Words from the wise for the week that was (November 19 – 25, 2007)

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This week’s edition of “Words” is again a “high-altitude delivery” as it comes from above the clouds en route from Cape Town to Ljubljana, the romantic capital of Slovenia right in the heart of Central Europe. After three recent aircraft incidents in South Africa (my home country), notwithstanding the fact that none resulted in any serious injuries, I am acutely aware of the risks of spending a disproportionate amount of time in the sky. It sure is a long way to the ground from up here …

Does the stock market have a tried and tested parachute? We can only guess, but in the words of market veteran Richard Russell (Dow Theory Letters), “it’s always best to hope for the best and be prepared for the worst

In the aftermath of Thanksgiving, may I remind you of the following old stock market adage: “The bears have Thanksgiving and the bulls have Christmas.” Let’s hope for an early Christmas! 

Before highlighting some thought-provoking quotes from market commentators during the past week, let’s briefly review the markets’ actions on the basis of a performance chart

The past week’s movie has been playing for a while and was characterized by investors becoming increasingly jittery about the possibility of a US recession. Uppermost in their minds were burning questions such as: How is the economy going to perform during the next few months in the light of a deteriorating housing market and rapidly increasing number of mortgage delinquencies? And what are the investment implications of credit conditions being tighter now than before the Fed began cutting rates, the oil price trading just shy of $100 a barrel, and the US dollar hitting an all-time low against a basket of currencies?

Black Friday could not have arrived a moment sooner as the financial markets need a clearer picture of how the US consumer will be affected by this environment. The weekend numbers will be very important in assessing the lie of the economic land.

The performance charts usually obtained from StockCharts were unfortunately not available as a result of the short week, but the Wall Street Journal Online came to my rescue with the following chart indicating how different global markets fared during the past week. (Financial markets in the US and Japan were closed on Thursday and Friday respectively.) 


Source: Wall Street Journal Online, November 25, 2007.

Global stock markets continued their slide and ended the week in the red as investors concerned about an array of negative factors (as mentioned under “Economy”) dumped stocks. Emerging-market stocks in particular performed poorly and shed 4.8% during the week, although the 52-week performance of 37.4% was still highly respectable. China’s Shanghai Index has lost more than 17% since its peak in October.

Wednesday witnessed the Dow Jones Industrial Index tumbling by 211 points, thereby confirming a so-called Dow Theory bear market signal with both the Industrial Index and the Transportation Index trading below their lows of August 16, 2007. Financial stocks dominated investors’ worries, but the week’s losses were tempered by a low-volume relief rally on Friday.

Economic woes caused a further steepening of the US yield curve with the yield on 10-year Treasuries falling to a two-year low at 4.01% (after having dipped to below 4.0% at one stage) as investors switched from stocks to bonds perceived to offer safe-haven status. Eurozone and UK bond yields were also sharply lower.  

With credit markets pricing in further US interest rate cuts, the US dollar had another dreadful week and recorded an all-time low against the euro (approaching $1.50) and a fresh 30-month low against the Japanese yen. The latter, as well as the Swiss franc, gained more ground on the back of further unwinding of carry trade transactions.

With the dollar hitting new lows, the Dow Jones-AIG Commodity Index strengthened by 1.4% to trade near its highs. The star performers among commodities were gold bullion (+4.9%) and crude oil (+4.6%), with the latter reaching its highest level ever in thin and volatile post-Thanksgiving trade. Platinum also recorded an all-time high. Industrial metals, including copper (-5.3%), were the only weak spot in the commodities complex.

This week promises to be a key week for the direction of financial markets. Hopefully the words (and graphs) from the investment wise below will assist in guiding us through the stormy waters and making the correct investment decisions.

Richard Russell (Dow Theory Letters): Dow Theory – bear market signal
“I don’t know the full meaning of the (Dow Theory) bear market signal of November 21. Nobody does. But one guess is that the real surprise will come later. The real surprise could be that conditions are fated to become much worse than expected. For instance, analysts are talking about a ‘difficult 2008, but maybe not a recession.’ Others are talking about just a ‘growth slowdown.’ I hope I’m wrong, but the surprise could be a severe recession, even a global recession. In which case people will look back and say, ‘I should have taken that bear market signal of November 21 more seriously. The US, the market and my finances are in much worse shape than I had anticipated.’

“I expect a lot of wild and confusing movements from the stock market in the days ahead. But … a rally here, even a powerful rally, will not mean that the bull market has suddenly been reborn. Bear markets tend to be both costly and discouraging to stockholders. It is only natural and human nature that stockholders treat every rally as a sign that the bear market is over, and therefore that they’ll ‘get their money back.’ I warn subscribers not to be taken in by the powerful rallies that are certain to occur. They’ll be corrective rallies within the framework of a primary bear market.”

Source: Richard Russell, Dow Theory Letters, November 23, 2007.

John Hussman (Hussman Funds): Financial markets are at a critical point
In short, the financial markets are at a critical point. It’s possible that investors will somehow adopt a fresh willingness to speculate, but my impression is that in the weeks ahead, investors will be forced to recognize that recession risk has tipped. That’s not to say that this realization will produce one-way market movements. Seasonal factors tend to buoy the market a few trading days before holidays and a few days around the turn of each month, and … oversold conditions lend themselves to periodic short squeezes and spectacular but short-lived rebounds. So we will almost certainly observe advances driven by investors frantic to ‘buy the dip’ and ‘catch the rebound.’ Overall, however, the return/risk profile on both stocks and the economy as a whole appear increasingly lopsided toward bad outcomes.”

Source: John Hussman, Hussman Funds, November 19, 2007.

GaveKal: Stocks – downside breakout or rebound? 
“… history shows that when the Fed cuts rates and stocks rally, then the US economy is likely facing no more than a mid-cycle slowdown. However, when rate cuts are met by sinking stocks, the US economy has tended to go into recession. So, will equity markets break out on the downside? Or will we see a rebound from the current levels?

“1. On the continued meltdown fears: The news, especially in the financial sector, continues to be dreadful! Needless to say, whipping oneself into a bearish frenzy is not such a hard thing to do today. And yet, there may still be hope …

“2. On the rebound hopes: The obvious hope is that, today, sentiment indicators are all once again painting a picture of a one-way market. Any kind of bad news is a reason to sell, while good pieces of news are swept away in the tide of negativity and uncertainty. … with a massively undervalued US$ and low interest rates, a recession would be quite surprising. Low rates and a weak US$ are the recipe for a boom, not a bust!

“We thus hope that the markets will be able to rebound from this important juncture. But we are fully cognizant of the fact that the next few days of trading are very important.”

Source: Gavekal – a Checking the Boxes, November 21, 2007

BCA Research: Too soon to bottom-fish global banks
“Global banks are becoming more attractive on a number of valuation measures. However, they do not look cheap versus the broad market. In addition, price-to-book valuations could be misleading until the hit to capital from the sub-prime and SIV losses are fully realized. Similar price-to-book-value buy signals were seen in the US homebuilding sector over the past year, which were erased by downward revisions to book value. Global dividend yields are now higher than G7 bond yields. However, dividends have the potential to be cut if the earnings environment continues to deteriorate. The average global bank dividend payout ratio is 35%, which is more than three times the 2000 payout ratio. Bottom line: Further de-rating of the banking sector is required before bottom-fishing.”


Source: BCA Research, November 19, 2007.

John Hussman (Hussman Funds): Bonds are strenuosly overbought
“Bonds … remained characterized by unfavorable yield levels … Bond prices have extended their strenuously overbought run, which is a testament to increasing risk aversion, but presents risks of its own. It’s difficult to believe that investors in say, 10-year Treasury bonds are really willing to accept annual total returns of just 4.15% for the next decade, and to the extent that they will probably demand somewhat higher returns over time, it implies that some part of the recent Treasury market rally is inherently speculative. To some extent, I think the speculation over the short-term will be correct, but we’re much more comfortable with TIPS than straight Treasuries, and even there we’ve clipped our exposure a bit on the recent price strength.

“Historically, the yield curve has tended to steepen during recessions, meaning that long-term rates either fall slower than short-term rates, or increase (which they have done, on average). While I don’t place much faith in Fed actions (other than for psychological effect), Fed officials have attempted to discourage expectations for further cuts in the Fed Funds rate, most likely because of the weakness in the dollar, combined with the 4% year-over-year headline inflation rate that is virtually baked-in-the-cake for the November CPI. That may cause some re-adjustment in short-term rates, and in turn, a quick spike in long-term rates (not that I expect it would develop into a sustained uptrend). In any event, we’ll continue to respond to such yield spikes, if they occur, to modestly boost our exposure in TIPS.”

Source: John Hussman, Hussman Funds, November 19, 2007.

Paul Farrel (MarketWatch): America needs a recession
“America needs a recession. Bernanke and Paulson won’t admit it. And investors hate them. We’re all trapped in outdated 1990s wishful thinking about a ‘new economy’ and ‘perpetual growth.’ But the truth is, not only is a recession coming, America needs a recession.

“To begin with, recession may be an understatement. Jeremy Grantham’s GMO firm manages $150 billion. In his midyear report before the credit crisis hit he predicted: ‘In 5 years I expect that at least one major ‘bank’ (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private-equity firms in existence today will have simply ceased to exist.’ He was ‘watching a very slow motion train wreck.’ By October, it was accelerating: ‘Train hits end of track at full speed.’

“Also back in August, The Economist took a hard look at the then emerging subprime/credit crisis: ‘The policy dilemma facing the Fed may not be a choice of recession or no recession. It may be between a mild recession now, and a nastier one later.’ However, the publication did admit that ‘even if a recession were in America’s long-term economic interest, it would be political suicide’ for Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson to suggest it. Then The Economist posed the big question: Yes, ‘central banks must stop recessions from turning into deep depressions. But it may be wrong to prevent them altogether.’

“Wrong to prevent a recession? Why? Because recessions are a natural and necessary part of the business cycle. Remember legendary economist Joseph Schumpeter, champion of innovation and entrepreneurship? Economists love Schumpeter’s ‘creative destruction’: Obsolete firms get destroyed and capital released, making way for new technologies, new businesses …

“… for the folks at the Fed, Treasury and Wall Street, ‘eternal growth’ is still America’s mantra. Unfortunately, the American investors’ brain has also developed this blind obsession with ‘growth-at-all-costs,’ coupled with a deadly fear of all recessions, as if recessions are a lethal super-bug more powerful than Iran with a bomb.

“… the fact is, we let the housing/credit boom become a massive bubble, it popped and a recession is coming.”

Source: Paul Farrel, MarketWatch, November 19, 2007.

Asha Bangalore (Northern Trust): Leading Economic Indicators point to weak economy
“The Index of Leading Economic Indicators (LEI) declined 0.5% in October after downward revisions to readings of September and August. The year-to-year change in the LEI (monthly and quarterly) has turned negative once again after a brief year-to-year change that was positive in the third quarter. The chart below sends a convincing message of the risks of weak economic conditions in the months ahead.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, November 21, 2007.

BCA Research: Fed – falling behind the curve
“Financial markets are forcing the Fed’s hand and another rate cut looms in December. The Minutes from the October FOMC meeting noted that the need for a rate cut at that time was a ‘close call’. The Fed observed ‘scant evidence of negative spillovers’ from housing to the rest of the economy, while credit market strains were moderating. The rioting in the financial markets this month must be reversing this economic complacency. Credit conditions are tighter than they were before the Fed began cutting rates, and strains could be spreading into the prime mortgage market. Bottom Line: The financial markets are warning of real economic damage, which will force the Fed to drop its concerns over inflation and provide a significant amount of additional easing.”


Source: BCA Research, November 22, 2007.

Asha Bangalore (Northern Trust): Fed remains biased toward easing
“The minutes of the October 30-31 meeting indicate a FOMC significantly concerned about the ramifications of the housing market weakness and the credit crunch. Despite this view, the October 31 easing was cited as a ‘close call.’ The tone of the minutes suggests that the FOMC is predisposed toward easing but the timing remains unclear. The minutes noted that ‘even with some further easing of monetary policy participants expected economic growth to slow over the next few quarters, reflecting continued sharp declines in the housing sector and tightening standards and terms across a broad range of credit products.’ At the same time ‘members felt that it was appropriate to underscore the upside risks of inflation stemming from the recent increases in the prices of energy and other commodities, even though recent readings on core inflation had been favorable.'”

Source: Northern Trust Daily – Daily Global Commentary, November 20, 2007.

MarketWatch: Fed forecast sees slower growth, tame inflation in 2008
“The US economy will slow by more than previously thought in 2008 but inflation will remain tame, according to the economic forecasts of top Federal Reserve officials released for the first time on Tuesday. Fed officials said growth would slow to a range of 1.8% to 2.5% next year, down from growth around 2.45% in 2007. Some Fed officials were more pessimistic, putting growth down as low as 1.6% next year. Inflation is expected to remain contained. Headline inflation, as measured by the PCE index, is expected to slow to 1.8% – 2.1% in 2008, down from around 2.95% this year. Core inflation will remain steady in a range of 1.7% – 1.9%. The Fed forecasts go out to 2010. The Fed sees the economy growing at a moderate pace in the neighborhood of 2.6% in 2009 and 2010, with a steady unemployment rate and continued low inflation.”

Source: Greg Robb, Market Watch, November 20, 2007.

Ambrose Evans-Pritchard (Telegraph): Credit ‘heart attack’ engulfs Asia
“The global credit crisis has hit Asia with a vengeance for the first time, triggering a massive flight to safety as investors across the region pull out of risky assets. Yields on three-month deposits in China and Korea have plummeted to near 1% in a spectacular fall over recent days, caused by panic withdrawals from money market funds and credit derivatives.

“‘This is a severe warning sign,’ said Hans Redeker, currency chief at BNP Paribas. ‘Asia ignored the credit crunch in August but now we’re seeing the poison beginning to paralyse the whole global economy,’ he said.

“Korean and Chinese three-month yields have fallen from 4% to 1% in a matter of days in a eerie replay of events on Wall Street in late August when flight from banks and the US commercial paper markets caused yields on three-month Treasuries to fall at the fastest rate ever recorded. Asian investors appear to be opting for deposit accounts with government guarantees.

“It is unclear what prompted this latest ‘heart attack’ in the credit system, though rumours abound that Asian banks have yet to own up to their share of the expected $400bn to $500bn losses from the US mortgage debacle.”

Source: Ambrose Evans-Pritchard, Telegraph, November 23, 2007.

David Fuller (Fullermoney): This is gold’s era  
“I maintain that this is gold’s era … not least that it is being steadily remonetized in the eyes of investors. Many investors tend to associate a bull market in gold with an inflation scare and to a degree that view is justified, however gold’s price action today is motivated by many more factors than this narrow view. It is also a further iteration of the “supply inelasticity meets rising demand” theme we have espoused for much of the last six years.

“Supply from mines is falling and central banks are not selling nearly as much. While on the demand side median incomes are increasing across the emerging world and gold continues to be a status symbol and the gift of choice for many grooms to their brides as well as comprising part of a dowry. On top of this, you have investment demand for the metal as a store of value in a fiat currency world.

“This uptrend will unavoidably be punctuated by corrections but these will most likely continue to provide good buying opportunities. Over the long-term, the secular theme would require a fundamental change to supply or demand to question its integrity.”

Source: David Fuller, Fullermoney, November 21 & 22, 2007.

Dave Galland (Casey Research): Realignment of Middle Eastern currencies on the horizon
“Years ago there was a Canadian doctor turned currency guru by the name of Dr. Morton Shulman. I recollect one of his signature lines. It went something like this: ‘Making money trading currencies is easy!; he would say with an air of supreme confidence from the podium. ‘Just listen to what monetary officials say, and then expect the opposite.’

“Well, this week we have heard a spate of announcements from central bankers in the Middle East saying that they have absolutely no plans to stop pegging their currencies to the US dollar, despite the pain that peg is beginning to cause. Foreign currency traders seem to be taking Dr. Shulman’s words to heart. This out of Bloomberg: ‘Merrill Lynch & Co. predicts either the United Arab Emirates or Qatar will cut their dollar peg within half a year. Standard Chartered Plc says the six Gulf Cooperation Council nations need to raise the value of their currencies 20 percent. The difference between the price of the Saudi Arabian riyal and the cost of buying it in a year using forward contracts has widened 10-fold since October as traders bet the kingdom will sever its 21-year-old link to the dollar.’

“The most immediate effect of the Middle East satrapies dropping their dollar pegs would be that oil would head much higher, much faster. That, in turn, will only add to the already rising inflationary pressure in the US. There is much more to this possible realignment in currencies. Consider, for instance, that sovereign wealth funds now control about $2.5 trillion, about half of the official currency reserves in the world … an amount estimated to grow to $17.5 trillion over the next 10 years. A trend toward central banks adopting a more ‘currency neutral’ stance for their reserves is entirely logical, and something we will almost certainly see more of.”

Source: Dave Galland, Casey Research – The Room, November 23, 2007.

Financial Times: Indian tourist sites refusing entry to dollar
“Supermodels (Gisele Bundchen) are not the only ones worrying about the value of their dollar contracts. After years of urging foreign tourists to pay in dollars whenever possible, the Taj Mahal, and other Indian heritage sites will now insist on a proper hard currency – the rupee. The country’s culture ministry took the step after confronting a sharp fall in the rupee value of its dollar ticket sales.

“‘Keeping in view international practices and also to avoid any anomaly on account of falling exchange rates of the US dollar vis-a-vis rupee and consequent fall in revenues, the government has decided to denominate the entry fee for the foreigners for all the monuments in Indian rupees only,” the ministry said.

Source: Jo Johnson, Financial Times, November 16, 2007.

David Fuller (Fullermoney): US dollar – signs of short-term reversal?
“… I don’t know in which direction the US dollar’s next big move will be, and neither does anyone else … it warrants close monitoring and I am now particularly interested in the daily chart below. It failed to maintain a downward break today, which is a small warning but far from conclusive. However if the US Dollar Index were to break up out of its recent range, clearing 76.20 for more than a day or two, I would conclude that we had seen a low of at least short-term significance. Given the steepening of this year’s long, ranging downtrend, I suspect that a break above the small range immediately overhead would signal the onset of a medium-term recovery for the US Dollar Index. Of course if it cannot do this, the steepening downtrend remains very much intact, with the clear possibility of an additional acceleration.

“Similar levels can be identified and monitored on many of the US dollar’s other cross-rates. For instance, the euro stalled beneath $1.50 today. That is an understandable psychological resistance level, so for real deterioration we would need to see a break beneath $1.45. Sterling fell back against the dollar following the key day reversal earlier this month. A break beneath $2.035 would further question the ranging overall upward trend. The dollar’s downtrend against the yen is much more recent and a move back above ¥112 would be required to question sideways to lower scope.”


Source: David Fuller, Fullermoney, November 23, 2007.

Chuck Butler (EverBank World Markets): A strong dollar policy?
“I have to laugh every time I hear US Treasury Secretary, Henry Paulson, talk about the US strong dollar policy. Think about this: while Paulson goes around telling people that a “strong dollar is in our nation’s best interest,” the dollar has lost 1/3rd of its vale against the euro.

“And usually any time that line is uttered, it’s followed by “we also believe that the best way for a currency to become valued is through the markets.” Hmmm … To that I say, “the markets only give value to currencies with good fundamentals.” And I’m sure that Mr Paulson knows that all too well! So, when he tells us about a strong dollar policy, he’s got his fingers crossed behind his back!

“I think what the Government cares about is that the selling of the dollar is orderly.”

Source: Chuck Butler, Everbank World Markets, November 1, 2007.

David Fuller (Fullermoney): Bull market in agricultural commodities
“While one can argue about the implications of climate change there are a number of other factors which point towards a bull market in food commodities. On the supply side, it is a fact that inventories are at record lows and are not being replenished. It is also a fact that unpolluted water is becoming an increasingly scarce commodity, particularly in countries with large populations which are industrialising rapidly. Costs for energy and fertilisers are on the increase and show little sign of abating. On the demand side, the first thing people do when their incomes increase is improve their diets. When a sufficient number of people’s median incomes increase this leads to a sustained jump in demand. Biofuels are also taking up an increasing portion of land which would once have been dedicated to food production.”

“All of these factors point toward a sustained bull market for agricultural commodities. However this sector will continue to be volatile because every country in the world produces and consumes these commodities and weather will always play a role in how they are priced. This means that they are best purchased following corrections and patience is needed for them to recover.”

Source: David Fuller, Fullermoney, November 22, 2007.

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4 comments to Words from the wise for the week that was (November 19 – 25, 2007)

  • ferruccio

    useful and interesting…thanks

  • Neil Larratt

    Very usefull, how about some insight as to how one should be structuring a defensive portfolio for what may be very difficult times ahead. The SA context adds another dilema which also requires consideration

  • I think the Euro will decline from this level(1.49 US$).
    I have illustrated on my site, how the low US Dollar has made the Us globally competitive as evinced by Exports soaring, leading to an improving Trade Deficit.
    The USD has deteriorated despite a rise in Real Interest rates. I illustraded the strong relationship between the price of Oil and US Imports. A decline in oil prices will decrease Imports improving Net Exports and lowering CPI, leading to higher Real Interest Rates. All these events help the USD.
    See “Oil and the US Dollar” at

  • Very comprehensive, thanks for the effort and sharing with us.

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