whole again.” Or was he? The trouble is that we are so anchored to the recent past. Investors are fearful of what now seems so familiar and recognisable; at what they perceive as the reckless behaviour of our monetary authorities. “Inflation is a monetary phenomenon” is their Friedmanite dogma. Their salvation can only be found in the safe sanctuary of gold and the embrace of risky assets, but are they truly safe?

This is my home. Don’t be so sure about anything, Big Horace. Not about anything in this world.

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The Orphan’s Home Cycle
Horton Foote

And so, just as the Church of England commissioners became convinced by the cult of equity way back in the whimsical days of 1999 and went 100% long the stock market, investors today recant a new mantra of, “anything but the dollar (A-B-D)”. Inflation bets are all the rage. Some would insist that it is their fiduciary duty to protect their clients’ capital; I say tell that to the Church of England pension fund, whose assets today are just £461m against liabilities of £813m. Austerity beckons for the clergymen; heaven will have to pay their stipend.

But the spell cast by a contemporary cult is hard to resist. Take another august body, the Harvard Endowment Fund. Not typically renowned as a hotbed of reactionary fervour, the fund is nevertheless radical in its construction and has come to typify the A-B-D stance.

Harvard’s position could well be construed as a one-way bet. Almost half of the fund is invested in emerging market equities, commodities, real-estate, private equity and junk bonds. It is as though the rap artist 50 Cent has taken over the advisory board. The fund is going to, “get rich or die tryin’”.

We, on the other hand, approach risk by considering the worst possible outcome. For a current pension scheme the greatest torment would be a repeat of last year’s final quarter when 30 year Treasuries yielded just 2.5%. This would require a CAGR of 20% or more from the fund’s riskier assets at precisely the time that their future returns would seem most questionable; insolvency would beckon. And yet, they blithely run the risk of ruination.

Of course, they are not alone. Another popular argument is that the emerging economies have to urgently diversify their immense dollar reserves. And so the Chinese are colonising the African continent in the pursuit of commodities and the Indian government has just agreed to buy 200 tons of the IMF’s gold hoard.

Is this not a reincarnation of the 1980 trade of the brothers Hunt? It is hardly an exaggeration to suggest that China, for all intents and purposes, is already the commodity market. For despite providing less than 8% of global GDP, China accounts for more than half of the world’s steel production and more than half of global seaborne iron ore freight. Indeed, this peculiarity is circular in nature. Consider that a modern aluminium plant requires 25% of the project’s cost to be spent on buying aluminium in the first place. And remember that investments in fi xed capital formation (think new aluminium plants et al.) have made up 95% of Chinese GDP growth this year. China Inc. is Commodities Inc.

Accordingly, China shares the same risk as the world’s largest pension schemes. An over- leveraged American consumer does not return to his/her manic buying of old. As William White, former chief economist of the BIS, has argued:

Many countries that relied heavily on exports as a growth strategy are now geared up to provide goods and services to heavily indebted countries that no longer have the will or the means to buy them.

Surely, the Chinese stash of Treasuries is a prudent elimination of the fat tail risk that private sector deleveraging in the west ends up killing the golden goose of the trade surplus. But instead, in exercising good ol’ Texan tradition, they have opted, like the Hunt brothers did, to double up. It is the old dice game, Mort Subite, played by the employees of the National Bank of Belgium in the busy lunch time cafes of Brussels in 1910. If the players didn’t have time to complete their business, they played a final round with a sudden ending where the loser would be pronounced dead.

Much is made of the comparison between today’s balance sheet recession and Japan’s demise back in 1989. Despite their bubble never coming close to matching China’s prominence in industrial commodities, the loss of Japanese economic growth in the 1990s was nevertheless a major factor in the waterfall crash in commodities. This plunge ultimately saw oil trade for as little as $10 per barrel in the next decade. Just consider how much more devastating the experience would have been had they gone very long the commodity market in 1989 rather than golf courses and Rockefeller Centre. At least the Harvard endowment scheme did not share their enthusiasm for golf. But, this time around, I fear a Mort Subite beckons for the losers in Asia and the pension market.
Last Orders: Inflation or Deflation?
If a poet knows more about a horse than he does about heaven,
he might better stick to the horse… the horse might carry him to heaven.

Charles Ives

I am now going to return to the torturous and binary debate concerning inflation. As you know, I am in the deflation camp for now, and we own a modest amount of government bonds and a series of asymmetric bets which would receive a boost from a return to some form of risk aversion. You could say that I am sticking to my horse.

My intellectual foes, on the other hand, are adamant that long duration government bonds are a short. I even hear that some Wall Street legends are so convinced of the argument made by the likes of Niall Ferguson that they personally own Treasury put options and are actively counselling others to do the same. The argument can be condensed into just two fears.

First, they will suggest that 4.5% is not an adequate return for lending your money to the profligate United States for 30 years. I agree wholeheartedly. Again, I fear it is my accent, but let me stress once more that I do not propose that anyone adopt a buy-and-hold policy for the next thirty years in bonds. However, a nominal rate of 4.5% might prove very profitable over the coming year should breakeven inflation expectations head south again.

Second, the bears contend, a lower Chinese trade surplus will eliminate a very large source of Treasury buyers at a time of burgeoning supply. Again, we find ourselves agreeing vigorously. However, it is our contention that US savings are heading north over the months and years to come. And an America that saves is an America that does not run a current account deficit. It is an American that can finance its own spending domestically. The US produced a small surplus back in the 1990-91 recession, so why not again?

As a consequence the Chinese surplus is set to fall further and, with fewer dollars needing to be recycled to maintain the currency peg, their demand for Treasuries will continue to shrink. Now this is potentially a huge headache owing to the massive projected American budget deficits for this year and next, and the Treasury’s desire to extend the maturity of the existing stock of government bonds which is becoming perilously short dated. Some estimate new issuance of around $2.5trn for the upcoming year. Perhaps, it is better that we buy those Treasury put options after all?
American Gothic
Or is it? I have quoted Don Coxe’s definition of a bull market before and I intend to do so again. “The most exciting returns are to be had from an asset class where those who know it best, love it least.” On this point, America has fallen out of love with its own currency and bond market. Foreigners own over half of the outstanding Treasury stock. But, like I said, I think events could reignite some of the natives’ old amour.

It is almost like declaring an enthusiasm for Say’s Law. Think of it this way, a greater supply of Treasuries would be a very obvious by-product of weaker than anticipated economic growth. And in this environment risk aversion stimulates the investment desire for risk free assets. So, in a round about way, there are circumstances when supply and demand can match in the bond market. But weaker economic growth? Surely the governments’ interventions this year have remedied the economy?

The surprise might concern the role that rising leverage has played in boosting GDP and in anchoring investors’ expectations to an unrealistic level of nominal GDP. Over the last decade, each marginal dollar of debt has generated less and less marginal income. We knew that there would be a “zero-hour” for the economy when the creation of new debt would not contribute to GDP growth. The government’s reaction to last year’s demand shock has been to increase its own leverage. But, with the economy operating at its zero-hour, we believe this incremental leverage will actually have a negative impact. That is to say, the public sector will fail in its attempt to bring the economy back to its previous level of nominal GDP. In this scenario, the outcome will disappoint the market’s expectations, which are rampantly bullish as evidenced by this year’s dramatic re-pricing of risk assets.

This zero-hour for America has perhaps arrived sooner than many had anticipated. It was heralded by the Japanese experience. Japan is the bogeyman that confronts all academic thinkers, regardless of creed, from Krugman to Ferguson, as well as all who would choose to intervene in the workings of the economy. In a debate I had with Mr. Ferguson in London last month, he claimed that Japan was an extreme outlier and could be ignored. Really?

No sex, no drugs, no wine, no woman, no fun, no sin, no wonder it’s dark
Everyone around me is a total stranger.
Everyone avoids me like a psyched loan-ranger
That’s why I’m turning Japanese,
I think I’m turning Japanese,
I really think so

The Vapors, 1980

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Japan has championed both Friedman and Keynes. They have built bridges to nowhere and dropped Yen notes from helicopters for twenty years and still they have nothing to show for it. Clearly the additional return from Yen debt in Japan is close to zero and it exposes the nightmare of interventionists everywhere: it may just be that there are no policy remedies for a debt deflation. So to elaborate further, our chances of financial success are greatest under conditions where investors believe government spending will succeed but in reality it fails.

However, where will the demand for all of this additional government debt come from? Let us review the Fed’s Z1 numbers. The US has household wealth of some $67trn. Of that, $20trn is accounted for by real estate and is perhaps out of bounds for our purposes. But $8trn is held in the form of private pensions and insurance funds. And yet, remarkably, these institutions presently allocate just $630bn to Treasuries et al. Households have a further $22trn in time deposits and other financial assets. But again they own just $500bn of Treasuries, and commercial banks own a tiny $130bn or, 1% of their total asset base of $12trn.

Consider that in 1952, at the very end of the supernova bond bull market formed from the ashes of the Great Depression and the Liberty Bonds that financed the Second World War, US banks held 40% of their gross assets in Treasuries. That is a potential $5trn of demand from this one source alone, albeit spread out over a number of years. And again, the Japan experience lends support. Japanese financial institutions have quadrupled the percentage of their assets held in JGBs. Furthermore, their households have lifted their government bond weightings five-fold over the last ten years. Should the same pattern repeat itself stateside, American households would need to buy another $2.5trn, but again, over ten years.

And let us not forget that a trend of rising prices allied to the most basic human emotion of avarice encouraged commercial banks and other financial institutions to buy $3.2trn of questionable mortgage backed securities in 2004, $1.9trn in 2005, $2.2trn in 2006 and $2.1trn in 2007. So it is not inconceivable, at least in my mind, that financial institutions, and notable amongst them the nation’s pension and endowment schemes, could be motivated by another basic human emotion, namely fear for their own survival, to snap up all these new government bonds. Perhaps in the end supply will create its own demand.

Again, it all really comes down to your take on the ratio of total debt-to-GDP. If you believe, like I do, that it peaked in 2007 then the repercussions are enormous. The leverage does not necessarily have to come down (after peaking in 1932 at 300% it troughed 20 years later at 150%). Rather, it may well be that low interest rates allow the mountain of debt to continue to be serviced. This has been the Japanese experience to date. However, everything in our economic life exists at the margin, and the consequences of just maintaining the leverage constant would be a very low delta in nominal GDP growth. Consider that the Japanese, under these very circumstances, have managed to grow nominal GDP at just 1% compound since 1990.
In Bernie We Trust?
This is why China’s mad dash for commodities and its investment splurge this year is so worrying. In my marketing presentations I show a picture of Madoff superimposed on a dollar bill and ask, “…in Bernie we trust?” My point is that if the hedge fund fraudster had been given the responsibility for US GDP accounting, he would surely have overstated the figure. And in a similar way, the rise in leverage has probably misrepresented the truly recurring nature of nominal GDP. Now, if we repeat the Japanese experience then it is possible that nominal US G DP will rise from $14trn today to perhaps just $16trn in ten years time. Along similar lines, the German government does not anticipate its economy exceeding its previous GDP high until 2014. And yet it is as though the other surplus countries are behaving like Bernie’s former investors who, believing in the stated NAV and its promise of more of the same (i.e., predictable and attractive compound growth rates), were happy to spend lavishly. The Chinese are building capacity to meet a world where US nominal GDP is $25trn in ten years time. I fear they could be in for a nasty shock.

What Do I Mean?
Consider the steel market. The homogeneous nature of steel, as well as other factors such as its price-to-density, allows for the export of the finished good across trade boundaries. Now with China having been on such an expansionary tear, it may not surprise you to hear that finished Chinese steel prices today trade below their production cost. Furthermore, import license applications to sell steel in the US, the world’s largest export market, rose 24% last month. Now, mostly this comes from Mexican and Korean producers, but clearly there is the implicit threat that their Chinese competitors might also be tempted.
But the Economy is Growing?
Clearly it would be inappropriate to annualise the production of the US steel industry in the fourth quarter of last year when capacity utilisation plummeted to just 32%. So consider, instead, the annual run rate this year from January to August. This was a period of stabilisation in tandem with the cash-for-clunkers program, which boosted the industry’s largest customer, the car sector. It is quite chilling to note that steel production in America is on a par with output back in 1938, when GDP was a mere 7% of its current size. The industry’s run rate dropped to a paltry 13% during the Great Depression. However, output only troughed at its 1908 level; a twenty year retracement that is a far cry from our 70 year retracement. So the physical developments in the western steel markets should raise some concern. However, with an active steel futures market in China turning over $15bn a day (consult the Bloomberg page <RBTA CMDY CT>), speculative fears concerning the dollar have overcome the paucity of industrial demand in the west.

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Of course, it is not just steel. Consider the aluminium market. We recently had a very bearish meeting with the Norwegian company Norsk Hydro. Admittedly, their strong petro-currency does not help and you have to discount the solace I seek in finding people even more miserable than myself. Even so, the aluminium situation mimics that of steel, but with an even mightier inventory overhang. Four and a half million tons reside at the London Metal Exchange, perhaps 20% of world ex-China annual capacity. It is probable that 75% of this surplus stock is accounted for by financial players exploiting a contango.

Does Life Imitate Art?
The advocates of Prechter’s socio-economics would not be surprised to hear that the Romanian writer Herta Mueller has been awarded this year’s Nobel Prize for literature for her work depicting “the landscape of the dispossessed”. In a Los Angeles Times review of her book, The Appointment, they noted,

“…it is sometimes difficult to tell whether we are reading about people driven mad by a mad regime or people who may not have had all their marbles in the first place.”

My partner, Mr. Lee, reflected on this as he sat in the chilly offices of Norsk Hydro last week watching the snow fall outside. The Norwegians continued with their tale of woe: a couple of million tonnes of inventory remains unaccounted for on the world stage and are believed to be hidden in cheaper warehouses in Russia. The rationale behind this is the same as the rationale used by LME speculators. Furthermore, the big Russian players like Rusal are under intense pressure from Putin not to cut capacity (check out ‘Putin bitch slaps Deripaska’ on http://www.youtube.com/watch?v=PprlM5R3Hbg), and are rumoured to be surviving only by not paying their electricity bills.

To make matters even worse, the Chinese have stopped importing and are eager to ramp up domestic aluminium production. They havethe capacity to produce another 13mt annually, which is equivalent to 52% of global production. Lastly, there is the fact that Rio Tinto bought Alcan right at the very top of the cycle, though they dare not admit it is a terrible business.
Poor Old Norsk Hydro?
Who would want to share a stage with so many mad villains? The Norwegians noted that construction demand had just taken another leg down as buildings started pre-crisis are now finished whilst no further pipeline exists outside of China. Even Ryanair are talking about suspending their aggressive growth plans and may delay the purchase of more planes.

The Norwegians suffer the most pain at present, but if the dollar were to strengthen Alcoa could conceivably go bust. Their dollar cost is the company’s only competitive advantage. Let us not forget Alcoa has the most exposure to aircraft construction and still has $10bn of gross debt lording over an almost equivalent market cap. Imagine that we have not even considered their pension liabilities. Yet the Alcoa CDS trades at 200 basis points, down from its high of 1200 earlier this year. Why?!

“May sorrow break these chains of my sufferings, for pity’s sake”

Lascia ch’io pianga
Handel

Now remember I have been describing a positive macro scenario: a world in which low interest rates make the debt load manageable and that we muddle through with lower growth rates in nominal GDP. But clearly the consequences for corporate profitability are very poor. The alarming thing is that my opponents (see Ferguson et al.) believe that government bond yields are going much higher. Effectively, the world’s bond vigilantes are going to punish the Fed and tighten monetary policy. It is almost as if the world’s greatest speculators are agitating for their own demise. It is my contention that the leverage of the economy is only tenable if interest rates stay low and yet, whilst I believe some of them agree, they still fervently expect a rise.

Je consens, ou plutôt j’aspire à ma ruine.

Pierre Corneille
Polyeucte, 1642

Do not forget that the US does not share the distinction of the British or Australian housing markets. According to FSA data, 55% of UK mortgages are fixed rate and 45% are floating. The latter have, of course, collapsed and have proven a boon for disposable income. We must remember, however, that British fixed rates are determined by two and three year swap rates; so effectively the entire stock of UK mortgages are determined by the central bank and could be thought of as floating. In the US, however, things are very different. Total single-family mortgages outstanding are $11trn but $9trn is fixed to the prevailing 30 year Treasury yield. Banks just do not offer variable rate or teaser mortgages anymore. You might say that the American housing market hangs by the tender threads of the bond market’s generosity. Lose it, and let us say that the markets demand 6% yields on 30 year durations and mortgage rates would then shoot back up to 7%. And, I would argue, the econo my would come to a crashing halt. Do speculators really want this to happen?

Perhaps I am describing a pressure cooker. The private sector’s debt may be sustained by maintaining low nominal interest rates.But the pressure from so much issuance at a time of great reluctance from financial institutions to purchase bonds could break the stalemate. And with it the ominous precedent of 1931, outlined in our February report, when a back up in ten year Treasury yields from 3.1% to 4.4% undoubtedly accelerated the rate of deflation in the US economy.

Conclusion and Investment Review: The Augustus Gloop Song

Oompa loompa doompety doo I’ve got a perfect puzzle for you Oompa loompa doompety dee If you are wise you’ll listen to me What do you get when you guzzle down sweets Eating as much as an elephant eats What are you at, getting terribly fat What do you think will come of that…

Oompa loompa doompety da If you’re not greedy, you will go far Charlie and the Chocolate Factory Roald Dahl, 1964

I now return to Japan. Sometimes I find myself sounding like an apologist for Bernanke and big government. In my debate with Mr. Ferguson it was expected that I would represent Paul Krugman (yuck!) so let me attempt to clear any misapprehensions. I think our present lot of politicians and government officials are “filthy”. There are no limits as to how far they are willing to go in order to prevent a market inspired liquidation of all the economy’s rotten apples. After all, that is what deflation is all about. The government insists it understands the policy gaffes of the 1930s and has assured everyone that these will not happen again.

I want to punish them for this monstrous nonsense and their intellectual arrogance as much as you do. I want nothing to do with them. I want to watch them squeal as higher and higher gold prices rebuke their interventionist ways. But I also want to make money; lots of money. I simply do not want to do this in a manner in which my errors could cost the Fund a great deal of money and heartbreak. So I fall back on my old argument. It is perhaps too subtle, but at its core lies today’s most pertinent question. What if Bernanke, the Chinese, Putin, Obama, his Congress, and all the other interventionists, are simply impotent? What if they do not matter? Perhaps it is the debt, stupid. Perhaps the incremental GDP from all of this additional stimulus spending is zero. And, as Japan has foretold, perhaps all of this year’s interventions will be unable to lift the global economy from its funk. If this is so, you will not require all those inflation hedges; you have been sold a FAKE.

But first, it may require the spectacle of seeing Japan implode and so we have been actively positioning the Fund to profit from such a scenario. As many of you know, the fiscal situation in Japan is rapidly rising out of control. Government tax receipts are down 14% over the last 12 months; government spending is twice the receipts and the trade surplus appears structurally impaired. We have to go back to 1991 to find the last time they ran a primary surplus sufficient to meet their national debt’s interest payments. Today they would need the equivalent of 4.4% of GDP. Failing this, and assuming they do not shorten the debt maturity of the JGBs that they sell to the public, then the ratio of public debt to GDP is guaranteed to rise further. It is currently 196% of GDP with the IMF estimating that it will rise to 234% by 2014.

This situation has not gone unnoticed. The sovereign dollar default swap has doubled to 75bps since August, and Japan is now the most expensive credit to insure against a dollar default in the G10. However, we have been active buyers of corporate debt default swaps. We find it remarkable that one can insure highly leveraged utilities at 23bps despite their considerable yen debt. Consider the Tokyo Electric Power Co. (9501 JP) with a market capitalisation of $32bn and net debt of $81bn. The debt is 7x EBITDA, the interest cover is 1.9x, and the average interest cost for now is thankfully just 1.9% p.a.

The Japanese government has been sensible in one area; two thirds of all their JGB issuance has been in maturities of ten years or more whereas the US has a skew to shorter dated issuance. However, it is probable that the public sector in Japan is crowding out the private sector from the long end, for whilst only 24% of the government debt is of 2-5 year maturity, the corresponding figure for the utility company is 57%. Furthermore, they are dependent on 70% of their debt being sourced from non-banking sources, i.e., from the market place. Clearly there are two prominent risks: debt rollover and higher interest rates. The “cheap” risk is a normalisation of interest rates brought about by a dearth of buyers at these levels. Should Tokyo Electric’s interest cost double to 4.6%, the company’s EBITDA-less-CAPEX would just cover the interest bill. What cost would credit underwriters insist for the CDS in this scenario?

We have a notional exposure representing almost 40% of the Fund’s NAV. It represents a large notional risk exposure with a quantifiable and manageable downside loss of just 9 bps of the Fund’s NAV every year for five years. However, the potential return to the Fund in the event of a default would be 23% of NAV, or 250x our annual outlay. Whilst we would still make 1% point of NAV should it trade in line with the sovereign credit risk, or 1 0x our annual cost. We might get rich but we certainly will not die tryin’.

The above is typical of our portfolio today. Gone are the cavalier days of large gross exposures across multiple asset classes and large monthly volatility. Instead we own a basket of cheap sovereign and corporate default swaps and the asymmetry of interest rate option packages which enjoy high pay-offs should the enormous debt load of the private sector keep rates lower for longer. I began this lengthy letter quoting from Keynes’ Economic Consequences of the Peace. With the benefit of hindsight, future historians might conclude that the major blunder of last year’s bailout was the failure to reduce or even address the economy’s debt burden. If this turns out to be the case, I believe that the Fund is well positioned to make money.

Tags: Art Historian, BRIC, China, Commodities, Dutch Painter Vermeer, Economic Consequences Of The Peace, Economic Lessons, Emerging Markets, Emerging Stock Markets, Entrance Examination, Forger, Forgeries, Global Economy, Gold, Hugh Hendry, Indelible Mark, India, Industrial Commodities, Insightful View, Investment Outlook, John Maynard Keynes, Jonathan Lopez, Management Letter, Monetary Inflation, oil, Timelessness, Van Meegeren
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Words from the (Investment) Wise (November 16, 2009)

Monday, November 16th, 2009

“Words from the Wise” this week comes to you in a shortened format as I do not have access to my normal research resources while on the road in Europe. Although very little commentary is provided, a full dose of excerpts from interesting news items and quotes from market commentators is included.

While the Dow Jones Industrial Index and other benchmark indices reached 52-week highs last week and pleased Wall Street, the cartoonists reminded us that worrisome economic issues remained in Main Street …

Source: Jeff Parker, Comics.com, November 11, 2009.

The past week’s performance of the major asset classes is summarized by the chart below - a mixed bag, so to speak, with government bonds, equities, corporate bonds and gold closing the week in positive territory.

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below. With the exception of only a few indices - notably the Japanese Nikkei Dow that recorded a third consecutive down week - most global stock markets made headway last week, adding to the gains for the month.

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

Top performers among stock markets this week were Romania (+8.1%), Russia (+6.1%), Jamaica (+6.1%), Hungary (+5.2%) and Israel (+5.2%). At the bottom end of the performance rankings countries included Latvia (‑5.1%), Cyprus (-4.4%), Greece (-4.2%), Serbia (-4.0%) and Kuwait (‑3.8%).

Of the 99 stock markets I keep on my radar screen, 66% recorded gains (last week 52%), 31% (43%) showed losses and 3% (5%) remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that, as far as exchange-traded funds (ETFs) are concerned, the winners for the week included PowerShares Global Coal (PKOL) (+7.6%), iShares Cohen & Steers Realty Majors (ICF) (+7.4%), Vanguard REIT (VNQ) (+6.4%) and Market Vectors Russia (RSX) (+6.4%).

At the bottom end of the performance rankings, ETFs included United States Natural Gas (UNG) (-4.9%), ProShares Short Emerging Markets (EUM) (-3.7%), ProShares Short QQQ (PSQ) (-3.4%), SPDR Russell/Nomura Small Cap Japan (JSC) (-3.0%) and WisdomTree Japan Small Cap (DFJ) (-2.5%).

Still on the topic of ETFs, Clusterstock reported that investors have been pouring $108 billion into ETFs during the year to date, with $24 billion coming in during the last three months.

“Yet while investors have been pouring money into commodity, fixed income and global equity ETFs, one very important category has remained a complete pariah - US stocks. Despite the stock market rally …, money has continued to flow out of US equity ETFs. Thus while some might be able to argue that the crowd has jumped into commodities, fixed income and global equities, it’s pretty hard to say that investors are in love with stocks again …,” said Clusterstock.

Source: Clusterstock - Business Insider, November 11, 2009.

Referring to the surge in the gold price, the quote du jour this week comes from Richard Russell, 85-year-old author of the Dow Theory Letters. He said: “America’s Fed Chairman, Ben Bernanke, is convinced he knows the secret of avoiding hard times. The Fed can halt deflation and turn the picture into asset inflation. All it takes, thinks Bernanke, is zero interest rates and the creation of trillions of new dollars - and they will come, and they will spend. This is the path the Bernanke Fed has chosen. So far, it has not worked - they are not coming, and they are not spending. The Fed’s strategy has not even succeeded in bringing down unemployment. Bernanke’s solution - more of the same: ‘Whatever it takes, and as long as it takes.’

“Thus we have a strange and ironic situation. We have world deflation, and a Fed Chairman who believes he can manipulate the primary trend. Bernanke’s strategy is leading to a weakening dollar. The more dollars that are created, the weaker the dollar. As the dollar’s very status comes into question, wise and seasoned investors move to protect their wealth. They move to the time-honored ’safe haven’: the one unit of wealth that cannot be destroyed in that it is not a liability of any government. And, of course, I’m talking about the one unit of wealth that is never questioned - gold.

“So it’s the gold bull market that I trust and believe in. I think and I ponder - what can halt the gold bull market? The only thing that can halt the gold bull market is a complete reversal by the politicians and the Fed, and that would allow the US to sink into a state of deflation and depression. Unthinkable.”

Next, a quick textual analysis of my week’s reading - mostly done on airplanes and between meetings in Europe. This is a way of visualizing word frequencies at a glance. Although “bank” still features prominently, the key words have started taking on a more normal pattern compared to the crisis-related words that have dominated the tag cloud for many months. Unsurprisingly, “gold” is gaining in prominence.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town) are given in the table below. With the exception of the Russell 2000 Index, most of the indices are trading above their 50-day moving averages, with all the indices also above their respective 200-day moving averages. The 50-day lines are also above the 200-day lines in all instances.

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

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

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

The announcement of Wal-Mart’s results marked the end of the Q3 earnings season. Research outfit Bespoke provided the following summary of the Q3 earnings results as well as Q4 estimates:

“The estimates for the year-over-year change in Q3 earnings at the start of earnings season were -23.2% for the S&P 500. Currently, the actual number sits at -17.2%. As shown below, the Financial sector has seen its earnings grow by 358.8% in Q3 ‘09 versus Q3 ‘08! Given how bad things were last year, it’s not surprising to see a reading this high, but it is a sign that things have gotten much better. Health Care, Utilities and Consumer Staples (all non-cyclical) are the only other sectors that have seen year-over-year earnings growth this quarter. Energy has seen the biggest decline in earnings at -62.9%, followed by Materials (-43.4%), Industrials (-37.3%), and Consumer Discretionary (-29.3%).

“The Financial sector is currently expected to see growth of 133.8% in Q4 ‘09 versus Q4 ‘08. This high estimate in the Financial sector helps put estimates for the entire S&P 500 at +65.2% in the fourth quarter. Ex-Financials, the S&P 500 is expected to see Q4 earnings actually decline by 7.6%. Technology is expected to see growth of 21.5% in Q4, while estimates for the Materials sector are currently at 97.5%.”

Source: Bespoke, November 11, 2009.

From across the pond, David Fuller (Fullermoney) said: “Veteran subscribers will recall a remark often used on this site [Fullermoney]: Bull markets do not die of old age - to which I will add warnings by Roubiniesque economists. Instead, they are assassinated - usually by central banks. So how many rate bullets does it take to fell a bull? You may not be surprised to hear that there is no precise answer, because it depends mainly on sentiment and liquidity. We know when central banks start to reduce liquidity, or at least increase its price, but we do not know precisely when that will affect sentiment adversely.

“Note the still widening spread between US 10-year yields over 2-year yields, otherwise known as the yield curve, on this historical. It is still rising, indicating to me that quantitative easing continues. The time to start thinking about closing long portfolios in anticipation of the next bear market, I suggest, will be when the yield curve next inverts by moving below zero. However, the lead was so early last time (early 2006) that some of us became complacent about it.”

Source: Fullermoney.com

For more discussion on the economy and financial markets, see my recent posts “Picture du Jour: Dow rally in perspective“; “Richard Russell: Six reasons to invest in gold“; “Albert Edwards still über-bearish, calls for new lows in 2010“; “Roubini’s RGE: Global monetary policy outlook“; “Bull markets do not die of old age; they are assassinated - usually by central banks” and “WealthTrack: Jim Grant interview - transcript“.

Twitter and Facebook
I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those not doing so already, you can follow my “tweets” by clicking here. You may also consider joining me as a friend on Facebook.

Economy
The Recession Status Map below, courtesy of Dismal Scientist Economy.com, aggregates growth statistics from around the world and allows one to see at a glance which economies are in recession, at risk or beginning to recover. Click on the map to link to the interactive version.

Source: Dismal Scientist

“Global business confidence has remained largely unchanged during the past two months through mid-October. Sentiment is consistent with a very tentative and fragile global economic recovery,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. “Businesses … are more upbeat about the outlook into next year … and their broad assessment of current business conditions. South Americans are the most positive, and North Americans generally the most negative.”

Source: Moody’s Economy.com

As far as hard data are concerned, the Eurozone emerged from recession in the third quarter, but the speed of the recovery fell short of expectations - and the growth rate of 0.9% achieved by the US. “Eurozone gross domestic product expanded by 0.4% compared with the previous three months, after having previously contracted for five consecutive quarters, according to official figures on Friday. Powering the rebound were Germany and Italy, which saw GDP rising by 0.7% and 0.6% respectively,” reported the Financial Times.

A snapshot of the week’s US economic reports is provided below. (Click on the dates to see Northern Trust’s assessment of the various data releases.)

November 13
• Widening of trade deficit reflects oil imports and improving economic conditions
• Michigan Consumer Sentiment Index - households remained gloomy in November

November 12
• Noteworthy news from labor market - total continuing claims are trending down

November 10
• Yellen on budget deficit and inflation
• Inflation expectations - an update

November 9
• October Senior Loan Officer Opinion Survey - improved picture of lending conditions, but demand for loans was weak

Meanwhile, James Bullard, the president of the Federal Reserve Bank of St Louis, has told the Financial Times that uncertainty over the outlook for inflation “is as high as it has ever been since 1980″. “I think there’s still some risk of deflation, but I do think the deflation risk is fading as the economy recovers,” he said. In the medium term, “you have inflation that will be possibly substantially above target over a horizon of two to four years, and that, I think, is because of the combination of very large fiscal deficits in the US with very easy monetary policy.”

Week’s economic reports
Click here for the week’s economy in pictures, courtesy of Jake of EconomPic Data.

Source: Yahoo Finance, November 13, 2009.

Click the links below for the following economic reports:

• Wells Fargo Securities: Weekly Economic & Financial Commentary
• Wells Fargo Securities: Monthly Economic Outlook (November 2009)
• Wells Fargo Securities: Global Chartbook (November 2009)

In addition to a speech by Fed Chairman Ben Bernanke to the Economic Club of New York, US economic data reports for the week include the following:

Monday, November 16
• Retail sales
• Empire manufacturing
• Business inventories

Tuesday, November 17
• PPI
• TIC flows
• Capacity utilization
• Industrial production

Wednesday, November 18
• Housing starts
• Building permits
• CPI

Thursday, November 19
• Initial jobless claims
• Leading indicators
• Philadelphia Fed

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

Source: Wall Street Journal Online, November 13, 2009.

“Amateurs measure potential while professionals measure risk,” said hedge fund legend Steve Cohen, founder of SAC Capital Advisors (hat tip: The Kirk Report). Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards to properly assess the risk associated with specific investments.

That’s the way it looks from Geneva (from where I will be making my way back to Cape Town later today).

Source: Larry Wright, Comics.com, November 10, 2009.

The Wall Street Journal: German, French economies continue to grow
“The euro zone’s two largest economies continued to recover from recession in the third quarter, as exports boosted both German and French gross domestic products.

“Germany’s GDP rose 0.7% in the three months to September 30 from a quarter earlier when adjusted for working days, data from the Federal Statistics Office showed Friday. Private consumption, however, dragged on the economy, the office said.

“In France, GDP grew for the second consecutive quarter, rising 0.3%, after shrinking for a year. Exports outpaced imports by growing 2.3%, with the result that the external sector contributed 0.4% to overall economic growth, the data showed.

“Household consumption, the main pillar of the French economy, remained unchanged from the previous three months, when it had gained 0.3%. Investment fell 1.4%, a faster pace of decline than the -1.2% posted in the previous quarter.

“The outlook for the German economy remains uncertain as unemployment is expected to rise in the coming months, hurting consumer demand. And with the euro trading at high levels against the dollar, German exporters may suffer from weaker demand, economists have said.

“The third-quarter growth marked the second quarterly gain after weak activity in the previous quarters, indicating that the euro zone’s largest economy is making progress in easing out of its worst recession since World War II.

“But overall economic activity remains low, with German GDP shrinking 4.8% in the third quarter from a year earlier, when adjusted for the number of working days each year, the data showed.”

Source: Andrea Thomas and Gabriele Parussini, The Wall Street Journal, November 13, 2009.

MoneyNews: Chanos - huge China crash coming
“To the growing number of China bears, add Kynikos hedge fund manager Jim Chanos, who is reportedly shorting the entire Chinese economy.

“Chanos, among the first to see through Enron’s web of accounting tricks, told Politico.com he sees a similar situation evolving in China - starting with the fact that the $4.3 trillion Chinese economy is under-performing despite a $900 billion stimulus program.

“Also, China seems to be cooking its books, making claims such as a huge surge in car sales while gasoline sales stay flat.

“Finally, there’s a concern that China may have too much capacity to produce too many goods for too few buyers, notes financial journalist Ed Conway.

“‘China has grown to its current size, as do most ‘young’ economies, by exporting cheap goods to richer countries. … (resulting in) the biggest trade surplus in history,’ Conway writes in the UK Telegraph.

“Chinese leaders, Conway points out, are doing whatever they can to keep the value of their currency low.

“‘Such a policy made sense when China had an economy that was relatively underdeveloped, and was trying to shield nascent exporters from volatility; but now, by keeping assets artificially cheap, it serves to exacerbate the bubble that is building up as a result of those low US interest rates,’ Conway writes.

“This, combined with trying to pump up the economy further by channeling cheap credit to companies, ‘could hardly be a more reliable recipe for an asset bubble,’ Conway says.”

Source: Julie Crawshaw, MoneyNews, November 12, 2009.

Asia Times.com: China trade surplus shadows Obama visit
“China’s surging trade surplus, with the increase last month almost double the September figure, makes it impossible that trade issues will not be a key topic when United States President Barack Obama makes his first visit to Beijing this Sunday.

“The surplus was US$24 billion in October, compared with $13 billion in September, bringing the total for the year so far to $159.23 billion.

“Trade tension between the two countries was already rising before the latest data were released on Wednesday, with the US imposing a series of anti-dumping sanctions on Chinese imports and Beijing investigating the possibility of action against imports from the US.

“This week, before leaving on his nine-day trip to Asia, Obama warned that the economic relationship between the countries had become deeply imbalanced in recent decades, with a trade gap between the countries and huge Chinese holdings of US government debt.

“The US and China had to work together on the big issues facing the world, and any competition between them had to be fair and friendly, Obama said in a White House interview with Reuters.

“He said he would be raising with Chinese leaders the sensitive issue of their currency, the yuan, which is seen by some in US industry as significantly undervalued and as an important contributor to the imbalances.

“‘As we emerge from an emergency situation, a crisis situation, I believe China will be increasingly interested in finding a model that is sustainable over the long term,’ Obama said. ‘They have a huge amount of US dollars that they are holding, so our success is important to them … The flip side of that is that if we don’t solve some of these problems, then I think both economically and politically it will put enormous strains on the relationship.’

“China holds about $2.27 trillion in foreign reserves, about two-thirds of it in US dollars, as of the end of September, up 19% from a year earlier. The country held Treasury bills worth about $797.1 billion in August, making China the world’s largest holder of US Treasuries outside the United States, according to the US Treasury Department.”

Source: Olivia Chung, Asia Times.com, November 13, 2009.

Clusterstock: California’s no. 2 export to China - trash
“American exports to China soared 341% from 2000 to 2008, according to the US-China Business Council. In fact, China is the third largest US export market, behind Canada and Mexico.

“Spearheading the charge is sunny California, the largest American exporter to China by state.

“No surprise, right? California’s right on the Pacific coast and filled with innovative companies.

“Well sort of.

“While computers and electronics are indeed California’s top export to the giant nation, the sad truth is that ‘Waste and Scrap’ are the Golden State’s second largest export to China. California sends about as much junk to China as both machinery and transportation equipment combined.

“The rest of the US isn’t doing that much better either. As a nation, ‘Waste and Scrap’ is America’s fifth largest export to China, at a whopping $7.6 billion. We might need to rethink what ‘Made in the USA’ exactly means to the Chinese.”

Source: Vincent Fernando and Kamelia Angelova, Clusterstock - Business Insider, November 12, 2009.

Financial Times: EU states given stark warning on debt levels
“The European Union’s public debt could by 2014 rise to 100% of gross domestic product - a year’s economic output - unless governments take firm action to restore fiscal discipline, EU finance ministers will be warned on Monday.

“The stark message is contained in a European Commission analysis, which highlights the rapid deterioration in EU public finances caused by emergency measures in the past 12 months to rescue Europe’s financial sector and combat recession.

“As recently as 2007, the euro area’s public debt was only 66% of GDP. But, even at this level, it was above the 60% target set for countries aspiring to join the eurozone.

“In its latest six-month economic forecast, published last week, the Commission predicted that the eurozone’s public debt would rise to 84% of GDP next year and 88.2% in 2011. But the new document paints a more sombre picture.

“The document says, based on projections of a return to long-term pre-crisis growth levels, that ‘without consolidation, the gross debt-to-GDP ratio for the EU co