Words from the wise for the week that was (Dec 3 – Dec 9, 2007)
I am writing this week’s edition of “Words” from New York as a cold Big Apple readies itself for the Christmas season (and tempts European tourists with dollar bargains). Irrespective of the fact that NYC was supposedly displaced by London as the financial capital of the world, it remains a fascinating hub for the investment fraternity and a seriously good adrenalin booster.
My meetings of the past two days are testimony of this. Included on the itinerary were: a discussion with friend Barry Ritholtz’s about his new stock-screening system, IQ Fusion; a visit to the headquarters of Minyanville, the very slick cyberspace financial community created by Todd Harrison and his team (I have recently started contributing editorial content to the ‘Ville.); a “happy hour” at the classic Bull & Bear bar at The Waldorf-Astoria where Fox Business Network’s Cody Willard was interviewing a number of investment luminaries, including Jeff Saut and Tony Dwyer; a unique “Holiday Festivus” BBQ in the heart of Manhattan in aid of Minyanville’s Ruby Peck Foundation for children’s education; and a superb viewing, together with business partner John Mauldin, of the Radio City Christmas Spectacular featuring The Rockettes.
Enough said of the good times in NYC. Let’s get back to another adrenalin booster – the business of reviewing the financial markets’ actions of the past week on the basis of economic statistics, a performance chart and some thought-provoking quotes from an array of market commentators.
On Thursday the White House announced a “bail-out plan” to stem the wave of residential mortgage foreclosures in the US by offering many sub-prime borrowers burdened with adjustable-rate mortgages a five-year mortgage-rate freeze. This announcement was not universally praised as gleaned from Richard Russell’s reaction: “… all it will do is allow selected homeowners to hang on a while longer to their homes, but for most it will just delay the inevitable”.
In general, investors were hesitant to make large moves before next week’s policy-setting meeting.
WEEK’S ECONOMIC REPORTS
Source: Gold Seeker Weekly Wrap-Up, December 7, 2007.
This week’s economic highlights include Pending Home Sales on Monday, Wholesale Inventories and an FOMC policy statement on Tuesday, Export and Import Prices, the Trade Balance, and the Treasury Budget on Wednesday, Retail Sales, PPI, Initial Jobless Claims, and Business Inventories on Thursday, and CPI, Industrial Production, and Capacity Utilization on Friday.
Source: Wall Street Journal Online, December 2, 2007.
The US stock market indices rallied on the back of the Bush Administration’s “sub-prime rescue plan”, recording gains for the second week running. Europe also edged higher, helped by Wall Street and a good performance from interest-rate-sensitive stocks in the UK. The Nikkei 225 Average rose to a one-month high (notwithstanding disappointing GDP data), with the rest of Asia and other emerging markets also jumping on the bandwagon.
The Bank of England (BoE) cut interest rates by 25 basis points to 5.5% on Thursday, following a surprise quarter-point cut to 4.25% by the Bank of Canada on Tuesday.
Interest-rate differentials (factoring in a smaller-than-previously-expected Fed Funds rate cut) resulted in the British pound coming under pressure and the US dollar index edging up against a basket of currencies. Global bond markets also cottoned on to the less gloomy economic outlook, causing the first weekly increase in yields in a month.
The oil price was influenced during the week by OPEC’s decision on Wednesday not to increase its oil output, but it eventually edged lower on doubts that demand levels can support current prices, as well as reports of additional exploration for new deposits.
As far as other commodities were concerned, precious metals gained handsomely during the week, but industrial metals (-2.3%) came under renewed pressure.
Now for some words (and graphs) from the investment wise that will hopefully assist to make sense of the ups and downs of financial markets in the run-up to the Christmas holiday period.
Fox Business Network: “Happy Hour” interview with Jim Rogers
Source: Fox Business Network, December 5, 2007
Wallstrip: Interview with Barry Ritholtz
Bloomberg: Bush’s subprime mortgage freeze stymies bond market
“Bush and Treasury Secretary Henry Paulson yesterday announced an agreement with lenders that will fix rates on some loans for five years. The deal will help borrowers who will fall behind once rates reset to higher levels through July 2010. The plan may force investors in the $6.3 trillion market for home-loan bonds, created by pooling loans and funneling interest payments to bondholders, to revalue their holdings.
“‘It could end up there’s less confidence in the viability in the bond markets and the mortgage markets going forward and it could lead to higher interest rates and higher mortgage rates for everybody,’ said Kenneth Hackel, managing director of fixed- income strategy at RBS Greenwich Capital Markets. Hackel said in an interview … that he has been ‘fielding a lot of calls’ from clients ‘pounding the tables and beating the drums.’”
Source: Caroline Salas and Jody Shenn, Bloomberg, December 7, 2007.
Richard Russell (Dow Theory Letters): President Bush’s housing plan
“The clueless politicians, as usual, want to do something. President Bush has a plan, he wants to freeze mortgage rates for the next five years! I don’t think this is legal. But since when has illegality stopped this administration. If Bush actually gets away with this, all it will do is allow selected home owners to hang on a while longer to their homes, but for most it will just delay the inevitable.”
Source: Dow Theory Letters, December 6, 2007.
DavidFuller (Fullermoney): Subprime rate five-year fix
“The question is who pays for the subsidised mortgages? The firms which enticed unsuitable borrowers, if there is any moral justice to all this.
“I would not be surprised to see US short-term rates cut further than most people currently expect – sort of a Marshall Plan for homeowners, the housing sector and lenders – and stay lower for longer than generally forecast. If so, this would be far better for the US stock market than for bonds or the dollar over the next couple of years.”
Source: David Fuller, Fullermoney.com, December 6, 2007.
Financial Times: FedEx warns over economic slowdown
“In an interview with the Financial Times … Mr Smith dismissed suggestions that the rapid pace of economic development in emerging markets would offset a US slowdown. ‘Growth elsewhere helps cushion the shock but nothing can displace a slowdown in the US,’ he said. ‘I don’t care how optimistic people are about China or anything else, [the US] is still 25 per cent of the world’s economic activity so when it slows down it is going to have an effect.’”
Asha Bangalore (Northern Trust): Employment report – headlines justify posture of hawks but details favor doves
“A lively debate at the December 11 FOMC is nearly certain. Bernanke last week noted that the Federal Reserve ‘is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.’ This statement with Kohn echoing similar concerns supports expectations of a lower federal funds rate on December 11. The compromise is likely to be lowering the federal funds rate 25 basis points to 4.25% and a 50 bps cut in the discount rate to 4.50%.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 7, 2007.
Source: Asha Bangalore: Northern Trust – Daily Global Commentary, December 7, 2007.
Chart of the Day: US home price decline greatest since 1970
Source: Chart of the Day, December 7, 2007.
The Washington Post: It’s not 1929, but it’s the biggest mess since
“We are only at the beginning of the financial world coming to its senses after the bursting of the biggest credit bubble the world has seen. Everyone seems to acknowledge now that there will be lots of mortgage foreclosures and that house prices will fall nationally for the first time since the Great Depression. Some lenders and hedge funds have failed, while some banks have taken painful write-offs and fired executives. There’s even a growing recognition that a recession is over the horizon.
“But let me assure you, you ain’t seen nothing, yet.
“What’s important to understand is that, contrary to what you heard from President Bush yesterday, this isn’t just a mortgage or housing crisis. The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts.
“It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will. And it is why the Federal Reserve is now willing to toss aside concerns about inflation, the dollar and bailing out Wall Street, and move aggressively to cut interest rates and pump additional funds directly into the banking system.
“This may not be 1929. But it’s a good bet that it’s way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.”
Source: Steven Pearlstein, The Washington Post, December 5, 2007.
MarketWatch: Serious housing downturn – Fed will have to be very aggressive
“’The Fed will have to be very aggressive. The futures market is anticipating a 3.5% Fed funds target and I would agree with that,’ Zandi said.
Source: Greg Robb, MarketWatch, December 4, 2007.
David Fuller (Fullermoney): Central banks to use all policy pools at their disposal
“They also need to slash short-term rates and reassure everyone that they will use all policy tools at their disposal to mitigate downside risks for the economy. I believe the Fed and even the BoE is now moving in this direction, albeit grudgingly. We will soon know and I recommend 50 basis point cuts this month, followed by another 25 basis points in January, and more later on if necessary.”
Source: David Fuller, Fullermoney, December 4, 2007.
Bloomberg: US corporate profits are in a recession, and the entire economy may not be far behind.
“’The earnings recession has already arrived,’ says David Rosenberg, North America economist for Merrill Lynch in New York. ‘We are going to see an economic recession in ’08.’
“Corporate profits, as measured by the Commerce Department, fell at an annual rate of $19.3 billion in the third quarter from the second, as domestic earnings dropped by $41.2 billion. The drag from sagging US sales and huge writedowns offset robust earnings abroad, fueled by the weak US dollar. The fourth quarter may be an even bigger bust.
“’In the third quarter, the tide shifted, and for the worse,’ says Joseph Quinlan, chief market strategist for Bank of America Corp. in Charlotte, North Carolina. ‘The domestic-profits squeeze is in its early stages and will be severe enough to overwhelm strong foreign earnings.’
“Profits for the Standard & Poor’s 500 companies fell almost 25 percent on a per-share basis in the third quarter, the biggest year-over-year decline in almost five years. David Wyss, S&P’s chief economist, expects their earnings to fall as much as 30 percent in the fourth quarter as companies take more writedowns for bad investments. Excluding such extraordinary items, operating profits may fall as well, he says.
Source: Rich Miller, Bloomberg, December 3, 2007.
Richard Russell (Dow Theory Letters): Stock market strategies to follow at this point
“For my money, there are two intelligent strategies that one can follow at this point. Subscribers know that I’ve always advocated the compounding way. That means accumulating good quality, dividend-paying stocks – and buying this type of stock whether the market rallies or declines. Rallies increase the value of your portfolio. Declines present the opportunity to accumulate additional stocks at increasingly attractive prices. An essential part of the compounding process is that ALL dividends must be reinvested in dividend-paying stocks or even in bonds.
“For those who are unable to follow the compounding ‘road to riches,’ my advice now is to thin out your holdings. The idea is to have cash for the purpose of buying good stocks when the bear market hits bottom. Where or when will this bear market hit bottom? The answer is ‘blowin’ in the wind.’
“I have many subscribers who have been compounding good stocks and bonds over the years, some for decades. So far, I haven’t heard any complaints. Millionaire compounders may have complaints, but one of them is not a complaint about poverty.”
Source: Richard Russell, Dow Theory Letters, December 3 and 5, 2007.
John Hussman (Hussman Funds):
“It’s possible that investors could adopt a fresh willingness to speculate on the hopes and eventuality of a Fed rate cut (the economic news this week will determine the likelihood of 25 vs. 50). Regardless, given the economic backdrop, my impression is that any such speculation would be short-lived – as it has after other Fed cuts this year. For now, we don’t have evidence to support any amount of bullish speculation. Our own investment position doesn’t rely on a recession or a bear market, but those outcomes are increasingly probable rather than simply possible.
Source: John Hussman, Hussman Funds, December 4, 2007.
GaveKal: An equity market rebound in stall?
• US$-euro exchange rate: could one have imagined a worse possible news-flow for the US$? Not only did the Fed turn dovish last week but we also saw very weak US durable good orders, new and existing and home sales and jobless claims. In fact, almost every piece of economic data last week confirmed that the US economy is slowing hard; a fact driven home by the growing number of companies warning of weaker than expected sales (Sears, Dell …).
• Oil: meanwhile the news on the energy front, from the 208 militants arrested in Saudi Arabia that were trying to blow up the country’s energy infrastructure, to the fire in the Enbridge pipeline, should have been bullish for a market currently perceived as massively tight. Yet, it was not and oil failed to break though the psychological US$100/bl mark.
“From our experience, news-flow tends to come in waves. For example, one may get for a few weeks a bunch of bullish energy news. But then, this reverses and gives way to a few weeks of bearish news. And with that in mind, one has to be very wary of assets that do not rise on the perceived ‘good news’, for when the ‘bad news’ hits, these tend to go down. With that in mind, we must say that we are very encouraged by the US$’s recent resilience in the face of bad news, and the fact that commodity prices are no longer rising in the face of good news. If these latest moves announce a greater US$ bull market, and a commodity market correction, then the Fed will have plenty of room to follow a more accommodative policy. We may be moving into a period where the combination of a dovish OPEC, a dovish Fed and a booming China triggers a solid equity market rebound.”
Source: Gavekal – Checking the Boxes, December 3, 2007.
BCA Research: Global versus domestic – a no longer a one horse race?
“Our recent portfolio shifts have been to get less negative on select domestic industries (banks, consumer electronics retailers), and book profits in a few global industries (i.e. aerospace & defense, communications equipment), but we do not envision a more concerted or aggressive move into domestic groups. Exporters continue to do far better than producers reliant on domestic demand, as highlighted by the widening gap between the ISM export index and US consumer spending. The weak dollar and relatively better overseas demand are helping to support exporters in the face of a still sluggish domestic picture. Consequently, there are still gains to be had from holding a globally-skewed equity portfolio, but investors will need to become more selective.”
Source: BCA Research, December 6, 2007.
Sakthi Siva (UBS Investment Research): Is Shanghai finally deflating?
“Current 20% correction is the biggest correction this year
“Taiwan bubble did get to 105x on historic PE
“But is Shanghai different because of strong EPS growth?
Shanghai versus 3 other bubbles (Shanghai in 2001, Japan in 1980s, Nasdaq)
Source: Sakthi Siva, UBS Investment Research, November 28, 2007.
David Fuller (Fullermoney): Financial covers – contrary indicators
This is not because the financial press is stupid – far from it. However it would not sell as many copies of newspapers and magazines without reflecting back the consensus view. In that roll the press can be more descriptive and emotional than analytical.
“And in case you missed their [The Economist’s] latest cover …”
Source: David Fuller, Fullermoney, December 6, 2007.
Resource Investor: ECB sells off 42 tonnes of gold – will China start buying?
“A move to increase gold holdings by China appears to be a question of when rather than if, because at the rate with which they are piling up forex reserves, the weighting of gold in China’s reserve portfolio is actually decreasing. When China starts buying, gold will begin the next leg up in its bull run.
“Russia has already begun buying gold, adding 310 000 ounces in October for a total reserve base of 1.5 million ounces.
Source: Jane Louis, Resource Investor, December 3, 2007.
Richard Russell (Dow Theory Letters): Gold is in a primary bull market – hold on to it
Source: Richard Russell, Dow Theory Letters, December 4, 2007.
Asha Bangalore (Northern Trust): Gold to benefit from demise of fiat currencies
“As the Chart illustrates further, central banks in the developed world are cutting their policy interests as their all-items inflation rates go vertical. So, while fiat currencies float along in tandem as their supplies increase in tandem, all of them are likely to sink in value relative to the genuine ‘reserve currency’ – gold. As developed-world central banks attempt to figuratively and literally ‘paper-over’ the credit market implosion by creating more central bank money, the price of gold in terms of these fiat currencies – not just the US dollar – is likely to keep on rising.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 4, 2007.
AJ Cilliers (Marketviews): Invest with the best of the Brits
“Well, how about Anthony Bolton? Anthony who? We’ll forgive your ignorance, because he’s not exactly a household name, is he? Yet, as the UK’s Money Observer magazine points out, Bolton would probably be regarded as a national hero had he plied his trade in the U S of A. As it is Bolton is British-born and bred, and known only to an admiring City (as the Brits refer to their financial capital) and to a grateful band of investors …
“In case you think that Bolton has been something of a flash in the pan, you should know that he has been running Fidelity’s UK-based Special Situations fund since its inception in 1979. Over almost three decades he has achieved a mind-boggling average annual compound return of around 20%, compared to the market’s far more modest average of 7.7 percent.
“Based on his years of experience, where does Bolton see the markets going right now? He believes that, after a four-year bull market, we are more likely to have a full-blown bear market than a mere correction. The good news, though, is that the bull market will then resume its course. Britain’s best investor does warn, however, that the US mortgage crisis is not one that will be solved overnight. As he says, ‘When people buy a lot of assets they thought were riskless and then lose a bundle, it is a behaviour-changing event whose effects do not disappear really quickly.’
“If Bolton is right, and he has certainly called the markets correctly in the past, then it would appear that the picnic could be over for a while as the bears re-emerge from the woods. But, on the brighter side, this could also herald an era of opportunity – especially for old-fashioned, contrarian value investors.”
Source: Marketviews, AJ Cilliers, December 3, 2007.
Richard Blackden (Telegraph): FSA issues stark warning on mortgage defaults
“The FSA estimates that 1.4 million homeowners have fixed-rate mortgages that expire in 2008, and Mr Briault said that many of these borrowers will ‘find it difficult (if not impossible) to refinance their mortgages on favourable terms, which will leave them facing a significantly higher rate on their borrowings, which may prove too much for them to afford.’
“The warning is the clearest indication of the mounting concern that the financial crisis, which began in the US sub-prime mortgage market, will prove a significant drag on the UK economic growth next year.”
Source: Richard Blackden, Telegraph, December 5, 2007.
MarketWatch: Bank of England cuts key rate quarter point to 5.5%
“At the start of the month, most economists had been predicting the bank would hold off until January or February to lower rates. But those expectations shifted shortly ahead of the decision after data showed activity in the dominant services sector hit a four-year low, leaving the bank’s decision on a knife edge. Also likely weighing on the rate-setting committee’s decision was a sharp fall in consumer confidence and a 1.1% drop in house prices in November, according to the latest figures from HBOS division Halifax.
“At 2.1%, inflation stands only slightly above the government’s 2% target. But Governor Mervyn King warned a parliamentary committee at the end of November that rising energy prices could add upward pressure.
“New Star Asset Management’s Simon Ward was one of the economists already predicting a rate cut ahead of the most recent data. ‘Inflation indicators are still flashing warnings signals,’ Ward said in his blog ahead of the rate decision. ‘However, the Monetary Policy Committee has historically been prepared to ease policy despite unsatisfactory inflation indicators if activity data or financial market conditions have shown sufficient weakness,’ he added.
“The Bank of England’s cut came ahead of a rate decision by the European Central Bank, which is expected to keep rates unchanged. It also followed a surprise rate cut from Canada’s central bank earlier in the week.”
Source: Simon Kennedy, MarketWatch, December 6, 2007.
Bloomberg: Wall Street firms subpoenaed
The subpoenas, sent by the office of New York state’s attorney general, Andrew Cuomo, are broadly written and request information from firms including Merrill Lynch, Bear Stearns and Deutsche Bank AG, people familiar with the matter say.
Source: Kara Scannell, Bloomberg, December 4, 2007.
Reuters: Questions on Paulson’s role at Goldman
The article, by columnist Ben Stein, said Goldman also was selling the securities short. It said a Goldman Sachs spokesman told the newspaper it ‘routinely shorts the securities it underwrites and said that this is disclosed.’ Paulson headed Goldman Sachs until taking over Treasury last year.
“Dodd said he was concerned because it appeared that Goldman Sachs was ‘aggressively pushing subprime mortgages that they knew to be of concern while simultaneously shorting collateralized mortgage obligations.’ Dodd said Paulson should ‘address the concerns’ raised by the New York Times article and added a warning: ‘Failure to do so may be cause for a formal investigation.’”
Source: Glenn Somerville, Reuters, December 4, 2007.
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