Energy and Natural Resources Market Highlights (3/15/2010)

Monday, March 15th, 2010

Energy and Natural Resources Market

The source of this graph is IHS Herold. The securities identified in the graph were selected for inclusion by IHS Herold and may or may not be held by portfolios managed by U.S. Global Investors, Inc., whose holdings may change daily.

Strengths

• Chinese crude oil import surged in the first two months of the year up 45 percent year over year. The apparent demand growth is up 25 percent over the same period.
• Chinese floor space under construction rose 29.3 percent year over year in January and February (combined).
• German crude steel production increased 34 percent year over year to 3.4 million metric tons in February 2010, according to WV Stahl. This marks an acceleration on the rate of increase recorded in January, when crude steel production rose by 28 percent year over year.
• Crude steel production in China, the largest maker, rose 22.5 percent to 50.36 million metric tons, according to data from the National Bureau of Statistics.
• Indian coal imports climbed 20 percent year over year in February. It received 6.1 million metric tons of the fuel from suppliers in Australia, Indonesia and South Africa. India plans to almost double electricity generation capacity by 2012 and by then the shortage of coal is expected to exceed 200 million metric tons.
• In January 2010, U.S. coal exports were up 17.5 percent year over year to 5.8 million tons, driven by a 62.9 percent year-over-year increase in metallurgical coal exports, the highest level since September 2008.
• Copper imports by China, the world’s largest consumer, increased 10 percent in February from the previous month on sustained demand.

• Italian oil and gas group Eni SpA cut its production growth target on Friday and said investors would have to wait until 2011 to see any growth in output or dividends. Eni, the world’s seventh-biggest listed oil company, said production is expected to grow more than 2.5 percent per year on average through 2013—this estimate was down from 3.5 percent per year in its previous plan.

Opportunities

• ExxonMobil, the largest U.S. oil company by market value, said at its annual analyst meeting in New York that it expects to boost its capital spending 3.3 percent to $28 billion in 2010 and that it would spend $25 to $30 billion per year through 2014. The bulk of the company’s capital budget would go toward developing dozens of major projects around the world.
• Quadra Mining Ltd. gained 10 percent this week after State Grid Corp. of China agreed to buy 9.9 percent of the company for $148 million to secure a share of the copper from Quadra’s Chilean projects. Beijing-based State Grid is the larger of China’s two grid operators.
• BP on Thursday confirmed it would enter the deep waters off the coast of Brazil, one of the world’s most promising areas for oil exploration, with a $7 billion deal to buy international oil and gas assets from Devon Energy.
• The active land-drilling rig count is on the rise, but North Dakota has been one of the fastest growing in the Lower 48 since the bottom last year, more than doubling its rig count since mid-2009. Driving the North Dakota rig count higher has been a sharp rebound in activity in the Bakken Shale, considered one of the largest oil formations in the U.S.

Threats

• China’s inflation reached a 16-month high, industrial output climbed and new loans exceeded forecasts, adding to the case for the government to pare back stimulus measures. Consumer prices rose 2.7 percent in February from a year earlier, the National Bureau of Statistics said, compared with the 2.5 percent median estimate of 29 economists surveyed by Bloomberg News. Seasonal factors stemming from a weeklong holiday may have boosted prices. Production rose 20.7 percent in the first two months of 2010, the most in more than five years.
• A glut of unconventional natural gas supplies from U.S. shale deposits has fundamentally recast the long-term prospects for liquefied natural gas imports that were once considered the linchpin of the nation’s energy security, industry executives said at the Ceraweek energy conference in Houston.
• China is idling up to 40 percent of its wind-turbine factories following a surge in investment driven by the government’s renewable energy goals, the vice president of Shanghai Electric Group Corp. said this week.

Tags: Bureau Of Statistics, Coal Exports, Coal Imports, Commodities, Crude Oil, Crude Steel Production, Electricity Generation Capacity, Eni Spa, Floor Space, Gas Group, Growth Target, Herold, Italian Oil, Metallurgical Coal, Million Metric Tons, Months Of The Year, National Bureau Of Statistics, Oil Company, Oil Import, U S Global Investors, U S Global Investors Inc
Posted in Markets, Oil and Gas | No Comments »

Following up on Nordic American Tankers (NAT) one year later

Wednesday, March 10th, 2010

One year ago, yesterday, I shared the transcript of the CNBC interview with Herbjorn Hannson, CEO of  Nordic American Tankers, an oil shipping company whose business fundamentals were profoundly good, particularly given the backdrop the market bottom, when things appeared most dire. This is but one company, and it captured my attention 12 months ago.

Nordic American T - NAT

30.36

+0.05

On March 9, 2009, Nordic Shares closed around $23.43. Subsequently they closed at a high of 36.22, two months later on May 7, 2009. Currently, the shares are trading around 31.

NAT has no debt.

Here is the company’s dividend record:

NAT has made the following dividend payments to its shareholders:

Amount per share (USD)

	1st Quarter	2nd Quarter	3rd Quarter	4th Quarter
2010	0.25
2009	0.87	0.88	0.50	0.10
2008	0.50	1.18	1.60	1.61
2007	1.00	1.24	1.17	0.40
2006	1.88	1.58	1.07	1.32
2005	1.62	1.15	0.84	0.60
2004	1.15	1.70	0.88	1.11
2003	0.63	1.27	0.78	0.37
2002	0.36	0.34	0.33	0.32
2001	1.41	1.19	0.72	0.55
2000	0.34	0.45	0.67	1.10
1999	0.32	0.35	0.35	0.36
1998	0.40	0.41	0.32	0.30
1997				0.30

The table illustrates the dividend declared by quarter in which the dividend was paid and is based on the earnings of the previous quarter.

Here is Hannson’s March 8, 2010 letter to shareholders.

Dear Shareholder,

As Chairman and CEO I strive to keep all our shareholders well informed about key aspects of the development of our Company. It is therefore now time for me to send you another letter.

Since my letter of September 29, 2009 to you, the Company has acquired two more suezmax vessels, of which one was delivered to us on November 17, 2009 and the other was delivered to us on March 2, 2010. We paid $51.5 million for each of these 2002 built suezmax tankers. Including the two newbuildings expected to be delivered to us later this year, the fleet of our Company consists of 18 suezmax vessels. The acquisitions are accretive and the dividend potential of the Company has increased.

Accretive growth is a key element in our strategy. Over time the fleet must grow faster than the share count in order to create value for shareholders. In January 2010 we priced a follow-on offering from which the proceeds to the Company were $137 million before cash offering costs. The Company currently has the resources to acquire 4 more vessels without tapping the equity market. An increase of the fleet from 18 to 22 vessels would represent a 22% increase of our fleet whereas the share count was increased by about 10% in connection with the follow-on offering. This is an example of accretion while recognizing that net debt is expected to be slightly higher after such prospective acquisitions.

Having a fleet consisting solely of suezmax vessels, we experience cost benefits and in today’s environment we also pursue possibilities of further reductions in our costs. The Company also has low general and administrative costs which together with our low debt contribute to a very low cash breakeven.

So far into the first quarter of 2010, at the time of this writing, we observe a spot suezmax tanker market which on average is well above the level of the fourth quarter of 2009. Based on the market so far in 2010 we therefore expect the dividend of the Company for the first quarter of 2010 to be substantially higher than the dividend for the fourth quarter of 2009, which was $0.25 per share.

Our primary objective is to maximize total return to our shareholders, including maximizing our quarterly cash dividend. Over time we have in the past produced a very competitive total return for our shareholders and we believe that we are in an excellent position to achieve such results also going forward.

With our proven model and strong balance sheet we aim to be in a position to reap the benefits in the markets as they develop, be they soft or strong from time to time.

I would like to finalize my letter to you by stressing a key dimension in our model: the alignment of interests between our shareholders and our management. If our shareholders do well, so do management and vice versa. We do not believe in special, supermajority shares, for our management. In our Company, all shares have one vote, plain and simple.

As you understand, I am optimistic about the future of our Company.

All the best!

Sincerely,
Herbjørn Hansson
Chairman & CEO

This is by no means a recommendation, I’m not promoting it, nor is not intended to be. What I believe is that this company and others like it are very attractive in a world where credit is difficult to come by.

Disclosure: No positions

Tags: 12 Months, 4th Quarter, 5 Million, Acquisitions, Backdrop, Business Fundamentals, Ceo, Cnbc, Cnbc Interview, Dividend Payments, Dividend Record, Earnings, Element, Fleet, Letter To Shareholders, Market Bottom, Newbuildings, Nordic American Tankers, September 29, Share Count, Shareholder, Shipping Company, Suezmax Vessels
Posted in Commodities, Markets, Oil and Gas | No Comments »

Robert Arnott: Lessons from the “Naughties”

Wednesday, March 3rd, 2010

By Robert Arnott and John West - Research Affiliates

ROBERT ARNOTT, Chairman and Founder of Research Affiliates, LLC.

JOHN WEST, CFA, Director, Product Specialist of Research Affiliates, LLC.

Last month, we examined the Lost Decade and learned that much of the pain of the past 10 years was caused by an overreliance on the equity risk premium and the corrosive effect of capitalization weighting our equity holdings. Simply bypassing these two practices would have delivered respectable 7–8% annual returns. But past is not prologue. History is littered with the folly of building yesterday’s army to fight tomorrow’s war.

In this issue we apply the lessons of the recent Lost Decade to current market conditions. From an asset allocation perspective, the outlook for the ubiquitous 60/40 blend remains bleak. Unfortunately, moving away from this standard mix to a broader toolkit of risk exposures is likely to be less profitable than it was in the past decade as yields from diversifiers like REITs, TIPS, and emerging market bonds are well below the levels of 10 years ago. The key to better returns will be to respond tactically to the shifting spectrum of opportunity, especially expanding and contracting one’s overall risk budget. This approach, combined with “better beta” choices like the Fundamental Index® concept (which currently sports an unusually deep discount, relative to capitalization weighting), should help us to achieve our targeted returns in what—we shudder to suggest—is likely to be another tough slog for investors.

Busting Out The Crystal Ball

Naive mean reversion would indicate that 10 lean years for the 60/40 blend (60% S&P 500/40% BarCap Aggregate) ought to be followed by a decade of relatively strong results, especially when the recent lean years delivered the first ever decade of negative real returns! Of course, this assertion can only be verified with a perfectly tuned crystal ball.

While we take great pride in our asset class forecasting, we unfortunately don’t have such a device buried in our research department.[1] But we can reasonably project likely future asset class returns by starting with their key Building Blocks. The long-term return on any investment can be broken down into income, growth in income, and changes in valuation levels. Table 1 illustrates these components, save for changes in valuations levels (more on that later), for the S&P 500 and BarCap Aggregate Bond Index as of December 31, 1999, and December 31, 2009.

Let’s start with equities because we spent most of last month’s issue of Fundamentals on their Lost Decade. The dividend yield on the S&P 500 was 2.1% as of December 31, 2009.True, that’s almost double the rate at the end of the 1990s, but it’s still puny relative to a long-term average of 4.5% since 1900. If we add a historic growth rate to those dividends, we arrive at an annualized real long-term expected return of 3.3% for stocks, assuming no change in valuations. Clearly, 10 years of poor returns hasn’t materially impacted expected future returns. As some wags have suggested, the Tech bubble discounted not only future growth but also growth in the hereafter.

On the bond side, the current yield to maturity is an excellent predictor of future long-term returns. Accordingly, bonds helped the 60/40 portfolio in the Lost Decade as they started with a yield of over 7%. Today the yield is about half as large. Backing out today’s breakeven rate,[2] we see a core bond portfolio can be reasonably expected to achieve only an annualized 1.8% real return.

So, a reasonable expectation for a standard 60% stock and 40% bond mix over the next 10 years is a real return of 2–3% per year, again assuming no change in valuations. Yikes! The Lost Decade has most assuredly not paved the way for easy times in the years ahead. We’re still in a low return environment. This is a commonplace observation but most observers refer to low returns relative to the 1980s and 1990s, not the last decade.

The Impact Of Valuations—The BIG Wild Card

But valuations do change and have large multiplier effects on 10-year returns from asset classes, especially stocks. Consider that during the Naughties a rise in dividend yields from 1.1% to 2.1% implies a 48% drop in the value that the market was willing to pay for each dollar of dividends. That works out to a 6.5% annualized drop in valuation multiples. If we examine Table 1, we find that a valuation change of 6.5% pulls our annualized real return down from 2.3% to –4.2%. What was the actual result? A whole lot closer to the latter: –3.6%!

The annualized contribution of changing valuations to equity returns has ranged from +11% to –7% over the past six decades. So where are we today in the stock market? Figure 1 shows the performance of the Shiller P/E ratio over time. The Mother of All Recoveries has pushed equity valuations, marginally cheap in a historical context back in February 2009, back into the low 20s, a 25% premium to the long-term average.

Source: Research Affiliates based on data from Robert Shiller

As you can see in Figure 1, equities traded at the same P/E ratios as they did in early January 2010 in four distinct time periods (highlighted): 1928–1930, 1936–1937, much of the 1960s, and 1992–1995. Table 2 shows the subsequent average 10-year equity returns, inflation, and ending P/E ratios from each of these periods. Not surprisingly, the subsequent 10 years after 1928–1930 (even to those who slept through American history classes) showed negative nominal returns and deflation due to the Great Depression. The 10-year periods following 1936–1937 and the 1960s showed average annual inflation in the 4% range, well higher than we’ve seen in the past 25 years. With equity P/E ratios contracting into the 14–15 range, against a headwind of inflation, stock investors suffered skinny real returns of 1.5–2.5%. Only following the early 1990s did 10-year returns bump into double digits, as low inflation and rising valuation multiples allowed the S&P 500 to average 10.6% per annum, gains that were subsequently lost.

If we believe in higher long-term inflation over the next decade,[3] then equity valuations are likely to contract, meaning our Building Blocks return forecast for stocks and bonds may be too high. Stocks will produce less due to the downward pressure on valuation multiples, while higher inflation eats into today’s skinny nominal bond yields. So, one lesson of the Lost Decade is likely to hold true—an equity-centric mix of mainstream stocks and bonds is likely to disappoint. Again. Net of inflation, it could even be worse than the past 10 years.

Diversification And Alternative Assets: With No Fat Pitch, Think Tactical

A key tonic to the past 10 years was a more diversified, less equity-centric approach. A risk premium over government bonds isn’t restricted to equities; plenty of assets offer premiums in line with stocks and occasionally higher. In the last issue we used the 16-asset class portfolio[4] to illustrate the benefits of diversifying across a wider spectrum of asset classes. For the decade 2000–2009, this more-diversified approach achieved an annualized return of 6.8%, a 450 bps premium over 60/40. Abandon cap weight for stocks and the return jumps to 8.5%, nearly matching most investors’ targeted returns.

Looking forward, the outlook is not as “attractive” as it was in 2000. Today, yields on most of these diversifying assets are well off the rich premium levels at the turn of the century. Back then, NASDAQ-induced neglect led to a whole spectrum of alternative asset classes, favorably priced for attractive long-term returns. Today, we aren’t so lucky, as many off-the-beaten path categories sport rock bottom yields (and, therefore, low forward-looking returns). Figure 2 provides a quick snapshot of “Then Versus Now” in four asset classes: REITs, TIPS, emerging market bonds, and high-yield bonds.

Emerging markets bonds, REITs, and TIPS offer half of their Y2K yields. Even high-yield bonds, whose 1999 yields were pushed down due to heavy issuance by adored tech and telecom players, show significantly lower yields today. The fat pitch of diversification into risk premiums beyond mainstream stocks and bonds is largely gone.

So what to do? Manage the asset mix! Vitally important in this exercise is to shift risk postures. Too often asset allocation programs are governed by a relatively constant risk tolerance, say on par with a 60/40 stock/bond mix. This approach encourages swapping one risky asset class out for another (e.g., non-U.S. developed stocks for emerging markets stocks, REITs for U.S. stocks, etc.). But in the current environment, when all asset classes are rich, shouldn’t we consider a more conservative posture? This approach isn’t market timing but risk budgeting. We choose to take long-term risk when risk-bearing is likely to be rewarded, and a conservative, well-diversified posture when it is not. Rich forward-looking risk premiums typically prevail when investors are terrified, as they were in early 2009. As Warren Buffett suggests, we should be “greedy when others are fearful and fearful when others are greedy.”

Out-of-mainstream markets can still add value if we use them tactically and opportunistically. Inevitably, investors sell the assets they least understand when times get rocky, and buy them when conditions are calm. Thus, diversification can still be powerful, but only if we practice diligent tactical asset allocation.

Outlook for Equities? Depends On Your Index!

Stocks were terribly disappointing during the Naughties, but the results of the Fundamental Index approach (and, for that matter, equal weighting) illustrate that the shortfall was largely attributable to the cap-weighted construction of traditional indexes. The destruction of capitalization weighting wasn’t restricted to the two bookend years as evidenced in Table 3. A global, all-country Fundamental Index (FTSE RAFI® All World 3000) portfolio beat the representative global, all-country cap-weighted portfolio (MSCI ACWI) 9 years out of 10, falling short by a scant 30 bps in 2008. Even equal weighting, the most naIve of all price-indifferent approaches, managed to win by 600 bps per annum and did so consistently (8 years out of 10).

Of course, yesterday’s winners typically become tomorrow’s laggards. However, a comparison of current valuation discounts for Fundamental Index strategies versus cap-weighted ones indicates that avoiding the negative alpha of capitalization weighting is likely to still be profitable at today’s valuation levels. Previously, we noted that when RAFI US Large trades at a price/book ratio 27% or more “cheaper” to the S&P 500, the odds are good for subsequent outperformance—in the United States, the RAFI portfolio beats the S&P 500 in over 80% of subsequent three-year periods, with an average of 3.6% of additional return.[5]

So where does this discount stand today? Despite achieving in 2009 its second-best year ever of relative outperformance, the FTSE RAFI US 1000 still trades at a discount of 48% to the S&P 500. Similar discounts can be had elsewhere, including 38% for a global all-country application as evidenced in Table 4. These approach the historical peak discounts seen at the top of the tech bubble in early 2000. It’s not realistic to expect another 10 years of 600–700 bps per annum return drag from capitalization weighting. Nonetheless, given today’s discount levels, we expect continued sizable gains from noncap-weighted indexes and, therefore, continued benefits from using a Fundamental Index approach.

Conclusion

“Lost and Found” will not describe investment results for the first two decades of this millennium, as sizable real returns will prove to be difficult for the second 10-year stretch in a row. Most investors will fall short of their goals, as almost all asset classes—whether mainstream or alternatives—are priced richly relative to historical norms. But odds can be tilted back in our favor by tactically altering our portfolio risk based on measures as simple as yields and yield spreads. The most successful investors are those with the discipline to shun risk when the markets seem tranquil, and the fortitude to seek risk when others are terrified. The best path to future success marries risk management—tactical asset allocation—with a more efficient beta like the Fundamental Index methodology and a full toolkit of alternative markets.

Endnotes

1. Ironically, many of our turn-of-the-century predictions proved remarkably—and sadly—prescient. Early drafts of “The Death of the Risk Premium” (published in early 2001) were circulated as early as February 2000. Before the top! But, even a good crystal ball doesn’t assure success with clients. The mid-decade bull market caused some shorter-term investors to bail out of asset allocation programs, despite their eventual reliability over the full decade. Many paths can be taken to achieve a spot-on 10-year forecast. Successfully managing expectations is often harder than successfully managing assets!

2. Admittedly, breakeven rates are a poor predictor of future inflation, as they can be influenced by many things. In 2000, the relative newness of TIPS and the tech bubble allowed TIPS yields to briefly cross 4%. On the flip side, the liquidity-based sell-off in the fall of 2008 disproportionately hurt TIPS vs. nominal Treasuries.

3. See “3-D Hurricane Force Headwind,” Fundamentals, November 2009. http://www.rallc.com/ideas/pdf/Fundamentals_200911.pdf Incidentally, this longer-term near inevitability of inflation probably isn’t going to be an issue shorter term—next 12–24 months—as a weak recovery and falling rents will put pressure on CPI figures. But on a 10-year outlook (the minimum planning horizon for institutional investors and most retirement programs), our bet is on higher inflation. Perhaps even far higher.

4. The equally weighted portfolio comprises the following 16 indexes, rebalanced monthly: ML US Corporate & Government 1–3 Year; LB US Aggregate Bond TR; LB US Treasury Long TR; LB US Long Credit TR; LB US Corporate High Yield TR; Credit Suisse Leveraged Loan; JPM EMBI + Composite TR; JPM ELMI + Composite; ML Convertible Bonds All Qualities; LB Global Inflation Linked US TIPS TR; FTSE NAREIT All REITs TR; DJ AIG Commodity TR; S&P 500 TR; MSCI Emerging Markets TR; MSCI EAFE TR; Russell 2000 TR.

5 .“Discounts and Relative Performance,” Fundamentals, February 2009. http://researchaffiliates.com/ideas/pdf/Fundamentals_200902.pdf

Tags: Assertion, Asset Allocation, Capitalization, Cfa, Corrosive Effect, Crystal Ball, Current Market, Director Product, Emerging Market Bonds, Equity Holdings, Equity Risk Premium, Folly, Lean Years, Mean Reversion, Naughties, Product Specialist, Reits, Research Affiliates, Risk Exposures, Robert Arnott
Posted in Markets, Oil and Gas | No Comments »

China, The Countervailing Force

Monday, February 22nd, 2010

If the by-products of the western credit crisis - tight credit, stimulus and quantitative easing, zero-percent interest rates,  winning trades in risk - are elemental to the prevailing trend, then China, with its massive $586-billion spending program, its $1.35 trillion in new lending, and its (too?) rapid recovery, should be viewed as a significant balancing concern.

China is the countervailing global economic force, the antithesis of America, its cash-rich economy cantilevered against the weight of its debt-laden counterpart. Whether we believe it or not, China’s decisions do affect us, either balancing in our favour or not.

In a decade, China has amassed the bulk of it $2.4-trillion (U.S.) foreign exchange reserve, making it the lead financier of the spendthrift U.S. economy, owing to blockbuster exports growth to consumers seeking cheap manufactured goods.

In 2008, however, the credit crisis hollowed out the export sector as credit, the global shipping business, and consumption froze, and it’s growth engine seized. China’s reaction was, forcibly, to fix its exchange rate, and subsequently embark on a bold and massive $586-billion spending plan.

Read the full article here.

Pierre Daillie, (AdvisorAnalyst.com), GlobeAdvisor.com, February 21, 2010.
http://www.globeadvisor.com/advisoranalyst/aa20100221.html

Tags: Antithesis, Blockbuster, Cantilevered, China, Counterpart, Credit Crisis, Economic Force, Emerging Markets, Exchange Reserve, Export Sector, Financier, Global Shipping, Globeadvisor, Hollowed, Prevailing Trend, Rapid Recovery, Rich Economy, Shipping Business, Spendthrift, Stimulus, Tight Credit, Zero Percent
Posted in Markets, Oil and Gas | No Comments »

Last Year’s Winners Unwinding Along With Dollar Carry Trades

Friday, February 5th, 2010

The weakness in the Euro is causing a short-squeeze in the U.S. dollar funded carry trade. The short dollar trades used to fund so many speculative investment activities in 2009, are being covered, newest to oldest. Europe’s woes are forcing a more rapid-fire unwinding than was previously foreseen, and as a result we are seeing a rapid risk aversion imbalance in all of last year’s profitable trades, in commodities, commodity complex economies, such as Canada and Australia, crude, emerging markets, and financials.

“Pi Economics estimated recently that the size of the dollar carry trade may have swelled to between $250 billion and $550 billion (U.S.) in the first half of 2009. Analysts say the yen carry trade grew as large as $1 trillion between 2004 to 2007,” according to a Thomson Reuters report.

Here are a selection of clippings from various media outlets shedding light on the effects of the unwinding of dollar carry trades, unwinding debt and the reaction to sovereign debt concerns arising in the PIIGS, or all of the above.

WSJ: “The concerns are global, with sovereign debt issues in Greece, Spain and Portugal affecting investor sentiment,” said Macquarie Private Wealth associate director Marcus Droga. “That’s putting some pressure on U.S. dollar carry trades. Any deterioration in the U.S. jobs data would not be taken well tonight.”

Reuters India: “What we are seeing is dollar-carry-trade unwinding by foreign investors,” said Neeraj Dewan, director, Quantum Securities. “They borrowed when the dollar was cheap and now that the dollar is recovering, they are unwinding.”

Barron’s: “it’s all just part of the debt deflation that’s to be expected in a balance sheet recession. The carry trade unwind continues, driven by the type of mini-flight-to-quality I wrote about in our quarterly commentary.  The main beneficiary has been the U.S. dollar as many of the favored assets of the reflation trade, which was funded by borrowing in dollars, are sold and repatriated back into the greenback.  Sentiment in the dollar has gotten very bullish, very quickly… not what you typically see at major turning points.  While trends in broad stock and commodity indexes remain largely in place from early-2009 lows, many leading indicators have broken down… like a couple of the emerging markets and the Baltic Dry Index (below).”

BusinessSpectator: “The really risky plays would have been to fund the trades in US dollars and then short the greenback to exaggerate the gains – a relatively low-risk play while the US economy remained weak, official US real interest rates were effectively negative, and Asian economies were growing.

The Australian dollar was a significant beneficiary of the carry trades, because of the relatively strong state of the economy and the rebound in Asian demand for resources. The Reserve Bank’s rapid-fire rate increases last year supported the dollar and, indeed, offered (until this week’s unexpected pause) the probability of an additional layer of gain from a strengthening currency.

The problem with momentum trades – carry trades that become so popular that the weight of money creates self-fuelling trends in asset prices – is that they create bubbles and are ultimately self-reversing. When they do reverse it can be ugly, because everyone tries to exit through the same gates at the same time, exacerbating the volatility and damage.”

Barron’s: “By all indications, that rush was to unwind so-called carry trades, which consist of borrowing dollars to fund purchases of other, presumably higher-returning assets. And with U.S. interest rates near zero, the allure of the carry trade is well nigh irresistible.

That means carry traders effectively are short the dollars they borrowed to buy commodities, emerging-market stocks, junk bonds, which beckoned with higher-potential returns. When those positions start to go against the carry traders, the leverage turns painful.”

WSJ: “Investors are anxious that more negative factors may emerge. European debt concerns have strengthened the U.S. dollar and this has stoked concerns that the dollar carry trade may end soon and risk aversion may heighten further,” said Min Sang-il at E*Trade Securities in Seoul.

Tags: Associate Director, Canada, Commodities, Debt Issues, Deflation, Emerging Markets, Foreign Investors, India, Investment Activities, Investor Sentiment, Media Outlets, oil, Private Wealth, Profitable Trades, Quantum Securities, Quarterly Commentary, Rapid Fire, Reuters Report, Risk Aversion, Risk Trades, Short squeeze, Sovereign Debt, Speculative Investment, Wsj, Yen Carry Trade
Posted in Emerging Markets, India, Markets, Oil and Gas | No Comments »

Foreigners Caused America’s Financial Crisis? A Closer Look

Monday, February 1st, 2010

In his State of the Union address, President Obama reiterated his ambitious agenda to improve the economy and enact sweeping financial reform aimed specifically at the Big Banks. The European Union is also pursuing similarly ambitious changes aimed at preventing another crisis in the future.

At the World Economic Forum in Davos, Switzerland, where more than forty heads of state met, the proposals for financial regulatory reform were part of the focus of deliberation.

There is undeniably an inexorable drive on both sides of the Atlantic to find new ways to tighten bank and capital market regulations in response to an international financial crisis triggered by the bursting of a U.S. property price bubble and the resulted global domino effects.

Foreigners to Blame?

The financial crisis of 2007–2010 has been called the worst since the Great Depression of the 1930s.  Many causes have been proposed and recently, MIT economist Ricardo Caballero made a suggestion that caught the attention of TIME:

“There is no doubt that the pressure on the U.S. financial system [that led to the financial crisis] came from abroad….Foreign investors created a demand for assets that was difficult for the U.S. financial sector to produce. All they wanted were safe assets, and [their ensuing purchases] made the U.S. unsafe.”

Did foreign investment demand really “make the U.S. unsafe”? Let’s go back and take a closer look.

Close Point of Origin – Housing

Most economists and pundits seem to agree that the collapse of the U.S. real estate market in 2006 was the close point of origin of the crisis. The housing bubble bursting caused the values of securities tied to real estate pricing to plummet, thus damaging financial institutions globally.

Sophistication Beyond Comprehension

Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address the 21st century financial markets.

However, the entire financial system had become fragile as a result of one factor, among others, that is unique to this crisis - the transfer of risky assets from banks to the markets through creation of complex and opaque financial products.

In fact, these derivative products are so complex that they mystified even Alan Greenspan, the former chairman of the Federal Reserve.

Unknowing & Unwilling Participants

The banks’ strategy of unloading risk off balance sheets backfired when investors, foreign or otherwise, finally became aware of the complexity and risk underlying these asset backed securities.

A vicious cycle of asset liquidation and price declines was set in motion thereafter as these securities were brought back into the balance sheets, banks had to record losses based on the fair value accounting. Global financial integration made possible for the crisis to spread virtually worldwide.

So, how did we get here?

FSMA – Root of Crisis

The root cause of the financial crisis that led to the current recession may be traced back to the Financial Services Modernization Act of 1999 (FSMA), also know as the Gramm-Leach-Bliley Act (GLBA). The FSMA essentially repealed part of the Glass-Seagull Act of 1933 that prohibited the integration of investment bank, a commercial bank, and/or an insurance company into one entity.

The repeal fostered the consolidation of banks, securities firms and insurance companies, which ultimately lead to “too big to fail.” As a result, these institutions have bulked up their profits primarily through areas far beyond the traditional banking. Some have bought or sponsored hedge funds, while others have moved to invest their own money in the markets.

The investment banking units, far more profitable than the banking operations, have grown dramatically since the FSMA, and the related excessive risk taking along with the subsequent offloading to market played a far more significant role than others in the crisis.

Bigger & Back to Risk

After the collapse of Lehman Brothers about 18 months ago, many of these Wall Street companies were in danger of going under only to be rescued by federal bailout programs. The Trouble Asset Relief Program (TARP) practically guaranteed banks easy profit by providing capital at virtually zero interest cost.

Now, big banks are getting even bigger after scooping up smaller competitors weakened by the housing collapse. According to Bloomberg, the six biggest financial institutions now hold assets equivalent to 62% of the economy, up from 58% before the crisis and 20% in 1994.

There are also indications that some big financial institutions are going back to the same risk taking practices that got us into this crisis. The USA Today recently pointed to an independent research by the Demos highlighting that through the third quarter of last year, big banks were increasingly reliant on trading revenue and were taking on more risk in their investment portfolios.

In essence, government guarantees designed to spur lending by letting banks borrow cheaply were instead funding banks’ speculative investments and fueling soaring profits.

Their size and complexity raise the risk of a future financial crisis.

Foreigners Do Not Bring Systemic Risk

In the end, foreigners demand did not bring about the systemic risk. It is the lack of check-and-balance in our system allowing a concentration of risk into the hands of a few that almost brought the world to an utter collapse.

The drivers for enacting the Glass-Seagall Act in 1933 are the same as those for financial reform in 2010. However, a meaningful and globally consistent financial reform seems unlikely amid divided politicians and special interests fighting for short-term advantage.

Endgame and checkmate could come when unfettered financial institutions again push the economy to the brink, and there is no resources left for another bailout or rescue.

Tags: Ambitious Agenda, Credit Rating Agencies, Davos Switzerland, Deliberation, Domino Effects, Financial Institutions, Financial Sector, Foreign Investors, Great Depression, Housing Bubble, International Financial Crisis, Investment Demand, No Doubt, Obama, Point Of Origin, Regulatory Reform, Ricardo Caballero, S Real Estate, State Of The Union Address, World Economic Forum
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2010 Investment Strategies: Six Areas To Buy, 11 Areas To Sell

Monday, January 18th, 2010

This week I am really delighted to be able to give you a condensed version of Gary Shilling’s latest INSIGHT newsletter for your Outside the Box. Each month I really look forward to getting Gary’s latest thoughts on the economy and investing. Last year in his forecast issue he suggested 13 investment ideas, all of which were profitable by the end of the year. It is not unusual for Gary to give us over 75 charts and tables in his monthly letters along with his commentary, which makes his thinking unusually clear and accessible. Gary was among the first to point out the problems with the subprime market and predict the housing and credit crises. His track record in this decade has been quite good. I want to thank Gary and his associate Fred Rossi for allowing us to view this smaller version of his latest letter.

If you are interested in his letter, his web site is down being re-designed, but you can write for more information at insight@agaryshilling.com. If you want to subscribe (for $275), you can call 888-346-7444. Tell them that you read about it in Outside the Box and you will get the full 2010 forecast with price targets, but an extra issue with his 2011 forecast (of course, that one will not come out until the end of the year. Gary is good but not that good!) I trust you are enjoying your week. And enjoy this week’s Outside the Box….

John Mauldin, Editor

Outside the Box

2010 Investment Strategies: Six Areas To Buy, 11 Areas To Sell

(excerpted from the January 2010 edition of A. Gary Shilling’s INSIGHT)

Our investment strategies for 2010 follow from our forecast of continued economic weakness and deflation, as discussed earlier in this report and in previous Insights, especially our Dec. 2009 edition. We see the 2010 investment climate dominated by weak economic growth here and abroad, led by U.S. consumer retrenchment. More government fiscal stimulus and continuing Fed policy ease are likely in this setting. So is low inflation or deflation.

INVESTMENTS TO BUY

1. Buy Treasury Bonds. Long-term Insight readers know we started recommending long Treasury bonds back in 1981 when we forecast secular and huge declines in inflation and interest rates. So we declared back then that “we’re entering the bond rally of a lifetime.” The yield on 30-year Treasurys was 14.7% and our eventual target was 3%. Last year, yields blew through 3% to reach 2.6% at year’s end, so in our Jan. 2009 Insight we declared “mission accomplished” and removed Treasury bonds from our recommended list.

But then Treasurys sold off, pushing the yield on the 30-year bond to 4.7% at the end of 2009. So we’ve reactivated the strategy with our forecast of a return in yields to 3.0% or lower. Treasurys will continue to be a safe haven in a troubled world and benefit from deflation as well as their three sterling features. They are the best credits in the world. They are highly liquid. And they generally can’t be called by the Treasury, and calls limit price appreciation when interest rates fall.

A decline in yields from 4.7% at present to 3.0% may not sound like much, but the bond price would appreciate over 34%. If it occurs over two years, then two years’ worth of interest is collected, and the total return on the 30-year Treasury would be 44%. On a 30-year zero-coupon Treasury, which pays no interest but is issued at a discount, the total return would be about 64% — most attractive! Recall that in 2008 when 30-year Treasurys rallied from 4.5% to 2.7%, their total return for the year was 42%..

Treasury bonds way outperformed equities in the 1980s and 1990s in what was the longest and strongest stock bull market on record. The superiority of Treasurys has been even more so since then. Chart 1, our all-time favorite graph, shows the results from investing $100 in a 25-year zero-coupon Treasury bond at its yield high (and price low) in October 1981, and rolling it into another 25-year Treasury annually to maintain that 25year maturity. In November 2009, that $100 was worth $16,972 with a compound annual return of 20.1%. In contrast, $100 invested in the S&P 500 at its low in July 1982 was worth $2,099 in November for an 11.8% annual return including dividend reinvestment. So Treasurys outperformed stocks by 8.1 times!

Doubters

Many believe Treasury yields are headed up, not down. They think that all the bank reserves created by the Fed that have not generated bank loans will do so, flooding the economy with money and then create excess demand and inflation. They also think the continual heavy issuance of Treasurys to fund the nonstop federal deficits will push up yields. In contrast, we don’t foresee the rapid economic growth needed to induce chastened banks to lend and cautious creditworthy borrowers to borrow. And if we’re wrong, it will take at least several years to eat up global excess capacity during which the ever-inflation-wary Fed will no doubt remove the excess bank reserves, as Fed officials have already indicated.

We do expect large federal deficits for many years, in part because of pressure on government to create jobs and restrain unemployment in a slow growth economy. But those deficits will increasingly be funded by U.S. consumers as their saving spree continues. Although stock market bulls salivate over the prospect that increased saving will mean more equity purchases, we believe most of the money will continue to reduce the immense debt consumers have accumulated in recent decades.

Repaying debt will be attractive to many Americans in 2010 and beyond as they shun many investments after their huge losses in stocks throughout this decade and their shocking setbacks in real estate. A number will want to be less leveraged as slower economic growth makes employment less stable and unemployment more likely. Chastened lenders, pressed by regulators, will be pushing individuals to lower their leverage by repaying debt.

Another concern for Treasury bonds is that continued huge federal deficits and the required Treasury financing will erode confidence in these issues by Americans and foreigners, as noted earlier. This seems unlikely, especially before the end of this year. Also, as U.S. consumers save more and curb spending on domestic products and imports, the trade and current account deficits will continue to shrink. Earlier federal deficits were financed by foreigners as they recycled back to the U.S. the dollars gained from their trade and current account surpluses. The growing U.S. current account deficit measured the increasing gap between domestic saving and investment, or, in effect, and the need for foreigners to not only finance government deficits but also make up for declining U.S. consumer saving.

But now, the current account and trade deficits are shrinking, and further declines will accrue in future years if, as we forecast, exports grow faster than imports. So foreigners will have smaller American current account deficits to finance. At the same time, much more of federal deficits will be financed by rising U.S. consumer saving.

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With 3-month treasury bills yielding 0.046%, we’ve moved out on the yield curve for what is essentially cash positions in some cases. Sure, 5-year obligations are much more volatile than 3-month bills and do have risk of loss if interest rates rise. But we think the direction is down in that part of the interest rate curve, and 2.6% returns vs. 0.046% seem enough to offset the risks.

2. Buy Income-Producing Securities. This includes high-quality corporate and municipal bonds as well as stocks of utilities, consumer product companies, health care firms and others that pay meaningful dividends that are likely to rise. Master Limited Partnerships are also possibilities, but only if their underlying businesses are secure enough to continue significant income flows to limited partners and stockholders. Banks used to pay significant dividends but slashed them when their earnings collapsed. Nevertheless, their deleveraging and reversion to safer but less growth-oriented businesses will probably pressure them to again pay attractive dividends.

Utilities lagged behind the stock market last year, but at the end of November, the dividend yield on utilities averaged 4.5% compared to 2% for the S&P 500 index. That low return compares with 3%, which used to be the floor (Chart 2). Payout ratios recently have been essentially meaningless with the collapse in corporate earnings, but low, 31% in the third quarter of 2009. Under pressure from stockholders, dividend yields are likely to return to 3% or more. The current high level of corporate cash will also encourage dividend paying.. Also, the S&P utility sector has returned 53%, including dividends, since 2000 while the total return on the S&P 500 index has been a minus 11%.

With stocks likely to be weak this year, dividend yields may constitute 100% or more of total returns. Note, however, that although the prices of utility and other defensive stocks sometimes rise in bear markets associated with recessions, that’s not always the case. That was clearly true in 2008 when virtually every stock sector went down. Utility and other dividend-paying stocks and ETFs based on them, however, can be hedged against general stock market declines.

3. Buy Consumer Staples and Foods. Items like laundry detergent, bread and toothpaste are basic essentials of life that are purchased in good times and bad. In fact, as we’ve seen lately, consumers are buying more of their calories in supermarkets and they economize by eating at home rather than in restaurants. Note, however, that they are downgrading from national brands to cheaper house brands, and likely will continue to do so as a weak economy and high unemployment persist. Among retailers, the winners may continue to be discounters. Producers of national brands will need to continue to adapt to consumer downgrading by emphasizing cheaper “value” products.

4. Buy Small Luxuries. This is an investment concept we developed years ago. Consumers, especially when they’re hard pressed, tend to buy the very best of what they can afford, even if it’s within a low-priced category. We first noticed this tendency years ago, before apartheid ended in South Africa. We read that urban blacks there often carried the elegant, slim and expensive umbrellas typical of investment bankers in London. They couldn’t afford cars or maybe even taxi fares, but did achieve status and satisfaction with fine umbrellas. We also learned of a currently unemployed man who enjoyed the status of morning coffee at 7-Eleven six days a week. By reusing his cup and the one he takes home to his wife, he gets a 32-cent discount per $1.37 serving and saves $655 a year on this small luxury.

Companies are adapting to small luxury modes in various ways. Some are offering the same products with lower cost and selling prices. Coach is cutting ladies handbag prices and working with suppliers to reduce costs. Neiman Marcus is pressing suppliers for lower-cost versions of designer styles.

Others are putting their prestigious names on different products. C.F. Martin reintroduced its stripped down 1930s guitar for under $1,000. Average prices were in the $2,000 to $3,000 range and its top of the line guitar sells for $100,000. California winemakers are emphasizing cheaper wines as sales of those over $25 per bottle slump. Consumers are retrenching and dining out less at upscale restaurants where fine wines are sold. Tiffany sales of products over $50,000 are weak, but high-quality small items continue to sell well–always in its trademark blue box. Procter & Gamble has not cut prices on its top of the line products that sell at premiums but carry high-quality images. Consumers still splurge on such small luxuries as Gillette’s five-blade Fusion razor and Olay’s Pro-X moisturizer. But P&G has introduced cheaper “value” versions of Tide and other products to compete with the growing consumer interest in lower-cost national and house brands.

5. Buy The Dollar. Dumping on the dollar was the favorite sport of investors and the financial media until very recently. The financial meltdown in 2008 drove investors to the dollar as the global safe haven, but in early 2009 that status faded as fears of financial collapse melted. Buck-busters cited the record low short-term interest rates, with the fed funds target rate at 0-0.25%, even lower than in Japan. This made the greenback the preferred funding currency for the carry trade in which it is borrowed and then sold for other higher yielding currencies with rising interest rates. The falling dollar against those currencies enhances the profitability of those trades. Buck dumpers also emphasized the tremendous amount of dollars being pumped out by the Fed and the Treasury 70 in their attempt to revitalize the economy 68 and the Fed’s clearly-stated commitment to keep short-term interest rates low for an extended period.

Despite all its drawbacks, however, the dollar remains the world’s reserve currency and safe haven, regardless of suggestions by the Chinese and others that the dollar should eventually be replaced by a global currency. This status for the buck appears to be reemerging and will grow if we’re right and hopes for a rapid economic recovery are dashed. Furthermore, almost everyone was on the dump-the-dollar side of the boat, a situation similar to early in 2008 that preceded the dollar’s jump starting in mid-year (Chart 3). History suggests that when that happens, the winds often shift and all those folks will get tossed into the water as the boat sails in the reverse direction.

We favor selling British sterling since the U.K. economy remains in deep trouble, with even higher external debt than in the U.S.– a ratio to GDP of 404% in 2008 compared to 95% in this country, which has caused bond rating agencies to threaten a downgrade of U.K. government debt. Also, the troubled British financial sector accounts for 21% of total jobs compared with 14% in the U.S. The U.K. was almost alone among advanced countries in suffering a falling economy in the third quarter of last year.

The euro is vulnerable, in our view, because the eurozone has a one-size-fits-all monetary policy but its economies vary in strength from Germany and the Low Countries at the top to Portugal, Italy, Spain, Greece and Ireland at the bottom. Those lands can’t use independent monetary policies to stimulate their economies since that’s the providence of the European Central Bank. So they need to resort to fiscal stimuli and increasing government borrowing to finance the resulting deficits. A number have suffered sovereign debt rating downgrades, which increase their borrowing costs, and more are likely. This could spark renewed threats that one or more countries will withdraw from the eurozone and go back to using drachmas, draculas or whatever as their currencies. That probably won’t happen as the ECB will do all it can to prevent dissolution, but serious discussion of the likelihood could depress the euro considerably against the dollar.

These concerns are not new for us. Just as the euro was being launched 10 years ago, we wrote in our Dec. 1998 Insight that with a common currency, individual countries would be forced to rely on fiscal policy to deal with local business conditions and “the limit on fiscal stimulus will be default risks. Government bond investors and rating agencies will become the policemen and will blow the whistle…. It’s even possible that economic differentials among countries may be so great that the common currency doesn’t hold together, especially in the next European recession when unemployment leaps….”

Commodity-driven currencies like the Canadian, Australian and New Zealand dollars are also likely to weaken against the greenback as commodity prices fall. The Japanese economy remains weak and back in deflation, but the yen’s involvement I the carry trade makes it a tricky currency for investment.

6. Buy Eurodollar Futures. In most markets, traders want to be where the action is, where liquidity is the greatest even though that’s where competition is the strongest. Years ago, a jeweler in New York City complained to us about how fierce the competition was in his location. His shop was on 47th Street between Fifth and Sixth Avenues, the heart of the jewelry district. We asked why he didn’t move to a less competitive area. He shrugged and said, “This is where the action is.” In the case of short-term credit instruments used in futures trading, eurodollars are where the action is.

Our interest is in eurodollar futures contracts. Eurodollar futures are a way for companies and banks to lock in an interest rate today, for money it intends to borrow or lend in the future, and for investors to bet on the future direction of short-term interest rates. Each Eurodollar futures contract has a notional or “face value” of $1 million, though the leverage used in futures allows one contract to be traded with a margin of about $1,000. Trading in Eurodollar futures is extensive, and the market for them tends to be very liquid. The prices of Eurodollars are quite responsive to Fed policy, inflation, and economic indicators. It’s ironic that eurodollar futures markets dominate trading, not those for Treasury bills or federal funds on which eurodollars are essentially based.

Eurodollar futures prices are determined by the market’s forecast of the 3-month US$ LIBOR interest rate expected to prevail on the settlement date. Eurodollar futures contracts extend out for 40 quarters or 10 years, so they can be used to bet on interest rate movements many quarters ahead.

Long positions in eurodollar futures have been one of our most successful investments in recent years. Earlier, the futures market did not price in the full extent of the Fed-engineered decline in short-term interest rates. With our forecast of the financial crisis and the worst recession since the 1930s, however, we believed that the Fed would ease dramatically. So we reasoned that eurodollar futures prices would rise as they reflected the Fed’s action. So far, they have.

Now the futures market assumes that the Fed will raise its target rate in the course of this year, so the LIBOR rate on which eurodollar futures settle will increase by 1.22 percentage points between January and December. We, however, believe that a weak economy will keep the Fed on hold throughout this year, so the interest rate implied by the December 2010 contract will fall by 1.22 percentage points. That would result in a $3,050 profit on a $1 million futures contract. That’s a mere 0.3% gain. This is hardly worth the investment without leverage. But with only a $1,000 margin requirement on the futures contract, well, you do the math.

INVESTMENTS TO SELL OR AVOID We hope these six investment strategies for 2010 that involve buying or being long securities are useful. But given our forecast that, at best, the U.S. and global economies will be sluggish this year, it won’t be a surprise that we have a longer list of strategies that involve selling or avoiding various sectors. In fact, there are 11, or nearly twice as many. 7. Sell U.S. Stocks in General. The S&P 500 index in late December was selling at 19 times top-down Wall Street strategists’ operating earnings estimate of $60.59 per share for this year, as noted earlier. That’s an historically high P/E to start with that makes stocks vulnerable going into the year. Even more so because it assumes a steep economic recovery in 2010. And even more so if our forecast of continuing recession or sluggish recovery at best proves out. Our $50 estimate of operating earnings, down 11% from estimates for 2009, puts the S&P 500 index P/E at a nosebleed 22.5 level, as noted earlier. Selling stock indices short, either through futures contracts or ETFs, strikes us as a prudent idea. Index shorts can also hedge long positions in utilities or other long strategies we discussed earlier. Be well aware that our forecast of a declining U.S. stock market is critical to many other strategies we’ll discuss later that involve selling or avoiding equity sectors here and abroad. We believe they all will perform worse than the stock market overall, but if we’re wrong and the stock market leaps this year, we’ll probably also be wrong on many of these other strategies. 8. Sell Homebuilder and Selected Related Stocks. Homebuilder stocks rebounded sharply from their March 2009 lows, along with stocks in general, but peaked in September with a slight downward trend since then. This may be beginning to reflect our forecast of another 10% decline in house prices (Chart 4). Excess inventories of houses for sale, the mortal enemy of prices, remain huge. And inventories may rise, even with housing starts at very low levels, as people foreclosed out of their houses double up with family and friends. Also, a quarter of homeowners with mortgages are under water, 40% of those who took out mortgages in 2006. Increasing numbers of these people are convinced that they’ll never regain positive home equity and are abandoning their abodes in favor of renting other houses at lower monthly costs. Still, the subsequent foreclosures on their mortgages will keep them from qualifying for a government-guaranteed mortgage for three to five years and will stay on their credit records for seven years. Despite leaping mortgage delinquencies, federally-mandated but mostly unsuccessful mortgage modification programs are keeping many houses, especially middle- and higher-priced homes, from being foreclosed and sold–temporarily. Furthermore, the investment tax credit for new and some existing home buyers, which was extended beyond November 2009, is scheduled to expire in April. The overhang of aging new single-family homes available for sale is huge (Chart 5 ). Also note that new residential mortgages are almost entirely dependent on guarantees from government entities such as Fannie Mae, Freddie Mac and the FHA, and they are tightening their credit standards. Low mortgage rates are a plus, but are only meaningful to those who qualify for loans as lending standards tighten. Most now need to meet the old conservative standards of 20% down, good credit, full documentation of income and assets, etc. And lower borrowing rates don’t help underwater homeowners either refinance or buy other houses. Furthermore, rates on large “jumbo” mortgages remain high. Finally, lower house prices don’t induce buyers who expect the downward trend to continue and hold out for even-lower prices. 9. Sell Selected Big-Ticket Consumer Discretionary Equities–for two powerful reasons. First, as consumers persist in their saving spree they’ll continue to curtail spending on expensive postponeable items. Second, as widespread price declines persist, they will be anticipated. Prospective buyers will wait for lower prices. As a result, excess inventories and unused capacity will mount, forcing prices lower. That will confirm prospective buyers’ suspicions so they’ll wait for still-lower prices in a self-feeding downward spiral. Deflationary expectations are clearly at work in the vehicle market. The cash-for-clunkers program generated one-time sales as buyers viewed it as just one more rebate inducement in a never-ending stream. But who would dare announce to a friend that he paid the full sticker price for any car? Of course, deflationary expectations don’t work for small, inexpensive items. Suppose you know for sure that toothpaste will be cheaper next month. If you run out, you won’t brush your teeth with Ajax while waiting for lower prices before buying a tube. Even the rich, normally immune to recessions, are cutting back and downgrading. Note the weak sales at Tiffanys, Nordstrom and Saks Fifth Avenue and the poor auction results for Sotheby’s and Christie’s. A Merrill Lynch study found that the number of people in the world with $1 million or more in investable assets fell from 10.1 million in 2007 to 8.6 million in 2008. Those assets dropped from $40.7 trillion to $32.8 trillion. Their equity holdings fell in step with the S&P 500, about 40%, and their real estate also dropped in value. Ever since the data series began in 1967, the share of income of the top 20% has trended up while all other shares fell. Note that these are shares, not income levels–which have grown on balance for all quintiles. Studies have found considerable rotation in and out of the various quintiles, with many of those in the top bracket in a given year absent from it in earlier and later years. Still, the drop in purchasing power for many middle-income people in the last year in addition to the collapse in their homes’ values has created considerable anger at those at the top. The equities of most producers of big-ticket consumer discretionary goods and services collapsed in the 2007-2009 bear market, reflecting consumers’ buying strike, but have recovered somewhat since March. With our conviction that American consumers have reached a watershed and switched from a quarter century borrowing-and-spending binge to a decade or longer saving spree, we are very suspicious of the sustainability of any rebound in stocks of producers of major consumer discretionary products such as cruise lines and airlines. 10. Sell Banks and Other Financial Institutions. During the financial free-for-all days, large banks moved well beyond traditional spread lending–taking deposits and then lending them with interest rate spreads to cover their costs, loan risks and reasonable profits. They hyped their leverage–and their risk–as they set up off-balance sheet vehicles, engaged in proprietary trading and in the origination of and investment in derivatives. Regulators stood by under the theory that free markets would discipline excessive risk-taking. Both the big banks and the regulators, however, knew or should have known that those institutions were too big to fail and could take the financial system down with them. So those financial institutions were really playing a game of, heads we win, tails we get bailed out. And fail they did, and bailed out they have been. Many investors seem to believe that’s the end of the unpleasantness and now it’s back to business as usual. The recent big trading profits by some financial institutions certainly point in that direction as did the stock rebounds until recently. We doubt it, though. The financial sector expanded its leverage over about three decades and its deleveraging will probably consume most or all of the next decade. Big risk-taking CEOs like Ken Lewis at Bank of America are being forced out, sending a clear message to the senior officers who remain. Stringent, probably excessive regulation is replacing the laissez faire model. Higher capital requirements and other limits on risk-taking will curb bank profitability. So will the limits on executive pay aimed at reducing the incentive to take big risks. Weak Loan Demand Furthermore, with slow economic growth, consumer zeal to save and repay debts, and weak capital spending this year, loan demand will likely be weak. In addition, the present steep yield curve makes borrowing cheap deposits and lending long-term at higher interest rates very profitable. But it will probably flatten as the year progresses and long rates fall. Banks, of course, can increase fees on checking and other accounts, but are limited by competition from money market funds and other alternatives. Also, banks’ costs of borrowing in the bond market is well off its highs relative to Treasurys, but still elevated compared to pre-crisis years. The spread now runs over three percentage points compared to about one in pre-crisis days. Much of the cheap debt banks acquired from private markets in earlier years and the government more recently will mature in the next several years and need to be replaced at much higher costs. The maturities for U.S. banks have dropped from 7.8 to 3.2 years in the past five years. Regional and community banks are also likely to be unattractive investments this year. Ironically, in the go-go days, many of them were unwilling to virtually abandon their underwriting standards to compete with nonblank residential mortgage lenders. So they lent to the commercial real estate market instead. That’s proving to be a jump from the frying pan into the fire, as discussed earlier, and is shown by weak demand, falling prices and rising delinquencies. Regional banks have more than their share of the $1.7 trillion in outstanding commercial real estate owned by all banks. These loans constitute 35% of regional banks; total loans, up from 25% in 2000. Due to bad commercial as well as residential real estate loans, smaller banks are dropping like flies, 140 so far this year (Chart 6 ). Individually, they aren’t too big to fail, but collectively they are since they are the primary financers of smaller businesses. Those businesses don’t have access to commercial paper and other credit market vehicles and must rely on their local banks for loans–or on the personal credit cards of their owners. 11. Sell Consumer Lenders’ Stocks. Consumer lenders’ stocks have also rebounded sharply from their March 2009 lows. We were wrong on our strategy of selling them last year, but believe it will work in 2010. Consumer lenders had their hey day during the long consumer borrowing-and-spending spree. Consumers were trained–and we use that word deliberately–to believe they deserved instant material gratification. Buy now, put it on the plastic card and pay later– much later–became the norm. And creditworthiness was no problem for credit card issuers and other consumer lenders. They sliced and diced consumers’ financial statuses, used sophisticated models to determine payment risks and charged fees and interest rates to fit any risk category. But their models and analyses inherently assumed that the borrowing-and-spending binge, as well as the ability to repay, would last indefinitely. But then consumers suddenly switched to a saving spree and started to pay down credit card and other debts. Also, heavy layoffs, leaping unemployment and collapsing house prices and inadequate consumer incomes spiked credit card delinquencies. Congress last year restricted credit card fees and interest charges. Also, consumers went on a buyers strike a year ago and cut back on their use of credit, debit and charge cards. Recent developments are virtually all negative for the credit card business now and for years to come. The cottage industry to help these people deal with their huge credit card debts is exploding in size. As noted earlier, charge cards and debit cards are replacing credit cards as consumers realize they can’t trust themselves to restrain debt and need to pay off monthly or accumulate the money in a bank account before spending it. Layaway plans are replacing the buy now-pay later approach. With the switch from a quarter century consumer borrowing-and-spending binge to a long run saving spree, the credit card business has moved from a growth industry to a laggard.

12. Sell Many Low and Old Tech Capital Equipment Producers. Low and old tech producers will remain depressed in a world of chronic excess capacity. When operating rates are low, producers don’t need more capacity and worry that revenues, prices and profits won’t be adequate to justify even existing capacity. And note that the volatility of the producers of equipment is much greater than that of the users. Auto sales declined by over 47% from their peak in July 2005, but orders for machine tools, automatic transfer lines and other equipment fell much more as auto assemblers and parts makers almost froze orders. Recall as well how the recession-sired excess capacity in airlines has caused massive cancellations and postponements of orders for Boeing’s Dreamliner.

Earlier, we discussed our statistical models that explained capital spending. They show that in accounting for the year-over-year change in the equipment and software or in equipment and software plus nonresidential structures components of GDP, thelevel of operating rates is far and away the most important explanatory variable, even more so for the year-over-year change in operating rates. This indicates that even if capacity utilization is growing rapidly, if it remains at low levels as at present, the growth in capital spending will be subdued.

Other variables, such as the year-over-year changes in cash flow, profits and interest costs, were statistically significant in our models, but much less effective in explaining the change in capital spending. These findings are important because many believe that the negative gap between capital expenditures and internal funds is sure to generate a capital spending surge. But our models, based on history, say that with huge excess capacity, that cash flow won’t burn holes in corporate pockets. And our models don’t quantify and add in the extra corporate caution spawned by today’s recessionary climate and financial crises.

Besides the depressing effects of excess capacity, low and old tech companies suffer from ongoing problems. Foreign competition continues to grow as their technology is transferred to China and other cheap production locales. Some suffer rising cost pressures due to lack of productivity gains. High-cost unionized labor forces are sometimes a problem. And many sell into saturated, slow growth markets.

13. If You Plan to Sell Your House, Second Home or Investment Houses Any Time Soon, Do So Yesterday. This strategy has worked for the last two years and will continue to do so if we’re correct and house prices nationwide fall another 10%. Sure, prices have been weakest in states like Florida, Arizona, Nevada and California where the biggest bubbles preceded the collapses. But almost every area of the country has experienced price declines (Chart 7 ).

Many owners have tried to wait out the bear market in housing, a technique that worked in earlier years when any price declines were small and short-lived. But huge excess inventories, a flood of distressed sales after mortgage modification attempts are over, depressed incomes and rising unemployment will probably keep sellers plentiful, buyers reluctant and prices falling throughout 2010 and perhaps beyond. In past regional house price collapses, it’s taken homeowners a year-and-a-half to give up and throw their houses on the market for whatever they will bring. After the final bottom is reached, house prices will likely mirror inflation, or in future years, deflation as they have historically.

14. Sell Junk Bonds. During the dark days of the financial crisis, the yields on junk bonds leaped to 19.3 percentage points over Treasurys as investors worried about complete financial collapse and widespread defaults among low-grade issues. Triple-C rated bonds, the lowest junk tier, sold at 42.6 cents on the dollar at the beginning of last year.

But the bailout of the big banks and easing of the financial crisis allayed investor fears and junk spreads narrowed. Institutional investors piled in, followed by individual investors, many of whom sought alternatives to low returns on bank deposits and money market funds. So the spread has dropped to 4.6 percentage points, much closer to where it was before the crisis began. Last year, junk bonds returned over 50%, much more than the 25% gain on the S&P 500 index.

Nevertheless, we believe this rally is way overdone. Default rates on junk bonds normally peak late in recessions or in the year after it ends. Also, the default rate may reach or exceed the previous peak in 2002 if the economy remains weak, suggesting major declines in junk bond prices. Furthermore, the value of bonds after default is likely to go lower if the recession drags on, as we forecast. Slow revenue and cash flow growth will make it difficult if not impossible for a number of financially weak and weakening firms to service their bonds and other debts.

15. Sell Commercial Real Estate. As discussed earlier, excess capacity and big refinancing requirements in coming years will continue to plague hotels, malls, warehouses and office buildings. Moody’s/REAL Commercial Property Price Index was down 44% last October from its October 2007 peak. Retailers closed 8,300 stores last year, more than the previous peak of 6,900 in 2001. Businesses will continue to cut costs this year, not only by holding down employment and therefore the need for office space, but also by moving in the partitions to fit the remaining people in less space, as mentioned earlier.

Increasing use of telecommuting will also reduce need for office buildings. And more teleconferencing will cut hotel-utilizing business trips, especially after intensified airport security in reaction to the recent terrorist incident in Detroit on Christmas Day. At the same time, frugal consumers will restrain discretionary travel and the hotel and motel use involved. Weak consumer spending will keep mall and warehouse space under pressure.

Some believe that commercial real estate woes may exceed the residential collapse, and they may be right. Commercial tends to be less leveraged but if refinancing isn’t available, it may note make much difference how leveraged it is. Also, distressed commercial real estate owners definitely don’t have the political sympathy and bailout prospects enjoyed by troubled homeowners. The Fed has set high standards for bailout loans on commercial real estate. Commercial real estate REITs rebounded last year along with the overall stock market (Chart 8 ), but strike us as vulnerable. These leaps combined with plummeting real estate prices have pushed REIT prices to a 25% premium over their net asset values.

16. Sell Most Commodities. Commodity prices rebounded last year and benefited from cheap and available money. Some live in their own worlds. Petroleum is not only influenced by fundamental supply-demand conditions, but also by OPEC decisions. Natural gas prices in the U.S. weakened last year with the recession, but also because of new production technology that unlocked abundant shale gas. The prices of agriculture commodities, including honey, are highly dependent on weather.

In any event, we believe that economic supply and demand will rule most industrial commodity prices this year and result in weakness due to sluggish global business conditions. Also, investors put a record $50 billion into commodities in 2008 but then retreated last year after prices nosedived. They learned the hard way that commodities aren’t an asset class but speculations, and may be cautious this year. And the strengthening dollar should depress the prices of the many commodities traded worldwide in dollar terms. We look for falling commodity prices this year. Also, we believe that many commodity-producing companies and their suppliers of equipment and supplies will be unattractive investments as weak demand, excess capacity and soft prices persist. The same is true for economies such as Persian Gulf sheikdoms that depend heavily on petroleum, as witnessed by the financial collapse of Dubai.

17. Sell Developing Country Stocks and Bonds. As late as the end of 2007, most forecasters believed in decoupling. Even if the U.S. economy suffers a setback, they said, the rest of the world, especially developing countries like China and India, would continue to flourish. Indeed, the strength of those economies could even aid the U.S. as they bought more American exports.

We disagreed. We did a study two years ago that found that China was not yet developed sufficiently to have enough people with discretionary spending to support the economy domestically. She remained export-led, with most of those exports going directly or indirectly to U.S. consumers. So, with our forecast of a major retrenchment by U.S. consumers, we predicted big trouble for China. Our analysis revealed that in China, it takes about $5,000 per capita to have meaningful discretionary spending power. About 110 million Chinese had that much or more, but they constituted only 8% of the population. In India, that class was a mere 5% of the population. In contrast, it takes $26,000 per capita in the U.S. to have discretionary spending power and 80% of Americans have at least that much.

Well, as they say, the rest is history. The Chinese and most other developing Asian countries nosedived as U.S. consumers retrenched. But in the wake of China’s huge $585 billion stimulus program last year, massive imports of industrial materials like iron ore and copper, jumps in construction of cement, steel and power plants and other industrial capacity, and a pick up in economic growth, many forecasters again believe in decoupling.

We continue to disagree. Sure, some countries such as Brazil were not hurt too severely by the global recession, at least so far. Still, most developing economies depend on exports for growth, and the U.S. consumer has been the biggest buyer of those exports and far and away the globe’s biggest spenders. As the American consumer saving spree continues to shrink the U.S. trade and current account deficits (Chart 9), those developing economies will be subdued.

China’s economy looks like a house of cards. Her most recent fiscal stimulus not only went into industrial capacity-building but also bank lending-spawned stock market and real estate speculation. But what will utilize that capacity and justify those speculations? The usual outlet, exports, is curtailed by retrenching U.S. consumers. And, as noted, China is not far enough down the road to industrialization for local consumers to fill the gap.

We doubt that the rebounds in emerging market stocks and bonds correctly forecast robust, decoupled economic growth that is sustainable. While the S&P 500 now trades at 20 times earnings over the last 12 months, normally cheaper emerging markets are more expensive. Recently, the Shanghai Composite Index sported a 32 P/E while South Korea’s was at 35 and Indonesia’s was at 29. And note that the 65% jump in emerging market stocks in 2009 only offset two-thirds of the 54% drop in 2008.

Furthermore, as was made clear by the universal weakness in security markets in 2008, bond and stock markets around the world are highly correlated. With globalization, the days are gone when a globe-trotting sleuth can discover gems in the remote reaches of Asia or Latin America. The similarity of bond and stock performance is even greater when adjusted for risk. Emerging market stocks and bonds may climb more in bull markets, but have greater falls when the bear arrives, as we believe he is about to. There’s no such thing as free lunch.

Disclaimer

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Tags: Buy Sell, Canada, China, Commodities, Crises, Decade, Economic Growth, Economic Weakness, Economy, Emerging Markets, ETF, Fed Policy, Fiscal Stimulus, Forecast Issue, Gary Shilling, India, Insight Newsletter, Investing, Investment Climate, Investment Ideas, Investment Strategies, John Mauldin, Price Targets, Retrenchment, Subprime Market
Posted in Emerging Markets, India, Markets, Oil and Gas | No Comments »

Higher bond yields raise caution

Friday, May 29th, 2009

While investors’ attention was focused on global government bond yields marching higher, the holiday-shortened week produced a surprisingly small number of video clips.

Some quality footage was nevertheless produced, featuring the likes of David Rosenberg, now in his new role as chief economist and strategist of Gluskin Sheff, Mohamed El-Erian, Barry Ritholtz, Puru Saxena and Mario Gabelli.

And then there is “out of the box” analyst Marc Faber arguing that the US economy will enter “hyperinflation” approaching the levels in Zimbabwe. “I am 100% sure that the US will go into hyperinflation,” Faber said in an interview with Bloomberg. “The problem with government debt growing so much is that when the time comes and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

The selection kicks off with a humorous take by Emmy Award winner Hoofy and Boo on “How not to save Detroit”, and concludes with a clip featuring Twitter co-founders Biz Stone and Evan Williams explaining how they plan to attain their goal of generating revenue by the end of the year. (By the way, you can follow me on Twitter by clicking here.)

Hoofy & Boo (Minyanville): How not to save Detroit
“Chrysler is in dire straits and hoping that Fiat will save the company. Join Hoofy and Boo as they watch two turkeys combine in an ill-conceived effort to make an eagle.”

Source: Hoofy & Boo, Minyanville, May 2009.

Financial Times: GM’s future
“Spencer Jakab says once General Motors emerges from almost certain bankruptcy, it may be in surprisingly good shape.”

Source: Spencer Jakab, Financial Times, May 26, 2009.

Fox Business: End of recession? Not so fast
“David Rosenberg, chief economist at Gluskin Sheff & Associates, gives his take on the end of the market downturn.”

Source:Fox Business, May 26, 2009.

CNBC: Outlook from the Bond King - Mohamed El-Erian
“Current perspectives on the future of the economy, with Mohamed El-Erian, Pimco CEO/co-CIO.”

Source: CNBC, May 27, 2009.

Bloomberg: Wachovia’s Vitner says consumers seeing better economy
“Mark Vitner, managing director at Wachovia Corp., talks with Bloomberg’s Erik Schatzker about data showing that confidence among US consumers jumped this month to the highest level since September. The Conference Board’s sentiment index surged to 54.9, higher than forecast and the biggest gain since April 2003, the New York-based research group said today.”

Source: Bloomberg, May 26, 2009.

CNBC: Blitzer on S&P/Case-Shiller home price declines
“The data shows home prices fell at the fastest rate ever in the first quarter. Insight with David Blitzer, Standard & Poor’s managing director/chairman.”

Source: CNBC, May 26, 2009.

CNBC: Ritholtz - how far from the housing bottom?
“Searching for the housing bottom, with Barry Ritholtz, FusionIQ CEO and the Fast Money traders.”

Source: CNBC, May 26, 2009.

John Authers (Financial Times): House prices key to consumer confidence
“John Authers, FT’s investment editor, says that until US house prices recover we will not see consumer confidence return in earnest.”

Click here for the article.

Source: John Authers, Financial Times, May 26, 2009.

The Wall Street Journal: The rise of a financial stability regulator
“Just as the Great Depression led to the creation of new institutions and financial practices, the Obama administration is on track to impact financial regulations. One of the new concepts involves a financial stability regulator, David Wessel explains.”

Source: The Wall Street Journal, May 27, 2009.

The Washington Post: Geithner dismisses GOP socialism charge as “ridiculous”
“Treasury Secretary Timothy Geithner admits private investors are worried about investing in new government-backed commercial mortgage securities and dismisses as ‘ridiculous’ a recent Republican National Committee resolution stating that Democratic policies bordered on socialism.”

Source: The Washington Post, May 24, 2009.

The Wall Street Journal: Mythology of bulls and bears
‘As the bulls gain force, investors must avoid getting trampled in a stampede. Barron’s Steven Sears comments.”

Source: David Ranson, The Wall Street Journal, May 21, 2009.

CNBC: Puru Saxena - expect a mild correction
“As markets have run ahead of themselves, expect a mild correction or consolidation soon, predicts Puru Saxena, money manager and CEO, Puru Saxena Wealth Management. He tells CNBC’s Chloe Cho why this will be positive for the US dollar.”

Source: CNBC, May 27, 2009.

Bloomberg: Gabelli says stock market finding “place of equilibrium”
“Mario Gabelli, chairman and chief executive officer of Gamco Investors Inc., talks with Bloomberg’s Betty Liu about the outlook for the US economy and stocks.”

Source: Bloomberg, May 28, 2009.

CNBC: Faber - market correction will unfold
“Marc Faber, editor and publisher of The Gloom, Boom & Doom Report, says the overbought market will correct but he is uncertain about the magnitude of the correction. He speaks to Sean Callow of Westpac Bank, CNBC’s Martin Soong & Sri Jegarajah.”

Source: CNBC, May 25, 2009.

CNBC: Dr Gloom - paper money will become worthless
“Hold onto gold as paper money will become worthless in the future, warns Marc Faber, editor & publisher of The Gloom, Boom and Doom Report. CNBC’s Martin Soong & Sri Jegarajah asked Faber how he was gaining exposure to the precious metal.”

Source: CNBC, May 25, 2009.

The Street: Gold can hit $1 000
“Is a perfect storm of a weak dollar, weak markets, options expirations and physical demand going to push gold higher? Carlos Sanchez, Associate Director of Research for CPM Group offers his take at TheStreet.com.”

Source: The Street, May 28, 2009.

CNBC: OPEC secretary general - oil should be above $70
“OPEC is looking for a ‘reasonable’ oil price, which is not below $70 a barrel, OPEC secretary general Abdalla Salem El-Badri told CNBC after the organization left output unchanged Thursday.”

Source: CNBC, May 28, 2009.

MarketWatch: Twitter founders aim for revenue by year end
“Twitter co-founders Biz Stone and Evan Williams tell MarketWatch columnist Therese Poletti how they plan to attain their goal of generating revenue by the end of the year.”

Source: MarketWatch, May 27, 2009.

Tags: Barry Ritholtz, Biz Stone, Bond Yields, Chief Economist, Cnbc, David Rosenberg, Financial Times, Global Government, Gluskin Sheff, Good Shape, Government Bond, Hyperinflation, King Mohamed, Marc Faber, Mario Gabelli, Market Downturn, Mohamed El Erian, Puru Saxena, Quality Footage, Shape Source
Posted in Canadian Stocks, Emerging Markets, Gold, Markets, Oil and Gas, Outlook | No Comments »

Words from the (investment wise) for the week that was (May 18 – 24, 2009)

Sunday, May 24th, 2009

“Words from the Wise” this week comes to you a bit later than usual and in a shortened format as my “day-job” demands keep me from doing my customary commentary. However, a full dose of excerpts from interesting news items and quotes from market commentators is provided.

Stock markets kicked off the last week on a high note, but then the US parted ways with other markets as the remaining four days went downhill for American stocks. In contrast, global markets in general had only one down day on Thursday.

In addition to non-US equities, risky assets such as commodities, oil, gold, silver and platinum, and high-yielding currencies performed strongly amid fresh signs of “less bad” economic and financial conditions. However, safe-haven trades like the US dollar and government bonds got whacked, especially following Standard & Poor’s decision on Thursday to mark down its medium-term outlook for the UK’s AAA credit rating from “stable” to “negative”. This raised concerns that the US may face a similar fate.

Source: New York Post, May 23, 2009.

As the implications of surging government debt levels move to center stage, the US Debt Clock makes for sobering reading. Click here or on the image below for the live version.

Source: US Debt Clock, May 23, 2009.

David Rosenberg, Merrill Lynch’s former chief North American economist, who has just commenced duty with buy-side firm Gluskin Sheff & Associates, commented as follows: “While the UK government debt-to-GDP ratio is around 40%, the rating agencies are looking at 100% in coming years. The US government debt/GDP ratio right now is near 65%, but clearly heading higher. It seems as though 100%+ is the trigger point for downgrades …

“So the view out there that the US is about to receive a credit downgrade despite the dramatic expansion of the government balance sheet is a little premature. For now, it makes for nice cocktail conversation but as super-sized as the deficit is (13% of GDP), there is enough room in the debt ratio that the US would likely have to run three more years of this sort of fiscal policy to be seen as a candidate for a downgrade.”

The performance of the major asset classes is summarized by the chart below.

Source: StockCharts.com

Following the previous week’s bruising, the MSCI World Index last week gained 2.2% (YTD +2.3%) and the MSCI Emerging Markets Index 5.4% (YTD +31.6%).

Similarly, the major US indices reversed course, but in a much more subdued fashion, as seen from the fairly flat movements of the major indices: S&P 500 Index (+0.5%, YTD -1.8%), Dow Jones Industrial Index (+0.1%, YTD -5.7%), Nasdaq Composite Index (+0.7%, YTD +7.3%) and Russell 2000 Index (+0.4%, YTD -4.4%).

The Nasdaq remains the only major US index still in the black for the year to date, finding itself in the company of the majority of emerging and mature markets.

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

India’s BSE 30 Sensex Index (+14.1%) was the strongest market for the week, having rallied by 17.3% on Monday on unexpected election results. This was the biggest one-day gain in the 30-year history of the Index.

Elsewhere, returns ranged from top performers Sri Lanka (+12.5%), Cyprus (+12.3%), Luxembourg (+9.4%), Macedonia (+9.0%) and Nigeria (+8.8%), to Ghana (-8.9%), Malta (-1.2%), Palestine (-1.2%), Côte d’Ivoire (-1.1%) and Uganda (-1.1%), which experienced headwinds. Japan’s Nikkei 225 Average (-0,4%) put in the worst performance among the major markets. (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, Indian ETFs such as WisdomTree India Earnings (EPI) (+22.7%) and PowerShares India (PIN) (+21.6%) were going great guns. Other top-performing sectors were concentrated among commodity funds, helped by investors becoming less risk averse. Strong performers included MarketVectors TR GoldMiners (GDX) (+10.6%), United States Oil (USO) (+4.1%), and iShares Silver Trust (SLV) (+4.6%).

Conversely, safe-haven-related ETFs - US dollar and government bonds - and regional banks reacted negatively, with iShares Dow Jones US Regional Banks Index (IAT) declining by -5.3%, iShares 20+ Year Treasury Bond (TLT) by -4.8%, and PowerShares DB US Dollar Index Bullish (UUP) by -2.9%.

On the credit front, I updated my regular “Credit Crisis Watch” last week and concluded as follows:

“In summary, the past few months have seen impressive progress on the credit front, with a number of spreads having declined substantially since their ‘panic peaks’. The TED spread (down to 0.48% from 4.65% on October 10), LIBOR-OIS spread (down to 0.45%% from 3.64% on October 10) and GSE mortgage spreads have all narrowed considerably since the record highs.

“In addition, corporate bonds have seen a strong improvement, although high-yield spreads remain at elevated levels. Credit derivative indices for companies in all the major geographical regions have also shown a marked tightening since the November highs.

“Most indications are that the credit market tide has turned on the back of the massive reflation efforts orchestrated by central banks worldwide and that the credit system has started thawing. However, although the convalescence process seems to be well on track, it still has a way to go before confidence in the world’s financial system returns to more ‘normal’ levels and liquidity starts to move freely again.”

The quote du jour relates to the monetization process and belongs to Bill King (The King Report): “The dollar collapsed and inflation accelerated with Bernanke’s Treasury monetization. More monetization will yield higher inflation and a dollar debacle. The Fed, Treasury, administration and solons are being checked by the dollar and commensurate inflation … You can reference Jimmy Carter, G. William Miller, stagflation, dollar flight, the Misery Index and public revolt if you don’t believe us.”

In other news, Treasury Secretary Timothy Geithner on Wednesday testified before the Senate Banking Committee, saying that “there are important indications that our financial system is starting to heal”, and that the Treasury would soon be introducing its plan to team up with private investors to buy toxic assets from the banks. Separately, President Barack Obama on Friday signed into law a bill to put new restrictions on the credit-card industry, compelling card issuers to spell out their terms in fewer words - in plain English - and treat customers more fairly.

Next, a quick textual analysis of my week’s reading. No surprises here, with the word “banks” dominating the media. Strikingly, “dollar” is increasingly prominent as the greenback hit a five-month low.

Back to the stock market. An analysis of the moving averages of the major US indices shows the spring rally having encountered resistance at the important 200-day line and/or the early January highs. The highs of May 8 are the most immediate target to the upside, whereas the levels from where the rally commenced on March 9 should hold in order for base formations to remain in force.

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

For more about key levels and the most likely short-term direction of the S&P 500, Adam Hewison of INO.com prepared another of his popular technical analyses. Click here to access the short presentation. (The analysis was done on Wednesday with the Index at 912, but is still as relevant as it was a few days ago.)

Jeffrey Saut (Raymond James) said: “… our sense is the equity markets are forming at least a near- to intermediate-term TOP and we are cautious. As Sy Harding writes, ‘Our Seasonal Timing Strategy is now in its unfavorable season. Our non-seasonal Market Timing Strategy is now on a new sell signal. We remain on the recent buy signal for gold and remain neutral on bonds.’

“Indeed, over the past few weeks technology, retail, housing, and cyclicals have broken their relative strength uptrends that have been intact since the March lows. Whether this turns out to be just another shallow correction, or something more enduring, will likely be determined by those groups whose relative strength still remains intact. Such groups include financials, agriculture, chemicals, oil drillers, and emerging markets.”

“Speaking of stocks, with the Averages backing off from their thrust at the May highs, it’s clear (at least to me) that the market is having second thoughts about the picture,” said Richard Russell, venerable writer of the Dow Theory Letters. “My guess is that those thoughts have to do with the sliding dollar, the sinking bonds with their higher yields - and last but not least - the surging price of gold. Dollar down, bonds down, gold up, it all fits together - trouble.”

For more discussion about the direction of stock markets, also see my recent posts “Gold bullion glitters brightly“, “Video-o-rama: Wall Street slumps on economic worries” and “Credit Crisis Watch: Thawing - noteworthy progress“. (Also, Donald Coxe’s webcast has been updated for May 22 and makes for good listening. This can be accessed from the sidebar of the Investment Postcards site.)

Economy
The Ifo World Economic Climate Indicator also rose in the second quarter of 2009 for the first time since autumn 2007. According to the Survey, “The rise in the indicator was the result of more favorable expectations for the coming six months; the assessment of the current economic situation, however, worsened again, falling to a new record low.”

Economic expectations have improved in all major regions, especially in North America and Asia. But the expectations for the coming six months for Western Europe, Central and Eastern Europe, Russia and Latin America are also clearly upwards.

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

May 22
• Road map for the near-term performance of the economy

May 21
• Index of Leading Indicators signals improving economic conditions
• Auto industry events will continue to distort jobless claims data

May 19
• Plunge in multi-family starts conceals small gain of single-family units

May 18
• Homebuilders Survey records improvement; will new home sales follow?
• Discount window borrowing continues to trend down

The chart below shows the Conference Board’s Leading Economic Indicator, which rose 1% month over month and is comparable to the increases seen at the end of the last recession.

Source: US Global Investors - Weekly Investor Alert, May 22, 2009.

According to Moody’s Economy.com, the minutes from the Federal Open Market Committee’s meeting late in April indicate that participants were more optimistic about the economy than they had been at their previous meeting in mid-March. While the economy remained in recession, there were numerous signs that the pace of contraction was slowing down.

“FOMC members agreed that the steps the committee had previously taken appeared to be providing an economic stimulus and that the Federal Reserve should continue with its previously announced policy actions, in particular ‘quantitative easing’, an expansion of the Fed’s balance sheet through the purchase of longer-term Treasuries, designed to bring down long-term interest rates,” said Moody’s Economy.com.

Gallup’s latest Consumer Mood poll, dealing with economic and market implications, shows that only 6% of Americans have a “positive” mood on the economy, but that the percentage of those that are ”negative” has dropped significantly since early March when the stock market advance started. Also, Americans whose mood is described as “mixed” have increased from the mid-teens to 36% as the negativity has subsided.

Source: Gallup Daily: Consumer Mood, May 22, 2009.

“This ‘mixed’ mood goes along with the ‘green shoots’ theory that some things are getting better and most things have stopped getting worse,” said Bespoke. “With Americans moving from ‘negative’ to ‘mixed’ before turning ‘positive’, does this imply that we’ll have a U-shaped recovery instead of a V?”

The last quote comes from Nouriel Roubini, via a Facebook status update: “The Green Shooters are starting to sweat and getting cold feet as evidence of pestilent yellow weeds is mushrooming.”

Week’s economic reports

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

Source: Yahoo Finance, May 22, 2009.

The US economic highlights for the week include the following:

Source: Northern Trust.

Click here for a summary of Wachovia’s weekly economic and financial commentary.

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, May 22, 2009.

Louis Pasteur said: “Chance favors the prepared mind.” Hopefully the “Words from the Wise” reviews will assist Investment Postcards readers with the ongoing preparation that is required to manage your money wisely.

I hope you’re enjoying a great Memorial Day holiday weekend.

That’s the way it looks from Cape Town.

Source: Daryl Cagle, Slate.

CNBC: PIMCO’s El-Erian on this week’s selloff “Mohamed El-Erian, CEO and co-CIO of PIMCO, discusses this week’s market selloff and the possibility of the US losing its AAA credit rating.”

Source: CNBC, May 22, 2009.

The New York Times: Banks raised billions, Geithner says “The country’s biggest banks have made moves to bolster their balance sheets by about $56 billion since the government disclosed the results of its financial ’stress tests’ two weeks ago, Treasury Secretary Timothy Geithner said Wednesday.

“Testifying before the Senate Banking Committee, Mr. Geithner said that the financial system had begun to ‘heal’, and that the Treasury would soon be introducing the next phase of its financial rescue effort - the plan to team up with private investors to buy billions of dollars in toxic assets from banks.

“‘There are important indications that our financial system is starting to heal,’ Mr. Geithner told lawmakers, though he cautioned that it was still too early to talk about an ‘exit strategy’ for the government.

“But lawmakers in both parties complained that the $700 billion aid plan, known as the Troubled Asset Relief Program, or TARP, had yet to revive bank lending in many parts of the country.

“‘The frustration level is mounting on an hourly basis,’ said Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the banking committee.

“Senator Richard C. Shelby, Republican of Alabama who voted against the entire program last year, said the Treasury had ‘treated many sick banks’ but ‘certainly has not cured them’.

“In describing the banking system, Mr. Geithner, said that the country’s largest financial institutions had raised billions by issuing common stock and new debt, including $8 billion in bonds not guaranteed by the government.”

Source: Jack Healy and Edmund Andrews, The New York Times, May 20, 2009.

Financial Times: Smaller US banks need additional $24 billion “Small and medium-sized US banks must raise some $24 billion to meet the capital standards set by the government in its stress tests of large institutions, research for the Financial Times shows.

“News of the potential capital shortfall could increase pressure on many of the 7,900 US banks that form the backbone of the US financial system.

“As many as 500 more banks could close, according to investment bank Sandler O’Neill, which carried out the research.

“Since this month’s release of the tests for the 19 largest banks, regulators and investors have increased their focus on the next tier of lenders, amid concerns some of them might struggle to survive if the economy worsens.

“The government’s stress-case would result in capital shortfalls for 38% of the 200 banks below the 19 largest financial institutions, leading to a deficit of around $16.2 billion in common equity, according to Sandler O’Neill.

“Applying similar criteria to the remaining 7,700 banks in the US would result in a further $7.8 billion capital deficit.

“The banks have to repay a combined $27 billion in aid from the Troubled Asset Relief Programme (Tarp) but they could do that from internal resources rather than raising more funds.

“The US Treasury has said that it does not intend to extend the stress tests beyond the 19 top institutions it examined. But analysts say that the public release of the government’s test methodology and capital adequacy philosophy means that the tests’ standards will become a model for the rest of the US banking system.”

Source: Saskia Scholtes, Julie MacIntosh and Francesco Guerrera, Financial Times, May 17, 2009.

Financial Times: US banks scramble to repay bail-out cash “US banks are scrambling to be in the first wave of lenders to repay Washington bail-out funds after the authorities told Wall Street executives they would allow five or six big financial groups to return taxpayers’ money before the rest of the industry.

“Bankers said they expected the Treasury and Federal Reserve - which doled out billions of dollars from the $700 billion troubled assets relief programme to lenders last year - to name the first repayers in the next few weeks.

“The authorities decided to allow a group of banks to return the funds, rather than approving individual applications, to avoid a ‘rush for the exit’ by lenders vying for bragging rights of being the first to repay, said people close to the matter.

“The timing of the repayment and the number and identity of the banks in the first wave is still under discussion.

“Goldman Sachs, JPMorgan Chase and American Express, which were found not to need additional equity in the recent stress tests, are almost certain to be in the first grouping.”

Source: Francesco Guerrera and Krishna Guha, Financial Times, May 18, 2009.

Bloomberg: Geithner says Treasury may move “quickly” to sell TARP warrants “Treasury Secretary Timothy Geithner said he’s inclined to ‘quickly’ sell warrants the government got when injecting capital into banks, offering prospects of a speedy exit to lenders seeking to retire government stakes.

“‘In general, our objective will be to sell these warrants as quickly as we can,’ Geithner told the Senate Banking Committee today. ‘What I’m reluctant to do is have the government be in a position where we hold these investments for a long period of time, longer than is desirable, in the hopes that we’re going to maximize value.’

“The Treasury received warrants with nearly every capital injection it made with its $700 billion bank-rescue fund, called the Troubled Asset Relief Program. As big banks begin to pay back the assistance years earlier than expected, the Treasury may use market bidding to break a logjam over how to value a key component of the government’s equity stakes.

“The total value of the government’s bank warrants is roughly $5 billion, according to Treasury calculations.

“If the Treasury can’t agree with banks about the value of the warrants, the government may try to sell them at auctions, a Treasury official said in an interview this week. That’s because investor offers may be the only way to put a clear value on warrants that can vary widely depending on the model used.”

Source: Rebecca Christie, Bloomberg, May 20, 2009.

Financial Times: US poised for finance regulation shake-up “Congress will next month start the biggest regulatory overhaul of the US financial system in decades, bringing into the open a frantic lobbying effort between banks, regulators and policymakers on what it contains and who pays for it.

“The House financial services committee, chaired by Democrat Barney Frank, will hold hearings early in June into reforms outlined by Timothy Geithner, Treasury secretary, say people familiar with the timetable.

“But the complexity, coupled with a crowded legislative agenda, means one key pillar - a resolution authority allowing a regulator to seize a failing bank holding company - is not likely to be put in place until year-end.

“The cost of the resolution authority and a proposed systemic risk regulator could be borne by both large banks and small, according to people involved, in spite of the entreaties from the hundreds of small US institutions that they should not pay a levy.

“Cam Fine, chief executive of the Independent Community Bankers of America, said the authority ’should be totally funded by those institutions that are regarded as systemically important or too big to fail’. He said he ‘felt pretty good about where we stand’ and was confident of Mr Geithner’s support.

“Other smaller institutions such as hedge funds are also expressing concern that they will suffer from severe ‘haircuts on contracts’ entered into as counterparties with the seized institution, according to one lobbyist.

“Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, has been lobbying for early introduction of seizure powers that could be used to take over a large systemically important bank if it was severely weakened by another sudden downturn in the economy.

“Mr Geithner has said new powers would allow for an orderly winding up of a systemically important institution, avoiding a repeat of the messy fall-out from Lehman Brothers’ collapse last year or the expensive bail-out of AIG, the insurer.”

Source: Tom Braithwaite, Sarah O’Connor and Krishna Guha, Financial Times, May 17, 2009.

The New York Times: Senate passes bill to restrict credit card practices “The Senate voted overwhelmingly on Tuesday to put new restrictions on the credit card industry, passing a bill whose backers say will make card-issuers spell out their terms in fewer words, using plain English, and treat customers more fairly.

“The 90-to-5 vote, following a 357-to-70 vote in the House on April 30, made it likely that President Obama will have a measure on his desk before the Memorial Day recess. The differences between the House and Senate versions will have to be worked out, but given the political atmosphere it seems likely that the House-Senate negotiations will move quickly.

“The industry has asserted that the legislation may backfire, forcing banks to issue fewer credit cards at greater cost to the current cardholders and making credit harder to get at a time when many Americans need it.”

Source: David Stout, The New York Times, May 19, 2009.

Financial Times: UK looks towards sale of bank stakes “Britain has begun taking soundings with sovereign wealth funds and other investors about selling stakes in its part-nationalised banks as it seeks to tap into a revival of stock market confidence in the financial sector.

“UK Financial Investments, which manages the government’s 43.5% stake in Lloyds Banking Group and 70% stake in Royal Bank of Scotland, could start the process of selling tranches in both banks within a year, according to people briefed on the organisation’s plans.

“Lloyds on Monday launched an open offer to replace £4 billion of preference shares held by the government with new ordinary shares. The move followed the weekend announcement of the planned departure of Sir Victor Blank as Lloyds chairman amid investor unrest over his role in the bank’s much-criticised takeover of HBOS last year.

“UKFI has already had substantial contact with potential investors, including UK institutions and foreign organisations such as sovereign wealth funds, to gauge their interest.

“‘A lot of people around the world think once you get through the losses the earnings power of these banks will be formidable,’ said one person familiar with the situation.

“The organisation is likely to exit its stakes in tranches over a period of time although ‘these might be quite large dribs and drabs’, according to people close to the matter.”

Source: Jane Croft and Patrick Jenkins, Financial Times, May 18, 2009.

BCA Research: Euro area banks - stressful situation “The euro area’s attempt to stress-test the banking system is likely to prove fruitless.

“The Committee of European Banking Supervisors has designed a set of scenarios, which are currently being used by national regulators and central banks to evaluate the euro area banking system. However, the stress tests will not conclude until September, the assumptions used and the results will remain a secret, and the focus will not be on individual banks but rather the system as a whole.

“It is hard to argue that this process will help provide clarity regarding bank balance sheets or ease investor concerns over the potential for enormous losses. Up to the end of last year, European banks (excluding the UK) had only accounted for $224 billion in bad loans. The IMF estimates that another $875 billion will need to be written down by the end of 2010, compared with another $550 billion in the US banking system. Losses for the next two years are enough to wipe out all of the European banking system’s tangible capital, before considering earnings over the period.

“The IMF results are roughly consistent with our own calculations for the top 20 banks. It would take just over 2% in writedowns of assets to eliminate all tangible equity (US banks have roughly 3%). It is possible that banks’ access to private capital will improve and, together with future operating earnings, further asset writedowns will be easily absorbed. Still, the stress tests as currently envisioned will do little to bring clarity to the situation or restore investor trust.

“One positive development is that the German Cabinet has agreed to a ‘bad bank’ scheme to remove toxic assets from bank balance sheets. The proposal still needs parliamentary approval but would be helpful, at least for the German financial sector.”

Source: BCA Research, May 19, 2009.

The New York Times: GM draws another $4 billion from Treasury “General Motors, facing the almost certain prospect of a bankruptcy filing, said Friday that it had drawn another $4 billion from the Treasury Department, raising its total from the government to $19.4 billion.

“GM originally said that it would need an additional $2.6 billion from the government to operate through June 1, but added $1.4 billion to that amount.

“The company, in a regulatory filing, also increased - to $7.6 billion - the amount it said it would need from the Treasury after June 1, the deadline set by the Obama administration for a restructuring plan.

“GM gave the Treasury a note for $266.8 million as security against the additional money that it borrowed on Friday. The financing does not appear to be the last that GM will draw, according to the filing with the Securities and Exchange Commission.

“It says that by June 1, it expects to have borrowed a total of $21.4 billion from the Treasury. In its original request to Congress last fall, GM asked for $18 billion in loans to keep it afloat while it restructured. With its latest injection from Treasury, it has surpassed that request.

“Lawyers for GM and the government are preparing documents for a GM bankruptcy filing, which is expected to come around June 1.

“People briefed on GM’s finances said the automaker would require debtor-in-possession financing during its reorganization of $40 billion to $70 billion.

“If GM drew the full $70 billion while in bankruptcy, the government would have provided the company with more than $90 billion in total, including the money it has drawn to date.

“Also on Friday, the Canadian Auto Workers union said that it had reached a second cost-cutting agreement with General Motors of Canada, even as bondholders for the parent company stood firm in their decision to reject an offer to convert their debt into GM stock.

“The automaker has offered its bondholders 225 shares for each $1,000 worth of debt, which over all would give them a 10% stake in the company.

“The company has said that it needs 90% approval from its bondholders by Tuesday if it is to avoid a bankruptcy filing. But the committee of GM’s biggest bondholders, which represent 20% of the overall debt, said there was no support for the current offer. Bondholders have said that competing creditors, like the UAW, have received better treatment.”

Source: Bill Vlasic and Ian Austen, The New York Times, May 22, 2009.

ClipSyndicate: In-depth look at GM bankruptcy looming “Interview and discussion with White House Economic Adviser, Austan Goolsbee. He talks about President Obama’s plans for GM’s restructuring, the resignation of AIG CEO Edward Liddy and the impact of the credit-card bill that the President will sign this afternoon [Friday].”

Source: ClipSyndicate, May 22, 2009.

Financial Times: Declining Libor “As a barometer of the financial crisis, it’s been hard to beat Libor, the London interbank offered rate for borrowing short-term funds in the banking system.

“On Wednesday, dollar Libor for the benchmark three-month sector set at 0.71625 per cent, extending its run of declines for 36 straight days. A comparison of Libor with the Fed funds rate shows that the gap between these two rates is at its lowest level since February 2008. Traders forecast further improvement on Thursday. The mood is a world away from the stressful peaks of Bear Stearns’ rescue last March and the failure of Lehman Brothers in September when Libor took a rocket ship to the moon.

“Further evidence that the banking system is stabilising is seen by activity in financial commercial paper. Lending for three months is back above that of the one-month sector for the first time since late January when the Federal Reserve’s support temporarily boosted 90-day paper. Quantitative easing and the smooth completion of the stress tests for banks has eased tension. That has helped nurture the recovery in risky assets.

“For the banking system, however, there are still signs of dislocation. Swap spreads, the difference between government bond yields and money market rates and a measure of bank credit quality, remain some way from looking normal. Liquidity also remains questionable as banks seek stronger balance sheets and raise capital to pay back government support.

“The steady declines in three-month Libor have also reduced the Ted spread, which compares the bank lending rate with that of three-month Treasury bills. After surging to record levels, the much lower Ted spread is another good sign. But with bills only yielding 0.18 per cent, it’s clear there remains an aversion to lending money at the much higher unsecured rate of three-month Libor.”

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

Ifo: Ifo World Economic Climate brightens “The Ifo World Economic Climate Indicator rose in the second quarter of 2009 for the first time since autumn 2007. The rise in the indicator was the result of more favourable expectations for the coming six months; the assessment of the current economic situation, however, worsened again, falling to a new record low.

“The economic expectations improved in all major regions, especially in North America and Asia. But also in Western Europe, Central and Eastern Europe, Russia and Latin America the expectations for the coming six months have been clearly corrected upwards. In contrast, the current economic situation in all major regions is still assessed as markedly unfavourable, with the worst appraisals coming from North America and Western Europe.”

Source: Ifo, May 19, 2009.

Nouriel Roubini (Forbes): Don’t believe the optimists “Recent data suggest that the rate of economic contraction in the global economy is slowing down, and that we are closer than we were six months ago to the trough of the recent severe global recession.

“But while the rate of economic contraction is now lower than the free-fall and near-depression experienced by many economies in the fourth quarter of 2008 and the first of 2009, the recent optimism that ‘green shoots’ of recovery will lead to the recession to bottom out by the middle of this year - and that recovery to potential growth will rapidly occur in 2010 - appears grossly misplaced, for three noteworthy reasons.

“First, the current deep and protracted U-shaped recession in the US and other advanced economies will continue through all of 2009, rather than reach a trough in the middle of this year as expected by the optimists.

“Second, rather than a rapid V-shaped recovery, growth will remain sluggish and sub-par for at least two years into all of 2010 and 2011. A couple of quarters of more rapid growth cannot be ruled out as we get out of this recession toward the end of the year or early next year as firms rebuild inventories and the effects of the monetary and fiscal stimulus reach a delayed peak. But structural weaknesses of the US and the global economy will cause both a below-trend growth and even the risk of a reduction of potential growth itself.

“Third, we cannot rule out a double-dip W-shaped recession, with the wings of a tentative recovery of growth in 2010 at risk of being clipped toward the end of that year or in 2011. This will result from a perfect storm of rising oil prices, rising taxes and rising nominal and real interest rates on the public debt of many advanced economies, as concerns rise about medium-term fiscal sustainability and the risk that monetization of fiscal deficits will lead to inflationary pressures after two years of deflationary pressures.”

Click here for the full article.

Source: Nouriel Roubini, Forbes, May 21, 2009.

Casey’s Charts: Recession hits the Treasury “The magnitude of the recession was underscored by the latest numbers from the US Treasury: last month’s individual income tax receipts dropped 44% and corporate tax revenue plunged 65% compared to April 2008. Alarming news, as April is historically the biggest collection month of the year and usually results in a sizable budget surplus for the month.

“As Casey Research Chief Economist Bud Conrad correctly predicted back in January, the initial $1.2 trillion deficit for 2009 was grossly underestimated. The Congressional Budget Office estimate is not only riddled with low-ball expenditure figures and accounting trickery, it also failed to anticipate a precipitous collapse in tax revenues.”

Source: Casey’s Charts, May 19, 2009.

Asha Bangalore (Northern Trust): Index of Leading Indicators signals improving economic conditions “The Conference Board’s Index of Leading Economic Indicators (LEI) moved up 1.0% after a string of monthly declines between October 2008 and March 2009. The increase of the index in April reflects a widespread improvement as seen in the 70% diffusion index for April.

“On a year-to-year basis, the LEI fell 3.0% in April, after a 4.0% drop in the November-December months of 2008. The year-to-year change in LEI on a quarterly basis dropped 3.6% in the second quarter (based on April data). It is the second consecutive decline which is smaller than the 3.9% drop of the fourth quarter of 2008.

“The chart below illustrates that the year-to-year change in LEI bottoms out well ahead of the end of a recession. The table lists the details related to this observation. Based on the history of the LEI, the 3.9% drop in the fourth quarter could be the bottom for the current cycle; we will need additional monthly data to confirm this assessment.

“At the present time, we can temporarily conclude that the worst of the decline in economic activity is part of history. The number of quarters, deduced from the history of the LEI, before recovery commences after the year-to-year change of the LEI has recorded a bottom for the cycle varies between one and four quarters.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 21, 2009.

Asha Bangalore (Northern Trust): Auto industry events will continue to distort jobless claims data “Initial jobless claims fell 12,000 to 631,000 during the week ended May 16. The prior week’s reading of initial jobless claims was raised to 643,000 from the earlier estimate of 631,000.

“The large movements of initial jobless claims in the past two weeks from 605,000 in the week ended May 2 is largely due to auto industry events. The four-week moving average of initial jobless claims is 628,500 and it appears to have peaked in the first week of April at 658,750. The Chrysler and GM plant shutdowns and reopening in the next few months are most likely to distort jobless claims data.

“The tentative conclusion is that initial jobless claims are trending down, albeit holding at a high level.

“The 1990-91 and 2001 recessions were both jobless recoveries with jobless claims posting significant declines only well after the recovery was underway. There is a strong likelihood the current recession may also be followed by a jobless recovery. We will need to see significant and consecutive weekly declines in jobless claims to declare that the worst is behind us.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 21, 2009.

Asha Bangalore (Northern Trust): Homebuilders survey records improvement, will new home sales follow? “The Housing Market Index (HMI) of the National Association of Home Builders rose to 16 in May from 14 in April. The HMI has advanced in three out of the four months ended May. Sales of new single-family homes rose 8.2% in February and edged down 0.6% in March. The sales tally for new single-family homes during April will be published on May 28. There is a strong positive correlation with the HMI and actual sales of new homes.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 18, 2009.

Asha Bangalore (Northern Trust): Plunge in multi-family starts conceals small gain of single-family units “Housing starts fell 12.8% to an annual rate of 458,000, a new record low. Total housing starts have fallen 80% from the peak in January 2006.

“In April, multi-family starts plunged 46.1% and single-family starts advanced 2.8%. Single-family starts held steady in February and rose 0.3% in March. Starts of new single-family homes have declined each month during July 2007-January 2009, with the exception of a small increase in May 2008. The recent movements suggest that single-family starts appear to be establishing a bottom.

“At the same time, the elevated level of unsold new single-family homes (10.7-month supply in March, down from peak of 12.5-month supply in January) is a drag on new construction. The good news is that inventories of new unsold single-family homes appear to have peaked in January 2009.

“Pulling together the different pieces of news from the housing market, the housing starts report for April leans on the side of optimism because the pace of decline could have accelerated further. Instead, it appears that there is a moderating trend in place with support from other reports. The key to a complete recovery is, of course, a turnaround in employment conditions.”

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

Bespoke: Country returns “With global equity markets still in rally mode, below we highlight the year to date performance of the major indices for 83 countries around the world. After nearly every country was down earlier in the year, 62 out of the 83 are now up in 2009.

“Peru is up the most at 72.92%, while Costa Rica is down the most at -39.94%. And the BRIC (Brazil, Russia, India, China) countries are significantly outperforming the developed G-7 countries. Russia, India, and China rank 2nd, 3rd, and 4th in terms of year to date performance, and Brazil isn’t far behind in 10th place.

“Canada has been the best performing G-7 country with a gain of 12.62% in 2009, but it ranks 35th out of 83. The rest of the G-7 countries are bunched up in the 0%-5% range, which is closer to the bottom of the list than the top. And the US is the worst of the seven with gains of less than 1%. While the markets here in the US have rallied nicely off of their March lows, most other countries have bounced back even more 2009.”

Source: Bespoke, May 19, 2009.

Bespoke: Recent performance of key ETFs “For those interested in a quick snapshot of how various ETFs across all asset classes have performed recently, below we highlight their 1-day, 5-day, and 1-month performance. As far as equities go, there was lots of red today [Thursday], but there’s still lots of green over the last month.”

Source: Bespoke, May 21, 2009.

Bespoke: Strategists keep 2009 S&P 500 price target at 949 “The Wall Street strategists that Bloomberg polls each week haven’t changed their year-end S&P 500 price targets since mid-March. But by doing nothing, they’re collective price target has gotten much closer to the actual level of the index since the market has rallied so much.

“At the start of the year, strategists as a whole were looking for a year-end S&P 500 price of 1,049, which would have meant a gain of 16.2% for the year. When the market was down more than 20% in early March, this bullish price target was pretty bad. As the market fell, strategists cut their year-end target, which is now 100 points lower at 949. But as the market has risen, they haven’t increased their expectations yet, so they are now just looking for another 4.19% gain through the end of the year.

“UBS and JP Morgan remain the most bullish of the bunch with a target of 1,100. And four strategists have price targets below the current level of the S&P 500, with Barclays the most bearish at 757. At the start of the year, Barclays was looking for 874.”

Source: Bespoke, May 19, 2009.

Jeffrey Saut (Raymond James): A stoopers’ market ” … our sense is the equity markets are forming at least a near- to intermediate-term TOP and we are cautious. As Sy Harding writes, ‘Our Seasonal Timing Strategy is now in its unfavorable season. Our non-seasonal Market Timing Strategy is now on a new sell signal (as of the close on May 13). We remain on the recent buy signal for gold; and, remain neutral on bonds.’

“Indeed, over the past few weeks technology, retail, housing, and cyclicals have broken their relative strength uptrends that have been intact since the March lows. Whether this turns out to be just another shallow correction, or something more enduring, will likely be determined by those groups whose relative strength still remains intact. Such groups include financials, agriculture, chemicals, oil drillers, and emerging markets.

“We continue to favor emerging/frontier markets and as ISI’s Francois Trahan notes, ‘If you are bullish on US equities, global stock markets have become more correlated over the past decade. And, generally when the S&P 500 has risen it has underperformed the global equity complex.’ Obviously, we agree …”

Source: Jeffrey Saut, Raymond James, May 21, 2008.

David Fuller (Fullermoney): Substantiating bullish bias for equities “I have described conditions as being more bullish than bearish for a number of months. However such claims need to be substantiated by technical (market) evidence, which is best monitored every day.

“I will review the process, discussed at length in Fullermoney, in what can be a template for subscribers, not only for today’s environment but also the transition from every other bear to bull market in future:

“Climactic capitulation - Bear markets usually end in climactic fashion, which is the phase of greatest capitulation and despondency. This is what happened late last October and also in November.

“Base building - The most persistent capitulation stage marks the beginning of the end for the bear market, which by definition, must also be the beginning of the new bull market, although all one may see for some months will be ranging, including some new lows by indices for less fundamentally attractive markets, but also rising lows by indices for the next bull market’s leaders.

“Reversion to the mean - If the bear really is ending or over, you will see the evidence accumulate in several ways, which are different from the redistribution bear market rallies which occur on the way down. Mean reversion (we use the 200-day moving average to measure this because it is a widely followed medium to somewhat longer-term trend smoothing device) will become evident due to a combination of different developments.

“Uptrends are established - Indices will be breaking up out of their ranging bases, with the best performers establishing step sequence uptrends, one above the other. These will eventually break above the 200-day MAs, which will eventually turn upwards sometime later. The rising MA becomes a potential support level during minor mean reversions throughout the duration of the new uptrend.

“Summary - Perspective is gained by monitoring many indices, as there will inevitably be leaders and laggards. This is Fullermoney’s commonality approach. For instance, if stock market indices are mostly ranging but downward breaks are no longer being maintained, in contrast to some rallies which are being extended, one does not need to be a genius to deduce that demand (buying pressure) is beginning to exceed supply (selling pressure).

“The performance of upside leaders when looking for evidence of market bottoms and recovery potential is much more important than focussing on laggards, because we are looking for a transition from bear, which includes all stock market indices in its latter stages, to bull in which case markets will break away from the prior downtrend one by one over time.”

Source: David Fuller, Fullermoney, May 18, 2009.

SmartMoney: Why Jeremy Grantham changed his mind “If people had paid attention to veteran investor Jeremy Grantham over the past two years, their investment portfolios would be looking much better than they likely are. While many investors were caught up in bull-market euphoria in 2007, Grantham, who oversees $85 billion for Boston-based institutional money-management firm GMO, told anyone who would listen there was a global bubble: ‘It’s everywhere, in everything’. Then, in early March of this year, when the market looked its worst, he wrote that people needed to get over their fears and invest, because US stocks were cheap and foreign stocks even cheaper.”

Click here for the full article.

Source: Russell Pearlman and Jonathan Dahl, SmartMoney, May 21, 2009.

John Hussman (Hussman Funds): Stock market advance - “leadership by losers” “As of last week, the market climate for stocks remained characterized by mixed valuations - modestly overvalued on the basis of most fundamental measures except those that assume a sustained return to the record profit margins of 2007, and slightly undervalued if one assumes that a return to those profit margins is a given.

“Market action was also mixed - volume continues to show fairly tepid sponsorship relative to durable market advances. Meanwhile, price action has been very favorable on the basis of breadth, but with the strongest leadership from industry groups with the least favorable balance sheets and financial stability. It is not typical for the industries that suffer worst in a bear market to be the ones that lead the subsequent bull market. That sort of ‘leadership by losers’ however, is very characteristic of bear market rallies.

“That’s not to say that we can immediately conclude that stocks are in a bear market advance as opposed to a new bull market, but as usual, we don’t spend much of our energy making assumptions about things that aren’t observable. At present, the observable evidence is that stocks are priced to deliver modestly sub-par long-term returns, but still in the range of about 8% annually over the coming decade …”

Source: John Hussman, Hussman Funds, May 18, 2009.

Richard Russell (Dow Theory Letters): Characteristics of secondary reactions “The most difficult and puzzling study of the stock market is that which deals with secondary reactions against the primary trend. Because we’re in a bear market, I’m going to limit the following discussion to (upward) reactions in bear markets.

“Over the weekend I pulled out my volume of Robert Rhea’s ‘The Dow Theory’. I went over some of Rhea’s comments on secondary reaction in bear market.

“‘For the purpose of this discussion, a secondary reaction is considered to be an important advance in a bear market, usually lasting three weeks to as many months, during which interval the price movement generally retraces from 33% to 66% of the primary price change since the last preceding secondary reaction.

“‘Those who try to place exact limits on secondary reactions are doomed to failure, just as surely as would be the weather man who forecasted a snowfall of exactly three and one half inches within a specified time.

“‘In a bear market steady liquidation of securities by those who prefer or need cash reduces quotations day after day, with professionals, realizing there is more room on the bottom than on the top, hastening the decline with short sales. Eventually, the market is forced to a lower level than is warranted by conditions. The short interest is perhaps too extended, with wise traders sensing the fact the liquidation has, for the time, at least, run its course.

“‘Quiet, weak spots in bear markets are generally good ones to short, as they generally develop into serious declines.

“‘In a primary bear market the rallies are apt to be violent and erratic, and always occupy less time than the decline, which they partially recovery. Often the primary movement of several weeks is retracted in a few days.

“‘Rallies in a bear market are sharp, but experienced traders wisely put out their shorts again when the market becomes dull after a recovery.

“‘In bear markets, primary movement has an average duration of 95.6 days, whereas the secondary movement averages 66.5 days or 69.6% of the time consumed in the preceding primary movements.’

“All the above pertains to the price action during rallies in bear markets. But what about business conditions during bear market rallies? My studies show that bear market rallies are technical phenomenons which do not necessarily reflect on business. I’m looking at a chart of the great 1929 to 1930 rally which occurred after the 1929 crash. The Federal Reserve Index turned down in late-1929, and despite the great bear market rally, the Fed Index continued lower into early 1932.”

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

Bloomberg: Birinyi says S&P 500 may reach 1,700 within three years “Laszlo Birinyi, president of research and money-management firm Birinyi Associates Inc., talks with Bloomberg’s Matt Miller about the outlook for US stocks. Birinyi also discusses his investment strategy and the outlook for the US economy.”

Source: Bloomberg, May 20, 2009.

Barry Ritholtz (The Big Picture): Normalizing earnings during profit freefalls “I am becoming terribly enamored of the charts Ron Griess highlights each week form The Chart Store. Now that earnings season is all but over, Ron looks at a few charts that are revealing of the extent of the damage done to corporate profitability. It is, in a word, breathtaking.”

How cheap are stocks?

How much have profits fallen?

Source: Barry Ritholtz, The Big Picture, May 18, 2009.

Randall Forsyth (Barron’s): Gain from the greenback’s pain “The dollar continues to be yin to the stock market’s yang.

“As the perception that the worst of the economic and financial crisis has passed bolsters equities, the greenback is giving back its gains.

“The dollar’s declines are being blamed by the sado-monetarists (to steal once again a terrific turn of phrase from John Liscio, our late friend and colleague at Barron’s) on the aggressive expansion of liquidity by the Federal Reserve.

“And, indeed, the US Dollar Index, which measures the greenback’s value against a basket of America’s major trading partners, broke below its 200-day moving a couple of weeks ago. The further drop in the US Dollar Index to below 82 essentially puts it back to where it started the year.

“The dollar’s reversal actually represents a relief of sorts. In the global scramble for scarce dollar liquidity, the dollar’s price was bid up. Borrowers of dollars - nearly the whole world in the global credit crunch - had to pay them back. That made for a classic short-covering rally for the greenback.

“Make no mistake: the fundamentals for the dollar are negative, given the huge US current-account deficit (though it’s shrinking, courtesy of the recession that’s curbed imports) and America’s debtor-nation status. But deflating the economy in a credit crisis to maintain the exchange rate is worse. It was tried in the 1930s; it was one of the things that made the Great Depression ‘great’.

“So we’ve picked our poison, and it is a cheaper currency. For investors, the question is how best to react.

“ISI Group’s Portfolio Strategy Group, led by Francois Trahan, suggests that if you like US equities, you should be buying the big, global companies that may be domiciled outside the US but compete in the same markets as American companies around the world.

“Even though this is supposed to be a global world, there remain many portfolio managers who are restricted to buying “US companies,” an archaic notion.

“… if you’re bullish on US stocks that will benefit from an economic recovery and reflation, why not buy foreign stocks, which should get the added benefit of currency gains from the dollar’s decline?

“You can wring your hands and bewail the demise of the dollar. Or you can take advantage by investing abroad. Never has it been so easy for Americans to do so.”

Source: Randall Forsyth, Barron’s, May 21, 2009.

Bespoke: India has biggest one-day change ever “India’s Sensex rallied 17.34% today on unexpected election results for its biggest one-day gain ever in its 30 year history. The next biggest one-day gain came in March 1992 when the index rallied 13.14%. From its peak in January 2008 to its recent low, the Sensex dropped 60.91%. From its low, however, the index has now rallied 75.04% in just over two months. Even after this 75% gain, India needs to rally another 46.13% to reach its old highs.”

Source: Bespoke, May 18, 2009.

Richard Russell (Dow Theory Letters): US dollar cracking down “On the edge - below, a weekly chart of the Dollar Index. The 10-week blue moving average is about to drop below the red 40-week moving average in what technicians call ‘the death cross’. As I write the dollar is flirting with a serious break to new lows. The bearish target is 80, below which the dollar could swoon. Is it any wonder that international holders of dollar-denominated securities are white-knuckled?

“The status of the dollar is now so extremely important that I’ve decided to include a daily chart as well. What you see on the daily chart is an enormous head-and-shoulders top with the dollar right on the edge of support. A break below support (the blue line) would be ominous, and would probably send the dollar down to test its December low at 81.41.”

Source: Richard Russell, Dow Theory Letters, May 20, 2009.

Barron’s: New dilemma for the UD dollar “China isn’t just talking about supplanting the dollar as the center of the international monetary system. It is taking concrete steps away from the greenback for both finance and trade.

“The Financial Times reports China and Brazil have discussed using their own currencies for trade, a marked shift away from the use of dollars, the norm for the conduct of international trade.

“There have been proposals over the years to use currencies other than the dollar for trade, most notably by the Organization of Petroleum Exporting Countries. OPEC has made noises about pricing its oil in a basket of currencies or perhaps the euro to offset the cartel’s currency losses when the greenback would take one of its periodic headers.

“But nothing ever has come of those threats. And even with the introduction of the euro as the first, real potential rival, world trade continues to be conducted overwhelmingly in dollars.

“The global use of dollars has been an enormous advantage to the US, affording the nation the ability to spend and borrow nearly without limit. As long as the rest of the world wanted and needed dollars for trade in goods and financial transactions, America could effectively just reel off greenbacks to pay its bills.

“As noted here previously, the rest of the world quite simply is getting its fill of dollars. The head of the People’s Bank of China, that nation’s central bank, has called for a ’super sovereign’ international currency that would take the place of the dollar. More recently, a Japanese official called on the US to issue Treasury bonds denominated in yen, which couldn’t simply be repaid by the printing of dollars.

“Now, talks between China and Brazil on setting up bilateral trade in their own currencies moves the possible supplanting of the dollar out of the financial realm.

“It is no coincidence that the US has been replaced by China as Brazil’s biggest trading partner. As such those two nations see less of a need to use dollars for their bilateral trade. Moreover, China and Argentina last year entered an agreement to transact trade in their respective currencies, cutting out the dollar as an intermediary.”

Source: Randall Forsyth, Barron’s May 19, 2009.

Eoin Treacy (Fullermoney): Outlook for British pound “The pound was one of the world’s worst performing currencies from late-2007 through to the end of the 2008. As a major European economy, outside the Eurozone, with a burst housing bubble and a heavy reliance of the City’s financial sector, the UK is more exposed to the effects of the credit crisis than many others.

“The UK took no action to support the currency as it declined, since it helped to make UK exporters more competitive. As short-sellers focused on sterling as a vehicle for taking advantage of the credit crisis, the pound’s fall outpaced that of its trading partners and on a trade weighted basis, it fell over 30% between mid-2007 and late 2008.

“The Deutsche Bank British Pound Trade Weighted Index ranged from 2001 to the middle of 2007. However, it broke emphatically below 95 in December 2007 and fell to 90 where it distributed for four months. It broke downwards again in August and began to accelerate lower from October. The Index found support in December and has posted a succession of higher lows since.

“This action is in contrast to the bearish sentiment towards the UK economy and the pound generally. The fundamental economic condition of the country is still deeply troubling but we should not forget that currency trading is a relative value endeavour. It could be argued that the pound became undervalued relative to its main trading partners too quickly and that rather than the pound being strong, other currencies are now getting weaker.

“If we accept the proposition that the pound is bottoming, then foreign investors looking at potentially making relatively long-term investments in Europe could justifiably start looking at the UK as a preferred destination.”

Source: Eoin Treacy, Fullermoney, May 18, 2009.

Joe Weisenthal (Clusterstock): John Paulson’s big bet on inflation “Earlier this week we mentioned that hedge fund manager John Paulson, who made his fortune betting against the housing market, is moving forward with plans to pounce on cheap real estate.

“Prior to that Paulson was betting on gold, taking sizable stakes in some gold miners.

“The Pragmatic Capitalist smartly connects the dots: Stringing together the recent SEC filings of John Paulson, the billionaire hedge fund manager, makes one thing clear: he is betting big on the reflation trade. Paulson’s latest 13-F filing shows large positions in Anglogold, Kinross gold, Gold Fields, market vectors gold ETF and the S&P gold ETF.

“More interesting is a recent filing by Paulson to start raising money for a hundred million dollar “real estate recovery” fund.

“At first, the news of large gold purchases early last month were seen as potential Armageddon plays based on Paulson’s big bets on the collapse of the economy last year, but it’s now clear that Paulson is betting big on inflation in the coming years.”

Source: Joe Weisenthal, Clusterstock, May 21, 2009.

Business Intelligence: Gold will ultimately hit US$1,300 on inflation hedging, says JPMorgan Chase “Jan Loeys, the global head of market strategy at JPMorgan Chase & Co said commodities are going to move higher as investors start to get concerned about inflation.

“Speaking on Bloomberg Television from Hong Kong, Loeys said: “The global recession and the US recession probably is over this month, maybe next month. Commodities, materials in particular, are going to be benefiting right now as investors start to get a bit worried about future inflation.”

“‘Over the next year or so, we think we are going to be crossing US$1,000, probably go ultimately to US$1,200, US$1,300 just for inflation hedging and lack of supply,’ Loeys said.

“Clients ‘are very worried about inflation in two, three years time,’ Loeys said in the interview. ‘The buying we are seeing now in commodities is really hedging, hedging off the potential risk that we will see a spike in inflation.’

“Loeys said crude-oil prices may rise faster than gold in the next few months as energy demand picks up.”

Source: Business Intelligence, May 17, 2009.

Bespoke: Gold breaks downtrend and dollar breaks down “Gold is up another $12.40 today to $939/ounce. Ever since the metal hit support at its 200-day moving average in April, gold has been rallying nicely. And based on technicals, gold has quite a bit of room to run on the upside before it starts to hit resistance again. As shown below, when the metal broke its multi-month downtrend at the start of May, it turned the technicals from negative to positive.

“Gold’s gain has coincided with the dollar’s demise. The dollar tried to mount a comeback after taking a big hit in March, but it didn’t get close to a retest of its 52-week highs. Once it tested and failed at support levels a couple of weeks ago, the trend turned from neutral to negative. The next area of support for the dollar doesn’t come into play until it gets down to its December lows. For now, investors should play the stocks with high international revenues as a play on the decreasing dollar.”

Source: Bespoke, May 20, 2009.

Bespoke: Oil seasonality “With gas prices steadily rising in recent weeks, drivers are nervously watching movements in crude oil and hoping that last week’s sell-off is the beginning of a trend rather than a just a quick pullback. Unfortunately, if crude oil’s seasonal pattern over the last 25 years is any indication, we shouldn’t expect any relief until September. The chart below shows the average YTD percent change in the price of crude oil over various time periods. For each period, we also show the date the high was reached. As shown, over the last twenty-five (9/30), ten (9/19), and five (9/22) years, the price of crude oil has typically peaked in mid to late September.”

Source: Bespoke, May 18, 2009.

BCA Research: Oil breaks out - is it sustainable? “The rally in oil from the low $30s is technically impressive against the weak global demand backdrop and elevated inventories.

“Oil prices reached $62/bbl this week, despite lofty US oil inventories (notwithstanding this week’s inventory decline) and the fact that Americans are driving much less than last year. The higher price of oil reflects in part the upturn in Chinese oil imports and car sales at a time when oil production is lagging. Russia continues to have difficulty boosting output and oil production has been flat for most OPEC countries. Saudi Arabia has cut production sharply.

“As with other commodities, oil should benefit from both a weaker US dollar and a shift in investor portfolio preference toward real assets as a hedge against inflation. The upturn in our global leading economic indicators is another positive sign for the commodity complex. Bottom line: Our strategists have upgraded commodities to overweight recently, with energy at the top of the buy list. Investors should consider playing the oil bull market by buying North American exploration and production stocks, or by going long the Norwegian krone and the Canadian dollar.”

Source: BCA Research, May 22, 2009.

Financial Times: S&P warns UK over high debt level “Britain on Thursday became the first big economy to be warned in the financial crisis that it might lose its top-notch credit rating, in a move that raised fears of possible downgrades for other large industrialised nations.

“Standard and Poor’s lowered its medium-term outlook on the triple A rating for the UK’s debt to ‘negative’ from ’stable’ for the first time since the credit ratings agency started analysing the country’s public finances in 1978.

“Though the agency lowered its outlook, it affirmed Britain’s AAA long-term and A-1+ short-term sovereign credit ratings.

“S&P based its warning on a forecast that net government debt risked approaching 100% of national income and staying at that level. ‘A government debt burden of that level, if sustained, would in Standard & Poor’s view be incompatible with a AAA rating,’ the agency said.

“A loss of the top credit rating could raise the cost of financing the national debt, putting further strain on public finances and adding to pressure on Gordon Brown to bring down borrowing faster than the Treasury has planned.

“The agency’s warning sets a precedent for other big economies with triple A ratings whose debt burdens are also approaching 100% of national income. The UK debt burden is forecast over coming years to be similar to that of the US, France and Germany, all of which may now be vulnerable to an S&P downgrade.

“Investors worried that the US - which is also running record government deficits - might be in line for a similar warning. Yields on long-term US government debt rose sharply, the dollar fell to a new low for the year, while gold rallied 1.7% in New York towards $955 an ounce.”

Source: Chris Giles and Dave Shellock, Financial Times, May 21, 2009.

Bespoke: S&P cuts UK’s credit outlook to negative … we’re shaking in our boots “The fact that the major credit ratings agencies still make news is one of the more peculiar financial topics of the 21st century. After being worthless during the credit crisis and then being labeled worthless after the fact by the media, somehow S&P’s cut of the UK’s credit outlook to negative is reverberating through global markets today. And now investors are wondering if the US is next.

“Without laying out a thousand more reasons why no one in the world should pay attention to this, below we highlight a chart of the credit default swap (CDS) price per year to insure $10,000 of UK sovereign debt for 5 years. Since default risk peaked in late February, the cost to insure UK debt is down 50%! The S&P outlook cut today moved the CDS price from 72 bps to 82 bps. This move barely shows up on the chart and highlights that the bond market surely doesn’t care about S&P’s call. And where the heck was S&P prior to and during the 900% (yes 900%!) rise in UK default risk in 2008 and early 2009?”

Source: Bespoke, May 21, 2009.

Gabriel Stein (Lombard Street Research): Russian stimulus is not working “Russia’s central bank could once again face a choice between allowing the rouble to weaken and taking steps to support the economy, says Gabriel Stein, chief economist at Lombard Street Research.

“‘According to estimates, Russian GDP shrank by 9.5% in the first quarter from a year earlier,’ he says. ‘There are some ‘green shoots’ of recovery - but even President Medvedev has acknowledged stimulus measures to boost the economy have so far not worked.’

“Mr Stein says Russia is paying the price for its double exposure to the ‘most serious hazards of the modern world - energy and exports to continental Europe.’ The former, he says, is the result of Moscow’s single-minded pursuit of energy control, regardless of the damage to Russia’s business climate.

“The rouble has strengthened this year, partly on optimism about emerging markets, partly due to - but also a cause of - Russian stock market gains and partly on high interest rates.

“‘Rates were cut to 12% last week, but remain attractive - and should provide a barrier to the rouble collapse that the state of the economy seems to call for.

“‘If maintaining the value of the rouble remains the goal, it will be very difficult to ease monetary policy further. Better to act now to moderate a devaluation which represents the loss of income implied by the collapse of energy prices.’”

Source: Gabriel Stein, Lombard Street Research (via Financial Times), May 18, 2009.

Peter Attard Montalto (Nomura): Fears over South African sovereign risk “Investor fears of heightened sovereign risk in South Africa have been crystalized by the events of the weekend when a Pretoria court threw out a case by the telecoms regulator and unions objecting to the listing of Vodacom, says Peter Attard Montalto, economist at Nomura.

“‘Investors are particularly concerned at the increase in influence of the unions in government now they hold several key seats in the new cabinet,’ he says. ‘Regulatory flip-flopping is embarrassing and adds to investor uncertainty but we are cautiously constructive on the bigger issue of sovereign risk.’

“Mr Attard Montalto believes having Cosatu, the umbrella union organisation, as well as the SACP (communist party) in government with the ANC will be a noisy affair for investors as each jockeys to have its agenda heard.

“‘We put the events of the weekend down to such noise,’ he says. ‘Investors need to look beyond this to the fact the government will find itself heavily constrained in policy terms by the need to maintain investor sentiment in order to raise the funds needed to push forward its social agenda. This is especially true given South Africa already runs a substantial current account deficit.

“‘This is only the first hurdle for President Zuma. To keep investors onside, he must publicly stamp on any cabinet disagreement on the Vodacom issue and assert a continuation of investor-friendly policy in both what he says and prudent policy action.’”

Source: Peter Attard Montalto, Nomura (via Financial Times), May 19, 2009.

Tags: Aaa Credit, American Economist, American Stocks, BRIC, Canada, David Rosenberg, Day Job, Debt Levels, Dramatic Expansion, Emerging Markets, ETF, Gdp Ratio, Gold Silver, Government Bonds, Government Debt, High Note, India, Interesting News, Market Commentators, Medium Term Outlook, Merrill Lynch, New York Post, oil, Risky Assets, Stock Markets, Us Debt Clock
Posted in Commodities, Credit Markets, Economy, Emerging Markets, Gold, India, Markets, Oil and Gas, Outlook | No Comments »

Wall Street slumps on economic fears

Sunday, May 24th, 2009

Stock markets came under pressure over the past few days as skepticism crept in that economic green shoots could be withering. On top of that, fears that the the US could be facing a credit rating downgrade (are the rating agencies now relevant again?) also caused losses for the US dollar and bonds.

These issues, together with another dose of discussion about the repayment of TARP funds, featured prominently in this week’s video clips. Commentators included in the selection below include James Galbraith, Jim Bianco, Robert Shiller, Sam Stovall, Bill Gross, David Rosenberg, Jim Rogers and Steve Leuthold.

The compilation kicks off with a top-quality interview with James Galbraith, saying that the banks can hardly lose but the rest of us aren’t so lucky, and concludes with the “American Casino” movie trailer.

Yahoo Finance, Tech Ticker: Galbraith - banks can hardly lose
“Big banks have raised billions since the stress tests and policymakers are now turning their bailout affections to life insurers and automakers. Is the government trying to tell us the crisis in the financial sector (proper) is over?

“While it’s too soon to say they’re out of the woods, ‘the government has set up a situation where the banks can hardly lose’, says James Galbraith, economist, professor and author of ‘The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too’.

“Beyond the TARP funds - which Galbraith calls an ‘unproductive use of Federal borrowing’ - banks are benefiting from lending programs that effectively allow them to borrow at zero and reinvest in Treasuries at around 3%. ‘A bank doesn’t have to do anything to make money,’ he says. ‘The banks’ return on equity is going to be very good. They’re going to be able to restore their finances.’

“While this is good for banks and a justification for the sector’s recent rally, the problem is the government’s ‘free money’ program means banks have little or no incentive to do any actual lending. Combined with rising unemployment and the ongoing housing crisis, this means any recovery is likely to be muted, at best, Galbraith says. Furthermore, anyone hoping for a return anytime soon to the salad days of the mid-2000s is delusional.”

Source: Yahoo Finance, Tech Ticker, May 21, 2009.

CNBC: Geithner - banking hearing
“Treasury Secretary Timothy Geithner gives his testimony before the Senate Banking Committee on TARP.”

Source: CNBC, May 20, 2009.

CNBC: Implications of repaying TARP
“Repaying TARP and what that means, with Bob Jones, Old National Bancorp; Lou Brien, DRW Trading Group strategist; and Jim Bianco, Bianco Research president.”

Source: CNBC, May 19, 2009.

CNBC: Credit card overhaul
“The Senate voted overwhelmingly on Tuesday to rein in rate increases and excessive fees, and the House could pass this legislation tomorrow [Thursday]. CNBC’s Bertha Coombs has the details.”

Source: CNBC, May 20, 2009.

Business Week: The Fed is in no rush to raise rates
“Tame inflation means Bernanke has time. With so much idle labor and production capacity, the economy would have to grow beyond the most opimistic forecast for three years before wages and prices felt any notable upward pressure.”

Source: Business Week, May 20, 2009.

Financial Times: Robert Shiller on the outlook for house prices
“Robert Shiller of Yale University talks to Martin Sandbu about the outlook for housing and equity markets, the value of sovereign debt, and the government response to the economic slowdown.”

Source: Financial Times, May 19, 2009.

Fox Business: S&P’s Sam Stovall - recovery by 3Q

Source: Fox Business, May 19, 2009.

Political Math: The national debt road trip
“How do the Obama deficits compare with past presidents? And how did the national debt get so big anyway. This video tries to answer those questions by looking at the debt as a road trip and seeing how fast different administrations have been traveling.”

Source: Political Math (via YouTube), May 15, 2009.

CNBC: US could lose AAA rating
“Investors are concerned the US will follow the UK and lose its AAA rating, according to Bill Gross, Pimco, and that could be driving today’s drop in the dollar.”

Source: CNBC, May 21, 2009.

The Wall Street Journal: Market focus on dollar weakness
“The US dollar could be on the brink of a major drop in value as investors and central bank reserve managers start to question their appetite for Treasurys and the greenback’s safe-haven status wears off, prominent currency watchers warn. The euro and even embattled sterling have shot higher against the US currency in recent days despite a lack of meaningfully positive economic news.

“Now some heavyweight strategists think the euro could sweep up to 9% higher against the dollar in a matter of weeks, in a move that could prompt a new era of official intervention in the currency markets.”

Source: The Wall Street Journal, May 21, 2009.

John Authers (Financial Times): Low volatility
“When volatility is down it means investors are getting calmer. But equity volatility currently seems to have a stronger impact on currencies.”

Click here for the article.

Source: Financial Times, May 21, 2009.

Bloomberg: David Rosenberg says US stocks may retest March lows
“David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, talks with Bloomberg’s Erik Schatzker about the outlook for the US stock market. Rosenberg, former chief North American economist at Bank of America-Merrill Lynch, also discusses the state of the global economy, consumer spending and the currency market.”

Source: Bloomberg, May 21, 2009.

CNBC: Rogers - markets yet to bottom
“Markets have yet to see the bottom, warns Jim Rogers, chairman of Rogers Holdings. He tells Michael Yoshikami, president & chief investment strategist of YCMNET Advisors, CNBC’s Martin Soong & Amanda Drury why. He also reveals what he is buying.”

Source: CNBC, May 20, 2009.

Bloomberg: Leuthold says he may boost stock holdings to 70%
“Steve Leuthold, chairman of Leuthold Weeden Capital Management, talks with Bloomberg’s Betty Liu about the outlook for the US stock market. Leuthold, whose Grizzly Short Fund returned 74% last year, also discusses his expectations for the economy, attempts by banks to repay funds from TARP and investments in gold and silver.”

Source: Bloomberg, May 20, 2009.

Financial Times: Indian Congress victory welcomed by business
“James Lamont, FT South Asia bureau chief, on the reasons for the Congress Party’s unexpected victory in the Indian elections and the key role of party leader, Sonia Gandhi.”

Source: Financial Times, May 18, 2009.

CNBC: Rogers - choose silver over gold
“Although Jim Rogers owns gold, he sees better returns in agricultural commodities and silver. Rogers & Michael Yoshikami, president & chief investment strategist, YCMNet Advisors talk strategies with CNBC’s Martin Soong, Amanda Drury & Sri Jegarajah.”

Source: CNBC, May 20, 2009.

CNBC: OPEC wary of rising oil prices
“‘Certainly OPEC’s members are happy, but in the back of their minds they’re looking at the oil price rally coming against a background of rising oil inventories and contracting economic indicators,’ Harry Tchilinguirian of BNP Paribas told CNBC Tuesday.”

Source: CNBC, May 19, 2009.

CNBC: America’s big money bet on Africa
“Insight on why the American investor loves Africa, with Quintin Primo, Capri Capital Partners.”

Source: CNBC, May 21, 2009.

Vimeo: American Casino movie trailer

American Casino movie trailer from Leslie and Andrew Cockburn on Vimeo.

Source: Leslie and Andrew Cockburn, Vimeo, March 2009.

Tags: Affections, American Casino, Automakers, Bailout, Bill Gross, David Rosenberg, Emerging Markets, Financial Sector, India, James Galbraith, Jim Bianco, Jim Rogers, Life Insurers, Money Program, Return On Equity, Robert Shiller, Sam Stovall, Slumps, Steve Leuthold, Stock Markets, Stress Tests, Treasuries
Posted in Commodities, Credit Markets, Economy, Emerging Markets, Gold, India, Markets, Oil and Gas, Outlook | No Comments »

US-China Trade Visualized

Thursday, May 21st, 2009

Mint.com creates great, attention getting charts. As the old saying goes, a picture says a thousand words. The US-China trade chart below does a great job of presenting how both countries trade with each other and the rest of the world.

Introduction by Mint.com

Like it or not, the US and China have a trading relationship that has global repercussions. The plastic US flags that say Made in China don’t tell the whole story. No, not everything is made in China. In fact the US manufactures and exports almost as much as China but it consumes a great deal more. Hence, the trade imbalance. What’s interesting is exactly what the US imports, stuff like machinery and toys and as much steel and iron as it does shoes. And what we export — high-tech stuff like airplanes and medical equipment and, for some reason, 7 billion dollars worth of oleaginous fruit which is used to make cooking oil, presumably for Chinese food.

Click On The Image For A Larger Version (Note:Image accessed via Mint.com)

Tags: Airplanes, Billion Dollars, China Trade, China Trading, Chinese Food, Cooking Oil, Countries, Flags, Global Repercussions, Job, Medical Equipment, Mint, Reason, Relationship, Rest Of The World, Shoes, Stuff, Toys, Trade Imbalance, World Introduction
Posted in Economy, Emerging Markets, Markets, Oil and Gas | No Comments »

Gloomy economic reports rein in investors’ optimism

Friday, May 15th, 2009

A batch of gloomy economic reports during the past few days suggested that recent optimism about a global recovery might have been premature. This caused Doug Kass to warn that “stock prices have moved ahead of fundamentals” and Kenneth Langone to caution that “investors seem to be getting ahead of themselves”, although he maintained that the long-term outlook on the market was positive.

Big banks across the US announced large common stock offerings and plans to repay the government, and the US administration attempted to bring transparency to the credit derivatives markets and also crack down on the credit card industry.

In addition to Kass and Langone, commentators featured on camera in this post include Elizabeth Warren, Meredith Whitney, Alan Greenspan, Peter Boockvar, Giles Keating, Jim Rogers, Barry Ritholtz, Dennis Gartman, Abby Cohen, Peter Eliades and Laszlo Birinyi.

The selection kicks off with a discussion on why the bubble burst, and concludes with a clip on Jacob Zuma being sworn in as South Africa’s (my home country) new president.

John Authers (Financial Times): Why the bubble burst
“Why did the bubble burst last year? Was it due to overconfidence, too much reliance on the efficient markets model, or an explosive mixture of human nature and the free market? Or all of the above? John Authers, FT investment editor, summarizes the views of leading market experts he spoke to at a conference in Orlando, Florida, including Michael Mauboussin of Legg Mason, Richard Thaler of Chicago University and Russell Napier, author of Anatomy of the bear.”

Source: John Authers, Financial Times, May 8, 2009.

Charlie Rose: A conversation with Elizabeth Warren
“A conversation with Elizabeth Warren, chair of the Congressional Oversight Panel created to oversee the US banking bailout.”

Source: Charlie Rose, May 11, 2009.

CNN Video: Bailout - banks had no choice
“CNN business correspondent Christine Romans reports on the pressure the Treasury Department put on the banks.”

Source: CNN Video, May 14, 2009.

CNBC: Whitney’s wisdom
“CNBC’s Maria Bartiromo discusses big banks’ plans to sell common shares in order to repay TARP funds, with Meredith Whitney, Meredith Whitney Advisory Group founder & CEO.”

Source: CNBC, May 11, 2009.

Bloomberg: Ken Lewis says he’s focused on bank, not job security
“Kenneth Lewis, chief executive officer of Bank of America Corp., talks with Bloomberg’s Margaret Popper about his focus on the bank’s operations after US regulators demanded the lender raise more capital after it failed a bank stress test.

“Regulators told Bank of America that it needs to raise $33.9 billion in order to survive a prolonged recession. Lewis, who was stripped of his chairman’s role after last month’s annual shareholders meeting, also discusses the results of the stress test, capital needs and the bank’s acquisition of Merrill Lynch & Co. They speak from Bank of America’s headquarters in Charlotte, North Carolina.”

Source: Bloomberg, May 8, 2009.

The Wall Street Journal: Pay dirt - the rogues gallery
“A look back at some of the biggest and most egregious pay packages.”

Source: The Wall Street Journal, May 12, 2009.

CNBC: Regulating derivatives
“Insight on the new derivatives rules, with Bart Chilton, CFTC commissioner and CNBC’s Larry Kudlow.”

Source: CNBC, May 14, 2009.

CNBC: Credit card crackdown
“President Obama wants to sign the Credit Card Bill of Rights into law by Memorial Day, and Jared Bernstein, chief economist for Vice President Biden, discusses the legislation.”

Source: CNBC, May 14, 2009.

Bloomberg: Roubini says bank stress tests “not stressful enough”
“Nouriel Roubini, the New York University economics professor who predicted the current financial crisis, and Joseph McAlinden, a fund manager at Catalpa Capital, talk with Bloomberg’s Pimm Fox about the government’s stress tests of the 19 largest US banks. Roubini and McAlinden also discuss their expectations for the US economy, government regulation of banks and the outlook for the European and Chinese economies.”

Source: Bloomberg, May 12, 2009.

MSNBC: Show me the stimulus money
“Since President Barack Obama signed the stimulus bill three months ago, only $46 billion of the $787 billion has been given out. Jared Bernstein, chief economist for Vice President Joe Biden, discusses.”

Source: MSNBC, May 13, 2009.

McAlvany: An interview with economics professor Walter Block - The 1930’s Depression versus today

Audio clip: Adobe Flash Player (version 9 or above) is required to play this audio clip. Download the latest version here. You also need to have JavaScript enabled in your browser.

Source: McAlvany, May 13, 2009.

Clip Sindicate: Green shoots of inflation?
“Analysis and Discussion with Peter Boockvar of Miller Tabak.”

Source: Clip Syndicate, May 14, 2009.

Giles Keating (Credit Suisse): Top 10 investment themes for 2009
“Most countries were in recession at the beginning of 2009. Analysts foresee that the slowdown will continue for at least another year. Giles Keating, head of the Credit Suisse Global Economics and Strategy Group, lists the top 10 investment themes that offer opportunities during the course of the year.”

Click here for the article

Source: Giles Keating, Credit Suisse, May 12, 2009.

Bloomberg: Jim Rogers - dollar rally will end; may short stocks

Click here for the article.

Source: Chen Shiyin and Haslinda Amin, Bloomberg, May 12 2009.

John Authers (Financial Times): Stock valuations do nor represent a bargain

Click here for the article.

Source: John Authers, Financial Times, May 14, 2009.

Yahoo Finance, Tech Ticker: Barry Ritholtz - rally “guilty until proven innocent”

Click here for the article.

Source: Yahoo Finance, Tech Ticker, May 14, 2009.

CNBC: Bull market or B.S.?
“Insight on the markets, with Dennis Gartman, author of The Gartman Letter, and the Fast Money crew.”

Source: CNBC, May 14, 2009.

CNBC: Stocks are ahead of fundamentals
“Hedge fund manager Doug Kass of Seabreeze Partners Management (the man who called a generational low in the stock market back on March 10) says stock prices have moved ahead of fundamentals. Kass calls it the ‘Miley Cyrus’ stock market recovery where a premium is being paid for less-than-stellar value.”

Source: CNBC, May 13, 2009.

CNBC: Cohen on the current market bounce
“Discussing concerns over whether the bulls will be caught in a sucker’s rally, with Abby Joseph Cohen, Goldman Sachs senior investment strategist.”

Source: CNBC, May 12, 2009.

MarketWatch: Dow 4,000 still in the cards
“Peter Eliades of Stockmarket Cycles says the Dow still could retreat to 4,000. He tells MarketWatch’s Stacey Delo that the current range at the 8,400 level is an important benchmark to watch.”

Source: MarketWatch, May 11, 2009.

Bloomberg: Birinyi on the outlook for stocks
“Laszlo Birinyi, president of Birinyi Associates Inc., talks with Bloomberg’s Betty Liu and Julie Hyman about equity investment strategy. Birinyi, speaking from Westport, Connecticut, also discusses the outlook for the US stock market, the banking industry and corporate earnings.”

Source: Bloomberg, May 12, 2009.

CNBC: Kenneth Langone - investors getting ahead of themselves
“Investors seem to be getting ahead of themselves right now but the long term outlook on the market is positive, says Kenneth Langone, Invemed Associates chairman/president & Home Depot founder.”

Source: CNBC, May 12, 2009.

Financial Times: Intel fined €1 billion
“If the example of Microsoft is anything to go by, the record €1 billion fine slapped on Intel will not have much of an impact on the company, says FT’s Dan McCrum.”

Source: Financial Times, May 13, 2009.

The Wall Street Journal: The cream of the hedge fund crop
“Barron’s David Schutt and Jack Willoughby speak about the release of this year’s best 100 Hedge Funds.”

Source: The Wall Street Journal, May 9, 2009.

CNBC: China’s dual economy
“China is unlikely to grow 8% in 2009 as Jan Friederich, senior economist for global forecasting at the Economist Intelligence Unit has noted two different economies operating there. He shares his observations with CNBC’s Martin Soong.”

Source: CNBC, May 11, 2009.

CNBC: Jim Rogers - teach your kids Mandarin
“Commodities king and Quantum Fund co-founder Jim Rogers explains to CNBC’s Larry Kudlow why he remains bullish on Asia and commodities, his skepticism about the recent stock market rally, and why he left the United States to raise his daughters abroad.”

Source: CNBC, May 11, 2009.

CNBC: RICS - UK housing slump easing
“According to a recent survey, the UK housing price slump softened in April, and new buyer enquiries rose at their fastest pace in a decade. Simon Rubinsohn from RICS has more.”

Source: CNBC, May 12, 2009.

Financial Times: Zuma sworn in as SA president
“Nelson Mandela, a symbol of the country’s anti-apartheid struggle, and thousands of supporters and heads of state came to watch South Africa’s fourth democratic leader being sworn in.”

Source: Financial Times, May 10, 2009.

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