Investment Postcards from Cape Town

Stock markets succumbed to a bout of profit-taking last week, sparked by concerns that the rally has overshot the pace of economic recovery. Riskier assets were showing signs of fatigue as the US dollar - the catalyst of many recent moves - stabilized and was perceived to be near its trough (if only short-term in the books of ardent dollar bears).

The greenback, usually the remit of the US Treasury, received support from Fed Chairman Ben Bernanke in a speech. He noted that the Fed was “attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the US economy, will help ensure that the dollar is strong and a source of global financial stability.” These comments spurred some buying interest.

Bill King (The King Report) summarized the situation as follows: “For the past few months, bad economic news was perceived to be good news for stocks on the rationale that it ensured more juice. Dollar down, stocks and gold up has been the routine. Are we at an inflection point, where bad economic news is becoming bad news for stocks?”

Source: Ed Stein, Comics.com, November 20, 2009.

The past week’s performance of the major asset classes is summarized by the chart below. With the exception of equities and investment-grade corporate bonds, most asset classes closed higher on the week despite nervousness creeping in before the weekend. Gold bullion touched a record high of $1,152.74 on Thursday and helped platinum, silver, palladium and copper reach fresh peaks for the year.

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 (-1.1%) and the MSCI Emerging Markets Index (+0.3%) followed different paths last week, resulting in year-to-date gains of 24.5% and an impressive 70.2% respectively. Notwithstanding solid gains since the March lows, no major index has yet been able to reclaim the 2007 pre-crisis peaks.

As far as the US indices are concerned, the Dow Jones Industrial Index eked out a small gain for the week as investors emphasized high quality, but the other major indices all reversed a two-week up-patch. Six of the ten economic sectors closed lower for the week, with Technology (-1.4%) and Consumer Discretionary (-1.1%) underperforming,

The year-to-date gains in the US remain firmly in positive territory and are as follows: Dow Jones Industrial Index 17.6%, S&P 500 Index 20.8%, Nasdaq Composite Index 36.1% and Russell 2000 Index 17.1%.

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

Top performers among stock markets this week were Bangladesh (+21.3%), Latvia (+4.5%), Kazakhstan (+4.3%), Qatar (+4.1%) and China (+3.8%. At the bottom end of the performance rankings, countries included Ecuador (‑9.3%), Egypt (-7.6%), Greece (-7.1%), Turkey (-7.0%) and Macedonia (‑6.3%).

Of the 98 stock markets I keep on my radar screen, 39% recorded gains (last week 66%), 58% (31%) showed losses and 3% (3%) remained unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

While other benchmark indices have been going from strength to strength, the Japanese Nikkei Dow has been in a downtrend since August and last week recorded a fourth consecutive down-week. The weakness in Japanese stocks coincided with a surge in the price of credit default swaps (CDSs) on Japanese government bonds (JGBs) - under stress of sovereign solvency fears. The chart below shows the significant underperformance of the Nikkei (red line) versus the S&P 500 (green line) - in absolute terms in the top section and on a relative basis (blue line) in the bottom part.

Source: StockCharts.com

John Nyaradi (Wall Street Sector Selector) reports that, as far as exchange-traded funds (ETFs) are concerned, the winners for the week included iShares Silver Trust (SLV) (+6.2%), PowerShares DB Silver (DBS) (+6.2%), PowerShares DB Base Metals (DBB) (+4.6%), SPDR S&P Metals and Mining (XME) (+3.8%) and Market Vectors Agribusiness (MOO) (+3.8%).

At the bottom end of the performance rankings, ETFs included iShares MSCI Turkey Investible Market (TUR) (-8.1%), HOLDRS Merrill Lynch Market Oil Service (OIH) (-4.3%), First Trust ISE-Revere Natural Gas (FCG) (-3.9%), SPDR S&P International Financial Sector (IPF) (-3.9%) and iShares Dow Jones US Home Construction (ITB) (-3.7%).

“Short-term US interest rates turned negative on Thursday as banks frantically stockpiled government securities in order to polish their balance sheets for the end of the year,” reported the Financial Times. Three-month T-Bills traded at a yield of -0.03% and six-month Bills fell to 0.12% - the lowest six-month yield since 1985.  “Conventional wisdom says it’s year-end window dressing … But why Bills? If you want to park cash, why not place it in some short-term paper with a positive yield? … those pundits that exclaim there is no problem are not correct. If there were no concerns, the cash would not eagerly run to a negative yield vehicle,” observed Bill King.

Signs of heightened risk aversion also came from a widening of the spread of emerging-market bond yields over Treasuries and an increase in credit default swap spreads on corporate bonds and sovereign debt (notably the US and the UK). Risk aversion also resulted in the selling of some commodity-linked currencies.

In other news, a US congressional panel on Thursday approved the Ron Paul-Alan Grayson initiative to open the Federal Reserve’s monetary policy decisions to government audits. The panel approved the amendment to broader legislation to revamp financial rules, but put off a vote on the broader measure.

Also, the Fed announced a reduction in the term of discount window loans from 90 to 28 days, effective January 14, 2010. Asha Bangalore (Northern Trust) argued that the need for discount window loans had decreased significantly from the period following the collapse of Lehman Brothers. “This [Fed's announcement] marks the beginning of a gradual withdrawal of the extraordinary support the Fed has extended to the global financial system as signs of stability have emerged,” she said.

Next, a tag cloud of all the articles I read during the week. This is a way of visualizing word frequencies at a glance. “Gold” has been rising in prominence for a while, and now occupies the top slot in the media. Words such as “rates”, “dollar”, “prices” and “China” are not far behind.

Back to the stock markets: The S&P 500 Index broke above 1,100 on Monday, but reversed course later in the week and again closed below what was seen as an important resistance level.

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, 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 European 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.

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 and up-volume recently having been mediocre, the Dow Industrial and S&P 500 are up against significant medium-term downward trendlines. Also, negative divergences are showing up in a number of breadth indicators, often good leading indicators at tops, as discussed below.

The number of S&P 500 stocks trading above their respective 50-day moving averages has declined from 92.6% in September to 56.8%, having made a series of declining tops while the underlying index was making new highs for the move. “This means that less and less stocks have been helping the index move higher, and it’s definitely something that favors the bearish argument,” said Bespoke.

Source: StockCharts.com

The Bullish Percent Index shows the percentage of stocks that are currently in bullish mode as a result of point-and-figure buy signals. The figure is still relatively high at 77.0%, but the indicator appears to be topping out.

Source: StockCharts.com

Richard Russell, 85-year-old writer of the Dow Theory Letters newsletter, said: “I keep thinking that the stock market is on thin ice … I’m still bothered by the fact that this ‘bull market’ never started from an area where stocks were selling below ‘known values’. Every bear market I’ve ever seen has ended with stocks selling below ‘known values’. We never saw anything like that at the October 2008 lows or at the March 2009 lows. For this reason, I continue to think that maybe the final bear market bottom lies ahead. Suspicion, thy name is Russell.”

In case you have missed Adam Hewison’s (INO.com) short technical analysis videos during the past week, click on the following links to access these excellent presentations: S&P 500, Dow and Nasdaq, the US dollar, gold and crude oil.

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.

For more discussion on the economy and financial markets, see my recent posts “Velocity of US money supply at long last edging up“, “2009 Rally vs. 1982 Bull Market“, “Picture du Jour: Plunging dollar erodes non-US investors’ returns“, “WealthTrack: Bruce Berkowitz - golden rules of investing“, and “Donald Coxe - Investment Recommendations (November 2009)“. (And do make a point of listening to Donald Coxe’s webcast of November 20, 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 not doing so already, you can follow my “tweets” by clicking here. You may also consider joining me as a friend on Facebook.

Economy
“Global business confidence is slowly improving. Businesses remain cautious, but sentiment is much better than at the beginning of the year and is 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 were much more upbeat … notably optimistic about the economy’s prospects next spring. South American businesses are the most positive, and North Americans generally the most negative.”

Source: Moody’s Economy.com

The Ifo World Economic Climate Indicator rose in the fourth quarter of 2009 for the third time in succession, with the economic climate improving in all major economic regions. The improvement was particularly marked in Asia, where the indicator even surpassed its long-term average, but the climate indicator also rose clearly in Western Europe and North America in the fourth quarter. While the recovery of the world economy is driven especially by Brazil as well as India, China and other Asian countries, the economic expectations are now optimistic almost everywhere, with the exception of several countries in Central and Eastern Europe.

Source: Ifo, November 19, 2009.

As far as hard data are concerned, the Japanese gross domestic product grew by 1.2% quarter on quarter between July and September - the biggest quarterly expansion since the first quarter of 2007. A growing trade surplus and stimulus-fuelled private consumption combined to help the world’s second-largest economy recover from its worst postwar recession.

The latest acronym used in the context of economic recovery is “LUV”, indicating an L-shaped economic recovery in Western Europe, a U-shaped improvement in the US and a V-shaped reversal in the BRIC and other emerging countries.

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.)

Thursday, November 19
• Index of Leading Economic Indicators underscores US economy will continue to grow
• Labor market data point to stabilizing conditions

Wednesday, November 18
• Higher prices for cars and energy lifted CPI in October
• Housing starts - permits show a more stable trend

Tuesday, November 17
• Fed reduces term of discount window loans
• Factory production slips in October
• Higher prices for food and energy lift wholesale prices, core price index declines

Monday, November 16
• Chairman Bernanke stresses job market and credit conditions; the dollar receives special mention
• October retail sales - noteworthy gains of several components

Bespoke’s “Economic Indicator Diffusion Index” measures the pace at which US indicators are coming in ahead of (or below) expectations over a 50-day period. Interestingly, the Index last week fell into negative territory as data reports failed to live up to (higher) expectations.

Still bearish, Nouriel Roubini (RGE), according to The Money Game - The Business Insider, predicts a slow recovery, quoting the following ten reasons why we will see a U-shaped US recovery:

1. A U-shaped US consumer. Roubini argues against a “V-shaped” recovery, which he says puts too much confidence in this year’s strong equity rally. Eighty percent of the population reacts to home prices, not equity prices, and he forecasts that home prices will fall further.

2. Difficult labor market conditions. Expect a strong second half of 2009 and a sluggish 2010, with growth below potential and continued job losses.

3. Balance sheet recession caused by over-leverage and debt accumulation. There are signs of a massive re-leveraging in the public sector. The cost of maintaining this level of debt will be very high and a drag on the economy.

4. Investment usually is a strong recovery component. But investment will not recover while one third of current capacity is not utilized.

5. A damaged financial system and the related credit crunch. Only half of the estimated $3 trillion global credit losses (IMF recently lowered their estimates) have been recognized so far. Expect more to come, especially in Europe.

6. Home prices said to fall further and commercial real estate bust continuing.

7. Exit strategy: Damned if you do and damned if you don’t. Removing fiscal accommodation will constrain a recovery that still appears weak. It has already been determined that it is too early to remove fiscal accommodation, but if it continues it will fuel persistent large budget deficits and lead to inflation.

8. Fall in potential GDP levels and possibly in potential growth.

9. Global imbalances: Over-spenders retrench while over-savers don’t compensate. Fall in demand from countries that tend to be over-spenders (US, UK) has not been neutralized by countries that tend to be over-savers (Japan, Germany).

10. Emerging markets (EMs) fared better, but can’t close the consumption gap. Can China/India be the engine of global growth? No. Can EMs decouple from anemic growth in G3? No. Is the policy response of China/Asia appropriate and sustainable? No. There are not the necessary social safety nets in EM countries, so the motive to save is high. Private demand has to take over and drive growth.

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

Date	Time (ET)	Statistic	For	Actual	Briefing Forecast	Market Expects	Prior
Nov 16	08:30 AM	Retail Sales	Oct	1.4%	0.7%	0.9%	-2.3%
Nov 16	08:30 AM	Retail Sales ex auto	Oct	0.2%	0.1%	0.4%	0.4%
Nov 16	08:30 AM	Empire Manufacturing	Nov	23.51	20.5	30.00	34.57
Nov 16	10:00 AM	Business Inventories	Sep	-0.4%	-1.0%	-0.7%	-1.6%
Nov 17	08:30 AM	Core PPI	Oct	-0.6%	0.2%	0.1%	-0.1%
Nov 17	08:30 AM	PPI	Oct	0.3%	0.7%	0.5%	-0.6%
Nov 17	09:00 AM	Net Long-term TIC Flows	Sep	$40.7B	$30.0B	$30.0B	$34.2B
Nov 17	09:15 AM	Capacity Utilization	Oct	70.7%	70.5%	70.8%	70.5%
Nov 17	09:15 AM	Industrial Production	Oct	0.1%	0.2%	0.4%	0.6%
Nov 18	08:30 AM	Housing Starts	Oct	529K	585K	600K	592K
Nov 18	08:30 AM	Building Permits	Oct	552K	585K	580K	575K
Nov 18	08:30 AM	CPI	Oct	0.3%	0.2%	0.2%	0.2%
Nov 18	08:30 AM	Core CPI	Oct	0.2%	0.0%	0.1%	0.2%
Nov 18	10:30 AM	Crude Inventories	11/13	-0.887M	NA	NA	1.76M
Nov 19	08:30 AM	Initial Claims	11/14	505K	510K	504K	505K
Nov 19	08:30 AM	Continuing Claims	11/13	5611K	5580K	5598K	5650K
Nov 19	10:00 AM	Leading Indicators	Oct	0.3%	0.5%	0.4%	1.0%
Nov 19	10:00 AM	Philadelphia Fed	Nov	16.7	12.0	12.2	11.5

Source: Yahoo Finance, November 20, 2009.

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

US economic data reports for the week include the following:

Monday, November 23
• Existing home sales

Tuesday, November 24
• GDP
• Case Shiller 20 City Index
• Consumer confidence
• FHFA Home Price Index

Wednesday, November 25
• Personal income and spending
• PCE prices
• Initial jobless claims
• Durable goods orders
• Michigan Sentiment Index
• New home sales

Thursday, November 19
• Thanksgiving Day

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

“The recipe for perpetual ignorance is to be satisfied with your opinions and
content with your knowledge,” said Elbert Hubbard, American writer (hat tip: The Kirk Report). Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will make a contribution towards continuously shaping new opinions and increasing the knowledge of the readers of Investment Postcards to enable them to make the appropriate investment decisions.

This week, the markets will be closed on Thursday, Thanksgiving Day, and on Friday from 13:00 EST.

That’s the way it looks from Cape Town (where I am enjoying beautiful summer days before making my annual early-December trip to New York City).

Source: Tom Toles, The Washington Post, November 17, 2009.

(more…)

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This post provides links to a number of interesting articles I have read over the past few days that you may also enjoy.

• Jim Jubak (MSN Money): 3-step strategy for a twitchy market, November 19, 2009.
Many investors are deeply suspicious of the 60% run-up in stocks this year and are itching to sell. But then what? Here’s how to take some gains now while setting up a profitable 2010.

• Randall Forsyth (Barron’s): Treasury yield plunge sends warning, November 20, 2009.
Collapse in note yields suggests economic distress will keep Fed on hold well into 2010 or beyond.

• Gordon Chang (Forbes): When in doubt, blame Bernanke, November 19, 2009.
According to Liu Mingkang, China’s chief bank regulator, low American interest rates and the falling dollar have “seriously affected global asset prices, fueled speculation in stock and property markets and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies”. Does Liu have a point? Of course.

• The Economist: Stemming the tide, November 19, 2009.
Unprecedented levels of government debt may require radical solutions.

Reading break: Considering the short-term technical picture of the US dollar, Adam Hewison (INO.com) provides valuable insight with a short analysis. Click here to access the presentation.

• Mark Trumbull (The Christian Science Monitor): Does US need a second stimulus to create jobs?
With the economy still in rough shape, calls mount for extra infusions of federal money. But critics say the first stimulus hasn’t created the jobs it was supposed to.

• David Streitfeld (The New York Times): With F.H.A. help, easy loans in expensive areas, November 19, 2009.
In its efforts to prop up a shattered housing market, the government is greatly extending its traditional support of real estate, including guaranteeing the mortgages of middle-class and even upper-class buyers against default.

• Mish Shedlock (Mish’s Global Economic Trend Analysis): Ron Paul, Alan Grayson audit the Fed Bill approved in house finance committee, November 20, 2009.
The Bill to audit Federal Reserve passes key hurdle. Chalk up a rare victory for the little guy (and the nation itself).

• Carmen Reinhart and Kenneth Rogoff (Harvard): This time is different - panoramic view of eight centuries of financial crises, April 2008.
This paper offers a “panoramic” analysis of the history of financial crises dating from England’s fourteenth-century default to the current United States sub-prime financial crisis. Our study is based on a new dataset that spans all regions. It incorporates important credit episodes seldom covered in the literature, including for example, defaults in India and China.

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This podcast features an excellent interview by FT’s David Stevenson with Dylan Grice, strategist of Société Générale. Dylan, who has been described as “the Robin to Albert Edward’s Batman”, discusses stock market bubbles, China and geo-politics.

Click here for the interview (but be warned that the running time is 44 minutes).

Source: David Stevenson, Financial Times, November 6, 2009.

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Bill Gross, co-founder and co-CIO of PIMCO, is to my mind one of the shrewdest money men around. His monthly newsletter, this month entitled “Anything but .01%”, therefore always makes for thought-provoking reading.

The following are a few excerpts from the report:

“Almost all money market accounts - totaling over $4 trillion dollars, yield close to nothing, so close to nothing that I mistakenly did a double take when reviewing my monthly portfolio statement. “Yield on cash”, read the buried line on page 15 of the report, “.01%”.

“Well now, I say to myself, this is very interesting from a number of different angles. If I was hoping to double my money, it would take approximately 6,932 years to get there at that rate! Secondly, being a savvy professional investor and all, I knew that money market funds actually earned 20 basis points or so on my money, but in this case were allocating a paltry one basis point to me.

“Let me tell you what I’m doing. I figure, why not just buy utilities if that’s what the future American capitalistic model is likely to resemble. Pricewise, they’re only halfway between their 2007 peaks and 2008 lows - 25% off the top, 25% from the bottom. Their growth in earnings should mimic the U.S. economy as they always have, and most importantly they yield 5-6% not .01%! In a low growth environment, it seems to me that a company’s stock should yield more than its less risky debt, and many utilities provide just that opportunity. Utilities and even quasi-utility telecommunication companies now yield between 5 and 6%, whereas their 10- and 30-year bond yield less and at a higher tax rate to you the investor.

“Look at your monthly statement, zero in on that .01% yield and say to yourself, “I’m as mad as hell, and I’m just not going to take this anymore!” You can’t buy the Burlington Northern - Warren Buffett has scooped that up - and most other choices offer tempting returns, but potential bullets as well. Buy some utilities. It may not be as much fun as running a railroad, but at least you’ll know who to call if the lights go out.”

Click here for the full article.

Source: Bill Gross, PIMCO - Investment Outlook, December 2009.

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