Energy and Natural Resources Market Highlights (week ending 02/07/10)

Sunday, February 7th, 2010

Energy and Natural Resources Market

Despite Concerns over the Global Economy, Leading Indicators & Global Industrial Production are Improving

Strengths

• The American Iron & Steel Institute reports that for the week ending January 30, steel utilization rates increased to 66.9 percent versus the prior week of 65.6 percent and 42.4 percent last year.
• Prices for Indian iron ore shipments to China jumped $1-2 per metric ton to a range of $127-130 per ton after news broke that India may increase export duties to 15 percent.
• The U.S. Rig Count is up 18 from last week to 1,335 but is still down 64 year-over-year.

Weaknesses

• Commodities such as crude oil and copper declined by 1.3 and 6 percent, respectively, in response to fears that some European nations could default on their debt as budget deficits widen due to the global recession.
• Chinese steelmakers are “almost not profitable” in their main business because of overcapacity and high raw material costs, Nanjing Iron & Steel United Co. said.

Opportunities

• According to the International Copper Study Group, global copper mine capacity will expand to 20.04 metric tons in 2010, versus 19.51 metric tons in 2009.
• An article from Reuters states that Transocean is nearing a deal with Exxon to build a $1 billion arctic drillship. The article mentioned the new rig could be deployed to places such as Greenland, Iceland or offshore Alaska at a rig rate in the range of $650,000 per day.
• Zimbabwe’s platinum exports are set to double after Impala Platinum Holdings Ltd. completed an expansion project in the country during the last quarter of 2009, according to Mines Minister Obert Mpofu.
• Indonesia’s Department of Energy and Natural Resources expects coal exports from the country to fall 1.5 percent in 2010 despite a predicted production rise of 6.3 percent to 270 metric tons. The department expects domestic demand, led by the electricity generation sector, to rise by 34 percent.

Threats

• U.S. Interior Secretary Ken Salazar said that drilling for oil and natural gas on government land will face increased environmental scrutiny and slower approvals under new requirements currently being debated in Congress.

Tags: American Iron, Budget Deficits, China, Coal Exports, Commodities, Copper Mine, Drillship, Electricity Generation Sector, Emerging Markets, Export Duties, Global Recession, Impala Platinum Holdings, India, Indian Iron Ore, International Copper Study, International Copper Study Group, Leading Indicators, Offshore Alaska, oil, Overcapacity, Raw Material Costs, Rig Count, Steel Institute, United Co, Week Ending January
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Dubai – floating on an island of debt

Monday, November 30th, 2009

This post is a guest contribution by Dian Chu*, market analyst, trader and author of the Economic Forecasts and Opinions blog.

Stock markets around the world cracked on Friday with the Dow Jones industrial average down more than 150 points (Fig. 1), and commodities plunging as Dubai debt woes unnerved investors, and sent tremors of uncertainty throughout all markets.

The crisis flared after Dubai, a part of the United Arab Emirates (UAE) federation, asked to delay interest payment for six months on $60 billion of debt issued by the state-run conglomerate Dubai World and its main property unit Nakheel.

Concerns that a government-backed investment company risked default ripped through world markets. Investors read it as a sign of yet another sovereign implosion after Iceland and Ireland, and recoiled from risk and piled into dollars.

Las Vegas on Steroids

Dubai World has served as Dubai’s main driver of growth, operating ports, transportation groups, spearheading real-estate & infrastructure projects both at home and abroad. Its real-estate subsidiary Nakheel built Dubai’s iconic palm-tree-shaped island, packed with luxury villas and hotels, many still under construction. Real estate and construction accounts for about 23% of Dubai’s GDP.

With little oil, Dubai financed much of this rapid real estate development with debt. After incurring its estimated $80-$90 billion of debt in a four-year construction boom to transform its economy into a regional financial and tourism hub, Dubai suffered the world’s steepest property slump in the first global recession since World War II.

Deutsche Bank estimates that Dubai’s property prices, both commercial and residential, have halved since August last year, and could fall a further 15-20% this year.

U.S. Banks Less Exposed

Most analysts believe U.S. banks are probably less exposed than European rivals to a potential debt default by Dubai World, but a lack of transparency and the interconnection of the modern financial system make it difficult to know which institutions are ultimately exposed.

Dubai World’s largest creditors are reportedly domestic banks in Dubai and Abu Dhabi. MarketWatch noted data from the Bank for International Settlements which put cross-border banking exposure for the UAE as a whole at $123 billion at the end of June. Of that total, European banks hold 72%, with the United States and Japan only holding 9% and 7% of the exposure, respectively. The United Kingdom is by far the biggest creditor with a share of 41%.

Reminder of Other Risks

On a global scale, Dubai World’s debt problem seems relatively minor, but it illustrates the impact from one tiny country in an increasingly interconnected world. The Dubai news also cast doubt over the strength of the U.S. economic recovery, and the prospects for a bottoming of property prices.

Commercial Real Estate

As pointed out in my previous article that the commercial real estate sector posed a much greater threat than the over-hyped “mother of all carry trades.”  The Dubai debt crisis further reinforces this viewpoint.

The potential for contagion from Dubai’s debt woes could further unhinge an already fragile U.S. commercial real estate sector, whose values have already fallen 42.9% from their 2007 peak, close to the lowest since 2002, according to Moody’s. (Fig. 2) The latest Moody’s projection is for prices to bottom at 45-55% below their peak, but could drop as mush as 65% from their peak in a “stress case”.

As commercial property values fall, debt defaults rise. The $3.4 trillion outstanding in debt backed by commercial real estate poses a real threat to the recovery. Trepp LLC reported that last month, delinquencies on U.S. commercial real estate loans that were packaged into commercial mortgage-backed securities reached 4.8%, more than six times the year earlier level. Hotel loans, at 8.7% distressed, have begun falling into delinquency faster than any other kind of commercial real estate debt.

Write-downs and losses at banks around the world have risen to more than $1.7 trillion since 2007 as the credit crisis undermined the value of assets owned by financial institutions, according to data compiled by Bloomberg. Any further deleveraging and the resulting credit tightening from commercial real estate would impede the financial sector and probably derail the U.S. economy sending it into another recession.

Housing Market Mortgage Crisis

So far, the appearance of recovery in the housing sector is being driven primarily by reduced prices combined with federal programs to lower mortgage rates with the goal of bringing more buyers into the market.

Based on a study released by Zillow.com, the foreclosure crisis has moved beyond subprime mortgages and into the prime mortgage market. (Fig. 3) While subprime borrowers are still a factor in the current foreclosure epidemic, it’s becoming increasingly apparent that the weak labor market is the driving force behind the mortgage crisis we face today.

According to the Mortgage Bankers Association, one in seven U.S. home loans was past due or in foreclosure as of Sept. 30, putting that quarterly delinquency measure at its highest level since the report’s inception, 1972, and up from one in ten at the beginning of the year.

The continued surge in delinquencies suggests that a recovery in the housing market could be hindered by the weak job market as well as by further fallout from the easy money and loose lending practices of the past. The foreclosures and delinquencies are expected to keep rising well into 2010, not leveling off until the unemployment rate starts to moderate.

In a study by First American CoreLogic found that one in four of all U.S. mortgage-borrowers owe more than the value of their properties in the 3rd quarter. And many experts didn’t expect U.S. home prices to hit bottom until early 2011, perhaps falling another 5-10%, as more foreclosures get pushed onto the market.

Negative equity is another outstanding risk hanging over the mortgage market.

Dubai Is No Lehman

The circumstances behind Dubai’s moves are murky, making it hard to gauge the exact risk to the pertaining bonds and Dubai’s own general creditworthiness. UBS cautioned that Dubai’s overall debt “might be higher than the generally assumed $80 billion to $90 billion, due to potential off-balance sheet liabilities. These could include unlimited and unquantifiable amount of credit default swaps (CDS) and other derivatives against the underlying assets, and once unraveled, could potentially erupt into a subprime-like crisis.

The current expectation; however, is that there’s a good chance that Dubai’s problems will probably prove a local issue. Most likely, Dubai, or its neighboring emirate, Abu Dhabi, won’t risk tarnishing their images and reputation further, and will come up with a reasonable resolution.

Even if Dubai goes into sovereign default, the amount is probably not enough on its own to threaten the financial system since any actual losses would be a fraction of the total. So, the problems in Dubai are unlikely to be as serious as last year’s Lehman Brothers collapse, nor is it a reflection on the ability of emerging markets to lead a global economic recovery.

Rational Expectations?

But Dubai could well spur a broader crisis of investor confidence in overly leveraged economies as market confidence world-wide is still fragile from the severity of the financial crisis.  The debts of many emerging markets have risen even further as the countries governments have fought the ravages of the global recession by issuing more stimulus debt to fill the gap voided by private investment.

The spread of credit-default swaps on developing-nation’s bonds jumped 14 basis points after the Dubai news broke, the most in a month, to 3.24 percentage points, according to JPMorgan Chase & Co.’s EMBI+ Index. There is also a clear sign of potential contagion effects of global risk aversion on basically all risky assets, with the dollar and yen being the prime beneficiaries.

Rational expectations or not, for now, the Dubai crisis is simply a reminder that the severe global recession has relegated much debt to near junk status, and there still remains a high degree of uncertainty as to the percentage recoverable on all outstanding debt which is going to be coming due over the next 5 years.

Despite some seminal signs of green shoots in the news headlines during this 9 month liquidity driven rally in many asset classes around the globe, we should be reminded that all that glitters is not gold, and that the global economic recovery is still on shaky ground.

*Dian Chu, Market analyst, trader and financial writer for Seeking Alpha, Zero Hedge, Daily Marksts, iStockAnalyst & StraightStocks. My articles also appear in Reuters, USA Today and BusinessWeek, etc. Professional credentials include M.B.A., C.P.M. and Chartered Economist with extensive professional experience in market segment forecasting and strategies. Previous employers include Enron, Time Warner & Clear Channel. I’m currently working in the U.S. for the energy sector.

Source: Dian Chu, Economic Forecasts & Opinions, November 28, 2009.

Tags: Commodities, Construction Boom, Debt Default, Debt Woes, Dian, Dow Jones, Dow Jones Industrial Average, Economic Forecasts, Emerging Markets, European Rivals, Global Recession, Gold, Implosion, Infrastructure Projects, Interconn, Interest Payment, Luxury Villas, Market Analyst, oil, Palm Tree Shaped Island, Tourism Hub, Transportation Groups, United Arab Emirates, World War Ii, Year Construction
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China’s Empty City

Monday, November 16th, 2009

China’s economy is continuing to grow despite the global recession, helped by a massive government stimulus package of $585 billion. But doubts remain whether such strong growth can be sustained by public spending alone. Al Jazeera’s Melissa Chan reports from Inner Mongolia, where a whole town built with government money is standing empty.

Source: YouTube, November 10, 2009.

Tags: Al Jazeera, China, China Economy, China S Economy, Doubts, Emerging Markets, Global Recession, Government Money, Inner Mongolia, Massive Government, Melissa Chan, Public Spending, Stimulus Package
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Albert Edwards still uber-bearish, calls for new lows in 2010

Friday, November 13th, 2009

The post below is republished courtesy of Trader Mark, writer of the Fund My Mutual Fund blog (hat tip: Damien Hoffman of Wall St Cheat Sheet).

Societe Generale’s Albert Edwards is generally considered an uber bear, although there were times in the past year he has tactically increased exposure to equities to take advantage of oversold conditions. Now is not one of those times. In fact, Edwards chimes in with many similar thoughts we’ve posted on the fundamentals … but sticks his neck out calling for new lows in 2010.

While the belief from this blog writer is this will all end badly, knowing when and how will be the ultimate question. Without the massive intervention by central banks and governments we’d have a different landscape; and without knowing to what lengths these people will continue to go to, it’s much more difficult to predict the intermediate road ahead. But unless the basic laws of economics are repressed permanently, the ultimate destination seems no different.

As with “intellectual bears” today, the Nasdaq bears of 1999 and real estate bears of 2006 were ultimately correct; but in the interim a lot of money was made by those who ignored warnings on the upside before it all came crashing down. And specific to Nasdaq, most bears who attempted to step in front of the freight train had little equity left to actually profit from their (eventual) accurate prognostications. Irony at it’s best.

At this point many who are non believers have finally jumped on board, with everyone assuming they can jump right back out, through the same narrow door when “some day” arrives.  If only it were that easy …

Via Reuters:

• Albert Edwards, an analyst at French bank Societe Generale who correctly predicted the Asian financial crisis, sees global equity markets at a new low and chances of another global recession in 2010.

• Edwards, a prominent equities bear and a long-term critic of the policies of Western central banks, is skeptical of popular opinion that extreme policy responses will safeguard the West against a repeat of Japan’s ‘lost decade’ of the 1990’s.

• “People should question the happy clappy nonsense from sellside analysts,” London-based Edwards, a global strategist with SocGen’s Corporate & Investment Banking group, told a media briefing. “We are not saying that people should not participate in the rallies — that will get you fired as a fund manager — but they should not become too convinced of the recovery,” he said. (hand raised)

• Edwards expected China to go into a recession at some point as cyclicality catches up with the economy, and called people’s excessive faith in growth stories a “sick joke”.

• He said while inflation was a concern, deflation was a bigger worry in the near term, at a time when western and Japanese governments were effectively insolvent.  (print, print, print until your daddy takes the T bond away?)

• “If we get an economic downturn next year, when you have got core inflation at half a percent, I think there will be a real deflation panic, a bit like in Japan.”

• Edwards picked grains like corn, wheat and soybeans as a more secular bet on China’s growth story over other commodities and their related stocks as these have lagged the broad rally in the markets.  (interestingly these agriculture commodities have lagged big time … my belief is because one can stockpile many commodities such as oil or copper with the cheap money being handed out - whereas foods spoil)

• Edwards is more worried about Japan in the near term as he expects the world’s second-largest economy to run into difficulty funding itself next year as demand for Japanese government bonds wane and bond yields rise further.  The significance of higher Japanese government bond yields was that it would cause some Japanese investors, who have been investing overseas in search of higher returns, to bring that money back home, he said.

• “Equity valuations have been totally ridiculous for the last ten years but I’m less bearish than I was two years ago because we have had one round of correction,” said Edwards, who thinks the S&P 500 should have dropped to 500 points last year to hit the bottom of the valuation cycle.

Some more recent Edwards below.

1)  ZeroHedge provided further Albert Edwards thought process two weeks ago here.

2)  Investment Postcards blog has a blurb from September here.

Edwards concludes that the global crunch is not receding, but intensifying, stating that the unwinding of the “grotesque debt excesses” of the last decade has only just begun. “As Japan experienced before, it is deleveraging that is the problem and retrenchment takes many years, rendering the economy extremely vulnerable to rapid relapses back into recession when any reverse or pause in extreme stimulus occurs.”

3)  Edwards is one the prominent bears quoted often in this piece from The Economist in early October [hit fullscreen option for easy reading].

Source: Trader Mark, Fund My Mutual Fund, November 10, 2009.

Tags: Asian Financial Crisis, Bank Societe Generale, Central Banks, Cheat Sheet, China, Commodities, Edwards, Ees, Emerging Markets, Freight Train, French Bank, Global Equity Markets, Global Recession, Hat Tip, Hoffman, Irony, Laws Of Economics, Lows, Massive Intervention, Mutual Fund, Nasdaq, oil, Reuters, Societe Generale
Posted in Markets | 1 Comment »

Roubini’s Canada Outlook: Supported by Easier Credit and Commodities Recovery

Tuesday, August 18th, 2009

Nouriel Roubini’s RGE Monitor recently published “Are There Bright Spots Amid the Global Recession?,” which provides a comprehensive global economies roundup, and says that Canada’s economy will lag that of the US, though it is supported by easier credit conditions, stronger banks, and the commodities recovery.

Canada

Despite relatively sound finances that helped it outperform the rest of the G7 in 2008 and early 2009, Canada’s exposure to the U.S. for trade and investment suggests its recovery may lag that of the U.S. (a trend that Q2 2009 data seems to support).  However, a more consolidated financial sector with lower leverage, lower default rates, as well as a revival of domestic demand, should support recovery in 2010, albeit one characterized by below- potential growth.  Canadian households and corporations still have more access to credit than their U.S. counterparts, a factor that helped buffer Canada from a more severe property market correction. Yet the nascent revival in consumption may be weaker than the Bank of Canada expects. The rebound in commodity prices is mixed news. Higher commodity prices and greater demand for metals, if not yet for oil and cheap natural gas, should contribute to an expansion of mining and energy output–but too strong a surge could boost the Canadian dollar, exacerbating Canada’s manufacturing weakness as it boosts labor costs.

Source: RGE Monitor, August 5, 2009

Tags: Bank Of Canada, Banks Canada, Canada, Canadian Dollar, Canadian Households, Commodities, Commodity Prices, Counterparts, Default Rates, Energy Output, Financial Sector, G7, Global Economies, Global Recession, Leverage, Natural Gas, oil, Rebound, Recovery Canada, Revival, Roubini, Roundup
Posted in Commodities, Markets | No Comments »

Nouriel Roubini: The Phantom Economic Recovery

Tuesday, August 18th, 2009

The following article is a guest contribution from RGE Monitor, and Nouriel Roubini’s Project Syndicate, August 16, 2009.*

Where is the US and global economy headed? Last year, there were two sides to the debate. One camp argued that the recession in the US would be V-shaped—short and shallow. It would last only eight months, like the two previous recessions of 1990-1991 and 2001, and the world would decouple from the US contraction.

Others, including me, argued that given the excesses of private sector leverage (in households, financial institutions and corporate firms), this would be a U-shaped recession—long and deep. It would last about 24 months, and the world would not decouple from the US contraction.

Today, 20 months into the US recession—a recession that became global in the summer of 2008 with a massive recoupling—the V-shaped decoupling view is out the window. This is the worst US and global recession in 60 years. If the US recession were—as is most likely—to be over at the end of the year, it will have been three times as long and about fives times as deep—in terms of the cumulative decline in output—as the previous two.

Today’s consensus among economists is that the recession is already over, that the US and global economy will rapidly return to growth and that there is no risk of a relapse. Unfortunately, this new consensus could be as wrong now as the defenders of the V-shaped scenario were for the past three years.

Data from the US—rising unemployment, falling household consumption, still declining industrial production and a weak housing market—suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.

Moreover, for a number of reasons, growth in the advanced economies is likely to remain anaemic and well below trend for at least a couple of years.

The first reason is likely to create a long-term drag on growth: Households need to deleverage and save more, which will constrain consumption for years.

Second, the financial system— both banks and non-bank institutions—is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.

Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anaemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending.

Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.

Domestic private demand, especially consumption, is now weak or falling in over-spending countries (the US, UK, Spain, Ireland, Australia and New Zealand, etc.), while not increasing fast enough in over-saving countries (China, other Asian countries, Germany and Japan, etc.) to compensate for the reduction in these countries’ net exports. Thus, there is a global slackening of aggregate demand relative to the glut of supply capacity, which will impede a robust global economic recovery.

There are also now two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. If they take their fiscal deficits (and a potential monetization of these deficits) seriously and raise taxes, reduce spending and mop up excess liquidity, they could undermine the already weak recovery.

But if they maintain large budget deficits and continue to monetize them, at some point—after the current deflationary forces become more subdued—bond markets will revolt. At this point, inflationary expectations will increase, long-term government bond yields will rise and recovery will be crowded out.

A second reason to fear a double-dip recession concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created a major income shock for the US, Europe, Japan, China, India and other oil-importing economies. The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.

So, the end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anaemic rather than robust in advanced economies, and there is a rising risk of a double-dip recession. The recent market rallies in stocks, commodities and credit may have gotten ahead of the improvement in the real economy. If so, a correction cannot be too far behind.

©2009 / PROJECT SYNDICATE

Nouriel Roubini is chairman of Roubini Global Economics and a professor at the Stern School of Business, New York University.

Tags: Commodities, Consensus, Contraction, Economic Recovery, Economists, Eight Months, Emerging Economies, Emerging Markets, Excesses, Financial Institutions, Global Economy, Global Recession, Household Consumption, Households, Housing Market, India, Leverage, Nouriel Roubini, oil, Private Sector, Project Syndicate, Recessions, Relapse, RGE Monitor
Posted in Emerging Markets, Markets | No Comments »

Rebecca Wilder’s economic updates (May 8 – 15): still heading down, but “not as fast”

Sunday, May 17th, 2009

This post is a guest contribution by Rebecca Wilder*, author of the of the News N Economics blog

This week, the hard economic data reminds us that the global recession is ongoing: exports remain deep in the red; retail sales disappoint; inflation gets a small energy bump but still down; and industrial production declines. However, the data are consistent with the story of a slowing economic decline, foretold by several the “green shoot” survey reports (see last week’s World Economic Reports).

Industrial Production: Still heading down, but at a slower rate

The chart illustrates the industrial production index for Germany and the UK (seasonally adjusted), and the growth rate for Malaysia and India (to adjust for seasonal variations) through March 2009. The rate of decline is slowing in Germany - actually, Germany’s index went unchanged over the month - and the UK, improving over the year in Malaysia, but still heading down in India. A stabilization in the industrial sector may be afoot: the cliff diving is likely complete.

Exports: Same as industrial production…stabilization?

The chart illustrates annual export growth through March for Canada, Germany, Malaysia, and the US, and through April for China. Although China, Malaysia, and Canada turned down on an annual basis, the precipitous decline seems to have passed. We look for a trend to show stabilization.

Retail Sales: Struggling

The chart illustrates annual retail sales growth through April for China and the US, and through March for Singapore. Retail sales are struggling to make way. We wait to see if the various stimulus packages will get consumers back to the stores and auto dealerships; but let’s not hold our breath quite yet.

Inflation: Energy and food prices create some volatility

The chart illustrates annual inflation through April 2009. Clearly, the momentum is down on a sharp drawback in aggregate demand. However, the recent bump in energy and food is creating some volatility (some upward momentum against the downward pressure). Norway is experiencing stronger-than-expected inflation, as the economy fairs better than others; but don’t worry, inflation will probably fall, too.

The headline of the day: Eurozone economy took a dive in Q1

The chart compares Eurozone GDP to US GDP: ironic that the US is the epicenter of the global economic crisis,; was able to pass on the pain simply through trade flows; and now foreign economies take a sharper U-turn.

Overall, the global economic decline appears to be slowing; however, the recovery is still tentative.

Source: Rebecca Wilder, News N Economics, May 15, 2009.

* Rebecca Wilder is an economist in the financial industry. She was previously an assistant professor and holds a doctorate in economics.

Tags: Aggregate Demand, Auto Dealerships, Bump, Canada, Canada Germany, Cliff Diving, Drawback, Economic Data, Economic Decline, Economic Reports, Economic Updates, Emerging Markets, Food prices, Global Recession, India, Industrial Production Index, Industrial Sector, Precipitous Decline, Retail Sales Growth, Seasonal Variations, Stimulus, Survey Reports, Volatility
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Words from the (investment) wise for the week that was (May 11 – 17, 2009)

Sunday, May 17th, 2009

A long-awaited reversal in the monumental global stock market rally since early March finally arrived last week. As the first-quarter earnings season started winding down and post stress-test capital-raising weighed on some banks, investors were faced with a slew of gloomy economic reports suggesting the recent optimism about a global recovery might have been premature.

“This week, the hard economic data remind us that the global recession is ongoing: exports remain deep in the red; retail sales disappoint; inflation still volatile on food and energy but down on year; and industrial production declines. However, the data are consistent with the story of a slowing economic decline, foretold by several ‘green shoot’ survey reports,” said Rebecca Wilder (News N Economics).

Source: Tom Toles, Washington Post.

“Less bad” economic reports provided investors with little comfort, sparking a reassessment of their risk appetite and leading to profit-taking on most bourses. Also, commodities retreated after recording four-month highs earlier in the week, and high-yield corporate bonds and emerging-market currencies came off the boil. On the other hand, safe-haven assets such as government bonds, gold bullion, the US dollar and Japanese yen attracted buying. Investment-grade corporate bonds and Treasury inflation-protected securities also closed the week in positive territory.

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

Source: StockCharts.com

After nine straight weeks of gains, global stock markets succumbed to profit-taking last week with the MSCI World Index falling by 3.4% (YTD +0.1%) and the MSCI Emerging Markets Index down by 2.4% (YTD +24.8%).

Similarly, the major US indices reversed course. The Nasdaq Composite Index (-3.4%, YTD +6.5%) and the Russell 2000 Index (-7.0%, YTD -4.7%) declined after rising for nine consecutive weeks and the Dow Jones Industrial Index (-3.6%, YTD -5.8%) and the S&P 500 Index (-5.0%, YTD -2.3%) fell after being up eight out of nine weeks.

After last week’s sell-off the Nasdaq is the only major US index still in the black for the year to date, finding itself in the company of the majority of emerging and mature markets.

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

Returns around the world ranged from top performers Serbia (+10.0%), Cyprus (+9.7%), Bermuda (+9.5%), Namibia (+8.5%) and Vietnam (+6.5%) to Romania (-12.2%), the Czech Republic (-8.3%), Finland (-6.9%), Luxembourg (-6.9%) and Indonesia (-6.0%) which experienced headwinds. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

China (+33.3%), one of the leading stock markets for the year to date together with Brazil (+46.7%) and Russia (+94.6%), notched up another gain (+0.5%) last week despite disappointing economic data. A revival in Chinese property transactions has been a major contributor to China’s recent recovery in industrial activity. Good news for Chinese equity bulls is the close historical relationship between property sales and the performance of Chinese stocks.

Source: US Global Funds - Weekly Investor Alert, May 15, 2009.

With nearly all the US companies having reported first-quarter earnings, the S&P 500 saw earnings decline by 34.6% compared to the same quarter in 2008, reported Bespoke. At the start of the earnings season, a decline of 38.2% was expected. The percentage of companies lowering guidance was cut by more than half, while the percentage of companies raising guidance increased by over 70%. A tough second quarter undoubtedly still lies ahead, especially as companies will not have the advantage of non-recurring cost cutting.

John Nyaradi (Wall Street Sector Selector) reports that the strongest exchange-traded funds (ETFs) on the week were SPDR Russell/Nomura Small Cap Japan (JSC) (+6.1%), Market Vectors Agribusiness (MOO) (+5.4%) and iShares MSCI Chile Index (ECH) (+4.4%). On the other end of the performance scale KBW Bank (KBE) (-15.4%), iShares Dow Jones US Regional Banks Index (IAT) (-14.5%) and KBW Regional Bank (KRE) (-13.7%) were underwater as positive catalysts for the banking sector dried up.

As far as the economic sector ETFs are concerned, defensive sectors outperformed during the week, with Health Care SPDR (XLV) and Consumer Staples SPDR (XLP) leading the way. Financial SPDR (XLF) and cyclicals such as Consumer Discretionary SPDR (XLY) and Industrial SPDR (XLI) were on the receiving end of the selling pressure.

Source: StockCharts.com

Lower interbank lending rates indicated reduced strains in the financial system, as seen from the three-month dollar, euro and sterling LIBOR rates declining to record lows. After having peaked at 4.82% on October 10, the three-month dollar LIBOR rate declined to 0.83% on Friday. LIBOR is therefore trading at 58 basis points above the upper band of the Fed’s target range - a great improvement, but still high compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.

Gold bullion seems to be regaining its luster and again edged higher last week. “As sure as night follows day, the Federal Reserve’s purchase of bonds and home mortgages and the resulting rapid increase in bank reserves (quantitative easing in Fed-speak) - unless soon reversed - are underwriting a coming acceleration of inflation,” said gold specialist Jeffrey Nichols. “… by the time the broad financial markets register a worsening of inflation expectations gold will already have made a major move to the upside. It provides an early warning or leading indicator of inflation, signaling the coming acceleration long before financial markets begin to quiver.”

As to be expected, there is a strong relationship between the yellow metal (green line) and Treasury inflation-protected securities (red line).

Source: StockCharts.com

The quote du jour relates to whether the fact that bank stocks have rallied and in some instances been able to raise private capital, augurs an end to the financial crisis. Barry Ritholtz, editor of The Big Picture blog and author of Bailout Nation, a newly published and must-read book, succinctly remarked: “You can’t drink yourself sober and you can’t leverage your way out of excess leverage.” Many big banks remain technically insolvent and “are only being held together by spit, bailing wire and tape,” said Ritholtz in an interview with Yahoo Finance, Tech Ticker.

The banking system needs more time, at least three to five years, to deleverage before it can be left to its own devices, Ritholtz remarked, suggesting only time can heal the sector’s wounds.

In other news, the US Treasury announced that it would make $22 billion available to insurers from the Troubled Asset Relief Program (TARP), and the Obama administration sought new authority to bring transparency to the credit derivatives markets and also to crack down on the credit card industry.

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”, “financial”, “prices”, “banks”, “government” and “economy” again featured prominently. For the rest, it is really a bit of everything.

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

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

A useful indicator of market breadth is a chart showing the percentage of S&P 500 stocks trading above their 50-day moving averages. Although this measure has declined to 78% from 92% in early May, it is still at a level typically seen at prior peaks during the bear market. This still looks overdone in the short term, but for a primary uptrend to manifest itself, the bulk of the index constituents should remain above the 50-day line and also trade above their 200-day averages (31% at the moment).

Source: StockCharts.com

Interestingly, Bespoke highlights that on a sector basis the percentage of stocks trading above their 50-day moving lines has fallen the most in Technology, Consumer Discretionary, Utilities and Financials. However, Health Care has actually seen its reading increase over the last few days as investors rotate from cyclical to defensive stocks.

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.

Marc Faber, the author of “The Gloom, Boom & Doom Report”, wrote in his latest research report (via CNBC): “… I think that, at least in nominal terms (inflation-adjusted), the global printing presses being run by the world’s central banks and fiscal deficits have begun to impact asset prices positively. The lows reached by resource and mining stocks, as well as Asian equities and most emerging markets, are likely to hold for now.” But very high volatility and “price fluctuations that don’t appear to make any sense” will be the new dominant characteristic of the market, he warned.

Asking Richard Russell (Dow Theory Letters) what fundamentals he thought could cause the market to break the March lows, he replied: “You want guesses? Here are mine. (1) A collapse of the dollar along with a collapse in the bond market. (2) The US losing the reserve status of the dollar. (3) US consumers going on a long and unexpected buying strike plus a consumer saving campaign that shocks the economists and the Fed. (4) The Fed unable to halt asset deflation. (5) Federal budget deficits growing completely out of control, the compounding interest on the federal debt paralyzing the country with the catastrophic result that nobody will lend money to the US.”

According to the Telegraph, James Montier of Société Générale said prolonged suckers’ rallies tend to be especially vicious as they force everyone back into the market before cruelly dashing them on the rocks of despair yet again,” he said. Genuine bottoms tend to be “quiet affairs”.

“Teun Draaisma, Morgan Stanley’s stock guru, expects another shake-out, as reported by the Telegraph. “We think the bear market rally will end sooner rather than later. None of our signposts of the next bull market has flashed green yet. We’re not convinced the banking system has been fully fixed,” he said. He anticipates the new bull market to kick off later this year - perhaps in October - anticipating real recovery in 2010.

I am of the opinion that the US and other mature stock markets are in the process of mapping out a base development formation, which probably means toing and froing between policy tailwinds and economic headwinds.

But the “too-much-too-fast” rally made it inevitable for markets to either consolidate or retrace some of the past nine weeks’ gains prior to moving higher. Such a pullback as is now taking place is natural and necessary and should not be too much cause for concern, provided the levels from where the rally commenced in March hold.

For more discussion about the direction of stock markets, also see my recent posts “Stock markets: Reversal time?“, “Technical talk: Nasdaq in correction mode” and “Video-o-rama: Gloomy economic reports rein in investors’ optimism“. (Also, Donald Coxe’s webcast has been updated for May 15 and makes for good listening material. This can be accessed from the sidebar of the Investment Postcards site.)

John Mauldin’s “Conversations”
For those of you not familiar with John’s latest project (he is the author of Thoughts from the Frontline), it is called “Conversations with John Mauldin”. The most recent Conversation was with Gary Shilling and Donald Coxe, sharing in a rather lively debate their very different views on whether commodity prices will rise or fall. Previous Conversations included the views of Chris Whalen on the banking crisis, Lacy Hunt and Ed Easterling on the fundamentals of the economic crisis, and Nouriel Roubini.

Audios and transcripts of the Conversations are being produced. Although an annual subscription for a dozen Conversations retail at $199, I have negotiated a special price of $109 (-45%) for Investment Postcards readers. To find out more, just click here and enter code JM55 (at the end of the form), which will give you the discounted price.

Economy
“Global business sentiment has meaningfully improved since mid-March. The global confidence index remains consistent with ongoing recession, but the intensity of the downturn is abating. Most notable is a sharp gain in expectations regarding the outlook six months hence; it turned positive last week for the first time since the summer of 2007 just prior to the start of the current financial crisis,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com.

Jean-Claude Trichet, European Central Bank president, said on Monday the global downturn had bottomed out with some large economies already able to put the recession behind them and looking forward to renewed growth, according to the Financial Times. His remarks came as the Organization for Economic Co-operation and Development said there were signs of a “pause” in the economic slowdown in France, Italy, the UK and China.

Source: Financial Times, May 11, 2009.

“The economic free fall has been stopped, the collapse of the financial system averted. National economic stimulus programs are starting to take effect. The downward dynamic is easing,” billionaire investor George Soros was quoted as saying to a German newspaper (via Yahoo Finance).

“I expect the recovery to make up for around half of the downturn we have had and then to move into stagnation. Asia will be first out of the crisis, but America is also currently doing that,” he said.

The International Monetary Fund said the recovery would take longer than normal because the slump was precipitated by a worldwide financial crisis, expecting the global economy to contract by 1.3% this year.

Focusing specifically on China, the Financial Times reported “the total value of Chinese exports fell 22.6% to $91.9 billion last month compared with the same month a year earlier - a faster rate of decline than the 17.1% year-on-year drop in March”. However, Kevin (Sinolese.com) highlights that whereas total trade is down compared with March on an annual basis, this is because of a big increase from March 2008 to April 2008. ”When compared with the March number of this year, the result is positive. Not only so, total trade has been up for two consecutive months, with imports increasing faster than exports.”

Source: Kevin (Sinolese.com), May 15, 2009.

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

May 15, 2009
• The hike in core Consumer Price Index is temporary
• Factory production - moderation in pace of decline
• Consumer sentiment improves in May

May 14, 2009
• Auto industry shutdowns lead to jump in Initial Jobless Claims
• Food prices raise Wholesale Price Index

May 13, 2009
• Retail sales are stabilizing, but Q2 consumer spending should be weak
• Higher prices for petroleum imports lift overall import prices

May 12, 2009
• Small Business Optimism Index improves
• Trade balance widens slightly in March

May 11, 2009
• Fed’s program to purchase Treasuries, mortgage and agency securities - update

Also, RealtyTrac on Wednesday released its April 2009 US Foreclosure Market Report, which shows foreclosure filings - default notices, auction sale notices and bank repossessions - were reported on 342,038 US properties during the month, an increase of less than 1% from the previous month and an increase of 32% from April 2008.

Nobel Prize winning economist Paul Krugman argues that a rapid recovery is “extremely unlikely”. According to Bloomberg, he said: “Some of the measures that have been taken to deal with the crisis seem to be predicated on the belief that this is going to be a short, short recession. Everything says that’s wrong, that this is going to be a sustained period of weakness.”

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

Source: Yahoo Finance, May 15, 2009.

In addition to the Federal Open Market Committee (FOMC) releasing minutes of its April 29 meeting (Wednesday, May 20) and the Bank of Japan announcing its interest rate decision (Friday, May 22), the US economic highlights for the week include the following:

Source: Northern Trust.

Click the links below for the following reports:

• Wachovia’s Weekly Economic and Financial Commentary (May 15, 2009)

• Wachovia’s Monthly Economic Outlook (May 2009)

• Wachovia’s Global Chartbook (May 2009)

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

Source: Wall Street Journal Online, May 15, 2009.

Elroy Dimson, professor at the London Business School, said: “Risk means more things can happen than will happen.” Hopefully the “Words from the Wise” reviews will assist Investment Postcards readers in taking informed decisions to make sure “fewer things” happen to their investment portfolios.

That’s the way it looks from Cape Town (where the days are getting shorter and colder as winter approaches).

Source: Dilbert.com (via Barry Ritholtz’s The Big Picture).

Reuters: US banking crisis may last until 2013
“A day after saying big US banks probably needed to raise only one-fourth the capital demanded by the government, Standard & Poor’s said the nation’s banking crisis has ‘merely entered a new phase’ and might not end before 2013.

“The credit rating agency said the industry is being propped up by hundreds of billions of dollars of government support, especially for lenders considered too important to the financial system to fail.

“While efforts to spur lending, take bad assets off banks’ balance sheets, and restart the market for packaging and selling securities may help the sector, S&P said banks will have a tough time surviving absent a bigger capital cushion than regulators require.

“‘There’s nothing to say that this banking crisis can’t go on for another three or four years,’ S&P Managing Director Tanya Azarchs said.

“On Tuesday, S&P said major US banks need to raise about $18 billion of capital to protect themselves from the economic downturn, though this amount could grow if conditions worsen.

“The amount is well below the $74.6 billion that the government last week ordered 10 of the largest US banks, led by Bank of America Corp and Wells Fargo & Co, to plug potential capital shortfalls.

“S&P on May 4 said it may lower its ratings for 23 US banks and thrifts, including 10 that underwent stress tests, citing concern about the industry’s capitalization.”

Source: Reuters, May 13, 2009.

Financial Times: US to roll out latest phase of rescue plan
“With bank stress tests out of the way and favourably received by the markets, the Obama administration will now roll out the next phase of its financial rescue plan: schemes to deal with toxic ‘legacy assets’.

“Senior administration officials are keen to get new private-public marketplaces for these bubble-era loans and securities up and running quickly so banks can clean up their balance sheets and attract the $74.6 billion in equity they need to meet their stress test targets.

“Treasury has drawn up a shortlist of fund managers eligible to partner in the scheme and is expected to announce its selection in early June. The Federal Reserve has been interviewing private firms with a view to hiring one to help it analyse collateral pledged in return for loans.

“Many economists challenge the idea of public-private partnerships - where the government not only co-invests but provides loans to buy assets - as a scheme to funnel subsidies to the banks.

“There will be close attention when the Fed and the Federal Deposit Insurance Corporation release the terms on their loans to see whether these charges look valid.”

Source: Krishna Guha, Financial Times, May 14, 2009.

The New York Times: US considers limits on financial pay
“Obama Administration officials are contemplating a major overhaul of the compensation practices in the financial services industry, moving beyond banks to include more loosely regulated hedge funds and private equity firms.

“Federal policymakers have been discussing ways to ensure that pay is more closely linked to performance.

“Among the ideas under consideration are incorporating compensation as a ‘safety and soundness’ concern on official bank examinations as well as expanding the existing regulatory powers of the Securities and Exchange Commission and Federal Reserve to obtain more information.

“Any overhaul is likely to be tied the Obama Administration’s broader efforts to curb systemic risk to the economy. That means the new rules could apply to financial firms like hedge funds or private equity firms that never accepted money from the Troubled Asset Relief Program, or TARP. It would also mean greater oversight on compensation for banks that are seeking to return the TARP money in an effort to avoid the new strings attached to pay.

“Administration officials have been contemplating sweeping pay reforms since early this year. In February, the Treasury Department was instructed to write detailed guidelines to the executive pay clause that was inserted at the 11th hour into the economic stimulus bill.

“Treasury officials have said new executive compsenation rules could be released shortly, with some bankers and lawmakers expecting them to be formally released before the Memorial Day recess.”

Source: Louise Story and Eric Dash, The New York Times, May 13, 2009.

The New York Times: Obama urges rules on credit derivatives
“In its first detailed effort to overhaul financial regulations, the Obama administration on Wednesday sought new authority over the complex financial instruments, known as derivatives, that were a major cause of the financial crisis and have gone largely unregulated for decades.

“The administration asked Congress to move quickly on legislation that would allow federal oversight of many kinds of exotic instruments, including credit-default swaps, the insurance contracts that caused the near-collapse of the American International Group.

“The Treasury secretary, Timothy Geithner, said the measure should require swaps and other types of derivatives to be traded on exchanges or clearinghouses and backed by capital reserves, much like the capital cushions that banks must set aside in case a borrower defaults on a loan. Taken together, the rules would probably make it more expensive for issuers, dealers and buyers alike to participate in the derivatives markets.

“The proposal will probably force many types of derivatives into the open, reducing the role of the so-called shadow banking system that has arisen around them.

“‘This financial crisis was caused in large part by significant gaps in the oversight of the markets,’ Mr. Geithner said in a briefing. He said the proposal was intended to make the trading of derivatives more transparent and give regulators the ability to limit the amount of derivatives that any company can sell, or that any institution can hold.

“Derivatives are hard to value. They are virtually hidden from investors, analysts and regulators, even though they are one of Wall Street’s biggest profit engines. They do not trade openly on public exchanges, and financial services firms disclose few details about them. The new rules are meant to change most, but not all, of that opacity.”

Source: Stephen Labaton and Jackie Calmes, The New York Times, May 13 , 2009.

CNBC: Was Paulson’s pressure justified?
“Was former Treasury Secretary Henry Paulson justified in applying significant pressure on the banks receiving TARP money last October? Debating the issue: The New York Times’s Andrew Ross Sorkin along with CNBC’s Rick Santelli, Charlie Gasparino and Larry Kudlow.”

Source: CNBC, May 14, 2009.

Yahoo Finance, Tech Ticker: Barry Ritholtz - “You can’t drink yourself sober”; financial crisis far from over

Click here for the article.

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

The Wall Street Journal: US slates $22 billion for insurers from TARP
“The Treasury Department will make federal bailout funds available to a number of US life insurers, acting on the embattled sector’s long-running effort to get government help.

“The Treasury is prepared to inject up to $22 billion into the insurers under the rescue plan launched last fall as the Troubled Asset Relief Program, said a person familiar with the matter.

“The capital infusions mark the first new round of federal rescue funding since the biggest banks got more help around the turn of the year. Aid for the struggling life-insurance industry was expected, but the companies had been waiting for weeks since The Wall Street Journal reported in early April that the Treasury had decided to give federal money to qualified companies in the industry. As far back as November, some companies were taking steps such as agreeing to buy savings and loans in order to become eligible.

“The spokesman declined to provide figures on how much capital each company could receive. In return for aid, the government will get warrants as well as preferred shares that initially pay a 5% dividend.

“Many life-insurance companies, like others in the financial sector, got caught carrying too much risk when the financial crisis hit. Some were hurt by their variable-annuity businesses, under which they sold products often linked to equity markets that promised minimum payouts even if markets fell. Insurers also lost money on investments in bonds, real estate and other assets that back their policies.”

Source: Andrew Dowell and Jamie Heller, The Wall Street Journal, May 15, 2009.

Yahoo Finance: Soros says economic downward trend easing
“The downward trend in the financial crisis is easing and national economic stimulus packages are starting to work, billionaire investor George Soros was quoted as saying by a German newspaper on Monday.

“Soros also told the Frankfurter Allgemeine Zeitung daily that Asia would be the first region to pull out of the crisis and China was set to overtake the United States as the engine of world growth.

“‘The economic freefall has been stopped, the collapse of the financial system averted. National economic stimulus programs are starting to take effect. The downward dynamic is easing,’ Soros told the newspaper.

“‘I expect the recovery to make up for around half of the downturn we have had and then to move into stagnation,’ Soros said. ‘Asia will be first to find out of the crisis, but America is also currently doing that.’

“Soros said the US dollar was already weak, adding: ‘I don’t expect the dollar to lose much value against the euro, on the contrary.’”

Source: Yahoo Finance, May 11, 2009.

Financial Times: Services sector starts to feel more confident
“Service sector companies in European and emerging markets have recovered much of the confidence lost as the global recession took its toll, providing another sign of green shoots after a bruising six months.

“The majority of companies report that they expect the volume of business to improve over the coming year, revenues to grow and a rise in new orders

“Optimistic sentiment has returned more strongly in the Bric countries of Brazil, Russia, India and China than in large European economies and Germany stands as a gloomy outlier, still suffering from growing doubts that business will improve.

“The general mood of returning confidence is signalled in a twice-yearly survey of service sector sentiment from the same companies as are sampled in the closely-watched monthly purchasing managers’ indices. It will underpin the rally in equity markets worldwide that have been reassured that the outlook for the global economy is materially better than it appeared only weeks ago.

“The improving mood contrasts with the persistent gloom among international organisations, such as the International Monetary Fund, which continues to expect little or no growth among advanced economies this year, followed by a weak recovery in 2010.”

Source: Chris Giles, Financial Times, May 10, 2009.

Bloomberg: Paul Krugman says rapid recovery “extremely unlikely”
“Paul Krugman, Princeton University’s Nobel Prize-winning economist, said global economic prospects don’t justify the two-month rally that has restored $8.9 trillion to stock markets around the world.

“Speculation that government spending packages and interest-rate cuts worldwide will reinvigorate the global economy has helped the MSCI World Index rally 37% since falling to its lowest since 1995 on March 9. The US Standard & Poor’s 500 Index surged 34% in that time.

“‘It looks to me now as if the markets are now pricing in a rapid recovery, that they’re pricing in a V-shaped recession, which I consider extremely unlikely,’ Krugman, 56, said at a forum in Shanghai today. ‘The market seems to be looking as if this is going to be an average recession, but it’s not.’

“Krugman, who won the 2008 Nobel Prize for economics, joins New York University’s Nouriel Roubini in calling for a more cautious outlook on growth. Roubini said last week analysts expecting the US economy to rebound in the third and fourth quarter were ‘too optimistic’. Nassim Nicholas Taleb, the author of ‘Black Swan’, said the current global crisis is ‘vastly worse’ than the 1930s.

“The International Monetary Fund said on April 22 the global economy will contract 1.3% this year, downgrading its January projection of 0.5% growth. A recovery will take longer than normal because the slump was precipitated by a worldwide financial crisis, the IMF said.

“‘Some of the measures that have been taken to deal with the crisis seem to be predicated on the belief that this is going to be a short, short recession,’ Krugman said today. ‘Everything says that’s wrong, that this is going to be a sustained period of weakness.’

“The economist wrote in a New York Times editorial on April 16 that the ‘green shoots’ for a recovery being cited by government officials and investors could ‘breed a dangerous complacency’.”

Source: Patrick Rial and Stephanie Wong, Bloomberg, May 12, 2009.

Financial Times: America’s triple A rating is at risk
“Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.

“That warning from Moody’s focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we’re in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.

“Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the People’s Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.

“The US, despite the downturn, has the resources, expertise and resilience to restore its economy and meet its obligations. Moreover, many of the trillions of dollars recently funnelled into the financial system will hopefully rescue it and stimulate our economy.

“The US government has had a triple A credit rating since 1917, but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

“First, while comprehensive healthcare reform is needed, it must not further harm our nation’s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.

“Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.”

Source: David Walker, Financial Times, May 12, 2009.

Yahoo Finance: White House forecasts higher budget deficit
“The White House on Monday raised its forecast for this year’s US budget deficit by $89 billion due to the recession, millions of new unemployment claims and corporate bailouts.

“The new estimate predicted a deficit of $1.84 trillion, or 12.9% of gross domestic product, for the fiscal year ending September 30. It updated the White House’s February forecast of a $1.75 trillion deficit, or 12.3% of GDP.

“The report may add to the political challenges facing President Barack Obama as he seeks to push through a new healthcare plan and other domestic initiatives.

“White House officials said the gloomier picture reflected weaker tax receipts as the economy declined and higher costs for social safety-net programs such as unemployment insurance. Spending on government rescues for the financial and automobile industries also played a part.

“The report from the White House Office of Management and Budget also revised the deficit higher for fiscal year 2010, to $1.26 trillion, or 8.5% of GDP, $87 billion more than February’s $1.17 trillion projection.”

Source: Yahoo Finance, May 11, 2009.

Asha Bangalore (Northern Trust): Fed’s program to purchase Treasuries, mortgage and agency securities
“The March 18, 2009 Fed policy statement introduced the program to purchase $300 billion of Treasury securities. The plan to buy agency debt was raised by $100 billion to $200 billion and the mortgage backed securities purchase plan was increased by $750 billion to $1.25 trillion.

“As of today, the Fed has purchased $95.7 billion of Treasury securities (Federal Reserve Bank of New York - Permanent Open Market Operations), with roughly $204 billion remaining under the announced program. The 10-year Treasury security rallied on the day of the announcement to 2.51% but has since traded above this rate, with the latest reading at 3.16%, following a closing quote of 3.29% on May 8. The upward trend of Treasury yields appears to be a sign of improving economic conditions and an increase in supply of Treasury securities in the pipeline.

“The Fed’s announcement of enhanced purchases of agency debt (total purchases as of May 6 is $71.47 billion) and of mortgage-backed securities (total purchases as of May 7 is $365.8 billion) have resulted in bringing down mortgage rates. The 10-year Treasury note yield and mortgage rates are moving in opposite directions, a new record for the history books.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 11, 2009.

Asha Bangalore (Northern Trust): Factory production - moderation in pace of decline
“Industrial production dropped 0.5% in April versus a 1.7% decline in March. Factory production fell 0.3%, while output of utilities rose 0.4% and that of mining fell 3.2% in April. The decline in factory activity shows a moderation on a month-to-month and year-to-year basis. This is the most important aspect of the today’s report.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 15, 2009.

Asha Bangalore (Northern Trust): Retail sales are stabilizing, but Q2 consumer spending should be weak
“Retail sales fell 0.4% in April following a 1.3% decline in March. The earlier estimates for retail sales in February and March were revised down slightly. The 0.2% increase in auto sales contradicts the drop in unit auto sales (9.3 million versus 9.8 million in March) which are used in the computation of consumer spending in the GDP report. On a quarterly basis, the weakness in retail sales in April bodes poorly for consumer spending in the second quarter because the level of retail sales in April sales is below the first quarter average.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 13, 2009.

Asha Bangalore (Northern Trust): Auto industry shutdowns lead to jump in initial jobless claims
“Initial jobless claims increased 32,000 to 637,000 during the week ended May 9. The Labor Department indicated that a large part of this increase reflects auto plant shutdowns following Chrysler’s bankruptcy. In addition, some of the layoffs could have come from suppliers of auto parts. GM has announced shutdowns in July which should lead to another spike in initial jobless claims.

“The latest jump in initial jobless claims and those expected in July due to the auto industry woes should be excluded from the assessment of the underlying status of the overall labor market.

“Continuing claims, which lag initial claims by one week, rose 202,000 to 6.560 million, a new record high, and the insured unemployment rate rose to 4.9%, the highest since December of 1982.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 14, 2009.

Asha Bangalore (Northern Trust): Trade balance widens slightly in March
“The trade deficit of the US economy widened to $27.6 billion in March from $26.1 billion in the previous month. Exports and imports of goods and services fell in March, with exports (-2.4%) declining more rapidly than imports (-1.0%). The assumptions incorporated in the advance estimate of GDP expected a larger widening of the trade gap, which implies a small upward revision, holding all else constant.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 12, 2009.

Asha Bangalore (Northern Trust): Food prices raise wholesale price index
“The Producer Price Index (PPI) of Finished Goods increased 0.3% in April, following a 1.2% drop in the prior month. Food prices advanced 1.5% in April compared with declines in February and March. The energy price index edged down 0.1% in April after a 5.5% drop in March.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 14, 2009.

Asha Bangalore (Northern Trust): The hike in core consumer price index is temporary
“The Consumer Price Index (CPI) was unchanged in April following a 0.1% drop in the prior month. The energy price index fell 2.4% in April after a 3.0% drop in March. Energy prices are expected to show an increase in the May CPI report, based on the information available so far. The food price index fell 0.2%, the third consecutive monthly decline. In the first four months of the year the CPI has risen at an annual rate of 1.9% versus a 3.9% increase in all of 2008. On a year-to-year basis, the CPI has dropped 0.7% in April, the second consecutive monthly decline. The last time the CPI fell back-to-back for an extended period was in the 1954-1955 period.

“The core CPI, which excludes food and energy, rose 0.3% in April. The BLS indicated that over 40% of the increase in the core CPI was from higher tobacco prices for the second month. The tobacco price index went up 9.3% in April, which reflects the hike in federal excise tax on cigarettes. In addition, the jump in the medical care price index (+0.4%), higher prices for new cars (+0.4%), and gains in the shelter index (+0.2%) were the major gains recorded among the core items of the CPI. Lower prices for clothes (-0.2%) and air travel (-1.5%) helped to trim back the advance of the CPI in April. On a year-to-year basis, the core CPI rose 1.9% in April after holding between 1.7% and 1.8% for four straight months; the small acceleration reflects the hike in tobacco prices.

“The threat of inflation is not on the radar screen of the FOMC at the present time, the focus of the FOMC is financial market stability and economic growth. Financial.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, May 15, 2009.

Reuters: Former official slams Fed for inflation risk
“A sharp critic of the Federal Reserve and prominent authority on monetary policy on Tuesday slammed the US central bank for risking inflation and warned that government action had ‘caused, prolonged and worsened’ the country’s financial crisis.

“John Taylor, a former undersecretary of the Treasury for international affairs and author of the widely cited Taylor Rule of central banking, ran his own numbers for the US economy and said the Fed’s monetary stance was way too loose.

“‘My calculation implies that we may not have as much time before the Fed has to remove excess reserves and raise the rate,’ he said in remarks prepared for a financial markets conference hosted by the Federal Reserve Bank of Atlanta.

“‘We don’t know what will happen in the future, but there is a risk here and it is a systemic risk,’ he said.

“He noted a recent Financial Times report of internal Fed estimates using the Taylor Rule. This found interest rates should be minus 5% at the moment to compensate for the headwinds on the US economy.

“But Taylor said that his own analysis suggested a rate of 0.5%, indicating that the Fed could have a lot less time to raise interest rates than it may currently think.

“In addition, the Fed has pumped hundreds of billions of dollars into the economy to support credit markets in the face of a severe US recession, and may find it very hard to remove this expansion by shrinking its balance sheet in the future.

“‘While Federal Reserve officials say that they will be able to sell newly acquired assets at a sufficient rate to prevent these reserves from igniting inflation, they or their successors may face political difficulties in doing so.

“‘That raises doubts and therefore risks. The risk is systemic because of the economy-wide harm such an outcome would cause,’ Taylor said.”

Source: Reuters, May 12, 2009.

PR Newswire: Foreclosure activity remains at record levels
“RealtyTrac, the online marketplace for foreclosure properties, today [Wednesday] released its April 2009 US Foreclosure Market Report, which shows foreclosure filings - default notices, auction sale notices and bank repossessions - were reported on 342,038 US properties during the month, an increase of less than 1% from the previous month and an increase of 32% from April 2008. The report also shows that one in every 374 US housing units received a foreclosure filing in April, the highest monthly foreclosure rate ever posted since RealtyTrac began issuing its report in January 2005.

“‘Total foreclosure activity in April ended up slightly above the previous month, once again hitting a record-high level,’ said James J. Saccacio, chief executive officer of RealtyTrac. ‘Much of this activity is at the initial stages of foreclosure - the default and auction stages - while bank repossessions, or REOs, were down on a monthly and annual basis to their lowest level since March 2008. This suggests that many lenders and servicers are beginning foreclosure proceedings on delinquent loans that had been delayed by legislative and industry moratoria. It’s likely that we’ll see a corresponding spike in REOs as these loans move through the foreclosure process over the next few months.’”

Source: PR Newswire, May 13, 2009.

Bespoke: Gallup Well Being Index
“Gallup and Healthways started a number of daily polls at the start of 2008 that measure the well-being of Americans. Their main Well-Being Index ‘has been developed to provide the official measure for health and well-being. It’s the voice of Americans and the most ambitious effort ever undertaken to measure what people believe constitutes a good life.’

“The poll seems to be a good sentiment measure, and below we have overlaid a monthly chart of it with the S&P 500. As shown, the two tracked hand-in-hand until the end of 2008, when the Well Being Index began to positively diverge from the S&P 500. Throughout 2009, the Well Being Index has increased back to levels seen in September just before the US economy took a nose dive. While Well Being started increasing at the start of the year, the market didn’t swing higher until March, so it at least led this rally. But a big reason for the Well Being rally probably had a lot to due with Obama’s election, so the jury is still out on its effectiveness as a leading indicator. Nevertheless, it will be a good one to track in the years to come.”

Source: Bespoke, May 11, 2009.

Financial Times: Goldman agrees $60 million subprime deal
“Goldman Sachs has agreed to a $60 million settlement to resolve claims by a Massachusetts regulator that it participated in unfair and deceptive lending practices involving subprime mortgages, it was announced on Monday.

“The settlement did not involve an admission of wrongdoing by the bank. But Martha Coakley, Massachusetts attorney-general, said Goldman had ‘played a role’ in the ‘predatory lending’ associated with the subprime market. In a statement, the bank said: ‘Goldman Sachs is pleased to have resolved this matter.’

“Ms Coakley said Goldman agreed to forgo up to $50 million so it could restructure subprime loans it had helped underwrite or facilitate - in some cases forgiving up to half the unpaid balance. In addition, Goldman will pay $10 million to Massachusetts and continue to co-operate with the state’s regulators.

“The settlement with Goldman, which was not a major player in the subprime market, suggests Ms Coakley is also investigating other Wall Street banks that participated in subprime lending.”

Source: Greg Farrell, Financial Times, May 12, 2009.

Caroline Baum (Bloomberg): Curve watching beats room full of forecasters
“Like clockwork, the alarm bells are going off as long-term Treasury yields start their inevitable climb.

“‘Rising Government Bond Yields Frustrate Central Banks,’ trumpets yesterday’s Wall Street Journal.

“‘Rising bond yields present fresh Fed challenge,’ according to the April 29 edition of the Financial Times.

“It’s a funny thing about long-term interest rates. They’re pro-cyclical. They tend to rise when the economy is doing well, when demand for credit is strong. They fall when the economy is in the tank, and the private sector isn’t much interested in investing and spending.

“If there’s a way to accommodate the increased demand for credit that goes hand in hand with recovery without pushing up the price, no one has figured it out just yet.

“For a time, the federal government’s increased borrowing needs, both current and expected, were being met by more-than-willing lenders. The flight-to-quality into Treasuries drove yields to historic lows, with the benchmark 10-year note bottoming at 2.04% in December.

“Last Friday, the 10-year yield touched 3.38 percent as a proliferation of green shoots calmed investor fears of an endless dark winter.

“That’s not good news for the Treasury, which has to pay interest on the rapidly expanding debt. For the Fed, however, rising yields are a sign its medicine is working.

“The yield curve, or spread, has several things going for it:

“First, it’s a leading economic indicator, officially added to the index designed to predict the economy’s ebbs and flows in 1996. It was a leader well before that, even though it was unofficial.

“Second, what you see is what you get. The spread is never revised, always available and in no way proprietary.

“Third, and most curious, the majority of economists don’t get it. They see rising bond yields in isolation - without paying attention to what that price-setter, the Fed, is doing at the front end of the curve.

“It’s the juxtaposition of short and long rates, not their level, that conveys information about monetary policy.”

Source: Caroline Baum, Bloomberg, May 12, 2009.

Bloomberg: Bill Gross reduces US debt exposure
“Bill Gross, manager of Pacific Investment Management Co.’s $150 billion Total Return Fund, reduced his holdings of US government-related debt last month for the first time since January.

“Pimco’s founder and co-chief investment officer cut the holdings to 26% in April from 28% in March, according to the Newport Beach, California-based company’s Web site. In addition to Treasuries, the government debt category can include inflation-linked Treasuries, so-called agency debt, interest-rate derivatives and bank debt backed by the FDIC.

“Gross’ holdings of government debt in March were the most since April 2007 as he advised investors to favor debt of agencies such as Fannie Mae that have US government guarantees. Gross has counseled favoring stable income over speculative growth, saying 2009 marks a ‘demarcation’ in economic policy under the administration of President Barack Obama.

“This year ‘represents the beginning of government policy counterpunching’, Gross wrote in his May investment outlook posted May 4 on Pimco’s Web site. ‘Asset values should be negatively affected.’

“While the government debt category includes Treasuries, Gross has said that Pimco isn’t interested in buying them. Gross held about $4 billion in Treasuries in the fund at the end of March, or about 2.8% of the total, Mark Porterfield, a Pimco spokesman, said in an e-mail April 13. That was about the same as at the end of February, he wrote.”

Source: Dakin Campbell, Bloomberg, May 11, 2009.

Bloomberg: Mortgages over 5% mean Fed purchases as bonds slump
“The world’s biggest investors are increasing bets that Federal Reserve Chairman Ben Bernanke will boost purchases of Treasuries as the steepest losses on government debt since 1994 send mortgage rates above 5%.

“The slump in Treasuries the past seven weeks pushed yields on longer-maturity bonds up by more than half a percentage point and sent average rates on 30-year mortgages to the highest since the start of April, according to North Palm Beach, Florida-based Bankrate.com. Policy makers said March 18 they were committing ‘greater support to mortgage lending and housing markets’ when they pledged to buy as much as $300 billion of Treasuries and stepped up purchases of bonds backed by home loans.

“BlackRock Inc., American Century Investments, Federated Investors and Pioneer Investment Management say it’s time to buy Treasuries because the Fed will need to expand its purchases to keep consumer borrowing costs from rising further. While higher bond yields, the 37% increase in the Standard & Poor’s 500 Index since March 9 and US reports on housing and inventories show the economy may be stabilizing, Bernanke said May 5 that ‘mortgage credit is still relatively tight’.

“‘The Fed needs to consider increasing its purchases of Treasuries,’ said Stuart Spodek, co-head of US bonds in New York at BlackRock, which manages $483 billion in debt. Spodek said he resumed buying Treasuries. ‘We are still in a recession. It’s quite bad. They need to stabilize long-term rates.’”

Source: Daniel Kruger, Bloomberg, May 11, 2009.

Bespoke: New equity offerings tick higher
“As more and more Financials do secondaries to raise money in hopes of paying back TARP (GS, MS, WFC, COF), the amount of new equity offerings in the US is coming back strong. December, January and March saw the smallest amount of new offerings in years, if not decades. But April saw more than $16 billion of equity capital raised, and May has already seen more than $17 billion.

“And the companies that are doing the offerings are seeing share prices rally on the news because the fact that they can raise capital is being treated as a positive. In a market that was starved for deals for some time, it’s good to see some money begin to flow back in.”

Source: Bespoke, May 11, 2009.

CNBC: Dr. Doom - money printing pushed stocks up
“Major central banks’ efforts to lift the world economy by printing money have boosted asset prices, so stocks are unlikely to hit their lows from November and March, Marc Faber, the author of ‘The Gloom, Boom & Doom Report’, wrote in his latest research report.

“‘I have explained repeatedly in the past that if a government is really determined to try and postpone an inevitable collapse by ‘printing money’ in order to lift or support asset prices, it can be done,’ Faber wrote.

“‘This is not to say that the global economy is about to embark on a strong and sustainable growth phase. It also doesn’t mean that a new bull market in global equities a la 1982-2000 has begun,’ he said.

“‘But I think that, at least in nominal terms (inflation-adjusted), the global printing presses being run by the world’s central banks and fiscal deficits have begun to impact asset prices positively,’ Faber wrote.

“Many investors did not take advantage of the recent rally because they thought it was a bear-market rally, so they stayed on the sidelined, hoarding cash. But stocks are not likely to collapse, as more players take courage to dip into the market, he said.

“‘Put yourself in the shoes of a fund manager who, in the last 18 months, has lost 50% of his clients’ money and missed the recent rally,’ Faber wrote.

“‘What is he likely to do? I would think he would be inclined to purchase equities as they correct the sharp advance since early March, especially as the economic news in the near term becomes less negative,’ he said.

“But very high volatility and ‘price fluctuations that don’t appear to make any sense’ will be the new dominant characteristic of the market, he warned.

“The lows reached by resource and mining stocks, as well as Asian equities and most emerging markets, are likely to hold for now, according to Faber. But the US long-term government bond market ‘has the highest probability’ of having reached a high, he said.”

Source: CNBC, May 15, 2009.

Richard Russell (Dow Theory Letters): What fundamentals could trigger break of March lows?
“Russell, it’s all very interesting. What fundamentals do you think could cause the market to break the March lows?

“Answer - You want guesses? Here are mine. (1) A collapse of the dollar along with a collapse in the bond market. (2) The US losing the reserve status of the dollar. (3) US consumers going on a long and unexpected buying strike plus a consumer saving campaign that shocks the economists and the Fed. (4) The Fed unable to halt asset deflation. (5) Federal budget deficits growing completely out of control, the compounding interest on the federal debt paralyzing the country with the catastrophic result that nobody will lend money to the US.

“What to do? This is no longer a ‘buy and hold’ market. It’s a survival market. To survive, cash in case of deflation, physical gold in case of inflation or hyper-inflation, DIA ETFs in case of an important cyclical bull market.”

Source: Richard Russell, Dow Theory Letters, May 11, 2009.

Richard Russell (Dow Theory Letters): Are equities offering value?
“There’s no question that the huge break in the market from late-2007 to March 2009 was primary bear market action. During the decline from Dow 14,164 to Dow 6,547, the Dow lost over half of its value in a period of just 17 months. In my book, that qualifies the decline from the 2007 high as a severe or major bear market (actually, it was the second worst bear market on record). Going back over history, major bear markets tend to end with stocks selling at great values. Or as previous Dow Theorists put it, ‘stocks at bear market lows sell below known values’.

“So question - Have we seen stocks selling at great values or below known values in this bear market?

“Let’s take a look at previous bear market bottoms.

“In July 1932, the Dow sold at a yield of 10.2%.

“In June 1949, the S&P sold at a yield of 7.6%

“In December 1974, the S&P sold at a yield of 5.1%.

“In April 1980, the S&P sold at a yield of 5.7%.

“In September 1982, the S&P sold at a yield of 6.3%.

“And what was the yield on the S&P in March 2009 (the ‘supposed’ bear market bottom)? The yield on the S&P in March 2009 was 3.58%, hardly indicative of the bottom of a great bear market. Actually 3.58% is more what I’d expect at a market top. The current S&P dividend is now 2.45%.”

Source: Richard Russell, Dow Theory Letters, May 11, 2009.

The Wall Street Journal: By most measures, stocks no longer look cheap
“The outlook for stocks has brightened but, thanks to the big rally of the past two months, the market is no longer a bargain.

“By many measures, stocks are still on the cheaper side of the ledger. But they are approaching levels that bring them closer to long-term averages, making them neither a deal nor expensive.

“As a result, valuation has shifted from being a talking point of the bulls to one used by those bearish on the near-term outlook. And even many of those who think the market has hit bottom - a rapidly growing group - say valuations now suggest investors should tread more carefully.

“For now, the ‘less bad’ news has been enough for stock investors. Last week, the US government’s stress tests showed a number of the country’s biggest banks needed capital, but in largely manageable amounts. April chain stores sales were better than expected, reinforcing the idea that the bulk of the pullback in consumer spending is over.

“On balance, first-quarter earnings had enough positive surprises to cheer investors.

“While the rebound was a relief for battered stock investors, it complicated matters for those still trying to decide whether to get in or add new holdings. Higher prices have made stocks less of a screaming buy by several valuation measures.

“For example, based on the last 12 months of operating earnings, the S&P 500 was changing hands late last week at a price-to-earnings ratio of 14.7, according to Morgan Stanley.

“That is still below the average trailing P/E of 17 for the last 25 years but up sharply from 10.5 in February.

“Looking ahead to expected earnings for the next year, the story is less compelling for buying stocks. The S&P 500 was at a forward P/E of 14.5 late last week compared with a 25-year average of 15, according to the Morgan Stanley data.

“But many investors are reluctant to put too much weight on the forward P/E ratio during a period of significant uncertainty about the earnings outlook.

“Last October and November, for example, the S&P 500 appeared to be extremely cheap on that basis, trading below a P/E of 11. But it turned out that analysts had wildly overestimated the earnings for the year ahead.

“Analysts had forecast 2009 S&P 500 operating earnings of $89 a share; that is now down to $57. But for 2010, the consensus calls for an almost 30% rebound.

“Many investors also take issue with basing valuations against even historical earnings posted through the middle part of this decade. Profits from the period of record earnings growth that lasted into 2007 are now widely seen as having been significantly inflated by the credit and housing bubble.

“And current as-reported earnings, which don’t exclude one-time charge-offs, are creating readings seen as distorted. At the start of this month, the S&P 500 was at a P/E of 131 on that metric, according to Ned Davis Research. That is a record high that dwarfs the long-term average just south of 20.

“In this environment, valuation measures that compare stocks to longer-run earnings trends gain favor because they smooth out the cyclical peaks and valleys.

“Probably the most widely followed of these barometers, often known as ‘normalized’ earnings, is the one created by Yale University professor Robert Shiller.

“He compares stock prices to a 10-year trend in earnings adjusted for inflation. In March, his normalized P/E ratio dropped toward 13, its lowest since 1986.

“Now the measure is close to the historical average, with a reading of 15.9 at last Wednesday’s close of 920 for the S&P 500. That’s a reading that suggests ‘average returns for the next 10 years,’ Mr. Shiller says.

“‘However,’ he adds, ‘I still think the market is risky right now.’”

Source: David Ranson, The Wall Street Journal, May 11, 2009.

Henry Blodget (Clusterstock); So, you think this is another great bull market …
“Jubliation has replaced fear, and the consensus is now that the second-worst bear market in US history ended on March 9th and it’s all champagne and roses from here.

“Let’s hope.

“In the meantime, let’s review what happened after the two other biggest bear market bottoms of the past century, 1932 and 1974. In both cases, as now, the market had a sharp rally off the lows.

“In real terms (after adjusting for inflation), the 1932 market almost doubled in a year. The 1974 market, meanwhile, jumped about 35% over two years.

“But it’s what happened after that that matters now.

“After doubling off the low, the 1930s bear market pushed another 50% higher over the next three years to 1937 (not bad!). But it then got cut in half again, and it remained below the 1937 peak for 15 years. In 1949, 17 years after the 1932 bear-market low, when the next secular bull market finally began again, the market was 50% below the 1937 rebound peak and about 70% below the 1929 bull-market peak.

“In 1974, the market rebounded 35% in a couple of years. In 1982, however, eight years later, when the actual bull market began, it was back below the 1974 low. The 1973 peak, of course, was lower than the 1966 high, so the bear market that ended in 1982 was actually 16 years long.

“That’s why they call them ‘secular’ bear markets.

“So even if March 9th was the bottom of a Great Bear Market that took stocks down 60%+ in 9 years from the 2000 peak (in real terms), let us not celebrate too much about what is likely coming next. As Jeremy Grantham has said, the great bear markets don’t hurry, and this one probably has a long way to run.”

Source: Henry Blodget, Clusterstock, May 10, 2009.

Ambrose Evans-Pritchard (Telegraph): Enjoy the rally while it lasts - but expect to take a sucker punch
“Bear market rallies can be explosive. Japan had four violent spikes during its Lost Decade (33%, 55%, 44% and 79%). Wall Street had seven during the Great Depression, lasting 40 days on average. The spring of 1931 was a corker.

“James Montier at Société Générale said that even hard-bitten bears are starting to throw in the towel, suspecting that we really are on the cusp of new boom. That is a tell-tale sign.

“Prolonged suckers’ rallies tend to be especially vicious as they force everyone back into the market before cruelly dashing them on the rocks of despair yet again,’ he said. Genuine bottoms tend to be ‘quiet affairs’, carved slowly in a fog of investor gloom.

“Another sign of fakery - apart from the implausible ‘V’ shape - is the ‘dash for trash’ in this rally. The mostly heavily shorted stocks are up 70%: the least shorted are up 21%. Stocks with bad fundamentals in SocGen’s model (Anheuser-Busch, Cairn Energy, Ericsson) are up 60%: the best are up 30%.

“Teun Draaisma, Morgan Stanley’s stock guru, expects another shake-out. ‘We think the bear market rally will end sooner rather than later. None of our signposts of the next bull market has flashed green yet. We’re not convinced the banking system has been fully fixed,’ he said

“Mr Draaisma said US housing busts typically last nearly about 42 months. We are just 26 months into this one. The overhang of unsold properties on the US market is still near a record 11 months. He expects the new bull market to kick off later this year - perhaps in October - anticipating real recovery in 2010.

“The echoes of 1931 are ominous. That year began with green shoots, until Austria’s Credit-Anstalt buckled in the summer and took Central Europe with it. Continentals who still thought it was an American crisis learned otherwise. Plus ça change.”

Click here for the full article.

Source: Ambrose Evans-Pritchard, Telegraph, May 11, 2009.

Bespoke: Relative strength - sector rotation in motion
“The charts below highlight the relative strength for the Consumer Discretionary, Consumer Staples, Health Care, and Industrial sectors over the last year. In each chart, a rising line indicates the sector is outperforming the S&P 500 while a declining line indicates underperformance. We have also included markers to show those days when the Fed cut rates (red dots) and meetings where they left rates unchanged (black dots).

“As shown in the charts below, over the last few trading days, there has been a clear rotation out of cyclical sectors like Consumer Discretionary and Industrials and into defensive sectors like Consumer Staples and Health Care. Given the previous run in the cyclicals, some profit taking is to be expected, but with the string of weaker than expected economic reports we have seen this week, bulls are hoping this isn’t the beginning of a new trend.”

Source: Bespoke, May 14, 2009.

Bill King (The King Report): How to navigate equity markets with fully invested mandate
“A portfolio manager asked us a great question: ‘How does an institutional money manager with a mandate to always be fully invested with no short or hedge recourse navigate these troubled waters?’

“The most reasonable avenue given those parameters that we could conceive is some variation of sector rotation. When the market appears ready to rally high-beta (like techs), savagely beaten (finance) and advantaged sectors (building materials) should be over-weighted and defensive sectors under-weighted.

“When inevitable rebound rallies appear, one should rotate into defensive sectors or if possible cash-like positions. Of course tactics are probably more important than strategy. Ergo, one should have a plan that entails a gradual rotation and re-weighting as the market ebbs and flows.

“One of the clues that the recent rally might be ending is that the financial stocks, due to issuance and patsy exhaustion, have underperformed the S&P 500 the past week. Nasdaq and the Russell 2000 started to underperform the S&P 500 after the grandly bullish seasonal for stocks ended on April 30.”

Source: Bill King, The King Report, May 13, 2009.

Bloomberg: Mobius says Latin America commodity producers are “attractive”
“Shares of Latin American commodity producers are ‘attractive’ investments and the region’s banks are in ‘good shape’ because they hold few bad loans, Templeton Asset Management’s Mark Mobius said.

“‘Commodity companies should remain profitable and constitute attractive investment opportunities’ despite declines in oil and metals prices last year, Mobius, who helps oversee about $20 billion in emerging-market assets at Templeton, said in an e-mailed statement today [Wednesday]. ‘Latin American banks have minimal exposure to the toxic assets that have plagued financial institutions elsewhere. They are in a strong position to benefit from a recovery in the global markets.’”

Source: Michael Patterson, Bloomberg, May 13, 2009.

Bespoke: US Dollar Index enters downtrend
“After failing to take out its March highs on its most recent rally, the US Dollar Index has since broken below its recent lows and entered into a new downtrend. The Dollar Index also recently broke below its 200-day moving average, which is another negative technical sign.”

Source: Bespoke, May 12, 2009

Eoin Treacy (Fullermoney): US dollar heading lower
“The US dollar exhibited remarkable relative strength as it attracted massive inflows from investors worried about the safety of their cash. As currencies, other than the Yen, weakened against the greenback, rationalizations stating that the dollar is a true safe haven or that since the US was first into the crisis, it would be first out, emerged.

“However, none of these arguments address the underlying problems in the US economy such as the budget and trade deficits, financial sector balance sheet issues or the very real risk that the US administration will be tempted to print its way our of trouble.

“The impressive rallies in stock and commodity markets over the last two months have succeeded in decreasing the perceived need for a safe haven and investors are now beginning to think more in terms of what they want to own in the ‘post apocalyptic’ world that is quickly developing.

“The US Dollar Index surged from early August to late November and while it pulled back sharply in December, the broad pattern has been characterised by a loss of momentum. One of the most bullish characteristics of the price action was the way the Index found support at the ascending moving average on a number of occasions since October. However, it broke below the MA last week and a sustained move back above 85 would now be needed to question potential for some additional lower to lateral ranging.

“The Australian dollar, New Zealand dollar, Norwegian krone, Brazilian real, Canadian dollar and Korean won have been leaders against the US dollar. The Singapore dollar, Taiwan dollar and Russian ruble are also exhibiting notable relative strength. The presence of so many commodity-related and Asian currencies in this group is a further indication that it is to these markets investors are looking for relative performance.”

Source: Eoin Treacy, Fullermoney, May 12, 2009.

Seeking Alpha: Purchasing power of the US dollar

Source: Seeking Alpha, March 31, 2009.

Nouriel Roubini (The New York Times): The almighty renminbi?
“The 19th century was dominated by the British Empire, the 20th century by the United States. We may now be entering the Asian century, dominated by a rising China and its currency. While the dollar’s status as the major reserve currency will not vanish overnight, we can no longer take it for granted. Sooner than we think, the dollar may be challenged by other currencies, most likely the Chinese renminbi. This would have serious costs for America, as our ability to finance our budget and trade deficits cheaply would disappear.

“Traditionally, empires that hold the global reserve currency are also net foreign creditors and net lenders. The British Empire declined - and the pound lost its status as the main global reserve currency - when Britain became a net debtor and a net borrower in World War II. Today, the United States is in a similar position. It is running huge budget and trade deficits, and is relying on the kindness of restless foreign creditors who are starting to feel uneasy about accumulating even more dollar assets. The resulting downfall of the dollar may be only a matter of time.

“But what could replace it? The British pound, the Japanese yen and the Swiss franc remain minor reserve currencies, as those countries are not major powers. Gold is still a barbaric relic whose value rises only when inflation is high. The euro is hobbled by concerns about the long-term viability of the European Monetary Union. That leaves the renminbi.

“China is a creditor country with large current account surpluses, a small budget deficit, much lower public debt as a share of GDP than the United States, and solid growth. And it is already taking steps toward challenging the supremacy of the dollar. Beijing has called for a new international reserve currency in the form of the International Monetary Fund’s special drawing rights (a basket of dollars, euros, pounds and yen). China will soon want to see its own currency included in the basket, as well as the renminbi used as a means of payment in bilateral trade.”

Click here for the full article.

Source: Nouriel Roubini, The New York Times, May 13, 2009.

Jeffrey Nichols (Mineweb): Gold price braces for return to long upward march
“From a long-term perspective, gold is a bargain at recent prices in the $900 to $930 an ounce … and will remain so even as it begins to move into a higher trading range.

“Recent gold-market developments and technical price action - along with broader economic and financial-market developments - suggest gold is bracing for a resumption of its long march upward and a retest of its historic high in the months ahead.

“First and foremost, the bullish outlook for gold rests on the increasing likelihood of accelerating US inflation in the years to come - and an associated unprecedented rise in investor demand for the yellow metal.

“This nascent inflation has not yet been reflecting in world financial markets. But, judging from anecdotal evidence and the financial press - and the warnings of a growing number of institutional investment managers - we believe a gradual, subtle, but important, upward shift in inflation expectations is already underway.”

Click here for the full article.

Source: Mineweb, May 15, 2009.

David Fuller (Fullermoney): Gold has bottomed
“… have a look at this 30-year chart of the gold price adjusted for CPI inflation, which we all know presents a hedonic picture of the USA’s true inflation. Even allowing for this understatement, gold is still trading at less than half of its real (inflation-adjusted) peak in 1980.

“However, the real timing test is how gold is performing in the world’s other currencies. Veteran subscribers may recall that bullion does best when it is appreciating simultaneously against all currencies.

“The key factors are that gold peaked in February, as we know, and fell back in a mostly uninterrupted decline against all viable currencies. Subsequently, gold has steadied against all of them. While this is not confirmation that gold will now rise persistently, it suggests that bullion has bottomed in areas of probable support.”

Source: David Fuller, Fullermoney, January 14, 2009.

National Post: Faber - agricultural commodities offer great opportunity
“Going against the grain may be costly. Investing in agriculture today will be like investing in oil in 2001 to 2002 when oil prices halved to US$17 per barrel says Marc Faber editor of The Gloom, Boom & Doom Report. Agricultural commodities fell by half from June 2008 highs, but fundamentals remain strong says Faber.

“Faber points to a weak build in agricultural stocks (supplies) during the bumper harvest year of 2008. Low stocks, declining productivity, and increased demand persist from a long term perspective says Faber and will drive prices higher. Population growth is rising until 2030 and will have produced an additional billion mouths to feed between 2000 and 2012 alone.

“Faber is well known for highlighting long term trends in asset prices through a careful read of history. He points to the Green Revolution between 1976 to 1986 as the era when growth in food production transitioned from increased land usage to higher yielding agricultural methods yet those benefits have run their course. Productivity fell by almost half between 1990 and 2007 and will continue that trend over the next decade.

“Faber recommends only one-third allocation to commodity futures products due to the negative carry costs in those markets and also warns against farmland companies due to poor yields. One third of investor capital should go to listed agricultural companies and the other third to private companies. The long term opportunity is now.”

Source: National Post, May 12, 2009.

Mark Lacey (Investec Asset Management): US natural gas is ripe for rebound
“In contrast with the strong performance of oil in 2009, the US natural gas market has seen steady downward pressure - and looks ripe for a rebound, says Mark Lacey, Global Energy portfolio co-manager at Investec Asset Management.

“‘Onshore overproduction of gas has been met with declining industrial demand,’ he says. ‘While long-term US gas prices - 2011 and beyond - are above $7.20 per million British thermal units, spot prices have collapsed to about $3.80. This is the equivalent of about $23 a barrel of oil, making gas by far the cheapest source of energy in the US.’

“Mr Lacey argues that a potential rebalancing of the supply/demand equilibrium could push the US gas market from oversupply in 2009 to a slight deficit in 2010. And, without a pick-up in drilling activity from current levels, this deficit could widen even further in 2011. ‘In this downturn, the cut in drilling activity has amounted to 54% in just seven months.

“‘If gas prices remain at current levels, we do not expect activity to increase meaningfully in 2009,’ he says.

“‘Although we forecast that industrial demand will be weak in 2009 and potentially 2010, we believe this bearish scenario is now fully reflected in the market and that the current low levels of gas prices are unsustainable relative to coal and oil.

“‘Could it now be time for investors to stop overlooking the US natural gas market?’”

Source: Mark Lacey, Investec Asset Management (via Financial Times), May 13, 2009.

Ifo: Ifo Economic Climate for the euro area
“The Ifo World Economic Climate for the euro area has improved in the second quarter of 2009 for the first time since autumn 2007. The rise in the Ifo indicator is the result of less negative expectations for the coming six months; the assessments of the current economic situation, however, have worsened further and now stand at a new all-time low.

“The current economic situation has been assessed as very unfavourable in all countries of the euro area without exception. The expectations for the coming six months, however, have improved in almost all countries of the euro area, with the exception of Greece. Ifo World Economic Survey (WES) experts in Belgium, Germany, Italy and Luxemburg anticipate improvement, and in Austria, France and the Netherlands at least a stabilisation of the economic situation in the coming six months is seen.”

Source: Ifo, May 13, 2009.

Financial Times: Chinese exports fall sharply
“Chinese exports fell steeply in April for the sixth month in succession, suggesting the worst might not be over for the world’s third largest economy.

“The total value of Chinese exports fell 22.6% to $91.9 billion last month compared with the same month a year earlier - a faster rate of decline than the 17.1% year-on-year drop in March.

“Imports fell 23% from a year earlier to $78.8 billion in what some analysts said was a sign that domestic investors remained unwilling to invest in new capacity. Exports rose 6.9% between March and April. However, the month-on-month figures are not seasonally adjusted and are regarded by analysts as misleading.

“The monthly trade figures are being watched more closely than usual after some economists criticised Beijing’s stimulus efforts for relying too heavily on an assumption there would be a quick rebound in global demand for cheap Chinese exports.”

Source: Jamil Anderlini, Financial Times, May 12, 2009.

CNBC: China has real domestic growth
“There is a real inner growth story happening in China, especially when one looks at the second- and third-tier cities, notes Tim Mulholland, MD at China-America Capital Company. He shares his observations with CNBC’s Martin Soong.”

Source: CNBC, May 13, 2009.

NDTV Profit: India’s fiscal deficit puts rating at risk
“In just a few days from now a new government will be ready to take charge. But whoever comes to power will have a long list of economic worries to address including concerns over India’s sovereign rating.

“A slowing economy and election year populist policies have meant that the new administration will be handed a huge deficit. And that has international rating agencies like Fitch and Standard and Poors’ worried.

“Fitch Ratings on Thursday, for instance, warned that ‘weakness in public finances if unaddressed could undermine sovereign creditworthiness’. The global ratings agency added that the new government faces challenges in balancing the need for stimulus and balancing its finances.

“While Fitch says that the deficit alone will not prompt a ratings cut, an inability to curtail expenditure may be a concern for ratings.”

Source: Ira Duggal, NDTV Profit, May 15, 2009.

Financial Times: Zuma appointments ease business fears
“Jacob Zuma, South Africa’s new president, on Sunday appointed Trevor Manuel, the country’s respected finance minister, to head a powerful new centralised planning body, reassuring business critics who feared the new leader would shift policy to the left.

“In another appointment closely watched by financial markets, Pravin Gordhan, the highly regarded head of the country’s tax collection service, is to take over from Mr Manuel at the finance ministry.

“Investors had feared that Mr Zuma, whose election campaign was supported by the Communist party and the trade union movement, might oversee a populist lurch to the left.

“But his opening appointments, as well as his inauguration speech on Saturday, have been pitched at reassuring investors. In particular, Mr Zuma has stressed the need to improve government efficiency and provide better public services, one of the shortcomings of the former government.

“Mr Zuma said on Sunday that Mr Manuel was being ‘given a new structure, a very powerful structure, to work out a national plan of government. It will be all encompassing and is not going to exclude economic matters’.

“Jeff Gable, head of research at Absa Capital in Johannesburg, said: ‘There is not a lot that is scary here. The government has fallen short on delivery and has now introduced a structure designed to put things right.’”

Source: Richard Lapper, Financial Times, May 10, 2009.

Tags: BRIC, Canada, Dow Jones Industrial, Dow Jones Industrial Index, Earnings Season, Economic Decline, Emerging Markets, ETF, Global Recession, Global Stock Market, Global Stock Markets, Gold Bullion, Government Bonds, High Yield Corporate Bonds, India, Inflation Protected Securities, Market Rally, Msci Emerging Markets Index, Msci World Index, Nasdaq Composite Index, oil, Risk Appetite, Russell 2000 Index, Toles Washington Post, Tom Toles, Treasury Inflation Protected Securities
Posted in Emerging Markets, Gold, Markets | No Comments »

Roubini Global Economics: Re-emergence of global protectionism

Sunday, March 8th, 2009

By RGE Monitor

As governments around the world fight rising unemployment, falling exports and bank credit crunch, and several central banks are facing liquidity traps, many are turning to restrictions that privilege national producers. These populist measures attempt to minimize growth impact, social unrest and pain from the credit crunch that poses a risk to several ruling governments, especially those facing elections soon. Furthermore, some officials hope that such restrictions will reduce the leakage of the scarce funds used in bank bailouts and fiscal stimulus to other countries.

But as history shows, the impacts of trade protectionism on exports and job creation if any are small in the short-term and instead may lead to global retaliation, and in the long-term result in inefficient allocation of labor and capital and trade distortions, affecting potential output and employment. But given the increased capital flows and labor migration in recent years and dependence on external capital in developed and developing countries to drive domestic demand, asset markets and growth, rising financial and labor protectionism pose an even greater risk of exacerbating the current global recession as trade protectionism did in the recession of 1930s. Increased global integration since the 1930s also indicates the consequences of protectionism will also be larger.

The US and EU’s stance will provide clues to other countries policy towards globalization. So it might be somewhat alarming that US anti-recession policies propose protectionist elements, and Western Europe has rejected a bailout package for Eastern Europe while implementing policies that pose risk to EMU’s ongoing trade, capital and labor integration.

However, there are at least some signs of global policy co-operation to suggest that a return to the Smoot-Hawley era might be less probable. Countries around the world have been coordinating since the crisis began to cut interest rates, inject liquidity into the banking system and contain rising spreads in the money markets. Other instances include countries implementing fiscal stimulus packages, the Fed extending swap lines to South Korea, Singapore, Mexico and Brazil; surplus Asian countries increasing their contribution to the pool of regional swaps; Japan filling IMF’s coffin to help increase assistance to crisis-hit countries in spite of its dire economic situation; and Western European countries willing to offer a case-by-case bailout to some of the Eastern European countries.

Trade protectionism
Plunging global manufacturing activity and consumer demand along with the trade finance crunch, commodity correction and exchange rate fluctuations are already bound to cause a contraction in global trade in 2009. Increasing instances of imposition of trade barriers by countries to restrict imports and promote exports will only exacerbate and prolong the decline in global trade and make export-dependent economies worse-off. Furthermore they may do little to help the imposing countries. However, sharp devaluations in some countries, especially emerging markets may increase import substitution.

Trade barriers such as tariffs are the most common element of protectionism that countries use in difficult times as witnessed during the food shortages in 2008. Countries like Indonesia, India, Vietnam, Ukraine, Russia, Argentina, Ecuador and Turkey have raised import tariffs, duties or laid restrictions on import licenses or quotas.

In their fiscal stimulus packages, several countries are also offering distortionary subsidies, and credit and other incentives for exporting firms to sustain trade flows, especially countries with high export dependence and low domestic demand. But trying to promote exports amid global demand and industrial activity slump might only add to the global excess capacity and deflation pressures.

One of China’s first steps was to reinstate and then increase export rebates which create disincentives to sell goods at home, a move that might only increase the domestic imbalances, as might the government’s efforts to buy grain and metals to support prices.

As WTO bound rates, especially for developing countries, have fallen significantly in recent years, governments have ample room to raise tariffs closer to the bound rate levels without violating WTO rules. And with policymakers preoccupied with domestic economic challenges, Doha trade talks might not be revived in the near-term despite the exhortations of the G7, G20 and other groupings.

Plunging sales and tightened access to domestic and foreign credit have also led many auto companies to seek bailouts from their home governments. Amidst scarce resources and to promote domestic firms over competitors, governments are offering financial assistance to just the domestic auto firms over the foreign-owned ones despite the relative inefficiencies of several of these national champions compared to other global players.

After the US government’s bailout of domestic automakers, GM and Chrysler, several countries including UK, China, Brazil, and Canada and in EU such as Sweden, France, Germany, Italy and Spain have followed suit to help their own auto companies. Western European auto sector support, a move that may hurt Eastern European countries, is seen as a challenge to EU’s single-market ideology even if they have passed EU competition rules. In China’s case, government policy aims to finally consolidate the industry.

But restricting assistance to some firms via loans or loan guarantees, tax incentives to firms and households buying autos, subsidies to undertake R&D and invest in renewable energy is highly distortionary and undermines domestic as well as trade efficiency, particularly if the beneficiaries do not make the difficult cuts required as part of the funding.

There have been growing calls for a global fiscal stimulus policy partly to support global trade, as coordinated action will have a better chance of boosting aggregate demand especially for smaller, open economies. Given that the global supply chain is highly integrated today, import demand by one country will boost exports for other countries and therefore their incomes and import demand, which in turn will boost the source county’s exports. However, to prevent import leakages and promote production and jobs at local firms, fiscal stimulus in countries like US, Spain and France encourage spending on domestically produced goods at the expense of foreign-owned firms and nationals working at those firms.

The US fiscal stimulus package limits sourcing infrastructure spending related goods from WTO signatories like EU, NAFTA and Japan while excluding non-signatories like China, Brazil, India, Russia, Ukraine, Turkey and many other developing countries. Since close to 55% of the infrastructure spending will take place after 2009-10, the impact of this measure on jobs and growth will be limited in the short-term. But this has nevertheless led other countries implementing fiscal stimulus and infrastructure spending to retaliate with similar measures to protect their own jobs and firms. As a result, this will impact jobs at importing firms and also the demand for US exports and jobs, sometimes affecting output and jobs in the same industries and sectors that the policymakers were aiming to protect. As it is, Obama and the Democratic Congress’ stance to renegotiate trade deals to incorporate non-tariff barriers like labor and environmental standards, and promote influence of labor unions has already cautioned the world on the US trade policy going forward even if Obama emphasized the importance of trade on his recent visit to Canada.

Moreover as exports are slowing, several developing countries such as in Asia and Latin America are increasingly favoring an undervalued currency. The initial currency plunge may have been due to deleveraging but given the export collapse, few countries are likely to allow much appreciation. And this is leading other countries to follow suit with the risks being particularly high in Asia, as these export oriented economies might favor competitive devaluations. Some Japanese officials have argued for intervention to weaken the yen, which only recently slipped from the heights where they intervened in the early part of this decade.

The Chinese yuan, which rose about 6% against the US dollar early in 2008, and appreciated more in real terms, returned to its de facto peg at mid-year and even depreciated somewhat. Treasury Secretary Timothy Geithner’s confirmation testimony re-ignited US China currency tensions by noting that President Obama views China as a currency manipulator, a tag that would allow trade retaliation. China has similarly publicly expressed concerns about the value of its large stock of US debt (over $700 billion) acquired in the process of managing its currency. Given the collapse in China’s exports, it is unlikely to allow a stronger currency which might give it little choice but to keep buying US assets, albeit likely at a slower pace than in early 2008.

However, the probability of these measures becoming significant enough to lead to a trade war like the 1930s might be low given that counties understand that retaliation effects will counter-productive for domestic growth and jobs. Moreover, the WTO surveillance mechanism, absent during the 1930s, will help countries go to the WTO court if they face import barriers and thus prevent trade wars.

Financial protectionism
Global credit crunch and de-leveraging has reduced capital flows to emerging markets. Risk averse foreign investors are redeeming and repatriating funds where credit risk is perceived to be less or using the resources to offset other losses. The Institute of International Finance (IIF) estimates that net private sector capital flows to Emerging Markets in 2009 will be $165bn in 2009, less than half the 2008 inflow of $466bn and $929bn in 2007. The decline in capital flows is equivalent to about 6% of the combined GDP of EMs, way larger than the 3.5% of GDP during Asian crisis and 1.5% of GDP during the Latin American crisis.

Foreign commercial bank lending, which accounted for the largest share (over 50%) of capital flows to EMs in recent years, similarly accounts for much of the decline - such flows are expected to fall to $61bn in 2009 from $167bn in 2008 and $410bn in 2007. Portfolio flows to EMs will continue to contract in 2009 after declining to $89bn in 2008. FDI, the second largest component of capital flows to EMs in recent years, may not be as resilient as many economists assume and will drop to $198bn in 2009 from $263bn in 2008 and $304bn in 2007 as MNCs face lower corporate profits, lower export-related investment amid plunging global demand, credit crunch and decline in M&A and Private Equity activity.

Similarly the reduction in commodity prices will reduce the outflows from oil exporters to developed and developing economies - portfolio and direct investment from the GCC were a key capital source for some emerging economies, especially in the Middle East.

Hence, capital flows to EMs will contract at a time when domestic capital markets and bank lending activities are subdued. When exports and current account balances are easing, weaker capital accounts will pose risk to several EMs in financing or rolling over their external debt and maintaining stable asset prices and currencies. In fact, many short-term hot inflows and foreign bank borrowings to finance domestic consumption, corporate investment and drive asset markets such as real estate and stock markets and fuel economic growth.

Thus, ongoing bank losses and credit crunch will lead foreign banks to reduce credit availability, and at worse to cut credit lines to subsidiaries thus weighing down on domestic demand, raising bank defaults by firms and households and worsen the recession. Emerging Europe, which has seen foreign bank borrowing and foreign bank assets/GDP ratio surge in recent years, is the main victim of this trend. Going forward, Japan may be only one of several countries to apply its government savings to increase foreign exchange liquidity of corporations, many of whom lost out as FX markets became more volatile.

Therefore amidst capital outflows, end of the global liquidity boom, growing risk of increased global regulation and doubts over the benefits of financial globalization on risk sharing and financial stability, a rise in financial protectionism will only exacerbate the global credit crunch and financial crisis in several countries, posing the risk of slowing the pace of financial globalization.

As increasing number of banks are being bailed out, governments such as the UK, Germany, France, Greece, Denmark are imposing stringent conditions to lend their scarce capital to domestic firms and households rather than foreign ones and also direct credit to priority or recession hit sectors.

The stance of EU and US to monitor lending by banks is forcing them to increase lending in domestic markets relative to foreign ones. This is influencing banks’ commercial decisions, distorting credit allocation and reducing credit growth in EMs especially in emerging Europe like Hungary and Romania, and countries such as Russia, Ukraine and UK that are highly dependent on foreign bank borrowing. However in countries like China, state banks are responding to the government’s commands to lend, even if most of it is short-term, but foreign banks are more reluctant.

Banks including RBS, Citigroup, UBS, BoA are reducing lending abroad and even selling their overseas subsidiaries, especially the non-core assets in EMs to offset losses and manage their shrinking balance sheets. Risk-averse and loss-making banks also want to repatriate capital to their home markets where risks are perceived to be relatively less with an upside of having access to government assistance in times of crisis.

Additionally, governments are also imposing several capital controls to restrict capital outflows including on cross-border banking and corporate M&A activities even as they are easing capital inflow rules to support their currencies and finance their external balances. Further such controls are possible. Iceland, Ukraine, Argentina, Indonesia and Russia have imposed restrictions on the availability of foreign exchange.

Some governments have higher capital requirements and capital charges for foreign banks especially emerging market banks relative to domestic banks, leading banks to move assets to their domestic markets. To cope with domestic currency shortages, several countries have laid restrictions on currency conversion by importers and domestic banks and firms to meet their foreign currency needs.

The threat to financial globalization could be exacerbated by asset protectionism. On the one hand, many governments have worried that foreigners with surplus cash (especially sovereign wealth funds) might be able to snap up key assets more cheaply and end up with controlling stakes. France even created their own fund to provide capital lest foreigners buy up French companies too cheaply and both developed and developing countries have imposed new restrictions on investment in the last year.

On the other hand, the increasing need for capital by corporations and financial institutions may reduce political concerns. Yet it should perhaps not escape notice that the recent conversion of Citigroup’s preferred shares to common stock by Singapore’s GIC will leave it with a 11.1% voting share, an amount which would have raised congressional shackles a year or so ago. Perhaps the fact that the US may soon control 36% of shares dilutes these concerns.

Sovereign funds themselves are not as high-profile, a development that may be due to past losses, the need for greater liquidity and uncertainty about the value of assets. And at the same time, with less new funds available from the reversal in capital flows and commodity prices, past savings are being depleted to support domestic banks and finance fiscal stimulus packages. China may be a partial exception. It emerged in recent months as a capital source for several cash strapped resource companies, providing loans in exchange for oil supply contracts and using the opportunity to diversify its foreign assets.

Labor protectionism
Rising lay-offs and worker protests in UK, Ireland, Greece, France, Latvia and several other European countries is increasing political pressure to protect jobs for nationals. As a result, governments face pressure to lay off foreign workers rather than domestic ones, promote outflow of immigrants, put restrictions on firms to hire nationals over immigrants such as for the US banks using TARP funds, and in the fiscal stimulus packages create jobs for nationals than foreign workers and offer safety nets.

With slumping global manufacturing and exports, the International Labor Organization estimates up to 50 million workers will become unemployed due to the global recession while immigration itself will slow as job market and wages weaken in the host countries. These factors along with recent trends - rising income inequality, stagnant wage growth, impact of immigration on depressing job opportunities and wages for nationals, and impact of globalization and offshoring on job and income security - will rekindle workers’ anxiety and undermine the recent boom in labor migration.

The movement of labor within the EU, intra-Americas, to the GCC region and between developed and developing countries in general has led to a corresponding boom in the flow of skills and remittances that has also helped finance external accounts of several developing countries. These remittance flows are now under pressure as RGE Monitor’s Mikka Pineda details in a recent outlook for Filipino remittances in 2009.

In the GCC, where imported labor facilitated fast paced economic growth during the oil boom, there are reports that many work visas are being cancelled and the UAE has instituted policies to protect the jobs of nationals. This will reduce remittance flows to other countries in the MENA region and to South Asia. In the UAE, which will probably face the sharpest declines, job losses will exacerbate the slowing in domestic demand and reduced demand for housing even as though new restrictions may actually do little to increase employment of nationals as they are difficult to fire.

As Russia contracts, Central Asians working in Russia are losing jobs and are facing greater pressure from nationalist groups. With remittances as high as 30-50% of GDP in many Central Asian countries, the reduction in remittances will exacerbate the contraction.

As the global downturn worsens, so will workers’ anxieties about job and income losses, strengthening the need to increase spending on unemployment insurance, worker retraining and other social safety nets in the government’s fiscal stimulus packages around the world to keep the labor market flexible during the downturn while also creating long-term policies to cushion workers from changes in the economic structure that the recovery and globalization in general would bring about.

Source: Arpitha Bykere and Rachel Ziemba, RGE Monitor, March 4, 2009.

Tags: Asset Markets, Bailout Package, Canada, Central Banks, Credit Crunch, Emerging Markets, Fiscal Stimulus, Global Integration, Global Recession, India, Inefficient Allocation, Labor Migration, Liquidity Traps, National Producers, Populist Measures, Roubini Global Economics, Scarce Funds, Smoot Hawley, Social Unrest, Term Result, Trade Distortions, Trade Protectionism, World Fight
Posted in Credit Markets, Emerging Markets, Markets, Oil and Gas, Outlook | No Comments »

Words from the (investment) wise for the week that was (March 2 – 8, 2009)

Sunday, March 8th, 2009

“Down, down, deeper and down”. So goes the chorus of a Status Quo song, but it is eerily starting to sound like the stock markets’ anthem.

Another week and another plunge of equities on fears about the intensity of the global recession and renewed skepticism regarding the beleaguered financial sector. And, yet again, flight-to-safety trades such as the US dollar (at a three-year high) and government bonds took center stage.

Our family yesterday celebrated my son’s eighth birthday. While the kids were amusing themselves in pirate garb, the parents engaged in a more subdued deliberation about the exhausting stream of ugly news on the financial front. Interestingly, never in a career of 26 years have I had so many people sympathizing with my “day job” as investment manager. Will the arrival of food parcels at my front door perhaps herald a bottom in the stock market?

Back to the past week’s action on the markets. Globally, stocks were generally in the red, as summarized by the week’s movements of the MSCI Global Index (-7.1%, YTD -24.2%) and the MSCI Emerging Markets Index (-2.2%, YTD -13.9%). As far as mature markets are concerned, European countries like Italy (+15.6%), Denmark (-11.7%), Belgium (-10.0%) and Holland (-9.2%) were on the receiving end of the selling orders.

The FTSE Eurofirst 300 Index touched the lowest level in its 12-year history, whereas the Japanese Nikkei 225 Average (-5.2%) came to within a stone’s throw of a 26-year low.

But a few bourses also up put a good show, mostly among emerging markets. The Russian Trading System Index (+5.8%) and Chinese Shanghai Composite Index (+5.3%) brought some joy to investors, while Eastern European markets like Poland (+2.9%) and Romania (+2.3%) rebounded. (Click here to access a complete list of global stock market index movements, in local currency terms, as supplied by Emerginvest.)

As shown in the table below, the major US indices suffered another miserable week, recording eight losing weeks out of nine in 2009 and falling to 12-year lows. The Dow Jones Industrial Index’s 2009 year-to-date decline of 24.5% is by far the worst start to a year after 44 trading days since 1900. According to Bespoke, there have been 19 previous years where the Dow was down 5% or more at this point, and only four of those years ultimately finished in positive territory.

The Dow is currently down by 53.2% since its peak of October 2007. Chart of the Day points out that since 1896 only the bear market that started in 1929 has produced a larger slump.

On the exchange-traded fund (ETF) front, John Nyaradi (Wall Street Sector Selector) reports that “all things short” was again the theme of the week, with ProShares Short Financial (SEF) leading the way with a gain of 18.1%. Other inverse leaders were ProShares Short Russell 2000 (RWM) (+10.0%) and ProShares Short MidCap 400 (MYY) (+9.3%).

Among “long” ETFs the notable leaders were iShares MSCI Taiwan Index (EWT) (+5.0%) and US Oil (USO) (+3.5%).

Notwithstanding supply concerns, government bond yields in the US, UK and Germany declined as investors continued their flight to safety. Yields of 10-year Treasuries, Bunds and Gilts were down by 15, 58 and 20 basis points respectively.

In the case of the UK, the Bank of England introduced quantitative easing as its new monetary tool and unveiled an ambitious plan to buy UK government paper by printing money. Speculation rose that the Federal Reserve may also commence a program of buying longer-dated government securities. In typical David Fuller style, he offered the following advice to governments: “The patient is hemorrhaging on the operating table; do anything and everything to resuscitate (inflate) this deflating body.”

On the credit front, Markit’s spreads show that the cost of insuring corporate debt against default has increased markedly throughout the world over the past month. This is illustrated by the movement in the spreads (expressed in basis points) for the five-year credit derivative indices listed below.

• CDX (North America, investment-grade) Index: up from 196 to 250
• CDX (North America, high-yield) Index: up from 1,458 to 1,824
• Markit iTraxx Europe Index: up from 161 to 204
• Markit iTraxx Europe Crossover Index: up from 1,065 to 1,150
• Markit iTraxx Japan Index: up from 400 to 528
• Markit iTraxx Asia ex Japan IG Index: up from 363 to 462
• Markit iTraxx Asia ex Japan HY Index: up from 1,210 to 1,325

Next, a tag cloud of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. Key words such as “banks”, “economy” and “markets” dominated the list, whereas “China” seems to be gaining more prominence by the week.

Having breached the November 20, 2008 and October 2002 lows, the Dow and S&P 500 have fallen significantly below their respective 50- and 200-day moving averages, as shown in the customary table summarizing important chart levels. The large deviations of the moving averages point to a massively oversold situation - almost like a spring that is stretched too far. Meanwhile, I have added the July 1996 lows to the table as these levels are now in sight of the indices.

According to Thomas Lee, US Equity Strategist at JPMorgan, retracing 12-year lows for the Dow is an incredibly rare event (see chart below). “Besides the retest of 1997 lows seen on Monday, this has only happened two other times, on April 8, 1932, and December 6, 1974,” said Lee (via The Big Picture). It is noteworthy that the 12-year low in 1932 was three months before the end of the bear market and the one in 1974 was exactly the low for that bear market.

Barry Ritholtz added: “Hitting a 12-year low is by no means proof the bear market is over. And, two prior examples do not make a sufficient sample. [But] the oversold nature of the market, as well as the virtual straight down drop that brought us here, does present a real possibility of a strong market rally.”

The precipitous stock market declines are reflected in the results of this week’s survey of investor sentiment by the American Association of Individual Investors (AAII), courtesy of Bespoke. Investors are now at their most bearish levels since the start of the survey in 1987 with 70.27% of respondents currently in the bearish camp - a necessary prerequisite for a major market low.

James Montier, strategist of Société Générale, said (via FT Alphaville): “We have long argued that the final stage of the de-bubbling process is revulsion. This phase is characterized by overwhelmingly cheap asset prices. Recent price moves in the UK and European stock markets have taken us to levels that have generally been associated with revulsion. Of course, cheap markets can always get cheaper, but for the long-term investor this may provide an excellent entry point.”

Montier’s preferred valuation measure is the so-called Graham and Dodd price-earnings ratio that pitches the share price against a 10-year moving average of reported earnings. On this basis, the S&P 500 Index is currently trading at 13.6 compared with an average of 18 since 1871 and a typical “bargain basement” level of 10. (Keep in mind that this indicator dropped to 5 in the Great Depression.)

As usual, some interesting thoughts were also contributed by Richard Russell (Dow Theory Letters): “The stock market doesn’t live in a vacuum. This huge decline in less than two years is telling us (me) something. It’s a warning. I think it’s a warning of very hard times to come, maybe as difficult as those times we saw during the Great Depression.
“I know that I stand pretty much alone with this scenario. I don’t think most Americans see or even envision the potential danger ahead. They don’t believe in the ‘truth of the stock market’. Over 60 years of studying the stock market and the economy, I’ve learned to believe the ‘language of the market’.

“I know that great bull markets and great bear markets tend to overrun at the extremes. Let me leave you with one thought - prepare for the extremes. Just as the bull market that ended in 2007 rose to the extremes, I believe this bear market will go to the extremes.”

At this juncture, short-term movements are almost impossible to predict, although the sell-off over the past few days - a capitulation in some respects - could nourish the long-awaited tradeable rally. Also, Lowry’s 90% down-days, like we experienced on Monday and Thursday, are often followed by two- to seven-day bounces. But we are not yet at the point where we leave the defeated bear’s carcass behind, although each downward move brings us closer to the eventual bottom.

For more discussion about the direction of stock markets, also see my recent posts “Video-o-rama: Gloomy investors shun risky trades“, “Technical talk: Bounce not that impressive …“, “Louise Yamada: Don’t ‘venture into the waters’” and “Stock market performance round-up: Nowhere to hide“. (And do make a point of listening to Donald Coxe’s weekly webcast, which can be accessed from the sidebar of the Investment Postcards site.)

Economy
“A pall continues to hang over global business confidence as it has since sentiment collapsed last fall. Confidence remains near a record low,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “Most worrisome is the recent collapse in pricing power - a record over one-third of respondents now say they are cutting prices for their goods and services.”

Confidence is uniformly weak across all industries and regions of the globe, as highlighted in a recent Forbes article by Nouriel Roubini (RGE Monitor): “With economic activity contracting in 2009’s first quarter at the same rate as in 2008’s fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation).

“The scale and speed of synchronized global economic contraction are really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully-fledged financial crisis, starting with emerging Europe.”

The European Central Bank’s growth projections for the Eurozone were significantly lowered from a range of -1.0% / 0.0% to a range of -3.2% / -2.2% for 2009, while for 2010 the range was revised from +0.5% / 1.5% to -0.7% / +0.7%, incorporating the possibility of an extended recession. As a result, the ECB lowered its refinance rate by 50 basis points to 1.50%, bringing its cumulative rate cuts to 275 basis points since mid-October 2008.

In an attempt to restore flagging confidence, the Bank of England also cut its target interest rates by 50 basis points to 0.5% and announced plans to start quantitative easing by printing money to purchase government bonds and other securities with an initial amount of £75 billion.

On a more positive note, China’s manufacturing Purchasing Managers’ Index (PMI) strengthened for a third consecutive month in February, climbing to 49.0% from 45.3% the previous month. As discussed in a recent post (”China - better days ahead“) and as shown in the graph below, China’s improving PMI seems to indicate that the country might have seen the worst of its GDP growth statistics in this cycle. (The Hong Kong PMI is used as a proxy of the Chinese PMI prior to 2004.)

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.)

March 06
• February employment report underscores severity of recession

March 5
• Productivity decline reflects GDP revision
• Factory inventories-sales ratio registers new high
• Jobless claims - decline is noteworthy but too early to identify as a turning point

March 3
• Bernanke hints more may be necessary and notes that “premature removal of fiscal stimulus could blunt recovery”
• Auto sales decline once again
• The decline of the Pending Home Sales Index suggests home sales remain under stress

March 2
• Consumer spending gains strength in January, but underlying fundamentals raise questions
• ISM Manufacturing Survey - insignificant gain in February
• Construction spending - non-residential and public components deteriorate more
• Affordability - silver lining of housing sector

Commenting on the payroll employment data, Asha Bangalore (Northern Trust) said the statistics need to be evaluated within the context of the growth of the labor force. “The chart below takes into account the growth of the labor force and indicates the extent of job losses in each recession in the post-war period from the peak of payroll employment to the end of a recession. The 3.17% drop in payroll employment in the current recession of 14 months is the largest percentage drop in jobs since the 1957 recession.”

At the same time, Bangalore said there was a silver lining in the housing market that might have been overlooked. As shown in the chart below, the Housing Affordability Index of the National Association of Realtors shot up to a record high of 166.8 in January. Also, the Obama administration has made available details of the Homeowner Affordability and Stability Plan, which raises expectations of improvement in the housing market.

Week’s economic reports

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

Economatrix Here

Source: Yahoo Finance, March 6, 2009.

The US economic highlights for the week include the following:

Source: Northern Trust

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

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

Source: Wall Street Journal Online, March 6, 2009.

“Every man has a right to his opinion, but no man has a right to be wrong in his facts,” said legendary investor Bernard Baruch. Hopefully the “Words from the Wise” reviews will assist Investment Postcards readers to get the facts right, and provide some fodder for formulating sensible opinions. But remember the golden rule: don’t take investment decisions that will keep you from a good night’s sleep.

That’s the way it looks from Cape Town.

Dateline: Jim Rogers on the economy, markets
“George Negus speaks with Singapore-based financier, Wall Street veteran and former business partner of George Soros, Jim Rogers.”

Source: Dateline, March 1, 2009.

Bloomberg: Jim Rogers - China stimulus can’t pull world out of “hole”
“China cannot pull the world economy ‘out of the hole’ through its stimulus spending alone and the global recession is not going to end anytime soon, investor Jim Rogers said.

“China’s parliament convened today in its annual meeting in Beijing, where Premier Wen Jiabao reiterated the government’s pledge to ‘significantly increase’ investment in 2009 to help counter the slowest growth in seven years. He didn’t announce any new stimulus spending.

“‘China can’t solve the world’s problems,’ Rogers, the author of ‘A Bull in China: Investing Profitably In The World’s Greatest Market’, said in a phone interview today. ‘China is a wonderful and growing economy but it cannot pull the world out of the hole.’

“Wen’s report to lawmakers, the equivalent of a US State of the Union speech, reiterated the country’s 8% growth target. That’s more optimistic than the International Monetary Fund’s forecast that the nation’s economy will expand 6.7%, the least in almost two decades.

“‘One question people keep asking is can China bring the whole world along out of this recession,’ said Lee King Fuei, a Hong Kong-based portfolio manager at Schroder Investment Management, which oversees about $158 billion worldwide. ‘The fact that they’re even asking this question tells me they’re being unrealistic.’

“Rogers, chairman of Singapore-based Rogers Holdings, said he hasn’t bought any Chinese stocks since November as valuations are not attractive.

“The Hang Seng China Enterprises Index, which tracks Chinese companies mostly traded in Hong Kong, is valued at 8.9 times reported earnings. Valuations fell to 7.4 times the week ended October 24, the lowest in almost seven years, according to Bloomberg data. The Shanghai Composite’s 20% gain this year also made it the best performer among 91 benchmark indexes tracked by Bloomberg.

“‘I haven’t bought any Chinese stocks since November and haven’t sold anything either,’ Rogers said. ‘I’m waiting for cheaper prices. I’m not buying Chinese shares at these levels.’

“Rogers added he remains ‘extremely bullish’ on agriculture and that ‘commodities are the only sector in the world where the fundamentals are improving’.”

Source: Chua Kong Ho, Bloomberg, March 5, 2009.

Nouriel Roubini (Forbes): US financial system is effectively insolvent
“For those who argue that the rate of growth of economic activity is turning positive - that economies are contracting but at a slower rate than in the fourth quarter of 2008 - the latest data don’t confirm this relative optimism. In 2008’s fourth quarter, gross domestic product fell by about 6% in the US, 6% in the euro zone, 8% in Germany, 12% in Japan, 16% in Singapore and 20% in South Korea. So things are even more awful in Europe and Asia than in the US

“There is, in fact, a rising risk of a global L-shaped depression that would be even worse than the current, painful U-shaped global recession. Here’s why:

“First, note that most indicators suggest that the second derivative of economic activity is still sharply negative in Europe and Japan and close to negative in the US and China. Some signals that the second derivative was turning positive for the US and China turned out to be fake starts. For the US, the Empire State and Philly Fed indexes of manufacturing are still in free fall; initial claims for unemployment benefits are up to scary levels, suggesting accelerating job losses; and January’s sales increase is a fluke - more of a rebound from a very depressed December, after aggressive post-holiday sales, than a sustainable recovery.

“For China, the growth of credit is only driven by firms borrowing cheap to invest in higher-returning deposits, not to invest, and steel prices in China have resumed their sharp fall. The more scary data are those for trade flows in Asia, with exports falling by about 40% to 50% in Japan, Taiwan and Korea.

“Even correcting for the effect of the Chinese New Year, exports and imports are sharply down in China, with imports falling (-40%) more than exports. This is a scary signal, as Chinese imports are mostly raw materials and intermediate inputs. So while Chinese exports have fallen so far less than in the rest of Asia, they may fall much more sharply in the months ahead, as signaled by the free fall in imports.

“With economic activity contracting in 2009’s first quarter at the same rate as in 2008’s fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation). The scale and speed of synchronized global economic contraction is really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully fledged financial crisis, starting with emerging Europe.”

Click here for the full article.

Source: Nouriel Roubini, Forbes, March 5, 2009.

Prison Planet: Celente - US has entered “The Greatest Depression”
“Trends research analyst Gerald Celente, who has risen in prominence on the back of his deadly accurate economic predictions, says that the collapse of financial markets heralds the start of ‘The Greatest Depression’.

“In his latest Trend Alert bulletin, Celente attacks mainstream pundits who falsely predicted a market bottom and the start of a recovery, noting that conventional analysts have been proven ‘dead wrong’ again and that, ‘There will be no turn around in the second quarter of 2009 or 2010 or 2011.’

“‘The global financial system, built on endless supplies of cheap money, rampant speculation, fraud, greed, and delusion is terminally ill and will not be coaxed into remission by stimulus packages nor restored to health by government buyouts and bailouts,’ writes Celente.

“The most positive prediction that Celente makes is that the Dow will not reach zero, a tongue in cheek reaction to yesterday’s record plunge which saw the Dow rolled back to 1997 levels well below 7,000.

“Celente warns that the first signs of real panic are starting to set in, unrest that will cause governments to ‘take draconian measures to prevent total economic collapse and public panic’.

“‘Expect massive bank failures, runs on banks, and bank holidays,’ writes Celente. ‘Even if deposits are FDIC insured, quick access to money is by no means assured. At minimum, have reserves on hand for emergencies,’ he forecasts.

“Celente cites gold as one of the few investments that will continue to rise in value, eventually reaching $2,000 an ounce and beyond.

“Celente’s dire forecasts were initially scoffed at by the media but as the crisis has worsened, his credibility has soared.

“Celente, who successfully predicted the 1997 Asian Currency Crisis, the subprime mortgage collapse and the massive devaluation of the US dollar, told UPI in November 2007 that the following year would be known as ‘The Panic of 2008′, adding that ‘giants (would) tumble to their deaths’, which is exactly what we have witnessed with the collapse of Lehman Brothers, Bear Stearns and others.”

Source: Paul Watson, Prison Planet, March 3, 2009.

BCA Research: US Capital Assistance Program - a costly necessity
“It is difficult to estimate how much capital the government will need to inject into the financial sector under the Capital Assistance Program (CAP), but the number will likely be substantial.

“The Chairman of the FDIC, Sheila Bair, contends that US banks are well capitalized. However, she must be referring to the multitude of small banks, rather than large banks (i.e. there are many small banks that are well capitalized).

“The top 20 financial institutions have a thin capital cushion of only 3.4% (defined as tangible capital/total assets). In other words, it would require a writedown of total assets of only 3%-4% to wipe out all tangible capital for the largest banks.

“The FDIC data on the broader banking universe confirms that the capital cushion of large banks is much less than their smaller counterparts. Moreover, toxic assets are concentrated in large financial institutions. Level 3 assets represent 5.5% of total assets and are 62% larger than tangible capital, for the top 20 institutions.

“The implication is that the stress tests will likely reveal that many of these institutions are not properly capitalized even in the base-case economic scenario (not to mention the worst-case scenario). We suspect that the authorities are publicly downplaying the amount of recapitalization that is likely to be required, but behind closed doors they must realize that the CAP will be a large sinkhole for taxpayer funds. Indeed, the Administration has ‘penciled in’ another $750 billion for bank support in its budget proposal for the next fiscal year.

“Bottom line: The final cost of the bailout plan announced last week will be dramatic. Nonetheless, it is a critical element in ending the financial crisis and stabilizing the economy.”

Source: BCA Research, March 4, 2009.

Bloomberg: Ron Paul – Government needs to get out of the way and let the market sort itself out

Source: Bloomberg (via YouTube), March 3, 2009.

CNBC: Roubini - nationalization debate is moot
“The debate isn’t about nationalization anymore, says Nouriel Roubini, chairman of RGE Monitor. He tells CNBC’s Martin Soong and Sri Jegarajah that the real discussion is whether banks should be wholly or partially nationalized.”

Source: CNBC, March 3, 2009.

The Wall Street Journal: “Bad Bank” funding plan starts to get fleshed out
“The Obama administration, filling in some of the blanks in its bank bailout, is considering creating multiple investment funds to purchase the bad loans and other distressed assets that lie at the heart of the financial crisis, according to people familiar with the matter.

“The Obama team announced its intention to partner with the private sector to buy $500 billion to $1 trillion of distressed assets as part of its revamping of the $700 billion bank bailout last month. It’s central to the administration’s efforts to unglue credit markets, alongside a Federal Reserve program aimed at spurring consumer lending in areas such as credit cards and home loans that will be officially launched Tuesday.

“No decision has been made on the final structure of what the administration is calling a private-public financing partnership, but one leading idea is to establish separate funds to be run by private investment managers. The managers would have to put up a certain amount of capital. Additional financing would come from the government, which would share in any profit or loss.

“These private investment managers would run the funds, deciding which assets to buy and what prices to pay. The government would contribute money from the $700 billion bailout, with additional financing likely coming from the Federal Reserve and by selling government-backed debt. Other investors, such as pension funds, could also participate. To encourage participation, the government would try to minimize risk for private investors, possibly by offering non-recourse loans.

“… the government wants to encourage private investors to buy up the assets in a way that would come closer to setting a market price where no market currently exists. Some within the administration believe establishing multiple funds could help with that goal. The funds would most likely target all types of assets, such as mortgage-backed securities, rather than focusing on one specific type of distressed security.”

Source: Deborah Solomon and Jon Hilsenrath, The New York Times, March 3, 2009.

AFP: FDIC warns US bank deposit insurance fund may tank

“The Federal Deposit Insurance Corporation is warning banks that its deposit insurance fund could dry up this year amid rising bank failures although the deposits would remain fully backed by the government.

“The head of the Federal Deposit Insurance Corporation, Sheila Bair, in a letter to bank chief executives dated March 2, defended the FDIC’s plan to raise fees on banks and assess an emergency fee to shore up the fund and maintain investor confidence.

“Bair acknowledged the new fees, announced Friday, would put additional pressure on banks at time of financial crisis and a deepening recession, but insisted they were critical to keep the insurance fund solvent and protected.

“‘Without these assessments, the deposit insurance fund could become insolvent this year,’ Bair wrote.

“The FDIC chief said in the letter that the rapidly deteriorating economic conditions raised the prospects of ‘a large number’ of bank failures through 2010.”

Source: AFP (via Google), March 6, 2009.

Bloomberg: Gary Shilling says US getting “close” to depression

“Gary Shilling, president of A. Gary Shilling & Co., talks with Bloomberg’s Peter Cook about the outlook for the US economy. Shilling also discusses the labor market, housing and the government’s economic stimulus efforts.”

Source: Bloomberg, March 6, 2009.

CNBC: Fed Chairman Bernanke’s testimony to House committee
“Federal Reserve chairman Ben Bernanke discusses the stress in the markets and the significant decline in the economy with the House Financial Services Committee.”

Source: CNBC, March 3, 2009.

Asha Bangalore (Northern Trust): Bernanke hints more may be necessary
“Chairman Bernanke’s testimony before the Senate Budget Committee was noteworthy in two respects.

“One, he hinted that more policy action may be necessary when he noted the following: ‘The goal of the fiscal package is not just to provide a one-time boost to the economy, but to lay the groundwork for a self-sustaining, broad-based recovery. Historical experience strongly suggests that without a reasonable degree of financial stability, a sustainable recovery will not occur. Although progress has been made on the financial front since last fall, more needs to be done.

“‘As you know, in response to ongoing concerns about the health of financial institutions, the Treasury recently announced plans for further steps to ensure the strength and soundness of the financial system and to promote a more smooth flow of credit to households and businesses. The plan would use the remaining resources appropriated to the Treasury under the Emergency Economic Stabilization Act - approximately $350 billion - and also involve additional spending to support the activities of Fannie Mae and Freddie Mac.

“‘Whether further funds will be needed depends on the results of the current supervisory assessment of banks, the evolution of the economy, and other factors. The Administration has included a placeholder in its budget for more funding for financial stabilization, should it be necessary.’

“Two, he also indicated that any early consideration of reducing the accommodation from easy monetary and fiscal policy action carries the risk of stopping the recovery process. In other words, caution is the key. Here is the excerpt from the testimony: ‘In particular, the Congress will need to weigh the costs of running large budget deficits for a time against the possibility of a premature removal of fiscal stimulus that could blunt the recovery. We at the Federal Reserve will face similar difficult judgment calls regarding monetary policy.’”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 3, 2009.

Asha Bangalore (Northern Trust): Employment report underscores severity of recession
“The February employment report is bleak, with the unemployment rate at 8.1% versus 7.6% in January. In February, 651,000 jobs were lost, with the total job losses since the recession commenced in December 2007 amounting to 4.38 million. A little over one-half of the losses (2.6 million) have occurred in the last four months. This staggering decline in employment is the largest four-month loss of jobs since the war-related drop in jobs during the latter half of 1945.

“Even so, the sharp plunge in payroll employment needs to be evaluated within the context of the growth of the labor force. The chart below takes into account the growth of the labor force and indicates the extent of job losses in each recession in the post-war period from the peak of payroll employment to the end of a recession or after 14 months whichever is applicable (recessions vary in duration). The 3.17% drop in payroll employment in the current recession of 14 months is the largest percentage drop in jobs since the 1957 recession.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 6, 2009.

Bloomberg: Hatzius sees US unemployment rate rising into 2010
“Jan Hatzius, chief US economist at Goldman Sachs, talks with Bloomberg’s Julie Hyman about today’s February US jobs report and the US economy. The unemployment rate jumped in February to 8.1%, the highest level in more than a quarter century, as employers cut 651,000 jobs. Bloomberg’s Peter Cook also speaks.”

Source: Bloomberg, March 6, 2009.

CEP News: US Treasury unveils details of mortgage modification plan
“The US mortgage modification program will only apply to conventional mortgages that are owner occupied and primary residences, according to additional details released by the Treasury Department on Wednesday.

“The program announced last week aims to alleviate the terms of more than 7 million homeowners in the United States through smaller payments and debt reduction by banks.

“‘It is imperative that we continue to move with speed to help make housing more affordable and help arrest the damaging spiral in our housing markets, just as we work to stabilize our financial system, create jobs and help businesses thrive,’ said Treasury Secretary Tim Geithner in the Treasury Department’s press release. ‘Economic recovery requires action on all three fronts.’

“Lenders will have to reduce mortgage payments to no more than 38% of the Front-End Debt-to-Income (DTI) ratio, after which the government will match an additional reduction to 31% of this ratio.

“The program also includes reductions on principal for mortgage borrowers who make their payments on time, as well as incentives for lenders to participate in the program.

“Last week the Treasury also announced intentions to broaden portfolios on Fannie Mae and Freddie Mac.”

Source: Erik Kevin Franco, CEP News, March 4, 2009.

Breitbart: 12% in US behind on mortgage or in foreclosure
“A stunning 48% of the nation’s homeowners who have a subprime, adjustable-rate mortgage are behind on their payments or in foreclosure, and the rate for homeowners with all mortgage types hit a new record, new data Thursday showed. But that’s not the worst of it.

“The reckless lending practices in states like Florida, California and Nevada that were the epicenter of the housing crisis are no longer driving up the nation’s delinquency rate. Instead, the foreclosure crisis now is being fueled by a spike in defaults in states like Louisiana, New York, Georgia and Texas, where the economies are rapidly deteriorating and thousands are losing their jobs.

“A record 5.4 million American homeowners with a mortgage of any kind, or nearly 12%, were at least one month late or in foreclosure at the end of last year, the Mortgage Bankers Association reported. That’s up from 10% at the end of the third quarter, and up from 8% at the end of 2007.”

Source: J.W. Elphinstone, Breitbart, March 5, 2009.

Asha Bangalore (Northern Trust): Home sales remain under stress
“The National Association of Realtors Pending Home Sales Index (PHSI) fell 7.7% to 80.4 in January, after a 4.7% increase in December. The PHSI leads actual sales of existing homes by one-to-two months. The pickup in PHSI during December was not reflected in sales of existing homes in January (-5.3%). The Mortgage Purchase Index during the first three weeks of February was down roughly 20% from the first three weeks of January. There is only a small chance the increase in the PHSI in December may translate into actual sales in February.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 3, 2009.

Asha Bangalore (Northern Trust): Auto sales decline once again
“Sales of autos dropped to annual rate of 9.12 million units in February versus 9.54 million in the prior month. The February sales pace of autos is the lowest since December 1981 when 8.849 million units were sold. Consumer spending in January rose 0.4% after adjusting for inflation, which pointed to the possibility of less-than-expected weakness in consumer purchases in the first quarter. However, today’s auto sales numbers dampens these expectations somewhat.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 3, 2009.

Barry Ritholtz (The Big Picture): Vehicle sales halve
“The data on vehicle sales continues to be nothing short of abysmal:

• GM’s sales fell 53%
• Ford’s sales dropped 48%
• Toyota’s declined 40%
• Volkswagen US fell 18%
• Nissan sales dropped 37%
• Mercedes-Benz posted a 21% decline
• BMW’s total car sales fell about 24%
• Honda sales dropped 40%

“Hyundai Motor was the sole automaker to post a month over month sales gain (down 1.5% year over year).”

Source: Barry Ritholtz, The Big Picture, March 3, 2009.

Asha Bangalore (Northern Trust): Jobless claims - too early to identify a turning point
“Initial jobless claims for the week ended February 28 fell 31,000 to 639,000. Is the previous week’s reading of 670,000 initial jobless claims, the peak for the current cycle? It is premature to identify the latest decline as the turning point, particularly given the weakness of the US economy.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 5, 2009.

Asha Bangalore (Northern Trust): ISM Manufacturing Survey - insignificant gain in February
“The ISM Manufacturing Survey results for February show signs of stability, for the most part. The composite index was up slightly (35.8 versus 35.6 in January) from the prior month. The factory sector remains mired in weak economic conditions, but the good news is that sub-indexes are close to the levels seen in January, with the exception of the employment index.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 2, 2009.

Asha Bangalore (Northern Trust): Consumer spending gains strength in January
“Consumer spending, after adjusting for inflation, rose 0.4% in January, after posting only one monthly gain (November 2008) since June 2008. Among the three major components of consumer spending, purchases of non-durables (food, clothing, gasoline, shoes) increased 0.7% in January with food and gasoline outlays accounting for a large part of the increase in consumer spending in January. A 0.3% increase in services and a 0.2% gain in purchases of durables (cars, furniture, appliances) were also noteworthy.

“Personal saving as a percentage of disposable income was 5.0% in January. The spike in the saving rate in May/June 2008 was related to the tax rebates of 2008. On a monthly basis, the personal saving rate in January 2009 is the largest since March 1995.

“Net worth of households and the saving rate move in opposite directions. Given the large loss in net worth of households, the rising unemployment rate, and uncertainty in the economy, it is not surprising that the saving rate has risen in the past few months.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 2, 2009.

Casey’s Charts: Shop till you drop
“Americans have fueled the world’s economic engine for decades. But the deflating housing bubble has dropped home sales by 31% and housing prices by 25% in two short years, leaving the home equity credit well tapped dry.

“With consumers losing access to credit and incomes being threatened by rising unemployment, the spending spree has come to an end. As a result, retail sales have fallen 11% since June, GDP contracted by 6.4% in the fourth quarter, and consumer confidence is the lowest on record. The economy is barely running on fumes, and Washington has now become the ‘spender of last resort’.”

Source: Casey’s Charts, March 5, 2009.

Reuters: Food stamp enrolment jumps to record 31.8 million
“A record 31.8 million Americans received food stamps at the latest count, an increase of 700,000 people in one month with the United States in recession, government figures showed on Thursday.

“Food stamps, which help poor people buy groceries, are the major US anti-hunger program, forecast to cost at least $51 billion in this fiscal year ending September 30, up $10 billion from fiscal 2008.

“‘A weakened economy means that many more individuals are turning to SNAP/food stamps,’ said the Food Research and Action Center. Last summer food stamps were renamed the Supplemental Nutrition Assistance Program, or SNAP.

“The average food stamp benefit is $115 a month for individuals and $255 a month per household.

“In April, food stamp benefits will increase temporarily by 13% under provisions of the recently enacted economic stimulus law. Ellen Vollenger of the Food Research and Action Center said some families will see increases of $80 a month.”

Source: Charles Abbott, Reuters, March 5, 2009.

Bloomberg: Hidden pension fiasco
“Public pension funds across the US are hiding the size of a crisis that’s been looming for years. Retirement plans play accounting games with numbers, giving the illusion that the funds are healthy.

“The paper alchemy gives governors and legislators the easy choice to contribute too little or nothing to the funds, year after year.

“The misleading numbers posted by retirement fund administrators help mask this reality: Public pensions in the US had total liabilities of $2.9 trillion as of December 16, according to the Center for Retirement Research at Boston College. Their total assets are about 30% less than that, at $2 trillion.

“With stock market losses this year, public pensions in the US are now underfunded by more than $1 trillion.

“That lack of funds explains why dozens of retirement plans in the US have issued more than $50 billion in pension obligation bonds during the past 25 years - more than half of them since 1997 - public records show.

“The quick fix for pension funds becomes a future albatross for taxpayers.”

Source: David Evans, Bloomberg, March 3, 2009.

The Razor’s Edge: AIG and Hank - the divorce is final
“Hank Greenberg, the long time leader of insurance giant AIG, is reportedly suing the company as he believes mismanagement and even fraud have cost him $2 billion personally. The financial media has jumped on this story with vigor as it purportedly entails anger, greed, and betrayal.

“Former AIG CEO Hank Greenberg is now suing the embattled company. He’s accusing the company of securities fraud. Yesterday, AIG posted that unbelievable loss, $62 billion. Greenberg’s lawsuit claims that AIG’s material misrepresentations and omissions led him to buy shares in his deferred compensation participation plan.

“Greenberg lead AIG for more than 40 years until he came under pressure to leave the company because of fraud charges from the New York Attorney General, Elliot Spitzer. He now claims that he was encouraged to buy stock in AIG at more than $50 per share and was mislead by the current management as to just how bad the collateralized debt on AIG’s balance sheet would turn out to be.

“The dispute arose from an investor conference in December of 2007, when the company’s stock was trading in the high $50’s. Greenberg claims that management seriously downplayed the risks to the company and shareholders, and that their auditors had already told AIG about a ‘material weakness’.”

Source: The Razor’s Edge, March 3, 2009.

Financial Times: Bank of England plans to buy gilts

Click here for the article.

Source: John Authers, Financial Times, March 5, 2009.

Bespoke: Same markets, different year
“So much for those hoping that a change in the calendar year would also bring about a change in the direction of the market. After two more months of huge declines for global equity markets, 2009 is looking just like 2008, if not worse.

“Below we highlight the year to date performance for 83 equity markets around the world. As shown, just 10 countries are up year to date, with China leading the way at 14.97%. Venezuela, Colombia, Abu Dhabi, and Israel have also managed to register gains so far this year.

“Unfortunately, there are twice as many countries already down 20% year to date as there are countries that are up. Puerto Rico is down by far the most at -54%, followed by Qatar (-36.6%), Romania (-34%), Ukraine (-30%), and Kenya (-29.7%).

“Of the G-7 countries, Canada is doing the best this year with a decline of 9.62%. Germany has been the worst G-7 country with a decline of 21.74%. And with a decline of 18.62%, the US ranks in the bottom 30% as far as 2009 performance goes.”

Click on the thumbnail for a larger image.

Source: Bespoke, March 2, 2009.

Bespoke: 2009 - by far the worst start to a year since 1900
“The Dow’s current decline of 23.21% is by far the worst start to a year for the index this many days in since 1900. The second worst year at this point was 14.25% in 1920. There have been 19 prior years where the Dow was down 5% or more at this point, and only four of those years ultimately finished in positive territory.

“Below we highlight the five years where the Dow started the year down 10% or more at this point. In 1920, the Dow continued lower for the rest of the year, but in the three other years, the market ended higher from the level that it was at 41 trading days in.

“One positive is that 1933 is one of the five years that started off down 10% this many trading days in. While this did occur during the Great Depression, it was also FDR’s first year in office. With many comparing Obama and his plans to FDR and the New Deal, it’s interesting that the market got off to a very bad start in 1933 after he was elected, but reversed when he took office (in March) and finished his first year 66.7% higher! We can only hope that 2009 turns out that way, even though it doesn’t say much for 2010, 2011, 2012, etc.”

Source: Bespoke, March 3, 2009.

Bespoke: Top strategists still expecting a 46% gain from here
“While two more Wall Street strategists lowered their year-end S&P 500 price targets recently, collectively they’re still looking for a 46% gain from the index’s current levels.

“As shown below, UBS, Goldman, and Credit Suisse have now lowered their year-end price targets since the start of the year. The UBS move from 1,300 to 1,100 makes Deutsche Bank the most bullish with a target of 1,140. Barclays has the lowest price target of 874, which would be a 27% increase from here.”

Source: Bespoke, March 5, 2009.

CNBC: Yamada - Dow could hit 4,000
“Louise Yamada, managing director at Louise Yamada Technical Research Advisors, tells CNBC hope is not an investment strategy. Her primary target for the Dow is 6,000, and her secondary target is 4,000.”

Source: CNBC, March 6, 2009.

Bloomberg: Leuthold says stocks will surge, depression avoided
“Steve Leuthold, whose Grizzly Short Fund returned 74% last year betting against US stocks, said now is the time to buy equities because investors are too fearful about the economy.

“‘These comparisons people make with the Great Depression are totally out of touch with reality, and pretty stupid,’ he told Bloomberg Television in an interview today. ‘We’ve been in much worse, much more panicked and more scary situations in the US.’

“The economy isn’t as bad as it was in 1974, when stocks began rebounding, said Leuthold, who oversees $3.2 billion at Leuthold Weeden Capital Management in Minneapolis. He predicted the Standard & Poor’s 500 Index will surge to at least 1,000 in 2009, representing a gain of 44% from yesterday’s 12-year low of 696.33.

“Because a rally is likely, Leuthold said investors shouldn’t buy his Grizzly Short Fund. It has returned 26% in 2009. Short seller Bill Fleckenstein, who warned of the housing bubble in 2005, closed his 13-year-old bear market fund last year because valuations made it ‘too dangerous’ to bet on more losses, he said in a interview last month.”

Source: Betty Liu and Lynn Thomasson, Bloomberg, March 4, 2009.

John Authers (Financial Times): Awaiting the bottom
“This week’s brutal sales of stocks across the world brought indices to historic levels. Harder questions are how far stocks must fall to get there, and how long it will take to climb out, says John Authers.”

Click here for the article.

Source: John Authers, Financial Times, March 3, 2009.

Bespoke: US dollar at multi-year high
“Trillion dollar bailouts, trillion dollar deficits, and the largest spending bill in US history. These days, one would think that with all this spending, the US dollar would be as popular as a Wall Street CEO. However, this morning, the US dollar index hit its highest level since April 2006 even as news of another bailout for AIG hit the tapes. But when you’re competing against the likes of Europe, the dollar suddenly doesn’t look so bad. In a similar comparison, normally Lloyd Blankfein and Jamie Dimon would be worried about their jobs after GS and JPM have both declined by roughly 60%. But when your competition is Jimmy Cayne, Stan O’Neal, John Thain, Dick Fuld, etc. … they look like superstars.”

“Longer term, however, the US Dollar Index remains well off its highs of this decade, or even the last six years. As shown below, as recently as 2003, the index traded above 100, which is about 12.5% above current levels.”

Source: Bespoke, February 2, 2009.

Mansoor Mohi-uddin (UBS): Dollar strength will linger
“The inability of non-US banks to roll over short term funding of investments in illiquid US assets has been a key factor behind the dollar’s strength since last summer - and should continue to support the greenback, says Mansoor Mohi-uddin, managing director of foreign exchange strategy at UBS.

“‘At the height of the credit bubble in mid-2007, the Bank for International Settlements estimates that major European banks’ dollar funding needs was around $1,300 billion,’ he says.

“‘As the credit crunch ensued and then worsened after the bankruptcy of Lehman in September 2008, securing this funding became very difficult due to the severe disruptions in interbank and foreign exchange swap markets and in money market funds.

“‘Also, some central banks withdrew dollar foreign exchange reserves they had placed with commercial banks before the crisis.’

“Mr Mohi-uddin notes that to ease the dollar shortage, the Federal Reserve provided swap lines with other central banks in October 2008. These have been extended until October this year, reflecting the need of foreign banks to keep borrowing dollars from domestic central banks.

“‘Of course, foreign banks also bought dollars in the spot markets, as evidenced by the drop in euro/dollar since last summer.

“‘While the dollar funding shortage in global banking persists, investors in the foreign exchange spot markets should expect the greenback to stay supported against the other majors.’”

Source: Mansoor Mohi-uddin, UBS (via Financial Times), March 4, 2009.

Bloomberg: Stimulus cash to spur inflation, commodity rally

Click here for the article.

Source: Bloomberg, March 5, 2009.

Bloomberg: Dennis Gartman sees $40 oil for “long period of time”
“Dennis Gartman, an economist and the editor of the Virginia-based Gartman Letter, talks with Bloomberg’s Carol Massar and Matt Miller about the outlook for crude oil and gold. Gartman sees oil on ‘either side of’ $40 for a ‘long period of time’ and says he might cut his gold position.”

Source: Bloomberg, March 5, 2009.

Business Intelligence: Christopher Wood - gold may rise to US$3,500 by 2010
“CLSA’s International Equity strategist Christopher Wood, whom the Wall Street Journal dubbed in 2007, at the start of the subprime crisis, as ‘the man who saw it coming’, recently told a conference in Japan that gold will hit US$3,500 an ounce by 2010.

“The US is facing a deflationary collapse more severe than the crash that hobbled Japan’s economy in the 1990s, leaving gold as the only defensive play for investors, he said.

“Speaking at CLSA’s annual Japan Forum Conference last week, Wood said: ‘The collapse of securitization is a much more deflationary situation in the US than anything seen in Japan when the bubble collapsed in the early 1990s. What we need in the future is a more fundamentally disciplined system, even at the cost of higher levels of growth.’

“Gold is likely to more than triple from the current level to US$3,500 in 2010, he said. ‘It’s the only form of money or credit not contaminated by the credit system - and the fact it’s still money is that central banks still own a lot of it, the global paper currency system will steadily deteriorate, eastern and central Europe will face a full-scale currency collapse, putting huge pressure on western Europe.”

“Wood, who in 2003 predicted the US housing crisis and the subprime crisis, has been consistently rated among the top equity strategists on Asia - most recently by Institutional Investor magazine.”

Source: Business Intelligence, March 1, 2009.

CEP News: Euro zone manufacturing PMI hits record low in February
“Manufacturing activity in the euro zone fell at a record pace in February as companies reduced output and cut staff in response to slowing demand.

“According to Markit Economics, the euro zone manufacturing purchasing managers index fell to 33.5 in February, down from both the advance estimate of 33.6 and January’s 34.4 level.

“The decline in the activities indicator was driven primarily by new orders, employment and output contracting at record paces in the month.

“‘The final Eurozone PMI data are a further disappointment on the earlier flash numbers for February, and indicate that the rate of decline of manufacturing has yet to stabilise,’ Markit chief economist Chris Williamson said in a press release.

“‘The data are consistent with manufacturing output and employment falling at annual rates in the region of 12% and 5% respectively.’”

Source: CEP News, March 2, 2009.

CEP News: Euro Zone GDP confirmed to have contracted at record pace in Q4
“Eurostat has confirmed that the overall economic output in the euro zone has fallen at a record pace in the fourth quarter of 2008.

“According to preliminary estimates, euro zone GDP fell by a record 1.5% in the fourth quarter, in line with expectations and flash estimates. Economic output had contracted 0.2% previously.

“Disaggregating the figures, Eurostat noted that the weakness was widespread over the quarter. From Q3 to Q4, household consumption fell 0.9%, despite expectations of a 0.2% fall after rising 0.1% previously.

“At the same time, government expenditure fell 0.6% quarter-over-quarter, down from the +0.7% figure forecast, while investment spending also lost ground, falling 2.7% in Q4 and adding to Q3’s 0.6% slide.

“After remaining stable in the third quarter, exports fell 7.3% in the three months to December. Imports slid 5.5% after spiking 1.4% previously.

“Year-over-year, euro zone GDP fell 1.3% in Q4, down from both the 1.2% decline expected and Q3’s 0.6% annualized increase.”

Source: CEP News, March 5, 2009.

CEP News: ECB’s Noyer says EU will aid troubled member nations
“The probability of a country within the European Union failing seems far-fetched, but if such an event were to occur, the Union would be compelled to come to its aid, European Central Bank Governing Council member Christian Noyer told lawmakers in Paris on Tuesday.

“The central banker, who is also the governor of the Bank of France, echoed comments by European finance ministers and central bankers on Tuesday about the possibility that some European countries will have to seek IMF loans to finance their balance of payments deficits.

“Closer to home, Noyer also noted that credit conditions within France are improving and that a recovery in the country’s banking system is conceivable.

“He also criticized the so-called ‘Bad Bank’ plan, which would take troubled assets off the balance sheets of financial institutions, arguing that such a model is difficult to implement and not necessary in France.”

Source: CEP News, March 3, 2009.

CEP News: Quantitative easing is BoE’s new monetary policy tool
“Quantitative easing is the new monetary policy tool of the Bank of England now that the central bank cut its benchmark interest rate by 50 bps, as expected, to 0.50% on Thursday and unveiled an ambitious plan to buy UK government paper and private assets by printing money.

“‘Quantitative easing is clearly now going to be at the forefront in the Bank of England’s ongoing efforts to stimulate the economy,’ said IHS Global Insight Economist Howard Archer, who suggested that the BoE will expand the £75 billion in asset purchases authorized under the plan.

“The transactions will be made using the existing Asset Purchase Facility and will be funded using the central bank’s balance sheet rather than the original plan to finance the APF by using short-term debt from the Treasury, the majority of which would be government paper.

“The monetary policy decisions taken by the Bank of England on Thursday were fully expected, explained Rob Carnell at ING.

“‘At £75 billion, the amount earmarked for the expanded APF is at the lower end of expectations of £50-£150 billion. But it looks as if the Governor of the Bank of England had asked for the facility to be £150 billion,’ he said. ‘It is unclear at this stage whether there is a further £75 billion waiting in the wings and that might be only a first instalment.’”

Source: CEP News, March 5, 2009.

Financial Times: Martin Wolf - BoE’s monetary policy should start unfreezing credit markets
“If the Bank of England is sufficiently ruthless, expansionary and imaginative, its new monetary policy should begin to unfreeze credit markets and allow the government to increase its spending, says Martin Wolf.”

Source: Financial Times, March 5, 2009.

BCA Research: Japan - economic implosion!
“The Japanese manufacturing sector has collapsed, and further production cuts lie ahead.

“Industrial production plunged 10% in January, on the heels of a similar decline in prior months. Output has contracted a mind-boggling 25% in the past three months, exceeding the rate of decline in US production at any point during the Great Depression. The cuts in the transport and electronics sectors have been even more severe.

“Unfortunately, more pain looms in light of the spectacular surge in the inventory ratio, to the highest level on record. Firms will have to reduce production sharply to clear their excessive inventories in the absence of a pronounced pickup in demand, which is not in the cards.

“Last week’s export data reinforced how difficult the current situation is for Japanese producers, with overseas sales down 46% in the past year and even more sharply in the past few months.

“Policy is likely to provide little support in the near term. Instead, any improvement in Japanese activity awaits an upturn in external demand. There is no sign of that anytime soon. Bottom line: Japan’s economy will remain severely depressed in the coming months.”

Source: BCA Research, March 2, 2009.

CEP News: Chinese manufacturing PMI strengthens for third straight month
“China’s manufacturing sector continued to strengthen in February, according to a report from the National Bureau of Statistics and the Federation of Logistics and Purchasing on Wednesday, which noted a third straight monthly increase in its headline manufacturing index.

“The headline index increased to 49.0 from 45.3 in January marking a three-month rebound from November’s low of 38.8.

“The new orders component rebounded to 50.4 from 45.0 in January while the output index advanced to 51.2 from 45.5.

“The employment index also increased to 46.1 from 43.0.

“The report, coupled with expectations of additional stimulus from the Chinese government, are beginning to improve estimates of economic growth in 2009, according to Andrew Pyle, Wealth Adviser at ScotiaMcLeod.

“‘Estimates for the country’s growth outlook in 2009 have also started to levitate from the alarming 5-6% suggestions earlier this year back to 8%. Not as lofty as what we have been used to, but firm enough to put a floor under commodity prices and that’s what we’re seeing this morning,’ he said.”

Source: Erik Kevin Franco, CEP News, March 4, 2009.

Financial Times: China sets sights on 8% rise in growth
“Chinese premier Wen Jiabao promised on Thursday to deliver 8% economic growth and record government spending this year, although he failed to outline the new stimulus package many investors had been expecting.

“In a two-hour speech outlining his ‘work report’ to the National People’s Congress, China’s parliament, Mr Wen said the global financial crisis was deepening but the goal of 8% growth remained realistic.

“‘The global financial crisis continues to spread and get worse. Demand continues to shrink on international markets; the trend toward global deflation is obvious; and trade protectionism is resurging,’ he said.

“But, ‘as long as we adopt the right policies and appropriate measures and implement them effectively, we will be able to achieve this target’, he added.

“He provided few extra details to help clarify how much of that investment would be genuinely new spending and where the money would be allocated.

“Mr Wen said China would run a budget deficit this year of Rmb950bn, equivalent to nearly 3% of gross domestic product - a record in recent times for China but modest compared with some of the fiscal packages being considered round the world.

“Indeed, for all the talk about China’s big fiscal plans for 2009, the 21% increase in total government expenditures for this year is slower than the 25.4% rise last year.

“Economists said China’s relatively low debt levels meant the government could expand its fiscal stimulus during the course of the year if there were few signs of recovery.”

Source: Geoff Dyer, Financial Times, March 5, 2009.

CNBC: Chinese economy unlikely to grow 8%
“Gerard Lyons, chief economist and group head of global research at Standard Chartered, says China’s stimulus efforts will work, but it is unlikely the economy will grow 8% this year. He speaks to CNBC’s Martin Soong and Karen Tso.”

Source: CNBC, March 6, 2009.

Colbert Nation: Market psychology - Jim Cramer
“Jim Cramer discusses the psychology of the market with puppies and kittens behind him.”

Source: Stephen Colbert, Colbert Nation, March 6, 2009.

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Words from the (investment) wise for the week that was (February 16 – 22, 2009)

Sunday, February 22nd, 2009

A perfect storm of a deepening global recession and banking woes last week battered equities and supported the safe havens of the US dollar, government bonds and gold bullion.

A dismal corporate earnings outlook, fears about bank nationalizations, especially Bank of America (BAC) and Citigroup (C), and a warning by Moody’s Investors Service of possible downgrades of European banks exposed to the slumping economies of Central and Eastern Europe, stoked investors’ fears.

Few stock markets escaped the selling pressure as summarized by the week’s movements of the MSCI Global Index (-7.7%, YTD -16.0%) and the MSCI Emerging Markets Index (-9.3%, YTD -11.4%). Venezuela (+6.7%), Pakistan (+6.1%) and Morocco (+3.7%) were the top three performers, whereas potential debt defaulters - Russia (-17.1%), Ukraine (-12.5%) and Hungary (‑12.4%) - occupied the bottom end of the ranking (data courtesy of Emerginvest).

The major US indices suffered their worst weekly losses this year (to record six losing weeks out of seven): Dow Jones Industrial Index -6.2% (YTD ‑16.1%), S&P 500 Index -6.9% (YTD -14.7%), Nasdaq Composite Index ‑6.1% (YTD -8.6%) and Russell 2000 Index -8.3% (YTD -17.7%).

Negative sentiment dragged the S&P 500 to seven points below its October 2002 low, whereas the Dow stopped only 80 points short of this key level. It is noteworthy that it took five years for the latter to increase from 7,286 to 14,165, but only 16 months to wipe out the entire 2002-2007 advance.

Source: StockCharts.com

With the bears prowling Wall Street, none of the main economic sectors registered positive returns on the week. Among exchange-traded funds (ETFs), the KBW Bank Index ETF (KBE) and the Financial Select Sector SPDR ETF (XLF) lost 16.6% and 15.9% respectively. However, as highlighted by John Nyaradi (Wall Street Sector Selector), inverse exchange-traded funds (ETFs) such as ProShares Short S&P 500 (SH) (+6.8%), ProShares Short Dow30 (DOG) (+5.8%) and Short QQQ ProShares (PSQ) (+5.1%) gained handsomely.

As was the case the previous week with the announcement of Treasury Secretary Timothy Geithner’s financial stability plan, last week’s mortgage relief plan, designed to stem the foreclosure crisis, also made scant impression on the stock market. President Barack Obama earmarked $275 billion to help reduce mortgage payments for up to nine million struggling borrowers and enable Fannie Mae and Freddie Mac to keep mortgage rates down.

Jeff Randall (Telegraph) wrote: “… we are in denial about the causes of recession and therefore cannot face up to the action required to lift us out of it. As Niall Ferguson, professor of history at Harvard University, wrote: ‘The reality being repressed is that the Western world is suffering a crisis of indebtedness.’ In which case, pumping out yet more debt will not be the answer. It is simply a short-term fix that in the long run creates an even bigger disaster, like giving a shivering alcoholic a case of Special Brew.” (Also read RGE Monitor’s recent guest post on the US’s financing needs.)

Barry Ritholtz (The Big Picture) has an interesting post up that lists the names of those favoring and opposing nationalization of the bigger US banks. Yes, I know it is a politically controversial issue, but rather get it over and done with than pussyfooting with “behind-the-curve” measures as being experimented with by the policymakers week after week. If nationalized banks are still alive once the toxic junk has been marked to market, they can start acting like banks and stake their claim to be privatized once again in the next economic upswing.

Notwithstanding supply concerns, government bond yields in the US, UK and Germany declined as investors continued their flight to safety. Yields of 10-year Treasuries, Bunds and Gilts were down by 14, 12 and 12 basis points respectively.

Increasing financial turbulence also resulted in the gold holdings of the world’s largest bullion-backed ETF jumping to a record level. “The SPDR Gold Trust (GLD) holdings have risen by 228.6 metric tons so far this year, to a record 1,008.8 metric tons late on Tuesday, absorbing in the first seven weeks of the year about 10% of the world’s annual mine gold output,” reported the Financial Times. Gold bullion breached the $1,000 level on Friday and closed the week at $1,002 (+6.4%) - within striking distance of its record of $1,031 reached in March last year.

With the yellow metal behaving like “the last man standing”, David Fuller reminded us of the quote by the English poet Lord Byron: “O gold! I still prefer thee unto paper, which makes bank credit like a bark of vapour.”

Besides precious metals shining brightly, the other commodities performed poorly, as shown in the graph below. The Reuters/Jeffries CRB Index recorded a six-and-a-half year low as global growth deteriorated.

Next, a tag cloud of my week’s reading. This is a way of visualizing word frequencies at a glance. Key words such as “banks”, “China”, “financial” and “gold” featured prominently.

As far as the outlook for stock markets is concerned, the primary bear market was reconfirmed on Thursday, at least in terms of Dow Theory. Richard Russell (Dow Theory Letters) said: “The verdict, at long last, is in. Today the DJ Industrial Average closed below its November 20 bear market low. In so doing, the Dow confirmed the prior breakdown of the Transportation Average. The two Averages jointly closed at new lows today, thereby signaling that the great bear market remains in force.

“According to Dow Theory, neither the duration nor the extent of a bear market can be predicted in advance. However there are some useful hints. Most major bear markets end with stocks at ‘great values’. This has meant in the past that price/earnings (P/E) ratios for the Dow and the S&P have fallen to single-digit numbers. It has also meant that dividend yields have moved into the 5-6% zone.”

Standard & Poor’s estimated GAAP (or “as reported”) earnings of 32.3 cents for the S&P 500 for 2009 implies a ten-month prospective P/E ratio of 23.8. Hardly “great value”.

As mentioned above, the Dow and S&P 500 are floundering around the November 20, 2008 and October 2002 lows, as shown in the columns on the right-hand side of the table below.

Stock markets remain caught between the actions of central banks frantically trying to fend off a total economic meltdown on the one hand, and a worsening economic and corporate picture on the other. The next few days will tell whether the key chart levels will arrest the indices’ declines and the three-month trading range will hold, or whether more catastrophe lies ahead.

For more discussion about the direction of stock markets, also see my recent posts “Video-o-rama: Stocks between a rock and a hard place” and “Bennet Sedacca: Free Fallin’???“. (And do make a point of listening to Donald Coxe’s weekly webcast, which can be accessed from the sidebar of the Investment Postcards site.)

Announcement
Back to Richard Russell, 84-year old writer of the Dow Theory Letters. Business partner John Mauldin (Thoughts from the Frontline) is organizing a “Richard Russell Tribute Dinner” for April 4 in San Diego. This will be a night of memories and good fun with fellow writers and long-time readers of Richard’s newsletter. I will be making the trip from Cape Town and would encourage you, if at all possible, also to attend this very special event. You can register here.

Economy
A grim picture regarding the global economic situation emerges from the latest Ifo World Economic Survey (WES), showing that the World Economic Climate has declined to a record low in the first quarter of 2009. The deterioration is affecting all major economic regions and the export and import expectations indicate a clear decline in world trade in the first half of 2009.

Source: Ifo, February 18, 2009.

Further evidence of the economic malaise is provided by the GDP-weighted graphs of the global manufacturing Purchasing Managers’ Index and global services PMI.

Source: Plexus Asset Management

Source: Plexus Asset Management

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.)

February 20
• CPI report - underlying trend of deflation will fade only later

February 19
• Index of Leading Indicators improved, but wait before taking a leap
• Wholesale prices moved up, but inflation is a non-issue, for now
• Jobless Claims - dismal labor market conditions persist

February 18
• Industrial Production plunges, factory operating rate at record low
• Construction of new homes at new low
• Import prices - sixth consecutive monthly decline

February 17
• Housing Market Index - showing signs of stability?
• Foreign appetite for Treasury securities remains in place for moment

Given the nature of economics reports of recent months, the minutes of the Federal Open Market Committee (FOMC) meeting of January 27-28 come as no surprise. Asha Bangalore (Northern Trust) said: “The FOMC is more bearish about the economy compared with the forecast published in October 2008. The US economy is predicted to contract in 2009 (-1.3% to -0.5%) on a Q4-to-Q4 basis.

“The consensus forecast among the Blue Chip Survey participants is a 1.9% drop in real GDP on an annual average basis in 2009. We are predicting a 2.7% decline in real GDP … So, there is a general expectation of a significant weakening of business conditions during 2009.”

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

Source: Yahoo Finance, February 20, 2009.

In addition to Fed Chairman Bernanke’s semi-annual testimony on monetary policy before the US Senate Banking Committee (Tuesday, February 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 markets performed during the past week.

Source: Wall Street Journal Online, February 20, 2009.

“Analysts can tell you everything about the ship, the crew, the price - but they don’t let you know whether it’s in shallow water or is about to be hit by a tidal wave,” said Scott Cleland (hat tip: Charles Kirk). Hopefully the “Words from the Wise” reviews play a part in steering the portfolios of Investment Postcards‘ readers through the murky waters.

That’s the way it looks from Cape Town.

Bloomberg: Obama unveils $275 billion plan to shore up housing
“US President Barack Obama pledged $275 billion to cut mortgage payments for as many as 9 million struggling homeowners and enable Fannie Mae and Freddie Mac to keep loan rates down.

“The plan includes $75 billion to reduce monthly payments for borrowers, helps homeowners with loans owned or backed by Fannie Mae and Freddie Mac to refinance at lower rates and promises incentives to industry. Obama will double by $200 billion funding available for Fannie and Freddie to buy loans.

“‘It will give millions of families resigned to financial ruin a chance to rebuild,’ Obama said today in Mesa, Arizona. ‘By bringing down the foreclosure rate, it will help to shore up housing prices for everyone.’

“The program signals the Obama administration, which will release more details in two weeks, plans a more active stance to halt foreclosures than the Bush administration, which backed voluntary industry efforts. Record foreclosures in the past year are swelling the glut of properties on the market, forcing down home values and undermining homebuilders’ efforts to revive demand and lighten inventory by cutting prices.

“‘We tried voluntary, it didn’t work,’ Federal Deposit Insurance Corp. Chairman Sheila Bair said today at a briefing in Mesa before Obama spoke. Bair has pressed the banking industry to accelerate loan modifications to keep people in their homes.

“JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said the Obama plan will help the bank expand its modification of mortgages. ‘The plan is good and strong, comprehensive and thoughtful,’ Dimon said in an interview today. ‘I think it will be successful in modifying mortgages in a way that’s good for homeowners.’”

Source: Alison Vekshin and Roger Runningen, Bloomberg, February 18, 2009.

CNBC: Santelli’s “rant of the year”
“CNBC’s Rick Santelli and the traders on the floor of the CME Group express outrage over the notion they may have to pay their neighbor’s mortgage, particularly if they bought far more house than they could actually afford, with Jason Roney, Sharmac Capital.”

Source: CNBC, February 19, 2009.

CNN: FDIC’s Bair speaks out on housing

Source: CNN, February 20, 2009.

Bill King (The King Report): Why have banks not been nationalized?
“There is a major reason why banks have not been nationalized. Too many solons and insiders will lose their equity and stock options. There will be no structural revival until crony capitalism ends.

“Here is a major reason why a bank bailout plan cannot be orchestrated: Banks do not, because they cannot, reveal the amount and magnitude of their toxic paper. We said this in October before TARP and we will reiterate again. The market cannot withstand full disclosure of crappy paper.”

Source: Bill King, The King Report, February 17, 2008.

Bloomberg: Shiller says US needs long-term plan to exit crisis
“Robert Shiller, chief economist at MacroMarkets LLC and an economics professor at Yale University, talks with Bloomberg’s Kathleen Hays about the need for a long-term US strategy to emerge from the financial crisis. Shiller also discusses the US’s efforts to stem the crisis and the outlook for the housing market.”

Source: Bloomberg, February 20, 2009.

Financial Times: US carmakers to seek $21.6 billion in funds
“General Motors and Chrysler presented long-awaited plans to return to viability on Tuesday, but said they would need up to $21.6 billion more in federal funds between them to carry them out.

“The two Detroit carmakers made the plea as part of tougher new plans to restructure and downsize their businesses in submissions to the government required as a condition of the $17.4 billion of emergency bridge loans they received in December.

“Their request for more funds reflects more pessimistic assumptions about global demand for cars and credit market conditions than Chrysler and GM presented to Congress on December 2.

“It raises the ante for President Barack Obama’s administration as it juggles demands for federal aid from banks and other constituencies and prepares to implement its $787 billion stimulus bill.”

Source: John Reed, Bernard Simon and Andrew Ward, Financial Times, February 18, 2009.

Ifo: Indicator for the World Economic Climate falls further
“The Ifo World Economic Climate has worsened further in the first quarter of 2009. The indicator has fallen to a new historic low. The decline is solely the result of more unfavourable assessments of the current economic situation; the expectations for the coming six months have improved somewhat.

“The deterioration of the Ifo World Economic Climate has affected all major economic regions. The export and import expectations of the WES experts indicate a clear decline in world trade in the first half of 2009.

“Average inflation expectations for 2009 are clearly lower than the inflation rates of the previous year (3.3% versus 5.4%). Moreover, price increases will continue to weaken in the course of the next six months in the opinion of the WES experts. The decline in inflation will be particularly strong in Western Europe and North America.

“In light of the recessionary tendencies and the clear slowing of price increases, a further decline in central bank interest rates is expected nearly everywhere. Also long-term interest rates are expected to fall in the coming six months, according to the WES experts, albeit less than short-term interest rates.

“After the strong increase in value of the Japanese yen, for the first time since 2002 it is no longer regarded as undervalued but now as slightly overvalued. On the other hand, after the clear weakening in past months the British pound is now viewed as undervalued. The US dollar is largely seen as properly valued, and correspondingly, WES experts anticipate a stable dollar in the coming six months.”

Source: Ifo, February 18, 2009.

BCA Research: Financial crises and public finances - where is the greatest risk?
“Our fixed income team has just published a Special Report comparing 22 developed government debt in the face of the current financial crisis.

“The Special Report reviewed the vulnerability of these markets to rating downgrades as well as focused on the risks and potential costs associated with stabilizing their banking systems (after analyzing 150 banks around the world). A further loss of as little as 3% on total bank assets would wipe out most, if not all, of the remaining tangible bank capital in the countries we analyzed.

“UK, Ireland, Denmark and Switzerland have the greatest risk of widespread nationalization (outside of Iceland). When the other main factors that determine overall sovereign credit risk are included (e.g. economic structure and prospects, monetary flexibility, fiscal flexibility, and external liquidity dependence) Iceland, Portugal, Ireland, Spain, Italy and the UK are at the top in terms of the risk of downgrades.

“The cost of cleaning up the US banking system will also be painful, although the risk of a sovereign downgrade is less than in most of the other developed countries.”

Source: BCA Research, February 18, 2009.

Word Net Daily: Federal obligations exceed world GDP
“As the Obama administration pushes through Congress its $800 billion deficit-spending economic stimulus plan, the American public is largely unaware that the true deficit of the federal government already is measured in trillions of dollars, and in fact its $65.5 trillion in total obligations exceeds the gross domestic product of the world.

“The total US obligations, including Social Security and Medicare benefits to be paid in the future, effectively have placed the US government in bankruptcy, even before new continuing social welfare obligation embedded in the massive spending plan are taken into account.

“The real 2008 federal budget deficit was $5.1 trillion, not the $455 billion previously reported by the Congressional Budget Office, according to the ‘2008 Financial Report of the United States Government’ as released by the US Department of Treasury.

“The difference between the $455 billion ‘official’ budget deficit numbers and the $5.1 trillion budget deficit cited by ‘2008 Financial Report of the United States Government’ is that the official budget deficit is calculated on a cash basis, where all tax receipts, including Social Security tax receipts, are used to pay government liabilities as they occur.

“But the numbers in the 2008 report are calculated on a GAAP basis (‘Generally Accepted Accounting Practices’) that include year-for-year changes in the net present value of unfunded liabilities in social insurance programs such as Social Security and Medicare.

“Under cash accounting, the government makes no provision for future Social Security and Medicare benefits in the year in which those benefits accrue.”

Source: Jerome Corsi, World Net Daily, February 13, 2009.

Bloomberg: Roubini says Europe’s banking system faces growing risks
“Nouriel Roubini, the New York University economist who predicted the global financial crisis, talks with Bloomberg’s Erik Schatzker and Julie Hyman about the growing risks facing Europe’s banking system. Roubini also discusses the outlook for a ‘massive’ increase in the US deficit, the need to nationalize insolvent banks and the importance of global cooperation in financial regulation.”

Source: Bloomberg, February 20, 2009.

Asha Bangalore (Northern Trust): Minutes of January FOMC meeting
“The FOMC is more bearish about the economy compared with the forecast published in October 2008. The US economy is predicted to contract in 2009 (-1.3% to -0.5%) on a Q4-to-Q4 basis. The unemployment rate is predicted to advance higher than previously predicted and the inflation is expected to hold below the level seen in the October forecast.

“The direction of revisions to the Fed’s projections is not a surprise given the nature of the economic reports of recent months. The consensus forecast among the Blue Chip Survey participants is a 1.9% drop in real GDP on an annual average basis in 2009. We are predicting a 2.7% decline in real GDP on an annual average basis during 2009. So, there is a general expectation of a significant weakening of business conditions during 2009.”

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

Asha Bangalore (Northern Trust): Index of Leading Indicators advances in January, but wait before taking a leap
“The Index of Leading Economic Indicators (LEI) increased 0.4% in January after a revised 0.2% gain in December, previously reported as a 0.3% increase. The index of LEI has moved up for two straight months. Historically, the LEI has been a reliable indicator warning about turning points of the economy ahead of other economic indicators.

“The two consecutive monthly gains of the index have to be interpreted with caution. Inflation adjusted money supply has made hefty positive contributions for five straight months and the interest rate spread is another component that has been an advancing component for several months. Both of these components have risen for reasons that do not reflect bullish economic conditions. Inflation adjusted money supply is advancing because currency, demand and saving deposits have risen sharply. At the same time, bank lending has contracted. The two signals are inconsistent and they do not denote the underlying conditions that suggest a revival of economic activity.”

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

Asha Bangalore (Northern Trust): Industrial production plunges
“Industrial production fell 1.8% in January, following a downwardly revised 2.4% drop in the prior month. If utilities production had not advanced at a rapid clip of 2.7%, the headline would have been weaker. The 23.4% decline in auto production from extended shutdowns of auto plants subtracted more than one percentage-point from the change in industrial production. Manufacturing output fell 2.5% in January; excluding autos, factory production dropped 1.4%, which is indicative of widespread weakness in the factory sector.

“On a year-to-year basis, factory production fell 12.9% and excluding autos it declined 10.8% in January.”

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

Asha Bangalore (Northern Trust): Construction of new homes at new record low
“Construction of new homes fell to a record low of 466,000 in January, which is down 79.5% from the peak in January 2006. The 16.8% drop in housing starts during January reflects a 12.2% decline in starts of new single-family homes and a 27.9% decline in starts of multi-family homes.

“The grim news has a positive aspect because in an environment of a rising inventory of unsold new homes (12.9-month supply, record high in December 2008) a reduction in the construction of new homes is necessary to reduce the supply of new homes and bring about stability in the housing market.”

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

Asha Bangalore (Northern Trust): Housing Market Index showing signs of stability?
“The Housing Market Index (HMI) of the National Association of Home Builders inched up to 9.0 in February from 8.0 in January. It is a small but noteworthy improvement because a decline of the same magnitude would be seen in a different light. Also, it is necessary to note that this is a single monthly reading. Additional gains of the index in the months ahead will be necessary to confirm that the housing market has turned the corner.”

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

Asha Bangalore (Northern Trust): Wholesale prices moved up in January, but not problematic
“The Producer Price Index (PPI) for Finished Goods rose 0.8% in January, following a string of five monthly declines. The major culprit was a 3.7% jump of the energy price index which had declined for six consecutive months and a 0.4% increase of the core PPI, which excludes food and energy. The food price index fell 0.4% in January after a 1.4% drop in the prior month. Higher energy prices in February point to another monthly gain of the energy price index.”

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

Asha Bangalore (Northern Trust): January CPI report - underlying trend of deflation will fade only later
“The Consumer Price Index (CPI) rose 0.3% in January, the first increase since July 2008. The CPI is unchanged from a year ago, the lowest reading since August 1955. The core CPI, which excludes food and energy, moved up 0.2% after a steady reading in December. On a year-to-year basis, the core CPI advanced 1.7% in January, the lowest since August 2004. Although these headlines take the edge off concerns about deflation temporarily, the underlying trend of deflation will fade only much later in 2009.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, February 20, 2009.

Bespoke: Up days - the scarcest commodity of all
“While the world suddenly finds itself with a glut of oil and other related commodites, one thing that is certainly in short supply so far this year is an up day in the market. So far this year, the Dow has finished the day higher on 36.7% of the 32 trading days (through Wednesday). We all know that it has been a bad year, but this is down right depressing!

“In the table below, we highlight the 15 prior years where the Dow started off the year with 40% or less of the first 32 trading days finishing higher. You have to go all the way back to 1984 to find a year that started off with an even greater frequency of down days. As shown below, the rest of the year is hardly anything to get excited about. While the last three occurrences have been positive, the overall average return for the rest of the year is a decline of 2.1%.”

Source: Bespoke, February 19, 2009.

Bespoke: Fourth quarter earnings season - one we’d all like to forget
“The unofficial fourth quarter earnings season came to an end yesterday, and the numbers show that it’s one we’d all like to forget. From Bloomberg, diluted year-over-year earnings for the S&P 500 are down 36% with 80% of the reports in. As shown in the chart below, analysts were expecting an increase of 30% from Q4 ‘07 to Q4 ‘08 back in October.

“And on a sector basis, three sectors saw earnings decline more than the index as a whole, while seven came in better than the index. In the chart below we have excluded Financials because its declines were off the charts (-272%). Materials saw the second biggest decline in earnings at -78%, followed by Consumer Discretionary, Energy, and Technology. Three sectors did see year-over-year increases in earnings, however. Utilities were up 6.1%, Consumer Staples were up 9.6%, and Health Care was up 9.9%.”

Source: Bespoke, February 18, 2009.

Carl Swenlin (Decision Point): Earnings are crashing
“The real P/E for the S&P 500 is based on ‘as reported’ or GAAP earnings (calculated using Generally Accepted Accounting Principals), and it is the standard for historical earnings comparisons. The normal range for the GAAP P/E ratio is between 10 (undervalued) to 20 (overvalued). Market cheerleaders invariably use ‘pro forma’ or ‘operating earnings’, which exclude some expenses and are deceptively optimistic. They are useless and should be ignored.

“The following are the most recently reported and projected twelve-month trailing (TMT) earnings and price/earnings ratios (P/Es) according to Standard and Poors. I have highlighted GAAP earnings. Note that projected earnings for 2009 Q2 are $15.90. Keep in mind that the last earnings peak of $84.92 was for 2007 Q3. That’s a drop of over 80%!

“Based upon projected GAAP earnings the following would be the approximate S&P 500 values at the cardinal points of the normal historical value range. They are calculated simply by multiplying the GAAP EPS by 10, 15, and 20. I have highlighted the overvalued values. Note that the S&P would have to drop to 554 just to be overvalued based on 2008 Q4 earnings projections. The outlook by 2009 Q2 is much worse.

“Of course, the market doesn’t always follow these projections, but they are reasonable targets based upon the best fundamental estimates we have available.”

Source: Carl Swenlin, Decision Point, February 13, 2009.

David Fuller (Fullermoney): Invest in creditor nations
“The US has elected an interesting, intelligent and charismatic new president. This will help the country in terms of international relations. However, debt-laden economies and the USA in particular, given its size, remain at the epicentre of global economic risk. In a best-case scenario, the economic outlook might show some evidence of improvement during the secondhalf of 2009. I hope so but even in this event, global investment remains an international beauty contest.

“The investment question for all of us, I suggest, is would we rather back the debtor or creditor nations. Some may see this as a rhetorical question. Run it through a price chart filter showing relative strength since the climactic selling in October, and the choice becomes even easier for me. Not all creditor nations are doing well, but Fullermoney themes such as Brazil and especially China (note also the strength of A-Share Banks) certainly are.

“I do not doubt that if Wall Street experiences a new down leg of consequence, that its leash effect would pull other stock markets lower as well. This is an ongoing risk. However, it might not drag today’s better performers to new bear market lows. More importantly, I have already seen enough to feel confident that among larger countries, China and Brazil will be upside leaders in the next significant stock market recovery. This will occur sooner rather than later if, and this is a big IF, Obama’s policies can help the S&P 500 Index to remain within its current trading range.”

Source: David Fuller, Fullermoney, February 16, 2009.

Bespoke: Default risk ticks higher, but still below prior highs
“Below is a price chart of a North American investment grade credit default swap index that measures default risk for 125 companies. As shown, default risk peaked in early December 2008 and has declined somewhat since then, but it just broke above a short-term trading range today. This isn’t surprising given the recent troubles in equity markets, and from a technical perspective, this breakout doesn’t bode well for the market going forward.”

Source: Bespoke, February 18, 2009.

CEP News: Fed’s Bullard says buying Treasuries still not off the table
“Federal Reserve Bank of St. Louis President James Bullard said the possibility of the Federal Reserve making outright purchases of Treasuries is not off the table, but this may not take place until the spring.

“Speaking in New York, Bullard said there is effectively no large difference between buying agency debt - which the Fed is already doing - and long-term Treasuries.

“Bullard said it is fair to say the world is entering a period of exceptionally low interest rates.

“He said the global recession will carry through until at least the first half of 2009. As for the US, he expects the first half of 2009 to see employment and output continue to deteriorate.

“On inflation, Bullard said the risks of disinflation and even deflation are real, with core inflation close to zero. He advocated an unofficial inflation target rate of 2%. The most recent reports showed headline inflation at -0.7%.

“Bullard noted that the Fed’s recent efforts to expand its balance sheet have done nothing to prevent deflation.

“Bullard also said the Federal Reserve needs to find a way to keep monetary base growth rates high. He said there is no way to predict the pace of growth of the monetary base.”

Source: CEP News, February 17, 2009.

Asha Bangalore (Northern Trust): Foreign appetite for Treasury securities remains in place, for now
“The tremendous supply of US Treasury securities in the pipeline is cited as a factor that may deter foreign appetite for US Treasury securities. In December, net private sector purchases of US Treasury securities were $11.1 billion putting quarterly net purchases at $45.5 billion. Net purchases of Treasury securities were higher in the second ($86.7 billion) and third ($67.7 billion) quarters of 2008. Net official purchases of Treasury securities increased $3.9 billion in December, after two monthly declines. In the fourth quarter, official purchases of Treasury securities declined.

“In 2008, private sector net purchases of Treasury securities stood at $239.4 billion versus $195 billion during 2007, while official purchases were $76.6 billion in 2008 versus $3.0 billion in 2007.”

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

CNN Money: Who will buy all those Treasuries?
“Chinese doubts about the value of US Treasury bonds highlight a crucial question: Who will buy the estimated $2.7-4.2 trillion of debt expected to be issued over the next two years?

“With annual foreign purchases accounting for less than a tenth of the low end of that range, and domestic investors unable to bridge the gap, the Chinese are right to worry.

“Yu Yongding, former adviser to the People’s Bank of China, recently demanded guarantees for the value of China’s $682 billion of Treasury securities. Then Luo Ping, director of the China Banking Regulatory Commission, said that China had misgivings about the US economy, but despite this it would continue to buy Treasuries.

“The two statements appear designed to raise the issue non-confrontationally before new chief US diplomat Hillary Clinton’s visit to Beijing on February 20.

“China worries about the dollar’s value against other currencies, particularly the yuan. With US interest rates so low, the dollar’s value may slide. However, President Barack Obama has repeatedly said he wants a strong dollar, and indeed its trade-weighted value rose 13.9% between April and December 2008.

“The other area of concern for China is the value of its Treasuries. Given the US borrowing requirement and its lax monetary policy, T-bond yields could well rise sharply, causing a corresponding price decline.”

Source: Martin Hutchinson, CNN, February 13, 2009.

Bespoke: The curious case of the US dollar
“As equity markets test their November lows, the US Dollar index is testing its November highs. The US Dollar has been a peculiar ‘risk-flight’ trade throughout the credit crisis, as global investors have flocked to the currency with the belief that other sovereign nations are even worse off than the US. This comes at a time when gold is also rallying to new highs, and the US money supply is increasing at an astounding rate.”

Source: Bespoke, February 17, 2009.

Michael Metcalfe (State Street Global Markets): The yen is heading for a fall
“The yen is overvalued and its status as a ‘safe haven’ currency is likely to come under scrutiny, says Michael Metcalfe, head of global macro strategy at State Street Global Markets.

“He argues that analysts typically fall back on either current account positions or, better still, net foreign asset positions as a guide to which currencies should perform in times of heightened risk aversion.

“‘The rationale is that investors respond to reduced risk appetite by cutting their exposure to international investments,’ Mr Metcalfe says.

“This theory appears to be supported by the fact that Japan has one of the largest surpluses on its net foreign asset position - and therefore the biggest potential for repatriation flows - and the yen has appreciated strongly.

“But Mr Metcalfe points out the Japanese are not repatriating. ‘Indeed, quite the reverse. Money is flowing out of Japan into foreign bonds and, more unusually, foreign equity markets too. This implies it has been the perception of - or potential for - repatriation that has drawn investors into bets that the yen will rise.’

“He says both speculative and institutional investors now hold significant long positions in the yen.

“‘The question is whether investors will hang on to these bets, as the reality is that the yen is overbought and overvalued and Japan’s economy is sinking fast. It has the potential to be a safe haven, but the reality may prove different if Japanese investors keep buying foreign assets.’”

Source: Michael Metcalfe, State Street Global Markets (via Financial Times), February 17, 2009.

Business Intelligence: Jim Rogers advises Gulf states to get rid of dollar peg
“The Gulf countries’ currency peg to the dollar is a ‘terrible mistake’ and will cause problems for the region as the US currency is expected to decline, Jim Rogers said.

“The six Gulf Cooperation Council states should form a joint currency as soon as possible, the chairman of Singapore-based Rogers Holdings said at a conference in Dubai Monday.

“The new currency shouldn’t be linked to any other as the region has enough foreign reserves and oil to back it up.

“‘You’ve got good foreign exchange reserves and a lot of oil’ to back a common currency, Rogers said during a banking conference in Dubai.

“Saudi Arabia, Kuwait, Bahrain, Qatar, the United Arab Emirates and Oman agreed in 2001 to form a European Union-style monetary union by 2010 to boost regional trade. Oman later pulled out.

“Kuwait is the only Gulf Arab state to have dropped its currency peg to the dollar, giving it some control over monetary policy.

“Gulf Arab leaders in December approved an agreement to create a central bank and single currency for the region to boost trade and strengthen monetary policy.

“A single currency would allow the Gulf states to stop pegging their currencies to the dollar and implement independent monetary policy.

“Rogers said the dollar will suffer because the US government’s bailout plans and the economic stimulus will increase the US debt, weakening the US currency.”

Source: Business Intelligence, February 17, 2009.

Bloomberg: StockCharts’ John Murphy - gold to outshine

Source: Bloomberg (via YouTube), February 14, 2009.

David Fuller (Fullermoney): Gold bullion in solid uptrend
“The USD’s firmness had masked some of gold’s strength, until recently. However many other charts of bullion have been showing significant breakouts and resumptions of the long-term bull market for some time. You can see this in terms of bullion’s performance against most currencies, including: EUR, CHF, GBP, RUB, AUD, SGD and ZAR.

“How high will gold move on this particular run?

“I have no idea, particularly in this environment, and neither does anyone else. Targets are always pure guesswork, not least because the outcome depends on so many variables.

“However, we know what gold has done on its earlier advances during this decade. Once it began to appreciate against all currencies, it subsequently also moved to new all-time highs against all of them. These moves occurred in medium-term trends persisting for at least six months from the last reaction low in the prior trading range. If that consistency was repeated in the current cycle, gold should rally well into March. The best clue of a pending peak, which you can see on the charts and which veteran subscribers will certainly remember, has been clear evidence of trend acceleration.”

Source: David Fuller, Fullermoney, February 17, 2009.

Richard Russell (Dow Theory Letters): Potential buyers of gold?
“Here are some figures, the first number is the nation’s holding of gold and the second figure is the percentage that gold is of their reserves. Nations with low percentages of gold in their reserves may be expected to be potential buyers of gold.

US — owns 8,135 metric tons of gold … Gold makes up 64.4% of US reserves. The US will not sell any of its gold.
Germany — 3,412 … 64.4% of reserves
IMF — 3,217 …
France — 2,508 … 58.7%
Italy — 2,451 … 61.9%
Switzerland — 1,040 … 23.8%
Japan — 765.2 … 1.9% (a potential gold-buyer)
China — 600.0 … 0.9% (should be a big buyer)
Russia — 495. 9 … 2.2% (is a buyer)
Taiwan — 422.2 … 3.6% (should be a buyer)
India — 357.7% … 3.0% (should be a buyer)
UK — 310.3 … 14.5% (sold most of its gold at the low price)
Saudi Arabia — 143.0 … 11.4% (should buy gold)
South Africa — 124.4 … only 9.0%
Australia — 79.8 … 6.3%”

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

Financial Times: Fund amasses bullion holding
“Gold holdings at the world’s largest bullion-backed exchange-traded fund jumped above 1,000 metric tons for the first time, the latest indication of investor demand for bullion amid increasing financial turbulence and economic slump.

“The SPDR Gold Trust holdings have risen 228.6 metric tons so far this year, to a record 1,008.8 metric tons late on Tuesday, absorbing in the first seven weeks of the year about 10% of the world’s annual mine gold output.

“The industry-backed World Gold Council said that gold consumption last year rose 4% to 3,658.6 metric tons as a 64% surge in investment demand was counterbalanced by a 11% drop in jewellery demand and a 7% fall in industrial consumption.

“Supply fell 1% last year compared with 2007 … a 42% drop in official sales from central banks and a 3% drop in mine output. Gold scrap supply jumped 17%.

“The WGC said that the extreme uncertainty that currently surrounds the global economy was unlikely to abate and should continue to underpin net investment demand, particularly for bars and coins. ‘However, we expect this to be partly offset by ongoing weakness in both industrial and jewellery demand,’ it added.”

Source: Javier Blas, Financial Times, February 18, 2009.

James Turk (GoldMoney): ETFs no alternative to owning physical gold
“There is one chart I would like to share with you. Bill Murphy presented it on Friday in his commentary. It’s another one of the informative charts prepared by Nick Laird of www.sharelynx.com. This chart plots both the gold price and the weight of gold recorded in GLD, the gold exchange traded fund (ETF).

“When I look at the above chart, one key question arises immediately. How can a 150-tonne increase in demand for metal in recent weeks translate into such a relatively small increase in the price of gold? This disparity raises more questions as to whether the ETF really owns the metal supposed to be backing the shares it issues.

“I’m no fan of the precious metal ETFs, and haven’t been since they were first launched.

“In short, the ETF is at best a trading vehicle, and not an alternative to owning physical gold. In this sense, the ETF is like a futures contract, which of course is not an alternative to owning physical gold either. With these trading vehicles you have exposure to movements in the price of gold, but they also come with counterparty risk, which should of course be avoided because of the ongoing economic and financial problems around the globe. The lessons in this regard were learned in September when Lehman collapsed and AIG was on the ropes, which caused numerous commodity ETFs in London to suspend trading.

“So if you want to trade the price of gold, trade futures or ETFs. But do not view futures or the ETFs as an alternative to owning physical gold and silver.

“If you are still not convinced, or even if you are, I recommend reading an article by Jim Sinclair which questions the integrity of GLD and the other gold ETFs. His February 12th report is entitled ‘Where Do All The Gold ETFs Get Their Bullion From?‘.”

Source: James Turk, GoldMoney, February 15, 2009.

Financial Times: Are platinum, palladium and silver prices sustainable?
“Investors searching for a safe haven have pushed gold prices to $950 a troy ounce. In their rush to safety, they have also boosted the price of silver, platinum and palladium.

“In fact, the well-reported 7.5% rise in gold prices this year pales against the 20.5% gain in silver, 14.5% rise in platinum and 15.6% increase in palladium.

“Are the gains in these three precious metals sustainable? Part of the surge is a correction from last year’s crash, which saw platinum plunging from more than $2,000 an ounce to less than $800 in three months.

“Gold spikes traditionally boost other precious metals and this time is no exception, with a surge in exchange-traded funds’ holdings of silver, platinum and palladium. But investors should note that, even if usually grouped under the precious metals umbrella, these three resemble industrial metals more closely, albeit expensive ones.

“Platinum and palladium are used for catalytic converters in the automotive industry, accounting for 60% of their consumption. And for silver, electronics is a large consumer.

“For these three metals, demand for jewellery is less important than for gold. The supply side, which last year boosted prices - particularly for platinum - now looks less supportive, too. As HSBC says: ‘After many years of deficit, we anticipate that the platinum market will swing into a surplus  …  in 2009.’ Silver and palladium face a similarly loose market.

“Against that backdrop, investors will need to corner the market and sharply increase their holdings if silver, platinum and palladium prices are to sustain their upward trajectory. Further price gains are possible as long as the metals benefit from safe-haven buying. But without the support of industrial demand, any upside is probably limited.”

Source: Javier Blas, Financial Times, February 16, 2009.

Bloomberg: Shipping Index surge signals commodity currency gains
“Shipping costs have more than doubled this year, so it may be time to buy kroner, Aussies and loonies.

“The 147% jump in ocean-transport prices is evidence that China’s $580 billion stimulus plan will lift raw materials, said Ihab Salib, who oversees $3 billion at Federated Investments Inc. in Pittsburgh. That would benefit countries exporting them, so Salib is ‘actively trading’ Norway’s krone and Australian and Canadian dollars, nicknamed Aussies and loonies.

“Salib and other currency traders have started using the Baltic Dry Index’s global gauge of raw-material shipping costs to help make such decisions. The index and the value of a basket of those three resource-rich countries’ currencies are increasingly moving in tandem - 96% of the time in the past year, up from 84% in the past decade, data compiled by Bloomberg show.

“‘Historically, the Baltic Dry Index is a good leading indicator for commodity prices,’ said Salib, who declined to detail his investments. ‘Commodities are very depressed right now, and they offer good long-term value. Once they come back, these currencies should do well.’

“The shipping gauge is a sign that China’s stimulus spending on housing, highways, airports and power grids will have impact beyond its borders. By Feb. 28, it will have spent 25% of its stimulus budget, Deutsche Bank AG said, predicting the country’s economy will grow at a 12% annual rate between the fourth and first quarter, after shrinking 2.3% between the third and fourth.”

Source: Ye Xie and Candice Zachariahs, Bloomberg, February 17, 2009.

Financial Times: China/Russia oil deal
“China has what Russia wants: masses of US dollars. Russia has what China wants: energy, and lots of it. Hence Tuesday’s oil-for-loans agreement between Moscow and Beijing. Russia’s state-owned oil companies get 20-year loans to help them refinance while preserving capital spending; China gets cheap fuel for the duration.

“Bilateral deals happen all the time between countries. The difference here is that no one has tried to dress this up as a political or diplomatic event. This is an artifice-free exchange of one commodity for another.

“For their part, Russia’s national champions avert a nasty cash crunch. The world’s second-largest oil producer has been floundering amid depressed crude prices and declining production: aggregate volumes shrank by almost 1 per cent last year.

“China does very nicely too. 300,000 barrels a day amounts to about 4% of its total demand, or 8% of its total oil imports. Russia is paying 6% on the loans, implying that China is securing supplies at about $20 a barrel, according to UOB-Kay Hian, a Shanghai brokerage. As China buys most of its oil in the spot market, this is a significant saving.

“There are fringe benefits. Russia diversifies its customer base away from Europe, while China reduces its dependence on the Middle East. It also increases its chances of getting a stake in the long-term development of Russia’s fabled Siberian oil reserves - perhaps at the expense of Japan. But at bottom, this is barter. How very post-crunch.”

Source: Financial Times, February 18, 2009.

Financial Times: Brazil to supply oil to China for loans
“Brazil and China signed a landmark agreement on Thursday that will ensure long-term supplies of oil to China while delivering much-needed financing to help Brazil develop enormous reserves of oil and gas recently discovered in its coastal waters.”

Source: Jonathan Wheatley, Financial Times, February 19, 2009.

Financial Times: Japan growth plunges to a 35-year low
“Japan’s government faced pressure for another stimulus package on Monday after plunging exports pushed the country, the world’s second largest economy, into its worst slump in 35 years.

“Economists see little prospect for a quick rebound after a quarter-on-quarter fall of 3.3% in gross domestic product in the last three months of 2008.

“The decline was worse than economists had forecast and equivalent to an annualised fall of 12.7% - the steepest drop since 1974 when import-dependent Japan suffered because of soaring oil prices.

“This time, collapsing demand for exports and weak domestic consumption are to blame.

“‘This is the biggest economic crisis since the war,’ said Kaoru Yosano, minister for economic and fiscal policy.

“Government leaders have resisted announcing new action as a stimulus package drawn up last year, which includes a Y2,000 billion ($22 billion) cash handout, and the main budget for the year from April, move slowly through a parliament in which the opposition controls the upper house.

“The decline in GDP is fuelling calls for more aggressive measures from the government and the Bank of Japan.”

Source: Mure Dickie, Financial Times, February 16, 2009.

Financial Times: G7 softens tone on China
“The US and other Group of Seven industrialised countries have stepped back from criticism of China in a push for greater cooperation with Beijing and a more unified response to the global financial crisis.

“In a communique issued following their meeting in Rome at the weekend, G7 finance ministers adopted milder language than recently regarding China’s handling of its currency. Tim Geithner, US Treasury secretary, also used a more conciliatory tone towards Beijing than he did last month, when he accused China of manipulating its currency to benefit exporters.

“Hillary Clinton, US secretary of state, will this week become the first senior member of the new administration to visit China as analysts look for clues as to how Washington will handle one of its most important economic relationships.

“In a speech before she left, she labelled a ‘positive, co-operative relationship’ between Beijing and Washington as ‘vital to peace and prosperity, not only in the Asia-Pacific region but worldwide’ and also announced the resumption of military contacts between the two nations.

“However, in a sign of potential for tension, China on Sunday hit out at a ‘Buy American’ provision in the $787 billion economic stimulus package approved by the US Congress last week. ‘History and economic theory show that in facing a financial crisis, trade protectionism is not a way out, but rather could become just the poison that worsens global economic hardships,’ the official Xinhua news agency said in a commentary.

“‘The G7 has realised that China needs to be brought into the fold of the global financial system rather than be treated as a pariah just because of currency inflexibility,’ UBS said in a note on Sunday on the meeting. ‘This is also a realisation that as the world’s largest foreign exchange reserve holder and the US’s largest creditor nation, China not only holds the purse strings but its continued growth is crucial to helping the world recover from the economic crisis.’”

Source: Guy Dinmore, Daniel Dombey and Kathrin Hille, Financial Times, February 15, 2009.

Jing Ulrich (JPMorgan): China urges spending
“While the first phase of China’s stimulus plans involved massive infrastructure projects and tax relief measures for manufacturers, the country’s leaders have now begun speaking with greater urgency on the need to encourage consumption, says Jing Ulrich, chairman, China equities at JPMorgan.

“Recently, Premier Wen Jiabao said bluntly that the trick to spurring consumer spending was not to engage in slogans, but to put money in people’s pockets.

“‘This principle has been applied literally in the issuance of consumption coupons by some local governments to low-income residents,’ Ms Ulrich says. ‘This practice is likely to become more common as an alternative to income tax cuts - which might only encourage greater savings.’

“She adds that the government is also turning to rural residents to help stimulate growth.

“‘Having launched a rural subsidy programme for household appliances and electronics, authorities are planning to introduce a similar scheme for lightweight vehicles.’

“But she acknowledges that while consumer stimulus plans will help support growth, China will remain heavily dependent on trade and fixed investments until headway is made in addressing a lack of confidence in the country’s social safety net.

“‘Towards this end, the State Council recently approved plans to spend $123 billion by 2011 to implement a basic universal healthcare system.’”

Source: Jing Ulrich, JP Morgan (via Financial Times), February 19, 2009.

BCA Research: Chinese exports - not as weak as they appeared
“The Chinese New Year effect is mainly to blame for China’s extremely weak trade numbers in January.

“Yesterday’s data release showed that Chinese exports tumbled by 17% in January and imports collapsed by 43% from a year ago. However, it is important to note that China’s macro data in the first two months of the year tend to be distorted by the Chinese New Year holidays. There is no question that January’s shocking trade data suggests that the economic environment remains highly challenging. Nonetheless, they are greatly exaggerated by fewer working days last month than January 2008.

“Adjusting for this factor, it is estimated that exports actually increased by 6% from a year ago, while imports dropped by 26%. The latter is also impacted by the tumble in commodity prices. The export sector performance is consistent with the most recent purchasing managers’ surveys, which show a slight improvement in both export orders and industrial production.”

Source: BCA Research, February 17, 2009.

Peter Attard Montalto (Nomura): The threat from emerging Europe
“One of the biggest threats to financial stability in the eurozone comes from the region’s exposure to central and eastern European banks, says Peter Attard Montalto, emerging Europe economist at Nomura.

“During the boom years, he says, high interest rates in emerging Europe led to a huge increase in foreign currency borrowing by households and companies - most notably in euros and Swiss francs. ‘Borrowers took the view that the foreign currency risk was low and offset anyway by the credit cost saving.’

“But not only did eurozone banks lend to these countries, they also took very large stakes in local institutions. ‘Indeed, more than 80% of emerging Europe bank assets are owned by western European banks,’ Mr Attard Montalto says.

‘”This was fine during times of easy credit when the region’s economies were growing strongly. However, widening spreads and a painful slowdown in growth now point to a serious risk to these exposures as non-performing loans may reach above 25%.

“‘This will have grave consequences for the central eastern European and Baltic economies as well as for the European banks that hold the ultimate risk.

“‘Market sentiment is currently very fragile but there is no clear agreement from the EU or other bodies about how to tackle this problem. Swift action is needed as CEE currencies continue to weaken. This issue is not going to go away on its own.’”

Source: Peter Attard Montalto, Nomura (via Financial Times), February 16, 2009.

Financial Times: No escape from the eastern pain
“Can western banks extricate themselves from the pain of an eastern European collapse?

“These eastern neighbours owe western banks - mainly in Austria, Italy, France, Belgium, Germany and Sweden - about $1,635 billion.

“Such a figure is almost equivalent to the entire balance sheet of a major bank in any one of these countries, so the question is not trivial.

“However, a better question might be: should western banks extricate themselves from eastern Europe?

“For this group of countries, where exposures are largest, is like the canary in the coalmine of European trade. But as Poland, the Czech Republic, Hungary, Romania and Croatia sicken, western Europe cannot hope to survive with a dash back to the clean air.

“Eastern Europe is at the sharp end of the new financial protectionism, a natural consequence of government involvement in banking.

“But it is also a big contributor to western Europe’s economies, accounting for almost one-quarter of German exports for instance.

“There has been a certain amount of vendor finance at work here. High local interest rates as governments tried to cool growth and move in line with the eurozone encouraged consumers to import first western debt in euros and Swiss francs, then more western goods. Sadly, they have also imported the credit crunch through the same channels.

“The quandary is not going unrecognised - Hungary has already had European Union support. But neither is it fully appreciated. Some believe the euro is doomed to trail after its poorer neighbours. The more the Polish zloty or Hungarian florint sicken, the worse the euro will feel. There is a credit trade choice to be made, too: should you buy protection on, say, Austria or Germany? As the canary chokes, the answer looks like the latter.”

Source: Paul Davies, Financial Times, February 17, 2009.

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Major hurdles to stimulus

Saturday, February 7th, 2009

This post is a guest contribution by Richard Berner of Morgan Stanley.

Hopes are strong that a combination of timely fiscal stimulus and a fix for the financial system will end the US and global recession and promote recovery. Eventually, we think they will, but there are three major hurdles.

First, only 20% of the $819 billion fiscal stimulus package moving through the Congress will occur in FY2009, much of the spending and tax cut thrust will be deferred into 2010 and 2011, and it would be difficult to accelerate the spending.

Second, any plan to clean up lenders’ balance sheets, mitigate mortgage foreclosures and recapitalize lenders will also take time. Encouragingly, the Fed’s January Survey of Bank Lending Practices suggests that banks stopped tightening their lending standards last month. But credit is still tight. For example, “only” 47.5% of respondents (on a weighted-average basis) reported tightening their mortgage lending standards last month versus 79% in July, and an index of willingness to lend to consumers bounced to -16% from -47.2% in October. But both readings still indicate a bigger credit crunch than any in the survey’s history, and the cumulative impact of past tightening is still working its way through the economy with a lag.

Finally, and reflecting that lag, declining output, prices, and profits are connected in a vicious circle that is unlikely to abate soon. Pricing power is dwindling and margins are shrinking, in turn weakening corporate credit quality, access to credit, and capital spending. Although GDP declined by a less-than-expected 3.8% in the fourth quarter of 2008, the upshot is that we expect the economy to weaken further through the first half of 2009.

One more macro risk keeps us awake at night: Recessions always raise the threat of protectionism, and the threat of barriers to trade and capital flows this time may be especially high. Globalization has knit economies closer in the past two decades, bringing benefits for consumers but pressure on companies and workers in developed markets. Efforts to protect old jobs rather than create new ones would prolong the global recession, hobble productivity and raise the specter of stagflation. Signs of incipient protectionism and trade tensions are rising: Some EM countries have raised employment barriers. Officials in various countries have discussed directing credit from institutions that receive government assistance to domestic borrowers only. The US stimulus package contains Buy American clauses. And US officials are revisiting the question of whether China is manipulating its currency. None of these creates a favorable backdrop for financial markets.

Source: Morgan Stanley, February 5, 2009.

Tags: Awake At Night, Balance Sheets, Barriers To Trade, Berner, Credit Crunch, Credit Quality, Cumulative Impact, Fiscal Stimulus, Fourth Quarter, Global Recession, Hurdles, Morgan Stanley, Mortgage Foreclosures, Mortgage Lending, Protectionism, Recessions, Stimulus Package, Tax Cut, Upshot, Vicious Circle
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