Words from the wise for the week that was (Dec 24 – 30, 2007)
This week’s edition of “Words from the Wise” is briefer than most as I must answer the call of family to spend a last few days with them before putting shoulder to the 2008 wheel.
My kids have asked me to help them fly a kite, but the wind seems to be a bit too gusty to achieve this with much success. This makes me wonder how stock markets are going live through the various tailwinds and headwinds that will invariably come to blow during 2008.
In the words of market veteran Richard Russell, author of the Dow Theory Letters: “This market cannot make up its mind. The bullish case is strong, the bearish case is strong, and a lot of very big money is very divide on the outlook for the stock market. Thus – we have a very nervous, high volatility market with the Dow jumping over 100 points (up or down) every other day. It’s enough to give an honest man the ‘willies’.”
And in the spirit of the holiday period, David Galland of Casey Research observed: “… we have the US stock market, which, despite the energetic efforts of government on many levels, is stumbling along like a blind drunk after a long and well-lubricated holiday season party. One minute, Mr. Market has a big happy smile on his face, but the next he’s flat on his face. Struggling to his feet, he is barely able to whisper an ebullient toast before tripping over his own shoes and falling back to the ground.”
I will be watching the market carefully as 2007 fades out and the New Year comes in. The market action during the few days of December and January often provides hints regarding the rest of the year. For example, if the so-called “Santa Claus Rally”, which has one more trading day remaining in 2007 and two more in 2008, does not materialize, it typically is a harbinger of a sizeable correction or bear market in the coming year.
The “January Barometer”, stating that as the S&P 500 Index goes in January so goes the year, will also be watched with more than a cursory glance.
Furthermore, the best years for stock market gains have been years ending in 5, with the second best years being those ending in 8. Since 1891 there have been only two years ending in 8 that were negative, namely 1948 when the Dow was down 2.1% and 1978 when the index declined by 3.2%.
Here’s wishing you a wonderful New Year. May it be truly joyful and exceptionally rewarding on all fronts.
Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the market’s ups and downs on the basis of economic statistics and a performance chart.
An international crisis could not have appeared at a worse time with the global financial system appearing to be an unpredictable black hole. Also, further evidence of worsening economic conditions came in the form of new home sale tumbling by 9% in November to the slowest pace in 12 years and durable goods orders rising a disappointing 0.1% in November. More reassuring data on US mid-west manufacturing activity were largely brushed aside.
All this was piled on top of mounting concerns about more banking write-downs, rising inflation and a deteriorating outlook for economic growth.
Source: Yahoo Finance, December 28, 2007.
The next week’s economic highlights, courtesy of Northern Trust, include the following:
Source: Wall Street Journal Online, December 30, 2007.
US stock market indexes declined modestly during the past week on the back of increasing economic woes and worries about the situation in Pakistan. The worst casualties were REIT stocks (-2.1%), small caps (-1.8% in the case of the Russell 2000 Index) and financials (-1.2%). Energy (+1.4%), however, brought investors some joy.
The MSCI World Index recorded a gain of 1.1% for the week as a result of the strong performance of emerging markets (+2.6%), and also a small positive contribution from the Japanese Nikkei 225 Average (+0.3%).
On the currency front, the US dollar had its worst week in a year as the poor economic statistics increased expectations of more interest rate cuts, resulting in the US Dollar Index declining by 2.0%. Similarly, sterling hit its lowest level in one-and-a-half years against a basket of currencies after a report of slower growth in house prices raised expectations of interest rate cuts early in 2008. On the positive side, the euro, the Swiss Franc and Chinese renminbi increased strongly.
As far as money markets were concerned, the three-month dollar Libor rate eased to its lowest level since February 2006 and the three-month euro rate was set at its lowest level since November 22. Government bond yields declined during the course of the week, benefitting from more safe-haven buying.
The oil price came within sight of its all-time high after US fuel inventories fell more than expected and in reaction to tension in Pakistan and northern Iraq. Gold, fulfilling its role as a safe-haven investment in times of political uncertainty and a hedge against inflation, jumped by 3.4%. Silver (+2.8%) was in hot pursuit, but platinum (+0.3%) lagged somewhat after having hit a record on Thursday.
Although agricultural and base metal commodities experienced some profit-taking, the Dow Jones-AIG Commodity Index still managed a 1% gain for the week.
Now for a few news items and some words (and graphs) from the investment wise that will hopefully assist to make sense of financial markets’ shenanigans during the shortened week ahead.
John Carney (Dealbreaker): Why Bhutto’s assassination is very bad news
ABC News: US checking al Qaeda claim of killing Bhutto
“An obscure Italian Web site said Mustafa Abu al-Yazid, al Qaeda’s commander in Afghanistan, told its reporter in a phone call, ‘We terminated the most precious American asset which vowed to defeat [the] mujahedeen.’ It said the decision to assassinate Bhutto was made by al Qaeda’s No. 2 leader, Ayman al Zawahri in October. Before joining Osama bin Laden in Afghanistan, Zawahri was imprisoned in Egypt for his role in the assassination of then-Egyptian President Anwar Sadat.
“Bhutto had been outspoken in her opposition to al Qaeda and had criticized the government of President Pervez Musharraf for failing to take strong action against the Islamic terrorists. ‘She openly threatened al Qaeda, and she had American support,’ said ABC News consultant Richard Clarke, the former White House counterterrorism adviser. ‘If al Qaeda could try to kill Musharraf twice, it could easily do this,’ he said.”
Source: Brian Ross, Richard Esposito and R. Schwartz, ABC News, December 27, 2007.
Times Online: Main Bhutto suspects are warlords and security forces
“But fingers will also be pointed at the Inter-Services Intelligence agency, (ISI) which has had close ties to the Islamists since the 1970s and has been used by successive Pakistani leaders to suppress political opposition. Ms Bhutto narrowly escaped an assassination attempt in October, when a suicide bomber struck at a rally in Karachi to welcome her back from exile.
“Ms Bhutto said after the attack that she had received a letter, signed by someone claiming to be a friend of al-Qaeda and Osama bin Laden, threatening to slaughter her like a goat. But she also accused Pakistani authorities of not providing her with sufficient security, and hinted that they may have been complicit in the Karachi attack.”
Source: Jeremy Page, Times Online, December 28, 2008.
Moody’s Economy.com: Survey of Business Confidence for world
Source: Moody’s Economy.com, December 24, 2007.
Moody’s Economy.com: ECRI Leading Index for US
“The message being conveyed by the ECRI WLI is becoming increasingly pessimistic. The growth rate has been consistently moving lower over the past several months, bringing it to its lowest point in five years. Volatility in financial markets, led by concerns over subprime, is at the center of the current fragile nature of the economy. With continued concerns over housing and the unfolding subprime events, the possibility of a recession still looms.
“Whether recession will occur remains to be seen, but the quick downward trajectory of the ECRI WLI emphasizes that it is a distinct possibility. Risks toward housing and the subprime market are weighted to the downside, but the key is likely business confidence. If businesses start to aggressively accelerate layoffs, then the current expansion would be in jeopardy.
“Overall, the economy is in a troublesome spot with noticeable downside risk, which will likely lead to more cuts by the Fed down the road. The committee has already cut three times down to 4.25%, and expectations are for more.”
Source: Moody’s Economy.com, December 28, 2007.
Reuters: UK housing market weakens significantly
“That took the average house price down to ₤182 080 from ₤184 099 last month. ‘The housing market has weakened significantly in the closing months of 2007 after holding up more strongly than expected in the earlier part of the year,’ said Fionnuala Earley, Nationwide’s Chief Economist. ‘Most indicators now show that demand is responding to the pressures of weak affordability, past increases in interest rates and the lower house price expectations that we had expected to take hold earlier in the year.'”
Source: Sumeet Desai, Reuters, December 28, 2007.
MarketWatch: Case-Shiller – state of US housing market remains grim
“Both the 10-city and 20-city composites declined 1.4% from September – their single largest monthly decline on record. October’s results mark the 10th consecutive month of negative annual returns, and the 23rd consecutive month of decelerating returns, according to the report.
“‘No matter how you look at these data, it is obvious that the current state of the single-family housing market remains grim,’ said Robert Shiller, chief economist at MacroMarkets and co-developer of the index.
“Home prices are going to decline ‘considerably further’ in coming quarters, likely reaching a double-digit pace on a year-over-year basis, according to Joshua Shapiro, chief economist for MFR Inc. ‘Given conditions relating to mortgage financing, and the number of unsold homes that is piling up, all regions are likely to continue on a negative trend in the months ahead, and those with the greatest oversupply (at the bottom of the pack at the moment) will continue to fall by the most,’ wrote Shapiro in a research note.”
Source: Ruth Mantell, MarketWatch, December 26, 2007.
Source: Ruth Mantell, MarketWatch, December 26, 2007.
Barry Ritholtz (Big Picture): Retail sales point to weak holiday spending
“This weakness was despite the advantages the 2007 calendar gave retailers over 2006: Thanksgiving fell on November 23rd last year (versus November 22 ’07), and Christmas Eve was Sunday evening (versus Monday ’07). The calendar gifted stores with an extra day of holiday shopping. Plus, retailers even gained part of the final weekend (about a third) over last year’s inconvenient Sunday Christmas Eve.
Source: Barry Ritholtz, Big Picture, December 26, 2007.
Associated Press: Unpaid credit cards bedevil Americans
“An Associated Press (AP) analysis of financial data from the country’s largest card issuers also found that the greatest rise was among accounts more than 90 days in arrears. Experts say these signs of the deterioration of finances of many households are partly a byproduct of the subprime mortgage crisis and could spell more trouble ahead for an already sputtering economy.
“The value of credit card accounts at least 30 days late jumped 26% to $17.3 billion in October from a year earlier at 17 large credit card trusts examined by the AP. That represented more than 4% of the total outstanding principal balances owed to the trusts on credit cards that were issued by banks such as Bank of America and Capital One and for retailers like Home Depot and Wal-Mart.
“At the same time, defaults – when lenders essentially give up hope of ever being repaid and write off the debt – rose 18% to almost $961 million in October … Serious delinquencies also are up sharply: Some of the nation’s biggest lenders – including Advanta, GE Money Bank and HSBC – reported increases of 50% or more in the value of accounts that were at least 90 days delinquent when compared with the same period a year ago.”
Source: By Rachal Konrad and Bob Porterfield, Associated Press, December 23, 2007.
Bill King (The King Report): Non-borrowed reserves make 21-year low
“The decline after 1993 was Easy Al liberalizing reserve requirements, which increased leverage & risk. The recent contraction is the sign of enormous pressure in the financial system. Assets must be sold and capital must be increased. The unwind of 20+ years of increasing leverage and risk in the financial system accelerated this year and will probably accelerate further in 2008.”
Source: Bill King, The King Report, December 28, 2007.
John Hussman (Hussman Funds): “Liquidity injections” are misconceptions
“The eagerness of Wall Street analysts to hail the moves by the Fed and ECB as important, without even examining or understanding the data, is a discouraging reminder of how willing many investment professionals are to parrot common misconceptions rather than thinking for themselves. We should not be so alone in pointing out these issues.
“At present, the Fed has injected less than $20 billion in total ‘liquidity’ since March – nearly all of which has been withdrawn from the banking system as currency in circulation. Normally, the Fed would have done a ‘permanent’ open market operation by now, to finance this increase in currency demand (which predictably grows by $30-50 billion annually). But by constantly rolling over temporary repos every week or two instead, the Fed can act as if it is ‘doing more’. In short, the Fed is doing nothing more than predictably rolling over its repos, but with great flourish as if something more is going on.
“Just as in the US, the bulk of the reserves in the European banking system are financed by the continuous rollover of repurchase agreements. In the Euro-zone, the total outstanding amount of these repos has been fairly steady around 450 billion euro. Also, as in the US, the ECB has moderately increased the amount of repos outstanding to cover the holiday period through January 4. Still, this increase has only had minor effect on the 30-day average, and even measured daily, represents only about 38 billion in additional euro to cover the holiday currency demand for the entire Euro-area.”
Source: John Hussman, Hussman Funds, December 24, 2007.
Market Watch: Merrill raising capital to counter subprime write-downs
“Chief Executive John Thain, who assumed Merrill’s top position in November, said the private placement will bolster Merrill’s capital position. The private placement also creates a strategic partnership with Temasek, Merrill said in a statement, describing Temasek as having ‘sizable investments across Asia, particularly in Singapore, China and India.’
“Temasek will invest $4.4 billion in Merrill common stock, with the option to buy an additional $600 million in stock by March 2008. Its ownership position in Merrill won’t exceed 10%, Merrill said. Davis, meanwhile, will make a “long-term investment” of $1.2 billion, Merrill said.”
Source: John Letzing, MarketWatch, December 24, 2007.
Times Online: Goldman says that Citigroup must slash dividend
“William Tanona, a leading Goldman Sachs analyst, said that Citigroup, the world’s largest bank, would have to cut its payout to shareholders to preserve its capital position and write off $18 billion of assets in the fourth quarter, compared with earlier estimates of $11 billion.
“Goldman said that Citigroup would need fresh capital of between $5 billion and $10 billion in addition to a recent $7.5 billion commitment from the Abu Dhabi Investment Authority.
“Mr Tanona said that he had raised his loss estimates for Merrill Lynch and JPMorgan and forecast that, combined with Citigroup, the three will have chalked up $33.6 billion of writedowns in the fourth quarter. Goldman said it now forecast that Merrill and JPMorgan would record increased writedowns of $11.5 billion and $3.4 billion respectively – up from $6 billion and $1.7 billion. Most of the writedowns are linked to the banks’ exposure to collateralised debt obligations, special debt instruments that were invested in risky assets, such as US sub-prime mortgages. Mr Tanona said: ‘We still believe it will be a couple of quarters before the current credit crisis is fully digested by the markets.'”
Source: Siobhan Kennedy and Suzy Jagger, Times Online, December 28, 2007.
The Wall Street Journal Online: Happy New Year? Don’t bank on it
“Now comes the yard sale.
“In a sign that they see tough times ahead, US and European banks are considering sales of everything from branches to entire units. Possible sellers include Citigroup, which may unload or shut several midsize units, and United Kingdom banking giant HSBC, which could exit all or parts of its $13 billion auto-finance business, say people familiar with the situation.
“Talk of the potential moves comes days after Merrill Lynch announced that it would sell most of its commercial-lending business to General Electric for $1.3 billion. Morgan Stanley pocketed more than $250 million last month by selling a slice of its MSCI investment-analysis unit in a public offering.
“Some executives estimate that Citigroup could dispose of as much as $12 billion in so-called noncritical assets.”
Source: David Enrich and Carrick Mollenkamp, The Wall Street Journal Online, December 27, 2007.
Financial Times: More money funds are bailed out
“Janus, the fund manager, this week became the latest to bail out its money market funds. It put in $109 million to buy troubled asset-backed securities from its funds. Half a dozen firms have made similar moves.
“The bail-outs, in the form of guarantees, credit lines and the buying out of troubled securities, are intended to stop funds falling below the $1 a share promised to investors. They show how seriously the parent companies take the reputational risk of ‘breaking the buck’.
“Not all bail-outs have been made public but more are believed to be being drawn up. The extent of losses is not yet known.”
Source: Deborah Brewster, Financial Times, December 27, 2007.
John Hussman (Hussman Funds): Concerns about potential for stock market losses
“A risk-averse investor (or even a risk-neutral one) would decline that bet, even though there’s some potential for lost short-term gains if the wire doesn’t break immediately. A myopic risk-seeker will ignore the risk and keep speculating, assuming that some spontaneous impulse will move them to quit just before the wire snaps.
“Needless to say, our investment strategy is averse to those risks that have, on average, produced no return. We avoid such risks even though continued risk taking may produce further gains for a while, sometimes until those gains are abruptly forfeited. Currently, the combination of valuations and market action (not to mention recession probability) is one that has historically been associated with negative average returns. That doesn’t mean that investors who keep riding the unicycle can’t make a few more small bills, but it does mean that repeated risk-taking in conditions like the present has not been rewarding, on average, and has frequently involved significant and abrupt losses.
“… the market climate for stocks remained characterized by unfavorable valuations and unfavorable market action … The market moved back toward an overbought condition last week, which was accompanied by a surge in the Investors Intelligence sentiment figures, to 56.5% bulls and just 22.4% bears. Despite the lament by analysts on CNBC about pervasive bearish sentiment, the fact is that we’ve rarely seen higher bullish sentiment in recent years. Though the market tends to enjoy somewhat favorable seasonality about this time, through about the first week of the New Year, there is little room before the market is again overbought in an unfavorable market climate. Given high bullish sentiment and the continued likelihood of an oncoming recession, I remain concerned about the potential for steep and abrupt losses (particularly as we move into the New Year).”
Source: John Hussman, Hussman Funds, December 24, 2007.
David Fuller (Fullermoney): Wall Street leash-effect a factor for all stock markets
“With the US economy overly dependent on consumerism, the USA faces stagflation – the stagnation portion led by banks and overstretched consumers, and the inflation coming mainly from food and energy prices. I fear this combination will feel considerably worse for middle class and blue collar Americans than the 2001-2002 recession.
“The financial sector’s multiple own goals will make it a most unlikely candidate to take up the economic slack and lead the next US recovery. The good news, albeit for the longer term, is that US households may increase savings. Meanwhile, the Fed will be forced to remain accommodative. This will be a headwind for the USD but it might just prevent Wall Street from slumping, with food and other resources companies to the fore, along with quality multinationals and tech.
“The Wall Street leash-effect will remain a factor for all other stock markets, albeit not so powerful as it used to be. Weakness by the major US equity indices will exert a downward pull but Fullermoney themes such as Asia and resources will not necessarily be high-beta, except that they are likely to recover more quickly, as we have seen this year. Steadily ranging to rising US indices would allow the fundamentally bullish markets to extend their outperformance.”
Source: David Fuller, Fullermoney, December 27, 2007.
David Fuller (Fullermoney): No hurry to invest in banks
“I saw Warren Buffett say during a CNN interview earlier this week that he had been approached by a number of banks recently, offering SWF-type deals in search of capital. He declined the invitation to participate. If Warren Buffett is not yet willing to invest in the banks, on favorable terms no less, perhaps we should be in no hurry.”
Source: David Fuller, Fullermoney, December 29, 2007.
Richard Russell (Dow Theory Letters): Equities bull market still in third phase
“Ever since the November lows, the market has been undergoing an important TEST. I’ve continually directed subscriber’s attention to the recent November lows. Those lows were 4 366.78 for the Transports and 12 743.44 for the Industrials. Week after week we’ve heard reports about the dangers to housing along with the specter of hundreds of thousands of home defaults. On top of that, we’ve read about the massive losses to the leading banks brought on by the subprime mess. We’ve been warned of a potential collapse in the entire domestic and international banking system. We’ve heard that lending by the big banks had come to a virtual halt.
“In the face of all this ghastly news, the November lows in the D-J Averages have held like a rock. Increasingly, it appears, the Averages have discounted the worst that can be seen ahead. As I write, both Averages are well above their November lows.
A critical test is now in progress. The all-time high for the Dow was set on October 9 at 14 164.53. If the Dow breaks out to a new record high with the Transports at least following in direction, I’ll consider that the market has discounted all the bad news and that the third phase of the bull market is in the process of resuming.”
Source: Richard Russell, Dow Theory Letters, December 24, 2007.
Dennis Gartman (The Gartman Letter): US dollar’s downtrend re-asserting itself
“Were this not the turn of the year, we would almost certainly be buying EURs against the US dollar today. We are content to be long of gold instead. However, after the turn of the year, if the EUR has not moved too far from where it presently stands, we shall almost certainly be buying it … and so too the Canadian dollar.”
Source: Dennis Gartman, The Gartman Letter, December 27, 2007.
Richard Russell (Dow Theory Letters): Load up on gold
“It hasn’t been a bad policy. Below we see the latest three years of gold action. There’s the large triangle, which I took as a pattern of accumulation. Then we see the breakout and the latest run to 800 and above. Note the little ‘pennant’ pattern at the top of the chart. These pennants are usually little ‘continuation patterns’, meaning that they are little consolidations patterns, and they usually break out to the upside.
“The US is now churning out dollars in an effort to ward off a recession. The growth rate of M-3, the broad money supply, is running above 16%, the highest in 47 years. Most of the Asian central banks are pumping out paper even faster, as they seek to keep their own currencies competitive with the dollar. The result – all paper is being devalued against the ‘rock’, the center-piece, the only money that the central banks can’t devalue – gold.
“GOLD – understand it, be glad you can legally own it, buy it, accumulate it — hang on to it.”
Source: Richard Russell, Dow Theory Letters, December 29, 2007.
Moody’s Economy.com: US agricultural prices rising steeply
“Tight markets for various crops, stemming from reduced crops in various parts of the world and higher demand continue to push grains and oilseed prices higher at a time when post-harvest supplies would ordinarily result in at least price stabilization, if not outright decline. It now seems that the corn market is looking ahead at next year’s planting season and factoring in expectations of larger swings in acreage back to soybeans than in previous months. Corn supplies are generally sufficient, but the crop is now being rationed over the next growing season. Wheat prices and soybean price, in particular continue to spike. Three consecutive years of global drawdown in wheat stocks is supporting prices as is international demand for oilseeds and products. Exports of the soybean complex are supporting those prices. The result is likely to be a significant switch of acreage in the Midwest and southeast back into soybeans from corn next spring.
“Concerns remain regarding the South American soybean crop and whether it will be sufficient to meet international demand in the middle of next year at reasonable prices. Livestock markets that appear to have adjusted to higher feed costs could be in for further shocks if grain and oilseed prices continue to rise.
“Expect prices to be volatile over the next few months until southern hemisphere crop conditions give a clear signal for price levels and acreage next spring.”
Source: Moody’s Economy.com, December 29, 2007.
Bloomberg: Japan inflation quickens to 0.4% – fastest since 1998
“Core consumer prices, which exclude fresh food, climbed 0.4 percent from a year earlier, the statistics bureau said today in Tokyo. Factory output slid 1.6 percent from a month earlier. Households cut spending 0.6 percent, the first drop since July. Wages fell and employment prospects worsened as job seekers outnumbered vacancies for the first time in two years, the Labor Ministry said today. Surging energy costs rather than consumer spending are driving inflation, making it likely the Bank of Japan will refrain from raising interest rates as growth slows.
“‘Japan’s economy is entering into a new phase of accelerating inflation and slowing growth,’ said Susumu Kato, chief economist at Calyon Securities in Tokyo. ‘The bank will probably keep rates on hold in the next two to three quarters.'”
Source: Mayumi Otsuma, Bloomberg, December 28, 2007.
BCA Research: A change in tone from the Bank of Japan
Source: BCA Research, December 21, 2007.
GaveKal: Renminbi expected to continue rising
• Aggressive inflationary pressures could spur a faster revaluation rate.
• The Chinese economy has weathered the past appreciation of the RMB surprisingly well.
• Chinese authorities have a history of making big policy changes during holidays.
“There is little doubt that the RMB remains very undervalued which, in turn, severely distorts the global economy. There is also little doubt that the RMB will continue to rise over the foreseeable future. Having said that, it is probably wise to remember that China’s policymaking tends to be rather gradual, and big abrupt changes are frowned upon. This is all the more true since visibility of the US economy remains poor. Indeed, if US economic activity rolls over hard, it is difficult to imagine a big move on the RMB. Nevertheless, this is a very important issue and it needs to be monitored closely over the near future.”
Source: GaveKal – Checking the Boxes, December 27, 2007
Dennis Gartman (The Gartman Letter): China to guide investment strategy
Source: Dennis Gartman, The Gartman Letter, December 27, 2007.
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