Words from the wise for the week that was (Dec 10 – 16, 2007)
Phew – what a tumultuous week! MarketWatch very aptly described the events as “a central-banking version of the old playground poem ‘Solomon Grundy’.” “Ben Bernanke and company were speculated about on Monday, cut rates on Tuesday, took steps to inject credit-market liquidity on Wednesday, and were scrutinized and debated over on Thursday and Friday.”
Sub-prime issues, liquidity and credit crunch concerns continued to cause market jitters, especially as Morgan Stanley became the first major Wall Street investment house to warn that it may now be too late to stop a recession. And this report, entitled “Recession Coming”, came from Dick Berner, otherwise known at Morgan Stanley as the “resident bull”. Equally closely watched Nouriel Roubini went one step further stating that it was time to move away from the soft landing versus hard landing discussion and start concentrating on how deep the coming recession would be.
The past week was characterized by an avalanche of bearish reports and for the first time since the start of “Words from the Wise” three months ago not a single positive item regarding the US economy/markets made its way into the article. (This should normally start flashing a signal to contrarian investors.)
Before highlighting some of the thought-provoking quotes from market commentators, let’s briefly review the market’s actions on the basis of economic statistics and a performance chart.
The Fed’s rate cuts were followed by an announcement on Wednesday that the Fed, the European Central Bank, the Bank of England, the Bank of Canada and the Swiss National Bank would make coordinated liquidity injections of as much as $64 billion in the coming weeks in an effort to alleviate the credit logjam. This represents the biggest act of international economic cooperation since the September 11 terrorist attacks, raising concerns that problems in the financial sector and the global economy could be wider than feared.
The latter part of the week witnessed a surge in US inflationary pressures with the PPI (+3.2%) showing the biggest gain in 34 years and the CPI (+4.3%) jumping to a two-year high.
The usual summary by Gold Seeker of the week’s economic reports was not available at the time of going to print, but Yahoo Finance came to the rescue with an excellent table of economic statistics.
WEEK’S ECONOMIC REPORTS
Source: Yahoo Finance, December 14, 2007.
The coming week’s economic highlights, courtesy of Northern Trust, include the following:
Source: Wall Street Journal Online, December 16, 2007.
Global stock markets experienced a rollercoaster week, but closed in the red as investors became increasingly concerned about the snowballing of credit-related problems and central banks falling “behind curve”.
The Dow Jones World Index declined by 3.2% and emerging-market stocks by 3.0% (incorrectly reported on the chart above). Interest-rate-sensitive and smaller-cap stocks were big casualties of deteriorating investor sentiment. The Indian BSE 30 Sensex Index (+0.3%) was one of the few to escape the onslaught.
The US Dollar Index continued to strengthen during the week, spurred on by the Fed’s more-hawkish-than-expected statement. The surge in inflation data propelled the dollar to its biggest daily rise against the euro in almost three years on Friday. Higher-yielding currencies, in general, rose on the announcement of central banks’ plans to flood the system with cash.
Global bonds declined across the board as the spotlight fell on inflation, negating earlier safe-haven considerations. On the money-market side, one-month dollar and sterling Libor rates fell somewhat in response to the central banks’ announcement. Euro Libor rates, however, edged up as Eurozone inflation picked up the pace.
The stronger dollar and mounting concerns about a US recession weighed on the prices of copper (-5.4%) and other base metals (-4.1%). The precious metals complex had a mixed week with only platinum (+1.0%) making some headway.
Crude oil (+3.4%) ended the week higher as continued harsh weather conditions impacted much of the US and a refinery fire also added to supply problems.
Now for some words (and graphs) from the investment wise that will hopefully assist to make sense of financial markets as Santa Claus approaches, but firstly a cartoon in lighter vein.
Moody’s Economy.com: Survey of business confidence for world
Source: Moody’s Economy.com, December 10, 2007.
Nouriel Roubini: US recession will be protracted and painful
Source: Nouriel Roubini, RGE Monitor, December 11, 2007.
Bill Gross: Beware the shadow banking system
“Forward-looking bond investors should understand that the shadow banking system has been built on leverage and cheap financing and that to keep it from imploding, a return to Fed Funds levels closer to those of 2003 may be required. While the Fed is not likely to repeat its 1% “deflation insurance” levels of that year, current Fed Funds futures which predict a 3¼% bottom are not likely to be correct either. Standby for a tumultuous 2008 as the market struggles to move from the shadows back into the sunlight of sounder banking and financial management, accompanied by Fed Funds levels at 3% or lower.”
Source: Bill Gross, Pimco’s Investment Outlook, December, 2007.
Ambrose Evans-Pritchard (Telegraph): Morgan Stanley issues US recession alert
“‘Slipping sales and tightening credit are pushing companies into liquidation mode, especially in motor vehicles,’ it said. “Three-month dollar Libor spreads have jumped by 60 to 80 basis points over the last month. High yield spreads have widened even more significantly. The absolute cost of borrowing is higher than in June.’
“‘As delinquencies and defaults soar, lenders are tightening credit for commercial, credit card and auto lending, as well as for all mortgage borrowers,’ said the report, written by the bank’s chief US economist Dick Berner. He said the foreclosure rate on residential mortgages had reached a 19-year high of 5.59% in the third quarter while the glut of unsold properties would lead to a 40% crash in housing construction.
“Like Goldman Sachs, and Lehman Brothers, the bank no longer believes Asia and Europe will come to the rescue as America slows. Mr Berner said US demand is likely to contract by 1% each quarter for the first nine months of 2008, but the picture could be far worse if the Federal Reserve fails to slash rates fast enough. It is betting on a quarter point cut this week, with three more cuts by the middle of next year. ‘We expect the Fed to insure against the worst outcome,’ he said.
“Morgan Stanley is the first major Wall Street bank to warn that it is may now be too late to stop a recession, though most have shifted to an ultra-cautious stance in recent weeks. Mr Berner – known at Morgan Stanley as the ‘resident bull’ – is one of the most closely watched analysts on Wall Street. While he began to turn bearish last April as the credit markets turned nasty, the latest report is written in tones that may is rattle the fast-diminishing band of optimists.”
Source: Ambrose Evans-Pritchard, Telegraph, December 11, 2007.
Asha Bangalore (Northern Trust): Fed eases monetary policy – additional easing is imminent
“… the language of the statement today shows a strong undercurrent of an upside risk of weakening economic conditions. The FOMC’s comment in today’s statement about softening consumer and business spending, which did not feature in the October statement, is indicative of a more bearish outlook compared with the statement in October. Here is a comparison of the two excerpts.”
December 11, 2007
October 31, 2007
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 11, 2007.
Paul Kasriel (Northern Trust): TAF – Fed is not tone-challenged after all
“Although the TAF program is likely to alleviate some of the credit stringencies in the money markets, it is unlikely to meaningfully correct the lending errors made in this cycle. There was initial euphoria in the US stock market today when the TAF program was announced. Although the major stock market averages did finish in the black, albeit well off their session highs, indexes of bank and home builder stocks finished in the red, suggesting that, upon reflection, TAF may provide only marginal relief to a major economic headache.”
Source: Paul Kasriel, Northern Trust – Daily Global Commentary, December 12, 2007.
Nouriel Roubini: Central banks’ liquidity injections – too little too late
“The announcement today of coordinated liquidity injections by Fed, the European Central Bank (ECB), the Bank of England (BoE), the Bank of Canada (BoC) and the Swiss National Bank is however too little too late and it will fail to resolve the liquidity and credit crunch for the same reasons why hundreds of billions of dollars of liquidity injections by these central banks – and some easing of policy rates by Fed, BoC and BoE – has totally and miserably failed to resolve this crunch in the last five months. What was announced today are band-aid palliative that will not address the core causes of this most severe liquidity and credit crunch.
“… to mitigate the effects of an unavoidable US recession and global economic slump the Fed and other central banks should be cutting rates much more aggressively. The 25bps cut by the Fed yesterday is puny relative to what is needed; 25bps by BoE and BoC does not even start to deal with the increase in nominal and real borrowing rates that the sharp spike in Libor rates (the true cost of short term capital for the private sector) has induced.
“Central banks should have announced today a coordinated 50bps reduction in their policy rates as a way to signal that they are serious about avoiding a global hard landing. Instead the Fed yesterday gave a paltry 25bps with a neutral bias rather than the necessary easing bias.
“… this is the first real crisis of financial globalization and securitization; it will take years of major policy, regulatory and supervisors reform to clean up this disaster and create a sounder global financial system; monetary policy cannot resolve years of reckless behavior by regulators and supervisors that were asleep at the wheel while the credit excesses of the last few years were taking place. Now the US hard landing and global sharp slowdown is unavoidable and monetary policy – if aggressive enough with much greater and rapid reduction in policy rates – may only be able to affect how long and protracted this hard landing will be.”
Source: Nouriel Roubini, RGE Monitor, December 12, 2007.
MarketWatch: Scoreboard – subprime write-downs
Source: Simon Kennedy, MarketWatch, December 10, 2007.
Source: Cartoon by Dick Locher, Slate, December 10, 2007.
MarketWatch: Bank of America shutting $12 billion cash fund
“Big investors that want to redeem are being paid ‘in kind,’ which means they get their share of the fund’s assets put into a separately managed account, according to Jon Goldstein, a spokesman for Bank of America.
Source: Alistair Barr, Market Watch, December 10, 2007.
John Mauldin (Thoughts from the Frontline): Get out of risky cash funds
“The risk is that there is a ‘run on the bank’ in these funds, and that the funds sell the most liquid assets to meet redemptions, leaving the problematic assets in the fund. In theory, they are marked to market, but if there is not a market price, how do you know what the price is?
“Please note that I am not suggesting that you redeem from ordinary money market funds! There is a big difference. Just the funds with exposure to asset backed commercial paper. There is a simple rule. If you want higher returns, you are going to take more risk, and I think the lengthy period of stability that we have seen lulled investors into forgetting that principle. This is a market that is re-pricing risk.”
Source: John Mauldin, Thoughts from the Frontline, December 15, 2007.
David Galland (Casey Research): US PPI worst in 34 years
“Also this week, we read that food prices are up 37% over the same period a year ago. Of course, over time, with enough repetition, this sort of news catches in the corner of minds of consumers … confirming what they already know: everything costs a lot more today.”
Source: David Galland, Casey Research – “The Room”, December 14, 2007.
Financial Times: Concerns over food inflation as harvests fail
“Officials forecast US wheat stocks would shrink to their lowest level in 60 years, dropping from 312m bushels to 280m by the end of the 2007-08 crop year. The US is the world’s biggest exporter of wheat and importing countries are bidding heavily for its crops as other exporters cut supplies. Cold weather damaged crops in Argentina and drought affected Australia’s wheat production. Flooding also damaged European crops.
“Michael Lewis, of Deutsche Bank in London, said the decline in stocks and rising shortages in large parts of Asia suggested 2008 ‘could deliver another year of price shocks’.
“Corn and soyabean stocks will also be lower than expected as demand from emerging countries rises in spite of record prices.
“Food prices are boosting inflationary pressures just as central banks are trying to cut rates to cushion their economies from the effect of the credit squeeze.”
Source: Javier Blas and Chris Flood, Financial Times, December 11, 2007.
Marc Faber: Outlook for markets for 2008
“As of late November, stock markets around the world became very oversold. With the prospect of the money-printing Fed cutting interest rates further and now also with other central banks likely to follow the Fed, stock markets have begun to rebound. The rebound is likely to last until around the turn of the year whereby new highs will most likely not be achieved. Thereafter, stocks should resume their downtrend as it will become evident even to the diehard optimists that the economy is already in recession and that corporate profits will contract further. Therefore, we would use further strength in equity markets as a selling opportunity.
“On balance, conditions for a dollar rally have improved and a shift from euro into dollar or a long US dollar position versus the euro or the British pound is recommended as an intermediate trade. … the easier trade may be to buy the yen against the British pound or against the euro.
“I am cautious about industrial commodity prices, which could come under pressure as global liquidity growth and the global economy slows down. And while I still think that gold will outperform equities in the years to come I believe that a more meaningful correction in the price of gold is now underway.”
Source: Marc Faber, AME Info, December 11, 2007.
John Hussman (Hussman Funds): Stock market outlook deteriorates
“… the Treasury ‘plan’ to bail out homeowners (without bailing them out) is likely to be both very little and very late. Barring an almost immediate freeze on foreclosures and interest rate resets, we are likely to observe a rash of delinquencies and the need for soaring loan loss reserves even over the next few months. All of this talk of Federal help feels good, but it will be next to impossible to coordinate Federal assistance quickly and equitably. On the other hand, freezing lenders ability to collect on bad loans will simply allow balance sheets to deteriorate without any actual financial solution to the problem.
“The problem is simple: people bought houses during a boom, at bubble prices that they couldn’t actually afford. The US financial system is going to have a bad time with this – there will be major losses and major adjustments. Eventually we will work through it, but it is delusional to look for a bottom when the real losses haven’t even started to emerge.
“On the subject of multiple Fed rate cuts being bullish for stocks, it may be helpful to note that in those events that multiple Fed cuts helped the market, stocks had generally already experienced a bear market decline of 20% to 40% prior to the second rate cut, and the average P/E on the S&P 500 was typically below 14 and (generally less than 11). Stocks were largely poised to perform well anyway, generally by virtue of being sold off to depressed valuations. Even in the 1998 instance (which occurred at much richer valuations than previously), the S&P 500 had plunged about 20% prior to recovering.
“Investors let mottos like ‘don’t fight the Fed’ and ‘it’s a new economy’ do their thinking for them in 2000 to 2002, while the S&P 500 lost half its value and the Nasdaq lost three-quarters. There’s good reason to expect ‘motto-based investing’ to be disappointing again. Keynes may have been right in saying ‘the market can remain irrational longer than you can remain solvent,’ but provided you don’t do things that endanger your solvency (like taking large net short positions), there’s nothing wrong with avoiding risk in periods of market irrationality – particularly once market internals deteriorate measurably as they have now.”
Source: John Hussman, Hussman Funds, December 10, 2007.
David Fuller (Fullermoney): Stock market rally in jeopardy
“I am disappointed by the Fed’s action, including a discount rate reduction of only 25 basis points but the statement was its bigger mistake. The Fed should have shown stronger leadership because it remains behind the curve of events. Bernanke should have stated that inflationary pressures have waned due to the house price correction, sub-prime related credit problems and a softer economy. After all, today’s inflation is mainly in the form of energy and food prices, as I have said before. This is a global problem of supply and demand, and therefore not something that can or should be addressed by monetary policy.
“The Fed had a chance to underpin the US stock market today, and was naïve in not taking it. It did the same thing in October, although today’s statement was marginally less bad, it was still devoid of emotional intelligence. So I repeat my paraphrase of Oscar Wilde’s memorable quote from The Importance of Being Earnest: To lose one market (housing), Mr Bernanke, may be regarded as a misfortune; to lose both (meaning the stock market as well) looks like carelessness.
“To quote Yogi Berra: ‘It is déjà vu all over again’. Wall Street reversed a modest rally following the Fed’s announcement and fell sharply … There is now a risk that US stock market indices will retest last month’s lows, without some stronger leadership, if not from the Fed then Hank Paulson at the Treasury.”
Source: David Fuller, Fullermoney, December 11, 2007.
Bud Conrad (Casey Research): Falling consumer sentiment puts stock market at risk
“As indicated, the consumer sentiment measure reported December 6 shows the lowest level of confidence since 1992, except for the brief spike down in the aftermath of hurricane Katrina. The implication is for recession ahead, with the additional and related indication that stocks could be vulnerable.”
Source: Bud Conrad, Casey Research – “The Room”, December 14, 2007.
BCA Research: Equities need Fed’s support
“Stocks sold off sharply following the Fed’s 25 bps rate cut earlier this week and the release of a statement that provided little succor to investors worried about growth prospects. US financial stocks suffered the most, shedding nearly 5% and underscoring how dependent the sector is on aggressive monetary support to temper the fallout from the sub-prime crisis and to bolster confidence. More generally, markets are looking to the Fed to ensure that the near-term weakness in US earnings does not morph into a full-fledged profit recession.
“Neither our US or global profit models signal prolonged earnings weakness, but that could develop if the Fed does not soon stabilize credit markets. The announcement of central bank measures to bolster liquidity in the interbank market is encouraging, although it is too soon to tell how effective they will be. Bottom line: Global equity markets will likely be choppy in the near term, but we ultimately expect the Fed to validate market interest rate expectations and provide support to stocks.”
Source: BCA Research, December 13, 2007.
Richard Russell (Dow Theory Letters): Bull market or bear market rally?
“It’s ridiculous, but this is a question that can’t be answered with certainty at this time. I personally believe we’re dealing with a bear market rally, but if in the weeks ahead the Dow Jones Industrials and Transports both rise to new all-time highs the implication will be that we’re dealing with a resumption of the ‘old’ bull market.
Source: Richard Russell, Dow Theory Letters, December 11, 2007.
The Globe and Mail: Gold glitters in the eyes of Russia’s billionaires
“This week, OAO Severstal, the Russian steel maker owned and run by billionaire Alexei Mordashov, said most of London’s Celtic Resources Holdings shareholders, which has gold projects in Kazakhstan, had tendered to a $328-million (US) takeover bid. Last week, Russia’s richest man, Roman Abramovich, and his partners agreed to pay $400-million for a 40-per-cent stake in Highland Gold Mining, Russia’s fourth-largest bullion producer. The sudden focus of Russia’s billionaires on gold comes as the metal hit a 28-year-high last month and hovers near $800 an ounce.
“… bullish prospects for the metal may not be the only driver. With the Kremlin controlling the bulk of Russia’s oil and gas assets, gold is one of the few domestic resources left where the Russian oligarchs, who made their fortunes during the former Soviet Union’s chaotic transition from communism to capitalism, can park their funds. As well, the Russian parliament has drafted new legislation aiming to keep its largest gold deposits in Russian hands. If it passes, major gold mining operations will have to be majority Russian owned.”
Source: Andy Hoffman, The Globe and Mail, December 12, 2007.
UBS Metals Daily: Chinese investment in gold to soar
“After amassing an estimated 3 trillion yuan ($400 billion) from investing in red-hot real estate and stock markets which have risen five-fold in the past two years, the wealthy group from eastern China is looking for the next sure bet. Wang says that’s gold, and expects the amount of Chinese capital invested in the bullion market to soar 100-fold to some 500 billion yuan ($67.5 billion) in the next two years – a sum that could catapult China ahead of India as the world’s top buyer.
“‘We all agreed that upside room on stocks was limited, as was upside on property prices. But the gold price has only increased minimally, even after 20 years of China’s reform and market opening,’ Wang told Reuters …”
Source: John Reade and Robin Bhar, UBS Metals Daily, December 10, 2007.
Moody’s Economy.com: Germany’s ZEW Indicator of economic sentiment weakens
Source: Moody’s Economy.com, December 12, 2007.
BCA Research: China’s monetary tightening – shifting gears
“Looking forward … [we] expect more tightening measures, including interest rate hikes and a quicker RMB appreciation. However, there is no case for a monetary overkill. Although growth remains above the comfort level of policymakers, macro conditions are not yet threatening. Core inflation remains low and stable and there are no widespread bottleneck constraints in the economy. All of this means that the tightening campaign is still preemptive in nature. However, the escalating measures will likely lead to a period of increased volatility for the Chinese stock market. We remain cautious on Chinese H shares in the near term.”
Source: BCA Research, December 12, 2007.
Moody’s Economy.com: Tankan Survey shows deteriorating Japanese growth prospects
“Recent revisions to third quarter GDP growth – which was revised down from 0.6% q/q to 0.4% – will do little to stimulate confidence across Japan’s corporate sector. With almost the entire quarterly growth figure derived from exports growth, Japan’s economy is becoming increasingly reliant on its tradables sector to sustain the expansion. The uncertain outlook for exports creates considerable doubt regarding the future health of the economy.”
Source: Moody’s Economy.com, December 14, 2007.
Michael Bloomberg (Financial Times): America must resist protectionism
“Today, we would do well to remember this lesson. It is easy to say that times have changed and take a more protectionist viewpoint. In fact, times have changed. Dramatic advances in technology and increased global trade are creating enormous economic opportunities, but also challenges. If America is to remain the world’s economic superpower, it must capitalize on the opportunities and confront the challenges. Countries that run away from globalization in the 21st century – as with those that ran away from capitalism in the 20th century – will pay a heavy price for decades to come.”
Source: Michael Bloomberg, Financial Times, December 11, 2007.
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