Economy and Bond Market Highlights

Monday, March 8th, 2010

The Economy and Bond Market

The yield on the 10-year U.S. Treasury Note increased by 7 basis points during the week to 3.68 percent. The entire move came on Friday after the February jobs report showed fewer job losses than expected and the unemployment rate holding steady.

U.S. manufacturing expanded in February for the seventh consecutive month. Although February’s ISM Manufacturing Index came in at 56.5, a drop from January’s 58.4 and lower than the consensus of 57.9, any reading above 50 indicates an expansion. This expansion from August thru February can be seen in the graph below.

Strengths

• The February nonfarm payroll report showed a loss of 36,000 jobs, fewer than the 68,000 than was expected. The unemployment rate for February was unchanged at 9.7 percent, better than expectations of 9.8 percent.
• As explained above, U.S. manufacturing expanded in February for the seventh consecutive month.
• Service industries in the U.S. strengthened more than anticipated. The ISM Non-manufacturing Index for February was 53.0, above the 51.0 expected and the level of 50.5 that was reported in January.
• Same-store retail sales increased for the third consecutive month in February. The International Council of Shopping Centers’ Index of 31 retailers (excludes Wal-Mart) showed a 3.7 percent same-store sales increase in February from a year earlier.
• Figures from the Commerce Department showed that personal spending rose by 0.5 percent in January over December, slightly more than the 0.4 percent expected.

Weaknesses

• Pending sales of existing homes fell 7.6 percent month-over-month in January, below expectations for a 1.0 percent increase. Poor winter weather was a contributing factor.
• Commerce Department figures showed that personal income rose month-over-month in January by 0.1 percent, less than the 0.4 percent expected.

Opportunities

• If financial markets are a good mechanism for discounting the future, the future appears relatively robust. The markets have been able to shake off bad news relatively easily recently, a good sign for the economic recovery.

Threats

• When governments around the world begin to wind down the monetary and fiscal stimulus programs put in place during the economic crisis, it will likely present a headwind for the economy.

Tags: Advertisement Opportunities, Basis Points, Bond Market, Commerce Department, Consensus, Financial Markets, Graph, International Council Of Shopping Centers, International Shopping, Ism Manufacturing Index, Job Losses, Jobs, Market Economy, Nonfarm Payroll Report, Personal Income, Retail Sales, U S Treasury, Unemployment Rate, Wal Mart, Winter Weather
Posted in Markets | No Comments »

Gross: Life or Death Battle of Weakest Sovereigns

Thursday, March 4th, 2010

Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the top money men around. His monthly newsletter, this month entitled “Don’t Care”, therefore always makes for thought-provoking reading. (On a personal note, it does sound if he should get out more often!)

Here are the last few paragraphs:

“Government bailouts and guarantees such as those evidenced and envisioned in Dubai and Greece, as well as those for the last 18 months with banks and large industrial corporations across the globe, suggest a more homogeneous ‘unicredit’ type of bond market. If core sovereigns such as the US, Germany, UK, and Japan ‘absorb’ more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee. The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle.

“This metaphor doesn’t really answer the critical question of whether a debt crisis can be cured by issuing more debt. The answer remains: It depends - on initial debt levels and whether or not private economies can be reinvigorated. But it does suggest the likely direction of sovereign yields IF global policymakers are successful with their rescue efforts: Sovereign yields will narrow in spreads compared to other high-quality alternatives. In other words, sovereign yields will become more credit like.

“When sovereign issues become more credit-like, as evidenced in Greece, Spain, Portugal, and a host of others, they move closer in yield to the corporate and Agency debt that supposedly rank lower in the hierarchy. That process of course can be accomplished in two ways: high-quality non-sovereigns move down to lower levels or governments move up. The answer to which one depends significantly on future inflation, the aftermath of quantitative easing programs, and the vigor of the private economy going forward. But the contamination of sovereign credit space with past and future bailouts is a leveler, a homogenizer, a negative for those sovereigns that fail to exert necessary discipline. Only if global economies stumble and revisit the recessionary depths of a year ago should the process reverse direction and place Treasuries, Gilts, et al. back in the driver’s seat.

“Investors should obviously focus on those sovereigns where fundamentals promise lower credit or inflationary risk. Germany and Canada are amongst those at the top of our list while a rogues’ gallery of the obvious, including Greece, Euroland lookalikes, and the UK gather near the bottom. PIMCO’s ‘Ring of Fire’ remains white hot and action, as opposed to cocktail blather, is required to maintain or regain trust in sovereign credits approaching the rocks. Just last week Bank of England Governor Mervyn King said that it would be difficult to cut government spending quickly, but that there needs to be a clear plan for doing so. Not good enough, Mr. King. Don’t care. Show investors the money, not vice-versa. An investor’s motto should be, ‘Don’t trust any government and verify before you invest.’ The careful discrimination between sovereign credits is becoming more than casual cocktail conversation. A deficiency of global aggregate demand and the potential impotency of policymakers to close the gap are evolving into a life or death outcome for the weakest sovereigns, with consequences for credit and asset markets worldwide.”

Click here for the full article.

Gross has also just been interviewd by Bloomberg on the above. The clip is below.

Bloomberg (via YouTube), March 1, 2010.

Tags: Bill Gross, Bond Market, Credit Risk, Credit Spreads, Critical Question, Death Battle, Debt Crisis, Debt Levels, Gross Co, Industrial Corporations, Initial Debt, Money Men, Personal Note, PIMCO, Quality Alternatives, Rescue Efforts, Serfs, Sovereigns, Spain Portugal, Us Germany
Posted in Markets | No Comments »

Economy and Bond Market Highlights

Sunday, February 28th, 2010

The Economy and Bond Market

Consumer confidence took a dive this month, highlighting the fragile nature of the economic recovery. Most of the economic news out this week from consumer confidence, to housing and concerns regarding European stability had a negative bias to it.

Strengths

• Fed Chairman Bernanke reiterated his view that record low interest rates would be maintained for some time while the economy recovers from the recession.
• Fourth-quarter GDP, fueled by business spending, was revised higher to 5.9 percent from 5.7 percent.
• The Congressional Budget Office (CBO) estimated the emergency fiscal stimulus created more than 2 million jobs and boosted the economy more than many had expected.

Weaknesses

• New home sales hit a new record low, falling to just 309,000 annualized units.
• Existing home sales were also weak, falling 7.2 percent in January.
• Weekly initial jobless claims rose to 496,000 and hit the highest level in three months. This is a sign the economic recovery remains uneven.

Opportunities

• If financial markets are a good mechanism for discounting the future, the future appears relatively robust. The markets have been able to shake off bad news relatively easily this week, probably a good sign for the economic recovery.

Threats

• If one of the eurozone countries were to seriously threaten default, the whole eurozone system comes into question and threatens global financial stability.

Tags: Bad News, Bond Market, Bonds, Congressional Budget Office, Consumer Confidence, Economic News, Economic Recovery, European Stability, Eurozone Countries, Existing Home Sales, Fed Chairman Bernanke, Financial Markets, Fiscal Stimulus, Fourth Quarter, Fragile Nature, Global Financial Stability, Initial Jobless Claims, Low Interest Rates, Negative Bias, Quarter Gdp, Recession
Posted in Markets | No Comments »

The Economy and Bond Market Highlights

Saturday, February 20th, 2010

The Economy and Bond Market

In a surprise move this week, the Federal Reserve raised the discount rate (the rate at which banks borrow from the Fed), indicating that we have begun a new phase of monetary policy. Fed Chairman Bernanke just last week suggested that this process was just around the corner, but many market participants were surprised at how quickly the Fed acted. While it still may be some time before the Fed raises other short-term interest rates, the process could be faster than many had predicted. The fed funds futures market reacted to this week’s developments as can be seen in the chart below. The futures curve shifted higher, especially during 2011.

Strengths

• January CPI rose a modest 0.2 percent and “core” prices actually fell slightly. Inflation remains contained for the time being, which allows the Fed plenty of room to maneuver.
• Industrial production rose a very strong 0.9 percent in January to reach the highest level in more than a year.
• Housing starts hit a six-month high, even with suboptimal weather in many parts of the country.

Weaknesses

• The increase in the discount rate signals the beginning of a tightening cycle.
• China sold $34 billion in Treasury securities in December, a sign of waning demand for U.S. debt.
• While consumer prices were well-behaved in January, producer prices were another story. January PPI rose 1.4 percent driven by higher energy prices.

Opportunities

• If financial markets are a good mechanism for discounting the future, the future appears relatively robust. The markets have been able to shake off bad news relatively easily this week, probably a good sign for the economic recovery.

Threats

• If one of the eurozone countries were to seriously threaten default, the whole euro currency system comes into question and threatens global financial stability.

Tags: Bond Market, Bonds, China, Core Prices, CPI, Currency System, Economic Recovery, Economy, Emerging Markets, Energy Prices, Eurozone Countries, Fed Chairman, Fed Funds Futures, Financial Markets, Futures Market, Global Financial Stability, Higher Energy, Market Participants, Plenty Of Room, Ppi, Producer Prices, Surprise Move, Term Interest, Treasury Securities
Posted in Markets | No Comments »

The Economy and Bond Market Highlights (week ending 2/15/2010)

Monday, February 15th, 2010

The Economy and Bond Market

Treasury yields moved higher this week on the back of large Treasury auctions that met somewhat tepid demand. Domestic economic news was relatively uneventful; it seemed the poor weather conditions in many parts of the country were a bigger story. Internationally it was a different story. Chinese bank lending jumped in January to one of the highest totals on record and Chinese M1 money supply grew 39 percent on a year-over-year basis, see chart below. The Chinese government has enacted numerous tightening measures in recent weeks and another was announced on Friday, raising bank reserve requirements by another 50 basis points. Growth indicators are very strong but the government tightening has begun and in the short term the economy has a lot of momentum but the government needs to be careful and not make adjustments too rapidly as it would have a global impact.

Strengths

• January retail sales rose 0.5 percent and beat market expectations.
• The National Federation of Independent Business (NFIB) small business index hit a 16 month high.
• Weekly initial jobless claims fell to 440,000 breaking the recent trend higher.

Weaknesses

• China is tightening policy on an almost weekly basis and that raises the risk of doing too much too soon.
• February’s University of Michigan Confidence Index fell to 73.7, below expectations.
• The trade balance unexpectedly widened in December on higher oil imports.

Opportunities

• The economic recovery is still intact but looks more fragile now than just a couple of months ago, which likely keeps the Fed on hold for some time.

Threats

• If one of the Euro countries were to seriously threaten default, the whole Euro currency system comes into question and threatens global financial stability

Tags: Bond Market, China, Chinese Bank, Confidence Index, Currency System, Emerging Markets, Euro Countries, Federation Of Independent Business, Global Financial Stability, Global Impact, Growth Indicators, Initial Jobless Claims, Market Expectations, Money Supply, National Federation Of Independent Business, Nfib, Oil Imports, Poor Weather Conditions, S University, Treasury Auctions, Treasury Yields, University Of Michigan Confidence
Posted in Markets | No Comments »

The Economy and Bond Market Highlights (week ending 02/07/10)

Sunday, February 7th, 2010

The Economy and Bond Market
Treasury yields were mixed this week as the middle part of the curve rallied while the long end rose slightly. Concerns over the potential of a debt default in Greece early in the week quickly spread to wider problems in the euro zone which include similar concerns surrounding Spain and Portugal. The U.S. dollar rallied strongly on these concerns, which helped support the Treasury market.

Two important pieces of economic data were released this week: the ISM Manufacturing Index and the amount of change in nonfarm payrolls in the unemployment report. These two series are graphed below and represent the past 20 years of data and shows how these two series tend to move in tandem. This week the ISM index hit the highest level in more than five years, which bodes well for job growth in the near future if history is any guide.

Strengths

• The ISM Manufacturing Index hit 58.4, well above the economic breakeven level of 50, the highest level in over five years. The jobs index component also rose the highest levels since 2006.
• Retail sales in January broadly beat expectations, reinforcing the idea that the economy is improving and consumers are becoming more confident.
• The ISM Nonmanufacturing Index also rose in January, hitting 50.5 with strength seen in the amount of new orders.

Weaknesses

• Concerns over the potential of a debt default in Greece early in the week quickly spread to wider problems in the euro zone which include similar concerns surrounding Spain and Portugal. These concerns caused risky assets to fall across the board and are a threat to global economic recovery.
• January’s employment report was somewhat disappointing as nonfarm payrolls failed to break into positive territory as the economy lost 20,000 jobs last month.
• Construction spending fell 1.2 percent in December and a record 12.4 percent for the full year.

Opportunities

• The economic recovery is still intact but looks more fragile now than it did just a couple of months ago. This will likely keep the Fed on hold for some time.

Threats

• If one of the euro zone countries were to seriously threaten default, the entire euro currency system could come into question, threatening global financial stability.

Tags: Bond Market, Consumers, Curve, Debt Default, Economic Data, Economic Recovery, Economy, Employment Report, Euro Zone, Greece, Ism Index, Ism Manufacturing Index, Market Economy, More Than Five Years, Nonfarm Payrolls, Retail Sales, Risky Assets, Tandem, Treasury Market, Treasury Yields, Unemployment Report
Posted in Markets | No Comments »

Whither Deflation?

Thursday, February 4th, 2010

This article a guest contribution by Leo Kolivakis, of Pension Pulse.

Last week, I warned my readers to get ready for more upward growth revisions. I believe that US growth in Q1 2010 will surprise even the most optimistic forecasters.

Why am I so confident? After all, my last call before the December employment report was way off. The bond market didn’t go ‘boo’ back then and more jobs were lost. Today, Bloomberg published a sobering article stating that 824,000 jobs will disappear on February 5th.

No doubt, when all is said and done, and the government bean counters finish tallying up the wreckage, job losses from this recession will be far worse than what was initially thought. And this recession hasn’t been gender neutral. By far, men have suffered a lot more than women as cyclical industries got hit harder.

But all that is about to start changing in Q1 2010. Consider the following very carefully:

• The Conference Board Leading Economic Index™ (LEI) for the U.S. increased 1.1 percent in December, following a 1.0 percent gain in November, and a 0.3 percent rise in October.
• The January 2010 ISM Manufacturing report showed widespread growth. Importantly, the manufacturing sector grew for a sixth straight month, and both the New Orders and Production Indexes are above 60 percent, indicating strong current and future performance for manufacturing.
• US real GDP surged 5.7% in the fourth quarter 2009, confirming that the recession is over and the recovery is gaining traction. While the acceleration in real GDP growth in the fourth quarter primarily reflected an acceleration in private inventory investment, there was a pick-up in non-residential investment, exports and investment in equipment & software, a harbinger of future job growth.

In the near term, it is highly likely that US growth will continue to surprise to the upside. Interestingly, Tom Braithwaite of the FT reports that US deflation no longer seen as a risk:

The US has escaped the danger of a Japanese-style deflationary trap, according to James Bullard, a voting member of the Federal Reserve’s key policy-setting committee.

Mr Bullard, president of the Federal Reserve Bank of St Louis, told the Financial Times in an interview that his preoccupation throughout 2009 had been deflation, but the risk had “passed”.

Last week’s Fed meeting produced a dissenting vote for the first time in a year when Thomas Hoenig, president of the Kansas City Fed and a rate hawk, argued that financial conditions no longer warranted a policy of holding rates at “exceptionally low levels . . . for an extended period”.

Other members of the Federal Open Markets Committee voted to preserve the “extended period” phrase, generally taken to mean near-zero interest rates will continue for at least six months. But they are also working on an exit strategy from the exceptionally loose policy used to fight the financial crisis.

Mr Bullard, who is considered a centrist member of the FOMC, said he was happy to continue with the current guidance, but he did have some sympathy for Mr Hoenig’s argument that “if you come off zero and you move up a little bit, it’s still a very easy policy. You’ve still got a very large balance sheet and you’re still at very low interest rates.”

He added that, although it was not time to tighten policy, members of the committee would weigh in their decisions factors other than inflation and unemployment. Factors to consider would include asset bubbles.

“I think they’re gaining weight with many people because of the bad experience we had in the aftermath of the last recession, the housing bubble and how that really has blown up and caused so many problems,” he said.

When the Fed does come to raise rates it may have to switch from its traditional benchmark of targeting the federal funds rate to targeting a repurchase rate because of the upheaval in the two markets over the last two years.

“I think what the operating regime will really look like going forward is an open question and one that the committee is working on,” said Mr Bullard, who said the Fed could consider using interest it paid on reserves as the main rate but that it might prefer a market measure such as the repo rate.

The broader post-crisis economy was “on track” with its recovery, he said. “It’s not a real strong recovery but that’s what we had predicted anyway. But it will be above-average growth for the first half of 2010 and we’ll probably see some positive jobs growth in the first part of 2010 here.”

He “hoped” that improvement in the labour market would come in the first quarter.

Following harsh criticism of Ben Bernanke in the Senate ahead of his reconfirmation as Fed chairman last week, Mr Bullard warned that political interference with the Fed would be dangerous and he strongly opposed plans to strip banking supervision from the central bank’s roster of duties.

“I think it’s dangerous for America and dangerous for a global economy to try to divorce this central bank from true understanding of financial markets, and I think that that’s the direction we’ll be going in if we separated out the central bank from regulation,” he said.

“What this crisis has shown is that our understanding of financial mediation and how it can impact on macro economy was not good enough. So what you want is to force the central bank to get better understanding and more information about financial markets as they’re making monetary policy decisions.”

Not good enough? I’d say the Fed’s understanding of how financial mediation impacts the macro economy was downright pathetic pre-crisis and has only marginally improved post-crisis. Who is tracking flows into hedge funds, commodity funds, private equity funds, and flows coming from sovereign wealth and global pension funds?

More importantly, who is tracking leverage being built into the bond market? There too, pension funds are playing an increasingly important role as they leverage up their fixed income holdings to deliver on their required actuarial rates of return.

I urge you to carefully read Niel Jensen’s February 2010 letter from Absolute Return Partners, aptly titled If PIIGS Could Fly. Mr. Jensen’s conclusion is a stark reminder of the challenges that lie ahead:

As far as the bond market is concerned, as often pointed out by Martin Barnes at BCA Research, if you want to know where the next crisis will be, then look at where the leverage is being created today. And nowhere is there more leverage being created at the moment than on sovereign balance sheets. What is happening is an experiment never undertaken before. As John Mauldin puts it, we are operating on the patient without anaesthesia.

The big challenge will be to get the timing right. These situations can run for longer than most people imagine. Japan’s crisis has been widely predicted for almost a decade now, and the ship appears to be as steady as ever. As I suggested earlier, the key to predicting the timing of Japan’s demise – because there will be one – may very well be embedded in the savings rate, which could quite possibly turn negative in the next few years.

The Dubai crisis taught us that markets are in a forgiving mode at the moment and, before long, Greece could very well find some respite from its current problems. But then again, ultimately, governments will find – just like millions of households have found over the years – that you cannot spend more then you earn in perpetuity. The enormous debt levels being created at the moment will haunt us for many years to come and we may have to wait a long time to see PIIGS fly again.

While I agree with many of the arguments Mr. Jensen puts forward, I am not convinced that the bond market will be the next crisis. You will likely see the short end of the curve getting hit hard in Q1 2010 as the market adjusts its expectations on the Fed’s next move, but not a full-fledged crisis in bonds.

Neither am I convinced that deflation is dead. The risks of deflation have subsided but the bigger test will come in the following few years, especially if stimulus programs do not translate into a sustained improvement in US and global labor markets. And that still remains the overarching concern of policymakers across the planet. If they fail to achieve this, a nasty deflationary spiral will ensue, in which case high quality government bonds will look very attractive, even at historic low yields.

Tags: Bean Counters, Bond Market, Commodities, Cyclical Industries, Economic Index, Employment Report, Fourth Quarter, GDP Growth, Harbinger, Inventory Investment, Ism Manufacturing, Manufacturing Sector, No Doubt, Optimistic Forecasters, Private Inventory, Q1, Real Gdp, Recession, Residential Investment, Upward Growth, Wreckage
Posted in Bonds, Markets | No Comments »

Michael Belkin’s Model Points Up for Stocks

Tuesday, February 2nd, 2010

Kate Welling of welling@weedon has just conducted another of her top-class interviews with Michael Belkin. Belkin is the author of The Belkin Report that I used to read regularly, but have had difficulty in obtaining over the past two years or so. He has a huge reputation among institutional investors and got his calls right more often than not when I still had access to his material.

Friend Barry Ritholtz (The Big Picture) provides some insight into Belkin’s latest thinking with the following excerpts from Welling’s report:

“Where my views are probably different to what some of the higher profile names are currently saying is that I’m not pointing to the equity market now as the source of a bubble or of malinvestment, in Austrian terms.

“If not the stock market, where are you pointing?

“At the bond market. Specifically, since the March 20, 2009 turning point in the equities market, if you look at the AMG weekly data on inflows into ETFs and mutual funds, bond fund flows have been positive every week and have averaged $4 billion a week. There hasn’t been a single down-week. But meanwhile, for equity funds, there’s been a completely different pattern. They’ve been down two weeks, up one week, then down, up four weeks, down five weeks - and the average inflow is only $500 million a week.

“Just barely positive?

“Yes, at last count only $24 billion had gone into all kinds of equity funds over this entire recovery rally, versus $178 billion into bond funds. I’ve been looking at this for quite a while and sort of scratching my head and wondering what was going on. But finally it just occurred to me. They’re buying bonds. It’s rather obvious. I think what has happened is that the public in previous cycles bought emerging-market funds or internet stocks or whatever, when the Fed would lower interest rates to an artificially low level, thereby penalizing people on their savings. So right now, for instance, I have friends who inherited a lot of money and I’m an informal advisor to them, not a paid advisor. They keep asking me, what do I do now? They were investing in CDs, which were parceled out to a lot of different banks on which they were making 2, 3, 4%. But now they’re maturing and the banks are offering, like, nothing. So they are asking, what do we do, what do we do? They need the yield; they need income; they don’t want to lose the nominal principal. What to do? What to do?”

“Belkin’s time series regression analysis is not only data driven, but he is also aware of historical predecessors. I find his argument that bonds are at greater risk than stocks to be very counter-intuitive, contrary - and compelling,” added Ritholtz.

Source: Barry Ritholz, The Big Picture, February 1, 2010.

Tags: Barry Ritholtz The Big Picture, Bond Fund, Bond Funds, Bond Market, Class Interviews, Emerging Market Funds, Equity Funds, ETF, Friend Barry, Fund Flows, Funds Bond, Inflow, Institutional Investors, Internet Stocks, Michael Belkin, Model Points, Mutual Funds, Profile Names, Stock Market, Turning Point, Weedon
Posted in Markets | No Comments »

Economy and Bond Market Highlights

Monday, February 1st, 2010

The Economy and Bond Market The 10-year U.S. Treasury note was relatively stable this week, with the yield decreasing by one basis point to end the week at 3.60 percent. As reported this week, real gross domestic product (real GDP) increased at an annual rate of 5.7 percent in the fourth quarter of 2009, besting the consensus estimate of 4.7 percent. This was the best performance since the third quarter of 2003. The figure below shows the annualized quarter-over-quarter percentage changes.

Strengths

• The Reuters/University of Michigan final index of consumer sentiment for January rose to 74.4, exceeding the consensus of 73.0 and the preliminary estimate of 72.8. This was the highest level in two years.
• The Chicago Purchasing Managers Index increased to 61.5 in January, higher than the consensus estimate of 57.2. This was the highest level since November 2005.
• The S&P Case-Shiller 20-city home price index for November rose a seasonally adjusted 0.24 percent from October, the sixth straight monthly gain. The index was down 5.32 percent year-over-year, the smallest year-over-year decline in two years.
• The Conference Board’s index of consumer confidence rose to 55.9 in January from a revised 53.6 in December, besting the 53.5 median estimate of economists.

Weaknesses

• Durable goods orders for December rose 0.3 percent from November, less than the 2 percent advance expected by economists. Orders for durable goods excluding transportation increased by 0.9 percent, more that the 0.5 percent consensus.
• Initial jobless claims for the week ended January 23 were reported at 470,000, more than the 450,000 expected.
• December new home sales declined 7.6 percent month-over-month to 342,000, less than the forecast of 366,000.
• Sales of existing U.S. homes in December fell 16.7 percent from November levels to an annual rate of 5.45 million, worse than the consensus of 5.90 million. November sales had been helped by the government tax credit, which was originally scheduled to expire on November 30.
• The Richmond Fed’s manufacturing index for the central Atlantic region for January came in at -2.00, slightly worse than the consensus estimate of 0.00. It did edge up a bit from December’s index of -4.00. For each of the seven months prior to December, the index had been positive.
• The Mortgage Banker’s Association index of mortgage applications for the week ended January 22 dropped by 10.9 percent after rising for the preceding three weeks.

Opportunities

• The fourth-quarter GDP of 5.7 percent reported this week provides another indication that the global economic recovery appears to be taking hold.

Threats Coordinated global removal of fiscal and monetary stimulus are the biggest threats to the financial markets.

Tags: Basis Point, Best Performance, Bond Market, Consensus Estimate, Durable Goods Orders, Economists, Fourth Quarter, Government Tax, Gross Domestic Product, Home Price Index, Index Of Consumer Confidence, Index Of Consumer Sentiment, Initial Jobless Claims, Median Estimate, Percentage Changes, Purchasing Managers Index, Real Gdp, Reuters, Treasury Note, U S Treasury
Posted in Markets | No Comments »

Howard Marks: Investing for Inflation (January 2010)

Monday, January 25th, 2010

Howard Marks, founder of California based Oaktree Capital, manager of $67-billion in fixed income funds, has just released his latest letter to investors, provides his in-depth  case for inflation and how to invest for it. Marks’ letters have a strong following on Wall Street, and he is considered a bond market genius. You can full-page the document in your browser from the slidedeck below, and if you like you may download the letter here.

Read Howard Marks complete newsletter in the slidedeck below:

Tell Me I’m Wrong

Tags: Bond Market, Capital Manager, Fixed Income, Genius, Income Funds, inflation, Investing, Investors, Newsletter, Oaktree Capital, Wall Street
Posted in Markets | No Comments »

Give Bernanke A Break

Sunday, January 24th, 2010

As populist politicians, long on hypocritical outrage and short on fiscal rectitude, begin the witch hunt for the parties to blame for the Great Recession, fingers are being pointed at Federal Reserve Chairman Ben Bernanke. Their criticism is that Bernanke and the Fed contributed to the housing bubble by keeping short-term interest rates too low for too long early in the decade and then not increasing them quickly enough to snuff out escalating house prices.

In a recent speech, Bernanke pointed out that it was low real long-term rates (i.e. nominal rates less inflation) determined in the bond market that were a major contributor to the housing bubble, not the short-term interest rates engineered by the Fed.

The facts support Bernanke. As depicted in the following graph, real long-term rates trended downwards for much of this decade, hitting bottom just before Lehman’s failure in September 2008. Even the Fed tightening in 2004 and 2005 failed to push real rates up to the levels of the 1990’s. Long-term real rates were just too low and consumers got the message – instead of saving, they spent.

As depicted in the following graph, this view is also supported by the failure of long-term mortgage rates (in red) to respond to the increase in the fed funds rate (in green) in 2005-2006 as they had in previous tightening cycles.

In 1994-95 and 1999-2000, long-term mortgage rates were 2.0% or so higher than the fed funds rate as they peaked, while in 2006 the spread was in the 1.0% range. Monetary policy was less effective at driving up mortgage rates than previous cycles.

The real culprit in keeping long-term real interest rates low was the global savings glut that was in large part created by the recycling of U.S. dollars by China and other Asian countries. The chronically undervalued currencies of those countries have created a permanent trade imbalance and yawning current account deficit in the United States. In fact, Bernanke himself coined the phrase “global savings glut” in a speech that he made in March 2005. At that point, he warned that low real interest rates seemed to reflect an imbalance between global savings and investment – too much money chasing too few investments around the world.

Viewed from this vantage point, the seeds of the recent crisis were sown when China was allowed to join the World Trade Organization in 2001 in the absence of adequate safeguards to curb its policy of promoting exports through currency manipulation. The Great Recession is an unwelcome consequence of the structural faults that were allowed to develop in the world economic system.

Although China and other Asian exporters play leading roles, asset bubbles typically manifest themselves through the disparate actions of a cast of characters so there are many players to point fingers at. Blame the U.S. home buyer for thinking house prices always grow to the sky. Blame the bankers who sold collateralized mortgage securities to every Tom, Dick and Harry and, worse yet, kept some of this dreadful paper on their own books creating systemic risk for the entire financial system. An especially large share of the blame must go to the credit rating agencies who gave their AAA blessing to so much of this flawed paper. Blame also the mortgage brokers who turned “liars’ loans” into the raw material of defective investments as well as the financial engineers who mispriced the risk in a host of derivatives simply because they had never read a history book on the Great Depression. And finally politicians should look in the mirror – they consistently supported housing policies and programs that made housing accessible to buyers who couldn’t afford a down-payment let alone a house.

Instead of pointing fingers at Bernanke, his critics should lead a round of applause for his leadership of the Fed in initiating the dramatic increase in monetary expansion in March 2009 that was clearly the catalyst for the recovery in the stock market and the turn-around of the U.S. economy, however tenuous and fragile it may be. In addition, given the immense challenge faced by the Fed in unwinding its massive monetary stimuli, Bernanke’s second term should be confirmed by the Senate and he and his colleagues should be allowed to concentrate on steering the economy to terra firma.

This is vital. The recession and stock market collapse of 1937-38 that occurred after the initial recovery from the Great Depression was in part triggered by the Federal Reserve’s increase in bank reserve requirements. We cannot afford Bernanke and the Fed to get it wrong this time around.

Tacita Capital Inc. (”Tacita”) is a private, independent family office and investment counselling firm that specializes in providing integrated wealth advisory and portfolio management services to families of affluence. We understand the challenges of affluence and apply the leading research and best practices of top financial academics and industry practitioners in assisting our clients reach their goals.

Tacita research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it and is not intended to replace individually tailored investment advice. The asset classes/securities/instruments/strategies discussed may not be suitable for all investors and certain investors may not be eligible to purchase or participate in some or all of them. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Tacita recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor.

Tacita research is prepared for informational purposes. Neither the information nor any opinion expressed constitutes a solicitation by Tacita for the purchase or sale of any securities or financial products. This research is not intended to provide tax, legal, or accounting advice and readers are advised to seek out qualified professionals that provide advice on these issues for their individual circumstances.

Tacita research is based on public information. Tacita makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to inform any parties when opinions, estimates or information in Tacita research changes.

All investments involve risk including loss of principal. The value of and income from investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Management fees and expenses are associated with investing

Tags: Asian Countries, Bond Market, China, Culprit, Current Account Deficit, Emerging Markets, Fed Funds Rate, Federal Reserve, Federal Reserve Chairman, Global Savings Glut, Hitting Bottom, House Prices, Housing Bubble, Lehman, Monetary Policy, Mortgage Rates, Recession, Rectitude, Term Interest, Term Mortgage, Trade Imbalance, Witch Hunt
Posted in Markets | No Comments »

Economy and Bond Market Highlights

Sunday, January 24th, 2010

The Economy and Bond Market
Treasury yields rallied again this week as concerns over Chinese attempts to slow their economy may threaten the global economic recovery. It was reported that China’s government ordered banks to slow down their lending to prevent overheating the economy. The Chinese government has enacted several measures in recent weeks aimed at slowing their economy which expanded 10.7 percent on a year over year basis in the fourth quarter.

Economic data was mixed this week and other macro issues were more significant in driving the market. The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December. The chart below plots the LEI index and GDP on a year over year basis since 1980. If economic activity follows historical patterns, GDP is due for a significant recovery as we move through 2010.

Strengths

• The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December.
• China’s GDP rose a very robust 10.7 percent in the fourth quarter.
• 30 year mortgage rates dropped below 5 percent for the first time in four weeks.

Weaknesses

• The Chinese government has enacted several measures in recent weeks aimed at slowing their economy.
• Housing in general appears to be bouncing along a bottom but unable to make sustained improvement.
• The producer price index rose 0.2 percent in December and on a year over year basis has jumped 4.4 percent driven largely by rising energy prices.

Opportunity

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4 to 5 percent. The global economic recovery appears to be taking hold.

Threat

• Coordinated global removal of fiscal and monetary stimulus is the biggest threat to the financial markets.

The Economy and Bond Market

Treasury yields rallied again this week as concerns over Chinese attempts to slow their economy may threaten the global economic recovery. It was reported that China’s government ordered banks to slow down their lending to prevent overheating the economy. The Chinese government has enacted several measures in recent weeks aimed at slowing their economy which expanded 10.7 percent on a year over year basis in the fourth quarter.

Economic data was mixed this week and other macro issues were more significant in driving the market. The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December. The chart below plots the LEI index and GDP on a year over year basis since 1980. If economic activity follows historical patterns, GDP is due for a significant recovery as we move through 2010.

Strengths

• The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December.
• China’s GDP rose a very robust 10.7 percent in the fourth quarter.
• 30 year mortgage rates dropped below 5 percent for the first time in four weeks.

Weaknesses

• The Chinese government has enacted several measures in recent weeks aimed at slowing their economy.
• Housing in general appears to be bouncing along a bottom but unable to make sustained improvement.
• The producer price index rose 0.2 percent in December and on a year over year basis has jumped 4.4 percent driven largely by rising energy prices.

Opportunity

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4 to 5 percent. The global economic recovery appears to be taking hold.

Threat

• Coordinated global removal of fiscal and monetary stimulus is the biggest threat to the financial markets.

Tags: 30 Year Mortgage Rates, Banks, Bond Market, China, Chinese Attempts, Chinese Government, Economic Activity, Economic Data, Economic Recovery, Economy, Emerging Markets, Energy Prices, Financial Markets, GDP, Index Of Leading Indicators, Macro Issues, Market Economy, Measures, Producer Price Index, Rising Energy, Stimulus, Treasury Yields, Year Mortgage
Posted in Markets | No Comments »