Matt Taibbi: Wall Street’s Bailout Hustle - “The best 18 months of grifting this country has ever seen”

Thursday, February 18th, 2010

Rolling Stone Mag’s Matt Taibbi strikes Again, in Wall Street’s Bailout Hustle.

On January 21st, Lloyd Blankfein left a peculiar voicemail message on the work phones of his employees at Goldman Sachs. Fast becoming America’s pre-eminent Marvel Comics supervillain, the CEO used the call to deploy his secret weapon: a pair of giant, nuclear-powered testicles. In his message, Blankfein addressed his plan to pay out gigantic year-end bonuses amid widespread controversy over Goldman’s role in precipitating the global financial crisis.

The bank had already set aside a tidy $16.2 billion for salaries and bonuses — meaning that Goldman employees were each set to take home an average of $498,246, a number roughly commensurate with what they received during the bubble years. Still, the troops were worried: There were rumors that Dr. Ballsachs, bowing to political pressure, might be forced to scale the number back. After all, the country was broke, 14.8 million Americans were stranded on the unemployment line, and Barack Obama and the Democrats were trying to recover the populist high ground after their bitch-whipping in Massachusetts by calling for a “bailout tax” on banks. Maybe this wasn’t the right time for Goldman to be throwing its annual Roman bonus orgy. …

Read the whole article here.

Source: Matt Taibbi, Rolling Stone Magazine, Feburary 17, 2010

Tags: Bailout, Barack Obama, Controversy, Global Financial Crisis, Goldman Sachs, Lloyd Blankfein, Marvel Comics Supervillain, Matt Taibbi, Orgy, Right Time, Rolling Stone Magazine, Salaries, Secret Weapon, Stone Mag, Testicles, Unemployment Line, Voicemail Message, Wall Street, Work Phones, Year End
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Words from the (Investment) Wise (January 17, 2009)

Sunday, January 17th, 2010

“Words from the Wise” this week comes to you in a somewhat shorter format as I do not have access to all my normal research resources while spending a few days with the gnomes in Geneva (also see my post “Blogging gone AWOL - to Switzerland“). Although the commentary is not as comprehensive as usual, a full dose of excerpts from interesting news items and quotes from market commentators is included.

With investors’ hopes of an economic recovery that might have gotten ahead of reality, the Dow Jones Industrial Index experienced its largest one-day drop (-0.9%) of the year in a sell-off on Friday - unnerved by China starting to rein in liquidity and cautious earnings guidance - causing the benchmark US indices to register a fourth down-week over an eight-week period. Not surprisingly, the CBOE Volatility (VIX) Index, also referred to as the “fear gauge” of US stocks, gained 1.2% over the week.

Providing “entertainment” of a dubious kind and reminding one of the 1933 Pecora Commission, the Financial Crisis Inquiry Commission on Wednesday started interrogating four of Wall Street’s top executives in Washington and promised to use wide-ranging powers to establish the causes of the financial crisis and pursue any wrongdoing.

Meanwhile, Christina Romer, who heads the president’s Council of Economic Advisers, said (via MoneyNews) the payment of big year-end bonuses for bailed-out financial institutions would be “ridiculous” and “offensive” and “is going to offend the American people. It offends me”.

Similarly, according to The Canadian Press, President Barack Obama said with reference to his proposed plans to impose a levy on big financial institutions to recoup some of the costs of the financial crisis: “If the big financial firms can afford massive bonuses, they can afford to pay back the American people.”

Source: Steve Sack, Comics.com

The past week’s performance of the major asset classes is summarized in the chart below - a set of numbers indicating a degree of risk aversion has crept back into financial markets. Steps by the People’s Bank of China to tighten liquidity by increasing the bank reserve requirement ratio and raising inter-bank interest rates negatively impacted oil and other commodities, causing the first decline in five weeks.

Source: StockCharts.com

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

The MSCI World Index and the MSCI Emerging Markets Index declined by 0.2% and 0.6% respectively during the past week. Among mature markets, Japan (+1.7%) bucked the trend and added a seventh consecutive week of gains - coinciding with a weaker yen over the period. (Also see my post “What to expect from Japan’s new finance minister“.) Among emerging countries, Russia (+7.2%) performed solidly, while China (+0.9%) also eked out a gain after having to balance adverse monetary developments in that country with impressive trade data early in the week.

Notwithstanding the huge rally since the March lows, only the Chile Stock Market General Index - again a solid performer on the expectation of a positive election result - has been able to reclaim its 2007 pre-crisis peak and is now trading 8.1% higher. Mexico could be the next country to eliminate the bear market losses.

As far as the US indices are concerned, Wall Street managed to hit 16-month highs on Monday and then again on Thursday, but reversed course on Friday as traders closed positions before the Martin Luther King long weekend, pulling indices into the red.

Seven of the ten economic sectors (as measured by the SPDR exchange-traded funds [ETFs]) closed lower for the week, with the defensive sectors outperforming the cyclical ones. Health Care (+1.4%), Consumer Staples (+0.8%) and Utilities (+0.6%) returned gains, whereas all the other sectors were under the water. Small caps, in particular, led the way down on Friday.

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

Top performers among stock markets this week were Estonia (+15.6%), Venezuela (+9.6%), Lithuania (+8.7%), Kazakhstan (+7.2%) and Kenya (+5.7%). At the bottom end of the performance rankings, countries included Greece (-7.9%), Jamaica (-6.7%), Cyprus (-6.5%), Luxembourg (-4.9%) and Portugal (-1.2%). “Greece on Thursday announced an ambitious three-year plan to curb its runaway budget deficit but failed to convince skeptical markets that its targets for growth and fiscal reform were feasible,” reported the Financial Times.

Of the 96 stock markets I keep on my radar screen, 53% recorded gains (last week 79%), 41% (15%) showed losses and 6% (6%) remained unchanged. The performance map below tells the past week’s rather bullish story

Emerginvest world markets heat map

Source: Emerginvest (Click here to access a complete list of global stock market movements.)

John Nyaradi (Wall Street Sector Selector) reports that as far as ETFs are concerned the winners for the week included iShares MSCI Japan (EWJ) (+4.8%), Claymore/Delta Global Shipping (SEA) (+3.6%), Vanguard Extended Duration Treasury (EDV) (+3.3%) and iShares MSCI Austria (EWO) (+2.7%).

At the bottom end of the performance rankings, ETFs included Claymore/MAC Global Solar Energy (TAN) (-8.7%), PowerShares WilderHill Clean Energy (PBW) (-7.2%), Claymore/AlphaShares China Real Estate (TAO) (-6.6%) and United States Oil (USO) (-5.7%).

Referring to the modern robber barons, or “banksters”, and Obama’s proposed bank tax to recoup bailout costs, the quote du jour this week comes from long-timer Richard Russell, writer of the Dow Theory Letters. He said: “Obama is fighting two wars, the war in Afghanistan and the war in Iraq. Now he’s got a third war going, the war on Wall Street. He’s joining the populist fury over Wall Street and its bonuses. It’s ‘payback time’, and Obama proposes a $90 billion tax on Wall Street’s banks.

“The Prez utters the words the crowd loves to hear, ‘We want our money back, and we’re going to get it.’ Obama’s words dovetails with Democrats’ worries that they would be blamed for the recession and the debts. Blame it on Wall Street, and get even with those greedy devils; maybe tax the greedy devils out of existence or at least tax their stinkin’ bonuses away. As Obama’s assistant Rahm Emanuel put it, ‘Its a shame to let a good crisis go to waste.’

“The $90 billion Obama will extract from Wall Street won’t even begin to shrink the monster deficit the Fed has run up. Let the next administration (probably Republicans) deal with that problem.”

How the lie of the land has changed! The Financial Times yesterday headlined an article: “Obama is right to clobber Wall Street”.

Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. As to be expected with the banking shenanigans moving to center stage, “banks” commanded poll position.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index (discussed above), the indices in the table are all trading above their 50-day moving averages, with all the indices also comfortably above their respective key 200-day moving averages.

As far as the S&P 500 Index is concerned, an upward sloping trend line extends from the August lows. A break below this line’s support level of 1,080 (and the December low of 1,092) could signal a deeper pullback.

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

Last week I discussed a long-term chart of the S&P 500. Let’s now also consider monthly data, going back to 1998, for the 10-year Treasury Note. As shown below, the MACD oscillator provided a sell signal about seven months ago and Treasuries are still classified as being in a primary bear market.

Source: StockCharts.com

This raises the question of when rising long-term rates start ruining the equity party. “For me, a sustained move above 4% by ten-year Treasuries will be equivalent to a yellow caution light for equity investors. Above 5%, stock markets could be in dangerous territory, as we saw in the last cycle,” commented David Fuller (Fullermoney). ”I will continue to view US Treasury 10-year yields as a lead indicator. Currently, they are still in a ’sweet spot’. However, when they move higher I will monitor stock market indices, particularly for Wall Street, even more closely for signs of fatigue in the form of inconsistencies, not least a loss of upward momentum.”

Looking beyond the low-growth economies of mature countries, Jeremy Grantham of GMO said (via Fortune): “I think there is a nascent bubble in emerging markets. Over the next three to five years, emerging markets are likely to sell at a handsome premium P/E because of the respect for their higher GDP growth.”

To which money man Bill Gross, head honcho of Pimco, added (according to Fortune): “If you’re looking for growth, you should venture outside the US. Brazil, China and other Asia equities are the cherry on top of the melting sundae. It’s not only their internal economies; they’re in better shape from the standpoint of reserves and balances. Ten years ago Brazil was a basket case and beggar. Now it has hundreds of billions of dollar reserves.”

Back to the US stock markets, John Hussman (Hussman Funds) is treading carefully with the current stock market make-up, saying: “There’s no denying that the beliefs of investors have been far more important, in the intermediate term, than economic realities, which are revealed more slowly and sporadically. Yet despite the high level of bullishness here, the market has gained only a few percent beyond its September highs. Most of what we are seeing now is a tendency to make marginal new highs, back off slightly, and then recover that ground enough to register another marginal new high.

“As I’ve noted frequently, when market conditions are characterized by unfavorable valuations, overbought conditions, over-bullish sentiment, and upward yield pressures, the market’s tendency is exactly that - to make continued marginal new highs for some period of time, followed by abrupt and often steep losses virtually out of nowhere.”

As we embark on the earnings season, the S&P 500 as a whole is expected to grow by 62.1% in Q4 2009 versus Q4 2008. As shown in the graph below, courtesy of Bespoke, the bulk of the growth is expected to come from the Materials and Financial sectors - the only two sectors with Q4 growth expectations that are higher than the S&P 500. Technology and Consumer Discretionary are the other two sectors expected to see growth. On the other hand, “Energy and Industrials are both expected to see earnings decline by more than 20% in the fourth quarter, while Telecom is not far behind at -19.2%. Health Care, Consumer Staples, and Utilities are all expected to see a drop of about 5%,” said Bespoke.

Source: Bespoke, January 12, 2010.

I do not have much to add to my conclusion of last week and repeat it: “It goes without saying that the strong rally since March is bound to be followed by a correction at some stage. But rather than pre-empting (and more often than not getting it wrong as a result of short-term noise), I will be guided by the longer-term charts and the yield curve to identify a major top. Meanwhile, I am watching valuations carefully, and specifically how the Q4 earnings reports stack up. (See my post “Earnings into focus“.)

“Although I am treading with caution after the 74% rally in the mature markets and 108% in emerging markets, I am not ignoring good old stock-picking, and specifically those companies with strong balance sheets that will be growing their dividends over time with a reasonable degree of certainty.”

For more discussion on the economy and financial markets, see my recent posts “Lessons from Bernstein, Rosenberg and Farrell“, “El Erian: Markets not facing reality of slow economy“, “Mark Mobius on emerging market valuations“, “Earnings into focus“, “Picture du Jour: Dow rally in perspective“, “Wealthtrack - making money in 2010 in stocks, bonds and foreign markets“, “Doug Casey: ‘Stock market set to crash’” and “Picture du Jour: Weak hands are heavily long the greenback“. (And do make a point of listening to Donald Coxe’s webcast of January 15, which can be accessed from the sidebar of the Investment Postcards site.)

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

Economy
“Global business sentiment has remained largely unchanged since the summer, consistent with a global economic recovery that is holding its own but is not gaining significant traction. Confidence is generally stronger in South America and among business services firms and weakest in North America and among those that work in real estate,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. Businesses are most upbeat when responding to broad questions about current conditions and expectations through mid-2010, but remain cautious when responding to specific questions about sales, pricing, inventories and hiring.

Source: Moody’s Economy.com

Meanwhile, sovereign debt default looms, according to George Magnus, senior economic adviser at UBS Investment Bank. He said (as reported by the Financial Times): “Concerted fiscal restraint could trigger another recession, but the lack of it could end up in bigger default risks. Even Japan, now into its third ageing decade, may be vulnerable, while some eurozone countries, though sheltered from currency turbulence, may yet falter in their deflation commitments and compromise the integrity of the single currency as we know it. The UK still lacks a credible debt management strategy, and the US cannot take investor goodwill for granted.”

Interestingly, the Financial Times says mounting fears about government debt has now caused the cost of insuring against the risk of debt default by European nations to exceed that for top investment-grade companies for the first time. “It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than it does for the collective risk of Europe’s top 125 investment-grade companies, according to indices compiled by data provider Markit.”

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

Friday, January 15
• Inflation - “Don’t worry, be happy”, for now
• December industrial production - mixed news from the nation’s factories

Thursday, January 14
• December retail sales - mixed news, focus on details necessary
• Ballooning Treasury deficits - it takes both outlays and receipts to tango
• Total continuing claims matter the most

Wednesday, January 13
• Recent Fed rhetoric and highlights from the Beige Book

Tuesday, January 12
• Trade deficit widens in November, volume of trade maintains upward trend

Monday, January 11
• Inflation expectations approach pre-crisis range

The latest Beige Book, published on Wednesday in preparation of the next Federal Open Market Committee (FOMC) meeting on January 26-27, indicates a modestly improving economy.

Regarding the benign CPI numbers, Asha Bangalore (Northern Trust) said: “The Fed continues to be a sweet spot with regard to inflation and can continue to focus on economic growth for several more months. Although the Fed has begun examining the ways in which inflation emerges at the December Federal Open Market Committee (FOMC) meeting, the more vigorous debate and concern about inflation is topic for several months ahead.”

“The Federal Reserve is unlikely to raise interest rates before next year,” Richard Clarida, global strategic adviser for money manager Pimco, told Bloomberg (via MoneyNews). “The Fed has never hiked until they have seen a sustained decline in unemployment. By the Fed’s own forecast, that is at least a year away. I don’t think the Fed’s going to do anything with rates until 2011 or perhaps very late in 2010.”

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

Source: Yahoo Finance, January 15, 2010.

Click the links below for three research reports from Wells Fargo Securities:

• Weekly Economics & Financial Commentary (January 15, 2010)
• Global Chartbook (January 2010)
• Monthly Economic Outlook (January 2010)

US economic data reports for the coming week include the following:

Tuesday, January 19
• Net long-term TIC flows

Wednesday, January 20
• Building permits
• Housing starts
• Core PPI
• PPI

Thursday, January 21
• Jobless claims
• Leading indicators
• Philadelphia Fed

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

Final words
Morris King “Mo” Udall, American politician (1922-1998) said: “If you can find something everyone agrees on, it’s wrong.” (Hat tip: David Fuller.) Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards in guarding against popular (and often wrong) market views.

That’s the way it looks from an icy cold Geneva (from where I will be making my way back to Cape Town on Monday).

Source: RJ Matson, Comics.com

CNN Money: Four pros - investing in the next decade
“The coming 10 years won’t necessarily resemble the past 10. Fortune enlisted four investing sages - Rob Arnott, Jeremy Grantham, Bill Gross and Jeremy Siegel - who lay out the opportunities and pitfalls.”

Click here for the full article.

Source: CNN Money, January 14, 2010.

Richard Russell (Dow Theory Letters): Pondering a deflation scenario
“I’ve been pondering over the following strange situation. The Dow is actually lower today than it was ten years ago. What does this really mean? To me, it means that the market over the last ten years has been discounting ‘no growth’ ahead. When you take an unbiased look at the picture, compared with gold almost everything today is cheaper than it was a few years ago. Since gold is the universal immutable standard around which everything else (including the dollar) fluctuates, this means that the price of literally everything has been going DOWN against the standard which is gold.

“This is deflationary. Of course you can say that a loaf of bread costs more now than it did a year ago, and this is inflationary. True, it’s inflationary in terms of dollars, but the dollar is lower in terms of gold. So in terms of gold, everything is deflating.

“This deflationary trend is continuing, and what’s more it’s continuing against a veritable ocean of central-bank created currencies. Subscribers know that I believe this bear market will end, as most others have, with stocks selling at extreme great values - dividends high, price/earnings low. And you ask, ‘How can this possibly occur?’

“This is the question I’ve asked myself. And the answer I come with is that stocks will be hit by brutal world deflation. That’s what the miserable performance of the Dow is telling me. That’s what the poor performance of everything else against gold is telling me. I’m not talking about the performance over recent months, but their performance over the years.

“Yes, I know that the conventional wisdom is that we’re heading for all-out inflation. This forecast is based on the thesis that the only way to handle America’s deadly multi-trillion debts is to inflate them out of existence. But suppose the Fed is unable to engineer inflation? Look how hard they’ve been trying over the last year to restart inflation. And what’s happened to housing, the chief object of the Fed’s inflation target? Housing prices have gone nowhere, well maybe they’re less weak then they were six months ago. But inflation in home prices? It’s just not happening.

“And now political pressure is on the Fed to cut back on stimulus, money-creation and at the same time raise interest rates. This, if it happens, will definitely be deflationary, and it will hit housing and the economy.

“Ever since World War II the Fed has been on the inflation path. Leverage, rising debt, speculation, and higher prices have been the ‘law’ of the land. Now, I believe we have hit the inflection point; we are just entering the huge deflationary spiral that will unwind six decades of leverage and inflation.

“In the big picture what I see is that China and Asia will become (they already are) phenomenal producers. The developed nations will not be able to compete with them. The result will be a crushing decline in the price of manufactured goods, which, in turn, will impact on all goods including foodstuffs and services and medical services. In a vain effort to compete with China, India and Asia, currencies will be devalued across the board.

“Currencies will sink in the face of competitive devaluations (think Venezuela), and whatever can go bankrupt will go bankrupt. Debt will become a dirty word again, as it was during the 1930s (if you can’t pay for it with cash, live without it).

“The one item that will withstand this crushing force of deflation will be gold, whereas most items have been sinking against gold. If the deflation that I foresee arrives, items will be plunging in price against the standard - gold. This will be the great deflation that nobody foresees and nobody understands and nobody has protected themselves against.

“When you’re willing to agree that gold, not the dollar, is the universal immutable standard, you can see that the forces of deflation are taking over.

“For the sake of argument, let’s just say that I am correct. Then as the great deflation envelopes the land, all things (merchandise, stocks, currencies) will sink against gold. So gold then becomes the single item that is not declining, because gold is the standard, and the standard can’t go down against the standard. In that case, everyone will opt for the safety of gold. Gold will be seen as the final and ultimate protection against deflation.

“Question - Russell, let me play the devil’s advocate. Suppose you are dead wrong, and suddenly all the money that the central banks have injected into the system ‘catches on’. Then what?

“Answer - In that case gold surges higher. It goes higher because the amount of fiat currency being produced is far greater than the available amount of gold. The sheer amount of new currencies overwhelms the relatively fixed amount of gold.

“Question - Then, Russell, you’re saying that gold is the place to be whether inflation or deflation materializes.

“Answer - Yes, that’s the way I see it. Gold will be ‘the last man standing’, as it is now in Venezuela and Zimbabwe.”

Source: Richard Russell, Dow Theory Letters, January 14, 2010.

George Magnus (Financial Times): Sovereign default risks loom large
“The sustainability of sovereign debt hangs heavily over bond markets, and the prospects for economic and financial stability.

“Since 2007, OECD government deficits have risen by 7 per cent of GDP to just over 8 per cent, and debt, excluding contingent liabilities, has risen by about 25 per cent of GDP to just over 100 per cent.

“The biggest increases have occurred in Iceland, Ireland, the US, Japan, the UK, and Spain. There is no peacetime precedent for the current speed and scale of public debt accumulation and it is difficult to assess the social tolerance for high debt levels, and for the pain of protracted fiscal restraint. In several EU member states, the threshold has already been breached. The spectre of sovereign default, therefore, has returned to the rich world.

“Default does not have to mean outright debt repudiation. It can mean some type of moratorium on interest payments, and the restructuring of loan terms. Richer nations are assumed to be above such measures, but not in extreme circumstances. The US abrogated the gold clause in government and private contracts in 1934, and in 1971, it abandoned the gold standard altogether.

“Default can also occur via inflation, currency debasement, the imposition of capital controls, and the imposition of special taxes that break private contracts. Seen in this light, a few countries in eastern and western Europe may already be technically at risk of default.

“At the moment, higher spreads on sovereign bonds and credit default swap rates do not provide convincing evidence of an imminent default crisis, per se. Japan’s public debt has already risen above 200 per cent of GDP, but the government can borrow for 10 years at 1.4 per cent, while Australia’s government debt is about 25 per cent of GDP, but it pays over 5.5 per cent. Other rich countries with varying debt ratios all pay roughly 3.5-4 per cent. However, the status quo is not sustainable.

“Concerted fiscal restraint could trigger another recession, but the lack of it could end up in bigger default risks. Even Japan, now into its third ageing decade, may be vulnerable, while some eurozone countries, though sheltered from currency turbulence, may yet falter in their deflation commitments and compromise the integrity of the single currency as we know it.

“The UK still lacks a credible debt management strategy, and the US cannot take investor goodwill for granted.”

Click here for the full article.

Source: George Magnus, Financial Times, January 13, 2010.

CNBC: Bullard on US interest rates
“The greenback extended declines partly because of comments from St Louis Federal Reserve Bank president, James Bullard, that interest rates may remain low for quite some time. In an exclusive interview with Cheng Lei, Bullard says that maintaining low interest rates is all data dependant.”

Click here for a BusinessWeek article.

Source: CNBC, January 12, 2010.

MoneyNews: Pimco’s Clarida - Fed unlikely to hike rates this year
“The Federal Reserve is unlikely to raise interest rates before next year, says Richard Clarida, global strategic adviser for money manager Pimco.

“‘The Fed has never hiked until they have seen a sustained decline in unemployment,’ now 10 percent, he told Bloomberg.

“‘By the Fed’s own forecast, that is at least a year away.’ And thus, so is a rate hike, Clarida says.

“‘I don’t think the Fed’s going to do anything with rates until 2011 or perhaps very late in 2010.’

“In addition to improvement in the labor market, the Fed would want to see durable sources of demand in the economy before it raises rates, Clarida says.

“‘We had very modest growth in the third quarter (2.2 percent) and perhaps somewhat stronger growth in fourth quarter,’ he said.

“‘But all that is being driven by an inventory rebound and some temporary fiscal stimulus. The Fed’s going to want to see some durable demand from consumers, exports and investment.’

“It’s too soon to say the consumer sector has stabilized, Clarida says.

“‘If you believe as I do that the household sector in the next five years will be deleveraging, that means there will be more (trouble) to come.’”

Source: Dan Weil, MoneyNews, January 11, 2010.

Reuters: White House plans more to trim joblessness
“President Barack Obama plans more economic stimulus measures to bring down the high US unemployment rate, while cutting the bulging budget is a longer-term challenge, a top White House economic aide said on Sunday.

“‘We are … talking about actions right now to jump-start job creation,’ White House Council of Economic Advisers Chairwoman Christina Romer said on CNN’s State of the Union.

“‘You don’t get your budget deficit under control at a 10 percent unemployment rate,’ she said.

“Beating back unemployment will be a key yardstick by which US voters will measure Obama’s success in November congressional elections and will go a long way to determining his own long-term political future.

“Also troubling to many is a budget deficit that has ballooned from spending aimed at cushioning workers and businesses through the worst recession in decades.

“‘We have to do something,’ Romer said. ‘There are more targeted actions that we think absolutely will help.’

“Obama will focus is on getting the US fiscal house in order over the longer run, she said.

“Congress is considering proposals to help labor markets that include a $155 billion jobs package that has already cleared the House of Representatives.”

Source: Mark Felsenthal, Reuters, January 10, 2010.

Asha Bangalore (Northern Trust): Recent Fed rhetoric and highlights of Beige Book
“In speeches late yesterday [Tuesday], Fed Presidents Plosser and Fisher of Philadelphia and Dallas, respectively, were of the opinion that unemployment rate is most likely to trend higher than the December jobless rate of 10.0%. However, both of these non-voting hawkish members of the FOMC expressed concerns about inflation.

“Plosser was of the opinion that the Fed needs to be pre-emptive such that inflationary expectations remain anchored and an inflationary situation is avoided. He also noted that there is ‘extraordinary uncertainty about the prospects for inflation over the next two to five years.’

“President Fisher’s speech focused on lawmakers in Washington attempting to reduce the power and independence of the Fed.

“This morning [Wednesday], President Evans of Chicago, also a non-voting member of the FOMC, presented the Chicago Fed’s forecast for the economy in 2010. He reiterated that restrictive bank credit and cautious households and businesses are restraining the pace of recovery but indicated that these ‘headwinds’ would fade in the latter half of 2010.

“The next FOMC meeting is on January 26 and 27, with four new regional Fed Presidents as voting members - Presidents Bullard of St. Louis, Sandra Pinalto of Cleveland, Rosengren of Boston and Hoenig of Kansas City. President Hoenig is the most hawkish of these new voting members, with President Bullard painted as a hawk, while President Pinalto is seen as a centrist and President Rosengren is classified as a dove.

“The latest Beige Book, published today in preparation for the FOMC Meeting, indicates a modestly improving economy. Ten Districts indicated improving conditions compared with the last Beige Book reporting increased activity in eight Districts. Mixed conditions were reported for the Districts of Philadelphia and Richmond.

“The Beige Book assessment of consumer spending in the holiday season is consistent with the tally of chain store sales reports which indicated gains in retail sales from a year ago but below the levels seen in 2007.

“The labor market information in the Beige Book confirms the grim details of the December employment report published last week.

“Price and wage pressures were not problematic.

“The housing market was depicted as recovering from the lows of early-2009, with low mortgage rates and home buyer tax credit program lifting sales. The non-residential real estate sector remains a source of serious concern in nearly all Districts.

“On the financial side, weak demand for all loans, excluding residential mortgages, a deterioration of credit quality, increased loan delinquencies and defaults were noted. Against this backdrop, it is certain the Fed will hold the monetary policy stance unchanged. The minutes of the December FOMC meeting included differences in opinion about the Fed’s mortgage purchase program and prospects about inflation. The latest information does little to clarify these muddy waters. The nature of the incoming data after a deep recession and a financial crisis is bound to be mixed and present differences in the evaluation of the status of a recovering economy. Criticisms about the Fed’s handling of crises in the past suggest that the Fed is likely to err on the side of being cautious with an emphasis on economic growth.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 13, 2010.

Paul Kasriel (Northern Trust): Ballooning Treasury deficits - it takes both outlays and receipts to tango
“On Wednesday, the US Treasury reported a record cumulative deficit over the 12 months ended December 2009 of $1.472 trillion. Although the editorial board of the Wall Street Journal surely will rail against exploding federal spending, it will probably fail to mention another key driver of ballooning federal deficits - collapsing federal receipts.

“Yes, as shown below, the year-over-year growth in 12-month cumulative federal government outlays remains in double digits, which it entered in October 2008. But notice that the growth rate in federal outlays is slowing. It peaked at 19.2% in July 2009. As of December 2009, the year-over-year growth in 12-month cumulative federal outlays had slowed to 11.8% - the slowest since December 2008’s 12.8% growth. But look at what has been happening to the year-over-year rate of contraction in 12-month cumulative total federal receipts. In the 12 months ended December 2009 vs. the 12 months ended December 2008, total federal receipts contracted by 17.1%, a slightly slower rate of contraction than the 17.6% rate of contraction in the 12 months ended November.

“Of course, receipts are contracting. The US economy has only recently emerged from its longest and deepest recession in the post-war era in which both corporate profits and wage/salary income collapsed. Moreover, personal income taxes were cut by both the Bush (Jr.) and Obama administrations, something the editorial board of the Wall Street Journal presumably approved of.

“In sum, although high growth in federal spending is contributing mightily to our record federal deficit, the rate of growth in that spending is slowing. What often is forgotten is that the rate of contraction in federal receipts has accelerated.”

Source: Paul Kasriel, Northern Trust - Daily Global Commentary, January 14, 2010.

Asha Bangalore (Northern Trust): US trade deficit widens
“The trade deficit of the US economy widened to $36.4 billion in November from a revised $33.9 billion in the previous month. The inflation adjusted trade deficit of good in the October-November months nearly matches the average of the third quarter of 2009. The trade deficit is predicted to post a smaller deficit in the fourth quarter and help to lift overall GDP.

“Following the recession when world trade shrunk significantly, the volume of exports and imports now show a noticeable upward trend. In November, exports of goods and services rose only 0.9% to $138.2 billion, the highest since in the past year. Imports of goods and services increased 2.6% in November to nearly $175 billion, also the highest in the past year.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 12, 2010.

Clusterstock: Shipping into US unexpectedly jumped in December
“Shipping into the US climbed from November to December, defying typical seasonal trends and perhaps demonstrating growing demand in the US

“‘December was a surprisingly good month that put a promising end to 2009,’ the research company Panjiva said in a report issued today.

“Specifically:

“There was a 3% increase in the number of global manufacturers shipping to the US market.

“There was a 2% increase in the number of US companies receiving waterborne shipments from global manufacturers.

“Traditionally, these numbers decline from November to December (-5% in 2009 and -1% in 2008).

“You can expect that the good news will continue, although it may be more confusing than clarifying. For the first quarter, the year-over-year comparisons will likely look very good. But that will largely be a result of the global trade free fall in 2009. A better comparison is probably against 2008 or 2007.”

Source: John Carney and Kamelia Angelova, Clusterstock - Business Insider, January 12, 2010.

Asha Bangalore (Northern Trust): Industrial production - mixed news from the nation’s factories
“The Industrial Production Index rose 0.6% in December after a similar increase in November. However, the reasons for the gain were different. The December increase in production reflects a 5.9% jump in activity at utilities due to inclement weather, while the November gain was largely due to a 0.9% increase in factory production. In December factory production slipped 0.1%. “A mixed performance is seen in factory data for December. Production of consumer goods (+0.6%) and business equipment (+0.9%) increased but construction supplies fell 2.0%. Industrial production has risen 4.7% from the cycle low in June 2009.

“Production at factories has risen 4.5% from the cycle low in June 2009, while on a year-to-year basis, factory production dropped 1.9% in December. The decelerating pace of decline of factory production is noteworthy. The operating rate of the factory sector (68.9%) is still close to the historical low of 65.1%, which implies that businesses have room to meet a growth in demand without undertaking an expansion of capacity. There is nothing in this report that points to an inflationary threat and it is not likely to be seen for several more months.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 15, 2010.

Asha Bangalore (Northern Trust): Retail sales - mixed news
“Retail sales fell 0.3% in December, after an upwardly revised estimate for November (1.8% increase vs. 1.3% in the previous estimate). At first blush, the headline for December looks weak and contradicts the chain store sales reports published last week. These details should help to sort out the report.

“First, unit auto sales increased in December (11.2 million vs. 10.9 million in November) vs. the decline (-0.8%) reported in the retail sales report. Unit auto sales matter for consumer spending in the GDP report for the fourth quarter. But, the fourth quarter average for unit auto sales fell at an annual rate of 20.4% after a nearly 108% jump in the third quarter due to the cash for clunkers program. Therefore, unit auto sales will be a negative for fourth quarter consumer spending. Second, the upbeat chain store sales information published last week were comparisons from a year ago. Retail sales from a year ago presented in today’s report also show strong gains (see chart 4). The 2009 sales numbers look rosy compared with the 2008 weak holiday sales numbers. Third, on a quarterly basis, retail sales excluding autos or excluding auto and gas are stronger in the fourth quarter compared with the third quarter (see table below). Fourth, the level of retail sales excluding gasoline ($318.44 billion) in December compared with the fourth quarter average ($318.2 billion) is virtually flat, implying the absence of an arithmetical advantage.

“The main take away is that consumers are spending but gains are essentially lackluster when the details are sorted out.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 14, 2010.

Asha Bangalore (Northern Trust): Inflation - “Don’t worry, be happy,” for now
“If there is good cheer to go around, it is from inflation, for now. The Consumer Price Index (CPI) edged up 0.1% in December, putting the year-to-year change at 2.7%. The large jump after a string of declines in the eight months ended October 2009 is primarily due to higher energy prices. The energy price index moved up 0.2% in December, but was up 18.2% from a year ago. Food prices rose 0.2%, which translates into a 0.5% drop in food prices in all of 2009.

“Excluding food and energy, the core CPI, inched up 0.1% in December, with the year-to-year increase at 1.8%, matching the gain seen in 2008. The cycle low for the year-to-year increase of the core CPI is a 1.4% gain posted in August 2009. The main reason for the significantly contained core CPI is the decelerating trend of the shelter index (the single-largest component of the core CPI). The 0.3% year-to-year gain of the shelter index in December is smallest increase since record keeping began in 1953 for this price index.

“The Fed continues to be a sweet spot with regard to inflation and can continue to focus on economic growth for several more months. Although the Fed has begun examining the ways in which inflation emerges at the December FOMC meeting, the more vigorous debate and concern about inflation is topic for several months ahead.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 15, 2010.

Reuters: Fannie, Freddie re-defaults reach 34 pct
“More than a third of US residential loans modified by Fannie Mae and Freddie Mac early last year were in arrears again after six months, though the default rate has improved, according to the regulator of the two largest mortgage finance companies.

“About 34 percent of homeowners with loans guaranteed by the companies modified in the first quarter of 2009 were at least 60 days delinquent, the Federal Housing Finance Agency said in a quarterly report on Friday.

“That compares with 39 percent of mortgages going bad after the companies agreed to ease terms of the loans in the last quarter of 2008, the report said.

“The re-default measures cover loans modified before the start of President Barack Obama’s Home Affordable Modification Program that gives lenders a standard blueprint to ease terms of loans for troubled borrowers.”

Source: Al Yoon, Reuters, January 8, 2010.

Financial Times: US commercial property attracts new wave of money
“The beleaguered US commercial real estate sector has been attracting a new wave of money from sources including foreign banks, US private equity firms, and a leading Chinese sovereign wealth fund.

“Market participants warn that the activity represents ‘bottom-feeding’ by opportunistic investors whose strategies could be derailed by rising interest rates. Also, sums are tiny compared with the debts that need refinancing. Nevertheless, the growing interest from investors is a sign of stabilisation, making it less likely that worsening commercial real estate conditions will sink banks and choke off a US recovery.

“‘We believe the real story is that capital is ready to buy, even though it may not be so visible today,” said Bob Steers, co-chairman of Cohen & Steers, a real estate investment firm.

“Recently, state-owned China Investment Corporation has enlisted Cohen & Steers, Angelo Gordon and Morgan Stanley to identify commercial real estate opportunities, people familiar with the matter say.

“A public sign of such activity came on Friday when Colony Capital won a Federal Deposit Insurance Corporation auction for $1bn of commercial property loans formerly held by failed banks in states hit hard by the real estate downturn.

“The deal valued the loans at 44 cents on the dollar and was structured so the FDIC contributes $136m and holds 60 per cent of the equity, while Colony, a Los Angeles investment firm, puts in $90m for the remaining 40 per cent.

“Tom Barrack, Colony founder, called the investment ‘an implicit bet that rates stay low’ and warned: ‘If rates go up, everyone will be crushed.’”

Source: Henny Sender, Financial Times, January 10, 2010.

MoneyNews: Boskin: US economic data is almost criminal
“Former White House economist Michael Boskin says American investors no longer place much credibility in the economic and fiscal statistics being reported by the US government, and are ‘increasingly inclined to disbelieve them’.

“Boskin, the one-time economic adviser to President George H.W. Bush, says that solid, reliable information is needed by investors, because ‘as a society, and as individuals, we need to make difficult, even wrenching choices, often with grave consequences’.

“To base those decisions on misleading, biased, or manufactured numbers, is not just wrong, ‘but dangerous’, he wrote in The Wall Street Journal.

“But, due to the obvious fudging of numbers involved in the government’s health care insurance industry reform effort, most Americans now believe the health-care legislation will actually raise their insurance costs, rather than reduce them, and increase the federal budget deficit, rather than contain it.

“That’s not the only area where cynicism over official statistics is growing.

“‘Most Americans are highly skeptical of the claims of climate extremists,’ writes Boskin, now a professor of economics at Stanford University and a senior fellow at the Hoover Institution.

“And because of the spin over ‘jobs created and saved’ by the stimulus, they have a ‘more realistic reaction to the extraordinary deterioration in our public finances than do the president and Congress,’ Boskin adds.

“Squandering their credibility with these numbers games will only make it more difficult for America’s elected leaders to garner support for difficult decisions from a public increasingly inclined to disbelieve them, writes Boskin.”

Source: Gene Koprowski, MoneyNews, January 14, 2010.

Financial Times: FDIC chief blames Fed for crisis
“The Federal Reserve was blamed by a fellow regulator for contributing to the financial crisis on Thursday as the central bank and one of its former chairmen fought back against congressional moves to curb its powers.

“In unusually pointed criticism, Sheila Bair, chairman of the Federal Deposit Insurance Corporation, told the Financial Crisis Inquiry Commission that ‘much of the crisis may have been prevented’ had the Fed dealt with subprime mortgages seven years before it did.

“In New York, Paul Volcker, former Fed chairman and now White House economic adviser, was making the case for the defence.

“He said there was ‘a compelling case that central banks should have a strong voice and authority in regulation and supervisory matters’.

“Both Ms Bair and Mr Volcker carry weight on Capitol Hill, where the Fed has drawn blame for aspects of the crisis.

“Mr Volcker told the Economics Club of New York he was ‘particularly disturbed’ about moves to take away the Fed’s regulatory function.

“Chris Dodd, Senate banking committee chairman, has proposed consolidating bank supervision into a single regulator.

“The Fed published a paper on Thursday, which had been sent to Mr Dodd on Wednesday, arguing that its financial stability and monetary policy roles were complemented by supervising bank holding companies.

“Mr Volcker said: ‘What seems to me beyond dispute, given recent events, is that monetary policy and the structure and condition of the banking and financial system are irretrievably intertwined.’”

Source: Tom Braithwaite, Financial Times, January 14, 2010.

Bloomberg: Federal Reserve seeks to protect US bailout secrets
“The Federal Reserve asked a US appeals court to block a ruling that for the first time would force the central bank to reveal secret identities of financial firms that might have collapsed without the largest government bailout in US history.

“The US Court of Appeals in Manhattan will decide whether the Fed must release records of the unprecedented $2 trillion US loan program launched after the 2008 collapse of Lehman Brothers Holdings Inc. In August, a federal judge ordered that the information be released, responding to a request by Bloomberg LP, the parent of Bloomberg News.

“‘This case is about the identity of the borrower,’ said Matthew Collette, a lawyer for the government, in oral arguments today. ‘This is the equivalent of saying ‘I want all the loan applications that were submitted.”

“Bloomberg argues that the public has the right to know basic information about the ‘unprecedented and highly controversial use’ of public money. Banks and the Fed warn that bailed-out lenders may be hurt if the documents are made public, causing a run or a sell-off by investors. Disclosure may hamstring the Fed’s ability to deal with another crisis, they also argued. The lower court agreed with Bloomberg.

“”The question is at what point does the government get so involved in the life of the institution that the public has a right to know?’ said Charles Davis, executive director of the National Freedom of Information Coalition at the University of Missouri in Columbia. Davis isn’t involved in the lawsuit.

“The ruling by the three-judge appeals panel may not come for months and is unlikely to be the final word. The loser may seek a rehearing or appeal to the full appeals court and eventually petition the US Supreme Court, said Anne Weismann, chief lawyer for Citizens for Responsibility and Ethics, a Washington advocacy group that supports Bloomberg’s lawsuit.

“New York-based Bloomberg, majority-owned by Mayor Michael Bloomberg, sued in November 2008 after the Fed refused to name the firms it lent to or disclose the amounts or assets used as collateral under its lending programs. Most were put in place in response to the deepest financial crisis since the Great Depression.”

Source: David Glovin and Thom Weidlich, Bloomberg, January 11, 2010.

Financial Times: Wall Street titans face the flak
“Four of Wall Street’s top executives offered some contrition and a defence of their actions on Wednesday, as the head of the Financial Crisis Inquiry Commission promised to use wide-ranging powers to establish the causes of the financial crisis and pursue any wrongdoing.

“Lloyd Blankfeinof Goldman Sachs, Jamie Dimon, chief executive of JPMorgan Chase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America maintained a united front as the Financial Crisis Inquiry Commission, headed by Phil Angelides, probed the bail-out of AIG, risk management and executive compensation.

“Mr Blankfein, whose bank has become a lightning rod for public anger at Wall Street, bore the brunt of the panel’s questions. He mounted a robust defence after being asked whether part of his business was akin to selling a car with faulty brakes and then buying an insurance policy. But he added: ‘Anyone who says I wouldn’t change a thing, I think, is crazy.’

“The Goldman boss said that he and his rivals had been insufficiently sceptical of loose credit standards.

“‘We rationalised [it] because a firm’s interest in preserving and growing its market share, as a competitor, is sometime blinding - especially when exuberance is at its peak.’

“Mr Angelides, a former California treasurer appointed head of the panel by Congress last year, told the witnesses on the first day of public hearings: ‘We’re after the truth … the hard facts … we’ll use our subpoena power as needed. And if we find wrongdoing, we’ll refer it to the proper authorities.’

“Bonuses are drawing increasing political fire on Capitol Hill as the banks prepare to announce billions of dollars in pay-outs over the next few days.

“‘Clearly Wall Street has to be a lot more attuned to what’s going on in the economy,’ said Mr Mack. But he said that compensation had to allow the banks to compete for staff. ‘I have to run a company.’

“As part of a plan to quell anger and ensure that any government bail-out losses are recouped, the Obama administration is planning to impose a levy on banks.

“Mr Dimon told reporters: ‘Using tax policy to punish people is a bad idea.’ He added that the banks should not be paying for losses caused by car companies and other industries.

“Mr Dimon acknowledged that ‘certain subprime mortgages  …  weren’t great products. I think there were some unscrupulous mortgage salesmen and mortgage brokers. And, you know, some people mis-sold.’

“Mr Dimon and Mr Moynihan agreed that banks should not be considered ‘too big to fail’.

“Mr Obama will on Thursday announce a new levy on banks to try to recoup some of the stimulus funding they received.”

Source: Tom Braithwaite and Francesco Guerrera, Financial Times, January 13, 2010.

The Wall Street Journal: Goldman Sachs CEO singled out
“The Wall Street Journal’s Jerry Seib joins the News Hub from Washington, where he says Goldman Sachs CEO Lloyd Blankfein became a target at a hearing before the Financial Crisis Inquiry Commission.”

Source: The Wall Street Journal, January 13, 2010.

MoneyNews: Romer - big bonuses to bankers are offensive, ridiculous
“A White House economic adviser says big year-end bonuses for bailed-out financial institutions would be ‘ridiculous’ and ‘offensive’.

“Christina Romer says the Bush administration’s $700 billion bailout was necessary to avoid a collapse of the financial system.

“Now that banks are returning to profitability as a result of government help, Romer says that paying out billions of dollars in bonuses ‘does seem really ridiculous’.

“Romer, who heads the president’s Council of Economic Advisers, say that kind of big payout ‘is going to offend the American people. It offends me.’”

Source: MoneyNews, January 11, 2010.

Financial Times: Obama vows to recover crisis cash
“Barack Obama slammed ‘obscene’ bank bonuses on Thursday, as the US president formally revealed plans to impose a levy on big financial institutions to recoup some of the costs of the financial crisis.

“‘We want our money back and we’re going to get it,’ Mr Obama said, pledging to ‘recover every single dime the American people are owed’ for the troubled asset relief programme bail-out fund.

“Appearing keen to pick a political fight with the big banks, Mr Obama faulted them for trying to ‘return to business as usual’ with ‘risky bets to reap quick rewards’ and compensation practices that did not reflect the state of the nation.

“‘I’d urge you to cover the costs of the rescue not by sticking it to your shareholders or your customers or your citizens but by rolling back bonuses,’ he said. Aides said the levy would recover at least $90bn from 50 of the largest institutions, including US subsidiaries of foreign banks and insurance companies as well as US banks.

“Treasury secretary Tim Geithner told the Financial Times that the US would urge other countries to adopt a similar principle of recouping bailout costs from the financial sector. ‘We are going to see if we can encourage policymakers in other important financial centres to do something similar,’ he said.”

Source: Krishna Guha, Financial Times, January 14, 2010.

Financial Times: Banks braced for Basel battle
“Banks are gearing up to fight a proposal by global regulators to sharply increase capital requirements for institutions that bring in outside investors to fund subsidiaries, saying it will cripple their ability to expand in emerging markets.

“Bank executives fear the provision would create huge holes in the capital stocks of a wide range of UK, European and Japanese financial institutions, at a time when they are already under pressure to increase their regulatory capital.

“Analysts described the proposal as one of the most ‘draconian’ and ‘potentially devastating’ parts of a package of measures put forward in December by the Basel committee, which sets global standards that are implemented by local regulators.

“Credit Suisse analysts calculate the rule would substantially reduce the estimated equity buffers that banks hold against potential losses.

“They estimate the so-called equity tier one capital ratio, a key measure of balance sheet strength which excludes hybrid capital such as preference shares, would be cut by 0.7 percentage points from the current 9.6 per cent.

“In essence, the Basel committee wants to force banks to stop counting minority-owned stakes as part of their equity capital but insists they continue to recognise the entire potential losses of any subsidiary.

“Regulators are essentially saying that banks are on the hook for all the losses of their subsidiaries, but that equity owned by minority investors in a particular subsidiary would not be available to absorb group losses elsewhere in the world.

“Banking analysts at Citi and Evolution have concluded that HSBC, BNP Paribas, Credit Agricole and Natixis would be particularly hard hit. The banks either did not respond or declined to comment.”

Source: Brooke Masters and Patrick Jenkins, Financial Times, January 12, 2010.

The Wall Street Journal: Beware of bond bubble
“Bond traders are leery of a possible growing bond bubble. If the bubble bursts, people’s retirement savings may be in jeopardy, SmartMoney’s Russell Pearlman reports.”

Source: The Wall Street Journal, January 12, 2010.

Financial Times: Rate rise fears spark rush to issue bonds
“Businesses and governments have rushed to raise tens of billions of dollars from bond markets in a frenetic round of new year fundraising amid fears that interest rates are set to jump.

“A flurry of issuers, including Virgin Media, BMW and Manchester United football club, turned to the capital markets on Monday aiming to raise more than $20bn.

“Poland and Mexico were among a number of governments that also tapped international investors.

“So far this month more than $75bn has been raised, more than two-thirds of this by financial institutions trying to repair their balance sheets in the wake of the economic crisis.

“Last week, the US corporate bond market had its second busiest day on record.

“Wayne Hiley, of Barclays Capital, said a recent rally in the corporate bond markets had lowered the interest rate premium to government bonds that businesses pay. ‘There are issuers who are saying ‘let’s take advantage of this’ even if they hadn’t planned to come to the market until later on,’ he said.

“Companies usually aim to sell bonds early in the year when investors have fresh funds and before many companies enter a ‘purdah’ period ahead of earnings announcements.

“However, the current round of capital raising is particularly intense. Some companies believe a recovery in economic growth this year will lead to central banks raising interest rates, pushing up the cost of borrowing.

“Other companies, fearing market turbulence as the authorities begin to unwind last year’s emergency monetary and fiscal measures to prop up the economy - which have included buying bonds - are borrowing as much as they can while demand for debt remains strong.”

Source: Jennifer Hughes and Aline van Duyn, Financial Times, January 11, 2010.

Financial Times: Sovereign bonds seen as riskier than corporates
“The cost of insuring against the risk of debt default by European nations is now higher than for top investment-grade companies for the first time, as mounting government debt prompts fears over the health of many leading economies.

“It now costs investors more to protect themselves against the combined risk of default of 15 developed European nations, including Germany, France and the UK, than it does for the collective risk of Europe’s top 125 investment-grade companies, according to indices compiled by data provider Markit.

“Markit’s iTraxx Europe index of 125 companies is trading at 63 basis points, or a cost of $63,000 to insure $10m of debt over five years. This compares with 71.5bp, or $71,500, for Markit’s SovX index of 15 European industrialised nations.

“Fears over sovereign risk have risen sharply in the past few months as investors have become increasingly alarmed over rising budget deficits and record levels of government bond issuance needed to pay off public debt.

“By contrast, hopes of a recovery have helped support corporate credit markets. Since September, the SovX index has jumped 20bp, while the iTraxx Europe index has narrowed 30bp.

“Bankers are even warning that big economies, such as the US and the UK, could lose their top-notch triple A status because of the deterioration in public finances.”

Source: David Oakley, Financial Times, January 12, 2010.

MoneyNews: Gross - German, Brazil bonds better than Treasuries
“Bill Gross, who manages the world’s biggest bond fund for Pimco, expects German and Brazilian bonds to outperform US Treasuries.

“In the US, the budget deficit, which totaled $1.4 trillion last year, will push up Treasury yields faster than German government bonds, Gross said.

“And while the US will likely endure huge deficits for years, Germany has a constitutional amendment requiring a balanced budget by 2016.

“‘(It) is the most fiscally conservative, has half the deficit of the United States, potentially has a low inflation rate, and they yield about the same,’ Gross told Bloomberg, comparing US and German 10-year government bonds.

“The 10-year US Treasury now yields about 45 basis points more than the equivalent 10-year bund.

“Brazilian bonds, which make up 2 percent of Gross’ Pimco Total Return Fund, also are attractive, he says.

“‘Brazil has the highest real interest rates in the world,’ he pointed out.

“Brazil’s 10-year government bond yields 11.22 percent.”

Source: Dan Weil, MoneyNews, January 14, 2010.

Bespoke: Strategists get stock happy
“Each week Bloomberg asks Wall Street strategists (the same ones polled for their year-end S&P 500 price targets) for their recommended portfolio allocations to stocks, bonds, and cash. Currently, the consensus recommended stock allocation is 60.5%. As shown in the chart below, this number has spiked significantly in recent weeks. Throughout the financial crisis, strategists lowered their recommended stock allocations pretty much every week. They missed the bottom, however, as the market turned before their consensus hit bottom. During the week of the Lehman collapse, strategists were recommending that investors have 56.6% of their portfolio in stocks.

“Add this as another indicator that is currently back to its pre-Lehman levels, while the S&P 500 is still has about 9% to go.

“The current reading of 60.6% is up quite a bit from its level at the market lows. This doesn’t yet suggest that strategists are too bullish, however, as their average recommendation during the ‘03-’07 bull market was about 64%.”

Source: Bespoke, January 14, 2010.

Bespoke: And you thought the rally in equities was impressive
“Even though the S&P 500 has rallied more than 60% off its March 2009 lows, the index is still well below the 1,251.70 level it closed at on the Friday before Lehman’s bankruptcy filing. While the rally has been quite impressive, it pales in comparison to the gains we’ve seen in the corporate bond market. As of last week, the spread between Baa rated corporate bonds and 30-year US Treasuries had narrowed to its lowest levels since July 2007! Yes, you read that right - July 2007. Back then, the S&P 500 was trading above 1,500.”

Source: Bespoke, January 11, 2010.

Bespoke: Estimated Q4 S&P 500 and sector earnings growth
“S&P 500 earnings are currently expected to grow by 62.1% in Q4 ‘09 versus Q4 ‘08. In the first chart below, we highlight how this growth estimate has changed since the start of the fourth quarter. As shown, estimates are essentially right where they were at the start of Q4, but there was a lot of movement in the estimate throughout the quarter. From October to the end of November, the growth estimate rose on a weekly basis all the way up to 75.7%. Since peaking, however, estimates headed lower by quite a bit until finally bumping up from 60% to 62.1% in the last week. As we enter earnings season, it’s probably a good thing for the bulls that expectations have come down a little.

“While the S&P 500 as a whole is expected to grow by 62.1% in the fourth quarter, the bulk of this growth is expected to come from the Materials and Financial sectors. As shown below, these are the only two sectors with Q4 growth expectations that are higher than the S&P 500. And more sectors are still expected to see a decline in earnings than a rise. Energy and Industrials are both expected to see earnings decline by more than 20% in the fourth quarter, while Telecom is not far behind at -19.2%. Health Care, Consumer Staples and Utilities are all expected to see a drop of about 5%. Technology and Consumer Discretionary are the other two sectors expected to see growth.”

Source: Bespoke, January 12, 2010.

John Authers (Financial Times): Too soon for complacency
“Markets have set themselves up for some bad news to send them spinning. On Tuesday, the bad news broke.

“Markets move on the interaction of news with flows of greed and fear among investors. When fear is lowest, the danger of a fall is greatest.

“This week the CBOE Vix Index, measuring volatility in US stocks, hit its lowest level since May 2008, when a lull after the Bear Stearns rescue gave way to an implosion.

“Another great contrarian indicator is the survey of sentiment by the American Association of Individual Investors. Last week, this showed the lowest proportion of self-described “bears” since February 2007 - when volatility first started to spike as investors at last began to grasp the severity of the subprime mortgage crisis in the US.

“Bearishness in this survey hit an all-time high in March last year when the current rally first started, showing how much money can be made by betting against extremes of sentiment.

“Even bulls should concede that this optimism looks overdone. Stock market valuations enshrine very strong earnings growth for this year, while there are numerous possibilities of macroeconomic shocks around the world.

“Tuesday, China tightened monetary policy, in a necessary action which displeased the market, while the European Commission condemned Greece for falsifying data, in a broadside that raised fears once more that Greece could default without being bailed out by fellow eurozone members.

“Meanwhile, Alcoa, the aluminium producer, revealed disappointing results to launch the US earnings season for the fourth quarter of last year.

“If not exactly the sum of all fears, this combination of bad news showed that it is too soon for complacency. There are real risks in many different places and the chance of a sharp correction looks high. In that context, Tuesday’s falls for stock markets around the world look surprisingly muted.”

Source: John Authers, Financial Times, January 12, 2010.

Bespoke: Volatility at lowest level since May 2008 - should you care?
“Now that the VIX index is at its lowest levels since May 2008, and down nearly 80% from its record high in late 2008, there is a growing concern among some investors that there is not enough fear in the marketplace. As the chart below indicates, the current level of 17.55 is lower than the long-term average of 20.3 since 1990. However, during the mid-nineties and the middle part of this decade, which were both good periods for equity investors, the VIX not only traded at and below current levels, but it also remained at those levels for several years.

“While the VIX’s decline over the last year indicates that investors are not as fearful as they were a year ago, can you blame them for not being so? Things haven’t quite returned to normal, but they are a lot closer now than they were then.”

Source: Bespoke, January 12, 2010.

CNBC: Kass’ correction
“The man who called the bottom now calls for a correction, with Douglas Kass of Seabreeze Partners.”

Source: CNBC, January 13, 2010.

David Fuller (Fullermoney): Treasuries above 5% could harm equities
“The main risk to economic recovery will surface when long-dated interest rates back up, presumably as quantitative easing (QE) is phased out. However, every seasoned financial observer, including those at the Fed and US Treasury, will be aware of this risk. Therefore, will they blur the date at which QE supposedly ends? Will they extend it? Might they agree to no more than a partial phase-out, retaining the freedom to squeeze ‘bond vigilantes’ if rates rise too quickly?

“My guess in response to these questions is, yes, one way or another. After all, the Fed has always been active in government bond markets and it will not want to leave yields looking exposed, like ducks in a shooting gallery. Whether the Fed and US Treasury can prevent rates from rising too quickly, possibly later this year, remains to be seen.

“I will take my cue from the chart action, with particular interest in how higher yields affect stock markets. For me, a sustained move above 4% by US 10-year Treasuries will be equivalent to a yellow caution light for equity investors. Above 5%, stock markets could be in dangerous territory, as we saw in the last cycle.

“However every forecast for a precise repetition of a previous cycle assumes that all other factors remain equal, which of course, is never the case. Therefore stock markets, which remain mostly in consistent uptrends today, could weaken sooner or later relative to long-term rates.

“Consequently I will continue to view US Treasury 10-year yields as a lead indicator. Currently, they are still in a ’sweet spot’. However when they move higher I will monitor stock market indices, particularly for Wall Street, even more closely for signs of fatigue in the form of inconsistencies, not least a loss of upward momentum.

“Lastly, an eventual break in 10-year yields to the downside below 3%, which I do not expect, could also be bearish for equities by signalling weaker GDP growth and rising deflationary pressures.”

Source: David Fuller, Fullermoney, January 11, 2010.

Bespoke: The smaller the better
“The average S&P 500 stock is up 3.50% so far in 2010. We broke the index into 10 deciles (10 groups of 50 stocks) based on market cap and calculated the average YTD percent change of the stocks in each decile to see how a company’s size has impacted performance so far this year. As shown below, the 50 biggest stocks in the S&P 500 are up an average of 2.4% year to date. The 50 smallest stock in the index are up an average of 6.5%. In general, the bigger the stock, the smaller the gain so far in 2010.”

Source: Bespoke, January 14, 2010.

MoneyNews: Goldman - big banks, Latin America are best buys for 2010
“A recent report from Goldman Sachs’ shows the investment bank forecasting that big banks with consumer exposure and commodities will be among the best bets for 2010.

“Goldman says that corporate profits will grow, especially in tech, business travel, office supplies and advertising - and that excess corporate cash will drive more mergers and acquisitions, bigger dividends and more stock buybacks.

“Tech growth will be built on the move towards cloud computing and a corporate level refresh of personal computers and servers.

“E-commerce will also continue to grow, taking advantage of its strength to draw business away from traditional competitors.

“Commodity prices will rise as demand outpaces supply, and inflation on key agricultural and protein commodities will boost the agricultural and supermarket industries, but damage internationally underexposed restaurant companies because increased foreign demand won’t benefit their bottom lines.

“Market-oriented Latin American nations and China are best positioned for what Goldman describes as the “post-crisis economy” and will outpace slow US recovery.

“As a supplier of natural resources, Latin America is becoming the go-to destination for new commodities consuming behemoths, particularly China.

“Obamacare, Goldman claims, is less important than the fundamentals for health care, where financial engineering increasingly generates med-tech earnings per share.

“Brazil’s economy will not need additional stimulus in 2010, although some measures introduced in 2009 could become permanent.”

Source: Julie Crawshaw, MoneyNews, January 12, 2010.

BCA Research: Interest rate differentials are likely to weigh against the US dollar
“The upturn in the global economy, a renewed widening of the US current account deficit and a Federal Reserve that keeps interest rates near zero will spell trouble for the US basic balance and keep the dollar under downward pressure.

“During 2002-2008, there was a marked divergence between the widening US current account deficit and falling real yields, which weighed on the dollar. The current account represents the US’s need for foreign capital. Meanwhile, real interest rates help to attract the required inflows. As these two variables moved in opposite directions, i.e. the current account widened and real rates fell, the dollar suffered as a consequence. Then, the Great Recession narrowed the US current account deficit and the deflationary pressures lifted real interest rates. This combination helped support the dollar in late 2008 and into early 2009. But with the deflationary impulse receding, real interest rates are falling again. As the US current account begins to widen and diverge with real interest rates, the dollar will face renewed downward pressure.

“Bottom line: Low real interest rates and a renewed cyclical widening of the US current account deficit should push the dollar lower in the coming months. This dynamic will be in place at least until the Fed begins to normalize interest rates, i.e. for most of 2010.”

Source: BCA Research, January 12, 2010.

CNBC: Implications of a strengthening yuan
“Beijing will probably appreciate the yuan by about 3-3.5% in 2010, predicts Tony Raza, director of asset allocation at UOB Asset Management. He outlines the implications this yuan appreciation will bring.”

Source: CNBC, January 11, 2010.

Bespoke: Commodity prices and the consumer
“Since the start of 2010, the rally in commodities has been a boon for companies and investors in the Energy and Materials sectors. Consumers, on the other hand, are increasingly feeling the impact on their wallets. In the chart below we have calculated the cumulative daily price change of the major food and energy commodities in the CRB index (Corn, Soy, Wheat, Cattle, Hogs, Oil and Natural Gas) since the beginning of 2008. We then multiplied the changes by the annual per capita consumption of each item. When the line is in positive territory, commodity prices are acting as a tax on consumers, while readings in negative territory are indicative of a windfall for consumers. Although this method may oversimplify the actual costs, it provides a good idea of how changes in commodity prices have impacted consumers’ wallets over the last 24 months.

“As shown in the chart, the rally in commodities in 2008 was especially painful on consumers. During the Summer of 2008, commodity prices were acting as a $4.77 per capita daily tax on US consumers versus the start of the year. When the credit crisis escalated, commodities tanked, thus erasing the entire tax (and then some) on consumers. By the time commodity prices bottomed in early 2009, US consumers were now benefitting from nearly a $5 daily windfall due to the decline. Since commodity prices bottomed early last year, however, that windfall has been slowly dwindling away. While US consumers are still benefitting from lower commodity prices compared to the start of 2008, the windfall is less than 30% of what it was nearly a year ago.”

Source: Bespoke, January 11, 2010.

MoneyNews: Pickens - forget the wind, go with natural gas
“Famed Texas billionaire T. Boone Pickens is dramatically changing his position on alternative energy.

“Pickens spent most of the last two years, and $62 million of his oil investing fortune, on an advertising campaign in which he sought to persuade Americans to adopt his plan for wind-based energy.

“The scheme called for a massive expansion of wind energy to displace natural gas, leaving natural gas for use in vehicles, thus displacing foreign oil.

“‘No American with a television set could escape Mr. Pickens’s argument last year. But somehow, a mass conversion to natural gas cars failed to ensue,’ a recent report in The New York Times stated.

“But, now Pickens is changing his pitch.

“Pickens said Wednesday he has cut in half an order for General Electric Co. wind turbines and plans to use the rest in other areas instead of Texas, where he once planned a massive wind farm, the Associated Press reported.

“Pickens, who heads the hedge fund BP Capital Management LP in Dallas, purchased 333 turbines from GE, which was about half his initial order of about 687 turbines.

“Pickens scrapped his plan for a 1,000-megawatt wind farm in West Texas last summer because of technical problems in getting power from the site to transmission facilities.

“Pickens now is spending millions more on a new campaign, with the first advertisements scheduled to be broadcast Thursday on cable stations across the country.

“His aides reckon that a stronger message, concentrating on the national security aspects of energy independence, will be quite effective after the thwarted Christmas Day airliner bombing and other, recent terrorist actions in the United States.

“Natural gas is said to be the cleanest fossil fuel, emitting fewer greenhouse gases than either coal or oil.

“Many energy experts say they think it is underutilized as a fuel, especially since new technologies recently unlocked huge reserves in shale gas fields across the country.

“Some, however, say putting in place the infrastructure for natural gas vehicles would be too costly, and battery-powered electric cars and hybrids are a much better alternative.”

Source: Gene Koprowski, MoneyNews, January 14, 2010.

Financial Times: China’s exports rise as economy picks up
“China’s exports rose in December for the first time in 14 months, providing fresh evidence of recovery in the global economy but also placing renewed pressure on Beijing to appreciate its currency.

“Following strong export figures last month from South Korea and Taiwan, China said on Sunday that its exports climbed 17.7 per cent, well ahead of the modest increase that economists had predicted. These numbers put China on track to overtake Germany as the world’s largest exporter.

“Chinese imports surged by 55.9 per cent in December, the latest indication of buoyant domestic demand in China, although the figures are also likely to increase concerns about potential inflationary pressures.

“Exports to China’s two biggest markets both rebounded last month, with sales to the US increasing 15.9 per cent and to the European Union 10.2 per cent.

“However, the year-on-year comparisons were inflated by the low base of the previous year’s figures. Economists said some of the improvement was due to restocking by companies that had run down inventories.

“‘While December’s export figures are encouraging … a recovery to pre-crisis levels appears some time away,” said Jing Ulrich, head of China equities and commodities for JPMorgan.

“Andy Rothman, CLSA’s chief China economist, said a resumption of export growth was necessary before Beijing restarted appreciation of the renminbi, suspended over a year ago in the crisis. He said Beijing was unlikely to act on one month’s figures alone. But if the export recovery continued, China’s leaders would have the political cover to resume renminbi appreciation by mid-year, with a possible rise of 3 per cent for 2010.

“‘Beijing has been waiting for three things to happen before resuming gradual appreciation: strong economic recovery in China; stability in the US and European economies; and several months of [positive] Chinese export growth, which is important to sell appreciation to the domestic audience.’

Source: Patti Waldmeir, Financial Times, January 10, 2010.

Financial Times: China raises bank reserve requirements
“China has increased the amount banks must set aside as reserves in the clearest sign yet that the central bank is trying to tighten monetary conditions amid mounting concerns of overheating and inflation as a result of the credit boom.

“The People’s Bank of China also raised interest rates modestly in the inter-bank market on Tuesday for the second time in less than a week, as it engages with commercial banks in a tug-of-war over rapid lending.

“Stock markets and commodities fell in Asia on Wednesday after the surprise decision, sparking concerns that the move could slow China’s purchases of natural resources and other imported goods from around the region.

“Economists said that Tuesday’s announcements were a warning to the banks against lending too aggressively following reports in state media that loans in the first week of 2010 reached Rmb600bn ($88bn), not far short of the monthly average last year.

“‘This is a warning across the bows of the commercial banks,’ said Tom Orlik, of Stone & McCarthy in Beijing. ‘The central bank said that the high level of bank lending needs to come to an end but that the commercial banks do not seem to be taking it seriously.’

“Reserve requirements were raised by 0.5 percentage points, while rates on one-year paper increased by 0.08 per cent and on three-month paper by 0.04 per cent.

“The moves underline the increasingly delicate task the PBoC is facing in managing the consequences of China’s credit binge, when lending more than doubled from Rmb4200bn in 2008 to above Rmb9000bn last year.”

Source: Geoff Dyer, Financial Times, January 12, 2010.

The Wall Street Journal: China’s hot money headache
“While Beijing battles its coldest winter in half a century, Chinese officials are battling a major hot money problem. Heard on the Street’s Andrew Peaple ponders the government’s efforts to restrain the flow of funds into China.”

Source: The Wall Street Journal, January 12, 2010.

Bloomberg: China’s property prices rise most in 18 months
“Rong Ren, chief executive officer of Harvest Capital Partners, talks with Bloomberg’s Bernard Lo about the implications of China’s increase in the proportion of deposits banks must set aside as reserves. Ren, speaking in Hong Kong, also discusses his strategy for investing in China’s retail malls and development projects.”

Click here for the full article.

Source: Bloomberg, January 14, 2010.

Financial Times: Greece unveils 3-year plan to curb deficit
“Greece on Thursday announced an ambitious three-year plan to curb its runaway budget deficit but failed to convince sceptical markets its targets for growth and fiscal reform were feasible.

“The stability and growth plan calls for the budget deficit to be cut from 12.7 per cent to 2.8 per cent of gross domestic product by the end of 2012.

“The economy is projected to shrink by 0.3 per cent this year before rebounding with growth of 1.5 per cent in 2011 and 1.9 per cent in 2012.

“The deficit would be reduced this year by 4 percentage points of GDP, with deep cuts made in hospital and defence spending where waste and corruption are widespread, according to officials. Revenue increases would be driven by higher excise taxes on tobacco and alcohol, an overhaul of the tax system and a crackdown on tax evasion.

“‘This plan can be achieved, we’re confident of that,’ said George Papandreou, the prime minister, after an outline was presented at a televised cabinet meeting.

“The plan is seen as Greece’s passport to borrowing almost €54bn ($78bn) on international markets to fund a swollen public debt expected to rise this year from 113 per cent to more than 120 per cent of GDP.

“But markets reacted negatively almost as soon as George Papaconstantinou, finance minister, finished his presentation at a cabinet meeting broadcast live on Greek television under the government’s policy of promoting transparency.

“The cost to insure Greek debt rose to fresh heights as investors continued to worry about the parlous state of the country’s finances. The Greek bond markets also sold off, dipping to 12-month lows.

“‘We think these forecasts are too optimistic … we doubt the government will meet its fiscal targets - the recent renewed surge in government bond yields may therefore have further to go’, said Ben May of Capital Economics in note published on Thursday.

“‘The two targets - growth and public deficit - are inconsistent and at least one won’t be achieved,’ BNP Paribas said in a note.”

Source: Kerin Hope and David Oakley, Financial Times, January 14, 2010.

Tags: Asset Classes, Barack Obama, BRIC, Canada, Cboe, China, Christina Romer, Commodities, Council Of Economic Advisers, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Index, Economic Recovery, Emerging Markets, ETF, Financial Institutions, Gnomes, Gold, India, Inquiry Commission, Interesting News, Interrogating, Market Commentators, oil, Pecora, Research Resources, S Council, Steve Sack, Top Executives
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James Surowiecki: Why the Chinese Don’t Spend

Tuesday, December 1st, 2009

James Surowiecki, New Yorker columnist answers the question about China’s under-consumption.

“China makes, the world takes.” For decades, that has been the motto of the Chinese economy, which is built on providing an endless supply of goods for the rest of the world to buy. But these days there’s a palpable sense that this needs to change. Barack Obama, on his recent trip to Asia, called for a “rebalancing” of the world economy, meaning that China should save less and spend more, while the Chinese President, Hu Jintao, stressed his country’s “vigorous” efforts to promote consumer spending. Everyone wants Chinese consumers to spend more. So why don’t they?

Tags: Barack Obama, China, Chinese Consumers, Chinese Economy, Chinese President Hu, Chinese President Hu Jintao, Columnist, Consumer Spending, Consumption, Economy China, Emerging Markets, Endless Supply, Hu Jintao, James Surowiecki, Motto, New Yorker, Palpable Sense, President Hu Jintao, Rebalancing, Rest Of The World, Trip To Asia, Vigorous Efforts, World Economy
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Robert Zoellick: The World Economy and It’s New Hotspots

Friday, November 20th, 2009

In this three-part video interview, Robert Zoellick, president of the World Bank, discusses with Chrystia Freeland, FT’s US managing editor, a range of topical issues concerning the global economy, new economic hotspots, China’s currency peg and lessons from the crisis.

Part 1: China and the dollar
Zoellick talks about President Barack Obama’s recent trip to China and the effects of Chinese currency being pegged to the dollar. He also discusses increased criticism from China of US economic policy.

Click here or on the image below to view Part 1 of the interview.

Part 2: World economy
Zoellick talks about the state of the world economy, including the financial recovery, concerns about protectionism and the role the US consumer will play in the recovery. Additionally, he discusses America’s fiscal position, the weakening US dollar and the new economic hot spots.

Click here to view Part 3 of the interview.

Part 3: Lessons from the crisis
Zoellick talks about lessons from the crisis, including executive compensation, and whether the casino function of banks should be separated from the utility function.

Click here to view Part 3 of the interview.

Source: Chrystia Freeland, Financial Times, (here, here and here), November 19, 2009.

Tags: Barack Obama, China, Chinese Currency, Chrystia Freeland, Currency Peg, economic policy, Emerging Markets, Executive Compensation, Financial Times, Fiscal Position, Global Economy, Hot Spots, Interview Robert, Interview Source, Managing Editor, President Of The World, Protectionism, Robert Zoellick, Topical Issues, Trip To China, Video Interview, World Economy
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The Secret of Obama’s Success

Saturday, September 26th, 2009

Obama’s consistency is forever captured in photos in this amazing video montage:

Click play to view:

Barack Obama’s amazingly consistent smile from Eric Spiegelman on Vimeo.

Hat tip: Steve Rubel

Tags: Barack Obama, Consistency, Eric, Hat Tip, Photos, Smile, Spiegelman, Steve Rubel, Success, Vimeo
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Words from the (Investment) Wise (August 30, 2009)

Sunday, August 30th, 2009

Stock markets, in general, again logged gains last week as pundits perceived economic data to be better than expected. But the recovery path is not home and dry yet, as shown by declines in crude oil, a number of emerging stock market indices, small cap indices and high-yield corporate bonds. All said, risky assets displayed some fatigue despite positive economic reports.

Caution remained over the robustness of any economic upswing, as reflected by the solid performance of government bonds, with safe-haven currencies such as the US greenback and the Japanese yen also edging up.

As expected, Federal Reserve Chairman Ben Bernanke was appointed by President Barack Obama on Tuesday to serve a second term. “Mr Obama is said to credit Mr Bernanke with a leading role in helping to avert economic catastrophe. By reappointing Mr Bernanke - who worked in the Bush White House - Mr Obama can also emphasize his bipartisan credentials at a time when he is embroiled in a fiercely partisan battle over healthcare reform,” commented the Financial Times.

Source: LOLFed.com

However, critics of Obama’s decision were plentiful and Morgan Stanley’s Stephen Roach, blaming Bernanke for his pre-crisis actions, said (via the Financial Times): “It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor.” Bill King (The King Report) ascribed the stock market rising subsequent to Obama’s announcement to a “thank God it’s not Larry Summers” rally.

The past week’s performance of the major asset classes is summarized by the chart below - a set of numbers showing both the S&P 500 Index and government bonds rising, indicating an expectation of a subdued economic recovery and that the Fed’s monetary policy will stay easy for an extended period of time.

Source: StockCharts.com

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

The MSCI World Index (+1.3%) and MSCI Emerging Markets Index (-0.2%) again followed separate paths last week as China, Hong Kong and Brazil underperformed. Mature stock markets have recorded gains for a straight seven weeks, whereas emerging markets have seen two back-to-back weeks of declines. The end result is that emerging markets have now underperformed developed markets for four weeks running. Could this be a sign of a retrenchment in risk appetite?

The major US indices extended their gains to two consecutive weeks, including eight straight up-days in the case of the Dow Jones Industrial Index, before getting snapped by a decline on Friday. The year-to-date gains are as follows: the Dow Jones Industrial Index +8.7%, the S&P 500 Index +13.9% and the Nasdaq Composite Index +28.6%. With declines on three days, the Russell 2000 Index was the odd index out last week, but still boasts a respectable +16.1% gain since the beginning of 2009.

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

Top performers in the stock markets this week were Lithuania (+28.2%), Estonia (+17.3%), Latvia (+12.6%), Egypt (+9.6%) and Iceland (+9.1%). The top three positions were all occupied by eastern European countries where worries over the risk of some economies collapsing have receded. At the bottom end of the performance rankings, countries included Nepal (-4.0%), China (-3.4%), Kenya (-2.7%), Uganda (-2.6%) and Bangladesh (-1.8%).

The Chinese Shanghai Composite Index recorded its fourth consecutive down-week as investors remained concerned about how long China’s exceptionally loose monetary policy will continue. The banking regulator has already instructed lenders to raise reserves to 150% of their non-performing loans by the end of this year - up from 134.8% at the end of June, and the central bank has increased money-market rates to drain liquidity.

However, US Global Investors opines that historically sustainable market rallies out of a cyclical trough usually start with an expansion in valuation multiples followed by a recovery in earnings. “China may be poised to enter this second stage against a favorable macro backdrop. With surging money supply and significantly lower commodity prices from a year earlier, corporate earnings in China could produce upside surprises going forward,” said the report.

Source: US Global Investors - Weekly Investor Alert, August 28, 2009.

Of the 96 stock markets I keep on my radar screen, 77% (last week 47%) recorded gains, 18% (47%) showed losses and 5% (4%) remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the winners for the week included CurrencyShares Russian Ruble (XRU) (+5.0%), First Trust Amex Biotechnology (FBT) (+4.8%), iShares MSCI Australia (EWA) (+4.5%) and iShares Silver Trust (SLV) (+4.2%).

On the losing side of the slate, ETFs included Claymore/AlphaShares China Real Estate (TAO) (-4.2%), Market Vectors Coal (KOL) (-3.1%), SPDR KBW Regional Banking (KRE) (-3.1%) and iShares MSCI Brazil (EWZ) (-3.0%).

As far as credit markets are concerned, Bloomberg reported that banks were increasing lending to buyers of high-yield company loans and mortgage bonds at what might be the fastest pace since the credit-market debacle began in 2007. “Federal Reserve data show the 18 primary dealers required to bid at Treasury auctions held $27.6 billion of securities as collateral for financings lasting more than one day as of August 12, up 75% from May 6. The increase over that 14-week stretch is the biggest since the period that ended April 2007, three months before two Bear Stearns Cos. hedge funds failed because of leveraged investments.” This is a sign of credit markets moving towards normalization.

Referring to the mind-boggling US budget deficit, the quote du jour this week comes from 85-year old Richard Russell, author of the Dow Theory Letters. He said: “Comes the dawn - and the penalty. There’s a price to be paid for Bernanke’s all-out battle to thwart the bear market. And now it’s being told. Yesterday the White House itself admitted that the budget deficit over the next 10 years would be $2 trillion above their original outrageous estimate of $7 trillion dollars.

“As I said all along, it would have been better to have allowed the bear market to run its course to conclusion. That would have been extremely painful, but the US would have recovered. However, deficits in the trillions could ultimately ‘break’ this nation. I can’t imagine how Bernanke-Obama plan to handle the coming mind-blowing deficits, plus the interest on those deficits.

“The pressure will be on the reserve status of the dollar, the level of the dollar compared to other international currencies, interest rates, and the standard of living of all of us living in the new ‘banana republic’, the United States of ‘bankrupt’ America.

“When you take all this in, you can begin to see how this bear market could end with stocks selling below known values and people despising the stock market and capitalism.”

Other news is that the Fed must for the first time identify the companies in its emergency lending programs - created to address the financial crisis - after losing a Freedom of Information Act lawsuit against Bloomberg. The Fed is likely to appeal against the order on the grounds that such disclosure would threaten the companies and the economy.

Also, the Federal Deposit Insurance Corporation (FDIC) on Thursday said (via the Financial Times) the number of “problem banks” had grown from 305 to 416 during the second quarter, representing total assets of $299.8 billion. In the meantime, the FDIC’s deposit insurance fund, which insures up to $250,000 per depositor in each bank, had fallen to just $10.4 billion - the lowest level since March 1993 - as a result of all the bank failures, tallying 84 so far in 2009.

Next, a tag cloud of all the articles I read during the past week. This is a way of visualizing word frequencies at a glance. Key words such as “market”, “Fed”, “bank”, “prices”, “rates” and “economy” featured prominently. Interestingly, “recovery” is still moving up the ranks as the global economy seems to have turned the corner.

The key moving-average levels for the major US indices, the BRIC countries and South Africa (from where I am writing this post) are given in the table below. With the exception of the Chinese Shanghai Composite Index, which fell below its 50-day moving average about two weeks ago, all the indices are trading above their respective 50- and 200-day moving averages. The 50-day lines are also in all instances above the 200-day lines and therefore not threatening the bullish “golden crosses” established when the 50-day averages broke upwards through the 200-day averages.

The August 17 lows that represent short-term support levels for the major US markets and are as follows: Dow Jones Industrial Index (9,135), S&P 500 Index (980) and Nasdaq Composite Index (1,931).

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

For more on key levels and some ideas regarding the short-term direction of the S&P 500 Index, Adam Hewison’s (INO.com) short technical analysis provides valuable insight. Click here to access the presentation.

The chart below, courtesy of Bespoke, shows that the average short interest as a percentage of float for stocks in the S&P 1500 is currently at 6.9% - the lowest level since February 2007 when the average was 6.6%. “In 2008, it was the bulls who argued that high levels of short interest were a reason the market should rally. With the recent data, however, it is now the bears who will argue that low levels of short interest suggest that investors are now too bullish,” remarked Bespoke.

Source: Bespoke, August 26, 2009.

Doug Kass (The Street.com) said: “The authorities have created a sugar high for speculation, with a Federal Reserve that has maintained interest rates so low that there is no return on savings and with an Administration that promises to provide stimulus until it manufactures economic growth. My view is that investors will shortly see through the current sugar high and the better-than-expected earnings cycle and will begin to look over the valley at the chronic and secular issues that have emerged from the past cycle and from policy decisions aimed at returning the domestic economy toward self-sustaining growth.”

The last words on equities go to Jeff Saut, investment strategist of Raymond James, who said “‘Breakout or fake out?’ is the question du jour. Yet as market maven Arthur Zeikel wrote decades ago, ‘Despite what theoreticians tell us, investing - particularly at the margin - is not the product of rational and objective analysis, but an emotional relative analysis - anxiety about the future.” My colleague Bob Ferrell put it this way: ‘Emotions are simply stronger than reason; people do not change and people make markets!’ Indeed, fear, hope and greed are only loosely connected to the business cycle. And, at session 30 in the ‘buying stampede’, we are clearly in the ‘greed phase’. We continue to invest, and trade accordingly.”

For more discussion on the direction of financial markets, see my recent posts “Stages of a secular bear market“, “The lie of the investment land, according to Hugh Hendry“, “Picture du Jour: Stock market rally long in the tooth” and “RGE: Impact of China on financial markets“.

Economy
“Global business confidence remained positive last week for the third straight week. The last time confidence was consistently positive was nearly a year ago,” said the latest Survey of Business Confidence of the World by Moody’s Economy.com. “Businesses are responding most positively to broad assessments of the current economic environment and the outlook into early 2010; they are as strong as they have been since the financial crisis first hit in the summer of 2007.” The Survey results suggest that the global recession is coming to an end, but isn’t quite over yet.

Source: Moody’s Economy.com

The German economy expanded in the second quarter of 2009 with real GDP rising by 0.3% on a seasonally adjusted basis from the previous quarter. Also, the Ifo Business Survey reported that German business confidence improved to an 11-month high in August, indicating a further improvement in GDP in the second half of 2009.

Source: Ifo, August 27, 2009.

Heading home from Jackson Hole a week ago, the world’s central bankers seemed in no hurry to start increasing interest rates - intent on not repeating the monetary policy tightening mistakes of the Great Depression. As reported by the Financial Times, Martin Feldstein, a Harvard professor, thought it would be possible to have “two years or more of very low interest rates” without risk of excess inflation, given the labor and factory capacity in the economy.

Meanwhile, after keeping the interest rate at a record low of 0.5% from April to July 2009, the Bank of Israel (BoI) became the first central bank to raise interest rates in this cycle, increasing the benchmark rate to 0.75%. Analysts believe Australia and Norway will tighten first among the G-10 central banks in 2010, as reported by RGE Monitor.

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

Friday, August 28
• “Cash for clunkers” lifts consumer spending in July

Thursday, August 27
• Jobless claims decline, but continuing claims including special programs advance
• Q2 real GDP unchanged at -1.0%

Wednesday, August 26
• Sales of new homes advanced, inventories are shrinking
• Defense and aircraft orders lift durable goods in July

Tuesday, August 25
• Case-Shiller Home Price Index and FHFA House Price Index - noteworthy recovery
• Gain in consumer confidence during August nearly erases losses of prior two months

Monday, August 24
• Chicago Fed National Activity Index - confirms positive signals of other reports

The S&P/Case-Shiller Home Price Index for June showed its second straight monthly increase. According to Bespoke, the last time home prices increased two months in a row was back in the summer of 2006 at the end of the last housing boom. “June’s 1.4% monthly gain was also the largest monthly increase since June 2005. There’s no denying that these numbers are showing considerable improvement.”

Source: Bespoke, August 25, 2009.

The White House confirmed on Tuesday that the US deficit would be wider than they had previously estimated. The graph below, courtesy of Clusterstock - Business Insider, shows that although the budget deficit as a percentage of GDP has been revised down for 2009 - due to less bailout spending - it has been increased for every year through 2019.

Source: Clusterstock - Business Insider, August 25, 2009.

“The longest and deepest recession of the postwar era has ended,” said IHS Global Insight chief economist Nariman Behravesh (via MarketWatch). However, he expressed concern that the recovery could lose steam in a few quarters, warning: “A sustained, robust global recovery depends on renewed growth in consumer spending and capital investment. The coming expansion will be restrained by cautious consumers in the United States and Europe, who are saving to rebuild depleted assets and reduce debt burdens.”

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

Source: Yahoo Finance, August 28, 2009.

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

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

Monday, August 31
• Chicago PMI

Tuesday, September 1
• Construction spending
• ISM Index
• Auto sales

Wednesday, September 2
• ADP employment
• Productivity
• Factory orders
• FOMC minutes

Thursday, September 3
• Initial jobless claims
• ISM services

Friday, September 4
• Nonfarm payrolls
• Unemployment rate

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, August 28, 2009.

“Great minds talk about ideas. Average minds talk about events. Small minds talk about people,” said Eleanor Roosevelt. Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist Investment Postcards readers to generate money-making ideas that look past the noise investors so often wave to wade through.

For short comments - maximum 140 characters - on topical economic and market issues, web links and graphs, you can also follow me on Twitter by clicking here.

That’s the way it looks from Cape Town (from where I am leaving on a business trip to Slovenia in five days’ time - let me know if you are in Ljubljana at the time and would like to meet).

Source: Nate Beeler, August 28, 2009.

Clusterstock: The great banking recovery or next bubble?
“Should we be happy that the value of investments owned by commercial banks has begun to rapidly climb? Or should we be worried that the value is climbing at such a rapid clip that it looks a bit like an unsustainable bubble? Or is it just evidence of banks hoarding money and refusing to lend it out, holding Treasuries and securities instead?”

Source: John Carney and Rory Maher, Clusterstock - Business Insider, August 26, 2009.

Bloomberg: World economy emerging from worst recession since World War II
“The global economy may be coming out of the worst recession since World War II as record-low interest rates and trillions of dollars in fiscal stimulus spur demand.

“Sales of existing US homes jumped in July to the highest level since August 2007, and German service industries expanded this month for the first time in almost a year, reports yesterday showed. The Japanese economy grew for the first time in five quarters, according to a report earlier this week.

“‘There is no question the global economy is healing and emerging from recession,’ Kenneth Rogoff, a Harvard University professor and former chief economist for the International Monetary Fund, said in a Bloomberg Television interview yesterday.

“Federal Reserve Chairman Ben Bernanke and other global policy makers cautioned that the recovery is likely to be muted, indicating they would not soon remove all the stimulus injected into the financial system.

“‘Strains persist in many financial markets across the globe,’ Bernanke said in a speech yesterday at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming. ‘The economic recovery is likely to be relatively slow at first, with unemployment declining only gradually from high levels.’

“The US housing market, which led the way into the recession, is showing signs of righting itself after almost four years of declines. The 7.2% rise in sales of existing homes last month was the biggest since the National Association of Realtors began keeping records in 1999.

“In Germany, Europe’s largest economy, ‘business sentiment among service providers strengthened in August and was the most positive since January 2006,’ Markit Economics said yesterday, pointing to its purchasing managers’ survey.

“‘The recession is over,’ said Klaus Baader, chief European economist at Societe Generale SA in London, who called the Markit data an ‘incredible reading’.

“Japan’s economy is also being boosted by government measures ahead of an election. Prime Minister Taro Aso, whose party is trailing in opinion polls before the August 30 parliamentary elections, has put forward a 25 trillion yen ($265 billion) stimulus plan.

“The 3.7% rise in Japanese gross domestic product in the second quarter followed an 11.7% contraction in the first three months of the year. Exports led the revival of the world’s second-largest economy last quarter, jumping by 6.3%.”

Source: Rich Miller and Alison Sider, Bloomberg, August 22, 2009.

Nouriel Roubini (RGE Monitor): The exit strategy from the monetary and fiscal easing - damned if you do, damned if you don’t
“In the last few months the world economy has been saved from a near depression. That feat has been achieved by a range of extraordinary government stimulus measures: In the US and in China, and to a lesser extent in Europe, Japan and other countries, governments have pumped liquidity, slashed policy rates, cut taxes, primed demand and ring-fenced and back-stopped the financial system. All of this has worked, but it has worked at a cost. Governments have been spending and borrowing like never before. The question now is: how do they stop?

“This is not a simple problem. Restore normality too soon and the risk is that a weak recovery will double dip into a second and deeper recession. Restore it too late and inflation will already be ingrained.

“The second quarter GDP estimates for the US show just how significant this aggressive front-loaded policy stimulus has been. While total GDP growth was sharply negative in the first quarter - around -5.6% - the rate of decline in the second quarter had moderated to around -1.5%. Credit this relative improvement to governmental monetary, fiscal and financial stimulus. The private components of GDP, private demand and capex, were actually still very weak. But government spending rose by 5.6%, breaking what otherwise would have been another quarter of headlong GDP contraction.

“Necessary as the stimulus has been, it cannot go on indefinitely. Governments cannot run deficits of 10% or more of GDP, and they cannot go on doubling the monetary base, without eventually stoking inflation expectations, pushing up long term interest rates and eventually eroding their very viability as sovereign borrowers. Not even the US can do that.”

Click here for the full article.

Source: Nouriel Roubini, RGE Monitor, August 24, 2009.

Financial Times: Central bankers content to keep rates low
“The world’s central bankers were in no hurry to start raising interest rates as they headed home on Sunday from the US Federal Reserve’s annual retreat in Jackson Hole, Wyoming.

“In private and in public, most officials indicated they believed that rates could be maintained at ultra-low levels for a considerable time without generating excess inflation, in spite of better economic data and a return of ‘animal spirits’ in financial markets.

“Some used the platform of the conference to push back against calls for early implementation of ‘exit strategies’ that would reverse the current extraordinary degree of monetary stimulus.

“‘There is no reason to re-assess our monetary policy stance,’ Erkki Liikanen, Finland’s central bank governor, told Bloomberg news agency. Ewald Nowotny, Austria’s central bank chief, said he did not favour adding a surcharge to the European Central Bank’s next offer of one-year loans to banks - a view shared by some other European officials in Jackson Hole.

“If the ECB simply offers the money at its current policy rate, the market is likely to interpret this as a signal that it does not expect to raise interest rates for 12 months.

“Federal Reserve officials have edged up their assessment of economic conditions but have not significantly revised 2010 forecasts. They are encouraged by the shares rally, and see scope for this to support economic activity by restoring lost wealth and improving confidence, but are not betting too much on this.

“Don Kohn, vice-chairman of the Fed, said he saw no contradiction between its commitment to keep rates low for an ‘extended period’ and the desire to keep inflation at moderate levels - though he emphasised that this was a conditional commitment that could change if the economic outlook changed.

“Martin Feldstein, a Harvard professor, thought it would be possible to have ‘two years or more of very low interest rates’ without risk of excess inflation, given the spare capacity in the economy.

“Rick Mishkin, a former Fed governor, told the Financial Times the Fed would be easing policy further if it were not for the costs associated with monetising government debt.

“‘Optimal policy suggests more Treasury purchases would make sense. But that ignores the fiscal situation,’ he said. ‘The Fed is absolutely right to get off that programme - it cannot be seen to be accommodating the government deficit.’

“Jean-Claude Trichet, president of the European Central Bank, meanwhile spoke against a return to complacency and a failure to follow through on financial reforms, even though ‘we are a little bit out of the current episode’.”

Source: Krishna Guha, Financial Times, August 23, 2009.

The Wall Street Journal: Policy makers seek to learn from 1937’s stalled comeback
“A few months ago, Obama administration officials were sounding the alarm about another 1929. These days, it’s 1937 that has them in a sweat.

“The Great Depression was W-shaped. The stock-market collapse led to a steep economic decline. But by 1933, the economy had rebounded. Then a series of monetary and fiscal blunders drove the country back into a deep recession at the end of 1937.

“That episode is at the heart of the debate over how quickly the government and the US Federal Reserve should unwind the emergency measures they have taken to fend off a Depression-like contraction.

“For the administration, the answer is clear: Err on the side of continued expansionary policies. ‘What you learned from that episode in 1937 is that it’s not enough to be recovering,’ says Christina Romer, chairman of the president’s Council of Economic Advisers and an expert on the Great Depression. ‘You don’t want to do anything when you start recovering that nips it off too soon.’

“For fiscal conservatives, the answer is equally clear: Start cutting the federal deficit and slowing the growth in the money supply now, before the binge generates a burst of inflation.

“Ms. Romer is ’sending the absolutely wrong message - that we can’t do anything to worry about inflation until the recovery is locked in because of concern for unemployment,’ says Allan Meltzer, a political economist at Carnegie Mellon University. ‘The reason economists and central bankers have two eyes is so they can do two things at once.’

“The economy was recovering briskly during Franklin D. Roosevelt’s first term in the White House. The jobless rate, which had peaked at 25% in 1933, fell to 14% in 1937 - not exactly cause for celebration but a relief nonetheless.

“The comeback stalled in 1937. Banks, nervous about the fragile recovery, were holding huge amounts of cash in reserve at the Fed. Fearing an inflationary surge should the banks decide to lend that money out to businesses and individuals, the Fed - which had made the mistake of tightening monetary policy soon after the 1929 stock-market crash - miscalculated again. The Fed ratcheted up banks’ reserve requirements three times, starting in 1936. The banks reacted by cutting lending even further.

“‘There’s no doubt that [Fed Chairman Ben] Bernanke is heavily influenced by these two mistakes of the Fed during the Depression and is absolutely intent on not repeating them,’ says Alex J. Pollock of the American Enterprise Institute, a free-market think tank in Washington.”

Source: Michael Phillips, The Wall Street Journal, August 24, 2009.

Financial Times: Obama to offer Bernanke second term
“Ben Bernanke is to be reappointed by President Barack Obama for a second four-year term as chairman of the Federal Reserve, according to a White House official.

“Mr Obama will make the announcement on Tuesday in Martha’s Vineyard, where he is on holiday with his family. The decision is the ultimate seal of approval for the Fed chairman, who was originally appointed by George W Bush, the Republican former president, and whose reappointment was seen as far from guaranteed.

“It follows Mr Bernanke’s extraordinarily aggressive efforts to fight the economic crisis, including radical interest rate cuts, loans to non-bank financial institutions, Fed-led bailouts of Bear Stearns and AIG and gigantic asset purchases - exploiting the Fed’s powers to their legal limits in a bid to prevent a second Great Depression.

Economists, investors and fellow central bankers overwhelmingly favour Mr Bernanke’s reappointment. However, disquiet in Congress over the exercise of extraordinary Fed powers has raised a cloud over his future.

“The Fed chairman’s reappointment still has to be approved by the Senate, but his prospects look good. Chris Dodd, chairman of the Senate banking committee, on Monday said that ‘reappointing Chairman Bernanke is probably the right choice’, though he promised a ‘thorough and comprehensive confirmation hearing’.

“Mr Obama is said to credit Mr Bernanke with a leading role in helping to avert economic catastrophe. By reappointing Mr Bernanke - who worked in the Bush White House - Mr Obama can also emphasise his bipartisan credentials at a time when he is embroiled in a fiercely partisan battle over healthcare reform.”

Source: Krishna Guha, Financial Times, August 25, 2009.

The Wall Street Journal: Bernanke reappointment politically shrewd
“As President Obama trumpets the turnaround in the economy, WSJ’s Executive Washington Editor Gerald Seib says the reappointment of Federal Reserve chairman Ben Bernanke, therefore, is a politically shrewd move.”

Source: The Wall Street Journal, August 25, 2009.

Stephen Roach (Financial Times): The case against Bernanke
“Barack Obama has rendered one of his most important post-crisis verdicts: Ben Bernanke will be nominated for a second term as chairman of the Federal Reserve. This is a very shortsighted decision. While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing programme, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s. It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor.

“Mr Bernanke made three critical mistakes in his pre-Lehman incarnation:

“First, and foremost, he was deeply wedded to the philosophical conviction that central banks should be agnostic when it comes to asset bubbles.

“Second, Mr Bernanke was the intellectual champion of the ‘global saving glut’ defence that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia.

“Third, Mr Bernanke is cut from the same market libertarian cloth that got the Fed into this mess.

“Notwithstanding these mistakes, Mr Obama may be premature in giving Mr Bernanke credit for the great cure. No one knows for certain as to whether the Fed’s strategy will ultimately be successful. The worst of the US recession appears to have been arrested for now - a fairly typical, but temporary, outgrowth of the time-honoured inventory cycle. But the sustainability of any post-bubble recovery is always dubious. Just ask Japan 20 years after the bursting of its bubbles.

“While financial markets are giddy with hopes of economic revival - in part inspired by Mr Bernanke’s cheerleading at the Fed’s annual Jackson Hole gathering - there is still good reason to believe that the US recovery will be anaemic and fragile. US consumers are in the early stages of a multi-year retrenchment as they cut debt and rebuild retirement saving. The unusual breadth and synchronicity of the global recession will restrain US export demand from becoming a new growth engine.

“It would be the height of folly to reward Mr Bernanke for the recovery that never stuck. Yet Mr Bernanke’s apparent reward is, unfortunately, typical of the snap judgments that guide Washington decision-making. In this same vein, it is hard to forget Mr Greenspan’s mission-accomplished speech in 2004 that claimed ‘our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful’. Eager to declare the crisis over, the Obama verdict may be equally premature.”

Source: Stephen Roach, Financial Times, August 25, 2009.

The Wall Street Journal: Into the abyss - budget deficit deepens
“The White House has released its budget deficit estimates and the news is grim, WSJ’s Deborah Solomon reports. With economic output tipped to fall by almost 3% this year, the US economy is facing more tough times.”

Source: The Wall Street Journal, August 25, 2009.

Bill King (The King Report): Withholding taxes down
“For all the hope and hype of recovery, withholding taxes keep making new lows (via Matt Trivisonno’s blog).”

Source: Bill King, The King Report, August 28, 2009.

Asha Bangalore (Northern Trust): Q2 real GDP decline unchanged
“The real gross domestic product (GDP) of the economy declined at an annual of 1.0% according to the preliminary estimate, unchanged from the advance report. The revisions offset each other to leave the headline unchanged.

“The upward revisions of consumer spending (-1.0% vs. -1.2% in advance estimate), residential investment expenditures (-22.8% vs. -29.3% in the advance report), equipment and software spending (-8.4% vs. -9.0% in advance estimate) led to an upward revision of real final sales (+0.4% vs. -0.2% in advance report), which is the first gain after two quarterly declines.

“Exports were also revised up which led to a smaller trade gap than previously estimated. The decline in inventories (-$159.2 billion vs. -$141.1 billion) is larger than the earlier estimate, implying a big addition to inventories in the second-half of the year. The US economy is projected to show a mild recovery in the second-half of the year.

“The overall GDP price index was revised down to a flat reading but the core personal consumption expenditure price index was left unchanged at a 2.0% increase.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 27, 2009.

MoneyNews: Fed official - real unemployment at 16%
“The real US unemployment rate is 16% if persons who have dropped out of the labor pool and those working less than they would like are counted, a Federal Reserve official said Wednesday.

“‘If one considers the people who would like a job but have stopped looking - so-called discouraged workers - and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4% to 16%, said Atlanta Fed chief Dennis Lockhart.

“He underscored that he was expressing his own views, which ‘do not necessarily reflect those of my colleagues on the Federal Open Market Committee,’ the policy-setting body of the central bank.”

Source: MoneyNews, August 27, 2009.

ViktorCapitalist: US - 34% of workers have one week or less of savings
“An online survey reveals the thin savings cushion of American:

“(Mish’s Global Economic Trend Analysis) … Over a one week period beginning July 6 and running through July 13, more than 16,000 visitors to Monster.com participated in the Monster Meter Poll question ‘If you were laid off without severance, how long would your savings cover your living expenses?’

* One Week or Less: 34%
* 2-4 Weeks: 16%
* 1-2 Months: 16%
* 3-5 Months: 14%
* 6 Months or Longer: 20%

“Creating three broad groups, 50% have less than a month of savings, while only 20% have 6 months or more.”

Source: ViktorCapitalist, August 26, 2009.

Asha Bangalore (Northern Trust): “Cash for clunkers” lifts consumer spending in July
“Nominal consumer spending increased 0.2% in July, after a 0.6% gain in June. In July, the ‘cash for clunkers’ program accounted for the 1.3% increase in purchases of durables (mostly cars). After adjusting for inflation, consumer spending moved up 0.2% in July vs. a 0.1% increase in June. Outlays on non-durables dropped 0.3% in July and purchases of services rose 0.1%. Real consumer spending has now registered three consecutive monthly increases. The “cash for clunkers” program should raise consumer spending in August, albeit a large increase compared with July. The main implication is that consumer spending in the third quarter is most likely to grow around a 2.0% annualized rate after a 1.0% drop in the second quarter. This supports forecasts of an increase in real GDP in the third quarter.

“Personal income held steady in July, following a 1.1% drop in June and a 1.4% increase in May. Personal income data reflect the impact of the American Recovery and Reinvestment Act of 2009 in the past few months, with large transfer payments leading to the wide swings in personal income. Focusing on wages and salaries gives a better picture of earnings. Wages and salaries rose 0.1% in July, this is noteworthy because it is the first monthly increase recorded since October 2008.

“Personal saving as a percent of disposable income was 4.2% in July, down from 4.5% in June. It appears that the saving trajectory is close to 4.0% after excluding the distortions from transfer payments related to the American Recovery and Reinvestment Act. The personal saving rate was 1.7% and 2.6% in 2007 and 2008, respectively.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 28, 2009.

Standard & Poor’s: S&P/Case-Shiller Home Price Indices - home prices on an upswing in the second quarter
“Data through June 2009, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, the leading measure of US home prices, show that the US National Home Price Index improved in the second quarter of 2009.

“The chart above depicts the annual returns of the US National, the 10-City Composite and the 20-City Composite Home Price Indices. The S&P/Case-Shiller US National Home Price Index - which covers all nine US census divisions - recorded a 14.9% decline in the 2nd quarter of 2009 versus the 2nd quarter of 2008. While still a substantial negative annual rate of return, this is an improvement over the record decline of 19.1% reported in the 1st quarter of the year. The 10-City and 20-City Composites recorded annual declines of 15.1% and 15.4%, respectively. These are also improvements from their recent respective record losses of -19.4% and -19.1%.

“‘For the second month in a row, we’re seeing some positive signs,’ says David Blitzer, Chairman of the Index Committee at Standard & Poor’s. ‘The US National Composite rose in the 2nd quarter compared to the 1st quarter of 2009. This is the first time we have seen a positive quarter-over-quarter print in three years. Both the 10-City and 20-City Composites posted monthly increases, as did most of the cities. As seen in both seasonally adjusted and unadjusted data, as well as the charts, there are hints of an upward turn from a bottom. However, some of the hardest hit cities, especially in the Sun Belt, show continued weakness.’”

Source: Standard & Poor’s, August 25, 2009.

Asha Bangalore (Northern Trust): Sales of new homes advanced, inventories are shrinking
“Sales of new single-family homes rose 9.6% in July, after upward revisions for May and June. Purchases of new homes have risen in five of the first seven months of the year. Sales of new single-family homes are now up roughly 32% from a record low reading of 329,000 units registered in January 2009. On a regional basis, sales of new homes rose in the Northeast (+32.4%) and South (+16.2%), fell in Midwest (-7.6%) and was nearly steady in the West (+1.0%). The $8,000 credit for home buyers appears to have raised sales of new and existing single-family homes. Breakdowns of new home sales based on price ranges show a small increase in purchases of homes prices upwards of $400,000 and below $750,000.

“From a year ago, sales of new single-family homes are down only 9.3%; it is a significant improvement compared with double digit declines seen in recent months. The largest drop in the median price of a new single-family home for the cycle was in January 2009 (-45.5%).

“The inventories-sales ratio is encouraging because it declined to a 7.5-month mark, down from a cycle high of 12.4-months in January 2009. The median of this ratio during 1963-2000 is 6-month supply.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 26, 2009.

Clusterstock: New foreclosures dwarf new home sales
“New home sales are ticking up again, bringing some much-needed relief to the beleagured homebuilders. But watch out. Mark Hanson produced this chart, showing foreclosure starts against new home sales. As you can see, the new foreclosure starts jumped even more in July than new home sales, meaning trouble down the road for homebuilders - especially once that $8,000 first-time homebuilder tax credit runs out.”

Source: Joe Weisenthal and Rory Maher, Clusterstock - Business Insider, August 27, 2009.

Asha Bangalore (Northern Trust): Defense and aircraft orders lift durable goods
“Orders of civilian aircraft (+107%) and defense items (+14.8%) led to the 4.9% jump of bookings of durable goods during July. Excluding aircraft and defense, orders of durable capital goods fell 0.3% in July after a 3.6% increase in June and a 4.3% gain in May.

“The main message from the ISM manufacturing survey, industrial production report, and orders of durable goods is that the factory sector is moving toward a complete recovery.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, August 26, 2009.

Financial Times: US “problem” bank list hits 15-year high
“The number of US banks at risk of failure is at a 15-year-high while the fund protecting depositors is at its lowest level since 1993, according to figures that highlight the spread of the crisis to the lower reaches of the financial system.

“The Federal Deposit Insurance Corporation, a banking regulator, on Thursday said the number of ‘problem banks’ had risen from 305 to 416 during the second quarter. The FDIC does not name the lenders on the ‘problem list’ but said that total assets of that group had increased from $220 billion to $299.8 billion in the three months through June.

“That relatively low figure suggests that after hitting large institutions which traded complex securities, the financial crisis and the recession are taking a toll on smaller banks that lend to businesses and consumers.

“Sheila Bair, the FDIC chairman, said on Thursday that while earlier losses in the industry were related to troubled residential loans and complex mortgage-related assets, there were now problems with more conventional types of retail and commercial loans that have been hit hard by the recession. ‘These credit problems will outlast the recession by at least a couple of quarters,’ she said.

“Thursday’s news of a sharp fall in the FDIC’s deposit insurance fund, which insures up to $250,000 per depositor in each bank, underscored the problems faced by regulators when contemplating the rescue or wind-down of institutions with trillions of dollars on their balance sheets.

“The agency said its fund had fallen to just $10.4 billion from $13 billion in the quarter, the lowest level since March 1993 when the US was in the middle of the savings and loans crisis. The fund has been depleted by bank failures: regulators have shut 81 banks this year.

“‘In many important respects, financial markets are returning to normal,’ said Ms Bair. ‘Combined with the positive economic news in recent weeks, we’re hopeful that this will lead to a moderation in credit problems in coming quarters. But, as our report shows, cleaning up balance sheets is a painful process that takes time.’”

Source: Joanna Chung and Francesco Guerrera, Financial Times, August 27, 2009.

Asha Bangalore (Northern Trust): Some market spreads are widening again
“At the short end, financial market spreads continue to narrow. However at the long end, the situation is different. Two representative long end market spreads - Moody’s Baa less 10-year Treasury note yield and junk bond yield less 10-year Treasury note yield - have both widened during August 11-20. The reasons are not clear as economic reports strongly suggest that underlying fundamentals are improving. Concern about the nature of economic recovery and projected status of balance sheets of banks could be factors influencing these spreads.”

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

Bloomberg: Leverage rising on Wall Street at fastest pace since ‘07 freeze
“Banks are increasing lending to buyers of high-yield company loans and mortgage bonds at what may be the fastest pace since the credit-market debacle began in 2007.

“Credit Suisse Group AG and Scotia Capital, a unit of Canada’s third-largest bank, said they’re offering credit to investors who want to purchase loans. SunTrust Banks Inc., which left the business last year, is ‘reaching out to clients’ to provide financing, said Michael McCoy, a spokesman for the Atlanta-based bank. JPMorgan Chase & Co. and Citigroup Inc. are doing the same for loans and mortgage-backed securities, said people familiar with the situation.

“‘I am surprised by how quickly the market has become receptive to leverage again,’ said Bob Franz, the co-head of syndicated loans in New York at Credit Suisse. The Swiss bank has seen increasing investor demand for financing to buy loans in the past two months, he said.

“Federal Reserve data show the 18 primary dealers required to bid at Treasury auctions held $27.6 billion of securities as collateral for financings lasting more than one day as of August 12, up 75% from May 6.

“The increase suggests money is being used for riskier home-loan, corporate and asset-backed securities because it excludes Treasuries, agency debt and mortgage bonds guaranteed by Washington-based Fannie Mae and Freddie Mac of McLean, Virginia or Ginnie Mae in Washington. Broader data on loans for investments isn’t available.”

Source: Kristen Haunss and Jody Shenn, Bloomberg, August 28, 2009.

Bill King (The King Report): Foreign assets in the US

“The above chart illustrates why the dollar is under severe pressure and the US financial and economic system is on life-support from the Fed as well as why Bernanke and his ilk will not divulge its records, ways and means to the public.

“It also shows that the Fed is between a rock and a hard place because as the Fed increases its life support (balance sheet/debt monetization) it will increase the desire of foreigners to jettison dollar-denominated assets. This is why there is no exit strategy for the foreseeable future.”

Source: Bill King, The King Report, August 27, 2009.

Eoin Treacy (Fullermoney): Stock markets - give upside benefit of doubt
“There has been considerable debate about how the excess liquidity permeating rallies across asset classes and borders will be withdrawn. What seems clear is that changes will be made cautiously and economic recovery will be given precedence over worries about future inflation.

“The S&P 500 accelerated lower from September, lost consistency at the penultimate low and finally bottomed in March. It encountered brief resistance in the region of 1,000 and is now pulling away from that area. For months we have felt that the S&P’s bull market hypothesis was more faith based than analytical because it had not yet completed its base like so many of the leading markets. This is no longer the case. Current action is consistent with bull market type activity..

“In the short-term, a sustained move back below 1,000 would be needed to check momentum. A fall back below 975 would break the progression of higher lows and pull into the previous May-June range. A sustained move below 900 would indicate an increased likelihood of base formation extension. In the absence of any of these factors, the upside can continue to be given the benefit of the doubt. As stock markets advance, 10,000 points on the Dow Jones Industrials is the next potential area of resistance.

“The Nasdaq has been trending consistently higher from the March lows and appears to be in the process of completing another small range. A sustained move below 1,560 would be needed to question the consistency of the advance.

“Favourable stock market conditions are evident all over the world with an impressive number of markets moving to new recovery highs this week. The FTSE-100 consolidated above the 4,500 for much of the month and broke upwards last week. A sustained move back into the base, with a fall below 4,500 would be required to hinder upside potential. Germany’s DAX has a similar pattern with 5,000 being the operative level.”

Source: Eoin Treacy, Fullermoney, August 25, 2009.

Richard Russell (Dow Theory Letters): Are we in a new primary bull market?
“The stock market is at all times subject to three trends (1) the primary or great tidal sweep of the market which can be likened to the tide of the ocean. (2) The secondary trend of the market, which can be compared with the waves in the ocean. And (3) The daily action, which can be likened to the ripples on the waves.

“Right now we are at a most unusual and rare juncture. I say this because at this time there are questions and arguments regarding both the primary trend of the market and the secondary trend.

“Are we in a new primary bull market now? Personally, I doubt it.

“As for the secondary trend, I’m having some second thoughts about the secondary trend. On July 23, 2009, the Transports finally confirmed the Dow in closing above its June 11 high. This was a signal that the secondary trend of the market had turned bullish. From July 23 onward, the market gathered strength as the secondary trend continues to extend.

“At this point, it’s obvious that the secondary trend of the market remains strongly bullish. How far this counter-trend rally will carry is unknowable. I’ve been reluctant to recommend investing heavily in what I believe is a bear market rally or a correction against the prevailing primary trend. The great values haven’t been there, and playing bear market rallies can be dangerous and stressful.”

Source: Richard Russell, (Dow Theory Letters), August 25, 2009.

Brian Belski (Oppenheimer Asset Management): Reasons to be cheerful
“History shows that September is customarily the weakest month of the year for US equities - but this does not necessarily hold true following positive stock market performances during the summer, says Brian Belski, chief investment strategist at Oppenheimer Asset Management.

“He says that since the second world war, the S&P 500 has suffered an average September fall of 0.5%. But there has been a decided shift in seasonality patterns in the past 15 years.

“‘Given the dramatic change in the financial system during this period, we believe the new pattern provides a more relevant comparison,’ he says.

“‘Seasonal patterns actually favour the market in the current environment. We have found that Septembers that follow positive summer months, such as the one we have seen this year, exhibit positive S&P 500 performance, on average.

“‘In addition, the fourth quarter is typically a period of strength for the market regardless of summer performance.’

“Mr Belski notes that many investors are now anticipating a sizeable correction in the stock market following its strong ascent since March.

“‘While we do not completely discount the possibility of some sort of market pullback given recent gains, we remain optimistic regarding market performance in the months ahead and expect the S&P 500 to finish the year above current levels.”

Source: Brian Belski, Oppenheimer Asset Management (via Financial Times), August 24, 2009.

Bespoke: Missing in action - short sellers
“Last night [Wednesday] after the close, the major exchanges released their mid-month short interest data, or as some would say, their lack of short interest data. As shown in the chart below, the average short interest as a percentage of float for stocks in the S&P 1500 is currently at 6.9%. This is the lowest level since February 2007, when the average was 6.6%. In 2008, it was the bulls who argued that high levels of short interest were a reason the market should rally. With the recent data, however, it is now the bears who will argue that low levels of short interest suggest that investors are now too bullish.”

Source: Bespoke, August 26, 2009.

Bespoke: Investors Intelligence hits most bullish level since January 2008
“… short interest as a percentage of float is currently at its lowest level since 2007. Another group of investors who have turned decidedly less bearish are newsletter writers. According to the weekly data from Investors Intelligence, bullish sentiment among newsletter writers is at its highest levels since January 2008. At the other end of the spectrum, bears are practically in complete hibernation. At a level of 19.8%, bearish sentiment is at its lowest level since late 2007. While it is still far from standing room only, the bullish camp is starting to attract a crowd.”

Source: Bespoke, August 26, 2009.

Bespoke: Individual investors not as bullish as the pros
“In the last few days, we have noted how short interest is at multi-year lows and newsletter writers are more bullish than at any other time since the start of 2008. While the so-called pros are bullish, individual investors apparently need more convincing. According to this week’s survey of the American Association of the Individual Investors (AAII), only 1/3 of investors surveyed are currently bullish, while nearly half (49%) are bearish. Based on these surveys at least, not everyone is bullish.”

Source: Bespoke, August 27, 2009.

MoneyNews: Roubini missed the stock rally
“While perennial pessimist Nouriel Roubini has been prescient in predicting recent economic woes, investors sticking to his forecasts have suffered dearly since March.

“That’s because he’s been warning about continued problems in the economy while stock prices have soared.

“The New York University professor has been arguing for weeks that the economy is in danger of suffering a double-dip recession. And he hasn’t yet recommended that investors plunge into stocks, Bloomberg notes.

“Yet the Standard & Poor’s 500 Index has soared 53% from its March low.

“When the rally began, Roubini called it a ‘dead-cat bounce’, and in May he said the ascent may ‘fizzle’, Bloomberg reports.

“On March 9, Roubini said the S&P 500 was headed down to 600. Instead it has jumped 71% to 1,027 as of Wednesday morning.

“‘We’re looking at a bull cycle in phase one,’ investment guru Laszlo Birinyi told Bloomberg.

“‘No one wants to come out and say, ‘This is a bull market.’ Everyone’s just dancing around the term.’

“Birinyi says Roubini may have missed the upward move because he concentrates on the economy rather than stocks.

“Roubini certainly isn’t the only bear.

“Market sage Robert Prechter told Yahoo! News that recent stock gains represent a bear market rally and that the next wave will be down.

“‘I think we’ll definitely break the March 2009 lows, and I think the bear market will extend well into the next decade,’ he says.”

Source: Dan Weil, MoneyNews, August 26, 2009.

Clusterstock: The trashiest stocks are on fire
“Since the market hit its lows in early March, the trashiest, most beaten-down stocks have been the big winners. Some are arguing that the trash stocks have to slow down soon. But in the meantime, it looks like investors are reaching for the trashiest of the trash. Check out the crazy runs in Fannie Mae (FNM), Freddie Mac (FRE), AIG (AIG) and even the soon-to-be-liquidated GM over the last few weeks. This is the kind of behavior that might foretell the end of the junk rally.”

Source: Joe Weisenthal and Rory Maher, Clusterstock - Business Insider, August 24, 2009.

Eoin Treacy (Fullermoney): Carry trades being reopened
“The unwinding of the yen carry trade, from September, forced large positions in speculative assets all over the world to be sold, contributing to the synchronous decline in the price of most financial assets and the corresponding advance of the yen and the dollar. This tumultuous event is now part of our history and conditions, particularly since March, have been conducive to carry trades being reopened.

“Investors in speculative higher yielding assets have seldom been provided with such a wide menu of potential carry trade currencies. Interest rates in the Eurozone, UK, USA and Japan are all at historically low levels. While we tend to concentrate on the main currency cross rates it is evident from a perusal of the major currencies that some classic destinations for carry trades such as New Zealand (USD, GBP, EUR, JPY) or Brazil (USD, GBP, EUR, JPY) have currencies that are appreciating in all four potential carry currencies.

“In the past, a US, UK or European investor would have had to borrow Japanese yen and invest them in a third country. This exposed them to currency fluctuations in two crosses. The current environment is simpler, exposing a domestic investor in one of these countries to a single cross rate.

“We have long said that in the competitive world of globalisation, no country wants a strong currency but some are more motivated to have a weak currency than others. The strength of carry trade destination currencies will increasingly become a political issue. New Zealand’s government has already commented on the strength of Kiwi. The Kiwi has appreciated significantly in all of the crosses mentioned above but has only broke to new highs against the pound. This would suggest that the easiest part of the advance has already occurred and further improvement will have a greater near-term associated risk of reversion.

“Israel is the first country to raise rates following the credit crisis. Most of the potential carry trade funding economies are unlikely to raise interest rates before next year and when they do, rises are likely to be small and the pace slow. Destinations for carry trades are likely to be raising rates at the same time, and potentially faster, so the tightening of interest rate differentials is unlikely to be a major impediment to carry trades.

“Stocks, commodities and credits have all appreciated considerably over the last 6 months. While this move is not over, we are probably closer to the next larger reaction than we are to the next large advance. When some of the consistent trends that are currently evident roll over, profit taking may put upward pressure on carry trade currencies. Looking beyond a reversion to the mean, as long as interest rate differentials remain amenable and funding currencies relatively weak compared to their higher yielding counterparts, carry trades are likely to remain viable sources of funding.”

Source: Eoin Treacy, Fullermoney, August 27, 2009.

Financial Times: High prices necessary for producing Chinese commodities
“For mining companies, the drop in commodities prices earlier this year has been, ironically, good long-term news. True, in the short term earnings have suffered and share prices have tanked. The FTSE 350 Mining Index was down 45% between August 2008 and January this year.

“But amid all the negative news there was, nonetheless, an encouraging clue about the limits of China’s domestic commodities output that paints a brighter outlook for the natural resources sector.

“China’s geological endowment is critical for commodities companies as Beijing attempts to cap imports - and prices - supporting its domestic output. China is rich in iron ore, bauxite, zinc, nickel, coal and crude oil deposits.

“Although the size of the country’s geological endowment matters, what really makes a difference is the price at which Chinese companies can dig out the raw materials. Until this year, the country’s capabilities were mostly untested as most of the recent increase in output came on the back of rising global prices since 2002.

“The drop in global prices earlier this year has now revealed that China can only sustain high domestic production when global prices are near record highs.

“As raw materials prices declined in late 2008 and early 2009, output from Chinese mines plunged because their mines were uncompetitive. This forced the country to rely heavily on imports, mopping up global surpluses and boosting prices.

“The poor resilience of China’s local production to price crashes has been suspected for a long time. But the corroboration is great news for miners with high volume and low production cost assets, such as BHP Billiton and Rio Tinto.”

Source: Javier Blas, Financial Times, August 24, 2009.

Bespoke: Oil to national gas ratio highest ever
“With oil rallying and natural gas continuing to plummet on a daily basis, the ratio of oil to natural gas is at its highest level since at least 1990 at 26.35. When the line is increasing in the chart below, oil is outperforming natural gas, and as shown, it has been doing that now since the end of 2008. The ratio is currently in uncharted territory, so who knows when we’ll see some reversion to the mean.”

Source: Bespoke, August 24, 2009.

GoldSeek: GATA presses Fed to give up its golden secrets
“Yesterday GATA’s [Gold Anti-Trust Action] Washington-area law firm, William J. Olson P.C. of Vienna, Virginia filed with the Federal Reserve Board an administrative appeal of the Fed’s most recent refusal to grant us access to the agency’s records involving the US gold reserve.

“Really, why should any Federal Reserve record involving the national gold reserves be confidential, except perhaps records involving the most ordinary security of the reserve’s vaulting? Plainly the Fed has knowledge of something that has been done with the gold reserve that the US government does not want the American people and the financial markets to know.

“Further, GATA’s administrative appeal notes, the Fed’s search of its records in response to our request was negligent, insofar as it did not cite at least one document involving gold swaps that is posted and publicly accessible at the Fed’s own Internet site. That is, it seems that GATA’s lawyers looked harder for the relevant documents than the Fed itself did.

“It strikes GATA as remarkable that the financial market commentators who most often disparage suggestions that central banks are intervening surreptitiously as well as openly in the gold market never have tried to put a critical question about gold to any central bank. Even big financial news organizations have failed to do this when reporting on the gold market. But if they ever did start asking critical questions, they would have to report that the Fed has some big secrets about gold. It is more justification for US Rep. Ron Paul’s legislation to audit the Fed.”

Source: Chris Powell, GoldSeek, August 23, 2009.

TheStreet.com: Christian - gold will hit $1,000
“Jeffrey Christian, managing director of CPM Group, argues that once investment demand surges, gold will skyrocket to $1,000.”

Source: The Street.com, August 28, 2009.

Financial Times: The weather channel
“In the agricultural commodities market, nothing explains better the influence of weather than the difference between the price of tropical produce such as sugar and cocoa and crops such as wheat and corn.

“While sugar and cocoa hover at multi-decade highs, the price of wheat and corn is falling to its lowest since 2007.

“A poor monsoon in India and unseasonal rain in Brazil have hit sugar output in the world’s two largest producers. Cocoa prices have suffered because of poor weather in Ivory Coast, which produces 40% of the world’s cocoa.

“Meanwhile, the grains’ growing season in the US and Europe has been almost perfect - timely rains in the spring, and sunshine and warm temperatures during the summer - after a delayed start. Yields for wheat are, according to the International Grains Council, ‘unexpectedly good’.

“The corn harvest will not start until the autumn, but the scouters that check fields in the US midwest are reporting a large, if not record, crop.

“The fact that weather causes the price differences also helps to explain why hedge funds and investment banks have hired dozens of meteorologists in the past few years, seating them close to their traders.

“For agri commodities, weather research is now as important as research on consumption trends. Stay tuned to the weather channel.”

Source: Javier Blas, Financial Times, August 27, 2009.

Financial Times: China tightening
“Not for the first time, there is a gap between what China says and what China does. Premier Wen Jiabao warned this week that the ‘foundations of recovery are not stable  . . .  we cannot afford the slightest relaxation or wavering’. The subtext seemed obvious: that China’s exceptionally loose monetary policy will continue for the foreseeable future.

“But a subtle shift is already under way. Monetary policy in China is not qualitative but quantitative. The People’s Bank has a target interest rate but its focus is on economic growth and the assumed quantity of money needed to fund it. By that token, China has been tightening by stealth for a while.

“The banking regulator last month told lenders to raise reserves to 150% of their non-performing loans by the end of this year, up from 134.8% at the end of June. A communiqué last Friday canvassed views on deducting holdings of other lenders’ subordinated or hybrid debt from supplementary (non-core) capital.

“Then there are softer measures, such as reminding banks to ensure that loans for investment in fixed assets actually end up there. The central bank also has raised money-market rates to drain liquidity. The effects of all this can be seen in the M2 measure of money supply, which was up 28% at the end of July, year on year, but which fell 3 basis points from the end of June.

“This is how China tightens: imperceptibly, by degrees. As Goldman Sachs points out, China’s last tightening cycle began not when it raised rates in November 2004 but 18 months earlier when the central bank began to issue short-term bills to mop up excess cash. Listen to the rhetoric now, and you can almost hear the fluttering of doves. But look at the evidence, and it is obvious that hawks are gathering.”

Source: Ben McLannahan, Financial Times, August 25, 2009.

Financial Times: Troubling signs in Japan ahead of vote
“Japan’s consumer prices fell at a faster-than-expected pace in July and unemployment rose sharply, according to data released on Friday, as the country prepared to vote in a new government on Sunday to lead the economy’s recovery.

“The jobless rate jumped to 5.7% in July from 5.4% in June - the highest level since records began in 1960 - as businesses continued to cut their workforce and new graduates joined the labour market.

“Rising job insecurity continued to weigh on private spending. Japanese household spending fell 1.3% compared with June on a seasonally adjusted basis while worsening deflation could further dampen demand. Last month, core consumer prices, excluding fresh food, fell 2.2% from a year ago, compared with a drop of 1.7% in June. The decline was the worst since records began in the early 1970s.

“‘Much of the current bout of deflation is the result of huge falls in year-ago oil prices. However, these will dissipate, as oil prices have since risen. In fact, in six months time oil will likely be a strong positive contributor to headline inflation,’ said Daniel Melser, economist at Moody’s Economy.com.

“The economic data were worse than expected but unlikely to change the fact that most economists believe the economy has hit bottom.

“Japan, which emerged from recession in the second quarter, is expected to see another quarter of growth in the July to September period after volume of exports rose a seasonally-adjusted 2.3% in July from June.

“The long-ruling Liberal Democratic party is expected to face a landslide defeat in Sunday’s general election as Japanese voters demand for changes in the way the country is run.”

Source: Justine Lau, Financial Times, August 28, 2009.

Paul Biszko (RBC Capital Markets): Time up for Russia bears
“There is a growing sense that the worst is now over for Russia - but problems still lie ahead, says Paul Biszko, senior emerging markets strategist at RBC Capital Markets.

“‘In late 2008/early 2009 Russia looked vulnerable to a full blown crisis,’ he says. ‘Its externally over-leveraged private sector was hit by both a sharp credit squeeze and a commodity price collapse.’

“He says three factors have been critical to the country’s turnround.

“First, the risk asset rally and improved investor sentiment in the second quarter of this year helped halt capital flight and eased refinancing problems.

“Second, the partial oil price recovery and commodity bounce has improved both government and corporate cash flow.

“Third, the government acted relatively effectively in confronting a deep domestic liquidity shortage and stemming rampant panic, largely as it had a strong balance sheet coming into the crisis.

“‘Although Russia’s cash reserve cushion has been cut by a third, it is still relatively large at $400 billion - this remains its key near-term anchor, which should allow it to cope with any second-round crisis aftershocks,’ Mr Biszko says.

“‘We are not turning outright bullish on Russia, rather less bearish, at least on a three- to six-month horizon.

“‘Our biggest concern is that Russia remains highly sensitive to recurring commodity price shocks, and its willingness/ability to reduce this vulnerability is questionable.’”

Source: Paul Biszko, RBC Capital Markets (via Financial Times), August 27, 2009.

Nationwide: UK house price bounce extends into August
“Commenting on the figures Martin Gahbauer, Nationwide’s Chief Economist, said:

“‘The price of a typical house rose for the fourth consecutive month in August, increasing by 1.6% on a seasonally adjusted basis. The 3 month on 3 month rate of change - generally a smoother indicator of the near term trend - rose from 2.7% in July to 3.3% in August, the highest level since February 2007. At

£160,224, the average price of a typical UK property is still slightly lower than 12 months ago. However, the annual rate of change rose further in August, from -6.2% to -2.7%. Over the first eight months of 2009, the seasonally adjusted index of house prices has risen by 3.2%, though relative to the October 2007 peak it is down by 14.4%.

“‘The exceptionally low level of interest rates offers some explanation for why house prices have not repeated the very sharp falls of 2008. There are two main channels through which the low level of interest rates has impacted the housing market. First, mortgage payments for existing homeowners - especially those with tracker or standard variable rate loans - have been reduced substantially. Before the MPC began cutting rates, the average interest and principal payment per mortgage holder represented about 38% of the average post-tax labour income. Following the steep cuts in base rate, this has fallen to just 28% of post-tax income, despite historically high levels of outstanding mortgage debt.

“‘The fall in debt servicing costs has meant that fewer homeowners are under immediate financial pressure to sell than might have been expected in a recessionary economic background with rising unemployment. Partly as a result, fewer second-hand properties have come onto the market than is normally the case in recessions, which has contributed to moving the balance of supply and demand more in favour of sellers over the course of 2009.

“‘In addition to limiting the supply of second-hand homes, lower interest rates have also had an impact on the demand side. Even though house prices remain high relative to earnings, the fall in interest rates has improved the affordability of mortgages for those looking to buy a home. This helps to explain the strong rise in new buyer enquiries reported by estate agents for most of 2009. Although not all of these enquiries are turning into sales, house purchase transactions have continued to slowly increase from the record lows reached in late 2008.

“‘At the moment, a rise in interest rates is probably still some way off. However, the eventual exit from exceptionally loose monetary policy could make the recovery in the housing market bumpier than some might expect after the last few months of price increases.’”

Source: Nationwide, August 27, 2009.

James Lord (Capital Economics): Israel’s monetary policy
“The Bank of Israel’s surprise interest rate rise on Monday is unlikely to send other central banks rushing to tighten - but the move is nevertheless of great interest, says James Lord at Capital Economics.

“‘Although Israel is a relatively small economy, the BoI’s response to the global crisis has been sophisticated,’ he says.

“‘It cut rates aggressively and implemented quantitative easing, leading to a large expansion of the monetary base.’

“Mr Lord also notes that Stanley Fischer, the BoI governor, is a former IMF deputy managing director and was US Fed chairman Ben Bernanke’s PhD supervisor. ‘Mr Bernanke is likely to watch closely given that his former tutor is implementing policies that may be relevant for the Fed’s own exit from quantitative easing.’

“Indeed, the BoI started to unwind quantitative easing last month, while the rate of interest payable on commercial bank reserves will now rise - which is Mr Bernanke’s preferred method for reversing any inflationary impact from the Fed’s unconventional easing, Mr Lord says.

“‘But we doubt the BoI’s move has implications for other central banks. The BoI made clear rates went up to help anchor local inflation expectations. In most major economies, inflation is expected to stay low this year and next.

“‘Also, central bankers at Jackson Hole made it clear that ultra-accommodative policy is likely to remain in place in the major economies for some time.’”

Source: James Lord, Capital Economics (via Financial Times), August 25, 2009.

Bloomberg: Zuma may be African Lula as anti-inflation move lures investors
“South African President Jacob Zuma was propelled into office this year by union support. So far, it is investors who are reaping the benefit.

“Zuma, who campaigned on promises to create jobs and slash poverty, began by removing two union foes: Finance Minister Trevor Manuel and central bank governor Tito Mboweni. He then named replacements who once worked for Manuel and Mboweni and who have favored their predecessors’ economic policies, which labor officials say stifle growth and employment.

“That has some analysts comparing Zuma to Brazilian President Luiz Inacio Lula da Silva, who panicked investors with his anti-capitalist rhetoric when he came to power in 2003, only to implement market-pleasing measures later. Since Lula took office on January 1, 2003, Brazil’s gross domestic product has tripled to become the world’s eighth-biggest economy.

“‘Zuma is pulling a Lula,’ said Lars Christensen, head of emerging-market strategy at Danske Bank in Copenhagen. ‘Zuma is a pragmatist. I can’t see any big differences between Zuma’s policies and those of his predecessors. No one expected that.’

“The president has maintained the inflation-fighting policies of his predecessor, Thabo Mbeki, has met investors to reassure them, has said that public spending may need to be curbed and has commissioned a study on using tax revenue more effectively. Yesterday, Gwede Mantashe, secretary general of Zuma’s African National Congress, said labor unions have no undue influence over the president.

“South Africa’s rand is the second best-performing emerging market currency of the 26 monitored by Bloomberg this year. The first is the Brazilian real. Ex-union leader Lula kept spending in check and named as central bank president a FleetBoston Financial Corp. executive who resisted pressure from some members of Lula’s Workers’ Party to immediately cut rates.

“Almost four months into his term, Zuma is adhering to the free-market approach that angered his union backers when implemented by Mbeki. Investors who were irked by Zuma’s ties to labor now say Zuma’s South Africa is looking like a good bet.

“Since the April 22 election, the rand has gained 13% against the dollar, the benchmark South African stock index has advanced 26% and credit default swaps, the cost of protecting against a default, have dropped by more than a third.

“‘Zuma appears to be making very solid decisions,’ said Joseph Rohm, fund manager of the $300 million Africa & Middle East Fund at T Rowe Price International Plc in London. ‘We are encouraged that what was a business-friendly environment has been maintained.’ He said he has been buying South African assets, though he declined to be more specific.”

Source: Nasreen Seria, Bloomberg, August 28, 2009.

Financial Times: Ted Kennedy
“Edward Kennedy died on Tuesday night from the consequences of a brain tumour at the age of 77. He did not fulfil the ambitions of his dynastic family by becoming president of the United States, as one brother did and as another might have, both victims of the assassin’s bullets, but he became a lion of the US senate, liked and admired by friend and foe alike.”

Click here for the full article.

Source: Financial Times, August 26, 2009.

Tags: Barack Obama, BRIC, Canada, Commodities, Crisis Actions, Doctor Bill, Economic Catastrophe, Economic Upswing, Emerging Markets, Emerging Stock Market, ETF, Federal Reserve Chairman, Federal Reserve Chairman Ben Bernanke, Global Stock Markets, Gold, Government Bonds, High Yield Corporate Bonds, India, Japanese Yen, Larry Summers, Miracle Cure, Morgan Stanley, oil, Partisan Battle, Recovery Path, Risky Assets, Stephen Roach, Stock Market Indices
Posted in Emerging Markets, Gold, Markets | No Comments »

US dollar – a currency in decline

Thursday, July 16th, 2009

The comments below were provided by Peter Greene of Fusion IQ.

In the midst of the longest and deepest, post World-War II recession, America’s financial position relative to the rest of the world has deteriorated sharply. Three decades of massive trade deficits have turned the United States from the world’s top lender into the world’s largest debtor and as a result has made it dependent on the whims of so-called emerging nations, laden with huge foreign currency reserves, to finance the bailout of Wall Street Oligarchs, and President Barack Obama’s social programs.

Foreigners own roughly half of the US government’s publicly traded debt, or $3.47-trillion, representing nearly 25% of the size of the US economy - the highest level in history. If foreign lenders were to significantly reduce their purchases of US Treasury notes, without even dumping their current holdings, US long-term interest rates could zoom higher and the US dollar could crumble.

That would be a double whammy for the US economy. Higher yields on Treasury debt could translate into higher mortgage borrowing rates for homebuyers, which would weigh on the housing market, while a weaker US dollar could lift the price of crude oil to above $70 per barrel, resulting in an “oil shock” to the world economy. This nightmare scenario has been relegated to the den of doomsayers and fear mongers, yet is starting to become an increasingly realistic proposition.

Some of the biggest foreign lenders to the US Treasury, such as Brazil, China, India, Russia and Qatar, are grumbling aloud about the endless string of trillion dollar US budget deficits projected in the years ahead. Lenders are crying foul over the Federal Reserve’s radical experiment with “quantitative easing” (QE) - the printing of vast quantities of US dollars, and monetizing the US government’s debt.

The Congressional Budget Office (CBO) recently forecast the US budget deficit for fiscal 2009 to reach a mind-boggling $1.825-trillion or approximately 13% of GDP. Next year, the budget deficit is expected to total $1.43-trillion under Obama’s budget plan. Furthermore, the CBO sees the US deficits between 2010 and 2019 totalling $9.1 trillion, thereby raising doubts about America’s ability to finance its debt at low interest rates, and whether it can maintain its top-tier AAA credit rating.

Falling off a cliff - this would be a good technical description of what the US Dollar Index looks like. The risk of the dollar doing just that probably lies with what China decides to do. China’s holdings of US Treasury debt have soared by $257 billion from a year ago to $763 billion today, exceeding Japan’s holdings of $686 billion. Yet any precipitous move by Beijing to become a net seller of US Treasury debt runs the risk of igniting a US dollar selling panic, triggering massive losses in China’s own portfolio of Treasuries and the collapse of its main export market, the United States. Technically the recent triangular consolidation (orange lines) looks like a bearish wedge. While there is a support band in the 78.22 to 77.40 range (green lines) a violation of this would trigger a renewed bearish move downward.

[PduP: For more on the most likely near-term direction of the US Dollar Index, Adam Hewison's (INO.com) short technical analysis also provides valuable insight. Click here to access the presentation.]

Source: Peter Greene, Fusion IQ, July 15, 2009.

Tags: Barack Obama, Congressional Budget Office, Currency Reserves, Doomsayers, Double Whammy, Emerging Markets, Endless String, Fear Mongers, Foreign Currency, India, Mortgage Borrowing, Nightmare Scenario, oil, Oil Shock, Peter Greene, Price Of Crude Oil, Radical Experiment, Realistic Proposition, Three Decades, Us Budget Deficit, Us Treasury Notes, World Economy, World War Ii
Posted in Markets | No Comments »

Video Digest: Fresh Wave of Risk Aversion

Friday, July 10th, 2009

The first few days of the week have been characterized by a fresh wave of risk aversion as uncertainty over the global economic outlook took its toll on stock markets and investors favored safe-haven assets such as government bonds, the US dollar and Japanese yen. However, yesterday brought some relief for risky assets - now in corrective mode - and it remains to be seen whether the S&P 500 Index will close down for a fourth consecutive week as the US earnings season gets on the way.

The usual debate on the outlook for the economy and financial markets dominated the video channels over the past few days, but interesting snippets on the IMF’s improved forecast for the global economy, the viability of the Public-Private Investment Program (PPIP), the US dollar’s role as reserve currency, the prospects for the earnings-reporting season and President Obama’s visit to Russia were also featured in the clips.

This week’s somewhat shorter-than-usual edition of Video-o-rama includes interviews with the likes of Oliver Blanchard, Jim Bianco, Puru Saxena, Roger Altman, Peter Peterson, Wilbur Ross, Allen Sinia, Jeff Saut and Boone Pickens.

The compilation starts off with a contribution on risk aversion by John Authers, the Financial Times’s investment editor, and concludes with a Charlie Rose discussion on Barack Obama’s Russian rendezvous.

John Authers (Financial Times): Risk aversion makes comeback
“Commodities and currency markets are experiencing a new wave of risk aversion, driven in part by a swing from expectations of inflation to deflation fears, says FT’s John Authers.”

Click here for the article.

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

Bloomberg: Blanchard says recession lingers, sees “weak” recovery
“Olivier Blanchard, chief economist for the International Monetary Fund, talks with Bloomberg’s Peter Cook about the prospects for a global economic recovery. The IMF said in a report today [Wednesday] that the world economy will expand 2.5% in 2010, stronger than its 1.9% growth forecast in April. Blanchard also discusses governments’ fiscal stimulus plans and exit strategies for emergency programs.”

Source: Bloomberg, July 8, 2009.

CNBC: G8 set to move markets?
“This week’s G8 summit in Italy is going to be more philosophical than market moving, Jim Bianco, president of Bianco Research, told CNBC on Wednesday. Bianco considers the possibility of a second US stimulus package.”

Source: CNBC, July 8, 2009.

MSNBC: Stimulus a success - or spluttering?
“As lawmakers and analysts debate the effectiveness of President Barack Obama’s economic recovery plan, MSNBC’s Dylan Ratigan and a panel of guests offer their impressions.”

Source: MSNBC, July 9, 2009.

Charlie Rose: A conversation with Roger Altman, former United States Deputy Treasury Secretary

Source: Charlie Rose, July 8, 2009.

CNBC: Saxena - no recovery for at least 12 months
“An economic recovery will not be seen for at least 12 months, says Puru Saxena, money manager and CEO of Puru Saxena Wealth Management. He tells CNBC’s Amanda Drury why the rally we’ve seen is based on the wrong premises.”

Source: CNBC, July 7, 2009.

Charlie Rose: A conversation with Peter Peterson

Source: Charlie Rose, July 3, 2009.

Yahoo Finance, Tech Ticker: Ron Paul is right! We should audit the Fed
“An amendment based on Congressman Ron Paul’s House bill to audit the Federal Reserves was blocked by the Senate this week on procedural grounds.

“Speaking on the Senate floor, Republican Senator Jim DeMint and supporter of an audit said, ‘allowing the Fed to operate our nation’s monetary system in almost complete secrecy leads to abuse, inflation and a lower quality of life’.”

Source: Yahoo Finance, Tech Ticker, July 8, 2009.

CNBC: The unwinding of Lehman Brothers
“Bryan Marsal, CEO of Lehman Brothers Holdings, has been unwinding Lehman Brothers since the firm’s historic collapse. He discusses the process with CNBC.”

Source: CNBC, July 6, 2009.

CNBC: PPIP unveiled by Treasury
“The long-awaited Public-Private Investment Program (PPIP) has finally been unveiled by the Treasury. Wilbur Ross, chairman of WL Ross & Co, shares his thoughts on the program.”

Source: CNBC, July 9, 2009.

CNBC: Allen Sinai and Jeffrey Saut on markets
“Allen Sinai, of Decision Economics, and Jeffrey Saut, of Raymond James, share their outlooks on the market and the economy.”

Source: CNBC, July 8, 2009.

CNBC: Art Cashin on secular cycles
The following from Art Cashin, head of floor operations at UBS:

“Back on the cycle - David Rosenberg, formerly chief economist at Merrill Lynch and now at Gluskin Sheff was a guest host on CNBC’s Squawkbox this morning. During the discussion he alluded to an 18 year cycle in the market. Not to quibble but many traders have thought of it as the 17.6 year cycle.

“Here’s how I outlined it back in May 2002: Yesterday, as the elders were being asked about the hiding place of the great Bull Market one of the fogeys mentioned the ‘near 18 year cycle’. Like the fat and lean years, it refers to so-called ‘easy’ times to make money in the market versus times requiring much harder work. The fogeys suggested it was near 18 years because it was approximately 17 years, 7 months. For ease of explanation to the juniors, one of the fogeys decimalized the number as 17.6 years so they could use their calculators.

“He then postulated this example - Let’s say the markets topped out in about February 2000. Let’s call that 2000.2. Subtract 17.6 and your back in about July 1982 (1982.60). The Dow was around 900. So you could see why those were a fat (easy) 17 years. Take away 17.6 again and you are back around January of 1965 and the Dow is around 900. (Yup - just like 1982.) Many twists and turns in those 17 years. Lots of chances to make money. But you had to work for every penny. Take away 17.6 again and you are back around May of 1947. The war is over. The Dow is around 170. Lots of prosperity ahead. Take away 17.6 and you are back around Sept of 1929 and the Dow is around 350.

“He began to go on. The juniors had had enough. Folks don’t like to hear that you can do well only if you do your homework everyday. Having lived through two of those cycles, we can attest that it works.”

Source: CNBC, July 7, 2009 (hat tip: The Big Picture, July 8, 2009).

Fox Business: Sam Stovall - outlook for Q2 earnings
“S&P’S chief economist Sam Stovall on what the market can expect from the past three months’ earnings.”

Source: Fox Business, July 7, 2009.

CNBC: Prospect of a new reserve currency
“Discussing the prospect of a new reserve currency, with David Kotok, chairman and chief investment officer at Cumblerland Advisors, Andrew Freris, invesment strategist, BNP Paribas Wealth Management and CNBC’s Martin Soong.”

Source: CNBC, July 3, 2009.

John Authers (Financial Times): Curbs to oil speculation
“John Authers says that while regulating commodity trading may be risky, it seems to be justified in the current situation.”

Click here for the article.

Source: John Authers, Financial Times, July 7, 2009.

CNBC: The Pickens Plan - one year later
“Boone Pickens, chairman of BP Capital, gives CNBC an update on the progress of The Pickens Plan, which sets out to reduce America’s dependence on foreign oil.”

Source: CNBC, July 7, 2009.

Financial Times: BOE keeps rates and QE on hold
“The bank of England’s monetary policy committee surprised the market on Thursday by announcing it would not expand its programme of quantitative easing beyond the £125 billion already authorised. FT’s Chris Giles talks to Daniel Garrahan about how the bank will act next and whether the QE scheme is working.”

Source: Financial Times, June 8, 2009.

Charlie Rose: President Obama’s trip to Russia
“Update on President Obama’s trip to Russia with Michael Mandelbaum, Professor and Director of the American Foreign Policy program at the Johns Hopkins University and Martha Raddatz of ABC News.”

Source: Charlie Rose, July 7, 2009.

Tags: Barack Obama, Commodities, Corrective Mode, Currency Markets, Earnings Season, Global Economic Outlook, Government Bonds, International Monetary Fund, Jeff Saut, Jim Bianco, John Authers, O Rama, oil, Oliver Blanchard, Puru Saxena, Reserve Currency, Risk Aversion, Risky Assets, Roger Altman, Ross Allen, Russian Rendezvous, Wilbur Ross
Posted in Markets | No Comments »

Global Markets Analysis Review (June 15 - 21, 2009)

Sunday, June 21st, 2009

Caution last week crept back into investors’ vocabulary for the first time in more than three months as they faced up to President Barack Obama’s plan to reform the US financial market regulations, weighed the prospects of a global economic recovery and whether the “green shoots” needed more monetary water, and also started pondering the second-quarter earnings season.

As risk-taking moderated, profit-taking on equities and commodities set in after a colossal advance since early March. Government bonds rallied further, high-yield corporate bonds met selling pressure, spreads on credit derivative indices widened, and the US dollar marked time. “We could be seeing one of those occasional ‘all-change signals’ in short-term trends,” said Fullermoney editor David Fuller from across the pond.

From his new abode at Gluskin Sheff & Associates, David Rosenberg said: “Post-credit collapse and asset deflation cycles are always gripped with fragility; the intermittent beta trades and flashy rallies only serve to tell us that nothing moves in a straight line. In the meantime, the incoming data do suggest that recession pressures are subsiding, but it is difficult to see what the sources of recovery are going to be outside of government spending.”

Source: Gary Varvel

The week’s performance of the major asset classes is summarized by the chart below. Not shown, the entire precious metals complex was again out of favor with investors, with gold bullion’s (-0.5%) high-beta cousins - platinum (-3.7%) and silver (-4.1%) - being sold off by cautious investors.

Source: StockCharts.com

The US dollar ended the week virtually unchanged after Russian President Dmitry Medvedev told a regional summit on Tuesday that new reserve currencies, in addition to the dollar, were needed to stabilize the global financial situation. Meanwhile Brazil, Russia, India and China went on the biggest dollar-buying binge in eight months during May, adding $60 billion to their reserves, as cited by MoneyNews (via Bloomberg).

Many stock markets on Monday registered their worst single-session losses in a month. Mature markets perked up towards the end of the week, but emerging markets, in a number of instances, were down for all five trading days. After a four-week winning streak, the MSCI World Index (-3.0%) and the MSCI Emerging Markets Index (-5.0%) closed the week at their lowest levels since the last week of May.

Facing lackluster volume, the major US indices all ended the week in the red, but less so than most European and emerging bourses, as seen from the movements of the indices: S&P 500 Index (-2.6%, YTD +2.0%), Dow Jones Industrial Index (-2.9%, YTD -2.7%), Nasdaq Composite Index (-1.7%, YTD +15.9%) and Russell 2000 Index (-2.7%, YTD +2.7%).

To put the decline in context, the biggest pullback in the S&P 500 since the March 9 low happened in late March when the Index dropped by 5.9% over the course of two days. The most recent decline took the Index down by 5.0% between May 8-15. The S&P 500 is currently a more modest 2.7% off its high of June 12.

After climbing into the black for the year to date in the prior week, the Dow fell back to -2.7% last week - the only major US index in the red for 2009 - and, along with the FTSE 100 Index (-2.0%), one of the few global indices in this unenviable position.

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

As far as non-US markets are concerned, returns ranged from top performers - mostly African countries - Sri Lanka (+10.7%), Kenya (+9.5%), Namibia (+8.5%), Uganda (+7.3) and Côte d’Ivoire (+5.0%), to Russia (-9.8%), Qatar (-9.8%), Argentina (-8.4%), Ukraine (-6.9%) and Finland (-6.8%), which experienced headwinds.

In a bullish move, the Shanghai Composite Index - one of the leading markets in the advance over the last few months - bucked the downtrend with a gain of 5.0%. However, the Russian Trading System Index - the top-performer for the year to date (+70.7%) and since the November 20 lows (+104.8%), succumbed to profit-taking, losing 9.8% on the week. Also, the Bombay Sensex 30 Index (-4.7%) declined after rising for 14 consecutive weeks. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the leaders for the week included offshore “short” funds such as ProShares Short MSCI Emerging Markets (EUM) (+7.4%) and ProShares Short MSCI EAFE (Europe, Australia, Far East) (EFZ) (+3.3%). On the other side of the performance spectrum, losers centered in the energy sector, including Market Vectors Coal (KOL) (-13.4%) and iShares Dow Jones US Oil Equipment & Services (IEZ) (-11.6%).

In a white paper released on Tuesday night, the Obama administration detailed a number of proposals to overhaul the US system of financial regulations in an effort to restrain the reckless risk-taking that triggered the economic crisis.

The quote du jour this week is related to this regulatory reform and comes from Barry Ritholtz, editor of The Big Picture blog and author of Bailout Nation, a newly published and must-read book, who remarked: “The Federal Reserve, despite its role in causing the crisis, gets MORE authority. Under Greenspan, the Fed did a terrible job of overseeing banking, maintaining lending standards, etc. Why they should be rewarded for this failure with more responsibility is hard to fathom. It is yet another example of rewarding the incompetent.”

Ritholtz offers a better solution: “Have the Fed set monetary policy. They should provide advice to someone else - like the FDIC (Federal Deposit Insurance Corporation) - who hasn’t shown gross incompetence.”

Other news is that the US Treasury is planning to revamp securitization with new rules designed to reduce the incentive for lenders to originate bad loans and flip them on to investors. The aim is to restore confidence in and revitalize securitized markets, which financed more than half of all credit in the US in the years immediately prior to the credit crisis.

Next, a quick textual analysis of my week’s reading. No surprises here, with all the usual suspects such as “market”, “financial”, “credit”, “economy”, “stock”, “banks” and “China” featuring prominently.

Back to the stock markets: an analysis of the moving averages of the major US indices shows the S&P 500, the Nasdaq Composite and the Russell 2000 trading above their 50- and 200-day moving averages, albeit marginally so in the case of the S&P 500. On the other hand, the Dow Industrial and Dow Transportation are below the key 200-day line, but still a few points above the 50-day average. Only the Nasdaq Composite trades above its January peak. 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.

Not only are the indices very close to important moving average support levels, but a short-term oscillator such as the rate-of-change (momentum) indicator is on the verge of giving a selling signal, i.e. crossing through the zero line in the bottom section of the S&P 500 chart below. Also note the negative divergence between the Index and the ROC line - typically a warning sign that a near-term trend change will take place.

Source: StockCharts.com

The Bullish Percent Index shows the percentage of stocks that are currently in bullish mode as a result of point-and-figure buy signals. With the figure at 64.8%, this indicator conveys the message that the majority of stocks are in uptrends, but the line has turned down and the chart has the appearance of at least a short-term top.

Source: StockCharts.com

Richard Russell, veteran writer of the daily Dow Theory Letters, commented on Monday: “I’m of the opinion that this bear market rally is in the process of topping out. When a counter-trend rally tops out within an ongoing primary bear market, the odds are that the stock market will break to new lows during the period ahead. That means that the stock market will break below its March 9 lows in coming weeks. A violation of the March 9 lows would be a shocker to most investors, and it would be a forecast of an even worse economy coming up.”

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 Tuesday, but is still as relevant today as it was a few days ago.)

Turning to equity valuation levels, economist and strategist David Rosenberg, said: “The notion that we had moved to Armageddon lows in equities does not seem to hold water. After all, the forward P/E multiple on the S&P 500 at the lows was 11.7x. That was not a multi-decade low or some massive standard-deviation figure - we were actually lower than that at the October 1990 lows when the multiple was 10.5x and frankly, coming off the 1987 collapse, the forward P/E had compressed to 9.8x.

“As it now stands, the multiple is back very close to where it was at the October 2007 market high when the multiple had expanded to 15.0x. The range on the forward P/E over the last quarter-century is between 9.8x and 21.8x (excluding the tech bubble), so at 14.5x currently, it is hardly the case that this market can be viewed as a bargain. On a trailing earnings basis, the P/E multiple has actually widened, from 17.0x at the lows to 23.3x currently, a huge multiple expansion.”

Nouriel Roubini, professor at NYU’s Stern School and Chairman of RGE Monitor, shares the view that the stock market rally is long in the tooth. According to Yahoo, Tech Ticker, he pointed to three factors that would lead to a correction in the near future: (1) Volatility and uncertainty would increase; (2) Corporate earnings would disappoint; and (3) The global financial system still faced serious problems.However, Roubini was not convinced that the market would retest the rally lows.

Taking an opposite stance, Mario Gabelli, chief investment officer at Gamco Investors, sees rosy times ahead for the economy and stock market, as reported by MoneyNews. He noted that the Dow Jones Industrial Average was now at 8,500. “Twelve years ago it was 8,500 … In 10 years, 8,500 will look like a bargain, and it’s a bargain today. The best way to make money in the coming bull market is ‘plain old stock picking’,” said Gabelli.

In my opinion, it seems as if the spring rally has probably exhausted itself. It is difficult to envisage how much of a pullback we might see, but I maintain that it will still be part of a bottoming process. I would nevertheless assume a defensive position, as a bigger and longer correction than what many pundits are expecting cannot be excluded.

For more discussion on the direction of stock markets, also see my recent posts “Gold, gold, you’re making me old“, “Albert Edwards: Expect new equity lows in H2, China is global Achilles’ heel“, “Video-o-rama: Regulatory reform dominates debate“, “Stock markets: retreat in store?“, “The recession in historical context“, “Technical talk: S&P 500 turning down from 950 again” and “Have stock markets run away from reality?“. (And do make a point of listening to Donald Coxe’s webcast of June 19, which can be accessed from the sidebar of the Investment Postcards site.)

Economy
“Global business sentiment is much improved during the past three months. Most notable is the optimism regarding the economic outlook toward the end of this year. Assessments of current business conditions and the strength of sales have also measurably improved,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. However, confidence is still weak and fragile, consistent with an ongoing global recession.

Although the European Central Bank (ECB) has warned that Eurozone banks face additional losses of more than $283 billion this year and next, German investor confidence, as measured by the ZEW Economic Sentiment Index, rose to a three-year high in June. The improvement suggests that investors are more confident that the worst of the financial crisis and recession has passed. However, the ZEW Current Situation Index remained around its six-year low in June, indicating that the German economy remains in recession.

Source: ZEW

“‘Green shoots’ is no longer the favorite phrase among policymakers. During last weekend’s meeting of Group of Eight (G8) finance ministers, the message shifted to emphasize that it was far too early to sound the all-clear for the world economy,” writes the Financial Times.

“I don’t think we’re at a point yet where we can say we have a recovery in place,” said Tim Geithner, US Treasury secretary, and continued this theme a day later by saying “it is early still” and “we have a way to go”. Britain’s finance minister, Alistair Darling, said “we’re not there yet”, and the IMF’s Dominique Strauss-Kahn said “the recovery is weak”.

Focusing on the country that seems to have cruised best through the economic malaise, the World Bank raised its forecast for China’s 2009 gross domestic product growth to 7.2% (from 6.5% three months ago), saying the apparent success of the government’s stimulus package had improved the outlook from March, as reported by the Financial Times. The bank estimates a full six percentage points of this year’s 7.2% GDP growth will come from investment and spending either carried out by the government or directly influenced by it.

According to US Global Funds, another validation of China’s economic recovery is provided by the recent growth in government revenue, thanks to rising business tax receipts. “Going forward, a virtuous cycle may set in when improving private sector activity encourages corporate expansion, which in turn benefits employment, income growth, and consumption.”

Source: US Global Funds - Weekly Investor Alert, June 19, 2009.

However, Albert Edwards, global strategist at Société Générale, said (via the Financial Times): “I believe the bullish group-think on China is just as vulnerable to massive disappointment as any other extreme or bubble nonsense I have seen over the last two decades. The fall to earth will be equally as shocking.”

In the world’s second largest economy, the Bank of Japan opted not to make any changes to its monetary policy, stating that economic conditions in Japan “have begun to stop worsening”.

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

June 19
• June 23-24 FOMC meeting - coast is not clear yet, minor modifications of April statement likely

June 18
• Index of Leading Indicators suggests worst is over
• Continuing Claims post large decline
• Philadelphia Fed Survey points to improving factory conditions

June 17
• Subdued inflation data leave room for Fed
• Significant improvement in current account deficit

June 16
• Housing Starts - turning the corner?
• Factory Production and Operating Rate remain problematic
• Higher prices for energy and tobacco lift overall Wholesale Price Index

Also, Reuters reported that US credit card defaults rose to record highs in May, soaring to 12.5% from 10.5% in April in the case of Bank of America. This is yet another sign that consumers remain under severe stress.

Summarizing the outlook for the US economy, Asha Bangalore (Northern Trust) said: “For all purposes, although the nature of incoming economic data and current financial market conditions indicate that the worst is behind us, real GDP in the second quarter is projected to decline again. The headline reading of real GDP should show a noticeably smaller drop in the second quarter compared with the 5.7% drop in the first quarter.

“There is mixed opinion in the marketplace about the third-quarter performance of the economy. We expect the economy to gather steam only by the final three months of 2009. The FOMC’s projections show a decline of real GDP growth (Q4-to-Q4 basis) in 2009 to range between -2.0% and -1.3%. The bottom line is that the Federal funds rate will hold unchanged for several months ahead.”

Week’s economic reports

Source: Yahoo Finance, June 19, 2009.

In addition to an interest rate announcement by the Federal Open Market Committee (FOMC) (Wednesday, June 24), 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, June 19, 2009.

“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity. Both bring a permanent ruin. But both are the refuge of political and economic opportunists,” said Ernest Hemingway.

In these troubled times, let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will help Investment Postcards readers to spot the opportunities and invest wisely.

For short comments - maximum 140 characters - on topical economic and market issues, web links and graphs, you can also follow me on Twitter by clicking here.

Happy Father’s Day to all, and enjoy the longest summer’s day of the year (in the northern hemisphere)!

That’s the way it looks from Cape Town in the heart of winter (that I will shortly be leaving behind for a two-week visit to Slovenia and Switzerland).

Simon Johnson (The Baseline Scenario): Where are we now?
“1. Financial markets have stabilized - largely because people believe that the government will not allow Citigroup to fail. We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside. How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation.

“2. The real economy begins to bottom out, although unemployment will not peak for a while and could stay high for several years. Longer term growth prospects remain uncertain - has consumer behavior really changed; if finance doesn’t drive growth, what will; is the budget deficit under control or not (note: most of the guarantees extended to banks and other financial institutions are not scored in the budget)?

“3. More broadly, there is sophisticated window dressing in the pipeline but no real reform on any issue central to (a) how the banking system operates, or (b) more broadly, how hubris in finance led us into this crisis. The financial sector lobbies appear stronger than ever. The administration ducked the early fights that set the tone (credit cards, bankruptcy, even cap and trade); it’s hard to see them making much progress on anything - with the possible exception of healthcare.

“4. The consensus from conventional macroeconomics is that there can’t be significant inflation with unemployment so high, and the Fed will not tighten before late 2010. The financial markets beg to differ - presumably worrying, in part, about easy credit leading to dollar depreciation, higher import prices, and potential commodity price inflation worldwide. In all recent showdowns with standard macro models recently, the markets’ view of reality has prevailed. My advice: pay close attention to oil prices.

“5. Emerging markets are increasingly viewed as having ‘decoupled’ from the US/European malaise. This idea was wrong in early 2008, when it gained consensus status; this time around, it is probably setting us up for a new bubble - based on a ‘carry trade’ that now runs out of the US. The ‘appetite for risk’ among investors is up sharply. The G7/G8/G20 is back to being irrelevant or merely cheerleaders for the financial sector.”

Source: Simon Johnson, The Baseline Scenario: June 13, 2009.

The Washington Post: Obama blueprint deepens Federal role in markets
“The Obama administration last night detailed a series of proposals to involve the government more deeply in private markets, from helping to steer borrowers into affordable mortgage loans to imposing new limits on the largest financial companies, in a sweeping effort to curb the kinds of reckless risk-taking that sparked the economic crisis.

“The plan seeks to overhaul the nation’s outdated system of financial regulations. Senior officials debated using a bulldozer to clear the way for fundamental reforms but decided instead to build within the shell of the existing system, offering what amounts to an architect’s blueprint for modernizing a creaky old building.

“The White House makes its case for this approach in an 85-page white paper that describes the roots of the crisis. Gaps in regulation allowed companies to make loans many borrowers could not afford. Funding came from new kinds of investments that were poorly understood by regulators. Big firms paid employees massive bonuses, while setting aside little money to absorb potential losses.

“‘While this crisis had many causes, it is clear now that the government could have done more to prevent many of these problems from growing out of control and threatening the stability of our financial system,’ the white paper says.

“The plan is built around five key points, according to a briefing last night by senior administration officials and a copy of the white paper obtained by The Washington Post.

“The proposals would greatly increase the power of the Federal Reserve, creating stronger and more consistent oversight of the largest financial firms.

“It also asks Congress to authorize the government for the first time to dismantle large firms that fall into trouble, avoiding a chaotic collapse that could disrupt the economy.

“Federal oversight would be extended to dark corners of the financial markets, imposing new rules on trading in complex derivatives and securities built from mortgage loans.

“The government would create a new agency to protect consumers of mortgages, credit cards and other financial products.

“And the administration would increase its coordination with other nations to prevent businesses from migrating to less regulated venues.

“Congressional leaders say they hope to pass some version of the plan by year’s end.”

Source: Binyamin Appelbaum and David Cho, The Washington Post, June 17, 2009.

CNBC: Sheila Bair on the regulation revamp
“The White House this week unveiled a new financial regulatory framework, and FDIC Chair Sheila Bair shares her outlook on the new policy initiatives with CNBC.”

Source: CNBC, June 19, 2009.

Barry Ritholtz (The Big Picture): Obama reform plan fails to fix what is broken
“So much for ‘not letting a crisis go to waste’.

“The initial read on the Obama Regulatory plan was an enormous disappointment. Both supporters and critics who expected him to take a hard turn to the Left have been left either surprised or disappointed, depending upon their leanings.

“To the pragmatic center, including your humble blogger, what stands out is the number of half measures and omitted actions that were viewed as necessary to prevent a replay.

“Some very obvious omissions from the plan include:

“1) No major changes for the ratings agencies!

“This is a giant WTF from the White House. It implies that the team in charge STILL does not understand how the problem occurred.

“The ratings agencies are not the only bad actors, but they are a BUT FOR - but for the rating agencies putting a triple A on junk paper, many funds could not have purchased them, the number of mortgages securitized would have been much less, the insatiable demand on Wall Street for mortgage paper would have also been much lower.

“Why is this important? If mortgage originators couldn’t sell a mass amount of loans, they would not have had the need to give a mortgage to anyone who could fog a mirror - and that means no Liar Loans, no NINJA loans, and no huge subprime debacle.

“Better Solution: Take apart the ratings oligopoly! Eliminate the Pay-for-Play/Payola structure. Strip Moody’s S&P and Fitch from their uniquely protected status - they have proven they are neither worthy nor competent. Open up ratings to competition - including open source.

“2) Turn derivatives into ordinary financial products: The Obama team does a series of minor steps for derivatives, but they don’t go far enough.

“Better Solution: Force derivatives to be traded like option/stocks, etc. (including custom one-off derivatives). Trade them only on exchanges, full disclosure of counter-parties, transparency and disclosure of open interest, trades, etc. REQUIRE RESERVES LIKE ANY OTHER INSURANCE PRODUCT.

“3) ‘If they are too big to fail, make them smaller.’

“That is the famous quote from Nixon Treasury Secretary George Shultz, and it applies to the banks as well as insurers, Fannie & Freddie, etc.

“We have a situation where 65% of the depository assets are held by a handful of huge banks - most of whom are less than stable. The remaining 35% is held by the nearly 7,000 small and regional banks that are stable, liquid, solvent and well run.

“Better Solution: Have real competition in the banking sector. Limit the size for the behemoths to 5% or even 2% of total US deposits. Break up the biggest banks (JPM, Citi, Bank of America).

“4) The Federal Reserve, despite its role in causing the crisis, gets MORE authority.

“Under Greenspan, the Fed did a terrible job of overseeing banking, maintaining lending standards, etc. Why they should be rewarded for this failure with more responsibility is hard to fathom. It is yet another example of rewarding the incompetent.

“Better Solution: Have the Fed set monetary policy. They should provide advice to someone else - like the FDIC - who hasn’t shown gross incompetence.

“5) Require leverage to be dialed back to its pre-2004 levels. Have we even eliminated the Bears Stearns exemption yet? This was a 2004 SEC decision to exempt five biggest banks from the mere 12-to-1 prior levels. Note that all five are either gone, acquired or turned into holding companies.

“Better Solution: 12-to-1 should be enough leverage for anyone.

“6) Restore Glass Steagall: The repeal of Glass Steagall wasn’t the cause of the collapse, but it certainly contributed to the crisis being much worse.

“Better Solution: Time to (once again) separate the more speculative investment banks from the insured depository banks.

“All of which suggests that the status-quo-preserving, sacred-cow-loving, upward-failing duo of Lawrence Summers and Tim Geithner are still in control of economic policy. The more pragmatic David Axelrod and the take-no-prisoners, don’t-give-a-shit-about-Wall-Street Rahm Emmanuel have yet to assert authority over the finance sector.”

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

Roubini (Yahoo, Tech Ticker): New regulations “go in the right direction”, but not far enough
“The new Wall Street regulations announced by President Obama yesterday ‘go in the right direction’ but only accomplish about ‘75% of what needs to be done’, says Nouriel Roubini, professor at NYU’s Stern School and chairman of RGE Monitor.”

Click here for the article.

Source: Yahoo, Tech Ticker, June 18, 2009.

MoneyNews: Paul Volcker - put a brake on the bailouts
“Government bailouts should be limited and a clear policy set forth defining who would have access to the government’s financial safety net.

“That’s what former Federal Reserve chairman Paul Volcker told a meeting of the International Institute of Finance in Beijing recently, as reported in The Wall Street Journal.

“Volcker is also chairman of President Obama’s Economic Recovery Advisory Board, so his remarks on the economy may also reflect administration thinking on the subject, and may also be a forecast of reforms to come.

“‘One unfortunate consequence of the massive public assistance provided both banks and nonbanks in dealing with the present crisis is that moral hazard may, I am afraid, become more deeply embedded.’

“Moral hazard is defined as an absence of incentive to protect against risk if you are insured against risk.

“Volcker, in his speech, cited as a conflict of interest among those institutions which ‘engaged in substantial risk-prone proprietary trading and speculative activities.’

“Financial institutions beyond the government ’safety net’ should not count on government protection, said Volcker. But they may be subject to government oversight.

“In an effort to prevent another disastrous financial crisis, the Obama administration wants to empower the Federal Reserve as a ’systemic risk regulator’ with the right to seize large financial firms tottering near failure.”

Source: Marc Davis, MoneyNews, June 17, 2009.

Financial Times: Treasury plans strict rules for securitisation
“The US Treasury is planning a sweeping overhaul of securitisation markets with tough new rules designed to restore confidence by reducing the incentive for lenders to originate bad loans and flip them on to investors.

“The authorities plan to force lenders to retain part of the credit risk of the loans that are bundled into securities and to end the gain-on-sale accounting rules that helped spur the boom of the markets at the heart of the financial crisis.

“The aim is to revitalise the markets for securities backed by mortgages and other assets without re-creating the systemic risks that turned boom to bust in 2007. The plan is part of a wider overhaul of regulation to be unveiled on Tuesday.

“A Treasury spokesman said that while securitisation had made credit more widely available, breaking the direct link between borrower and lender had ‘led to a general erosion of lending standards, resulting in a serious market failure that fed the housing boom and deepened the housing bust’.

“Securitised markets - which financed more than half of all credit in the US in the years immediately preceeding the crisis - are essential for the US economy. Without a recovery in these markets, the flow of credit will not return to more normal levels, even if US banks overcome their problems.”

Source: Krishna Guha, Tom Braithwaite, Francesco Guerrera and Aline van Duyn, Financial Times, June 15, 2009.

Bloomberg: Congress backs war-funding bill, “cash for clunkers”
“A $106 billion war-spending bill won final congressional approval after the Senate voted to retain a ‘cash for clunkers’ provision aimed at helping the auto industry.

“Action by the Senate today sends the measure to President Barack Obama for his signature. The Senate passed the bill on a 91 to 5 vote; the House approved the measure earlier this week.

“Senator Judd Gregg, a New Hampshire Republican, led the effort to drop a provision providing as much as $4,500 to people who trade in their vehicles for more fuel-efficient models. He said the plan, which would cost $1 billion, was a poor use of tax dollars when the government is projected to run its biggest budget deficit since 1945.

“‘It is a clunker,’ Gregg said of the plan. ‘Why should our children and our grandchildren have to pay the bill’ for the government subsidizing ’somebody to buy their car today? How fiscally irresponsible is that?’ he said.

“The legislation provides more than $82 billion to fund military operations in Iraq and Afghanistan, which would bring total spending on the wars to more than $900 billion.

“Lawmakers agreed to Obama’s request to include $5 billion to secure $108 billion in aid, primarily in the form of a line of credit, to the International Monetary Fund. The legislation would permit US representatives to the IMF to agree to its planned sale of 13 million ounces of gold, one-eighth of the organization’s holdings, to help finance aid to poor countries.

“The bill also would provide $7.7 billion for pandemic flu programs.

“Other provisions would allow the Pentagon to transfer suspected terrorists held at the military prison at Guantanamo Bay, Cuba, to the US for trial, though not for long-term incarceration or release.”

Source: Brian Faler, Bloomberg, June 18, 2009.

Financial Times: “Green shoots” wilt
“‘Green shoots’ is no longer the favourite phrase among policymakers. During last weekend’s meeting of Group of Eight finance ministers, the message shifted to emphasise that it was far too early to sound the all-clear for the world economy.

“‘I don’t think we’re at a point yet where we can say we have a recovery in place,’ said Tim Geithner, US Treasury secretary, who continued this theme yesterday by saying ‘it is early still’ and ‘we have a way to go’. Britain’s finance minister said ‘we’re not there yet’. The IMF’s Dominique Strauss-Kahn said ‘the recovery is weak’.

“Financial markets dutifully responded to this message. It is a great example of effective jawboning - the attempt to influence by persuasion rather than by exertion of force or one’s authority, although weak economic data played its part.

“Stock prices fell, bond prices rose. Perhaps most importantly, commodity prices fell too. A persistent rise in oil and other commodities could lead to a return to high inflation expectations. With the US central bank pumping billions of dollars into the economy through purchases of government bonds and mortgage debt, any need to suck that out to curb inflation fears could be messy and lead to a surge in borrowing costs.

“Though there is now a plan to come up with ‘exit strategies’ - the G8 has asked for an analysis of how best to handle this - policymakers are clearly showing they do not want to repeat the mistakes made by Japanese officials in the 1990s, that of pulling back economic stimulus and credit expansion too quickly. This balancing act will be needed for some time. According to Ajay Rajadhyaksha, at Barclays Capital: ‘Policymakers want to see if they can buy another year or year-and-a-half without inflation expectations building up.’”

Source: Aline van Duyn, Financial Times, June 15, 2009.

SmartMoney: Red herrings - false signs of an economic rebound
“Because of the magnitude of the recent downturn, experts say some of the statistics that are widely used to track the economy are now red herrings - misleading, at best, when it comes to predicting a rebound. Here are three indicators that could lead investors astray.

What housing glut?

“Housing inventory measures the supply of unsold homes on the market. Right now it’s high - a 10-month supply of homes, up from the average of about five - and conventional wisdom says the housing market won’t recover until it declines. This time around, however, waiting for ‘normal’ could cost you. In fact, an improving economy might mean more homes on the market, not fewer. Some banks are sitting on foreclosed properties, waiting for a friendlier economic climate before putting them on the market, and many homeowners are essentially doing the same thing. Stephen Kim, senior analyst at Alpine Global Real Estate fund, thinks home-building stocks ‘will rally while inventory levels are still high.’

The hidden jobless

“It seems like a no-brainer: Once more people are working, stocks should rebound. But investors who rely solely on the official unemployment rate - the percentage of workers who are jobless - could be misled. The statistic excludes so-called discouraged workers who have given up looking for a job. And the data doesn’t capture companies that force employees to take pay and benefit cuts or furloughs. ‘You’d get a better idea just asking people on the street if they’re employed,’ scoffs John Williams, founder of economic research firm Shadowstats.com. Strategists put more trust in weekly unemployment-claims data, a different figure that gives a clearer sense of companies’ hiring and firing.”

Inflated expectations

“Many market watchers are hoping for a modest increase in inflation, as a sign that the global economy is starting to crawl out of recession. But investors who watch the so-called core consumer price index (CPI), the most widely used gauge, might miss the first stages of a rally and lose out on run-ups in stocks of energy and raw-materials companies. Core CPI excludes the cost of food and energy, and analysts like Strategas economist Don Rissmiller think energy is where prices may surge first, as billions of stimulus dollars pumped into infrastructure projects stoke demand for metals and fuel. Investors looking for a better indicator than the CPI should watch prices for commodities like copper and oil.”

Source: SmartMoney, June 18, 2009.

The Capital Spectator: A bull market in false dawns?
“Flat to a slight upside bias. That about sums up the prevailing state of inflation at the moment, based on this morning’s latest from the US Bureau of Labor Statistics.

“Seasonally adjusted consumer inflation rose 0.1% last month, up from zero the month before and a modest decrease in March. On its face, that’s good news, as it suggests that the risk of deflation, if not quite passed, is looking more and more like a shadow of its formerly threatening self. Meanwhile, inflation as a clear and present danger also remains thin as an imminent menace.

“We are in a transitory state, passing from severe danger to something less so. Anything’s possible, of course, especially in the current climate. But barring some extraordinary and largely unexpected event, we’re likely to press on through what we’ll call a pre-recovery period, when the economic numbers improve relative to the recent past yet the numbers don’t quite show the traditional bounce that typically accompanies the end of recessions.

“‘The economy seems to be out of intensive care,’ says David Shulman, senior economist at UCLA Anderson School of Management. ‘The freefall stage in dropping output and employment seems to be over, but the economy is still sick.’

“The prospect of false starts in the data looks quite high in the months ahead. The good news on one day will be reversed by bad news the next, and quite a bit of treading water at other times. The transition state that carries us from recession to growth, in short, will last longer than usual. The evidence will be particularly obvious in the lagging indicators, employment being the most conspicuous example.

“Indeed, the labor market is still shrinking and will probably continue to do so in the months ahead, perhaps followed by an extended bottoming-out period over several quarters. The economy’s capacity to create jobs is likely to come later and be more tepid than has typically been the case following the end of recessions in the post-war era.

“Extending the medical metaphor, Bruce Kasman, chief economist for JPMorgan Chase, predicts in BusinessWeek.com yesterday that ‘the economy will return to growth but not to health’.

“Last week we wrote of the ‘technical end’ of the recession and our expectation that NBER would eventually get around to declaring the downturn’s finish at, well, right about now, give or take a few months. That’s good news relative to the recent standard of economic activity. But the technical demise of the recession isn’t likely to bring easily recognizable good news on Main Street anytime soon.

“As frustrating as that outlook is, it’s even more hazardous than is generally recognized. If we’re facing an unusually long transition period, there are specific risks linked to this abnormal state of affairs. That includes figuring out how and when to adjust monetary policy to balance two conflicting forces: deflation and inflation. As the former gives way, the latter isn’t likely to suddenly pop out and yell ‘boo’. Nonetheless, the future inflation risk isn’t trivial, given the massive liquidity that’s been created of late and the historical lessons that go with fiat currencies.

“Tightening monetary policy too soon may risk choking off a nascent but weak recovery; waiting too long to raise interest rates may give inflation a solid foundation to thrive, an especially troubling thought, given the massive amount of debt incurred over the last 12 months or so.

“Overall, economic analysis faces unusually tough times in reading the incoming data and drawing reasonable conclusions about the implications for the future. As a basic example, our proprietary index of economic indicators, published in each issue of The Beta Investment Report, is currently flashing a robust sign of recovery, although this may be misleading because much of the rise has come from monetary policy and, so far, isn’t convincingly corroborated in the real economy.

“In short, interpreting the economic outlook promises to be quite difficult going forward, much more so than usual. Beware: The risk of false dawns is rising.”

Source: The Capitol Spectator, June 17, 2009.

Financial Times: Fed faces key policy decisions
“The sharp increase in both US bond yields and mortgage rates presents the Federal Reserve with two key decisions next week: whether to increase its purchases of Treasuries and whether to push back against expectations of early interest rate rises.

“With the US central bank unlikely to authorise large increases in Treasury purchases, the debate is between stopping at the declared $300 billion, or increasing this total modestly to enable a gradual phase-out.

“Some Fed officials think there could be merit in redirecting some money slated for purchases of mortgage-related securities towards Treasury purchases - giving it more latitude in this market without increasing overall purchases.

“Meanwhile, the Fed is likely to reiterate that it expects to keep rates near zero for an ‘extended period’, challenging market expectations of early tightening. But it will also repeat - and might sharpen - the message that it is not tied to any course of action.

“Fed hawks are getting edgy. ‘As the economy recovers, even at a modest pace, resource demands will begin to increase,’ Tom Hoenig, president of the Kansas City Fed, said on June 3. ‘At this point the current level of monetary accommodation will need to be withdrawn.’

“But some Fed officials highlight the low level at which activity is stabilising. ‘Not enough attention is being paid to how much ground we will need to cover before we return to our pre-recession level of activity,’ said Sandra Pianalto, president of the Cleveland Fed, on June 4.

“The Fed leadership - which puts considerable weight on spare capacity - almost certainly shares this view. Officials probably do not expect to raise rates late this year or early next, assuming sub-trend growth, projected drag as the fiscal stimulus fades and the phasing out of some financial market programmes first. However, the statement may accommodate some of the hawks’ concerns.”

Source: Krishna Guha, Financial Times, June 14, 2009.

MoneyNews: Prechter - US likely to lose AAA rating
“Technical analyst Robert Prechter on Monday said he sees the United States losing its top AAA credit rating by the end of 2010, as he stuck by a deeply bearish outlook on the US economy and stock market.

“Prechter, known for predicting the 1987 stock market crash, joins a growing coterie of market heavyweights in forecasting the United States will lose its top credit rating as the government issues trillions of dollars in debt to fund efforts to bail out the economy.

“Fears about the long-term vulnerability of the prized US credit rating came to the fore after Standard & Poor’s in May lowered its outlook on Britain, threatening the UK’s top AAA rating. That move raised fears that the United States could face a similar risk, with the hefty amounts of government debt issued in both countries to pay for financial rescues causing budget deficits to swell.

“Prechter, speaking at the Reuters Investment Outlook Summit in New York, said he sees investors’ confidence in an economic rebound fading, a trend that will drag the S&P 500 stock index .SPX well below the March 6 intraday low of 666.79 by the end of this year or early next.

“‘There will be a leg down in stock prices, and it will affect all other areas,’ including corporate bonds and commodities, said Prechter, who is executive officer at research company Elliott Wave International, based in Gainesville, Georgia.

“Prechter, who is known for his bearish views, has repeatedly forecast a steep decline in stocks this year, even as the stock market has rebounded from 12-year lows set in March as optimism about an economic recovery has risen.

“Despite the government and Federal Reserve’s massive rescues for financial companies and securities markets, Prechter expects credit markets to clam up again as they did in the first phase of the global financial crisis and for the US economy to sink into a depression.

“The economy ‘is obviously heading toward a depression’, despite the government’s efforts to dodge one, said Prechter.”

Source: MoneyNews, June 16, 2009.

Asha Bangalore (Northern Trust): Index of Leading Indicators suggests worst is over
“The Conference Board’s Index of Leading Economic Indicators (LEI) rose 1.2% in May after a revised 1.1% increase in the prior month. This is the best back-to-back performance of the index since the November-December 2001 period. On a year-to-year basis, the index declined 1.76%, the smallest drop since December 2007.

“The bottom for the year-to-year change appears to have occurred in March 2009 (-4.0%), which is subject to revision. On a quarterly basis, the trough of the year-to-year change of the LEI is probably the first quarter of 2009 (-3.91%), also subject to revision. The 3-month moving average of the index per se hit a low in March 2009 (98.2), with the latest 3-month moving average at 99.03. The 6-month change of the LEI was positive for the first time in two years. The main message from these numbers is that an economic recovery is not too far away.”

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

Asha Bangalore (Northern Trust): Factory production and operating rate remain problematic
“Industrial production fell 1.1% in May after a downwardly revised 0.7% drop in April. Output at the nation’s utilities and the mining industry fell 1.4% and 1.1%, respectively. Excluding these two sectors, factory production declined 1.0%, led by a 7.9% plunge in production in the auto industry. Production in the high-tech sector was down 0.9% in May.

“The operating rate of the factory sector at 65% in May is the lowest in the post-war period. The historically low operating rate of the factory sector offers support to maintain the current easy monetary policy stance of the Fed for an extended period.”

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

Casey’s Charts: Unemployment rate with and without the recovery plan
“This chart from innocentbystander.net clearly shows Team Obama’s projections in the American Recovery and Reinvestment Plan are overly optimistic. May’s 9.4% unemployment rate, a 25-year high, far exceeded expectations. But don’t worry, your tax dollars are hard at work.

“About 1.6 million jobs were shed since the stimulus bill was passed in February, while the roughly $44 billion borrowed and spent from the recovery act has ’saved or created 150,000 jobs’, claims the White House.

“As the president repeats his tales of an improving economy and spending our way back to prosperity, perhaps it’s time to start reading between the lines.”

Source: Casey’s Charts, June 16, 2009.

Asha Bangalore (Northern Trust): Housing Starts - turning the corner?
“Home builders broke ground to construct more homes in May, both multi-family and single-family homes, compared with April. Housing starts increased 17.2% to an annual rate of 532,000 after posting a 12.9% drop in April and a 9.2% decline in March. The headline number reflects swings in the multi-family sector in both April (-49.4%) and May (+61.7%).

“The 7.9% jump in permits issued for single-family homes and the fact that it is the third monthly increase in the last four months strengthens the bullish outlook gleaned from production of new homes.”

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

Asha Bangalore (Northern Trust): Significant improvement in current account deficit
“The current account deficit of the US economy was $101.5 billion in the first quarter from $154.9 billion in the previous quarter. This is the smallest deficit since the fourth quarter of 2001. The current account deficit as a percentage of GDP fell to 2.88%, the smallest in ten years.

“The deficit on goods declined nearly $55 billion from the fourth quarter of 2008 to $124.04 billion in the first quarter. This is the single largest quarterly narrowing of the deficit on goods on record.

“The significant improvement of the current account deficit places a smaller burden for raising funds from capital inflows. However, the large increase in the federal budget deficit requires the capital to continue flowing.

“Foreign owned assets (net capital inflows) declined $78.1 billion in the first quarter, following a decrease of $11.9 billion in the fourth quarter of 2008.”

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

Asha Bangalore (Northern Trust): Subdued inflation data leaves room for Fed
“Inflation is not and will not be a top priority in Fed policy decisions in the near term. Inflation is a lagging economic indicator which peaks long after a recession is underway and gathers steam long after an expansion is visible. A convincing economic recovery and strong expectations of a growing economy are necessary for the Fed to consider suitable actions to prevent inflation.

“At present time, the enormous slack in the economy supports expectations of subdued inflation data, which is what we see at the moment. In May, the Consumer Price Index (CPI) edged up 0.1% after a steady reading in the prior month. The CPI is down 1.3% from a year ago, the largest drop since April 1950, mostly due to the sharp 27.3% drop in energy prices. The energy index rose 0.2% after posting declines in March and April. Food prices fell 0.2%, the fourth monthly decline.”

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

Asha Bangalore (Northern Trust): Higher prices for energy and tobacco lift Wholesale Price Index
“The Producer Price Index (PPI) of Finished Goods rose 0.2% in May, following a 0.3% gain in the prior month. The 2.9% jump in the energy price index reflecting a 13.9% increase in gasoline prices and higher prices for heating oil combined with a 0.7% increase in cigarette prices led to an increase in the overall PPI. However, food prices fell 1.6% in May, following a 1.5% increase in April. Excluding food and energy, the core PPI of finished goods price index fell 0.1% in May, putting the year-to-year increase at 3.0%. The peak year-to-year increase of the core PPI was 4.7% in October 2008.”

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

CNBC: Marc Faber - hyperinflation looming
“Why the US has a good chance of hyperinflation, with Marc Faber, ‘The Gloom, Boom, & Doom Report’ editor and CNBC’s Erin Burnett.”

Source: CNBC, June 19, 2009.

Reuters: US credit card defaults rise to record in May
“US credit card defaults rose to record highs in May, with a steep deterioration of Bank of America Corp’s lending portfolio, in another sign that consumers remain under severe stress.

“Delinquency rates - an indicator of future credit losses - fell across the industry, but analysts said the decline was due to a seasonal trend, as consumers used tax refunds to pay back debts, and they expect delinquencies to go up again in coming months.

“‘I find it hard to believe that it is really a trend. You need to see stabilization in unemployment before you see anything else,’ said Chris Brendler, an analyst at Stifel Nicolaus. ‘It is too early to see some kind of improvement.’

“Bank of America Corp - the largest US bank - said its default rate, those loans the company does not expect to be paid back, soared to 12.5% in May from 10.47% in April.

“The bank is paying the price of expanding rapidly in recent years and of holding one of the highest concentrations of subprime borrowers among the top card issuers, analysts said.

“In addition, American Express Co, which accounts for nearly a quarter of credit and charge card sales volume in the United States, said its default rate rose to 10.4% from 9.9%, according to a regulatory filing based on the performance of credit card loans that were securitized.

“Citigroup - the largest issuer of MasterCard branded credit cards - reported credit card chargeoffs rose to 10.5% in May from 10.21% in April.

“Credit card losses usually follow the trend of unemployment, which rose in May to a 26-year high of 9.4% and is expected to peak over 10% by the end of 2009.”

Source: Juan Lagorio, Reuters, June 15, 2009.

Fox Business: Mortgage and credit delinquencies climb
“Perspective on the state of the credit and lending market from TransUnion Director of Consulting & Strategy Ezra Becker.”

Source: Fox Business, June 17, 2009.

Gretchen Morgenson (The New York Times): Debts coming due at just the wrong time
“To get a fix on how much work remains to be done, consider the substantial amount of short-term debt coming due at financial companies in the next year or two. As you absorb these figures, keep in mind that many of the entities that bought this debt when it was issued aren’t around now - they’ve either left the market or are gone, casualties of the crisis.

“As a result, they’re not around to step up and buy the debt again. So issuers can’t roll it over. They’ll be forced to buy back the debt, at a time when they’re already wallowing in other forms of troublesome debt and short on liquidity.

“Barclays Capital has analyzed financial company debt among US institutions coming due over the next decade. During the rest of the year, for example, roughly $172 billion in debt will mature; in 2010, an additional $245 billion comes due. That amounts to about $25 billion a month in debt rolling into a market with a shortage of buyers willing to invest in it.

“Of the $172 billion coming due by year-end, Barclays says, $123 billion was floating-rate debt. And of the $245 billion maturing next year, some $141 billion pays a variable rate.

“This much is evident: it is too soon to celebrate the end of the banking crisis. Less debt is the answer, but shrinking balance sheets is hard.”

Source: Gretchen Morgenson, The New York Times, June 13, 2009.

China Daily: China’s holding of US bonds drops first time in 11 months
“For the first time in 11 months China’s holdings of US Treasury bonds fell - to $763.5 billion in April, US government data showed.

“The figure, down from March’s $767.9 billion, was the lowest since June 2008.

“The decline in the China holding ’seems to stem from net selling of Treasury bills’, said Chirag Mirani of Barclays Capital Research.

“On the whole, foreigners decreased holdings of Treasury bills by $44.5 billion in April, the data showed.

“As the largest holder of US Treasury bills, which are crucial to funding Washington’s multi-trillion-dollar recovery plans, China had expressed concerns recently over what it called the safety of its dollar-linked assets.

“US Treasury Secretary Timothy Geithner traveled to Beijing about two weeks ago to reassure Chinese leaders, saying their money is ‘very safe’ despite the US budget deficit, which he pledged to cut.

“The United States has been running large budget shortfalls since the tenure of Democratic President Barack Obama’s Republican predecessor George W. Bush.

“Obama administration officials estimate a deficit of $1.841 trillion for the 2009 budget and $1.258 trillion in 2010.”

Source: China Daily, June 16, 2009.

BCA Research: US corporate credit quality warning
“Corporate credit quality remains weak according to our indicator, based on a composite of six key financial ratios from the non-financial corporate sector.

“The latest update to our Corporate Health Monitor confirms that the credit quality of the non-financial corporate sector has been in decline since the fourth quarter of 2006. Its persistent warning of weak balance sheet fundamentals in the current cycle should not be taken lightly. True, corporate spreads have narrowed sharply in recent months, but this largely reflects a reduction in the premium for liquidity and other factors unrelated to credit risk. The boost to corporate bond performance from this source is largely over. Any further compression in spreads must now come from a decline in corporate credit risk, which may take some time to unfold.

“Bottom line: We expect a significant deceleration in the relative outperformance of corporate bonds, until the outlook for corporate profits begins to improve.”

Source: BCA Research, June 16, 2009.

Dhaval Joshi (RAB Capital): Pricing debt
“When it comes to pricing debt, investors who are overly focused on the huge levels of government borrowing are missing the point, says Dhaval Joshi, economist at RAB Capital.

“Government debt may be ballooning but corporate and household debt is shrinking, he says. ‘So the total stock of debt in the economy is not rising. And the price of debt should depend on the supply of all debt, not just part of it.’

“Mr Joshi notes that one of the big holes that US government borrowing must fill has been left by the shutdown of the shadow banking sector.

“‘Between 2004 and 2007, over $4,000 billion of mortgages were lent in the US. However, most of this did not come from the conventional banking system but from the shadow system, where mortgages were packaged into securities and sold on, rather than held on the banks’ own books.’

“These securitised mortgages accounted for $1,900 billion of lending, equal to 13% of US GDP, he says. This mountain is now collapsing, as borrowers default and the underlying collateral (housing) plunges. Whether debt is reduced by default or repayment, it is a drag on demand, as spending power or net worth falls.

“‘Governments must offset this with more debt, effectively acting as borrower of last resort. Markets should not focus just on government issuance, but look at the bigger debt picture. If they do, the recent rise in bond yields may be short-lived.’”

Source: Dhaval Joshi, RAB Capital (via Financial Times), June 18, 2009.

Bespoke: Barron’s Roundtable head scratcher
“This weekend’s Barron’s provided a mid-year update to its annual ‘Roundtable’ report, and as the title of the article suggested, the consensus among panelists was that the market has come ‘too far, too fast’. While that view is certainly not a minority opinion, we are confused with the logic behind it. As noted in the article, ‘Many predicted at our January 5 confab that the stock market, oversold and under-loved, was due for a major bounce. Now they think stock prices have overshot corporate fundamentals and a correction is in order.’

“So on January 5, when the S&P 500 was at 927, the members of the Barron’s Roundtable were looking for a major bounce. Now, with the S&P 500 up 2% since then, they think the market has come too far, too fast?”

Source: Bespoke, June 15, 2009.

Roubini (Yahoo, Tech Ticker): Nouriel Roubini’s three reasons why stocks are bound to fall
“Believe it or not, Nouriel Roubini - professor at NYU’s Stern School and Chairman of RGE Monitor - has some good news: aggressive government intervention prevented a great depression.

“The bad news: Roubini says the stock market rally is long in the tooth. (They don’t call him Dr. Doom for nothing.) He points to three factors that will lead to a correction in the near future:

“1. Volatility and uncertainty will increase. Note: the CBOE Volatility Index is currently down more than 50% since the October panic.

“2. Corporate earnings will disappoint. He says the market is pricing in a robust ‘V’-shaped recovery. However, when earnings miss expectations, buyers will turn into sellers, as was the case this week with FedEx.

“3. The global financial system still faces serious problems. Roubini thinks unemployment will rise to 11%, bank losses will increase across the globe, and the recession in Europe will get worse.

“The silver lining: Roubini isn’t convinced the market will retest the lows.”

Source: Yahoo, Tech Ticker, June 19, 2009.

David Fuller (Fullermoney): How much of a pullback lies ahead
“I maintain that new lows for Wall Street and most other OECD country stock markets in March 2009 were not dissimilar to the October 2002 trough during the base building process following the previous bear market. Monetary policy was accommodative back then and a strong rally followed to retest an earlier high within the developing base. Most of those gains were subsequently retraced during the build-up to the invasion of Iraq, when everyone feared that Saddam Hussein had weapons of mass destruction.

“The rally commencing in March 2009 occurred against a background of record monetary stimulus and it reflected a belated acceptance that the world was not going to experience a 1930s style depression after all. This was not exactly a conversion on the road to Damascus because a number of leading emerging (progressing) markets such as China and Chile had bottomed in October and were already in uptrends as the US’s S&P 500 Index began to recover from its lows.

“Something very similar happened during the 2001 to 2003 base building process because leading markets at the time, such as India and Thailand had either not retested their lows in 2002, or were in a much stronger position as they completed bases shortly after the invasion of Iraq commenced.

“The S&P 500 rally from its March 2009 low was much stronger than its 2002 rally from the October trough. I attribute this to a realisation that the world was not ending, plus the market inflating success of quantitative easing, against the background of record cash levels for institutional investors.

“So, with the S&P 500 losing upside momentum, how much of a pullback might we see this time, considering that there is no obvious equivalent to the invasion of Iraq for investors to worry about, although the economic background is arguably much worse?

“I suspect we will see a bigger pullback, which lasts longer than most people expect. Technically, the stalk-like rally looks unbalanced compared to the earlier portion of the base formation, although I appreciate that this may seem like an esoteric point to some of you. Many of the optimists are recent converts, sucked in by a momentum move. I suspect that some of those ‘green shoots’ of spring will prove to have been no more than a mirage as a hot summer progresses.

“The risk, I maintain, is that we see a multi-month correction, of at least 10% but which could be 20% or more for some indices. Needless to say, this would weigh on sentiment. The good news is that it should ensure no change in monetary policy, which remains extremely accommodative. I also think that for the better performing emerging (progressing) markets to date, corrections may be little worse than mean reversion in terms of the 200-day moving averages.”

Source: David Fuller, Fullermoney, June 16, 2009.

Bespoke: Market breadth pulls in
“The percentage of stocks in the S&P 500 above their 50-day moving averages fell to its lowest level in two months after yesterday’s [Tuesday's] decline. As of this morning, 71% of the stocks in the index were trading above their 50-days.

“Health care, both consumer sectors, and telecom have seen the biggest decline in breadth, while the utilities sector has increased recently up to 91%. This increase in utilities breadth indicates that investors are rotating money into the most defensive sector as the market takes somewhat of a breather.”

Source: Bespoke, June 16, 2009.

Credit Suisse: Market rally is more than an illusion
“The stock market rally which started in March is still continuing. And the signals from the financial sector are far less dramatic than some months ago. We asked Giles Keating, Head of Global Research at Credit Suisse, how bright the situation in the financial markets really is.”

Click here for the article.

Source: Credit Suisse, June 15, 2009.

MoneyNews: Gabelli bullish on economy, stocks
“Mario Gabelli, chief investment officer at Gamco Investors, sees rosy times ahead for the economy and stock market.

“‘Business is getting better, coming back to some normalcy,’ he told CNBC.

“‘Look at the consumer wealth,’ Gabelli says. ‘We all know about the housing, we all know about the stock market.’

“Replenishment of dwindled inventories will buoy the economy, he says. ‘And then we get the stimulus checks,’ Gabelli adds.

“‘And then we have the global economy. China is going to work. (Its fiscal stimulus package) of $585 billion is going to work.’

“In the US, ‘the economy … is going to pick up slowly but surely. And 2010 and 2011 will be pretty good,’ Gabelli says.

“As for the stock market, we’re now at about 8,500 on the Dow Jones Industrial Average, he notes. ‘Twelve years ago it was 8,500 … In 10 years, 8,500 will look like a bargain, and it’s a bargain today.’

“The best way to make money in the coming bull market: ‘Plain old stock picking,’ Gabelli says.

“‘You look at specific stocks. Do I want to look at the broad market, do I want to look at fancy engineering?’ he asks rhetorically.

“‘We’re back to old simple things, plain old stock picking. What makes money?’”

Source: Dan Weil, MoneyNews, June 15, 2009.

MoneyNews: Birinyi - the bull is here, get on
“Those who say this isn’t a bull market are just plain wrong, says Birinyi Associates CEO Laszlo Birinyi, who expects the market to continue to climb for the next couple of years.

“‘Anxiety is in the part of the people who have missed the rally,’ Birinyi told CNBC. ‘And they’re trying to talk the market down so that they can get back in.’

“‘The market can adjust and adapt,’ Birinyi says. ‘This time it’s taken a little bit longer.’

“Right now, Birinyi says, the market is in a phase of getting better, which ‘makes it hard to pick the best of the best’.

“He advises investors to buy individual stocks, not funds, especially those of exchange-traded variety.

“‘We find that (on) 25% of the trading days, even the SPDRs don’t track the S&P by 20 basis points or more.’

“Birinyi also finds exchange-traded funds (ETFs) ‘terribly inefficient’, noting that returns for investors who bought an oil ETF in the beginning of the year are now flat while oil as a commodity is up nearly 40%.”

Source: Julie Crawshaw, MoneyNews, June 15, 2009.

Barry Ritholtz (The Big Picture): Are stocks cheap?
“Not really - but how ‘not cheap’ depends upon how you measure earnings and handle one time write downs.

First up: NDR:

“‘Ned Davis Research looked at market valuations after bear markets since 1929. The firm found that in the first three months after bear markets, the market’s P/E tends to climb by about 10%. And the multiple has traditionally expanded 22% in the first six months after a major market downturn.

“But since March 9, when the recent rally began, the P/E of the S&P 500 has jumped nearly 40%. Such a surge in P/E ratios may be warranted if the recession ends soon and profits recover quickly. While there are some signs that the worst of the recession may be behind us, few analysts expect profits to stage a major rebound. And, of course, it’s still unclear whether the recession and the bear market have ended.’

“The article also notes, however, that stocks are not terribly cheap ex-one time write-downs. If we look at just operating earnings - excluding one-time write-offs - the P/E of the S&P500 is 22, hardly bargain priced.

“NDR also looks at P/E in an interesting way - instead of just adding up all the SPX earnings them dividing into price, they assess each individual stock P/E ratio. Then, they find the median P/E for the group - the midpoint, with 250 stock P/Es above and 250 stock P/Es below.

“The result? The median P/E of the S&P 500 is 15.6 - well above the median P/E of 12 in March, but below the market’s historical median of 16.5.”

Source: Barry Ritholtz, The Big Picture, June 14, 2009.

Barry Ritholtz (The Big Picture): Looking at corporate profits
“Ron Griess of The Chart Store takes a close look at SPX profitability and comes away unimpressed.”

Source: Barry Ritholtz, The Big Picture, June 17, 2009.

Yahoo: Medvedev calls for new reserve currencies
“Russian President Dmitry Medvedev says the world needs new reserve currencies.

“Medvedev told a regional summit Tuesday that the creation of new reserve currencies in addition to the dollar is needed to stabilize global finances.

“Medvedev has made the proposal before. It reflects both the Kremlin’s push for greater international clout and a concern shared by other countries that soaring US budget deficits could spur inflation and weaken the dollar.

“Airing it at a summit meeting underlined the challenge to US clout.

“Medvedev spoke at a summit of the Shanghai Cooperation Organization, which includes China and four Central Asian nations.”

Source: Yahoo, June 16, 2009.

MoneyNews: Russia, China buy dollars, despite trash talk
“Recent talk from Russian and Chinese officials showing wariness about their huge dollar holdings and suggesting an alternative reserve currency has roiled financial markets.

“But while the Russians and Chinese are walking the walk, they aren’t talking the talk.

“Brazil, Russia, India and China (BRIC, as Goldman Sachs termed them) went on the biggest dollar-buying binge in eight months during May, adding $60 billion to their reserves. That’s according to data compiled by central banks and strategists, cited by Bloomberg.

“Brazilian officials have trashed the dollar just like the Chinese and Russians.

“So why the hypocrisy?

“First, these nations are protecting their exports. A stronger dollar makes their goods cheaper in dollar terms, boosting the exports.

“Second, the BRICs already have huge reserves of dollars, so a drop by the dollar would devalue their own holdings. The more they sell dollars, the less their remaining dollars will be worth.

“And finally, big dollar sales by the BRICs could exacerbate the global financial crisis.

“‘It would be shooting yourself in the foot to sell US assets and move away from dollars too quickly,’ Mitul Kotecha, Calyon’s head foreign exchange strategist, tells Bloomberg.

‘As much as we are seeing in terms of rhetoric, the central banks have so much exposure they will be very careful.’

“Most experts agree that the dollar isn’t going anywhere. ‘I think the dollar is the dominant currency for a while to come,’ hedge fund legend George Soros told CNBC.”

Source: Dan Weil, MoneyNews, June 12, 2009..

Bespoke: Commodity snapshot
“Even after a pullback in portions of the commodity sector over the last couple of weeks, most are still up year to date. As shown below, copper is up the most with a gain of 63.58%, and oil is not far behind at +60.85%. Platinum, silver, orange juice, coffee, and gold are the other commodities that are up year to date. Corn is down 5.76%, wheat is down 11%, and natural gas is still down the most at -26.98%.”

Source: Bespoke, June 19, 2009.

David Fuller: Timing gold’s next significant move?
“We have maintained a cautious view on gold and other precious metals since the key day reversal on 3 June. However the short-term overbought condition has been replaced by a short-term oversold reading, as one can see on the stochastics indicator, which in my view is useful after temporary contra-trend reactions, although it can be early.

“More importantly, gold’s last rally towards $1,000 had been flattered by the USD’s weakness. We know this because gold had not rallied against all currencies, which we look for as a signal that a major move is developing. Therefore Fullermoney has been looking for a consolidation, in line with quiet seasonal factors, which would balance bullion’s big medium-term pattern, from March 2008 to the present. Given the comparatively quiet nature of gold’s pullback over the last three weeks, I doubt that the previous reaction low near $865 will be tested.

“We have been looking for a reaction to the mid to lower $900 region. Consequently I now regard gold as being back in an accumulation zone, prior to renewed strength in 4Q 2009 and 1Q 2010. However the reaction low during this short-term consolidation is likely to come sooner. The clearest signal would be an upward dynamic.”

Source: David Fuller, Fullermoney, June 19, 2009.

Bloomberg: Pickens says oil will average $80 to $85 a barrel
“Crude oil will rise to an average $80 to $85 a barrel in the coming year as inventories decline, billionaire investor T. Boone Pickens said in Calgary today.

“Natural gas will average about $7 per million British thermal units, Pickens, 81, the founder and chairman of Dallas-based BP Capital, said at an event sponsored by the city’s Chamber of Commerce. Falling inventories will also lift gas, he later told reporters.

“‘I bought a 12-month gas strip for $6.02 the other day and I expect to make $1 on it,’ Pickens said during the presentation to about 700 people.

“The hedge-fund manager is promoting an energy plan that relies on US-produced natural gas to cut the country’s dependence on foreign oil.

“‘In this market you’re going to see oil inventories work off,’ Pickens said. ‘There’s no question what the Saudis want; they want a balanced market and they want $75 minimum for their oil.’”

Source: Reg Curren, Bloomberg, June 17, 2009.

Financial Times: World Bank raises China GDP forecast
“The World Bank raised its forecast for China’s 2009 gross domestic product growth to 7.2% on Thursday, saying the apparent success of the government’s stimulus package had improved the outlook from March - when the bank predicted 6.5% growth for the year.

“But the World Bank said a sustainable recovery was not yet assured, in spite of the government’s Rmb4,000 billion ($590 billion) fiscal stimulus, and that Beijing might have little room for additional measures this year.

“‘Government-influenced investment will strongly support growth in 2009. However, there are limits to how much and how long China’s growth can diverge from global growth based on government-influenced spending,’ said Ardo Hansson, the bank’s lead economist for China. ‘It is too early to say a robust, sustained recovery is on the way.’

“With government revenues falling and expenditure rising rapidly, the bank predicts that China’s fiscal deficit will climb to almost 5% of GDP this year, well above the 3% budgeted by Beijing and a large jump from last year’s deficit of 0.4%.

“‘On current projections it is not necessary, and probably not appropriate, to add more traditional stimulus in 2009,’ said Louis Kuijs, senior economist and main author of the quarterly update released on Thursday. ‘One reason is that the fiscal deficit is on course to be significantly higher than budgeted this year and additional stimulus now would reduce the room for stimulus in 2010.’

“Market-based investment and consumption are unlikely to rebound until the rest of the world starts to recover convincingly and the collapse in Chinese exports is reversed. Chinese exports fell about a quarter in the first five months of the year from the same period a year earlier.

“China’s economy grew 6.1% year-on-year in the first quarter, faster than any other leading country but well below the government’s full-year target of 8%.

“The World Bank said it expected China’s economy to grow 7.7% in 2010, a much slower pace than the 13% reached in 2007 and the 9% rate of last year.

“The bank estimates a full 6 percentage points of this year’s 7.2% GDP growth will come from investment and spending either carried out by the government or directly influenced by it.”

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

Albert Edwards (Société Générale): China bulls will be let down
“The wholehearted belief in China’s economic recovery could turn out to be the biggest disappointment yet for investors, warns Albert Edwards, global strategist at Société Générale.

“‘The ongoing enthusiasm for all things China reminds me of the way investors were almost totally blind to the fact the US growth miracle was built on sand,’ he says.

“‘We saw this same investor mania 13 years ago with the Asian Bubble, which the consensus thought was a growth miracle.’

“At the heart of Mr Edwards’ scepticism lies doubts about the accuracy of official data releases.

“‘The Chinese data is derided by economic commentators,’ he notes. ‘Many have highlighted that GDP growth seems inconsistent with other data, such as electricity output. Yet few dare to point out that the emperors’ clothes might be absent - and when they do, they are met with robust official rebuttals.’

“‘That is not to say that the fiscal stimulus has not had a beneficial effect on Chinese activity this year. What I question is the quaint notion that the Chinese economy can grow at a respectable rate when the rest of the world is in a deep recession.

“‘I believe the bullish group-think on China is just as vulnerable to massive disappointment as any other extreme of bubble nonsense I have seen over the last two decades.

“‘The fall to earth will be equally as shocking.’”

Source: Albert Edwards, Société Générale (via Financial Times), June 17, 2009.

Charlie Rose: Iranian election results
“Iranian election results with Nicholas Burns, Flynt Leverett, Abbas Milani and Hooman Majd.”

Source: Charlie Rose, June 15, 2009.

You Tube: George Friedman - Iranian elections, Israel and the United States
“In the latest instalment of the Stratfor Insights video series, CEO George Friedman discusses the tense future of the Middle East following the recent Iranian elections. With Israel offering a Palestinian state on terms that are unacceptable to the Palestinians, and freshly re-elected Iranian President Mahmoud Ahmadinejad expected to continue his hard-line policies, how President Barack Obama moves forward merits close observation.”

Source: You Tube, June 15, 2009.

Tags: Asset Classes, Barack Obama, BRIC, Commodities, David Fuller, David Rosenberg, Deflation, Dmitry Medvedev, Earnings Season, Economic Recovery, Emerging Markets, ETF, Fragility, Gluskin Sheff, Gold Bullion, Government Bonds, government spending, High Yield Corporate Bonds, Incoming Data, India, oil, precious metals, Regional Summit, Reserve Currencies, Russian President, Second Quarter Earnings
Posted in Emerging Markets, Gold, Markets | Comments Off

Mass hysteria over AIG obscures simple truths

Saturday, March 21st, 2009

This is a guest contribution by Michael Lewis*.

Last September the U.S. government began to dole out the first of $173 billion to American International Group. A big chunk of it passed right through to banks that had bought insurance from AIG against mortgage and corporate defaults — foreign banks such as Deutsche Bank and Societe Generale but also some domestic ones, such as Goldman Sachs and Bank of America.

U.S. government officials then went to great lengths to disguise from the public exactly what they had done, and why, going so far as to declare the ultimate list of recipients of taxpayer funds off limits to the taxpayer. To its immense credit, the media – or, rather, a handful of diligent reporters, the New York Times’ Gretchen Morgenson chief among them – prevented the public officials from getting their way.

This incredible act triggered hardly any political backlash. In effect, the U.S. taxpayer had paid off AIG’s gambling debts. The end recipient of the money was not AIG, but Goldman Sachs, Deutsche Bank and the others.

Some large portion of the billions obviously wound up, in one form or another, in the pockets of their employees and shareholders. A few people on Capitol Hill moan and groan but there is popular agreement on the wisdom of this transfer of ONE HUNDRED AND SEVENTY THREE BILLION dollars from the taxpayer to the financiers.

Hara Kiri

But when AIG itself pays out $165 million in bonuses – money it is contractually obliged to pay – the entire political system goes insane. President Barack Obama says he’s going to find a way to abrogate the contracts and take the money back. A U.S. senator says that AIG employees should kill themselves.

Every recriminatory bone in the political body is aroused; the one thing you can do right now in Washington without getting an argument is to rail against the ethics of AIG’s bonus payment.

Apart from Andrew Ross Sorkin at the New York Times, it occurs to no one to say that a) the vast majority of the employees at AIG had as little as you or I to do with its quasi- criminal risk taking and catastrophic losses; b) that the most- valuable of those employees can easily find work at AIG’s competitors; and c) that if the government insists on punishing those valuable employees they will understandably leave, and leave behind a company even less viable than it is, and less likely to give the taxpayer back his money.

And also – oh, yes – that if the government can arbitrarily break contracts made by firms in which it has taken a stake no one in his right mind will ever again make a contract with one of those firms. And so all of the banks in which the government has investment will be damaged.

Big Numbers

From this episode we can observe several general truths about the financial crisis, and the attempt to end it:

1) To the political process all big numbers look alike; above a certain number the money becomes purely symbolic. The general public has no ability to feel the relative weight of 173 billion and 165 million. You can generate as much political action and public anger over millions as you can over billions. Maybe more: the larger the number the more abstract it becomes and, therefore, the easier to ignore. (The trillions we owe foreigners, for example.)

2) As the financial crisis has evolved its moral has been simplified, grotesquely. In the beginning this crisis was messy. Wall Street financiers behaved horribly but so did ordinary Americans. Millions of people borrowed money they shouldn’t have borrowed and, not, typically, because they were duped or defrauded but because they were covetous and greedy: they wanted to own stuff they hadn’t earned the right to buy.

On the Line

But now that taxpayer money is on the line the story has changed: innocent taxpayers are now being exploited by horrible Wall Street financiers. The guy who defaulted on mortgages on his six spec houses in the Nevada desert has turned himself into the citizen enraged by the bonuses paid to the AIG employees trying to sort out the mess caused by his defaults.

3) The complexity of the issues at the heart of the crisis paralyzes the political processes’ ability to deal with them intelligently. I have no doubt that, by the time this saga ends, we will all know what happened to every penny of that $165 million in bonuses and each have our opinion of the morality of it.

I doubt seriously we will ever understand the morality of the $173 billion payment that is the far more serious issue. For instance, Goldman Sachs, which received about 8 percent of the pile, or $13 billion, has claimed publicly that the money was, to them, a matter of indifference, as Goldman had hedged itself against a possible collapse of AIG – by making bets against AIG.

Goldman’s Clue

This suggests that it was clear to at least one market player, before the collapse, that AAA-rated AIG was behaving in ways that might lead to its demise – which is to say that there was really no responsible place to lay off these bets. (So why bail out those who made them?)

It also suggests that it is a matter of indifference to Goldman Sachs whether AIG lived or died, as either way it was protected. (So why bail it out?)

Since the beginning of the crisis I’ve wondered why the government has found neither the will nor the way to attack the root of the problem – the people who borrowed money to buy homes they shouldn’t have bought.

Now I think I understand. It would be too simple. People would understand a lot of small payments to the guy down the street who doesn’t deserve them, and become outraged. Far better to throw trillions at opaque corporations, the inner workings of which no one still really understands.

*Michael Lewis is the author of “Liar’s Poker,” “Moneyball” and “The Blind Side” and a columnist for Bloomberg News.

Source: Bloomberg, March 20, 2009.

Tags: Aig, American International Group, Andrew Ross Sorkin, Bank Of America, Barack Obama, Bonus Payment, Corporate Defaults, Foreign Banks, Gambling Debts, Goldman Sachs, Gretchen Morgenson, Hara Kiri, Immense Credit, Mass Hysteria, Michael Lewis, New York Times, Political Backlash, Seventy Three, Societe Generale, Taxpayer Funds
Posted in Credit Markets, Gold, Markets | 1 Comment »

Europe on the Ropes

Thursday, March 5th, 2009

This post is a guest contribution by Niels Jensen*, chief executive partner of London-based Absolute Return Partners.

Many of today’s policy proposals start from the view that “greed” and “incompetence” and “poor risk assessment” are the ultimate source of what went wrong. In fact, they were not the true cause at all. Moreover, even if they had been, it is fatuous to think that we will now create a post-crash generation of bankers and traders who are not greedy, much less a new generation of quants who will be able to assess and manage risks much better than “the idiots” who have brought us to the current abyss. Greed cannot be exorcised. Nor can the inherent inability of any quants to determine the “true” probability distributions of all-important events whose true probabilities of occurrence can never be assessed in the first place.”

Woody Brock, SED Profile, December 2008

Policy mistakes “en masse”
The last few weeks have had a profound effect on my view of politicians (as if it wasn’t already dented). All this talk about capping salaries for senior bank executives is quite frankly ridiculous. It is Neanderthal politics performed by populist leaders. That Gordon Brown has fallen for it is hardly surprising but I am disappointed to see that Barack Obama couldn’t resist the temptation. The mob wants blood and our leaders are delivering in spades. The stark reality is that we are all guilty of the mess we are now in. For a while we were allowed to live out our dreams and who was there to stop us? Policy mistakes - very grave mistakes - permitted the situation to spin out of control. From the U.S. Federal Reserve Bank under the stewardship of Alan Greenspan being far too generous on interest rates to the British Chancellor of the Exchequer - who now happens to be our Prime Minister - advocating ‘Regulation Light’.

Policing must improve
If you really want to prevent a banking crisis of this magnitude from ever happening again, the focus should be on the way banks operate and not on how much they pay their staff. And, within that context, any discussion must start and end with how much leverage should be permitted. The French have actually caught onto that, but their narrow-mindedness has driven them to focus on hedge funds’ use of leverage which is only a tiny part of the problem. It is the gung ho strategy of banks which brought us down and which must be better policed. And guess what; if banks were better policed - and leverage restricted - then profits, even at the best of times, would be much smaller and there would be no need to regulate bankers’ compensation packages.

It is pathetic to watch our prime minister attacking the bonus arrangements of our banks when the UK Treasury, on his watch, spent £27 million pounds on bonuses last year as reward for delivering a public spending deficit of 4.5% of GDP at the peak of the economic cycle. Even my old mother understands that governments must deliver budget surpluses in good times, allowing them more flexibility to stimulate when the economy hits the wall. What Gordon Brown has done to UK public finances in recent years is nothing short of criminal.

So, with that in mind, let’s take a closer look at the European banking industry. The following is not pretty reading. I have rarely, if ever, felt this apprehensive about the outlook. So, if the crisis has made you depressed already, don’t read any further. What is about to come, will make your heart sink.

More leverage in Europe
Let’s begin our journey by pointing out a regulatory ‘anomaly’ which has allowed European banks to take on much more leverage than their American colleagues and which now makes them far more vulnerable. In Europe, unlike in the US, it is only risk-weighted assets which matter to the regulators, not the total leverage ratio. European banks can therefore apply a lot more leverage than their US counterparties, provided they load their balance sheets with higher rated assets, and that is precisely what they have been doing.

That is fine as long as you buy what it says on the tin. But AAA is not always AAA as we have learned over the past 18 months. Asset securitisations such as CLOs proved very popular amongst European banks, partly because they offered very attractive returns and partly because Standard & Poors and Moodys were kind enough to rate many of them AAA despite the questionable quality of the underlying assets.

Now, as long as the economy chugs along, everything is dandy and the AAA-rated assets turn out to be precisely that. But we are not in dandy territory. Many asset securitisation programmes are in horse manure to their necks, so don’t be at all surprised if European banks have to swallow further losses once the full effect of the recession is felt across Europe. The two largest sources of asset securitisation programmes are corporate loans and credit cards. Senior secured loans are still marked at or close to par on many balance sheets despite the fact they trade around 70 in the markets. The credit card cycle is only beginning to turn now with significant losses expected later this year and in 2010-11.

Not much of a cushion left
Citibank has calculated that it would only take a cumulative increase in bad debts of 3.8% in 2009-10 to take the core equity tier 1 ratio of the European banking industry down to the bare minimum of 4.5%. By comparison, bad debts rose by a cumulative 7% in Japan in 1997-98. One can only conclude that European banks are very poorly equipped to withstand a severe recession. Seeing the writing on the wall, they are left with no option but to shrink their balance sheets. Despite talking the talk, banks will use every trick at their disposal to reduce the loan book. No prize for guessing what that will do to economic activity.

The wheels are coming off
But that is not the whole story. It is not even the most worrying part of the story. For the true horror to emerge, we need to turn to Eastern Europe for a minute or two. Nowhere has the credit boom been more pronounced than in Eastern Europe. And nowhere is the pain felt more now that credit has all but dried up. One measure of the credit fuelled bonanza is the deterioration of the current account across the region. Credit Suisse has calculated that in four short years, from 2004 to 2008, Eastern Europe’s current account went from +6% to -6% of GDP. That is a frightening development and is likely to cause all sorts of problems over the next few years.

Meanwhile Western European banks, eager to milk the opportunities in the East after the iron curtain came down, have acquired many of the region’s banks (see chart 1). Now, with many Eastern European countries in free fall, ownership could prove disastrous for an already weakened banking industry in the West.

Chart 1: Western European Ownership of Eastern European Banks

Source: FT.com

The problem is widespread
To make matters worse, the problems in the East are beginning to look systemic. Credit Suisse has produced an interesting scorecard where they rank a number of countries around the world on factors usually taken into consideration when assessing the credit quality of sovereign debt (see chart 2). At the top of the tree (i.e. the worst credit score) you find Iceland - hardly surprising considering their current predicament. More importantly though, of the next 14 countries on the list, 8 are Eastern European - not what you want to hear if you are an already undercapitalised European bank with huge exposure to Eastern Europe.

Swedish banks are already reeling from their exposure to the Baltic countries. Austrian banks are in even worse shape, having been the most acquisitive of any European banks. Some Italian banks could be dragged under by their Eastern European exposure and even the conservative banking sector in Switzerland doesn’t look like it can escape the mayhem.

Worst of all, the problems in the East are just about to unfold at a point in time where the European banking industry is bleeding heavily from massive losses already incurred in other areas. With no access to private funding, banks find it virtually impossible to re-build their capital base with anything but tax payers’ money.

US banks are in less of a pickle. Unlike the subprime debacle which hit both the US and the European banks hard, US banks have little exposure to Eastern Europe. To prove my point, according to the IMF, European banks have 75% as much exposure to US toxic debt as American banks, but 90% of all cross border loans to Eastern Europe originate from Western European banks. And, to add insult to injury, European banks have been much slower than US banks in terms of recognising their losses. Write-offs now total about $750 billion in the US and only about $325 billion in Europe.

Chart 2: Country Vulnerability Scorecard

Click here for a larger image.

The great mortgage show
The problems in Eastern Europe begin and end with their large external debts. In recent years, ordinary people all over the region have converted their traditional mortgages to EUR- or CHF-denominated mortgages. Some have even switched to JPY mortgages. Who can possibly resist 3% mortgages? Didn’t anyone inform them of the risk? As currencies across the region have fallen out of bed in recent months, these mortgages have suddenly become 30-50% more expensive. No wonder the local economy is suddenly tanking.

Chart 3: Eastern Europe’s Net Foreign Liabilities as % of GDP

Credit Suisse has calculated that net foreign liabilities (as a % of GDP) have risen from 47% to 65% in recent months as a direct result of the loss of local currency values (see chart 3 - and don’t ask me why Credit Suisse has included South Africa in Eastern Europe!).

Chart 4: Eastern European versus Asian Crisis

Source: Wall Street Journal

Back in 1997-98 Asia went through a similar currency crisis. However, as you can see from chart 4, Asian current account deficits were much smaller than Eastern European deficits are now. So were debt levels. Despite that, the Asian crisis did enormous damage to the local economy. Eventually Asia came good, primarily because the devalued currencies allowed the Asian countries to export more. Eastern Europe does not share this luxury. With over 90% of the world’s GDP in recession, who are they going to export to anytime soon?

Austria is in greatest trouble
According to the latest estimates from BIS, Eastern European countries currently borrow $1,656 billion from abroad, three times more than in 2005 and mostly denominated in foreign currencies (ouch!). 90% of that can be traced to Western European banks. About $350 billion must be repaid or rolled over this year. Not an easy task in these markets. Austrian banks alone have lent about $300 billion to the region, equivalent to 68% of its GDP according to the Financial Times. A default rate of 10% on its Eastern European loans is considered enough to wipe out the entire Austrian banking system. EBRD has gone on record stating that defaults in Eastern Europe could end up as high as 20%.

An extra $250 billion to the IMF
Hungary, Latvia and Ukraine have already received emergency loans from the IMF and both Serbia and Romania are reportedly considering asking for help. Meanwhile the IMF’s coffers are draining quickly and it has asked leading industrial nations for new funding. At their summit a week ago, EU leaders coughed up an extra $250 billion but nobody said where the money is going to come from. Even if they find the money, it is likely to prove hopelessly inadequate. Our leaders must grow up. Measuring everything in billions is so yesterday. Trillions are the new billions, like it or not.

Conspiracy or…?
On the 11th February the Daily Telegraph’s Brussels correspondent Bruno Waterfield wrote an article under the header: “European banks may need £16.3 trillion bail out, EC document warns.” In the article, the reporter revealed that he has seen a secret document produced by the EU Commission which briefed the union’s finance ministers on the true extent of the banking crisis. Less than 24 hours later, the article’s header was changed to “European bank bail-out could push EU into crisis” and two paragraphs had mysteriously disappeared. Here they are:

“European Commission officials have estimated that “impaired assets” may amount to 44pc of EU bank balance sheets. The Commission estimates that so-called financial instruments in the ‘trading book’ total £12.3 trillion (13.7 trillion euros), equivalent to about 33pc of EU bank balance sheets.

In addition, so-called ‘available for sale instruments’ worth £4trillion (4.5 trillion euros), or 11pc of balance sheets, are also added by the Commission to arrive at the headline figure of £16.3 trillion.”

Do yourself a favour - read those two paragraphs again. Newspaper editors do not change content light-heartedly. Did the Telegraph editor receive a call from Downing Street? Or Brussels? Did he have second thoughts about the avalanche that he could possibly instigate? I don’t know and I probably never will. But one thing is certain. If the EU Commission’s estimate of £16.3 trillion of impaired assets is correct, then the crisis is far worse than any of us could ever imagine. Not only would we have to get used to the prospects of a systemic meltdown of our banking system, but entire nations may go down as well.

Public debt to rise and rise
Even if actual losses prove to be much, much smaller (and I sincerely hope so), the banking sector cannot, in the current environment at least, raise sufficient capital to stay afloat, so more, possibly a lot more, tax payers’ money will have to be put forward. This can only mean one thing. Public debt will rise and rise. The official estimate for the UK for next year is already approaching 10% of GDP, an estimate which will almost certainly rise further. We probably have to get used to running 10-15% deficits for a few years, a fact which seriously undermines the notion of government bonds being next to risk-free.

BCA Research has calculated the effect on public debt in a number of countries, as a result of further bank losses being underwritten by tax payers. Obviously, those countries with the largest banking industries (as a % of GDP) will be hit the hardest (see charts 5a and 5b).

Chart 5a & 5b: Eastern Europe’s Net Foreign Liabilities as % of GDP

For that very reason, and as pointed out in last month’s Absolute Return Letter, there is a real risk that investors will demand much higher risk premiums on government debt. Only a few days ago, Ireland issued 3-year bonds at almost 250 basis points over corresponding Bunds. As more and more debt is transferred to sovereign balance sheets, we will likely see the spreads between good and bad paper rise further but we will also witness increasingly desperate measures being applied by the men in power. If they could prohibit short-selling of banks on the stock exchange (which didn’t work), why wouldn’t they consider prohibiting short-selling of government bonds? Not that it would necessarily work any better, but desperate people do desperate things.

Can Germany rescue us?
Most investors remain convinced that Germany will come to the rescue - in my opinion not as simple a solution as widely perceived given the enormity of the crisis. One possible solution which has been mentioned frequently in recent weeks is for all the eurozone nations to get together and start issuing joint bonds. This would undoubtedly help the weaker nations, but the idea was shot down by the German Finance Minister only a few days ago when he said that closer economic harmony across the eurozone would be needed before Germany would be prepared to entertain such an idea.

The most obvious trick left in the book, therefore, is to inflate us out of this mess. With the enormous amounts of public debt being created at the moment, years of deflation a la Japan would be catastrophic. You will never get a central banker to admit to it, but a healthy dose of inflation is probably our best prospect of surviving this crisis. Given this outlook, do you really want to be long euros?

* Niels Jensen has 24 years of investment banking, private banking and asset management experience. He founded Absolute Return Partners LLP and is its chief executive partner.

Tags: Absolute Return, Alan Greenspan, Bank Executives, Banking Crisis, Barack Obama, British Chancellor, Chancellor Of The Exchequer, Executive Partner, Federal Reserve Bank, Gordon Brown, Grave Mistakes, Niels Jensen, Policy Proposals, Poor Risk Assessment, Probability Distributions, Profound Effect, Quants, Stark Reality, True Cause, True Probability
Posted in Bonds, Credit Markets, Economy, Markets, Outlook | No Comments »

Video-Rama: Stimulus ad nauseum

Friday, February 6th, 2009

“Stimulus” and “fixing the banks” are the key words dominating this week’s batch of video clips.

Although the mood is decidedly gloomy, if not outright doom, good viewing material was produced. A few of the more interesting clips are shared below, with the likes of Robert Arnott (whose Reseach Affiliates is a business partner), Frederic Mishkin, Julian Robertson, Paul Volcker, Carl Icahn, Nouriel Roubini, Martin Wolf, Ron Paul and Jim Rogers in attendance.

In lighter vein, this week’s compilation kicks off with Stephen Colbert stimulating the psyche in his own unique way.

Colbert Nation: The audacity of nope
“If Republicans can’t have a perfect bill to stimulate the economy, they’d rather have no economy at all.”

Source: Stephen Colbert, Colbert Nation, January 29, 2009.

Morningstar: Arnott - where the investment opportunities are

Source: Morningstar, February 3, 2009.

Bloomberg: Interview with Oppenheimer’s Meredith Whitney

Source: Bloomberg (via YouTube), February 4, 2009.

Bloomberg: Mishkin says US must fix banks for stimulus to succeed
“Former Federal Reserve Governor Frederic Mishkin talks with Bloomberg’s Kathleen Hays about the need to ‘fix’ the US financial system for President Barack Obama’s economic stimulus package to succeed. Mishkin, an economics professor at Columbia University, also discusses the outlook for the US economy, proposals to rescue banks and Fed policy.”

Source: Bloomberg, February 3, 2009.

CNBC: Julian Robertson - how to fix the banking mess
“Hedge fund legend Julian Robertson, chairman of Tiger Management, and David Roche, of Independent Strategy, discuss the best ways to fix the banking mess.”

Source: CNBC, January 30, 2009.

CNBC: Volcker on regulation
“Former Fed Chairman Paul Volcker tells the Senate Banking Committee what he believes needs to be done to modernize the financial regulatory system.”

Source: CNBC, February 4, 2009.

CNBC: Obama & Geithner on executive compensation
“President Barack Obama and Treasury Secretary Tim Getihner discuss executive compensation limits for TARP recipients.”

Source: CNBC, February 4, 2009.

CNBC: Icahn on Wall Street pay caps
“President Obama unveiled new rules to curb executive pay at companies that accepted TARP money. Billionaire investor Carl Icahn and the Fast Money traders discuss.”

Source: CNBC, February 5, 2009.

Bloomberg: Roubini says ECB “wrong”, rate cuts too little, too late
“Nouriel Roubini, professor at New York University’s Stern School of Business, talks with Bloomberg’s Ellen Pinchuk about the global economy and European Central Bank monetary policy.”

Source: Bloomberg, February 4, 2009.

Charlie Rose: A conversation about the World Economic Forum with Martin Wolf

Source: Charlie Rose, February 2, 2009.

Financial Times: Chris Giles on the gloomiest Davos in memory
“FT economic editor Chris Giles explains the lessons from this year’s annual WEF meeting in Davos.”

Source: Financial Times, January, 2009.

CNBC: Odey’s Carn - recession gets global
“Every country is in the same boat with the ongoing global recession and all will be affected, Nick Carn from Odey Asset Management told CNBC Tuesday.”

Source: CNBC, February 3, 2009.

YouTube: Ron Paul at Mises Institute on “End the Fed”

Source: YouTube, January 24, 2009.

CNBC: Blackrock’s Bob Doll on sectors to invest in

Source: CNBC, February 2, 2009.

Bespoke: Bespoke’s Hickey on the January effect

Source: Bespoke, January 30, 2009.

CNBC: Dr. Doom - Asian markets pay you to wait
“Marc Faber, Editor of The Gloom, Boom & Doom Report, feels that the US market at current levels isn’t cheap. Asian markets, on the other hand, are much more value for money - there are stocks that pay you to wait out the recession. He shares his thoughts with CNBC’s Martin Soong.”

Source: CNBC, February 6, 2009.

Financial Times: Lionel Barber profiles Wen Jiabao
Lionel Barber discusses his in-depth interview with Wen Jiabao, dubbed the “mandarins” mandarin. He looks at the Chinese premier’s disagreement with the US over the renminbi, and his plans to boost China’s consumer speding.

Source: Financial Times, February 2, 2009.

CNBC: More stimulus measures for China?
“Following comments from China’s premier Wen Jiabao that more stimulus measures may be needed to boost the economy, Glenn Maguire, Asia Pacific chief economist at Societe Generale tells CNBC’s Martin Soong China’s efforts have so far helped to stabilize some sectors.”

Source: CNBC, February 2, 2009.

Bloomberg: Rogers says Russia may break up
“Jim Rogers, chairman of Rogers Holdings, talks with Bloomberg’s Ellen Pinchuk about the outlook for the Russian economy, the ruble and his investment strategy. Rogers, speaking in Moscow, also discusses the outlook for oil prices and emerging markets.”