Offshore Oil The Warren Buffett Way

Monday, February 15th, 2010

By Dian L. Chu, Economic Forecasts & Opinions

Commodities, particularly crude, were trending down last week after China’s Central Bank raised bank reserve requirements boosting the US dollar against other major currencies. That marks the second time China has raised its bank reserve requirement in a month.

Ongoing worries about the economy stemming from European debt problems, specifically the lack of a firm Greek bailout plan from European leaders also prompted investors moving out of risky assets. Crude oil fell for the first day in five to below $75 a barrel also partly due to government data showing U.S. inventories rose more than forecast.

Meanwhile U.S. natural gas registered the largest one-day gain last Friday to $5.48 per mmbtu since the beginning of the month on a drop in jobless claims, signaling industrial demand is likely improving, and cold temperatures across the US are boosting residential demand. Industrial Demand accounts for 29% of U.S. consumption.

Oil Services Sector Bottoming Out

While the markets are in a finicky mood from the China and Greek factors, the return of relative stability in oil and natural gas prices has spurred producers to increase their capital budget and restart projects they slowed down or completely deferred a year ago. (Fig. 1)

Absorbing the impact of lower rig counts, weak global demand for fossil fuel and volatile energy prices, the majority of the oil services companies are reporting sharply lower earnings in Q1. However, the rising rig count and producers’ capital budget suggest that oil service markets are probably in the process of bottoming this year, which suggests a good entry point for long-term investors. (Fig. 2)

Oil Majors Go Deepwater & Subsea

Roughly from 2004 to 2008, the onshore, North America in particular, had outshined the offshore in terms of activity growth. But the Great Recession has shifted the tide towards offshore and international. Offshore is one of the few remaining places where the state as well as western oil majors can increase production, while emerging Asian demand is expected to outpace the U.S. and the OECD in coming years.

FBR estimates an increase in deepwater spending of almost triple expected growth in onshore spending will drive offshore spending overall at a rate of around 15% for the next few years. Energy consultants Douglas-Westwood also forecast offshore spending recovering to $439 billion in 2010, up 11% from 2009 with deepwater capital expenditure reaching new highs. (Fig. 3) South America, Mexico, Iraq, Russia, Africa, and the deepwater are the key areas.

Subsea has proven to be considerably more resilient in the downturn, and the secular growth story will continue to improve as the deepwater rig count is expected to increase by 30% in 2012 from 2009 and as projects get more complex and require greater amounts of equipment.

Offshore Infrastructure – The Buffett Way

Warren Buffett made headline last year when he placed the biggest bet of his life with the $34 billion purchase of Burlington North Santa Fe, expecting the infrastructure play will grow as the economy gets back on solid ground.

So, if we apply the same investment strategy as Buffett to the oil services sector, offshore infrastructure will be the logical choice.

Americans vs. Europeans

While oil companies typically fund and own the pipeline, platform, etc, they rely on oil services companies to provide project expertise and resources.

The oil services universe is made up of mainly two camps: Americans and Europeans. American firms such as Halliburton (HAL), Baker Hughes (BHI) and Weatherford (WFT) tend to have a stronger focus on drilling and production services mainly due to the existence of a vast American market, and higher margins.

The European firms, on the other hand, have essentially positioned as specialists in offshore drilling, infrastructure engineering and construction related services.

From Europe with Backlog

Therefore, the current offshore and deepwater trend bodes well for the major European service companies such as Saipem SpA and Technip SA (TKP).  Theses two companies are leaders of the European pack dominating in high-tech segments for deepwater activities such as the installation of platforms, the laying of subsea pipelines, the development of subsea fields, etc.,

The oil infrastructure business is generally later cycle and backlog driven, and thus tends to have less volatility in earnings than other energy stocks. That means even if we go into a double dip, these stocks should still be able to generate higher earnings.

Favorable Forex Trend

Dollar appreciation is also a major catalyst. Société Générale estimated that a 10% increase in the dollar translates into an 8% to 10% increase in EBIT for the oil services sector. All oil services companies should benefit but those that combine a sizeable proportion of dollar-based assets with borrowing denominated essentially in euros, for instance, Saipem and Technip (TKP), stand to benefit most.

Furthermore, with euro recently plunging to a near nine-month low amid Greek concerns, the downward momentum is favorable for U.S. investors wishing to add positions in some solid European companies with good long term prospects.

Americans with Niche

All is not lost with the American companies. Large manufacturers of capital equipment such as Cameron (CAM) are poised to benefit as well, since the tender activity for deepwater rigs, subsea equipment, surface, valves and compression will likely accelerate in 2010 with oil companies gaining confidence in the commodity recovery.

Drillers & Seismic – Grinding Ahead

Nevertheless, all services are not created equal. Average day rates for deepwater floating rigs have fallen from up to $550,000 to $350,000. So, the next two years are going to be a grinding period for drillers like  Transocean (RIG) and Diamond Offshore (DO) when they have to roll over old contracts at lower rates.

Meanwhile, seismic companies such as CGG Veritas (CGV) and Petroleum Geo-Services (PGS) are still struggling to find a bottom mainly due to vessel overcapacity on the marine side. The sector is also hammered by clients’ preference to use old data instead of shooting new ones in a bid to cut costs.

So, the downward earnings trajectory could signal a buying and/or shorting opportunity depending on investment time frame and strategy.

Oil or Gas, One Sector Does It All

Energy stocks, including shares of services companies, tend to be higher beta, so the sector still has to balance the downside risk of the global growth environment. But as the world journeys on a recovery path, likely with rising oil and gas demand, there is still a significant multi-year opportunity for earnings growth from the oil macro view. (Fig. 4)

In addition, oil services is one sector that stands to benefit from the expected uptrend of either crude or natural gas, or both. With crude and natural gas prices outlook remain diverged in the medium term, this unique characteristic could be a good hedge in any energy/commodities investment portfolio.

Disclosure: No Positions

Tags: Bailout Plan, Capital Budget, Cold Temperatures, Commodities, Economic Forecasts, European Leaders, Global Demand, Government Data, Jobless Claims, Mmbtu, Natural Gas Prices, Offshore Oil, oil, Oil Majors, Oil Service, Oil Services, Relative Stability, Rig Count, Risky Assets, Service Markets, Term Investors, Time China, Warren Buffett
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Sovereign Risk and the Price of Oil

Monday, February 8th, 2010

European and U.S. stock markets have taken a hit recently as spooked investors from Shanghai to Sao Paolo were fleeing risky assets amid concern that the financial crisis in Portugal and Greece could spread through the euro zone with vast implications for the fate of the fragile global economic recovery. (Fig. 1)

Liquidate & Buy Dollar

A steep drop in crude-oil prices triggered declines across the commodities spectrum, as investors nervous about the pace of the economic recovery gravitated back to the dollar. Crude oil tumbled to a seven-week low of $71.19 a barrel last Friday, down 14% since the 2010 high of $83.18 reached on Jan. 6.

Investors’ fled for safety drove the U.S. dollar near a nine-month high against the euro. Emerging market currencies also weakened in Asia, while U.S. stocks fell a fourth straight week, the longest streak since July.

A Shift of Sovereign Risk

According to EPFR Global, risk aversion has prompted a withdrawal of $1.6 billion from emerging market equity funds during the week ending Feb. 3, the biggest outflows in 24 weeks, and $516 million has left Asian equities outside of Japan.

The charts from CDR (Credit Derivatives Research) tell the story of this investors’ perception. According to CDR, there has been a dramatic shift of risk in developed nations relative to emerging and less-developed nations when comparing three sovereign risk indexes, SovV, EM and CEEMEA. (Fig. 2)

In SovX, the GIPSI (H/T Zero Hedge) - Greece, Italy, Portugal, Spain and Ireland, represent around 65% of the index risk. In EM, Venezuela accounts for 26%, Turkey, Brazil, and Argentina represents 12% respectively of the EM risk. In CEEMEA, Turkey and Russia represent 49% of the index risk (followed by Hungary and Ukraine each at over 8%).

In addition, CDR finds that the sovereign risks of the emerging economies appear to be closely tied to the price of oil:

“It would appear that the CEEMEA and EM sovereign risk indices are threatened more by commodity price pressures than credit risk currently - and given the ‘relatively’ high price of oil/gas, their risk remains less of a concern than developed nations where the Ponzi appears to be in question.”  (Fig. 3)

Oil Price - A Key Risk Factor

Emerging market countries, such as Brazil, China or India, are evolving since the early 90s. During this period, the issuance of bonds by these countries has increased significantly reflecting their needs for substantial long term and infrastructure investment.

Among the many determinants of risk bonds, the price of oil is a key factor as it plays a significant role in economic growth, inflation, production costs, trade balances and currency. Nine of the 10 economic recessions in the United States since the end of World War II were preceded by a dramatic increase in the price of oil.

A Sensitivity Issue

Oil prices nowadays are extremely volatile, and sharp fluctuations in oil prices contribute to macroeconomic volatility all over the globe. The impact of this volatility on economy varies according to a country’s relative dependence on oil production and exports.

For oil-exporting countries like Russia and Saudi Arabia, a rise in oil prices caused a perception of risk reduction relative to its obligations. Conversely, an oil-importing country sees its risk index increase due to a barrel price shock.

Financial Crisis 2.0?

Last week’s wild commodity price swings underscore how investors aren’t totally convinced that the world economy is on an upward trajectory. Investors are worried that multi-governments’ debt problems will spread globally similar to the subprime crisis in 2008.

In addition to concerns about GIPSI sovereign debt defaults in the 16-nation euro zone, the U.S. is grappling with its own deficits and the high jobless rate, while China began restricting lending last month to prevent high inflation.

Some analysts expect global commodity prices would eventually firm up reflecting economic recovery albeit high volatility; and fundamentals should increasingly dominate expectations and drive prices.

But there are others see the current “correction” as caused by factors very similar those brought on the “financial crisis of 2007-2010” and warned this could signal “a new crisis in development.”

Seeking Negative Beta

In this environment, a defensive play would be to invest or allocate a portion in regions that are less prone to the price of oil, which is a significant sovereign risk factor. Sector wise, agriculture and alternative investment vehicles in real estate or land development should provide some good diversification to any long term portfolios.

Jeff Rubin, Chief Economist at CIBC World Markets pointed out that the United States is less sensitive to oil price volatilities because it is itself an oil producer (5 million barrels out of 19 million barrels the US consumes are produced in the US), so it receives some of the benefit of both higher and lower oil prices. An IEA analysis also indicated that the U.S. should be less affected by oil price shocks than Japan, OECD and Euro zone. (Fig. 4)

This competitive edge probably partly explains how investors still see the U.S. dollar as a safe haven, and Mr. Geithner’s optimism that more debt won’t hurt U.S. credit rating, in spite of the fiscal and economic challenges quite similar to what the Euro Zone is facing.

BRIC minus R

In addition to the United State, GDP growth in Brazil, China and India could get boost from the softening and stabilizing of oil prices and should increase their competitiveness. Brazil and Chindia are all oil producers with aggressive state-sponsored exploration and production efforts and strong economic growth prospect. Brazil, with a new and improved investment grade credit rating, is now largely self-sufficient and has insulated its economy from oil price shock on net basis.

The economic impact of oil prices on oil-importing, developing countries such as China and India could be more pronounced primarily because Chindia are more energy-intensive due to its strong growth rate, and less energy efficient. From that perspective, Chindia, though good prospects could be more of a roller-coaster ride for investors.

Among the emerging economies, lower crude oil prices will be a big dampener for Russian economy. Russia’s two oil wealth funds declined by a total $1.54 billion over the last month, as more funds were transferred to aid federal budget shortfalls. The Reserve Fund, one of Russia’s two oil wealth funds, is expected to run out by the end of 2010.

Hat Tip: Professor Pinch

Tags: Asian Equities, BRIC, China, Commodities, Credit Derivatives, Crude Oil Prices, Derivatives Research, Developed Nations, Dramatic Shift, Emerging Economies, Emerging Markets, Equity Funds, Euro Zone, Gipsi, Global Risk, Greece Italy, India, Market Equity, oil, Portugal Spain, Price Of Oil, Risk Aversion, Risky Assets, Sovereign Risk, Sovereign Risks, Steep Drop
Posted in Emerging Markets, India, Markets | No Comments »

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

Sunday, February 7th, 2010

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

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

Strengths

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

Weaknesses

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

Opportunities

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

Threats

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

Tags: Bond Market, Consumers, Curve, Debt Default, Economic Data, Economic Recovery, Economy, Employment Report, Euro Zone, Greece, Ism Index, Ism Manufacturing Index, Market Economy, More Than Five Years, Nonfarm Payrolls, Retail Sales, Risky Assets, Tandem, Treasury Market, Treasury Yields, Unemployment Report
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Words from the (Investment) Wise (January 10, 2009)

Sunday, January 10th, 2010

Back from the festive season break, traders pushed stock market indices to new highs for the rally, logging a full house of five up-days for the S&P 500 Index and pushing the CBOE Volatility (VIX) Index - also referred to as the “fear gauge” of the US stock markets - down to levels last seen pre-Lehman in 2008.

Pundits shrugged off Friday’s unexpected decline in non-farm payrolls, as well as mixed economic data earlier in the week, focusing instead on the Federal Open Market Committee’s (FOMC) communiqué for its December 15-16 meeting which maintained its “extended period” stance for easy monetary policy, i.e. more “juice” for risky assets.

Asha Bangalore (Northern Trust) said: “The details and tone of the December employment report indicate that labor market conditions remain bothersome. A meaningful pace of hiring is unlikely in the next few months given the structural unemployment in the economy, the shortened workweek, and the large number of part-time workers. In other words, the December employment report reinforces expectations of the FOMC on hold in the near term. The Fed is unlikely to undertake a reduction of monetary accommodation until the unemployment rate has peaked.”

Source: Walt Handelsman

The past week’s performance of the major asset classes is summarized by the chart below - a set of numbers that indicates renewed investor appetite for risky assets. Silver (+9.5%), “the poor man’s gold”, and platinum (+7.0%) were the stars of the week, playing catch-up on historically cheap ratios relative to gold bullion. The yellow metal (+3.7%) also resumed its uptrend with a so-called “upward price dynamic” on Monday. Bonds performed poorly as Pimco and BlackRock, among others, cut holdings of US and UK debt as the two nations’ borrowings hit record levels.

Source: StockCharts.com

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

The MSCI World Index (+2.5%) and the MSCI Emerging Markets Index (+2.7%) experienced a strong first week of 2010. Only three emerging markets - the Shanghai Composite Index (-2.5%), the Russian Trading System Index (-0.4%) and the Venezuela Caracas General Index (-1.2%) - bucked the broader uptrend.

Notwithstanding solid gains since the March lows, only the Chile Stock Market General Index, one of the week’s strongest performers, has been able to reclaim its 2007 pre-crisis peak - now trading 6.5% higher. Mexico and Brazil could be the next countries to eliminate the bear market losses.

As far as the US indices are concerned, Wall Street managed to hit 15-month highs on Friday. This means that the S&P 500 Index and the Dow Jones Industrial Index have now retraced 55% and 54% respectively of their crisis losses. After the thin festive season period, volume on the NYSE came close to the one-year average.

Nine of the ten economic sectors (as measured by the SPDR exchange-traded funds [ETFs]) closed higher for the week, with the cyclical sectors in general outperforming the defensive sectors. Materials (+5.9%), Energy (+5.8%), Financials (+5.7%) and Industrials (+5.3%) all returned handsome gains, whereas Utilities (-1.0%) was the only sector in the red.

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

Top performers among stock markets this week were Latvia (+13.2%), Peru (+12.3%), Luxembourg (+6.1%), Greece (+6.0%) and Cyprus (+5.4%). At the bottom end of the performance rankings, countries included Slovakia (-14.1%), Bermuda (-2.5%), China (-2.5%), Nepal (-2.2%) and Venezuela (-1.2%).

The declines in the Shanghai Composite Index came in the wake of investors’ concerns about a flood of initial public stock offerings (IPOs) and the authorities’ actions to slow down lending. Of all the major indices, the Shanghai Composite is the only one trading marginally below its 50-day moving average. Also, as shown by the declining green line in the bottom portion of the chart below, Chinese stocks have since July been underperforming the S&P 500 Index - a reversal of roles since China turned the bear market corner five months before most other markets in November 2008. Interestingly, Marc Faber told CNBC (via MoneyNews): “My feeling is that the US will outperform emerging economies in the first six months of 2010.”

Source: StockCharts.com

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

Emerginvest world markets heat map

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

John Nyaradi (Wall Street Sector Selector) reports that, as far as ETFs are concerned, the winners for the week included SPDR S&P Metals & Mining (XME) (+13.8%), Claymore/Delta Global Shipping (SEA) (+12.3%) and Market Vectors Coal (KOL) (+11.4%).

At the bottom end of the performance rankings, ETFs included ProShares Short Oil and Gas (DDG) (-4.6%), HOLDRS Merrill Lynch Telecom (TTH) (-3.1%) and Vanguard Extended Duration Treasury (EDV) (-2.9%).

Referring to the issue of financial reforms, the quote du jour this week comes from Nobel economist Joseph Stiglitz. He recently warned (via MarketWatch): “Unless Wall Street’s incentive system is drastically reformed, ‘the financial sector will only try to circumvent whatever new regulations we put in place. We will simply have a short respite before the next crisis.’ Warning: nothing’s changed, it’s worse: Lobbyists run Obama, Congress and the Fed.”

To this, former IMF chief economist Simon Johnson added (according to MarketWatch): “Yes, ‘we’re running out of time … to prevent a true depression’. The ‘financial industry has effectively captured our government’ and is ‘blocking essential reform’, and unless we break Wall Street’s ’stranglehold’ we will be unable prevent the Great Depression 2.”

On a related note, The Wall Street Journal reports that the Financial Crisis Inquiry Commission, formed by Congress in 2009 to investigate the causes of the economic turmoil, will have public hearings on Wednesday and Thursday in Washington with top Wall Street bankers.

Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. The usual economic terms (”economy”, Fed”, “rate”, etc.) feature prominently, but “bonds” and “silver” also mustered some attention. Will we perhaps look back at these assets a year from now and see one of the worst and one of the top performers respectively for 2010? A long silver, short Treasuries trade makes perfect sense to me.

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

As far as the S&P 500 Index is concerned, the next upside target will be at the upper end of its upwardly sloping price channel at 1,250. A break below the lower level of the channel at 1,085 (and the December low of 1,092) could signal a deeper pullback.

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

“Anecdotally investors remain very skeptical of the continued advance which suggests the ‘wall of worry’ is still in place,” said Kevin Lane of Fusion IQ.

Source: Fusion IQ, January 7, 2010.

Casting his eye on 2010, David Fuller (Fullermoney) said: “Stock market action continues to confirm a bull market in every respect. Downside risk is probably limited to periodic mean reversions towards the rising 200-day moving averages.

“The main danger signs to look for will be an eventual, persistent tightening of monetary policy and an inverted yield curve. When this next happens, and both tend to be lead indicators, I will focus on introducing trailing stops for all equity positions, actual or mental, and ideally use strength to reduce equity exposure. Currently, I maintain that we are still in the second psychological perception stage of the bull market, characterized by the ‘wall of worry’. With any luck, we can look forward to the third and climactic stage of a bull market cycle, in which investors become euphoric.

“The time to start thinking about closing long portfolios in anticipation of the next bear market, I suggest, will be when the yield curve (US 10-year yields over 2-year yields) next inverts by moving below zero. However, the lead was so early last time (early 2006) that some of us became complacent about it.”

Source: Fullermoney

While on the topic of long-term charts, when considering S&P 500 monthly data, three momentum-type oscillators (RSI, MACD and ROC) all still signal a bullish trend. (As an aside, the long-term picture for US government bonds is in bearish mode as highlighted in a post a few days ago.)

Source: StockCharts.com

“Where breadth goes, the market usually follows,” goes an old market saw. Analyzing market internals, the number of NYSE stocks trading above their respective 50-day moving averages has increased to 86% from 30% in October (see chart below). “The fact that breadth has caught up with the new highs in the overall market is a good thing for the health of the bull market. If it gets up near 90%, however, there won’t be much more room for upside in the short term,” remarked Bespoke. For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 89% - somewhat down from its September peak of 93%, but nevertheless firmly in bullish terrain.

Source: StockCharts.com

Not everybody shares Fuller’s optimism. Having pinpointed the bottom in March, GMO’s Jeremy Grantham now warns that our irrational nightmare will repeat. “A year ago we came dangerously close to the Great Depression 2. Unfortunately, we’ve learned nothing … condemning ourselves to another serious financial crisis in the not-too-distant future,” he is quoted by MarketWatch. “We had our bear-market rally. Next, historical cycles plus our irrational behavior guarantees another, bigger global meltdown. We learned nothing.”

It goes without saying that the strong rally since March is bound to be followed by a correction at some stage. But rather than pre-empting (and more often than not getting it wrong as a result of short-term noise), I will be guided by the longer-term charts and the yield curve to identify a major top. Meanwhile, I am watching valuations carefully, and specifically how the Q4 earnings reports stack up. Although I am treading with caution after the 74% rally in the mature markets and 109% in emerging markets, I am not ignoring good old stock-picking, and specifically those companies with strong balance sheets that will be growing their dividends over time with a reasonable degree of certainty.

For more discussion on the economy and financial markets, see my recent posts “Byron Wien’s ten surprises for 2010“, “Bob Doll’s crystal ball into 2010 and the next decade“, “Bill Gross: Let’s get ‘Fisical’“, “Chart du Jour: Subpar recoveries follow financial recessions“, “Chart du Jour: No signs of imminent rate hike” and “Is there a decennial pattern in equity returns?” (And do make a point of listening to Donald Coxe’s webcast of January 8, which can be accessed from the sidebar of the Investment Postcards site.)

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

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

Source: Dismal Scientist

“Business sentiment around the globe remains about where it has been since last summer - consistent with a tentative global economic recovery. Businesses are most upbeat when responding to broad questions about current conditions and expectations through the middle of this year. However, they remain cautious when responding to specific questions about sales, pricing, inventories and hiring,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. Importantly, the survey results suggest that the global recovery is holding its own, but provide no indication that the recovery is gaining significant traction.

Source: Moody’s Economy.com

Released on Monday, purchasing managers’ surveys for December exceeded expectations from China to Europe and the US, reported the Financial Times. “Across the world, the combined scores of national purchasing managers’ indices, compiled by JP Morgan, rose to 55 in December, the highest since April 2006, with the index for new orders at a 5½ year high.”

The global economic rebound is likely to be even stronger than many have anticipated and developed markets have the potential to outperform emerging markets, Jim O’Neill, head of global economic research at Goldman Sachs, told CNBC. “I think what we’ve seen since the turn of the year … is actually really strong,” he said.

Goldman Sachs analysts estimate that the world economic growth will be 4.4% this year and 4.5% in 2011.

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

Friday, January 8, 2010
• December employment report - hiring freeze yet to thaw

Thursday, January 7, 2010
• Total continuing jobless claims post new high

Wednesday, January 6, 2010
• Minutes of December FOMC meeting - vulnerable aspects of economic recovery and inflation dynamics dominated deliberations
• ISM non-manufacturing survey shows improvement

Tuesday, January 5, 2010
• Auto sales advanced in December, but declined in Q4
• Decline of Pending Home Sales Index partly due to original expiration date of homebuyer tax credit program
• Factory inventories advance; noteworthy revision of shipments of non-defense capital goods

Monday, January 4, 2010
• Factory sector survey sends a strong positive signal
• Construction outlays dip in November, but Q4 residential construction spending could be noteworthy

The minutes of the FOMC’s December 15-16 meeting also point to few changes in monetary policy over the next few months. There was a consensus that near-term growth would be only slightly above the economy’s potential, but the minutes show a growing divide between FOMC members less worried about inflation, and thus arguing for more aggressive monetary policy steps, and those more worried about inflation.

As shown below, there is a significant and positive correlation (0.73) between the composite ISM purchasing managers’ index and the year-to-year change in US real GDP. According to Asha Bangalore, the noteworthy gains in the ISM survey over the past few months “suggest that an impressive headline reading of GDP for the fourth quarter should not be surprising”.

Source: Northern Trust - Daily Global Commentary, January 4, 2010.

Week’s economic reports

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

Source: Yahoo Finance, January 8, 2010.

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

The European Central Bank (ECB) will make an interest rate announcement on Thursday (January 14). US economic data reports for the week include the following:

Tuesday, January 12
• Trade balance

Wednesday, January 13
• Fed Beige Book
• Treasury budget

Thursday, January 14
• Jobless claims
• Retail sales
• Import and export prices
• Business inventories

Friday, January 15
• CPI
• Empire manufacturing
• Capacity utilization
• Industrial production
• Michigan sentiment

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

Final words
Bertrand Russell, English logician and philosopher (1872-1970) said: “What a man believes upon grossly insufficient evidence is an index into his desires - desires of which he himself is often unconscious. If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence. The origin of myths is explained in this way.” (Hat tip: David Fuller.)

Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will prevent the readers of Investment Postcards from falling into this trap, allowing them to build considerable wealth with their investment portfolios.

That’s the way it looks from Cape Town (whose balmy weather I will leave behind on Thursday for the snowy environs of Switzerland).

Source: Chuck Asay

David Fuller (Fullermoney): Themes for 2010
“Our favourite investment themes throughout 2009 were Asian-led emerging markets, South American-led resources markets and information technology. We were bullish of commodities, favouring precious metals, industrial resources and the agricultural sector subject to weather-related shortages.

“How will these Fullermoney themes perform in 2010?

“I receive at least as many bearish or cautionary stock market reports as bullish forecasts. I am inclined to regard these as contrary indicators, suggesting that we are still in the lengthy ‘wall of worry’ portion of this bull market. Crucially, monetary policy remains extremely accommodative as we approach 2010, although no one knows for how long these stimulative measures will persist, not even the central bankers. I will take my cues on monetary policy from the central banks, not the pundits.

“I am content to ride the stock market uptrends, with some provisos. For instance, most share indices have spent the last few months in a corrective phase. Having seen some partial mean reversion towards the rising 200-day moving averages, it is important that stock market indices sustain upwards breaks where sideways trading ranges are currently evident.

“Conversely, downward breaks from trading ranges would signal at least a further correction. I will give the upside the benefit of the doubt, at least while leading indices maintain their progressions of higher reaction lows. You do not need to watch them all, although I do, but I suggest monitoring the technical consistency where you have investments, and also China and the US, given their powerful leash effects.

“Incidentally, while China and India currently show additional upside scope following lengthy consolidations, Brazil may need some further ranging mean reversion towards its MA before another meaningful advance can be sustained.

“As for precious metals, they have underperformed since gold’s steepening advance was checked by a large downward dynamic on December 4. The US Dollar Index’s rally also provided a headwind, although this did not trouble many other commodities which were less overstretched on the upside than gold. Interestingly, platinum has subsequently rebounded and appears capable of extending its upward trend before long. Gold and silver appear oversold and have lost downward momentum recently, although they have yet to show reassuring upward dynamics. [PduP: This happened on Monday, January 4.] Seasonal conditions will remain favourable for precious metals through at least 1Q 2010.

“Among industrial metals, copper is the most influential and it is extending its ranging upward trend.”

Source: David Fuller, Fullermoney, December 31, 2009.

CNBC: Jim O’Neill - recovery will be stronger than forecast
“The global economic rebound is likely to be even stronger than many have anticipated and developed markets have the potential to outperform emerging markets, Jim O’Neill, head of global economic research at Goldman Sachs, told CNBC Tuesday [January 5] .”

Source: CNBC, January 5, 2010.

Financial Times: Rise in factory orders spurs markets
“Manufacturers around the world are at their most optimistic for almost four years after booking a sharp rise in new orders in December as Asia’s recovery spread to the US and Europe.

“Surveys of purchasing managers from China to Europe and the US in the final month of 2009 released on Monday [January 4] exceeded expectations, sending stock markets higher in advanced economies.

“Across the world, the combined scores of national purchasing managers’ indices, compiled by JP Morgan, rose to 55 in December, the highest since April 2006, with the index for new orders at a 5½ year high.

“Manufacturers’ intentions on employment rose above 50 for the first time since March 2008, signalling that the brutal shake-out of factory jobs over the past two years is coming to an end.

“David Hensley of JP Morgan said: ‘If a rebound in the manufacturing labour market can be maintained, this should aid with sustaining the broader recovery.’

“The surveys have long been good predictors of manufacturing output, the most volatile part of the economy.

“Although there were a few pockets of gloom, notably Australia and Spain, the strength of Asia’s recovery was underlined by sharply better sentiment in China and India, and steady improvements in South Korea and Taiwan. Brighter prospects were also recorded in the US, UK and the eurozone. The US Institute of Supply Management manufacturing report stood at 55.9 in December, its highest since April 2006.”

Source: Chris Giles, Financial Times, January 4, 2010.

CNBC: John Taylor on the real crisis culprit
“Insight on whether monetary policy is not the problem, with John Taylor, Stanford University economics professor.”

Source: CNBC, January 7, 2010.

Reuters: Rate hikes not best way to burst bubbles - Bernanke
“Federal Reserve Chairman Ben Bernanke said on Sunday that vigorous financial regulation would have been the best way to restrain the housing bubble that helped cause the deep recession, but said policy makers can no longer rule out monetary policy to curb the buildup of risk.

“In a speech defending the Fed’s rock-bottom interest rates in the early 2000s, a policy many say fueled a runaway housing boom that triggered a devastating crisis when it went bust, Bernanke said regulatory and supervisory actions, rather than rate hikes, would have been more effective ways to check the run-up in house prices.

“Bernanke and the Fed face sharp criticism over actions leading up to the crisis. Bernanke’s renomination as Fed chairman faces an unusual degree of opposition, and the Fed’s responsibilities stand to be curtailed if congressional proposals become law.

“Bernanke said, however, in a speech to the American Economic Association, that policy makers can no longer eliminate rate increases from their arsenal to prevent future crises.

“‘If adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplemental tool for addressing those risks,’ he said.

“Bernanke conceded that efforts by the Fed and other regulators beginning in 2005 came too late or were insufficient to slow the housing bubble.

“‘The lesson I take from this experience is not that financial regulations are ineffective for controlling emerging risks, but that their execution must be better and smarter,’ he said.

“The US Senate is poised to begin debate over financial rules reforms that would peel away the Fed’s authority for regulating large financial firms. The US central bank would be charged instead with focusing on monetary policy.

“Bernanke and other Fed officials have argued that such a change would hurt the Fed and oversight of the system in general by removing a crucial monitor from the pulse of the financial system.

“Analyzing the Fed’s decisions to keep rates low for an extended period in the early 2000s, the Fed chairman argued that those policies were a response to the worry about a possible deflationary spiral that hobbled the Japanese economy through much of the previous decade.

“Bernanke pointed to adjustable-rate mortgages and overconfidence that house prices would continue to rise as the main culprits behind the catastrophic housing bubble.”

Source: Mark Felsenthal, Reuters, January 3, 2010.

Time: Pimco’s Bill Gross sees 2010 as year of reckoning
“Pimco managing director Bill Gross not only oversees the world’s biggest bond fund, his views often sway markets. In a late December interview with TIME’s John Curran, Gross pointed to the second half of 2010 as a period when investors large and small will reckon with a new reality of poor economic growth and a Federal Reserve that is hard pressed to offer much help.

TIME: Where do you see the economy going over the next 6 to 12 months?
Bill Gross: The economy should be relatively strong in the first half of 2010 then weaken in the second half. That’s not to say we’ll return to recession but we’ll see weakness as opposed to a continuation of what will probably be a decent first half.

What will make the first half of 2010 so good?
The first half will be dominated by government stimulus and by inventory accumulation or a lack of [inventory] liquidation among businesses. I expect nothing from consumer [spending] and nothing really from housing or really any of the standard cyclical leading sectors. It’s hard to put a number on GDP growth rates, but let’s say 4% in the first half and then 2% in the second half, which would basically call for some additional help.

You’re talking about a second shot of federal stimulus?
Yes, something else is probably needed if the [government's] thrust is really reducing unemployment below double digits and re-normalizing the economy.

What does this say about the Federal Reserve’s hopes to start pulling its added liquidity out of the markets, either by raising short-term rates or just getting out of buying bonds, which has been keeping long rates low?

I think the Fed’s statements suggest that they really want to exit in some fashion from the buying program. The first step in that direction, logically, would be to stop buying and our sense is that they’re at least going to try that. But based on our forecasts for the second half of the year they may have to re-initiate it, and that will be difficult to do once they stop because it then becomes a political hot potato.

All that said, I think they’ll stop buying mortgage agency securities, and the trillion-and-a-half dollar check that’s been written over the past 9 to 12 months basically disappears. It’s significant from the standpoint of interest rates and interest rate spreads in certain sectors. And I would even go so far as to say it might be a mistake.

Because they might have to restart the buying program later?
Yes, I think the Fed wonders about this as well. But you have to understand that the Fed’s probably under political pressure - such as the hearings for new regulation of the Fed, the growing public unease about the supersized Fed balance sheet, etc. The Fed’s expanded balance sheet is not something that I consider to be a problem, but I think the market does - and so the Fed will probably be working in the direction of pulling some of the liquidity out of the marketplace. They won’t sell - it’s a near impossibility to unload what they’ve purchased over past 12 months. But they’ll at least stop buying.

Won’t that put upward pressure on interest rates?
I think it will. I mean the mortgage market would be your first place to look in terms of something that’s overvalued that would become normalized. Nobody knows what the Fed’s buying is worth - we think about half a percentage point on rates, but we don’t know.”

Click here for the full article.

Source: John Curran, Time, January 5, 2010

Bloomberg: Krugman sees 30-40% chance of US recession in 2010
“Nobel Prize-winning economist Paul Krugman talks with Bloomberg’s Steve Matthews about likelihood the US economy will slide into a recession during the second half of the year as fiscal and monetary stimulus fade. Krugman, an economics professor at Princeton University, also said the Federal Reserve’s plan to end purchases of $1.25 trillion of mortgage-backed securities and about $175 billion of federal agency debt in March could spur an increase in mortgage rates and lead to declines in home sales and prices.”

Source: Bloomberg, January 4, 2010.

MoneyNews: Rosenberg - economy is in post-bubble collapse
“David Rosenberg, chief economist for Gluskin Sheff & Associates, takes issue with the consensus view that a sustained economic recovery has begun.

“‘We are in a post-credit bubble credit collapse that is ongoing,’ he writes on The Big Picture.

“And that doesn’t bode well for financial markets, though the recent rally might continue for a while, Rosenberg says.

“‘Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.’

“Economists err in calling this downturn ‘The Great Recession’, Rosenberg writes.

“‘This is truly a gentle way of saying ‘Depression.”

“So first we must acknowledge that we indeed experienced a depression.

“‘Then … we can draw a conclusion that a sustainable recovery will not get under way until the ratio of household credit to personal disposable income reverts to the mean - and goes to an excess in the opposite direction,’ Rosenberg says.

“‘I know it sounds harsh, but we shall endure - believe it. Transition is rarely without pain.’”

Source: Dan Weil, MoneyNews, January 5, 2010.

Bloomberg: Stiglitz says Wall Street “talking up” recovery
“Nobel laureate Joseph Stiglitz said investors are ‘talking up’ signs of a global economic recovery in a bid to boost equities.

“‘Wall Street is talking up the recovery because it would like to sell stocks,’ Stiglitz told reporters at a conference in Paris today [Thursday, January 7].

“The MSCI World Index of stocks has surged 73% since its low of last March even while the economies of advanced nations grow below their potential rates following the worst recession since the Great Depression.

“Stocks are rallying because interest rates are low and companies have been cutting costs by reducing payrolls, factors that suggest economies remain weak, said Stiglitz, a professor at Columbia University in New York.

“‘Whenever rates are low, stock markets are often high,’ he said. By contrast, economists are ‘almost universally pessimistic’.

“Speaking at the conference, Stiglitz said US regulators haven’t done enough to address the risks posed by large banks, derivatives and executive compensation.

“He recommended a tax be introduced on financial speculation as a way of generating revenue and forcing investors to focus on the longer-term.”

Source: Isabelle Mas and Simon Kennedy, Bloomberg, January 7, 2010.

Asha Bangalore (Northern Trust): Minutes of December FOMC meeting
“The FOMC left the federal funds rate unchanged at the close of the December FOMC meeting. There is little doubt about the Fed staying on hold in the first-half of 2010. There are different points of view about when the Fed will start reducing the monetary accommodation in place. It is too early to find hints in the minutes about when the Fed is likely to implement a change of course in its monetary policy stance. The minutes of the December deliberations show varying points of view among the members of the FOMC on different aspects about the economy and monetary policy.

“Most members agreed that incoming economic data was consistent with forecast of growth and inflation envisioned in the November meeting. Employment conditions were seen to improve only gradually in 2010, in line with previous recoveries following a financial crisis. There appeared to be a broad consensus about the weakness in underlying labor market conditions. In addition to the high unemployment rate, members noted that the significant decline in production hours and the drop in the employment-population ratio as raising concern about the labor market.

“In the residential real estate sector, although home prices were showing signs of stability and sales and construction had moved up from their cycle lows, the improvements were seen as tentative. The expiration of the home buyer tax credit program in April 2010, likelihood of additional foreclosures leading to lower home prices, and the possibility of pressure in mortgage markets as the Fed winds down the mortgage securities purchase program were seen as factors that could create unfavorable conditions in the housing sector once again.

“There were three opinions pertaining to inflation. The significant slack in labor and product markets and contained inflation expectations were seen as factors helping to keep inflation subdued in the near term. Most members agreed about the forces keeping inflation under control but seemed to differ about the relative role that each would play. Inflation expectations have moved up in recent weeks and are holding at levels below the mark seen prior to the onset of the crisis in August 2007.

“There were mixed views about the monetary accommodation necessary in the future, which is evident in the following excerpt:

‘A few members noted that resource slack was expected to diminish only slowly and observed that it might become desirable at some point in the future to provide more policy stimulus by expanding the planned scale of the Committee’s large-scale asset purchases and continuing them beyond the first quarter, especially if the outlook for economic growth were to weaken or if mortgage market functioning were to deteriorate. One member thought that the improvement in financial market conditions and the economic outlook suggested that the quantity of planned asset purchases could be scaled back, and that it might become appropriate to begin reducing the Federal Reserve’s holdings of longer-term assets if the recovery gains strength over time.’

“All in all, 2010 will be a year of challenges for Fed and other policymakers.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 6, 2010.

Reuters: US Fed’s Duke sees low rates for “extended period”
“The US Federal Reserve sees a moderate economic recovery continuing in 2010, but needs to keep interest rates ‘exceptionally low’ for an ‘extended period’ to foster job growth, a Fed policymaker said on Monday.

“Fed Governor Elizabeth Duke told an economic forum that slack in the economy was likely to remain above historical norms for some time, helping to keep inflation subdued.

“‘In the current environment, the FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period,’ Duke said, referring to the US central bank’s policy-setting Federal Open Market Committee.

“‘Such policy accommodation is warranted to provide support for a return over time to more desirable levels of real activity and unemployment in the context of price stability.’

“Fed watchers have focused on any changes in that language for clues to the timing of a possible tightening of monetary policy as the economy recovers. The FOMC maintained the ‘extended period’ stance in its last statement on December 15.

“In remarks to the Economic Forecast Forum in Raleigh, North Carolina, Duke said recent data on production and spending suggested that economic activity continued to increase at a ’solid rate’ during the final months of 2009 after real GDP turned positive in the third quarter.

“‘I expect to see a continued moderate recovery in economic activity in 2010, supported by a further healing in financial markets and accommodative monetary policy,’ Duke said.

“But echoing comments by Fed Vice Chairman Donald Kohn in Atlanta on Sunday [January 3], Duke said constraints on lending would slow recovery.”

Source: David Lawder, Reuters, January 5, 2010.

Bloomberg: Hoenig says Fed should eventually lift main rate to 3.5%- 4.5%
“Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank should move ’sooner rather than later’ to reduce stimulus, with a goal of eventually boosting the benchmark interest rate to ‘probably between 3.5 and 4.5 percent’.

“‘The process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later,’ Hoenig, who votes on monetary policy decisions this year, said today in a speech in Kansas City.

“‘Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment - not today, perhaps, but in the medium- and longer-run.’

“Policy makers are considering how to exit from unprecedented stimulus and emergency credit programs amid signs the US economy is rebounding. They pledged at the end of their December 15-16 meeting to complete $1.25 trillion in purchases of mortgage securities and $175 billion of agency debt by the end of March, while holding the benchmark interest rate in a range of zero to 0.25 percent for an ‘extended period’.

“‘The Federal Reserve must curtail its emergency credit and financial market support programs, raise the federal funds rate target from zero back to a more normal level, probably between 3.5 and 4.5 percent, and restore its balance sheet to pre-crisis size and configuration,’ Hoenig said in remarks prepared for a speech to the Central Exchange, a group that promotes leadership development opportunities for women.

“Hoenig said he disagrees with economists who forecast the economy may falter and predicted growth will exceed 3 percent this year.

“‘Fiscal and monetary stimulus will continue to provide major support to the economy,’ he said. ‘Much of the fiscal stimulus package announced last year will have its impact in 2010, and it might well be more substantial than initially projected due to delays in implementing spending programs.’”

Source: Steve Matthews, Bloomberg, January 7, 2010.

Asha Bangalore: ISM non-manufacturing survey results show improvement
“The ISM non-manufacturing survey results showed an improvement in the service sector, with the composite index climbing to 50.1 in December from 48.6 in the prior month. The index measuring new orders slipped 3 points to 52.1 in December but the level denotes an expansion in activity.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 6, 2010.

Asha Bangalore (Northern Trust): Factory sector survey sends a strong positive signal
“The ISM manufacturing survey results of December indicate a noteworthy gain across several fronts. The composite index moved up to 55.9 in December from 53.6 in the prior month. The composite index has recorded readings above 50.0 for five straight months. Index readings above 50.0 denote an expanding sector. Indexes measuring new orders (65.5 vs. 60.3 in Nov.), production (61.8 vs. 59.9 in Nov.), employment (52.0 vs. 50.8 in Nov.), and supplier deliveries (56.6 vs. 57.7 in Nov.) advanced in December.

“The index tracking inventories (43.4 vs. 41.3 in November) is gradually moving toward the 50.0 mark. The cycle low was the 30.8 reading in June 2009. The new orders index in December (65.5) is the highest since April 2004.

“The significant and positive correlation (0.73) between the composite index and the year-to-year change in real GDP suggest that an impressive headline reading of GDP for the fourth quarter should not be surprising.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 4, 2010.

Asha Bangalore (Northern Trust): Factory inventories advance, noteworthy revision of shipments of non-defense capital goods
“Orders of factory goods rose 1.1% in November after a 0.8% gain in the prior month. Bookings of durable goods increased 0.2% and that of non-durables were up 1.1%, partly due to higher prices for food and petroleum items. The highlights of the report were the upward revision of shipments of non-defense capital goods excluding aircraft of November and the upward revision of inventories for October. The upward revision of shipments of non-defense capital goods excluding aircraft is a plus for the fourth estimate of equipment and software component of fourth quarter real GDP.

“At the same, the 0.2% increase in inventories in November and the upward revision of October estimates of inventories point to inventory liquidation being less of a drag in the fourth quarter. In other words, this reports presents a small upside risk to the headline reading of fourth quarter real GDP.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 5, 2010.

Asha Bangalore (Northern Trust): Pending Home Sales Index declines
“The Pending Home Sales Index (PHSI) plunged 16% in November, reflecting the temporary impact of the home buyer tax credit program. Sales of homes surged prior to the original expiration date (November 30, 2009) of the first-time home buyer tax credit program in order to beat the deadline. The program has been extended to April 30, 2010 and it is likely that the PHSI index following this extension will show a rebound.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 5, 2010.

Asha Bangalore (Northern Trust): Hiring freeze yet to thaw
“The unemployment rate held steady at 10.0% in December. The average jobless rate for 2009 is 9.3% vs. 5.8% in 2008. The October jobless rate was revised to 10.1% following annual revisions, which is a new cycle high reading; it was previously reported as 10.2%. The broader measure of unemployment which includes the number looking for working, discouraged workers, and those seeking full-time employment but able to find only part-time employment rose to 17.3% from 17.2% in November. The cycle high is 17.4% in October 2009.

“The labor force fell 1.07% from a year ago, the largest decline since June 1951. The participation rate and employment-population ratio continue to show a downward trend. The employment-population ration fell to 58.2 in December from 58.5 in the prior month. As the economy moves along the recovery path, folks who have left the labor force will gradually resume hunting for employment, which is most likely to keep the jobless rate at an elevated level.

“Non-farm payrolls declined 85,000 in December, after a revised gain of 4,000 jobs in November. The revisions of October-November data result in a net loss of 1,000 jobs. The bulk of the loss in employment was in the goods sector (-81,000), while the services sector recorded a loss of 4,000 jobs. A total of 7.242 million jobs have been lost since the recession commenced in December 2007.

“Conclusion: The details and tone of the December employment report indicate that labor market conditions remain bothersome. A meaningful pace of hiring is unlikely in the next few months given the structural unemployment in the economy, the shortened workweek, and large number of part-time workers. In other words, the December employment report reinforces expectations of the FOMC on hold in the near term.

“The FOMC will need to ensure that a self-sustained economic recovery in underway before it can tighten monetary policy and justification for its actions in the current politically charged environment has to be rock solid. Therefore, the Fed is unlikely to undertake a reduction of monetary accommodation until the unemployment rate has peaked. In the jobless recoveries following the 1990-91 and 2001 recessions, the Fed waited it was abundantly clear that the unemployment rate had peaked before implementing a tightening of monetary policy, despite gains of real GDP for several quarters. The unemployment rate peaked at 7.8% in June 1992 and the Fed raised the federal funds rate only in February 1994 when the unemployment rate has declined to 6.6%. After the 2001 recession, the Fed held the funds rate at 1.00% between June 2003 and June 2004 during which period the unemployment had dropped to 5.6% from 6.3%.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 8, 2010.

Asha Bangalore (Northern Trust): Total continuing jobless claims post new high
“Initial jobless claims were virtually unchanged at 434,000 during the week ended January 2 compared with the 433,000 reading of the previous week. Continuing claims, which lag initial claims by one week, fell 179,000 to 4.802 million. The insured unemployment rate declined to 3.6% from 3.8% in the prior week.

“Total continuing claims which include seasonally adjusted continuing claims (4.981 million for the week ended 12/19) and not seasonally adjusted claims under emergency programs (5.44 million) climbed to 10.42 million for the week December 19 (continuing claims under emergency programs lag initial jobless claims by two weeks).

“The initial jobless claims numbers indicate that the pace of layoffs has slowed but total continuing claims suggest that firms remain reluctant to hire and the budgetary costs of unemployment insurance continue to advance.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 7, 2010.

Clusterstock: Welcome to the jobless manufacturing recovery
“Manufacturing employment was smashed by the recent economic downturn, and remains down 18% vs. two years ago (when things began to tank) according to employment data released by ADP.

“Yet the Federal Reserve’s manufacturing output index has begun to recover. Either we’re currently experiencing a jobless (at best job-lite) recovery or the hiring is just around the corner.”

Source: Vincent Fernando and Kamelia Angelova, Clusterstock - Business Insider, January 6, 2010.

Clusterstock: How the government payroll replaced goods-producing jobs
“In the just-so story of the evolution of our economy, our old manufacturing based economy has been replaced by an innovative knowledge economy. That’s not quite true.

“In fact, the decline of the jobs in goods producing sectors of the economy - construction, manufacturing, mining and agriculture - has largely been met with an increase in jobs on the government payroll. We’ve gone from providing jobs in profit-making private industry to providing jobs in profit-eating government work. Toward the end of 2007, the total number of government jobs exceeded the total number of goods producing jobs. Welcome to the government payroll economy.”

Source: John Carney and Kamelia Angelova, Clusterstock - Business Insider, January 5, 2010.

Asha Bangalore (Northern Trust): Auto sales advanced in December, but declined in Q4
“Auto sales rose in December to an annual rate of 11.2 million units vs. a sales pace of 10.9 million in November. Attractive year-end incentives helped to push sales in December. However, the auto sales average in the fourth quarter was 10.9 million units compared with 11.5 million units sold in the third quarter. Therefore, despite an increase in auto sales during December, consumer spending is most likely to post an increase around 2.0% in the fourth quarter following a 2.8% annualized gain in the third quarter.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 5, 2010.

MoneyNews: Huffington - send Obama a message, shun big banks
“Moving your money from bailout banks into smaller, more local, more traditional community banks can help stabilize the financial system, Arianna Huffington says.

“‘Think of the message it will send to Wall Street - and to the White House,’ Huffington writes in The Huffington Post.

“‘That we have had enough of the high-flying, no-limits-casino banking culture that continues to dominate Wall Street and Capitol Hill,’ Huffington writes. ‘That we won’t wait on Washington to act, because we know that Washington has, in fact, been a part of the problem from the start.’

“Since April, the Big Four banks - JP Morgan/Chase, Citibank, Bank of America, and Wells Fargo - all of which took billions in taxpayer money, have cut lending to businesses by $100 billion, Huffington points out.

“‘The government policy of protecting the Too Big and Politically Connected to Fail is badly hurting the small banks, which are having a much harder time competing in the financial marketplace,’ Huffington says.

“‘As a result, a system which was already dangerously concentrated at the top has only become more so.’”

Source: Julie Crawshaw, MoneyNews, January 4, 2010.

Financial Times: Top banks invited to Basel risk talks
“The Bank for International Settlements will gather top central bankers and financiers for a meeting in Basel this weekend amid rising concern about a resurgence of the ‘excessive risk-taking’ that sparked the financial crisis.

“In its invitation, the BIS cited concerns that ‘financial firms are returning to the aggressive behaviour that prevailed during the pre-crisis period’.

“The BIS, known as the central banks’ bank, outlined in a restricted note to participants some specific proposals that it believes could create a healthier financial system. Those proposals include lowering return-on-equity targets for the banks as a way to discourage such risk taking.

“Private sector bank chiefs attending the meeting at the BIS in Basel include Larry Fink of BlackRock, Vikram Pandit of Citigroup, and John Stumpf of Wells Fargo.

“Lloyd Blankfein, Goldman Sachs chief executive, and Jamie Dimon, chief executive of JPMorgan Chase, were invited but are not planning to attend.

“The meeting comes at a moment of intense uncertainty, with the global economy’s tentative recovery shadowed by ‘the overhang of private-sector debt and rapidly rising public debt’, and high unemployment.

“‘The concern here is that the prolonged assurance of very cheap and ample funding may encourage excessive risk-taking,’ the BIS invitation note says.”

Source: Henny Sender, Financial Times, January 6, 2010.

Financial Times: US public pensions face $2,000 billion shortfall
“The US public pension system faces a higher-than-expected shortfall of more than $2,000 billion that will increase pressure on many states’ strained finances and crimp economic growth, according to the chairman of New Jersey’s pension fund.

“The estimate by Orin Kramer will fuel investors’ concerns over the deteriorating financial health of US states after the recession. ‘State and local governments are correctly perceived to be in serious difficulty,’ Mr Kramer told the Financial Times.

“‘If you factor in the reality of these unfunded promises, their deficits will rise exponentially.’

“Estimates of aggregate funding requirement of the US pension system have ranged between $400 billion and $500 billion, but Mr Kramer’s analysis concluded that public funds would need to find more than $2,000 billion to meet future pension obligations.

“A shortfall of that size could force state governments to take unpalatable decisions such as pouring more public money into their funds or reducing pension benefits. State and local governments have already cut spending to close budget deficits.”

Source: Francesco Guerrera and Nicole Bullock, Financial Times, January 4, 2010.

Rockefeller Institute: States see third consecutive double-digit drop in tax collections
“Tax collections nationwide declined by 10.9% during the third quarter of 2009, the third consecutive quarter during which tax revenues fell by double-digit percentages, according to the latest report from the Rockefeller Institute of Government.

“Combining current data with comparable historical figures from the US Census Bureau, the Institute reported that the first three quarters of 2009 marked the largest decline in state tax collections at least since 1963.

“Western states saw especially sharp declines in tax collections during the third quarter, while revenues fell by more modest levels in the Southeast, New England, Mid-Atlantic, and Plains regions.

“For the fourth quarter of 2009, early data showed continuing declines, although the negative trend of the past year appeared to be moderating. For 38 early-reporting states, personal income taxes fell by 6.5% during October and November while sales tax collections declined by 5.5%.

“‘While the recession may be over for the national economy, it is far from over for the finances of state governments, and many states are still uncertain as to when expect a return to positive revenue growth,’ said report authors Lucy Dadayan, a senior policy analyst at the Rockefeller Institute, and Donald Boyd, a senior fellow at the Institute. ‘Such improved news may begin in the early part of calendar year 2010. However, even if tax collections in the coming year move up from 2009 levels, the depth of the decline over the past two years will almost certainly leave state revenues significantly lower than those of any of the past several years.’”

Source: Rockefeller Institute, January 7, 2010.

David Fuller (Fullermoney): Bond yields on the up
“With the Fed and BoE buying most of the US Treasury and UK Gilts issues month after month, there is only one scenario under which long-term rates would not rise once the central banks complete this form of quantitative easing.

“Basically, for UK 10-Year Yields to retest their lows just beneath 3%, investors would need to anticipate once again the economic depression scenario briefly feared during 1Q 2009. The same would apply to US 10-Year Yields which bottomed at yearend 2008, just above 2%. While I will be guided by the chart action, I see no reason why this should happen, given all the quantitative easing that has occurred. Moreover, I see no technical action to suggest that long-dated yields will fall significantly.

“Instead, I expect long-dated yields to rise over the medium to longer term, although they may temporarily back away from the 4% level before eventually moving higher, reaching at least 5%.

“If correct, this would theoretically make 10-Year T-Bonds and Gilts attractive short-sale candidates. A number of institutional traders, not least hedge fund managers, also hold this view. However these trades are complicated by the presence of large, insider participants in the form of central banks, anxious to prevent yields from rising too quickly. They have deep pockets as a consequence of their unique freedom to print money.

“The Fed and BoE would happily lure speculators into helping them to finance the purchase of their government paper. Consequently, they almost certainly attempt to squeeze shorts from time to time, as the choppy chart action suggests. Therefore timing is critical. For those wishing to short long-dated US and UK debt, I would avoid upside momentum moves in yields and aim to establish shorts within the lower half of the ranges evident. Since one would be using futures, this would mean selling after price rallies towards prior resistance, and either covering on tests of prior support or any evidence of a loss of downside momentum for bond prices.”

Source: David Fuller, Fullermoney, January 5, 2010.

Eoin Treacy (Fullermoney): Bonds - increased supply assured
“Sovereign bond markets are one area of the financial markets where increased supply is practically assured. Nevertheless, prices remain relatively high in a number of markets, due to the distorting influence of central banks, acting as buyers of last, and increasingly first, resort.

“A number of countries share Gilts’ chart pattern. 10-year yields for the UK, USA, Canada, Singapore, South Korea, New Zealand, Australia, South Africa and Norway have all rallied from last year’s lows. Some are pressuring their range highs but the general theme is one of relative yield strength.

“Elsewhere the story is somewhat different. Swiss 10-year yields just tested their 2005 low near 1.8%. The yield jumped back to 2% in the last week and looks likely to form a failed downside break from the previous yearlong range. A sustained move to new lows is now needed to question scope for further upside. The respective price chart hit a 20-year peak in late December and is pulling back from the area near 138. A sustained move to new high ground would be required to question potential for some further weakness.

“Swiss bonds price action is notable but the same pattern, although less emphatic is evident across a large number of continental European bonds The Generic European 10-year found support in the region of 3% early last year but retested the low from September to late December and is currently pressuring the upper side of that range. A downward dynamic would now be required to question potential for some further upside. The Japanese 10-year has a similar pattern.

“Due to the interference of just about every central bank in their respective sovereign debt market, the risk of attempting to trade against them is higher than might normally be the case. This would suggest that the lowest risk time to short government bond futures is following major advances such as in Swiss bonds rather than UK government bonds which have already had a relatively large move.”

Source: Eoin Treacy, Fullermoney, January 6, 2010.

Bloomberg: Pimco cuts US, UK bonds as borrowing increases
“Pacific Investment Management Co., which runs the world’s biggest bond fund, is cutting holdings of US and UK debt as the two nations increase borrowing to record levels.

“Pimco is ‘more cautious’ on corporate bonds and holds fewer mortgage-backed securities than the percentages in the benchmarks it uses to gauge performance, wrote Paul McCulley, a portfolio manager and member of the investment committee, in his 2010 outlook. The company is also underweight Treasury Inflation Protected Securities, according to the report on Newport Beach, California-based Pimco’s website.

“‘This all leaves us with portfolios that appear, more than at other times, to be hugging the benchmarks with no bold positioning,’ McCulley wrote. ‘We’re making a very active decision to run light on risk.’

“Yields, which move opposite to prices, will rise in the US and the UK this year, according to Bloomberg surveys of economists. Treasuries fell 3.7 percent in 2009, the most in more than three decades, according to indexes compiled by Bank of America’s Merrill Lynch unit, as the US increased debt sales to snap the biggest economic slump since the 1930s. UK gilts fell 1.3 percent last year, the indexes show.

“Yields will climb to 3.97 percent by year-end, according to a Bloomberg survey, with the most recent forecasts given the heaviest weightings. U.K. 10-year rates will advance to 4.31 percent from today’s 4.01 percent, a separate survey showed.

“Under what Pimco has termed the ‘new normal’, investors will face lower-than-average returns with heightened government regulation, lower consumption, slower growth and a shrinking global role for the US economy.”

Source: Wes Goodman, Bloomberg, January 4, 2010.

Bespoke: High yield bonds continue to do well
“Over the past month or so, the only area of the bond market that has done well is junk. Both Treasuries and investment grade corporates have struggled, while high yield bonds have continued to surge. Below we highlight a six-month performance chart of the high yield bond ETF (HYG) and the investment grade corporate bond ETF (LQD). As shown, HYG is up 18.17% over the last six months, while LQD is only up 5.50%. You can see a clear split in performance (shaded in gray) at the start of December, where HYG continued to trade higher and LQD began to trade lower.”

Source: Bespoke, January 7, 2010.

Bespoke: Final 2010 strategist predictions
“Below is a list of the 2010 S&P 500 year-end price targets of major Wall Street strategists as surveyed by Bloomberg prior to the first trading day of the new year. As a whole, strategists are looking for a year-end price of 1,225 for the S&P 500, which translates into a gain of 9.82%. Deutsche Bank’s Binky Chadha has the highest target at 1,325, while Barclays’ Barry Knapp has the lowest at 1,120. All strategists are forecasting a 2010 gain.”

Source: Bespoke, January 5, 2010.

Bloomberg: Pessimism on US stocks drops to lowest since 1987
“Pessimism about US stocks among newsletter writers fell to the lowest level since April 1987, six months before the equity market crash known as Black Monday, following the biggest rally in the Standard & Poor’s 500 Index in seven decades.

“The proportion of bearish publications among about 140 tracked by Investors Intelligence fell to 15.6 percent yesterday from 16.7 percent a week earlier. Sentiment has improved since October 2008, when the financial crisis drove the figure to a 14-year high of 54.4 percent. After plunging 38 percent in 2008, the S&P 500 has risen 25 percent this year.

“Some analysts consider lower pessimism a sign stocks will stop advancing, under the theory that there are fewer bearish investors left to change their minds and purchase shares. The S&P 500 plunged 20 percent on October 19, 1987.

“‘Wow, I know things are better than they were one year ago, but are they so dramatically better with little downside risk?’ Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York, wrote in an e-mail to clients today. ‘Combine this sentiment reading with the VIX at 20 and 2010 will be interesting, especially with the very likely prospect of higher interest rates.’

“The VIX, as the Chicago Board Options Exchange Volatility Index is known, is posting a record annual drop as investors pay less for protection from declines in the S&P 500. It has fallen 75 percent since a record high of 80.86 in November 2008. The dollar climbed to a three-month high against the yen today on speculation the Federal Reserve will withdraw stimulus measures as the economy recovers.

“The percentage of surveyed newsletter writers who are bullish declined to 51.1 percent from 52.2 percent. Advisers expecting a correction, or 10 percent retreat, rose to 33.3 percent from 31.1 percent. Investors Intelligence, based in New Rochelle, New York, has examined forecasts in newsletters since 1963.

“When the S&P 500 and Dow Jones Industrial Average climbed to records in October 2007, the bullish percentage was 62 percent. The S&P 500 fell 57 percent from that record to a 12- year low of 676.53 on March 9, 2009. The benchmark index has since rebounded 67 percent to 1,126.42.”

Source: Nikolaj Gammeltoft, Bloomberg, December 31, 2009.

CNBC: Mobius - bull run at risk of 20% corrections
“Stocks are still in the grip of a secular bull market, but investors shouldn’t expect the same level of returns seen in 2009 and there is a risk of 20% corrections, Mark Mobius, executive chairman of Templeton Asset Management, told CNBC Thursday [January 7].”

Source: CNBC, January 7, 2010.

John Authers (Financial Times): Bear market rally
“The S&P rally may well be a rally within a bear market.”

Click here for the article.

Source: John Authers, Financial Times, January 5, 2010

David Fuller (Fullermoney): Stock markets remain in “sweet spot”
“… we remain bullish of Fullermoney themes - Asian-led emerging markets, South American-led resources markets and information technology - provided that primary trend consistency and momentum is maintained. We also remain bullish of commodities.

“How do we reconcile these bullish themes with the ‘awful’ economic background, at least for many OECD countries? Easily, for the time being, because even the worst affected economies are showing some evidence of recovery, and crucially, monetary policy remain extremely positive. What I fear is strong and / or synchronised global economic recovery, which would compete for liquidity currently flowing into stock markets and commodities, at a time when central banks would have little excuse not to tighten monetary conditions.

“Stock markets move in cycles, for which monetary policy is often the crucial influence, not least near turning points. Stock markets are also discounting mechanisms and the better they do now - they are doing very well - the more they will have discounted future economic recovery. Recognising this, more companies will rush to raise capital in the form of IPOs and secondary offerings, adding to the supply of equities which will eventually overwhelm demand as the easy money conditions dry up.

“Today, we remain in what I have previously described as a ’sweet spot’ in terms of opportunity. Enjoy it while it lasts, in the certain knowledge that it won’t last. No market trend ever does. I do not know how long these uptrends in equities and commodities will last and neither does anyone else because the outcome depends on events, not least eventual changes in monetary policy, among the known unknowns. Fortunately, this is something that we can monitor on a daily basis, along with our guiding price charts.”

Source: David Fuller, Fullermoney, January 6, 2010.

MoneyNews: Faber - buy stocks, US investments in 2010
“Choose US investments over emerging markets and buy stocks, not bonds, advises Gloom, Boom and Doom investment letter editor Marc Faber.

“‘My feeling is that the US will outperform emerging economies in the first six months of 2010,’ Faber told CNBC.

“‘Whether the outperformance comes because markets continue to move up or because the S&P goes down less than emerging stock markets … is debatable.’

“Faber believes that putting money into Treasurys is the worst thing investors can do for the long-term.

“‘More forecasters are very negative about Treasury bonds,’ Faber says.

“A year ago, when the yield on 10-year Treasuries dropped to 2.08 percent, the bullish sentiment on bonds was very high, Faber notes. ‘That was the perfect time to short US government bonds,’ he says.

“Government leveraging will continue to cause problems for investors, Faber says, even though the private sector has been de-leveraging.

“‘When it becomes apparent that the economy is not very strong, the Fed will continue to monetize,’ he says, thus causing inflation that will be bad for government bonds but relatively good for equities.

“‘I think 2010 will be a year of capital preservation because I expect a lot of volatility,’ Faber says.”

Source: Julie Crawshaw, MoneyNews, January 4, 2010.

Financial Times: Bill Miller - GDP boost for US stocks
“The US stock market could rise by as much as 20 per cent this year because markets are underestimating potential GDP growth, says Bill Miller, chairman of Legg Mason Capital Management.

“He believes a big restocking of inventories will help drive the US recovery. ‘The fall in industrial output seen in the US has far exceeded the actual drop in demand, the shortfall having been made up from inventories. I expect to see a rapid restocking by US companies that will stimulate a sharp rise in economic growth over several quarters,’ he says.

“The US economy will grow by 2.6 per cent this year, according to consensus estimates, and by 2.7 per cent according to the Federal Reserve - but Mr Miller believes there is a ‘good chance’ that growth will be higher, and possibly as high as 8 per cent.

“He also believes that equities are ‘extremely undervalued’ compared to bonds. He says US stocks are delivering earnings consistently above expectations and nearly always do well in the decade following a period of negative returns. ‘Every time stocks have performed poorly for 10 years, they have performed better than average for the next ten years and have beaten bonds every time by an average of two to one,’ he notes.

“Mr Miller says technology and financials are the sectors most likely to benefit from any upturn.”

Source: Bill Miller, Financial Times, April 2009.

Bespoke: Average P/E ratio by decade
“Even as some would have you believe that you have to be insane to buy stocks heading into 2010, there are many positive factors that investors can point to as reasons to be bullish. However, one that you won’t hear being cited is valuation. Based on trailing earnings, the average P/E ratio of the S&P 500 during the decade that just ended was higher than any other decade in its history. Even after declining since the turn of the century, the average P/E ratio for the ’00s rose to a record high of 20.2, and at the end of December ‘09 it stood at 27.9 (on an operating basis).

“Before rushing to hit the sell button, however, investors should be aware that the currently stratospheric P/E ratio of the S&P 500 is skewed by the negative quarterly results in Q4 2008 ($-0.09). That number will be replaced by an estimate of $16.73 in Q4 ‘09, which would drop the P/E ratio to a still lofty, although relatively more reasonable level of 20.1 times. What the bulls are really banking on, though, is strong results throughout 2010. Based on current forecasts from S&P, analysts are expecting S&P 500 earnings to rise to $74.98 per share in 2010. With the S&P 500 currently trading at 1,130, the P/E ratio on a forward basis comes all the way down to a much more manageable 15 times. Now all the companies have to do is deliver.”

Source: Bespoke, January 5, 2010.

Jeffrey Saut (Raymond James): Lessons
“Last Monday we wrote, ‘As we enter the New Year, we are once again turning cautious because the Treasury market is breaking down (higher rates) and the US dollar is rallying. Therefore, we think it prudent to ‘bank’ some trading profits and hedge some investment positions as we approach the new year.’

“Moreover, one of the lessons we have learned is that the beginning of a new year is often punctuated with head fakes, both on the upside as well as the downside. One of the greatest upside head fakes was in January 1973 when in the first two weeks of that year the DJIA rallied to a new all-time high of 1051.70 before sliding ~20%. While we are clearly not predicting that, what we have indeed experienced since the March ‘lows’ is the second greatest percentage rally (69%), adjusted for time (nine months), since the 1933 rally. Following that 1933 explosion of 116% in just five months came a pretty decent downside correction. Since we tend to be ‘odds players’, prudence suggests some caution is again warranted.”

Source: Jeffrey Saut, Raymond James, January 4, 2010.

Reuters: US stock trading volume hits 19-month low in December
“The volume of stocks traded in the United States hit a 19-month low in December and fell more than 14 percent from 2008 as investors shifted from equities to other assets.

“Average daily volume for the New York Stock Exchange, Nasdaq, NYSE Arca and NYSE Amex fell to 7.4 billion shares in December, down 14.3 percent from November and down 14.6 percent from December 2008, Sandler O’Neil Partners said in a research report on Monday.

“It was the lowest volume since May 2008 when 6.8 billion shares traded hands.” Source: Rodrigo Campos, Reuters, January 4, 2010.

Bespoke: S&P 500 sector technicals
“Below we provide our six-month trading range charts for the S&P 500 and some of its sectors. For each chart, the red zone represents between one and two standard deviations above the 50-day moving average, and vice versa for the green zone. Throughout the entire bull market, the S&P has been moving in an upward sloping trend channel, bouncing from its 50-DMA to the top of its red zone. As shown below, the S&P 500 is currently trading close to extreme overbought territory, but it’s not quite at the level that would suggest an immediate reversal.

“On the most recent rally to new highs, the defensive sectors (Health Care, Utilities, Telecom and Consumer Staples) have traded flat to down, while the cyclical sectors have picked back up. Energy and Materials have really moved up and are now trading at the very top of their ranges. The Financial sector has broken out of its short-term downtrend, and its move has really helped the overall market over the last week. Technology has been and remains in overbought territory, but it has yet to show signs that a pullback is imminent.”

Source: Bespoke, January 6, 2010.

Financial Times: Yen slides on finance minister’s U-turn
“Naoto Kan, Japan’s newly appointed finance minister , abruptly reversed his predecessor’s currency strategy immediately on taking office on Thursday, with his call for a weaker yen provoking an immediate sell-off in global markets.

“Mr Kan used his first press conference to express his support for a weaker yen and further stimulus measures to revive Japan’s economic health in a marked departure from Hirohisa Fujii, who stepped down earlier this week.

“‘It would be good if the yen would weaken a little more,’ said Mr Kan.

“His comments are likely to be welcomed by the business community, which relies heavily on exports.

“The yen, which rose to a high of Y86 against the dollar in late November, on Thursday weakened on Mr Kan’s comments, slipping at one point to Y92.90 against the US dollar.

“Mr Kan noted that many in the business community believed an appropriate level for the yen was about Y95 to the US dollar.

“He said: ‘We have to work to bring the exchange rate to an appropriate level, including co-operating with the Bank of Japan.’

“Mr Kan also suggested there would be pressure on the central bank to ease monetary policy further should the yen strengthen.

“Japan has not intervened in the foreign exchange market since 2004.”

Source: Michiyo Nakamoto, Financial Times, January 7, 2010.

MoneyNews: Eurozone set to collapse amid economic weakness
“The economic weakness of many members of the 16-nation eurozone has raised fears that the monetary union could crumble.

“Portugal, Ireland, Italy, Greece and Spain, the so-called “Piigs”, especially suffer from sluggish economies and burgeoning debt burdens.

“Credit rating agencies recently downgraded Greece and put Spain on credit watch.

“The rubber will meet the road for the eurozone when economic recovery in Northern Europe, particularly Germany and France, requires the European Central Bank (ECB) to raises interest rates.

“The question is whether the Piggs can weather a rate hike, given that their economies are likely to remain sluggish.

“‘If inflation picks up in France and Germany, the smaller economies will be left behind in stagnation and deflation,’ Jordi Gali, head of the Barcelona Center for Research in International Economics, told The New York Times.

“‘Such an asymmetric recovery is pretty likely. And if the ECB raises rates, it could get very ugly.’

“But many experts fear that governments in the weak economies might be reluctant to take the unpleasant steps necessary to restore fiscal prudence.

“And the weak countries can’t count on a bailout from the ECB.

“‘The ECB has no mandate or intention to take into account the situation of a specific country, especially not with regard to public finances,’ Ewald Nowotny, a member of the ECB’s Governing Council, told The Wall Street Journal.”

Source: Dan Weil, MoneyNews, January 5, 2010.

Bespoke: Commodity snapshot
“Below we highlight our trading range charts for a number of commodities. For each chart, the green zone represents between two standard deviations above and below the commodity’s 50-day moving average. Moves above or below the green zone are considered extremely overbought or oversold.

“Most commodities are trading at or near extreme overbought territory at the moment. Both oil and natural gas are right at the top of their trading ranges, and the same goes for platinum, copper and corn. After moving down to the middle of their ranges at the end of 2009, gold and silver have had a strong start to 2010 as well.”

Source: Bespoke, January 6, 2010.

Richard Russell (Dow Theory Letters): Silver - “poor man’s gold”
“They call it ‘the poor man’s gold’. But don’t turn your nose up at silver. The dollar was originally defined in terms of silver. When precious metals are on the rise (as now), silver tends to be seen as a monetary metal. When times are bad, silver is seen as an industrial metal. Silver has a huge number of industrial uses, silver is the best conductor of electricity. Unlike gold, silver is actually used (and used up) in industry. Thus, a large amount of silver is lost every year. In contrast, 85% of all the gold ever mined in all history is still around; it’s in your teeth or in your sweeties’ bracelet or in that ancient Egyptian ring that you see in your local museum.

“Historically, when silver gets going, it tends to make huge percentage moves. I think you can see that from the long-term chart below. For instance, back in November 2008, silver was selling for 8.65 an ounce. Today an ounce of silver is selling for 18.10 an ounce, more than double.

“Silver is now climbing back from a drastic correction, as you can see via the chart below. In December silver hit a high of over 19 dollars an ounce. Back in 1980 (and I remember this well) silver climbed wildly (limit up day after day), and it hit $50 dollars an ounce around January of 1980.

“Silver is now in an erratic bull market. How high it may go I don’t know, but I would not be shocked to see silver ultimately climb above its 1980 price of $50 bucks an ounce. Historically, once ounce of gold will buy around 15 ounces of silver. Today an ounce of gold will buy 62 ounces of silver. Silver compared with gold is dirt-cheap today.

“How to invest in silver? I like the 100 ounce bars if you can find them (they weigh about 8.5 pounds each). Or buy the 10 ounce bars. Or you can buy the exchange traded fund SLV.

“Yesterday, both gold and platinum closed at new highs for the move. Silver is lagging behind, but when silver finally catches up, it may be a stunner. Over the last year the price of silver doubled; gold didn’t perform that well.

“Below I show a point & figure chart of silver. The white metal is now in a well-established rising trend. The upside target is the 21 box. If silver hits the 22 box, that will light the fuse. If silver hits the 22 box, I will view the whole structure that you see on this chart as one huge base.

“To put it briefly, I like silver. Gold has one advantage over silver, every central bank owns some gold, and most want more.”

Source: Richard Russell, The Dow Theory Letters, January 6, 2010.

Financial Times: Chinese demand drives regional recovery
“Asian exports to China soared at the end of last year according to a slew of data released on Thursday [January 7], suggesting that Chinese demand is emerging as a stronger than expected engine of economic recovery in the region.

“The biggest jump came in South Korea, which said December exports to China jumped 94 per cent compared with the same month a year ago. Taiwan reported a 91.2 per cent jump in the value of shipments for December, and Malaysia said exports jumped 52.9 per cent in November from a year earlier.

“The strong demand from China compared with generally falling exports to the US and Japan, although shipments to the European Union were generally higher. Malaysia said exports to the US fell by 13 per cent, and to Japan by nearly 30 per cent.

“Overall export performance was more mixed, with South Korea reporting a rise of 33.67 per cent and Taiwan up 46.9 per cent while Malaysia was down 3.3 per cent.

“Australia said it suffered a 27.5 per cent drop in exports in November from the same period a year earlier, and New Zealand said exports in the same month were down by 16.7 per cent.

“However, economists said it was becoming clear that China’s strong economic growth in 2009 had generated much stronger consumer demand for Asian products than forecast.

“Frederic Neumann, an economist at HSBC in Hong Kong, said the size of the spike in exports to China in Thursday’s data was in part a reflection of the size of the falls in exports as the global financial crisis developed. However, Mr Neumann said there was ‘plenty of evidence’ that Chinese demand for consumer products such as flat television screens had replaced a large part of the falling demand in North America and elsewhere.”

Source: Kevin Brown and Justine Lau, Financial Times, January 7, 2010.

Nationwide: UK house prices up 5.9% over 2009
“House prices rose by a further 0.4% in December, continuing the recent trend of moderate month-on-month increases. The 3 month on 3 month rate of change - a smoother indicator of the near term price trend - dropped from 2.8% in November to 2.1% in December, as house price increases toward the end of the year moderated in comparison to those seen in the summer.

“At £162,103, the average price of a typical UK property has ended the year 5.9% higher than at the end of 2008. Few could have foreseen this development at the start of the year, when the near term price trend was still pointing to a repeat of the double digit annual decline experienced in 2008. Although house prices are still 12.2% lower than their October 2007 cyclical peak, they have now rebounded by an impressive 8.9% since their February 2009 trough.

“Looking ahead into next year, a number of factors appear key to the outlook for house prices. As ever, the prospects for interest rates will be an important driver. Although house prices remain quite high relative to earnings, the low level of interest rates has led to a significant improvement in mortgage affordability that has supported prices. At this stage, it looks like the Bank of England base rate will not increase until at least the second half of 2010, as the Monetary Policy Committee (MPC) will need to see firmer evidence of economic recovery before it considers increasing the cost of borrowing.”

Source: Martin Gahbauer, Nationwide, December 31, 2009.

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Tags: Asset Classes, BRIC, Canada, Cboe, China, Commodities, Emerging Markets, Employment Report, ETF, Federal Open Market Committee, Festive Season, Fomc, Global Stock Markets, Gold, Gold Bullion, India, Metal 3, Northern Trust, oil, Open Market Committee, PIMCO, Risky Assets, Set Of Numbers, Stock Market Indices, Structural Unemployment, Unemployment Rate, Unexpected Decline, Us Stock Markets, Walt Handelsman
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Chart of the Day: Subpar recoveries follow financial recessions

Thursday, January 7th, 2010

“Economic cycles associated with financial traumas such as banking crises or asset price collapses tend to have deeper downturns and weaker upturns. The current uptrend in US economic growth should be sustained, but the rebound will remain subdued compared to recent recoveries,” said BCA Research.

The chart below illustrates the typical recovery patterns following financial and non-financial recessions respectively. As they say, a picture paints a thousand words … Should the after-effects of the financial crisis indeed remain a serious headwind to economic growth, policy conditions should remain favorable for risky assets.

Source: BCA Research - Daily Insights, January 6, 2010.

Tags: Asset Price, Collapses, Crises, Current, Economic Cycles, Economic Growth, Financial Crisis, Headwind, Insights, January 6, Rebound, Recessions, Risky Assets, Traumas, Typical Recovery, Uptrend
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Words from the (Investment) Wise (November 29, 2009)

Sunday, November 29th, 2009

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

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

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

Source: Peter Brookes, Times Online

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

Source: Bespoke, November 27, 2009.

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

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

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

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

Source: StockCharts.com

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bespoke, November 25, 2009.

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

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

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

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

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

Source: Moody’s Economy.com

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

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

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

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

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

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

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

Source: Russell Investments, November 22, 2009.

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

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

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

Food for thought indeed.

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

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

Source: Yahoo Finance, November 27, 2009.

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

Monday, November 30
• Chicago PMI

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

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

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

Friday, December 4
• Nonfarm payrolls
• Factory orders

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

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

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

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

Source: Wayne Stayskal, November 11, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Click here for the full article.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: CNBC, November 24, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Standard and Poors, November 24, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: MoneyNews, November 25, 2009.

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

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

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

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

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

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

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

Click here for the article.

Source: Bloomberg, November 23, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bespoke, November 27, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bespoke, November 23, 2009.

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

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

Source: Bespoke, November 25, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: TheStreet.com, November 25, 2009.

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

Source: International Monetary Fund, November 25, 2009.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Words from the (Investment) Wise (November 1, 2009)

Sunday, November 1st, 2009

Rewind the movie to before the stock market lows of March 9: stocks down, corporate bonds down, commodities and gold down, emerging-market currencies down, safe havens in fashion, including the US dollar and government bonds. In short, risky assets closed sharply lower over the past few days as concerns mounted over the outlook for central bank policy and the sustainability of the global economic recovery, with investors only warming momentarily to the US emerging from recession as shown by the Q3 GDP report (announced on the 80^th anniversary of Black Tuesday, October 29, 1929).

Cameron Brandt, senior analyst of fund tracker EPFR Global, said (via the Financial Times): “Good corporate earnings - viewed in recent weeks as fuel for a sustained recovery - are currently being regarded as ammunition for policymakers looking to close the fiscal and monetary stimulus taps.”

Adding to the economic uncertainty, Chuck Butler of the Daily Pfennig, highlighted a study by Peter Bernholz (Professor of Economics in Basel) in which he analyzed the world’s 12 most important periods of hyperinflation and discovered that the tipping point occurred when deficits amounted to 40% of the expenditures. “For the United States we have arrived at exactly that point. The deficit of $1.5 trillion amounts to 41.7% of the $3.6 trillion in expenses,” said Butler.

Source: Walt Handelsman, October 30, 2009.

The CBOE Volatility (VIX) Index is a measure of the implied volatility of S&P 500 Index options, with very low numbers indicating extreme bullishness and very high numbers severe bearishness. It is also referred to as the “fear gauge” of US stock markets and is used as a contrary indicator as it moves inversely to equity prices. As shown below, it is noteworthy that the VIX has surged by 48.3% during the past seven trading sessions to its highest level since early July.

Source: StockCharts.com

The past week’s performance of the major asset classes is summarized by the chart below. The numbers indicate an all-change pattern in the performances from the past few months as risk aversion re-entered financial markets and investors moved money from stocks and commodities into government bonds and the US dollar.

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week, as well as since the October 19 peak and various other measurement periods, is given in the table below.

The MSCI World Index and the MSCI Emerging Markets Index declined by 4.1% and 5.5% respectively during the past week, resulting in the World Index being down 1.8% for the month of October and the Emerging Markets Index recording a zero return. As far as individual markets are concerned, Sweden and New Zealand were the only major markets closing the week in the black. However, a number of markets (mostly emerging) managed to see the month out with positive returns.

The US indices closed down for the second consecutive week, yo-yoing during the course of the week, but with a particularly ugly close (on steep volume) on Friday, marking the worst day in the case of the Dow Jones Industrial Index and the S&P 500 Index since the beginning of July. The benchmarks recorded their first loss-making month since February, with the exception of the Dow Jones Industrial Index that was unchanged from September.

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

Top performers among stock markets this week were Ecuador (+4.2%), Sweden (+1.2%), Bangladesh (+1.2%), Kenya (+1.1%) and Uganda (+1.0%). At the bottom end of the performance rankings countries included Peru (‑9.5%), Ghana (-8.9%), Ireland (-8.9%), Cyprus (-7.9%) and Argentina (‑7.9%).

Of the 99 stock markets I keep on my radar screen, only 15% recorded gains, 84% showed losses and 1% remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that, as far as exchange-traded funds (ETFs) are concerned, the winners for the week included ProShares Short Emerging Markets (EUM) (+7.7%), ProShares Short Russell 2000 (RWM) (+6.5%) and ProShares Short Financial (SEF) (+6.5%). Besides short funds, CurrencyShares Japanese Yen Trust (FXY) (+2.3%) and PowerShares DB US Dollar Bullish (UUP) (+1.2%) also performed well.

On the losing side of the slate, ETFs included SPDR S&P Emerging Europe (GUR) (-11.0%), Market Vectors Solar Energy (KWT) (-11.0%) and Claymore/MAC Global Solar Energy (TAN) (-10.9%).

Referring to the massive Wall Street bonuses, the quote du jour this week comes from Allan Sloan in The Washington Post (hat tip: The King Report). He said: “What do the record-high Wall Street bonuses have in common with the record-low yields for savers? Answer: They show yet another way that prudent people, especially those living on fixed incomes, are being cheated by the government’s bailout of the imprudent.

“Here’s the deal. The government is spending trillions to keep interest rates down to support the economy and prop up housing prices, and those low rates have inflicted collateral damage on savers’ incomes. ‘It’s a direct wealth transfer from savers and retirees to overly indebted borrowers,’ says Greg McBride, senior financial analyst at Bankrate.com.”

Other news is that the struggle to establish a government-backed healthcare plan in the US received new impetus on Thursday when the Democrats in the House of Representatives tabled an $894 billion bill that included a “consumer option”. Separately, the Federal Deposit Insurance Corporation (FDIC) closed nine more banks on Friday, bringing the tally of US bank failures in 2009 to 115 - the first year since 1992 that more than 100 banks have gone under.

Next, a quick textual analysis of my week’s reading. Although “bank” still features prominently, the key words have started taking on a more normal pattern compared with the crisis-related words that have dominated the tag cloud for many months.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (from where I am writing this report) are given in the table below. Most of the indices, including all the US indices, have fallen below their 50-day moving averages over the past few days, but all the indices are still holding above their respective 200-day moving averages. The 50-day lines are also above the 200-day lines in all instances.

The October lows are also given in the table. A break below these levels would indicate a reversal of the uptrend since March, i.e. reversing the progression of higher reaction lows. In fact, last week’s declines resulted in some indices - including the Dow Jones Transportation Index, the Russell 2000 Index and the Nasdaq Composite Index - already having fallen below these levels.

Not shown below, the Australian All Ordinaries Index has already broken through its 200-day moving average, albeit only marginally, with the 50-day average at the same level as the 200-day level.

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

Below is a chart not many analysts follow, namely the Dow Jones Composite Average, made up of the 30 industrial stocks, the 20 transportation stocks and the 15 utility stocks. According to Richard Russell (Dow Theory Letters), the Composite tends to lead the market on many occasions. “Note that the Composite is trading completely below its 50-day moving average. The divergence with MACD at the bottom of the chart is spectacular. Volume is expanding as the Composite declines. In all, a nasty picture, and one that I take seriously,” said the old-timer.

Source: StockCharts.com

According to Casey’s Daily Dispatch, State Street Global Markets has just released its Investor Confidence Index for October 2009, measuring investor confidence on a quantitative basis by analyzing the actual buying and selling patterns of institutional investors. The results indicate that the big money is starting to turn bearish. “Global investor confidence fell by 10.0 points to 108.4 from a revised September level of 118.4. The most pronounced decline was evident among North American investors, where confidence fell by 12.8 points from 113.9 to 101.1,” said the report.

Source: Cris Wood, Casey’s Daily Dispatch, October 30, 2009.

Breadth indicators are useful tools to assess the inner workings of the market’s rallies or corrections, and these indicators are used to identify strength or weakness behind market moves, i.e. to assess how the bulls and the bears are exerting themselves. Three of these measures are discussed below.

The advance/decline spread tracks the difference between advancing and declining issues and is widely used to measure the breadth of a stock market advance or decline. The chart below shows that the cumulative spread between declining and advancing issues on the Nasdaq turned down a few days prior to the October 19 peak and is leading the market lower.

Source: StockCharts.com

Net new highs are calculated by subtracting the number of new 52-week lows from the number of new 52-week highs. March 6 marked an “internal bottom” when a large number of the stocks on the NYSE recorded new lows (whereas a “price bottom” was recorded on March 9). Net new highs have since improved markedly, but it would seem that the ratio is close to falling below the zero line (i.e. when new lows will again exceed new highs).

Source: StockCharts.com

The number of NYSE stocks trading above their respective 50-day moving averages has dropped to 34.7% from 91.6% in September. In order to be bullish about the secondary trend, one would expect the majority of stocks to be above the 50-day line. For a primary uptrend to be intact, the bulk of the index constituents also need to trade above their 200-day averages. This is a slow indicator, with the number still at a lofty 85.9% but down from its recent peak of 93.4%.

Stock market breadth has been moving in the wrong direction over the past few days and the “internals” seem to indicate further downside.

A number of commentators have been making pronouncements about the extent of a possible decline. For example, Jeremy Grantham (GMO) expects the S&P 500 to drop by 15-25%, David Rosenberg (Gluskin Sheff & Associates) sees markets falling by 20%, Doug Kass is looking at -5% to ‑12%, David Fuller at 10-15% and Barry Ritholtz at 5-15% (The Big Picture), with Andrew Smithers (Smithers & Co) the most bearish, viewing the S&P 500 to be 40% overvalued.

Turning to fundamentals: as discussed in a post a few days ago, a good way of looking at valuation levels, and cutting through the uncertainty of having to forecast earnings, is by means of Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE), effectively muting the impact of the business cycle by averaging ten years of earnings. Using rolling ten-year reported earnings, my research (based on Shiller’s methodology, but including some refinements) shows that the “normalized” price-earnings ratio of the S&P 500 Index is currently 18.8. This compares with a long-term average of just more than 16.3 and implies an overvaluation of 13%. The graphs below show data since 1950, but the actual calculations date back to 1871.

From across the pond in London, David Fuller (Fullermoney) said: “In the short term, technical evidence suggests that we are now in a reaction and consolidation phase for most stock markets. Some of this is likely to be confined to primarily ranging patterns as we have already seen. For others, the mean reversion process towards rising 200-day moving averages is likely to include larger corrections than we have seen to date. At this stage of the stock market cycle, I regard mean reversion as a buying opportunity.”

I will bide my time while the fundamentals play catch-up. Meanwhile, caution remains the operative word.

For more discussion on the economy and financial markets, see my recent posts “Stocks and risky assets stumble“, “Stock markets - is uptrend still intact?“, “Picture du Jour: Stock market rally long in the tooth“, “Gross: Rally in risk assets at its pinnacle“, “Rosenberg: Stocks overvalued by 20%” and “Jeremy Grantham: Fair value on the S&P 500 is 860“. (And do make a point of listening to Donald Coxe’s webcast of October 30, which can be accessed from the sidebar of the Investment Postcards site.)

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

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

Source: Dismal Scientist

“There has been no meaningful change in global business confidence in almost three months. Sentiment improved sharply this summer and is now consistent with a global economic recovery, but a very tentative and fragile one,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. “Businesses are most upbeat about equipment and software investment and the broader outlook into early next year, and most negative about the strength of their current sales and hiring. South Americans are the most positive, and North Americans generally the most negative.”

Source: Moody’s Economy.com

According to Li & Fung Research Centre, the Purchasing Managers Index (PMI) in China rose to 55.2% in October, up by 1.3 percentage points from the previous month. The Index has stayed in the expansionary zone of higher than 50% for eight consecutive months, indicating that the manufacturing sector in China has continued to improve steadily.

“Several countries, such as India, Australia, Norway, and Japan, have already begun exit strategies to drain excess liquidity used to stimulate their economies to counter the global recession. India’s lenders are keeping more cash in bonds and raising statutory liquidity ratios, Australia and Norway have already hiked interest rates, and Japan has said it will stop buying corporate debt by year-end,” reported US Global Funds in its latest Weekly Investor Alert.

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

Friday, October 30
Consumer spending - mild increase in Q4

Thursday, October 29
Recession is history, economy back in business
Total continuing claims are stabilizing

Wednesday, October 28
Sales of new homes decline, but inventories and prices remain favorable
Durable goods orders - mixed performance in third quarter

Tuesday, October 27
Case-Shiller Home Price Index - further improvement in home prices

Monday, October 26
Chicago National Activity Index - more validation about economic recovery

Commenting on the US GDP annual growth rate of 3.5%, John Williams (Shadow Government Statistics, courtesy of The King Report) warned that one-time stimulus or inventory items represented 92% of the reported growth.

Many people who planned to buy a car in Q4 probably took advantage of “cash for clunkers” and bought in Q3. “To put this into GDP terms, according to the Bureau of Economic Analysis (BEA) the spike you see in the chart below added 1.66% to the US GDP growth figure. Thus without it, GDP growth would have been only 1.89% (3.5-1.66%) in Q3,” reported Clusterstock.

Source: Clusterstock - Business Insider, October 29, 2009.

Commenting on the US growth outlook, Asha Bangalore (Northern Trust) said: “Going forward, the lift to the headline GDP number in the third quarter is partly from future auto sales, which implies that consumer spending and GDP growth are most likely to show more muted growth in the fourth quarter of 2009 and first quarter of 2010. The Fed is on hold for several months until it is confirmed the unemployment rate has peaked.”

According to MoneyNews, bond guru Bill Gross of Pimco said the Federal Reserve would not “risk raising rates” until the US has had a year-and-a-half of sustained economic growth, at a solid 4% rate.

Meanwhile, Richard Koo, chief economist at the Nomura Research Institute, warned (via MoneyNews) that the United States may go through a “lost decade” of stagnant economic growth similar to Japan’s experience in the 1990s if Washington yanks stimulus money out of the economy too soon. “We still need more government spending,” he said, adding that it could take “three to five years to get out of this mess, even under the best of circumstances.”

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

Source: Yahoo Finance, October 30, 2009.

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

Next week sees interest rate announcements by the Federal Open Market Committee (FOMC) (Wednesday, November 4), the European Central Bank (ECB) (Thursday, November 5) and the Bank of England (BoE) (Thursday, November 5). In addition, US economic data reports for the week include the following:

Monday, November 2
ISM Index
• Construction spending
• Pending home sales

Tuesday, November 3
• Factory orders
• Auto sales

Wednesday, November 4
• ADP Employment Report
• ISM Services

Thursday, November 5
• Initial jobless claims
• Productivity

Friday, November 6
• Wholesale inventories
• Consumer credit
• Payrolls, etc.

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, October 30, 2009.

“Mistakes are a fact of life. It is the response to the error that counts,” said Nikki Giovanni, American poet, author and activist. Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards to formulate appropriate strategies to recover from mishaps that are bound to happen from time to time.

Wishing all my readers a Happy Halloween!

That’s the way it looks from Cape Town (where the early-summer weather is unbeatable).

Source: Pat Bagley, Salt Lake Tribune

Financial Times: Transcript - George Soros interview
“Chrystia Freeland, US managing editor, interviewed George Soros about the state of the world economy, relations between the US and China, his investment performance and regulating bankers’ compensation. This is a transcript of that interview.

FT: Thank you for joining us, Mr Soros.

GS: It’s a pleasure.

FT: How do you judge the state of the world economy? Has the world recovered from the crisis of 2007/2008?

GS: Well, certainly the financial markets have regained their composure so they’re beginning to function again, and also the world economy has overcome the shock that it has suffered because for a while everything froze and now things are moving again. So there is rebound, but I think that the facts of the crisis will take a long time for the world to absorb and the main source of the problem is in the United States. This is where consumers have spent more than they earned for a period of 25 years; where we have accumulated current account deficit that reached 6.5 per cent at its peak, which actually could have continued because there were other countries - particularly China and the Asian tigers - that were very happy to run a continuous surplus and to finance our deficit. So that could have actually continued, but the households became over-indebted and it’s the consumer who accounts for over 70 per cent of the US economy that has to cut down, and that will take a while.

Then also you’ve got the banking system that basically was bankrupted. It’s at the bottom and has to earn its way out of a hole and, again, it’s happening at a pretty fast clip because banks borrow at zero and buy 10-year government bonds, yielding 3.5 per cent, and that’s a pretty fast rate of earnings for no risk. So, they’ll earn their way out of a hole, but it will also take time. And then there’s still the whole area of commercial real estate, where the losses have not been recognised. So the source of weakness in the world will be mainly in the US consumer spending and in, let’s say, the decline in the banking sector.

FT: And is that weakness in the US sufficiently grave that there could be a W-shaped recovery, that there could be another dip downwards?

GS: Well, I think certainly there could be another dip in the stock market because, right now we are enjoying the confidence multiplier and there’s a sort of a hope that this is a crisis like the previous ones and we will just sort of recover in a V-shape recovery. So, when that hope is not fulfilled, I think that will be …

FT: Which you are certain it will not be fulfilled?

GS: Well, I can’t see it being fulfilled. I may be wrong. I’ve been wrong before, but I just don’t see where the growth in the US economy can come from.

FT: Given this continued weakness in the US economy, are people right to start to be concerned about the dollar?

GS: Well, they are of course and the dollar is a very weak currency except for all the others. So there is a general lack of confidence in currencies and a move away from currencies into real assets. The Chinese are continuing to run a big trade surplus and they’re still accumulating assets and basically the renminbi is permanently undervalued because it’s tied to the dollar. There is a diversification from assets that are normally held by central banks into other assets, especially in the area of commodities. So there is a push in gold, there’s a strength in oil, and that is in a way a flight from currencies.

FT: Is there going to be a tipping point, a moment at which the dollar is fatally weakened? Or does it just sort of carry on?

GS: As long as the renminbi is tied to the dollar, I don’t see how the decline in the dollar can go too far. Now, of course, to some extent it’s very helpful because with the US consumers saving more and spending less, exports can be way for the US economy to be balanced. So, an orderly decline of the dollar is actually desirable.”

Click here for the full interview.

Source: Financial Times, October 23, 2009.

Forbes: Roubini - are capital controls in fashion again?
“Currency appreciation in emerging markets has been particularly strong this year both because of external conditions - including high liquidity, a weak US dollar and strong risk appetite - and domestic factors such as strong fundamentals, high potential growth and wider interest rates differentials. With portfolio investments to emerging market (EM) countries also rising, policymakers need to figure out how to avoid losing international competitiveness while also containing asset inflation and the emergence of asset bubbles. So far this year, most countries have opted for or maintained either verbal intervention or reserves accumulation. Others have kept or chosen more aggressive administrative measures, including capital controls mostly targeting portfolio investments rather than FDI.

“The imposition of capital controls on capital inflows as well as currency intervention tends to be ineffective in reversing the appreciating trend of the local currencies, especially if the latter are primarily driven by external factors. However, capital controls may be helpful in easing volatility and the pace of the trend itself. The risk is that capital controls are seen as punitive measures against capital markets. They raise uncertainty about future policy actions, hurt the credibility of the central bank and increase the costs of external funding for local businesses. Overall, policymakers’ actions to contain the appreciating trend of their countries’ currencies depend on how fast capital is flowing in, sterilization costs, and monetary policy flexibility. Consequently, EM countries where currencies and equity markets have surged over the course of the year are the most likely to impose some sort of limitations on capital inflows.

“Capital controls alone may not be enough.

“It is important to recognize that the use of capital controls is not uniform and neither are the results. In addition, their impact can be subdued by global conditions. In today’s economy, EM currencies are up against a weakening dollar. The dollar is down 6.3% YTD and 14.3% from its March peak. The EM currency rally this year is even stronger than that of the US Dollar Index, with five different currencies gaining over 10% YTD. Only the Argentine peso has posted a significant loss against the dollar YTD.

“Governments are best served implementing measures aimed at smoothing currency appreciation as opposed to halting or reversing trends. This can be done in part by identifying and targeting areas of volatility and hence vulnerability. By addressing areas of greater volatility, countries can smooth currency flows without endangering macroeconomic stability. The recent tax in Brazil targets volatile portfolio flows as opposed to FDI. Portfolio investments fled Brazil following the Lehman collapse only to flow back this year. Meanwhile, FDI has remained relatively stable.

“Given the extraordinary flow into emerging markets, it is unlikely that capital controls or intervention alone will be able to put the brakes on EM currency appreciation. Indeed, the Brazilian real gave up 3% against the dollar following the announcement of the tax before appreciating 3.7% after four days. That said, Brazil and other governments may find themselves in a position where they need to tap a greater arsenal if their desire to stem appreciation is strong. With that in mind, look for central bank intervention to be a greater theme in the coming months.”

Click here for the full article.

Source: Nouriel Roubini, Forbes, October 29, 2009.

MoneyNews: Krugman - China simply stealing jobs
“China’s asset-buying binge inflated the US housing sector, setting the stage for the global financial crisis, but the Chinese policy of keeping the yuan-dollar rate fixed may be causing an even more harmful economic bubble, says Nobel Prize winner Paul Krugman.

“‘China has been keeping its currency pegged to the dollar - which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead,’ writes Krugman in The New York Times.

“China is creating a bubble for its own economy. Krugman says this policy is particularly precarious during a period when the world economy remains deeply depressed due to dampened demand.

“‘By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere,’ writes Krugman.

“‘The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.’

“The US government has been excessively tepid in addressing this issue.

“Last week, the Treasury Department testified in a required report to Congress that China is not manipulating its currency.

“‘They’re kidding, right?’ writes Krugman. ‘The thing is, right now this caution makes little sense.’”

Source: Gene Koprowski, MoneyNews, October 28, 2009.

Financial Times: Eurozone lending to private sector declines
“The eurozone saw the first year-on-year fall in bank lending to the private sector last month, even as signs became stronger that the 16-country region’s economy had returned to growth.

“September’s eurozone credit numbers indicated lending had been scaled back at an unprecedented pace, strengthening the case for the European Central Bank to maintain its ultra-loose interest rate policy.

“Loans to the private sector contracted at an annual rate of 0.3%, after a 0.1% rise in August, according to the ECB. That was the first time the annual growth rate had turned negative since comparable statistics began in 1992. The euro was launched in 1999.

“Although the data showed signs of a pick-up in lending to households in September compared with August, they could fuel policymakers’ fears that a weakened banking sector will fail to provide business with the credit needed to reboot the economy.

“‘A lack of credit growth could certainly undermine the pace of recovery,’ said Colin Ellis, European economist at Daiwa Securities SMBC Europe. Unlike the UK, the eurozone is thought by economists to have expanded in the third quarter compared with the previous three months, marking the formal end of its recession.

“‘To get a fully fledged business cycle upswing emerging, you need to see credit taking off - but that normally takes one or two years,’ said Julian Callow, European economist at Barclays Capital.

“But Mr Callow argued that the latest data might have been distorted downwards by banks securitising loans, which would have removed them from the ECB’s statistics even though the credit was still available to the economy.”

Source: Ralph Atkins, Financial Times, October 27, 2009.

MoneyNews: Koo - US risks Japan-style lost decade
“The United States may go through a ‘lost decade’ of stagnant economic growth similar to Japan’s experience in the 1990s if Washington yanks stimulus money out of the economy too soon, says Richard Koo, chief economist at the Nomura Research Institute, the research arm of Japan’s largest brokerage.

“‘This isn’t a cold. It’s more like pneumonia,’ Koo told Bloomberg News.

“‘We still need more government spending,’ adding it could take ‘three to five years to get out of this mess, even under the best of circumstances.’

“Koo and other noted economists such as Nobel laureate Paul Krugman believe US economic recovery expected for the latter half of this year will be short-lived if the Obama administration withdraws stimulus money.

“The administration is belatedly trying to narrow a record $1.4 trillion budget deficit and thus boost the sagging dollar.

“As an example, Koo says, look to Japan, where an asset bubble burst in 1990 and left companies repaying debt instead of taking on new projects that would have refueled economic growth via continued stimulus.

“‘When we see the private sector coming to borrow again, I’ll be the loudest person on earth arguing for fiscal reform. That’s the exit,’ says Koo.

“Nevertheless, White House Officials say stimulus spending has already kick-started the economy and will do little to help out next year.

“‘By mid-2010, fiscal stimulus will likely be contributing little to further growth,’ says Christina Romer, the chair of President Barack Obama’s Council of Economic Advisers, according to the Associated Press.”

Source: Forrest Jones, MoneyNews, October 26, 2009.

Bespoke: Is the NBER gearing up for a big announcement?
“The NBER (National Bureau of Economic Research) is the organization in charge of dating recessions and expansions in the US economy, so when the official announcement is made that the most recent recession is officially over, it will come from the NBER. Interestingly, over the weekend, the organization revamped its website for the first time in several years. While companies change their websites for multiple (and often insignificant) reasons, many revamps are often timed to coincide with major events. With most investors and economists agreeing that the economy has seen its trough (probably in June or July), we wonder if the NBER’s website update was put in place ahead of an announcement from them that the recession is over?”

Source: Bespoke, October 26, 2009.

Asha Bangalore (Northern Trust): Recession is history, economy back in business
“The recession is behind us. Real gross domestic product of the US economy grew at an annual rate of 3.5% in the third quarter after a 0.75 drop in the prior quarter. This is the first increase of real GDP after a string of four quarterly declines. Real GDP has declined in five out of the six quarters of the recession.

“The Business Cycle Dating Committee of the National Bureau of Economic Research will make the official announcement after it confirms the turning point based on revisions of economic data. This recession is the longest on record in the post-war period and the deepest also. Real GDP has declined 3.8% from the peak in the second quarter of 2008 to the trough in the second quarter of 2009. This is the largest peak-to-trough decline of real GDP in the post-war period

“In the third quarter, consumer spending accounted for the largest part of the growth in real GDP, followed by exports, inventories and residential investment expenditures. Of these four components, exports and inventories are most likely to continue to make large contributions in the quarters ahead. Consumer spending is projected to advance in the quarters ahead but at a noticeably slower pace. The surge in auto sales from the ‘cash for clunkers’ program in the third quarter provided the temporary lift to consumer spending.

“Going forward, the lift to the headline GDP number in the third quarter is partly from future auto sales, which implies that consumer spending and GDP growth are most likely to show more muted growth in the fourth quarter of 2009 and first quarter of 2010. The Fed is hold for several months until it is confirmed the unemployment rate has peaked.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, October 29, 2009.

Financial Times: US economy grows
“US GDP figures raise a number of important questions, says Martin Wolf, chief economics commentator of the Financial Times.”

Click here or on the image below to view the video clip.

Click here for the full article.

Source: Financial Times, October 29, 2009.

Asha Bangalore (Northern Trust): Consumer spending - mild increase in Q4
“The impact of the American Recovery and Reinvestment Act (ARRA) is visible in the third quarter GDP report and the President’s Council of Economic Advisers has estimated that the ARRA contributed between 3 and 4 percentage points to real GDP growth in the third quarter. The ‘Cash for Clunkers’ program was not part of the original ARRA but was included by a supplemental bill and funds were reallocated. The purchase of cars under this program accounted for the sharp increase in auto sales in July and August and the absence of this program following its expiration in August led to the 0.5% drop in consumer spending in September (-0.6% in inflation adjusted terms).

“Effectively, expenditures on cars accounted for a large part of the strong increase in real consumer spending in the third quarter. The question now is if the absence of rebates for cars will prevent an increase in overall consumer spending in the fourth quarter. The nature of consumer spending data for the last month of quarter helps to confirm or revise forecasts of the following quarter. However, the September estimate of real consumer spending ($9261.1 billion) is barely different from the third quarter average ($9265.2 billion). Based on the small negative bias and possibility of revisions, consumer spending is likely to show only a moderate increase in the fourth quarter of 2009 after a 3.4% jump in third quarter.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, October 30, 2009.

MoneyNews: Bill Gross - no Fed hikes for a while
“Bond guru Bill Gross of Pimco says that the Federal Reserve will not ‘risk raising rates’ until the US has had a year-and-a-half of sustained economic growth, at a solid, 4% rate.

“Consider this in light of the fact that he and his colleagues at the money management giant have long said that US growth is about to engage in a long period of a ‘new normal’ where growth rates are much lower, perhaps under 2%.

“‘Nominal GDP must show realistic signs of stabilizing near 4% before the Fed would be willing to risk raising rates. The current embedded cost of US debt markets is close to 6% and nominal GDP must grow within reach of that level if policymakers are to avoid continuing debt deflation in corporate and household balance sheets,’ writes Gross in his monthly economic forecast.

“The US economy will likely approach 4% nominal growth as early as 2009’s final quarter, says Gross. But, the ability to sustain those levels once inventory rebalancing and fiscal pump-priming effects wear off is ‘debatable’, he says.

“‘The Fed will likely require 12 to 18 months of 4% plus nominal growth before abandoning the zero percent benchmark,’ writes Gross.

The “negative wealth effect” caused by last year’s stock market crash must be ameliorated to reintegrate the private sector into the Wall Street economy, the investment guru adds.”

Source: Gene Koprowski, MoneyNews, October 29, 2009.

Asha Bangalore (Northern Trust): Chicago National Activity Index - more validation about economic recovery
“The Chicago Fed National Activity Index (CFNAI) slipped slightly in September to -0.81 from a revised -0.65 reading in August. However, the 3-month moving average improved to -0.63 in September from -0.96 in the prior month. According to the Chicago Fed, ‘when the 3-month moving average of the CFNAI moves below -0.70 following a period of expansion, there is an increasing likelihood that a recession has begun’. The September reading of -0.63 is confirmation that the weak economic conditions are behind us. This report confirms the message from the latest Index of Leading Economic Indicators.”

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

Asha Bangalore (Northern Trust): Durable goods orders - mixed performance in third quarter
“Orders of durable goods rose 1.0% in September after a 2.6% drop in August. In the third quarter, overall orders of durable goods rose at an annual rate of 12.3%, after a 4.00% gain in the second quarter following substantial declines in the fourth quarter of 2008 and the first quarter of 2009. A similar picture of recovery is applicable to orders of non-defense capital orders excluding aircraft.”

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

Asha Bangalore (Northern Trust): Total continuing claims are stabilizing
“Initial jobless claims were virtually unchanged at 531,000 during the week ended October 24 from the 530,000 reading of the prior week. Continuing claims, which lag initial claims by one week, fell 148,000 to 5.945 million, marking the fourth consecutive weekly decline. A part of this drop is attributed to the expiry of 26 weeks of eligibility for unemployment insurance.

“Upon the completion of 26 weeks, recipients can collect unemployment insurance under the Extended Benefits Program and Emergency Unemployment Compensation Program. Therefore, the true size of recipient of unemployment insurance is a sum total of recipients under these various programs. Data for the special programs lags initial jobless claims data by two weeks. During the week ended October 10, total continuing claims inclusive of seasonally adjusted continuing claims and those under the special programs dropped to 9.84 million from a revised peak of 10 million during the week ended October 3. This decline is noteworthy because it the first positive sign in the labor market after several weeks. We should be able to confirm the improvement as additional data become available.”

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, October 29, 2009.

Asha Bangalore (Northern Trust): Consumer confidence slips in October, job situation is main driver
“The Conference Board’s Consumer Confidence Index dropped to 47.7 in October from 53.4 in the prior month. The two sub-indexes, Present Situation Index (20.7 vs. 23.7 in September) and the Expectations Index (65.7 vs. 73.7) fell in October. The early University of Michigan survey results for the Consumer Sentiment Index also showed a decline.

“Consumers continue to view the labor market in unfavorable light. The number of respondents indicating that ‘jobs are hard to get’ rose (47.6 vs. 47.0 in September) while those responding ‘jobs are plentiful’ declined (3.4 vs. 3.6 in September). The net of these two indices moved up in October to 46.2 from 43.4 in September. Historically, there is a strong positive relationship between the net of the indexes about the job market and the unemployment rate. The latest information about a pessimistic perception of the labor market implies that a higher unemployment rate is likely in October. This confirms widely projected information.”

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

Asha Bangalore (Northern Trust): Sales of new homes decline, but inventories and prices remain favorable
“Sales of new single-family homes fell 3.6% to an annual rate of 402,000 in September after a downwardly revised gain in August. Sales of new single-family have moved up 22% from the cycle low reading of 329,000 in January 2009.

“It appears that existing homes inclusive of distressed properties were more attractive for new homeowners compared with new single-family homes in September. Sales of existing homes increased 9.4% in September. The combined sales of new and existing single-family homes have risen in six out of the last nine months and are about 21% above the cycle low seen in January 2009.

“Inventories of unsold new single-family homes have declined from a peak of 12.4-month supply in January 2009 to 7.5-months in the August-September period. The inventory-sales ratio was unchanged at the 7.5-month mark in September. The historical median of inventory of unsold new single-family homes is a 6-month supply.

“The median price of a new single-family home fell 9.1% from a year ago to $204,800 in September, representing a noticeable deceleration in the pace of price declines. Additional reductions in price, but at a slower pace are likely, given the large number of homes that are unsold. There will be setbacks and gains in the housing sector but the net result should be positive in the months ahead.”

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

Standard & Poor’s: Case-Shiller - home prices continue to improve
“Data through August 2009, released by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, show that the annual rate of decline of the 10-City and 20-City Composites improved compared to last month’s reading. This marks approximately seven months of improved readings in these statistics, beginning in early 2009.

“The chart above depicts the annual returns of the 10-City and 20-City Composite Home Price Indices, declining 10.6% and 11.3%, respectively, in August compared to the same month last year. Nineteen of the 20 metro areas and both Composites showed an improvement in the annual rates of decline with August’s readings compared to July.

“‘Broadly speaking, the rate of annual decline in home price values continues to improve’ says David Blitzer, Chairman of the Index Committee at Standard & Poor’s. ‘The two Composites and 19 of the 20 metro areas showed an improvement in the annual rates of return, as seen through a moderation in their annual declines. Looking at the monthly data, 17 of the MSAs and both Composites saw price increases in August over July. While many of the markets remain down versus this time last year, the relative rate of decline has shown some real improvement.”

Source: Standard & Poor’s, October 27, 2009.

The Wall Street Journal: Gloom spreads on economy, but GOP doesn’t gain
“Americans are growing increasingly pessimistic about the economy after a mild upswing of attitudes in September. But Republicans haven’t been able to profit politically from the economic gloom, according to a new Wall Street Journal/NBC News poll.

“The survey found a country in a decidedly negative mood, nearly a year after the election of President Barack Obama. For the first time during the Obama presidency, a majority of Americans sees the country as being on the wrong track.

“Fifty-eight percent of those polled say the economic slide still has a ways to go, up from 52% in September and back to the level of pessimism expressed in July. Only 29% said the economy had ‘pretty much hit bottom’, down from 35% last month.

“But a dark national view of how everybody in Washington is conducting the public’s business appears to be preventing Republicans from benefiting from concerns about the direction of the country or the Democrat-led government’s handling of the economy, as the minority party often does.

“In fact, disapproval of the Republican Party actually has ticked upward, along with the public’s general pessimism. Asked which political party should control Congress after next year’s midterm elections, Democrats now hold a clear edge over the GOP, 46% to 38%, a month after the Republicans were nearly as popular. In September, the Democratic edge was 43% to 40%.

“‘There was a bounce-back surge for Republicans, and that’s stalled,’ said Bill McInturff, a Republican pollster who conducted the Wall Street Journal/NBC News poll with Democratic pollster Peter Hart.

“‘The mood in America may be blue, but attitudes toward Washington are just jet black,’ Mr. Hart said.”

Source: Jonathan Weisman, The Wall Street Journal, October 28, 2009.

The Wall Street Journal: Geithner testifies on regulation
“The Federal Reserve should lose its authority to bail out big, failing financial firms like AIG and Bear Stearns under proposed reforms aimed at limiting the collateral damage from such failures, US Treasury Secretary Timothy Geithner said.”

Source: The Wall Street Journal, October 29, 2009.

Financial Times: Draft law would extend Fed powers
“The Federal Reserve could order a financial institution to sell a risky division or stop dangerous trading activity if the central bank determined there was a threat to the US financial system, under a draft law released on Tuesday.

“The landmark bill drawn up by the Treasury and the House financial services committee sets up a council of regulators charged with snuffing out systemic risks and gives the government and the Fed sweeping powers over financial companies at home and overseas.

“The Fed would require systemically significant companies - including foreign groups that own a large or risky US subsidiary - to abide by ‘heightened prudential standards’. These include leverage limits, liquidity rules and the drafting of a resolution plan, or ‘living will’.

“Companies would be placed in the new category if the council deemed that ‘material financial distress at the company could pose a threat to financial stability or the economy’.

“But the draft law goes further than expected - allowing the Fed to require any systemically significant company to ’sell or otherwise transfer assets or off-balance sheet items to unaffiliated firms, to terminate one or more activities, or to impose conditions on the manner in which the identified financial holding company conducts one or more activities’.

“If that does not save a company, the government could seize it and force rival banks that have more than $10 billion in assets to repay any taxpayer money used to seize or wind up their competitor.”

Source: Tom Braithwaite, Saskia Scholtes, Aline van Duyn and Francesco Guerrera, Financial Times, October 28, 2009.

Financial Times: Fed chief warns banks on capital
“Ben Bernanke, chairman of the Federal Reserve, placed capital at the centre of his recipe for improving the financial system’s safety on Friday, putting banks on notice that they faced a possible capital surcharge or higher equity buffers.

“In a speech to the Boston Fed, Mr Bernanke said the capital raisings that followed the bank ’stress tests’ were important, but needed to go further to help prevent future failures.

“Tier one common equity ratios increased to 7.5% at the end of June this year from 5.3% at the end of last year.

“‘Options under consideration include assessing a capital surcharge on these institutions or requiring that a greater share of their capital be in the form of common equity,’ he said.

“Institutions whose collapse could threaten the entire system would be forced to go even further, possibly being required to issue contingent capital - hybrid securities that convert from debt to common equity at times of financial stress.

“Economists who advocate the introduction of the requirement believe it would help, not only by reinforcing the capital base for when a bank gets in trouble, but also as it would prompt holders of the securities - who want to avoid conversion - to exert pressure on executives to avoid risky behaviour.

“Increased capital requirements look likely to be one of the few elements of the Obama administration’s regulatory reform plan to survive unscathed after the industry’s huge lobbying effort and wrangling in Congress.”

Source: Tom Braithwaite, Financial Times, October 23, 2009.

Financial Times: Why sovereign bond yields will explode
“For nearly two decades, every credit crisis has been palliated with a further wave of leverage, kicking off a new economic cycle. Can this work again? I think not. In this post-credit crisis world, some things will be permanently different.

“It will not be business as usual for government bond prices. That is because current bond yields and the increasing insolvency of our rulers are the biggest disconnect in financial markets today. This comes from two factors: quantitative easing by central banks and the collapse of credit demand by the private sector. Neither are permanent features of the economic landscape.

v”Some will note that, when Japan’s bubble economy collapsed, it was able to run huge budget deficits and raise outstanding government debt from 60% to 140% of gross domestic product, while still experiencing a fall in bond yields from 8% to 1%.

“But this ‘miracle’ was only possible because Japan’s household savings were huge and invested at home. Japan did not need foreigners to fund its government deficits. Even today, foreign ownership of Japanese debt is only 6% compared with 50% for US government paper.

“But Japan’s household savings rate has collapsed due to an ageing population who no longer save. This low saving rate is something death must undo, not the politicians or monetary policy. So, if Japan is now running budget deficits at double- digit percentage rates of GDP, it can no longer use low-cost excess domestic savings to do so.

v”The Japanese ‘miracle’ of the 1990s cannot be repeated in the US, the UK or even in Japan this time. The US and the UK will still have very low domestic savings rates with government debt heading towards 100 per cent of GDP. Neither is likely to suffer from prolonged deflation as Japan did. And both the US and the UK are heavily dependent on foreigners for financing that debt. So Treasury and gilt yields will rise sharply and the dollar and the pound will slide.”

Source: David Roche, Financial Times, October 26, 2009.

Reuters: PIMCO’s Gross - Fed programs end may pressure debt
“Bill Gross, the influential manager who runs top bond fund PIMCO, warned on Monday that the prospect of an end to the Federal Reserve’s debt buyback programs could add selling pressure to several credit markets, including US Treasuries.

“Asked about the risk that a recovering US economy hurts Treasury investors, he said ‘there’s not a heightened sense of concern, but there is some concern’.

v”‘It’s obvious that the programs in the United States, the Federal Reserve buyback programs … those purchases and that purchasing power will cease within the next three to four months,’ Gross told a Canadian business television channel.

“‘So, to the extent that that’s gone, then perhaps the upward influence in terms of those longer-term Treasuries will be felt more strongly in the next several quarters.’”

Source: Jeffrey Hodgson, Reuters, October 26, 2009.

Richard Russell (Dow Theory Letters): Two possibilities for stock markets
“We are now watching one of two possibilities. The frustrating part of it is that at this time there is absolutely no way of knowing which of the two scenarios is the correct one. Personally, I favor the first scenario which I will now describe.

“(1) The primary trend of the stock market and the economy remains bearish. The advance from the March lows represents a correction or a rally in the bear market. The rally now appears to be in trouble. In fact, the rally may now be in the process of topping out. If this is indeed a rally in a continuing bear market, then in due time the Dow and the majority of stocks will decline and violate their March lows. If both the Industrials and Transports violate their March lows, it will be a signal that the primary bear market has been reconfirmed. However, if both Averages decline, and then rise to new highs, this will be a very bullish indication. It will be a sign that I have been wrong, and that we are probably in a bull market.

“(2) This is the second possible scenario. A bull market started from the March lows, and the advance from the March lows was the first leg of a new bull market. The first leg of the new bull market may now be in the process of topping out. If so, we will have to monitor the decline very carefully. If the decline develops into a secondary reaction and then halts, what comes next is crucial. Following the decline, if both Averages then head higher and break out to new highs, we will know that we are in a new bull market.

“I might add that either way, if the market now declines substantially, I think it will have the effect of turning investors and consumer sentiment even more fearful than it presently is. In which case, consumers will cut back even more on their buying and at the same time boost their desire to save and reduce their debts.

“Admittedly, the first scenario would be a disaster. The disaster would be if the entire advance from the March low were to be wiped out. That would mean that we’ve been in a primary bear market all along, and that the advance from the March low was simply an upward correction in an ongoing bear market. If so, then it’s just a matter of time before the Dow and a majority of stocks break below the March lows, in which case the bear market would be in full force again.

“If the first scenario comes to pass, this would be a disaster, but we must deal what the market gives us. A violation of the March lows by both Industrials and Transports would mean that really hard times lie ahead and that deflation will dominate the US and probably the rest of the world. Furthermore, it would mean that all the trillions that the Obama administration has spent have gone for naught.”

Source: Richard Russell, Dow Theory Letters, October 29, 2009.

David Fuller (Fullermoney): Stocks to correct by 10-15%
“Currently the stock market reaction that we have often mentioned and associated with the anniversary of last year’s meltdown is underway, albeit slightly later than anticipated, and rapidly morphing into a correction for some stock market indices which had led the rally. Interestingly, China may be a template for what occurs, since it has led the recent corrective phase, as mentioned previously.

“At this stage of the bull cycle, I think a correction of approximately 10-15% for developed country stock markets and somewhat more for emerging markets would be good news for investors with cash to invest. Such a mean reversion towards rising 200-day moving averages would blow the recent froth off valuations and stem talk of an early change in monetary policy.

“Equities could then benefit from a second wind for the rally created by what should be good year-on-year comparative figures for GDP and corporate profits during 4Q 2009 and 1Q 2010. Conversely, if stock markets were to surprise us and extend their upward trends in early November, they would be discounting a bullish outlook for the next two quarters, leaving markets more susceptible to profit taking during the next round of favourable economic news.

“Meanwhile, very clear upward dynamics and follow through, similar to what we saw in the second half of July, are now required to check the current reactions / corrections.”

Source: David Fuller, Fullermoney, October 28, 2009.

MoneyNews: Smithers - S&P 500 40% overvalued
“The Standard & Poor’s 500 Index is heading for a fall because it’s 40% overvalued.

“Banks will probably sell more shares to raise the cash they need and drag down the index, said Andrew Smithers, economist and president of research company Smithers & Co., in an interview with Bloomberg.

“‘Markets are very vulnerable to an end of quantitative easing,’ said Smithers.

“‘Central banks, they’ve got to stop (buying) some time and if that happens everything will come down.’

“Smithers presciently warned investors off stocks in 2000 at the beginning of a bear market that growled on for two years.

“The heavy infusions of cash into credit markets by the Fed, the Bank of England, and other central banks around the world to save the collapsing financial system may soon stop, Smithers points out.

“Central bank purchases of debt and troubled assets may have worked short term, Smithers suggests.

“But now, as purchases have slowed and may stop altogether, he’s raising a red flag.

“‘Quantitative easing has set off another sharp, and so far containable, asset bubble,’ he said.

“‘But if it gets too high and starts to come down then we’ll go straight back (into recession).’”

Source: Marc Davis, MoneyNews, October 26, 2009.

Barry Ritholtz (The Big Picture): Rally getting tired?
“I have been pretty steadfastedly bullish throughout most of this move upwards.

“Given the recent market action, I am now starting to pull in my horns a bit, as this rally looks to be getting a little tired and showing signs of technical deterioration.

“We may yet see a new high in this move off of the lows (though that is not guaranteed). However, I see a significant increase in the odds for a fairly substantial correction - in the 5-15% range - over the next 60 days.

“5 factors are making me more cautious:

1) Over the past four days, we have had three failed rallies;

2) The number of new highs on the major indices is contracting;

3) Stocks seem to be reacting far less enthusiastically to earnings beats then they had been;

4) The Transports have been acting squirrelly lately;

5) The S&P is forming an ascending wedge.

“Note: This is not a major call, it looks to me like more of a minor reversal. (Sometimes, those can evolve into something more serious). The reason I expect it to remain modest/contained is the ongoing stimulus to the markets of zero percent interest rates …”

Source: Barry Ritholtz, The Big Picture, October 27, 2009.

MoneyNews: Morgan Stanley - this rally almost over
“According to Morgan Stanley euro analyst Teun Draaisma, we’ve got just a little bit more rally left, and then a long, low multi-year grind as money starts to get tight.

“The tightening phase may start in the next quarter or two, Draaisma observes.

“‘We believe investors need increasingly to consider the implications of monetary and fiscal stimulus withdrawal,’ he says.

“‘We expect the first Fed rate hike in mid-2010, but the tightening turning point could come sooner, for instance through higher oil.’

“‘The Fed language change ahead of the first hike, or a market timing sell signal, would indicate the start of that next phase, for us.’

“Draaisma says the start of tightening phases tends to lead to some indigestion and a defensive rotation in equity markets, for two quarters or more.”

Source: Julie Crawshaw, MoneyNews, October 26, 2009.

Bespoke: Earnings trends
“The percentage of US companies beating earnings estimates currently stands at 74%, but below we highlight how this ‘beat’ rate has changed throughout earnings season. As shown in the charts below, as earnings season has progressed, the percentage of companies beating estimates has declined, while the percentage of companies missing estimates has increased.

“Just like a balance sheet, the ‘beat’ rate gives you a snapshot of where things stand at a single point in time, but it’s the trend in this number that really matters. Right now, the fact that the ‘beat’ rate is high relative to other quarters isn’t as important as the downtrend of the ‘beat’ rate throughout the current earnings season, and this is probably one reason that the market has been struggling.”

Source: Bespoke, October 29, 2009.

Bespoke: Percentage of stocks above 50-Day moving averages falls sharply
“Only 43% of stocks in the S&P 500 are trading above their 50-day moving averages at the moment, which is below the low we saw at the end of September. The percentage isn’t as low as it got during the July correction, but another day like today, and it no doubt will be.

“The percentage of stocks above their 50-days in the Materials sector has fallen the most, from nearly 100% above all the way down to just 17%. Financials and Technology have taken big hits as well. Energy and Consumer Staples both still have more than 70% of stocks above their 50-days, so they’ve held up the best on the recent declines.”

Source: Bespoke, October 28, 2009.

BCA Research: Dollar breakdown = “go-global” theme breakout
“Following the recent consolidation phase, factors are falling into place for a breakout in the relative performance of global versus domestic focused stocks.

“While domestic demand is slowly reviving, global growth is already rebounding much faster, underpinned by the sharp recovery in emerging market economies (especially China). This trend should persist, as the deleveraging process continues in the US, while fully functioning financial systems in the emerging world foster renewed credit extension.

“The depreciating dollar represents another boon for globally-geared companies. A weakening U.S dollar is bullish for globally-sourced revenues as it cheapens prices for foreign buyers and boosts currency translation effects. Indeed, the trade-weighted dollar has a decent track record in leading relative corporate profitability, and the current message is positive.

“Bottom line: Continue to favor global over domestic stocks, given that relative profit drivers and valuations remain overwhelmingly in favor of globally-geared equities.”

Source: BCA Research, October 26, 2009.

Bloomberg: Roubini says carry trades fueling “huge” asset bubble
“Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling ‘huge’ bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

“‘We have the mother of all carry trades,’ Roubini, who predicted the banking crisis that spurred more than $1.6 trillion of asset writedowns and credit losses at financial companies worldwide since 2007, said via satellite to a conference in Cape Town, South Africa. ‘Everybody’s playing the same game and this game is becoming dangerous.’

“The dollar has dropped 12% in the past year against a basket of six major currencies as the Federal Reserve, led by Chairman Ben Bernanke, cut interest rates to near zero in an effort to lift the US economy out of its worst recession since the 1930s. Roubini said the dollar will eventually ‘bottom out’ as the Fed raises borrowing costs and withdraws stimulus measures including purchases of government debt. That may force investors to reverse carry trades and ‘rush to the exit’, he said.

“‘The risk is that we are planting the seeds of the next financial crisis,’ said Roubini, chairman of New York-based research and advisory service Roubini Global Economics. ‘This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals.’”

Source: Michael Patterson, Bloomberg, October 27, 2009.

MoneyNews: Faber - in a decade, dollar will fall to zero
“The dollar, which recently dropped to a 14-month low of 0.67 euro before recently recovering, will ultimately fall to zero, says financial guru Marc Faber.

“Faber, publisher of the Gloom Boom & Doom Report, told Bloomberg, ‘It will go to a value of exactly zero eventually, but not right now.’

“The dollar will drift for a while, with occasional rebounds, Faber says.

“‘The other currencies aren’t much better either. They are also paper currencies. But I think that against gold, it will continue to depreciate.’

“And when can we expect the dollar to be worthless?

“‘Looking at Mr. Obama and his administration, it should already be there,’ Faber says.

“‘But I think it will take roughly 10 years until people really realize that the fiscal position of the US is a complete disaster.’

“Faber maintains that in about 10 years, 50% of US tax revenue will be used just to cover interest payments on the government debt.

“‘That is unsustainable,’ he says. ‘Then you really are forced to print money.’”

Source: Dan Weil, MoneyNews, October 29, 2009.

Financial Times: Don’t write off the dollar
“The bear case for the dollar may be well-known, but there are a number of reasons why it seems too early to bet on a collapse in the US currency in 2010, says Donald Rissmiller, chief economist at Strategas Research.

“First, he says, as long as floors remain in housing and consumer confidence, the US economic recovery is sustainable. ‘Confidence eased slightly in October but remains above its recent low,’ he notes.

“Second, he believes the saving/investment equation is not yet sufficiently imbalanced to suggest a dollar crisis is imminent.

“Furthermore, the debt-to-GDP ratio remains below the 100% level typically considered problematic. ‘While there has been some talk of an eventual US debt downgrade, the timeframe still appears to be several years away.’

“Mr Rissmiller also argues the Federal Reserve will raise interest rates, while employing tools such as paying interest on reserves, leaving its balance sheet elevated. ‘There’s a lot of room for tighter US monetary policy before policy becomes ‘tight’,’ he says.

“Also, foreign central banks could intervene in support of the dollar, given the global push for exports as a solution to the economic downturn.

“Finally, pegged and semi-pegged currency countries, such as China, have little incentive to disrupt the current trade system. ‘Without inflation in developing Asia, there’s little need to make drastic changes now,’ he says.”

Source: Donald Rissmiller, Financial Times, October 29, 2009.

CNBC: Bottom in for the dollar?
“A look at where the dollar is headed, with Dennis Gartman of ‘The Gartman Letter’.

Source: CNBC, October 23, 2009.

Mineweb: China sovereign wealth fund speeding up investment - mining a target
“According to reports in the Chinese press, China’s $200 billion sovereign wealth fund, China Investment Corporation (CIC) is stepping up its rate of investment in overseas companies and institutions to take advantage of what it perceives as longer term values resulting from the global financial crisis.

“China’s People’s Daily reports CIC chairman Lou Jiwei as saying that the fund was circumspect in its investment in 2008 as markets plunged investing only $4.8 billion outside China that year, but this year it has been investing around as much each month overseas as it did in the whole of 2008 with the main targets including mining, energy and real estate.

“While the principal purpose of the Fund is to create wealth for the country with its huge dollar surpluses there does also seem to be a dual approach in play, particularly with regard to the mining and energy sectors where an element of securing long term supplies for China’s ever-growing industrial sector has to be an important factor.

“However as we have reported here beforehand, CIC, as well as various state-owned minerals sector companies, seem to be pushed by the Chinese government to work day and night to divest as much as possible in its surplus dollars in solid assets beneficial to the nation, as it sees the value of the US dollar declining almost daily.

“The purchasing power of CIC is huge. At the end of 2008 some 87.4% of its overseas investments were held in cash and cash equivalents. There have also been indications that the Chinese government is prepared to pump more funding into CIC should it be needed.”

Source: Lawrence Williams, Mineweb, October 23, 2009.

Financial Times: Oil could exceed $100 next year
“Crude oil prices could push above $100 a barrel heading into 2011 due to a combination of a cyclical improvement in demand, the rapid weakening in the US dollar and strong global liquidity growth, says Francisco Blanch, head of global commodities research at Bank of America-Merrill Lynch.

“Demand in emerging markets is coming back with a vengeance, led by China, and will lend tremendous support to the global oil market in 2010.

“Mr Blanch notes that, with Brent trading around $79 a barrel, oil currently sits at a 47% discount to its record high and is lagging behind most other real and financial assets in the recovery.

“‘A spike in oil prices above the $100-a-barrel level could create significant headwinds for the global economy,’ he adds, warning that a sharp increase could also lead to a repetition of last year’s price collapse.

“In spite of the weakening dollar and increased liquidity, he says the risk of a spike in the near term is low - ‘physical fundamentals are simply not very supportive of higher oil prices’. In the US, Merrill notes demand seems to be improving but only relative to the dismal levels registered after Lehman Brothers’ collapse last October.

“The other side of the Atlantic is not faring much better. ‘The reality is that petroleum demand in Europe remains in the doldrums,’ says Mr Blanch. That should change next year.”

Source: Francisco Blanch, Financial Times, October 26, 2009.

Financial Times: Saudis drop WTI oil contract
“Saudi Arabia on Wednesday decided to drop the widely used West Texas Intermediate oil contract as the benchmark for pricing its oil, dealing a serious blow to the New York Mercantile Exchange.

“The decision by the world’s biggest oil exporter could encourage other producers to abandon the benchmark and threatens the dominance of the world’s most heavily traded oil futures contract. It is the main contract traded on Nymex.

“The move reveals the growing discontent of Riyadh and its US refinery customers with WTI after the price of the price of the benchmark became separated from the global oil market this year.

“The surge in oil inventories in Cushing, Oklahoma, where WTI is delivered into America’s pipeline system, depressed the value of the WTI against other global benchmarks, throwing the global oil market into disarray.

“In January, WTI, which usually trades at a premium of $1-$2 a barrel to Brent, fell sharply, leaving it at a discount of almost $12 - a record gap. This dislocation in the market continued well into the summer.

“From January, Saudi Arabia will base the price of oil for its US customers on a new index developed by Argus, the London-based oil pricing company.”

Source: Javier Blas, Financial Times, October 28, 2009.

David Fuller (Fullermoney): Gold is “hard money”
“Gold shares are very volatile and usually sell at high valuations. For instance, the Philadelphia Gold Bugs Index (HUI US) saw a 16% correction this month before today’s rally [Thursday]. In comparison, gold bullion has seen a reaction of 4.2%.

“In my experience, some of the investment managers who know the least about gold are most vehemently opposed to it. Several have told me that they ‘hate gold’, or words to that effect. The gist of their reason: ‘If you are bullish of gold you expect everything else to collapse.’ They view gold as the Armageddon story.

“I don’t see it that way. I regard gold as ‘hard money’ in a fiat currency world. Unlike paper money which is often printed with abandon, gold is a supply inelasticity story.

“The best reasons for not investing in gold bullion, I believe, are because it has no yield, is hard to value beyond the eye of the beholder, and fluctuates in price. The later factor means that gold can be out of favour for a long time, as we saw from its bubble peak in 1980 until 2001.

“It can also be in favour for a long time and I maintain that it is in a secular bull market which is likely to end in a bout of gold fever at some stage. There is no sign of this euphoria today.”

Source: David Fuller, Fullermoney, October 29, 2009.

Telegraph: Miners’ debt problems threaten higher prices
“The debt burden means that companies cannot invest in bringing new capacity on stream and this is having a severe impact on future supply growth, the report says. Long-term fundamentals for metals and minerals demand remain robust, but supply is being curtailed and there is a real danger of a supply gap emerging in several metals and minerals.

“The study by the accountancy group tracked the performance of a sample of the world’s largest listed mining and metals companies over almost three decades. It showed that debt levels remain a major concern across the mining and metals sector because of the dramatic levels of borrowing that occurred during the peak of the cycle in 2007 and 2008.

“Lee Downham, the firm’s mining and metals partner, thinks the industry will struggle to bridge the future supply gap and he sees a return to equity funding instead of using bank borrowing in the sector.

“‘We will see a return to equity as the major source of growth funding, together with innovative transactions less reliant on debt funding,’ Mr Downham said. ‘We also predict an increasing role for sovereign wealth and private capital and possibly even a return to initial public offerings and separate listings for individual mine projects.’

“The firm also believes that the debt burden will mean that acquisitions by listed mining and metals companies will more often be proposed on the basis of all-share swaps, with little or no cash element involved.”

Source: Garry White, Telegraph, October 25, 2009.

Telegraph: Buy food - price rises are almost guaranteed
“There are two main drivers of commodity prices - supply and demand. This is just as true with soft commodities such as wheat, rice, sugar and cocoa as it is with copper and tin. The big problem for your weekly shopping budget in the future is that there are problems on both sides of the equation that are likely to squeeze prices higher, permanently.

“However, this also provides a great investment opportunity and now is a good time to buy into many areas of food production and distribution.

“In September, sugar prices hit a 28-year high after the failure of crops in India due to the poor monsoon season. Prices have fallen about 20% since then, but are still likely to charge ahead over the longer term.

“Cocoa prices are also close to a 30-year high after a mixed harvest in Ivory Coast. Production of the bean is expected to be 100,000 metric tonnes lower this year than the 1.22 million tonnes produced in the country last year.

“Weather is partly to blame for the cocoa problem - the other issue is the age of the trees. Older cocoa trees yield less cocoa.

“These multi-decade highs in food staple prices have been caused by constraints in the supply side of the equation. However, it is the demand side of the equation that provides compelling evidence that prices are trending upwards.

“In a recent report called The End of Cheap Food, analysts and economists from Standard Chartered have calculated that food production would need to rise by a staggering 70% by 2050 if the world’s population is to remain adequately fed.

“The emerging market-focused bank argues that water will become scarcer and restricted availability of arable land will increase imbalances in food production, while rising biofuels production will deny an increasing amount of grain output for human consumption.

“Whilst food production will continue to rise, the gap between increasing demand and slowing supply will ensure food prices will rise - and stay high, it says.”

Source: Garry White, Telegraph, October 25, 2009.

MoneyNews: Andy Xie - beware huge China property bubble
“China is encouraging property-market bubbles to stimulate growth and power past other countries hit by the global economic downturn, says Andy Xie, an economist formerly of Morgan Stanley Asia.

People are looking at the bubbles as a way to gain economic growth in the short term,’ Xie said on Bloomberg Television.

“‘They are not sure of long-term damages that they may suffer.’

“The Communist Party cabinet is carrying on with monetary and fiscal stimulus, even though the economy surpassed the government’s forecasts for the first nine months of the year.

“As a result of that policy, property sales - and property values - have soared there, while America and Europe have struggled.

“The Chinese government financed a $585 billion stimulus package and banks extended a new record $1.27 trillion of credit. China’s economy expanded 8.9% in the third quarter, while housing prices climbed at the quickest pace in a year.

“‘Land prices have become so elevated,’ said Xie, who accurately predicted in April 2007 China’s looming equities downturn.

“‘The economy has become so dependent on property and the prices are so high and it carries a lot of risk for the country going forward.’”

Source: Gene Koprowski, MoneyNews, October 26, 2009.

Financial Times: Brazil keeps economic excitement in check
“It is the kind of news that would normally spook investors: Henrique Meirelles, the governor of Brazil’s central bank, is preparing to go into politics.

“The threat of political interference used to hang over Brazil’s economy like a black cloud. Yet Mr Meirelles explains with customary aplomb that by joining the centrist PMDB, Brazil’s biggest political party, he is only exploring possibilities. He may enter politics at next October’s general election, perhaps running for the senate; he may stay at the bank; or he may rejoin the private sector.

“‘I am merely taking an option on my future,’ he tells the FT at the central bank’s offices in São Paulo.

“Whatever his choice, investors appear unperturbed. Even a 2% tax on foreign portfolio investments, imposed last week to stem the rise of the currency, seemed unlikely to cause more than a pause in the flood of capital to Brazil this year. Brazil’s benchmark Bovespa index dropped on the news but quickly rebounded, and the real continues to appreciate. It has gained 36% against the US dollar so far this year. The stock market is higher than before the collapse of Lehman Brothers.

“Hosting the 2014 World Cup and 2016 Olympic Games has added to Brazil’s sense of arrival on the world stage.

“Other concerns must be addressed before the country fulfils its enormous potential. Former president Fernando Henrique Cardoso identifies four main challenges. ‘Brazil suffers from a shortage of infrastructure, poor quality of education, environmental issues and crime.’ Mr Cardoso’s fears on that last point have been underlined by the violence in Rio’s favelas.

“Such realism helps explain why Brazilian self-confidence is different from the swagger of fellow Bric countries, such as China and India. Rational optimism, rather than irrational exuberance, is what you encounter among São Paulo’s bankers and business leaders.”

Source: Lionel Barber, Jonathan Wheatley and John Paul Rathbone, Financial Times, October 25, 2009.

Tags: Black Tuesday, BRIC, Canada, Cboe, China, Commodities, Corporate Bonds, Corporate Earnings, Daily Pfennig, Economic Uncertainty, Emerging Markets, Epfr, ETF, Fund Tracker, Gdp Report, Gold, Government Bonds, Implied Volatility, Index Options, India, October 29 1929, oil, Q3 Gdp, Risky Assets, Safe Havens, Th Anniversary, Trading Sessions, Vix Index, Walt Handelsman
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Central Banks Giveth, Central Banks Taketh Away

Friday, October 30th, 2009

Two articles published within a few weeks tell a compelling story of cause and effect. The first by Michael McKenzie, FT.com, is a history lesson. The second, by one of the finest financial columnists, Ambrose Evans-Pritchard, serves as a warning.

Central banks fuel risky assets, By Michael Mackenzie in New York

October 16 2009 20:56 | Last updated: October 19 2009 09:24

Thanks to generous liquidity support from central banks, risky assets have been moving in a broad relationship for some time, and this week several markets reached or approached key levels.

Of all the major markets, equities are the main barometer of risk taking. This week shares in Australia, Hong Kong, India, Russia, Europe, London, Brazil and New York all hit fresh peaks for at least the past 12 months.

Rising appetite for risk was perhaps most apparent in the US crude oil price breaking above $75 a barrel, which was its high in late August and had presented a barrier for oil bulls since June.

Central banks chill asset rally, by Ambrose Evans-Pritchard, October 30, 2009

The liquidity tide is turning. Authorities across large parts of the world have either begun to tighten the spigot or are taking steps to wean their economies off emergency stimulus. This is a treacherous moment for markets.

Oil-rich Norway raised rates a quarter point to 1.5pc on Wednesday, the first European country to move since the crisis. Governor Svein Gjedrem said asset prices have “risen sharply and probably excessively”. The Norges Bank is taking pre-emptive action to choke off a property bubble, though manufacturing remains sluggish. The era of “asset targeting” has begun.

Australia took the plunge earlier this month. It dodged recession over the winter and has since been lifted by China’s torrid demand for commodities. Israel kicked off in August.

Source: FT.com | Telegraph UK

Tags: Ambrose, Asset Prices, Cause And Effect, Central Banks, China, Commodities, Crude Oil Price, Emerging Markets, Evans Pritchard, History Lesson, India, Last Updated October, Late August, Liquidity Support, Michael Mackenzie, Michael Mckenzie, Norges Bank, oil, Quarter Point, Risky Assets, Russia Europe, Spigot, Taking Steps, Telegraph Uk, Torrid
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A Reversal in CAD in Synch with Reversal in Markets

Thursday, October 29th, 2009

Canadian central banker, Mark Carney’s concerns about the strong Loonie are well known. It threatens Canada’s economic recovery. Some currency analysts believe the Canadian dollar could test its $1.10 highs again. But what is Carney doing about it?

David Rosenberg says we should embrace this period in Canada’s economic history. “For its part, the Bank of Canada has said that “persistent strength in the Canadian dollar” is going to “slow growth and subdue inflation pressures.” So, in return for softer growth, what we get back is lower “inflation pressures.” The winner here is anyone who needs to borrow money – a strong loonie will prevent the Band of Canada from taking the interest-rate punchbowl away any time soon.”

But, last week, the Bank of Canada interrupted the Canadian dollar’s ascent when it left rates at 0.25%, and downgraded economic growth prospects for 2010 and 2011. The dollar lost 2 cents. There is pressure though for the BoC to ease further.

Carney’s wait-and-see stance on quantitative intervention, indicates he may not have to. Instead, he may be talking through this, while waiting for the G20 to sort out the US dollar; in effect, a policy of benign neglect.

At the G-20 meeting in Pittsburgh in late September, leaders made commitments to pursue policies to bring the world into greater economic balance. Following that meeting, the ECB’s Trichet said it is “extremely important” that U.S. authorities pursue policies supporting a strong dollar, and that excessive foreign-exchange volatility is an “enemy.”

There’s another G20 meeting scheduled for Nov. 6-7 in Scotland, and it’s most likely to serve as a forum where all concerns over the dollar’s weakness will be aired. “I think there will be fireworks at the G20,” said Stephen Jen, a well-respected currencies investor at hedge fund BlueGold Capital Management in London.

The US is wallowing in the advantage of a weaker dollar. Neil Mellor, Bank of New York currency analyst, says, “You can’t continue down this road without something giving way, and it’s clear that the U.S. is not going to do anything to put meat on the bones of its strong-dollar policy.”

US$450-billion has been sucked from money market funds (the dollar) into risky assets since March. Zero-percent-interest-rate policy (ZIRP) crowded investors out of the money market and into risky assets. In the simplest of terms, the global equity markets’ slingshot recovery has led to conversely rapid devaluation of the dollar.

Now, a “strong US dollar policy,” for which there is great political will globally, appears to hinge upon a reversal of fortune in markets or concerted monetary intervention via the IMF, or both.

Therefore, the price of relief from the Loonie’s climb could be a synchronized decline in commodity prices and equity markets, in the near term. The repatriation of cash to US money markets means a stronger US dollar, and thus a weaker Canadian dollar, hence the synchronization with the reversal in equity markets and commodities prices. Perhaps Carney is right to let the big players sort out and tighten the US Dollar.

In newer developments earlier this week, the US government, perhaps under some pressure, showed signs that it is willing to withdraw stimulus, thus tightening the Greenback, by closing down the housing tax credit, and calling on Bank of America to repay its bailout by selling shares. The market is reacting poorly.

It begs the question - Is the tail wagging the dog?

If the stimulus and zero interest rate policy is responsible for the markets’ huge recovery, then what effect will indications now, of the US government’s willingness to withdraw stimulus, have?

Either way, it would be prudent, at this point, to take the political pressure from the world’s other large economies to re-establish balance without jeopardizing their own recoveries, seriously.

Tags: Ascent, Bank Of Canada, Bank Of New York, Benign Neglect, Boc, Buybacks, Canada, Canadian Dollar, Capital Management, Commodities, Currency Analysts, David Rosenberg, Dollar Policy, ECB, Economic Balance, Economic History, Economic Recovery, Finance Minister, G20 Meeting, Global Equity Markets, Gold, Growth Prospects, Hedge Fund, Inflation Pressures, Interest Rate Policy, Late September, Loonie, Mark Carney, Money Market Funds, Neil Mellor, Punchbowl, Resumption, Risky Assets, Strong Dollar, Trichet, Volatility
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Stocks and risky assets stumble

Thursday, October 29th, 2009

I concluded a post on stock markets over the weekend saying: “After equities’ seven-month climb, stock markets certainly look vulnerable for a decline. Two downside reversal days - on Wednesday and Friday - would seem to indicate that stocks could commence a pullback to work off the overbought condition, allowing fundamentals to reassert themselves.”

Global stock markets, as well as other risky assets, closed sharply lower over the past few days as concerns mounted over the sustainability of the global economic recovery and the outlook for central bank policy.

The performance of the major asset classes is summarized by the charts below, with the top one showing the period from the March 9 stock market lows until October 19 peak and the second one the subsequent period. The numbers indicate an all-change pattern in the performances as risk aversion re-entered financial markets and government bonds and the US dollar regained some favor.

Source: StockCharts.com

Source: StockCharts.com

A summary of the movements of major global stock markets since the March 19 peak, as well as various other measurement periods, is given in the table below.

The MSCI World Index and the MSCI Emerging Markets Index have declined by 5.3% and 6.2% respectively since the highs of October 19, with markets like Ireland (‑13.2%), Brazil (-10.5%), Austria (-10.8%) and Belgium (-9.0%) falling by significantly more. Also, higher risk indices such as small caps have borne the brunt of the selling, with the Russell 2000 Index down by 9.0%. This is a pattern that one would expect as investors shift the emphasis to higher quality.

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

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based) are given in the table below. A number of indices, including the S&P 500 Index, have fallen below their 50-day moving averages over the past few days, but all the indices are still holding above their respective 200-day moving averages. The 50-day lines are also above the 200-day lines in all instances.

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

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

Over the past few days a number of commentators have made pronouncements about the extent of a possible decline. For example, Jeremy Grantham (GMO) expects the S&P 500 to drop by 15% to 25%, David Rosenberg (Gluskin Sheff & Associates) sees markets falling by 20% and Doug Kass is looking at -5% to -12%.

This brings me to the topic of valuations. Based on operating earnings (i.e. stripping out everything that is bad), the historical price/earnings (PE) multiple of the S&P 500 is 27.0; using “as reported” (GAAP) earnings the figure shoots up to a giddy 95.7! Getting past the loss-making fourth quarter of 2008 and calculating prospective multiples through December 31, 2009 reduce the valuations to 19.0 and 24.4 respectively. Looking further out to the end of 2010, the prospective PEs are 14.1 and 22.9 respectively - still hardly the type of valuations that will inspire one to be a buyer across the board. (The earnings estimates are courtesy of Standard & Poor’s.)

Another way of looking at valuation levels, and cutting through the uncertainty of having to forecast earnings, is by means of Robert Shiller’s cyclically adjusted price-earnings ratio (CAPE), effectively muting the impact of the business cycle by averaging ten years of earnings. Using rolling ten-year reported earnings, my research (based on Shiller’s methodology, but including some refinements) shows that the “normalized” price-earnings ratio of the S&P 500 Index is currently 18.7. This compares with a long-term average of just more than 16.3 and implies an overvaluation of 15%. Considering a geometric rather than an arithmetic average of earnings, the overvaluation increases to 25%. The graphs below show data since 1950, but the actual calculations date back to 1871

Meanwhile, David Rosenberg highlights that this is not the onset of a sustainable secular bull market as we had coming off the fundamental lows of prior bear phases, such as August 1982, when:

• Dividend yields were 6%, not sub-2%.

• Price-to-earnings multiples were 8x, not 27x.

• The market traded at book value, not more than twice book.

• Inflation and bond yields were in double digits and headed down in the future, not near-zero and only headed higher.

• The stock market competed with 18% cash rates, not zero, and as such had a much higher hurdle to clear.

• Sentiment was universally bearish; hardly the case today.

• Global trade flows were in the process of accelerating as barriers were taken down; today, we are seeing trade flows recede as frictions, disputes and tariffs become the order of the day.

• A Reagan-led movement was afoot to reduce the role of government with attendant productivity gains in the future, as opposed to the infiltration by the public sector into the capital markets, union sector, economy and of course, the realm of CEO compensation.

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

I conclude with a comment from David Fuller (Fullermoney) who said: “At this stage of the bull cycle, I think a correction of approximately 10-15% for developed country stock markets and somewhat more for emerging markets would be good news for investors with cash to invest. Such a mean reversion towards rising 200-day moving averages would blow the recent froth off valuations and stem talk of an early change in monetary policy.”

I will bide my time while the fundamentals play catch-up. Meanwhile, caution remains the operative word.

Tags: Asset Classes, BRIC, Bric Countries, Brunt, Downside, Economic Recovery, Emerging Markets, Financial Markets, Global Stock Markets, Government Bonds, Lows, Moving Averages, Msci Emerging Markets, Msci Emerging Markets Index, Msci World Index, October 19, Pullback, Risk Aversion, Risky Assets, Russell 2000 Index, Small Caps, Stock Market
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Jeremy Grantham: “Fair value on the S&P is 860″

Tuesday, October 27th, 2009

Jeremy Grantham has become a familiar and very popular face on this site. For those treasuring his insight, wisdom and prescient calls, the co-founder and chief investment strategist of Boston-based GMO has just published the October edition of his quarterly newsletter entitled “Just desserts and markets being silly again”.

Before quoting from the report, Grantham recently put matters into perspective in a Kiplinger article, saying: “The recent rally has been very speculative, favoring risky assets over the past few months. I’m sorry if you missed investing at the market’s March lows, but don’t compound the damage to your portfolio by chasing gains in risky assets. We’re at the beginning of a seven-year period of lean returns. You should only be buying the highest-quality blue-chip com­panies, where valuations are most attractive.”

Here are a few excerpts from the Grantham’s newsletter.

“Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year. Doesn’t it seem odd that we would be measurably overpriced once again, given that we face a seven-year future that almost everyone agrees will be tougher than normal?

“Price … does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors. First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labor cuts fades away. Second, the slow gravitational pull of value as US stocks reach +30-35% overpricing in the face of an extended difficult environment.

“It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of 1,100. It can certainly happen. Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again. I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. ‘Painfully’ is arbitrarily deemed by me to start at -15%. My guess, though, is that the US market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1,098 on October 19).

“Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.”

Click here for the full report on Grantham’s reasoning for his cautious stance.

Source: Jeremy Grantham, GMO, October 2009.

Tags: Chief Investment Strategist, Co Founder, Desserts, Excerpts, Gmo, Guess, Horizon, Jeremy Grantham, Lean Years, Lows, October 19, Panies, Price Earnings Ratios, Profit Margins, Quarterly Newsletter, Rally, Risky Assets, S Market, Valuations, Wreckage
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Words from the (Investment) Wise (October 18, 2009)

Sunday, October 18th, 2009

Risky assets remained in favor during the past week, generally helped along by fairly robust economic data and better-than-expected corporate earnings reports. A number of bourses, crude oil, inflation-linked bonds and high-yielding corporate bonds and currencies recorded fresh highs for the year, whereas gold hit an all-time high of $1,070.20 per ounce.

Assets such as government bonds and the US dollar saw fading demand as safe havens, now that the global economy is on the mend. Similarly, credit default spreads tightened markedly and the CBOE Volatility Index (VIX) declined to its lowest level since early September 2008.

The Dow Jones Industrial Index passed a psychological milestone this week as the Index broke above the 10,000 level for the first time in a year, although it then declined again to fall shy of the roundophobia number by four basis points by the closing bell. The Dow first broke above 10,000 more than ten years ago in 1999 and has since done so on 26 occasions. Yes, a ten-year buy-and-hold index investor has had no capital gain over the period!

Source: The Wall Street Journal, October 16, 2009.

Meanwhile, according to the Financial Times, a survey of 44 leading economists by the National Association of Business Economics (NABE) showed the jobs that were lost during the Great Recession are not expected to return before 2012, while anemic wage growth of only 1% this year and 2.2% next year is forecast - the slowest two-year period on record. “But the way that investors are almost relying on unemployment to stay high [and central banks not to start exiting from the exceptionally low interest rates any time soon] demonstrates that the recovery, in markets and the economy, remains on shaky foundations,” warned FT’s investment editor, John Authers.

Source: Walt Handelsman, October 14, 2009.

The past week’s performance of the major asset classes is summarized by the chart below - a set of numbers that indicates an increase in risk appetite.

Source: StockCharts.com

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

The MSCI World Index (+1.4%) and MSCI Emerging Markets Index (+2.1%) both made headway last week to take the year-to-date gains to +25.6% and an impressive +70.4% respectively. Interestingly, Chile is now only 1.5% down from its July 2007 highs and could be one of the first markets to wipe out all the financial crisis losses.

Notwithstanding a down-day on Friday, US indices closed higher for the week. The year-to-date gains remain firmly in positive territory and are as follows: Dow Jones Industrial Index +13.9%, S&P 500 Index +20.4%, Nasdaq Composite Index +36.8% and Russell 2000 Index +23.4%.

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

Top performers among stock markets this week were Sudan (+22.6%), Kazakhstan (+8.9%), Cyprus (+7.6%), Egypt (+6.0%) and Hungary (+5.5%). At the bottom end of the performance rankings countries included Nigeria (‑4.2%), Thailand (-4.0%), Qatar (-3.2%), Bahrain (-2.8%) and Ireland (‑2.4%).

Of the 99 stock markets I keep on my radar screen, 76% recorded gains, 21% showed losses and 2% remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that, as far as exchange-traded funds (ETFs) are concerned, the winners for the week included United States Gasoline (UGA) (+11.1%), United States Oil (USO) (+8.9%), PowerShares DB Energy (DBE) (+8.8%) and iShares S&P GSCI Commodity (GSG) (+7.4%).

On the losing side of the slate, ETFs included iShares MSCI Thailand (THD) (-6.0%), Market Vectors Solar Energy (KWT) (-2.8%), Claymore/MAC Global Solar Energy (TAN) (-2.6%) and ProShares Short MSCI Emerging Markets (EUM) (-2.5%).

Referring to the declining US dollar, the quote du jour this week comes from 85-year-old Richard Russell, author of the Dow Theory Letters. He said: “Now I’ll let you in on an awful secret. The US, despite all its BS talk, really wants a lower dollar. The fact is that the US is doing absolutely nothing to defend the dollar. Of course, if the Fed wanted to defend the dollar they could halt their mass printing of dollars, and they could raise interest rates. And Bernanke could win the 800 meter race at the next Olympics at Rio.

“But let’s be rational - how in God’s name is the US going to pay off trillions in debt? By raising taxes? Impossible. They could renege on the debt like Argentina - unthinkable. But there is a way - they’ll try to minimize the importance of the debt with a cheaper, devalued dollar. That’s the time-honored US way, but loyal Americans don’t believe it. If they did, gold would be selling at $4,000 an ounce.”

Russell added: “It’s all so smarmy, but c’mon, what do you think the Fed has been doing since World War II? It’s been systematically inflating. They can’t fool me, I was around after the War, and I remember prices in 1945. Maybe the chief culprit was Alan Greenspan, but Bernanke is carrying on. There’s a lot of inflating coming up. ‘Strong dollar policy.’ Bite your tongue, and give me a break.”

Other news is that the Federal Deposit Insurance Corporation (FDIC) closed another bank on Friday, bringing the tally of US bank failures in 2009 to 99 (124 since the beginning of the recession). Meanwhile, CreditSights, which tracks the dismal data, predicts (via MarketWatch) that we could be no more than 10% of the way through this cycle of bank collapses, which is sure to be the worst run of closures since the Great Depression.

Next, a quick textual analysis of my week’s reading. Although “bank” still features prominently, the key words have started taking on a more normal pattern compared with the crisis-related words that have dominated the tag cloud for many months. “Recovery” is also gaining in prominence.

The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based) are given in the table below. With the exception of the Shanghai Composite Index, which is trading marginally below its 50-day moving average, all the indices are above their respective 50- and 200-day moving averages. The 50-day lines are also above the 200-day lines in all instances.

The US indices are creeping closer to the so-called 50% retracement levels (i.e. regaining half the loss suffered between the October 2007 highs and March 2009 lows). The levels are: 10,346 for the Dow Jones Industrial Index and 1,121 for the S&P 500 Index.

The September highs and October lows are also given in the table as these levels could define a support area for a number of the indices.

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

“We regularly note that the earnings reporting season often marks the end of the market trend into earnings announcements. The reversal tends to occur during the second week [last week] of reporting. Given this is expiration week, which often creates a short-term peak on the usual manipulation, the odds favor a short-term stock market peak late this week or next week. Of course any unexpected ugly news, like negative revenue, earnings or guidance from several key companies could commence a stock downdraft,” said Bill King (The King Report).

Talking of earnings, the third-quarter earnings season has progressed on an upbeat note since Alcoa’s results announcement on October 7 marked the onset of the reporting cycle. It is still early days in this period, but 85% of US companies have so far beaten earnings estimates. According to Bespoke, the current beat rate is well above any other quarter since at least 1998. ”Even with analysts raising estimates significantly leading up to the earnings season, companies have still managed to come in better than expected so far,” they said.

Source: Bespoke, October 16, 2009.

Additionally, Bespoke also highlighted that while the earnings per share numbers grab the headlines, it is what companies say about future quarters that impacts equity prices most on their reporting days. As shown in the graph below, 20.3% of US companies have raised guidance so far this earnings season. Bespoke’s report said: “The highest reading for this number has barely broken 15% in any prior quarter this decade. And if we compare the percentage of companies raising guidance versus the percentage of companies lowering guidance, no other quarters come even close to this one. It will be hard to keep this up as the earnings season progresses, but it’s also shaping up to be a record-breaking quarter on the positive side.”

Source: Bespoke, October 16, 2009.

Importantly, one needs to assess what is priced in by the stock market. Useful research comes from David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, who said: “We re-ran our regressions with the latest tightening in spreads and breakout in equity valuation and found that US investment grade credit is now priced for 2.5% GDP growth in the coming year (was 2.0% two months ago) and the S&P 500 is now de facto pricing in 4.8%, which, by the way, is now basis points shy of what it was discounting in the summer/fall of 2007. And, backing out the fair-value P/E from the corporate bond market, and yields have been backing up sizably in recent weeks, we can see that the S&P 500 is now pricing in $85 of operating earnings, which we think will be, at best, a 2013 story. In other words, the rally continues to move further away from the fundamentals.”

However, Rosenberg’s bearish prognostications are not universally accepted. In a rebuttal (via Clusterstock), Eddy Elfenbein created the chart below of profits as a share of GDP. “They’re clearly compressed, and if they revert to a historical standard, it means earnings have some spring in them,” said the report.

Source: Clusterstock - Business Insider, October 9, 2009.

Jeremy Grantham, who has just announced his retirement as chairman of GMO, put matters into perspective in a Kiplinger article, saying: “The recent rally has been very speculative, favoring risky assets over the past few months. I’m sorry if you missed investing at the market’s March lows, but don’t compound the damage to your portfolio by chasing gains in risky assets. We’re at the beginning of a seven-year period of lean returns. You should only be buying the highest-quality blue-chip com­panies, where valuations are most attractive.”

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

Economy
“After improving steadily this past summer, global business sentiment has remained largely unchanged so far this fall, consistent with a global economy that is experiencing a tentative economic recovery. The recession is over but the nascent recovery is not quickly gaining traction,” according to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com. “Businesses remain more upbeat about the outlook into next year and broader economic conditions, and dourer when considering the strength of their sales and intentions to hire. South Americans are the most positive and North Americans generally the most negative.”

Source: Moody’s Economy.com

As far as hard data are concerned, China’s economy gained new impetus, according to US Global Investors. “Passenger car sales in September rose 84% year on year to 1.02 million units. Housing starts jumped 56% in September from a year earlier, the fastest pace of growth in at least five years.

“China’s exports declined 15.2% year on year in September, the smallest contraction in nine months, while imports dropped only 3.5% year on year as the domestic economy continued to recover. Exports rose 7.7% on a month-on-month basis, adjusted for seasonality.” The stronger export performance follows a similar trend in South Korea, Taiwan and Vietnam.

“Singapore, which led Asia into recession, on Monday pointed the way to further regional recovery with strong third-quarter economic growth … The Monetary Authority of Singapore (MAS) said GDP expanded 14.9% on a seasonally adjusted quarter-on-quarter annualized basis in the June to September period, after a comparable revised increase of 22% the previous quarter,” reported the Financial Times.

Further good news on the global economic front came from Eurozone industrial production that expanded for the fourth month in a row in August. Output rose by 0.9% from July, when it increased by a revised 0.2%.

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

Friday, October 16
• Widespread strength in factory report

Thursday, October 15
• Inflation remains a non-issue, for now
• The quandary between initial claims and total continuing claims

Wednesday, October 14
• Minutes of September 22-23 FOMC meeting - more of the same
• Q3 consumer spending expected jump likely, but muted growth in Q4
• Import prices are turning around
• Restocking - one of the conduits of economic growth in the months ahead

Further evidence that the recession that began in December 2007 has ended, came from the Philly Fed report that was positive for the third straight month. According to Bespoke, “the last time this indicator was positive for three straight months was from September through November 2007, which was the last three months leading up to the start of the recession”.

Source: Bespoke, October 15, 2009.

Dissecting the retail sales data shows that trends improved all over, with the exception of auto-related sales due to “Cash for Clunkers”. The chart below, courtesy of Clusterstock takes September’s year-on-year sales change (Sep 09 versus Sep 08) and subtracts August’s year-on-year sales change (Aug 09 versus Aug 08). It thus shows the change in the retail sales trend. “Yes, this matters: American retail trends have to become less negative before they go positive,” said the report.

Source: Clusterstock - Business Insider, October 14, 2009.

The minutes of the Federal Open Market Committee’s (FOMC) September meeting indicated that most participants thought the recession was over. Although they expected the recovery to be weak initially, most members also upgraded their expectation for near-term growth.

Participants generally expected inflation to remain low in the near term. “The Fed is in the most favorable spot in the near term with regard to inflation because the excess capacity in the economy allows the Fed to maintain a focus on economic growth and leave inflation on the back burner, for now,” said Asha Bangalore (Northern Trust).

Cautioning against bullish expectations, David Rosenberg said (via MoneyNews) that the economy was being held together by very strong tape and glue provided by the Fed, Treasury, and Congress, and that the recovery would be weak.

He predicted the economy would stagnate this quarter and then grow no more than 2% in 2010. The economy won’t take on the “V” shape of previous rebounds, Rosenberg said. “It’s going to look like this whole string of lowercase Ws for the next five