Words from the wise for the week that was (Dec 17 – 23, 2007)

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The commentary for this week’s edition of “Words from the Wise” is somewhat abbreviated as I am trying to finish the report a bit earlier in order to join my family at our beach house at Gordon’s Bay (40 minutes from Cape Town) for a few days over the Christmas period.

I will nevertheless still be following the markets closely as the next few days could see interesting movements. It has been observed by the Stock Trader’s Almanac that “beginning just before or right after the market’s Christmas closing, we normally experience a brief, yet respectable, rally from the last five trading days of the year through the first two of the New Year.” The S&P 500 Index has averaged a 1.5% increase during this seven-day period since 1969 and it is referred to as the “Santa Claus Rally”. However, it is also pointed out by the Stock Trader’s Almanac that “when this reliable seasonality has failed to materialize, it has often been a harbinger of a sizable correction or a bear market in the coming year.” Hence the saying: “If Santa Claus should fail to call; bears may come to Broad & Wall.”

As we approach the end of an eventful 2007 it is appropriate to thank each of my subscribers and readers for your friendship and support in making Investment Postcards such a fulfilling experience. The New Year will bring a new-look blog with a host of exciting features, but more about that in early 2008.

This is also a time for treasuring friends, especially those that are far away. One such friend and business partner is John Mauldin, author of the hugely popular Thoughts from the Frontline weekly e-newsletter. John is also one of five nominees for Motley Fool’s Investor of the Year – along with the likes of Warren Buffett and Carl Icahn. Don’t let the name fool you – this is a serious award. If you have enjoyed and benefited from John’s tireless effort researching and writing his newsletter and books over the years, please consider voting for him by clicking here.

Here’s wishing you a great festive season full of fun, laughter and joy, and a wonderful 2008. (In the spirit of the festive season, click here for a good laugh to see what happens when an investment manager gets “elfed”.)

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 prevailing mood remained cautious despite massive injections of liquidity into money markets by the world’s central banks. Leading the pack was the European Central Bank (ECB), adding an unprecedented €501 billion of liquidity in its two-week operation.

Markets took some comfort from reports that Temasek, Singapore’s state investor, might buy a $5 billion stake in Merrill Lynch. This would be the fourth time in a month that a US financial institution had raised capital from a sovereign wealth fund.


DateTime (ET)StatisticForActualBriefing ForecastMarket Expects
Dec 178:30 AMCurrent AccountQ3-$178.5B-$183.0B
Dec 178:30 AMNY Empire State IndexDec10.320.021.0
Dec 179:00 AMNet Foreign PurchasesOct$114.0B
Dec 188:30 AMHousing StartsNov1170K1175K
Dec 188:30 AMBuilding PermitsNov1180K1150K
Dec 1910:30 AMCrude Inventories12/14-7586KNANA
Dec 208:30 AMGDP-FinalQ34.9%4.9%4.9%
Dec 208:30 AMChain Deflator-FinalQ31.0%0.9%0.9%
Dec 208:30 AMInitial Claims12/15346K335K335K
Dec 2010:00 AMLeading IndicatorsNov-0.4%-0.4%-0.3%
Dec 2012:00 PMPhiladelphia FedDec-
Dec 218:30 AMPersonal IncomeNov0.4%0.5%0.5%
Dec 218:30 AMPersonal SpendingNov1.1%0.6%0.7%
Dec 218:30 AMCore PCE InflationNov0.2%0.2%0.2%
Dec 2110:00 AMMich Sentiment-Rev.Dec75.574.574.5

Source: Yahoo Finance, December 21, 2007.

The next two weeks’ economic highlights, courtesy of Northern Trust, include the following: 

Durable Goods Orders (Dec. 27) Durable goods orders are predicted to have risen (+0.9%) after the three consecutive monthly drops. In particular, orders of aircraft may have risen after a reduction in October. A likely decline in bookings of defense items is included in the forecast. Consensus: +3.0% vs. -0.2% in October.

New Home Sales (Dec 28) – The consensus forecast is for a small drop in sales of new homes to 720 000 from 728 000 in November. Sales of new single-family homes are down 47.6% from their peak in July 2005. On a year-to-year basis sales of new single family homes were down nearly 23.0% in October. Consensus: 720 000 vs. 728 000 in October.

Existing Home Sales (Dec 31) Sales of existing single-family homes are down 31.0% from their peak in September 2005. The consensus is for a steady reading in November. Consensus: 4.97 million.

ISM Manufacturing Survey (Jan. 2) The Manufacturing ISM survey for December is predicted to fall to 50.3 form 50.8 in November. Indexes tracking new orders, production and employment should be market movers. The employment index fell to 47.8 in November. Consensus: 50.3 from 50.8.

Employment Situation (Jan. 4) Payroll employment in December is predicted to have risen 40,000 after a gain of 94 000 in November. The gradual upward trend of initial jobless claims suggests that hiring was probably slow in December. The unemployment rate should have risen to 4.8% in December following three monthly readings of 4.7%. Consensus: Payrolls +65 000 vs. +94 000 in November; unemployment rate – 4.8%.

Other reportsConsumer Confidence Index (Dec. 27), Chicago Purchasing Managers’ Index (Dec. 28), Construction Spending (Jan. 2), ISM Non-Manufacturing Survey, and Factory Orders (Jan. 3).

The performance chart obtained from the Wall Street Journal Online indicates how different global markets fared during the past week. 


Source: Wall Street Journal Online, December 23, 2007.

Christmas Eve is still around the corner, but US stock markets were already in a festive mood towards the close of last week. Despite lingering worries about the US economy and the financial sector, stocks managed to finish a volatile week on a strong note. Small caps (+4.2% in the case of the Russell 2000 Index) charged ahead to pay heed to the so-called “January Effect” of small caps outperforming large caps from the middle of December through the end of January.

Despite the rally on Friday, European and Japanese stocks finished down on the week, whereas emerging markets were also taking a breather.

Central bank action eased money market pressures somewhat, resulting in lower one-month dollar, euro and sterling Libor rates. Despite kicking up a bit on Friday, government bond yields declined during the course of the week, benefitting from more safe-haven buying.

On the currency front, the US dollar was fairly stable against the euro, but recorded a four-month high against the British pound (on the back of expectations of further UK interest rate cuts) and a six-week high against the Japanese yen (as new carry trade positions were opened).

Commodities experienced an excellent week with gains on all fronts. Agricultural commodities surged on the back of tight supplies and strong demand from emerging countries. Solid demand from Asia also resulted in metals making headway, with copper (+4.8%) recovering from a nine-month low. Crude oil (+1.9%) and precious metals (gold +2.3%, platinum +3.7% and silver +3.6%) also performed strongly. The price of gold bullion looks set to record its first ever month-end close above $800.    

Now for some words (and graphs) from the investment wise that will hopefully assist to make sense of financial markets during and beyond the Christmas period, but firstly a cartoon.


Source: Jim Sinclair’s MineSet, December 16, 2007.

Eoin Treacy (Fullermoney): Sectoral performance for 2007
“Over the last year, the worst performing sectors have been Homebuilding (-60.69%) Thrifts & Mortgages (52.45%) Real Estate Management (-37.11%), Department Stores (-34.99%), Motorcycle Manufacturers i.e. Harley Davidson (51%) and Regional Banks (-31.2%) This is no secret and real estate related worries have dominated media coverage over the last year.

“However what is less well known is that of the S&P 500’s 147 sector indices, 85 are positive or unchanged for the year. Of these, 7 are up in excess of 50% year-to-date. These were Fertilizer & Agricultural Chemicals (+94.42%), Construction & Engineering (94.24%), Education Services (+84.89%), Coal and Con Fuel (+76.61%) Diversified Metals (71.97%), Internet Retail (64.89%) and Healthcare Services (51.21%. A number of these indices are consolidating their gains and need to sustain moves to new high ground to reaffirm their overall uptrends.

“In the coming year, we can probably expect banks to bottom out and they should perform better than they did this year. So I would be surprised to see them at the bottom of this list a year from now. However with the increase in interest in agriculture, the continued need for infrastructural improvements, not only in the USA, but globally, and the continued secular bull market in all commodities; it is difficult to imagine that the leaders for this year will not be in the upper quartile of performers again next year.”

Source: Eoin Treacy, Fullermoney, December 19, 2007.

Dick Green (Briefing.com): Earnings slowdown dissected

“There is a definite slowdown in aggregate earnings growth. The financial sector is the cause. Other sectors have yet to see a broad slowdown in earnings growth.

“The table below shows the trend in quarterly year-over-year operating earnings growth for the S&P 500 companies in aggregate for 2006 and estimates for the fourth quarter of this year and the first quarter of next year.


“There is a clear slowdown in profit growth starting in late 2006 and continuing into 2007. Then, of course, profits dropped sharply in the third quarter of this year, and another decline is expected for the fourth quarter. This is why the stock market has hit so much turbulence lately.

“The impact of the financial sector is huge. The drop in third quarter profits is entirely due to the financial sector. Excluding financials, profits were up 10.2% over the third quarter of 2007. The central issue in this debate is that which preoccupies the market – whether the problems in the financial sector (and the associated problems in the housing sector) will lead to a recession. If not, then investors will ultimately find good value among non-financial stocks that have maintained earnings growth.”

Source: Dick Green, Briefing.com, December 17, 2007.

Moody’s Economy.com: Survey of business confidence for world
“Global business sentiment is very weak and fragile. This is particularly true in the US where confidence slumped last week to its lowest level in the five years of this survey, and where it is now consistent with a contracting economy.  Expectations regarding the outlook through mid-2008 are particularly bleak, and responses regarding sales strength, inventory investment, and office space are also soft. Confidence is stronger outside the US, but it has notably weakened across the globe during the past month. While pricing pressures have risen with oil prices near $100 per barrel, they remain notably muted compared to the pressures that prevailed during previous oil price spurts.”

Source: Moody’s Economy.com, December 17, 2007.

Moody’s Economy.com: Germany’s IFO Business Index
“Both the IFO research institute and the Bundesbank (Bbk) announced significant downward revisions to their growth outlook for Germany last week. Forecasts for next year were slashed by the IFO to 1.8% from 2.5%, while the Bbk dropped their estimate to 1.6% from 1.9% previously. These figures suggest next year will be disappointing for the euro zone’s largest economy. Germany has been the powerhouse of Europe in recent years thanks to the 2.9% expansion recorded in 2006 and the 2.6% uptick anticipated for this year. Exceptional strength in exporting activity was the primary reason.

“Now that this engine is losing steam, business confidence is taking a hit.”

Source: Moody’s Economy.com, December 19, 2007.

Reuters UK: CBI – UK economy to slow sharply in 2008
“The economy will decelerate markedly next year as the credit squeeze and higher commodity prices take their toll, the Confederation of British Industry said on Monday. The business lobby now reckons the economy will grow by just 2.0% in 2008, having forecast growth of 2.2% in September. Growth this year is expected to be around 3.0%.

“It noted consumer confidence had already taken a hit but stressed the economy was not about to fall off a cliff. Indeed, it said the impact of the credit squeeze on most companies had so far been limited. ‘It’s never inconceivable that there will be a recession but we strongly believe in the soft landing scenario,’ said Ian McCafferty, CBI chief economic adviser.

“The CBI expects the Bank of England to cut interest rates again in the New Year but is not convinced they will fall much further.”

Source: Christina Fincher, Reuters UK, December 17, 2007.

BCA Research: Could UK housing follow the US?
“With the UK real estate market showing clear signs of weakness, it is natural to question whether house prices could follow the US by declining on a year-over-year basis. In our opinion, this is a very real threat.

“The UK housing market is arguably even more vulnerable than the US. Specifically, valuation measures are extremely stretched. UK house price appreciation has dramatically outpaced income growth in recent years. In fact, house prices have more than doubled relative to disposable incomes since bottoming in the late 1990s. This ratio has also risen in the US but not nearly to the same extent. Similarly, house prices have appreciated much more dramatically in the UK relative to rent costs and real house prices have deviated further from their underlying trend.

“In addition, the UK market has less diversification. London has a significant influence on aggregate measures due to the relative size and importance of the financial services industry. With bonuses set to plunge in the City, a key source of upward pressure on real estate will be lost. Finally, the UK housing market tends to be more volatile than its US counterpart and bear markets are typically much deeper.”


Source: BCA Research, December 14, 2007.

Moody’s Economy.com: Risk of recession for US – 52%
“With the global financial system unsettled, the housing correction intensifying and business and consumer sentiment very fragile, the risk of recession has increased appreciably since this summer’s subprime financial shock. In November, the Moody’s Economy.com probability of recession increased to 52%, up from October’s downwardly revised 44% (previously 47%) and its highest since 2001. With risks rising, additional Fed easing is needed to keep the economy from falling into a recession.”

Source: Moody’s Economy.com, December 17, 2007.

Asha Bangalore (Northern Trust): Leading Indicators send message of weak conditions
“The Index of Leading Economic Indicators (LEI) fell 0.4% in November following a 0.5% drop in October. The 1.2% drop in the LEI during the May to November period is the largest six month decline in six years. On a year-to-year basis, the October-November average translates into a 0.8% year-to-year drop, which is the largest drop on record since the third quarter of 2001 when the US was in a recession. On a year-to-year basis, the quarterly average of the LEI has fallen in three out of the last four quarters. The message from the downward trend of the LEI is that the risk of significantly weak economic conditions is growing rapidly.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, December 20, 2007.

Bill King (The King Report): Capital being destroyed faster than credit growth
“We have regularly noted that the Adjusted Monetary Base has been stagnant while MZM, which reflects repo growth/Fed largesse, has soared. The Fed has been running credit faster and faster just to keep the system running in place.

“The latest data shows the unthinkable is occurring. The Adjusted Monetary Base, as constructed by the St. Louis Fed, has collapsed while MZM growth has moved to new highs. This is a very serious, and extremely negative, development. The implications are ominous. Capital is now being destroyed faster than credit growth. So you can forget about that credit getting into the economy.


“The above charts are proof that ‘This time it’s Austrian!’

“Will historians many decades from now look at the above charts and conclude that the Fed foolishly contracted the money supply – like historians have claimed about the Fed during the early ‘30s?”

Source: Bill King, The King Report, December 21, 2007.

GaveKal: Fears of US recession are overblown
“… we believe the fears of recession in the US are overblown. Interestingly, we note that our daily indicator of prices sensitive to economic activity has just jumped back to positive territory after a brief dip into negative (see top chart below).

“As far as Europe is concerned, our regular readers know of our long-standing concerns on the sustainability of growth in the Eurozone. However, on the shorter term, the recent massive injections of liquidity by the ECB should go a long way to alleviate some of the concerns. Indeed, yesterday, the ECB added an unprecedented €350 billion to the market in an effort to ease the credit-market gridlock. As a result, the two-week interbank rate dropped by -55 bps to 4.40% (see bottom chart below). Hopefully, this will provide enough comfort for banks to cautiously start lending again.”



Source: Gavekal – Checking the Boxes, December 19, 2007.

Richard Russell (Dow Theory Letters): Gold is money
“The Russell advice – as always, ‘sit on it, better known as patience’. Remember, we’re not holding gold to make a killing. We hold gold because gold is real, Constitutional money. Gold doesn’t need any government or central bank to state by fiat that gold is money. Forget governments, forget central banks, forget politicians – thousands of years of history tell us that gold is money – and that’s good enough for me.”

Source: Richard Russell, Dow Theory Letters, December 18, 2007.

George Bernard Shaw: Gold
“The most important thing about money is to maintain its stability… You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of the government. With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold.”

Bloomberg: Platinum rises to record on demand outlook
“Platinum rose to a record on speculation demand for the metal used in car parts and jewelry will remain robust. … surged 31% this year, beating gains in gold and silver, as demand outstripped supplies.

“Consumption by the auto industry will gain 6% this year as production of catalytic converters increases, Societe General said last week. “Despite the economic shakeout in the US, automotive demand for platinum will remain strong,” said James Steel, an analyst with HSBC Securities in New York.

“The United Nations climate talks in Bali this month increased investor awareness about platinum as the world tries to reduce greenhouse-gas emissions, Steel said. The metal is used in catalytic converters, which help to control pollution emitted by cars. “The recent talks have helped to keep the attractiveness of platinum in people’s minds,” Steel said. The metal will gain as demand from the auto industry rises in China, the world’s fastest-growing major economy, Steel said. China’s demand for the metal in vehicle-emission filters will probably jump 35% this year, Johnson Matthey, which makes a third of all auto catalysts, said last month.

“The metal also gained today on speculation Russia, the world’s second-biggest producer, won’t approve licenses for next year. Prices climbed 9.7% in the first quarter as Russia delayed export quotas, halting shipments until May.

“Platinum has climbed this year as supplies were disrupted in South Africa, the world’s largest producer. Accidents, strikes and equipment breakdowns will contribute to the first drop in South African mine production since 2000, London-based Johnson Matthey forecast last month.”

Source: Millie Munshi, Bloomberg, December 17, 2007.

Ambrose Evans-Pritchard (Telegraph): Fatwa against the dollar?
“To all intents and purposes, the Wahabi religious establishment of Saudi Arabia has just issued a fatwa against the US dollar. This bears watching.

“Anti-dollar clerics have lobbied Ali al-Naimi, the Saudi oil minister. A message issued by 26 leading clerics warns that inflation has reached intolerable levels in the Gulf kingdom. While it does not vilify the dollar explicitly, the apparent political aim is to undermine the country’s dollar peg.

“‘The rulers should seek to try to remedy this crisis in a way that would ease people’s suffering. We direct this message to the rulers and officials: we remind you of Prophet Mohammad’s words that you are shepherds who are responsible for your flock,’ it said.

“The statement was posted across the Islamic world. The background to this has been a raging debate in Gulf religious and economic circles about the destructive effects of the sliding dollar. CPI inflation is 5.35% in Saudi Arabia, the highest in over ten years. It has reached 10.1% in the United Arab Emirates and 12.2% in Qatar.

“The dollar pegs – designed to anchor the currencies – are now forcing the Petrodollar economies to import US devaluation and monetary stimulus. What has been a simmering problem for over a year, has become untenable since the Federal Reserve began slashing interest rates.

“The Saudis, Qataris, and Emirates have all said they will preserve the pegs. But fatwas tend to up the ante.”

Source: Ambrose Evans-Pritchard, Telegraph, December 17, 2007. 

Market Watch: Scoreboard – subprime write-downs 

Bankers’ write-downs
UBS$13.7 bln
Citigroup*$13.7 bln
Morgan Stanley$10.3 bln
Merrill Lynch$8.4 bln
HSBC$3.4 bln
Bank of America*$3.3 bln
Deutsche Bank$3.1 bln
Barclays$2.7 bln
Royal Bank of Scotland$2.6 bln
Bear Stearns$1.9 bln
Credit Suisse$1.9 bln
JP Morgan Chase$1.6 bln
Goldman Sachs$1.5 bln
Wachovia Bank$1.1 bln
Lehman Bros.$0.8 bln
Total:$70 bln

* Estimate.

Source: John Spence, MarketWatch, December 19, 2007.

Financial Times: Old-fashioned interest rate relief needed
“The Federal Reserve’s new term auction facility (TAF) – and co-ordinated action with other central banks round the world – addresses the problem of liquidity in the financial system but will do little to alleviate the credit crunch, believes David Rosenberg, North American economist at Merrill Lynch.

“He says: ‘The facility does not do anything to prevent existing credits from going bad and won’t stop credit issues from continuing to surface. The size of the auctions are actually fairly small … and in no way does this solve … the massive write-downs and losses the banking sector is likely going to incur this cycle.’

He also says: ‘The Fed continues to underestimate the extent of the housing downturn, the heightened prospect of a consumer recession and a spreading credit crunch. In our view, this TAF does not address what is happening in the broad economy, nor does it address issues surrounding bank capital pressures and rising delinquency rates … from subprime to prime mortgages, credit cards, auto finance and commercial real estate, and the impact this loan quality deterioration is exerting on the availability of credit. Although we had hoped that Ben Bernanke’s academic background would lead to creative solutions, we hope that it doesn’t occur in place of what is most clearly needed – old-fashioned interest rate relief.'”

Source: Financial Times, December 13, 2007.

Paul Kedrosky: Subprime lawsuits rising rapidly
“Subprime lawsuits are rising rapidly, which you had to know was going to happen. Hey, what were all those lawyers going to do after the decline in option-backdating suits? Get real jobs? Become economically useful? Naaah.


“Somewhat more seriously, the first subprime suit was February 8, 2007, and the number of such suits quadrupled in the second half of the year versus the first half. I have to believe it will grow by at least the same amount over the next six months, making this one of the largest legal adventures in recent memory.”

Source: Paul Kedrosky’s Infectious Greed, December 21, 2007.

Financial Times: Lehman faces legal threat over CDO deals
“Lehman Brothers faces the threat of legal action by municipal councils in Australia over the sale of high-risk collateralised debt obligations by the Wall Street bank’s local subsidiary, Grange Securities. At least two councils in New South Wales and a third in Western Australia are considering litigation against Grange, which marketed Lehman-originated CDOs to dozens of Australian councils as well as to charities and a public hospital provider.

“The losses suffered by the councils and charities are further evidence of the damaging impact of the recent global credit turmoil as it spreads from sophisticated large investors to small communities round the world – and is increasingly starting to hurt mainstream, risk-averse investors such as local governments and pension funds.

“The Lehman-originated Federation CDO, exposed to the US subprime mortgage market, was last month marked down to just 16 cents in the dollar by the bank, leaving councils nursing paper losses of 84%.”

Source: Peter Smith, Financial Times, December 16, 2007.

Yahoo News: Credit crisis hits top bond insurer
“The credit crisis spread to the nation’s largest bond insurer Thursday (December 20), sending shares of MBIA plunging and calling into question the safety of tens of billions of dollars of company and local government debt held by investors.

“The Fitch Ratings service warned that it might cut its rating on MBIA in the next six weeks if the company cannot find $1 billion in new capital. That followed a disclosure by MBIA that of the $30 billion in mortgage debt guarantees it issued, some $8 billion were for the riskiest types. One analyst said he was shocked by the magnitude of that exposure.

“Because default rates have been low, bond insurers’ earnings and share prices had soared – until recently. The fear now is that if MBIA or competitors like Ambac Financial Group and Financial Guaranty Insurance Corp are unable to pay what could be a surge in claims on debt issues gone bad, it could overwhelm the already-suffering credit markets.”

Source: Stephen Bernard, Yahoo News, December 20, 2007.

GaveKal: Strong hands recapitalizing financials
“To us, this highlights that capitalism is once again at work, moving the capital from weak hands to stronger ones. And interestingly, today, for the first time, emerging markets are the strong hands. This is an abrupt reversal from the 1997 crisis, when overleveraged Asian financials (and governments) had to seek help from the OECD. This time, whether it is sovereign wealth funds (yesterday, Morgan Stanley announced that it had sold 9.9% of its stock to the state-controlled Chinese Investment Corporation) or individuals, who remain very underleveraged, (foreign buying of long-term US assets rose by a very strong US$114 billion in October, the third strongest month ever), emerging markets are undoubtedly coming to the rescue.

“While this development was to be expected, we are, however, surprised by the speed of adjustment. Normally, a financial crisis of the magnitude we are currently experiencing could potentially take years to work itself out. Now, after just a couple of months, the worst hit financials are already being recapitalized. In addition, this process is also being helped by central banks that are willingly adding liquidity into the market. Overall, we find these recent events encouraging, and we are heartened to see that Libor rates are continuing to come down.”

Source: Gavekal – Checking the Boxes, December 20, 2007.

Financial Times: Saudis plan huge sovereign wealth fund
“Saudi Arabia plans to establish a sovereign wealth fund that is expected to dwarf Abu Dhabi’s $900 billion and become the largest in the world. The new fund will be a formidable rival for other government-owned investment funds in the Middle East and Asia, which are playing an increasingly active role in channeling capital to western companies, particularly financial companies hard hit by the US mortgage meltdown.”

Source: Henny Sender, David Wighton and Sundeep Tucker, Financial Times, December 21, 2007.

BCA Research: BoE minutes – unanimous decision to cut
“The BoE monetary policy committee (MPC) remains concerned about price pressures but further easing can be expected. Yesterday’s release of the Minutes for the December 5/6 MPC meeting revealed that policymakers voted 9:0 in favor of cutting rates to 5.5%. The Committee acknowledged that the level of policy rates was restrictive, weakness in the housing market seemed more pronounced than expected, and that financial market turmoil (and the tightening of credit conditions) remained a significant threat. Coupled with apparent signs of slowing growth in the industrialized world, the MPC suggested that ‘a substantial loosening in policy might be needed.’

“However, policymakers remain hesitant due to their nervousness regarding near-term price pressures. The central bank suggested that measures of inflation expectations had edged up recently and that ‘a large reduction in the Bank Rate now would increase upside risks to inflation.’ In contrast, we are much less concerned about price pressures in the global economy, let alone in the UK where a rapidly slowing housing market presents a significant disinflationary shock. Consequently, we expect further rate cuts and remain overweight gilts within a global hedged bond portfolio. We are also short the pound versus the US dollar.”

Source: BCA Research, December 20, 2007.

Financial Times: World food price rises to hit consumers
“Global food prices were under further pressure on Monday (December 17) as benchmark prices for cereals at much higher levels came into operation, making it almost inevitable that a second wave of food price inflation will hit the world’s leading economies.

“In Chicago wheat and rice prices for delivery in March 2008 have jumped to an all-time record, soyabean prices are at a 34-year high and corn prices at an 11-year peak.

“Bill Lapp, analyst at US consultancy Advanced Economic Solutions, said: ‘We’ve already seen food prices increase this year at their fastest pace since the early 1980s, but the full brunt of those increases will begin in earnest in 2008.’

“The agricultural commodities price rises are the result of high demand, poor harvests and low stockpiles of food. Emerging economies, where rising incomes are boosting consumption of meat and dairy products, have added to pressures already generated by the biofuel industry.”

Source: Javier Blas, Chris Giles and Hal Weitzman, Financial Times, December 17, 2007.

BCA Research: Eurozone inflation – ongoing concern for ECB
“Inflation in the euro area reached a 6-year high, causing angst for the ECB.
Harmonized headline inflation accelerated more than expected in November to 3.1% YoY, driven primarily by rising energy and food prices. The core measure remained largely unchanged at 1.9% YoY.

“In Trichet’s latest policy statement, he reiterated that the central bank sees inflation risks skewed to the upside. We do not share this view, and expect that underlying price pressures will remain contained, especially now that external demand is softening and domestic demand remains weak. The ECB staff appears to have arrived at a similar conclusion, with forecasts now calling for inflation to moderate, dropping below the 2% ceiling over the next 12 to 18 months. While the Governing Council seems reluctant to embrace the staff forecasts just yet, we suspect that a further deterioration in the incoming data will encourage a shift. Bottom line: Inflation will remain a source of concern for the ECB but rate cuts remain likely in the first half of 2008. [We] … remain overweight euro area bonds within a global hedged portfolio.”


Source: BCA Research, December 17, 2007.


Source: Jim Morin, Slate, December 21, 2007. 


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2 comments to Words from the wise for the week that was (Dec 17 – 23, 2007)

  • Ian Nunn

    Letter writers of all stripes have been trumpeting the Fed’s “injection of liquidity” since the summer. Supporting this soporific market mantra, I have seen not a single shred of evidence. John Hussman, in a well-argued discourse (http://www.hussmanfunds.com/wmc/wmc071204.htm) demonstrated the Fed has injected a total of $16B in the last year through their temporary market operations in the form of repos. Combined with $16B in permanent market operation acquisitions, the total injection for the year is $32B. Most writers seem to think they inject this amount regularly.

    It is enlightening to see the actual Fed operations (go to http://www.newyorkfed.org/markets/omo/dmm/historical/tomo/search.cfm)

    When you study the daily operations, you see the NY Fed actually removed $1B in liquidity from the market in Nov.

    In keeping with their announced intension of two $20B auctions in Dec., they auctioned $27.75B on Dec. 12 but redeemed $12B in repos for a net injection of $15.75B. They auctioned another $20B on Dec. 20 but redeemed $39.75B in repos for a net liquidity removal of $19.75B from the market.

    Flatly, the Fed is not making significant liquidity injection. If you think otherwise, show me the numbers.

    As for Bill King’s MZM reflecting repo growth, the repos reported are commercial inter-bank repos and have nothing to do with the Fed. Do your homework, Bill.

  • Ian Nunn

    Further to my post, I have found the reference site (http://www.federalreserve.gov/monetarypolicy/taf.htm) for the newly created Term Auction Facility. These auctions are in addition to and separate from the NY Fed’s Temporary Market Operations (TMO), the individual transactions being mediated by any of the member banks of the Federal Reserve.

    The two auctions of $20B on Dec. 17 and 20 created repos maturing on Jan. 17 and 31 respectively. Terms are 18 and 24 business days. While longer than most TMO repos, they are not unusual.

    As a comment, this liquidity will be out of the system in 5 weeks and has no mid or long term impact on the adjusted monetary base.

    It has been noted elsewhere that the “shadow banking system” is many times larger than the formal system of central banks and their commercial partners. I have seen an estimate of a a $2T contraction in credit in the shadow system due to the current credit lock-up. Central bank short term liquidity would then disappear into the much larger credit contraction eliminating any possibility of inflationary effect.

    Outstanding questions for me are:
    1. Why is the ECB injecting so much more than the Fed ($500B vs $40B to date)?
    2. What is the maturity on the loans?
    3. Have central banks become largely ineffectual in terms of guiding monetary policy?

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