Words from the wise for the week that was (November 12 – 18, 2007)

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This week’s article comes from Windhoek and Swakopmund in Namibia where I am on a brief business visit. This desert country is located along the southwestern coast of the African continent and lies north of my home country, South Africa. Namibia is known for its contrasting landscapes – from the Namib dune sea to teak woodlands to the Etosha Pan, a dried-out saline lake surrounded by grasslands and bush that support a large and varied wildlife – and for its hospitality and orderliness (largely as a result of the German influence that has remained since the days when it was a German colony at the end of the 19th century).

Speaking of contrasts almost as stark as those in Namibia, is the performance of stock markets out of step with an increasingly recessionary looking US economy? On Monday widely-respected John Hussman (Hussman Funds) said: “I expect that a US economic recession is immediately ahead”, but on “turnaround Tuesday” (November 13) the Dow Jones Industrial Index shot up by 320 points (2.5%), representing the 17th largest points increase on record.

But wait, are markets not simply fulfilling their traditional role as a discounting mechanism of future events? Here is Richard Russell’s (Dow Theory Letters) take on matters: “Doesn’t the stupid Dow Jones Industrial Average see what’s going on? Is the stock market crazy or what?! I went through this same experience in 1957 when the Dow turned up amid a deepening recession. Of course, the stock market knows what’s going on. The stock market in late-1957 was looking past the bad news to a coming boom. I think the market (the Dow) is doing the same thing now.”

More from Russell in the paragraphs below, but before highlighting some thought-provoking quotes from market commentators during the past week, let’s briefly review the markets’ actions on the basis of economic statistics and my customary performance charts.

The past week’s US economic news tilted towards weak economic conditions. Indications from other parts of the developed world – notably Germany, the UK and Japan – also pointed to slowing economic activity.

Credit market concerns lingered, but without triggering the same degree of anxiety as in recent times, especially regarding the ongoing sub-prime-related write-downs by financial institutions. A large part of the economic debate focused on whether or not the American consumer is finally slowing down spending due to high energy costs, tighter credit conditions and a continuously falling dollar, and the implications thereof for global economic growth.


Source: Gold Seeker Weekly Wrap-Up, November 16, 2007.

This week’s economic highlights include Building Permits, Housing Starts, and FOMC minutes on Tuesday, and Initial Jobless Claims, Leading Economic Indicators and Michigan Sentiment on Wednesday.

US markets will be closed on Thursday for the Thanksgiving Holiday and markets will close early on Friday.

Global stock markets
Global stock markets, including both mature and emerging bourses, ended a rather volatile week in the red. The American markets, however, followed a different course, with the Dow Jones Industrial Index, the Nasdaq Composite Index and the S&P 500 Index all three registering modest gains. Smaller cap US stocks lagged in negative territory as investors preferred the larger export-oriented companies.

The Hang Seng Index declined by a further 4.1%, bringing its losses since an all-time high on October 30 to 13%. 


Source: StockCharts.com

Global fixed-interest and currency markets
Hawkish remarks by Fed Governor Randall Kroszner, implying a reluctance to lower the Fed funds rate on December 11, brought some reprieve for the US dollar after its relentless fall since mid-August. The Japanese yen and Swiss franc gained more ground on the back of further unwinding of carry trade transactions, hitting respectively 18-month and 12-year highs against the dollar. The British pound, on the other hand, came under pressure as a result of strong indications by Mervyn King, Governor of the Bank of England, regarding interest rate cuts.

Despite Kroszner’s comments, US treasuries gained over the week as the yield on the 2-year US Treasury Note declined to its lowest reading since February 2005 and the yield on the 10-year US Treasury Note dropped to a level not seen since September 2005. Elsewhere in the world the 10-year Japanese bond yield hit a 20-month low.


Source: StockCharts.com

Commodities experienced another mixed week as investors pondered on how global demand would be affected by the fall-out of the credit crisis.

Gold bullion suffered from exhaustion and used the pause in the US dollar’s decline as an excuse to correct after its big run-up. Silver traded in lock-step with gold and also pulled back, but platinum bucked the trend.

The US Energy Department’s weekly inventory data showed the first increase in crude oil inventories in four weeks, thereby diminishing supply concerns and putting downward pressure on oil prices.

Base metals posted red numbers, but “Dr Copper” (usually a fairly good gauge of global economic activity) rebounded and ended higher for the week after a four-week slide.


Source: StockCharts.com

Now for some words (and graphs) from the investment wise that will hopefully assist to make sense of the shenanigans of the credit debacle and other pertinent issues.

Economy.com: Business confidence for world
“US business confidence remains moribund. Sentiment has not changed appreciably since plunging in August during the height of the subprime financial shock, and it remains consistent with an economy that is expanding very slowly. Businesses are particularly dour in their broad assessment of current conditions and expectations regarding the six-month outlook. Confidence is stronger outside the US, most notably in Asia. Sentiment is weakest among firms in housing and financial services, and strongest among high-tech businesses.”

Source: Moody’s Economy.com, November 12, 2007.

John Hussman (Hussman Funds): US recession immediately ahead
“On Saturday, the consensus of economists surveyed by Blue Chip Economic Indicators indicated expectations that growth will be sluggish into next year, but that there will be no recession. Unfortunately, the economic consensus has never accurately anticipated a recession. For my part, the outlook has changed. I expect that a US economic recession is immediately ahead. This conclusion is based on the combined weight of several classes of indicators, including asset prices, reliable survey measures, and measures of labor market activity.

“In every instance we’ve observed these conditions, the US economy has either already been in a recession, or has been within a few weeks of what turned out in hindsight to be the official beginning of a recession. There have been no false signals. Few things in investing or economics are certain, but my impression is that current evidence moves recession risk from ‘possible’ to ‘probable’.”

Source: John Hussman, Hussman Funds, November 12, 2007.

BCA Research: Has the Fed fallen behind curve?
“Increasing stress in the financial system and signs of reduced credit availability mean that the Fed has a lot more easing ahead. The shift to a neutral bias by the FOMC was misplaced given the renewed rioting in the financial markets. The earlier implosion in housing-related stocks has progressed to banks and consumer finance shares, where massive write-offs are occurring. Ominously, last week’s Fed senior bank loan officer survey warned that a credit crunch might be developing. A crunch could easily tip the economy into recession and risk an outbreak of deflation. Rather than panic and bet on Armageddon, investors should stay focused on the rapidly rising odds of a major reflationary program, i.e. much lower rates and yields than most have envisioned.”


Source: BCA Research, November 12, 2007.

Asha Bangalore (Northern Trust): Fed on hold in December?
“Overall inflation is trending up, with food and energy prices providing the extra boost. On this front, the Fed needs to be concerned. But, the muted trend of core inflation, which has ranged between 2.1% and 2.3% for seven consecutive months, is allowing the Fed to focus on credit issues and weak economic growth. The favorable core inflation trend could spike up before weak consumer demand holds back inflation. Until then, the FOMC has prospects of weak economic growth, a troubled dollar, and a threat of inflation to juggle with.

“We are keeping close tabs on the message from economic reports between now and the FOMC meeting on December 11. The latest jobless claims report, the NFIB Small Business Optimism Index, and the six-months-ahead Business Outlook Index of the Federal Reserve Bank of Philadelphia point to a bearish outlook for the economy. But sluggish growth for the fourth quarter already is built into the FOMC’s forecast. The FOMC believes that the bulk of the effects of its cumulative 75 basis point cut in the fed funds rate will not start to be reflected in the economic data until 2008. Therefore, the FOMC is likely to keep its fed funds rate target steady at the December 11 meeting unless incoming data suggest that the economy has entered a recession.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, November 15, 2007.

John Mauldin (Thoughts from the Frontline): The Fed’s dilemma
“If they (the Fed) cut rates, the dollar will fall and import prices rise, and it will also likely have negative effects on food and energy prices. If they do not cut rates, the markets will simply throw up as it will interpret that as a Fed which is not concerned about a slowing economy.

“Not cutting rates risks an economy that could easily slip into recession due to a growing risk of a credit crisis turning into a credit crunch. Usually, that means that inflation will fall. Usually, but not always.

“The Fed is faced with a problem I predicted four years ago … as the Fed dramatically eased monetary conditions in an effort to fight deflation. In a word, stagflation. That terrible moment in time when an economy slows (is stagnant) yet inflation is high, limiting the monetary authority’s ability to act. With a clearly slowing economy, a credit crisis, and rising inflation, they have no good and clear choices. Whatever they do is likely to create problems in a multi-dimensional real world. I still think they cut, as core inflation is still close to their comfort zone. But if core inflation starts to rise, they will have to act. Or at least should.”

Source: John Mauldin, Thoughts from the Frontline, November 16, 2007.

Richard Russell (Dow Theory Letters): Dow is discounting US export boom
“Doesn’t the stupid Dow Jones Industrial Average see what’s going on? Is the stock market crazy or what?! I went through this same experience in 1957 when the Dow turned up amid a deepening recession. Of course, the stock market knows what’s going on. The stock market in late-1957 was looking past the bad news to a coming boom. I think the market (the Dow) is doing the same thing now.

“What’s really happening with the Dow? The new ‘cheap’ dollar is changing the import-export equation. America’s big corporations, the ones that do a lot of exporting, they’re having a ball. In a short while I believe we’ll be reading about a US export boom. Of course, the boom will be led by the biggies, the type of giant stocks represented in the Dow. There, I’ve given the secret away, but don’t tell your friends. America is on the edge of an export boom.”

Source: Richard Russell, Dow Theory Letters, November 16, 2007.

Martin Spring (On Target): Go for large caps
For decades investors have found the best returns, on average, to be in the less-researched and less-liquid small- and mid-cap sectors. However I believe the radical changes in bank lending policies as a consequence of the credit crisis is going to change that for a while. For the next few years I expect the best returns in developed markets to be in the large-caps – especially the best-managed with global brand and/or technological leadership (which will be targets for the sovereign wealth funds), turnaround candidates with strong asset bases that attract cheap credit, and multinationals with strong business operations in, or trade with, emerging economies.

“For the very short term, I think caution is called for. There are signs of dramatic change in the corporate earnings environment. Prices of many resources look too far above trend. And many of the charts of major stock markets seem to be signalling significant corrections ahead. Usually the November to February period is one of strength in global equity markets, but I fear that this time around we could suffer an unseasonal shock.”

Source: Martin Spring, On Target, November 14, 2007.

Richard Russell (Dow Theory Letters): Is this the end of gold as a monetary asset
“Is this the end of gold as a monetary asset? Hardly, it’s just an overdue correction in an ongoing bull market. There’s been a lot written lately about gold going to 1 000, 1 500, even 2 000. My own opinion is that gold is going well over 1 000. But not this month and not this year. Gold will rise in its own methodical way. And along the way it will correct, sometimes gently, sometimes brutally. Gold is traded in a free market, and free markets correct. The corrections always seem to come as a surprise, but the corrections do come. We’re experiencing one now.”

Source: Richard Russell, Dow Theory Letters, November 12, 2007.

GaveKal: The ever-falling US dollar
“Of the three possible catalysts (foreigners returning to US assets, less borrowing in US dollar and a currency revaluation in China) for a turnaround in the US dollar-euro exchange rate the most likely is a faster revaluation of the RMB, and the other trading currencies, against the US dollar. As such, remaining long the ‘trading currencies’ (SG$, RMB, JPY, MXP and HK$) seems to us a slam-dunk: their momentum is positive, they are not overbought, their valuations are still very attractive and their fundamentals are very attractive. The same can not be said of the ‘savings currencies’ (Euro, GBP and CHF). These tend to be massively overbought, may be starting to show less upward momentum and their fundamentals are clearly not attractive.

“Finally, the ‘commodity currencies’ (AU$, NZ$, CA$, ZAR, BRL and NOK) are even more overbought than the ‘savings currencies’ and nearly as overvalued. However, thanks to solid commodity prices, they continue to show decent upward momentum (especially the CA$) though this will most likely slow if the current liquidity squeeze continues.

“Putting it all together, it seems to us that the best strategy is to remain long the ‘trading currencies’, followed by the US dollar, followed by the ‘commodity currencies’. The ‘savings currencies’ are best avoided or used as a source of funding.”

Source: Gavekal – Checking the Boxes, November 6, 2007.

BCA Research: German growth set to slow further
“The expectations component of the German ZEW survey plunged more than expected in November to -32.5 (from -18.1 in October). This measure is now at a 15-year low, heralding that growth conditions are likely to deteriorate markedly in the coming months. On an industry level, gloom in the financial sector is spreading to interest sensitive sectors of the economy such as automobiles and construction. Rising energy prices and the lagged impact of higher interest rates are beginning to dent consumption, with retail sales growth slowing from low levels. Industrial production is also at risk because the rising euro and the US slowdown are having a noticeable impact on industrial orders and export growth. Bottom line: The ECB remains on hold for now but risks are tilted towards easing.”


Source: BCA Research, November 14, 2007.

BCA Research: ECB can’t get any tighter
“The euro area has the tightest monetary conditions among the major industrialized nations. Past rate hikes coupled with a surging euro have tightened monetary conditions dramatically, and have helped curb economic growth within the region. Correspondingly, we expect that credit conditions will slowly start to ease. This loosening could occur in one of three ways: 1) An easing in interbank rates as credit standards normalize; 2) The exchange rate may begin to lose traction as the economy weakens, given its heavy reliance on export growth; 3) The ECB might formally cut rates. While it may be difficult to reach the required consensus among committee members to ease, the market is likely to put pressure on the ECB and expectations of rate cuts will build.”

Source: BCA Research, November 16, 2007.

The Telegraph: Seeing little inflation, Bank of England ready to cut rates
“The Bank of England is poised to cut interest rates as many as three times in an effort to ease the pain of the credit crunch, it indicated today. In its closely-watched Inflation Report, the bank said it could comfortably allow interest rates to drop from their current level of 5.75 percent to around 5 percent without inflation getting out of control.

“It is the firmest indication yet that it is preparing to cut the cost of borrowing for the first time since August 2005. The first of the interest rate cuts could come as soon as next month, although most experts think it will be more likely to arrive in the new year.

“The bank slashed its economic growth forecast, acknowledging that next year would be the hardest for the British economy for many years. Governor Mervyn King also said that the housing slowdown had arrived, and said he expected house price inflation to drop even further in the coming months.”

Source: Edmund Conway, The Telegraph, November 15, 2007.

GaveKal: Reigning in China’s inflation
“ … the news and commentary out of China is dominated by concerns about runaway inflation, overvalued assets ready to burst, and how the government will handle such price activity. China’s CPI rose in October by +6.5% YoY, returning to the decade-high pace it established in August.

“ … we seek comfort in the fact that Beijing has thus far provided every indication that it has the desire and agility to deal with its inflation and asset appreciation problems, without causing a severe crash. To do this, Beijing chooses, from its myriad of policy options, just where and how it wants to slow down its roaring economy and overheated asset markets. For example, it recently simply told its domestic, state-owned banks to reign in loan growth (and for select companies, such as those that are heavy polluters or those invested in real estate, credits are completely shut down). Of course, if this method were to usher in undesirable, or overly dramatic, consequences, then Beijing has shown itself perfectly willing to quickly adjust the plan accordingly. As such, we have confidence that Beijing has a handle on the issues surrounding food and asset prices, and, as such, neither should spiral out of control.”


Source: Gavekal – Checking the Boxes, November 14, 2007.

Martin Spring (On Target): Slow-burning credit crisis
“Although the immediate panic is over, this is a slow-burning crisis that is going to take a long time to unfold, having an adverse impact on economic growth for years to come. Banks will hurriedly revert to conservative lending policies to digest their own toxic waste, rebuild their balance sheets, placate angry politicians and activist regulators, and shore up the confidence of their shareholders.

“One example of how much further revaluation of structured-credit assets still has to go is that Merrill Lynch was recently forced to cut by 57 per cent the value of one chunk if its mortgage products that had been given the highest credit rating, AAA. Lots of toxic waste remains buried in packaged investments scattered around the world in the portfolios of conservative financial institutions such as pension funds. It will be take years for the losses to become apparent, when the lower market values of those credits are recognized and taken to book.

“However, more damaging than the losses themselves – which could well turn out to be not all that great, relative to total assets – will be the damaging impact on sentiment of ongoing uncertainty and the drip-feed of continual announcements of losses. A serious outbreak of caution.”

Source: Martin Spring, On Target, November 14, 2007.

Joseph Stiglitz (Vanity Fair): Economic consequences of Mr Bush
“When we look back someday at the catastrophe that was the Bush administration, we will think of many things: the tragedy of the Iraq war, the shame of Guantánamo and Abu Ghraib, the erosion of civil liberties. The damage done to the American economy does not make front-page headlines every day, but the repercussions will be felt beyond the lifetime of anyone reading this page.”

Source: Joseph Stiglitz, Vanity Fair, December 2007.

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4 comments to Words from the wise for the week that was (November 12 – 18, 2007)

  • Tony Immarco

    Am I the only person to observe that the WSJ for the past week has posted a P/E ratio for the DJIA in excess of 45 when the prior YEARS P/E posting was of the order of about 16 ?????????????????

  • Tony Immarco

    In the “Week’s Economic Reports” you dislay two columns of data. Associated with each line item is either a month or a weekly date. Can you identify the column headings? Are they the periods’ beginning and ending values?

  • Tony, the first figure pertains to the month mentioned in the left-hand column and the second figure to the prior month. For example, retail sales rose by 0.2% in October, following an increase of 0.7% in the prior month (September).

  • E. Cartman

    Good stuff, M. du Plessis. I have a couple of questions.

    1) Why does the Fed necessarily have a “mandate to avoid a recession”? It is mandated to “achieve full employment.” However, an obvious ’emanation’ of that law is that it means full intertemporal employment. In other words, if a little more unemployment now leads to a lot more employment later – and if foreigners don’t lose confidence in the dollar and dump it – then that more fully maintains a state of full employment.

    So why do people assume the Fed will do anything to prevent a recession? Why is this the new benchmark, why has the business cycle been subconsciously repealed by the financial press?

    2) I have read some of GaveKal’s stuff too (extremely! smart guys but fundamentally China bulls) and I think the argument of China bears is that there is no middle ground between a very sharp recession and an inflation correction. There has been very strong evidence of institutionalization of a shadow banking system in China for some time, because Chinese real interest rates are running at -3% according to official figures after taking into account price caps; when you take into account gray-market behavior to dodge price caps, and probable lying about inflation figures, who knows what the actual inflation rate is, but it could easily be negative five percent.

    3) And finally, since the “China export bubble” seems to be rapidly rolling over from the United States to Europe, what do you see as the prospects for increasing dovishness in the ECB?

    I still see a “global inflation glut” looming once the ECB bows to the doves and starts easing the euro. The euro is only as good as the integrity of the monetary union, and the Europeans are simply not politically able to shoulder the brunt of China’s trade surplus. At least that’s how it sounds to me.

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