Words from the (investment) wise for the week that was (Feb 18 – 24, 2008)

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Investors had to stomach another roller-coaster ride last week as mounting concerns about a recessionary US economy and the implications for global growth and corporate earnings continued to weigh on sentiment


After Monday’s holiday, stock markets kicked off lower on Tuesday, rallied on Wednesday, fell again on Thursday and for most of Friday, and reversed fortunes during the final 45 minutes of trading before the week’s closing bell. Phew!

Besides directionless stock markets, the week saw the continuing themes of a weakening dollar and surging commodity prices.

The text of the minutes of the FOMC’s January meeting was released on Wednesday, indicating that “several participants noted that the risks of a downturn in the economy were significant”. It was furthermore clear that the Fed remained more concerned about slowing economic activity than rising prices.

The Fed cut its 2008 GDP forecast to a range of 1.3% to 2.0% from 1.8% to 2.5%. It also raised its core inflation forecast for 2008 to a range of 2.0% to 2.2% from 1.7% to 1.9%. The revised forecasts provided support for the view that further easing of monetary policy remained on the cards.

Firmly in the bear camp, Nouriel Roubini of New York University’s Stern School of Business (RGE Monitor) has been very vocal in painting a dire economic picture, stating that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”.

However, Richard Russell, author of the Dow Theory Letters, argued: “… the important fact is that the Dow and the Transports are still above their January 22 lows. In other words, the end of the world has not arrived yet. How do we know? The market is telling us so. That may change next week or next month, but so far, that’s the incredible story. And remember, the stock market is smarter than all the economists and the traders and the Treasury and the Fed taken together.

“We’re obviously experiencing a slowdown in many areas of the economy, but other areas (agricultural, mining) are booming. Let me put it this way – I don’t believe we’re going to be dealing with an old-fashioned across-the-board recession. We’re going to be dealing with an uneven economy, some areas in bad shape, some in fair shape, and other in excellent shape,” said Russell.

Before highlighting some thought-provoking news items and quotes from market commentators, let’s briefly review the financial markets’ movements on the basis of economic statistics and a performance chart.

A number of important economic reports were released last week, resulting in pundits either worrying about the magnitude of a US recession, being concerned about increasing inflation, or being troubled by the prospect of stagflation.

On top of the Fed’s minutes and revised economic projections referred to above, the overriding economic influences were rapidly rising commodity prices, a jump in the January CPI rate to 4.3% year on year (+2.5% excluding food and energy) and a weak Philadelphia Fed manufacturing report, coming in at -24.0 versus a consensus estimate of -10.0 – indicating a contraction in manufacturing activity and representing the lowest number since the 2001 recession.

David Rosenberg, Northern American economist at Merrill Lynch, argued that the manufacturing slowdown in the US mid-Atlantic region showed a “collapse in business confidence” to levels not seen since the 1990s recession, according to Reuters. He added: “The debate is no longer about whether the economy is in recession. It is about how hard the landing will be.”

Rosenberg also said the Fed will likely remain in “aggressive rate-cutting mode” as a result, cutting rates by 50 basis points on March 18. The Fed funds futures now see a 94% chance of a 50 basis point cut, a 100% chance of a 25 basis point cut and no chance of a 75 basis point cut.



Time (ET)




Briefing Forecast

Market Expects


Feb 20

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Building Permits





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Housing Starts





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Initial Claims






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Crude Inventories






Source: Yahoo Finance, February 22, 2008.

In addition to Bernanke’s semi-annual testimony on monetary policy on February 27 and 28 to the House and Senate banking committees respectively, the next week’s economic highlights, courtesy of Northern Trust, include the following:

1. Existing Sales (Feb 25): Sales of existing homes are predicted to have dropped in January. These sales have declined by 32.2% from their peak in September 2005. On a year-to-year basis sales have dropped by 23.2% from a year ago in December. Consensus: 4.84 million versus 4.89 million in December.

2. Producer Price Index (Feb 26): The Producer Price Index for Finished Goods is expected to have risen slightly by 0.2% in January, reflecting higher food and energy prices. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in December. Consensus: +0.3%, core PPI +0.2%.

3. New Home Sales (Feb 27): Sales of new homes are forecast to post a decline in January. These sales have fallen by 56.5% from their peak in July 2005. On a year-to-year basis sales have declined by 40.9% from a year ago in December. Consensus: 600 000 versus 604 000 in December.

4. Durable Goods Orders (Feb 27): Durable goods orders are predicted to reverse (-2.5%) a part of the sharp 5.1% increase posted in December. Orders of aircraft may have dropped following two consecutive monthly gains. Consensus: -3.5% versus +5.1% in December.

5. Real GDP (Feb 28): The downward revision of retail sales in the fourth quarter appears to be offset by a smaller than assumed trade deficit in the fourth quarter, with no net change on headline GDP as reported in the advance estimate. Consensus: 0.7%.

6. Personal Income and Spending (Feb 29): The earnings and payroll numbers for January suggest only a small gain in personal income during January. Auto sales dropped in January and non-auto retail sales were lackluster, which points to soft reading for consumer spending. Both of these suggest soft overall consumer spending (+0.1%). Consensus: Personal income +0.2%, consumer spending +0.2%

7. Other reports: Consumer Confidence (Feb 26) and Chicago PMI (Feb 29).

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


Source: Wall Street Journal Online, February 24, 2008.

Global stock markets closed the week generally higher, with the MSCI World Index gaining 0.8%. Emerging markets were the star performers and rose by 1.5% as a group irrespective of declines in China (-2.8%), Hong Kong (-3.5%) and India (-4.2%).

It was a fairly trendless week as investors took their lead from US economic reports. The net result was marginal gains for the Dow Jones Industrial Index (+0.3%) and the S&P 500 Index (+0.2%). The Nasdaq Composite Index, however, edged down by 0.8% on concerns about the technology sector. Gold and silver stocks (+7.1%) and oil service stocks (+3.0%) were the strongest sectors for the week.

After a down-day for most of Friday, the US markets reversed course during the final minutes after a CNBC report of an imminent bail-out of Ambac Financial Group. It was subsequently confirmed that a group of banks was preparing to inject $2 billion to $3 billion into the troubled bond insurer.

The weakest stock market among the majors was Japan, with the Nikkei 225 Average declining by 0.9% as Japanese investors were rumored to be switching equities for high-yielding New Zealand dollars on fairly large scale.

Government bonds experienced a great deal of volatility as the week progressed from one economics report to the next. However, mounting inflation concerns resulted in global yields across all maturities closing the week higher.

The US dollar continued its downward path during the past week as market participants focused on weaker US economic growth leading to further rate cuts by the Fed. The US dollar dropped by 1.1% against the euro, 0.5% against the British pound, 0.7% against the Swiss franc and 0.7% against the Japanese yen.

A very healthy trade balance as a result of booming commodities exports saw the Brazilian real jumping 3% to a nine-year high against the US dollar. Elsewhere, the high-yielding Australian dollar and New Zealand dollar were also exceptionally strong, rising by 1.4% and 1.6% respectively against the US dollar.

The Reuters/Jeffries CRB Index (+4.1%) skyrocketed to an all-time high during the past week as investor inflows into commodities increased strongly. Crude oil (+3.5%), gold (+4.6%), platinum (+5.3%) and agricultural commodities (+2.9%) all reached record levels.

Leading the pack in percentage terms were industrial metals that soared by 6.0% (with copper up by 7.5%) on the back of surging demand from China and other developing countries. Major Asian steel manufactures have started signing contracts to purchase iron ore at 65% more than previous prices.

Disappointing inflation data propelled gold bullion to a new high of $953.6 before profit-taking set in. Platinum, in turn, reached a new peak of $2 148 as it started dawning upon the market that South Africa’s electricity rationing could be a multi-year problem, creating shortages not only for platinum but also for products such as thermal coal and ferrochrome.

The West Texas Intermediate oil price breached $100 by midweek on supply concerns as escalating worries about Nigeria and Venezuela, several refinery problems and cold weather in the US supported prices. The price eased back on Friday as a result of an increase in US inventories.

Supply concerns resulted in another strong week for agricultural commodities.

Now for a few news items and some words and graphs from the investment wise that will hopefully assist in guiding us through the treacherous waters and making the correct investment decisions.

Roll up consumers – save the US economy


Source: About.com.

Moody’s Economy.com: Businesses remain negative on outlook
“Business sentiment has stabilized, but at a very low level that is consistent with a contracting US economy and marginal growth in Canada and Europe. Confidence remains stronger in Asia and South America, but is consistent with growth that is at the low end of potential. Businesses remain particularly negative on current conditions and the outlook six-month hence. Real estate firms and financial institutions are the most worried, but business service firms and even manufacturers and high-tech firms are measurably more nervous. Pricing pressures remain subdued despite currently high oil prices.”

Source: Moody’s Economy.com, February 19, 2008.

CESIfo: Ifo World Economic Climate declines significantly
“The Ifo World Economic Climate has worsened clearly in the first quarter of 2008. The indicator fell to its lowest level since mid-2003. Both the assessments of the current economic situation as well as the expectations for the coming six months are more unfavourable than in the previous survey. In the opinion of the World Economic Survey experts, the US subprime crisis is critically affecting, apart from the US, the financial systems of the UK, Switzerland, Ireland and Germany. The negative impact will be concentrated on the first half of 2008 and will weaken thereafter.”


Please click the thumbnails below for Western Europe and Asia.


Source: CESifo.de, February 20, 2008.

Moody’s Economy.com: Risk of US recession – 60%
“Falling employment, slumping retail and vehicle sales, and waning confidence signal that the US economy is contracting. It is no longer a question of if, but rather how severe the economic downturn will be. In January, the Moody’s Economy.com probability of recession increased to 60%, up from December’s unrevised 56% and its highest since 2001. The probability of recession is consistent with an economy in a mild recession and additional monetary easing is coming, which will help minimize the severity of the downturn.”


Source: Moody’s Economy.com, February 19, 2008.

Financial Times: Banks to aid Ambac with up to $3 billion
“A group of banks is preparing to inject $2 billion to $3 billion into the troubled bond insurer Ambac, which is racing against time to come up with fresh capital to avoid a sharp cut in its triple-A credit rating that could trigger wider financial market turmoil.

“The money from banks would be part of a plan to split Ambac’s operations, people involved in the discussions said. Ambac is also considering raising equity from shareholders and it is not yet clear how much capital it will need, or what credit ratings the split businesses will have.

“Talks between Ambac and the banks will continue this weekend, with a view to finalising a deal by early next week. The banks looking at supporting Ambac include Citygroup, Wachovia, Barclays, Royal Bank of Scotland, Société Générale, BNP Paribas, UBS and Dresdner. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer’s credit ratings drop far below the triple-A level.

“Last month, banks were called in to meet Eric Dinallo, the New York insurance superintendent, who urged them to discuss possible action to prevent downgrades. Federal policymakers did not arm-twist banks to take part in a rescue. But a senior Treasury official said it had to ‘blow some smoke away’ so market participants understood their ‘indirect interest’.”

Source: Aline van Duyn and Ben White, Financial Times, February 22, 2008.

Martin Wolf (Financial Times): America’s economy risks mother of all meltdowns, says Roubini
“‘I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.’ Alan Greenspan, The Age of Turbulence.

“That used to be Mr Greenspan’s view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University’s Stern School of Business, founder of RGE monitor.

“Recently, Professor Roubini’s scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006. At that time, his view was extremely controversial. It is so no longer. Now he states that there is ‘a rising probability of a ‘catastrophic’ financial and economic outcome’. The characteristics of this scenario are, he argues: ‘A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.’

“Here are his 12 steps to financial disaster.

“Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30% from their peak, which would wipe out between $4 000 billion and $6 000 billion in household wealth.


“Step two would be further losses, beyond the $250 billion to $300 billion now estimated, for subprime mortgages. About 60% of all mortgage origination between 2005 and 2007 had ‘reckless or toxic features’, argues Prof Roubini.

“Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth.

“Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150 billion writedown of asset-backed securities would then ensue.

“Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.

“Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.

“Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a ‘fat tail’ of companies has low profitability and heavy debt. Such defaults would spread losses in ‘credit default swaps’, which insure such debt. The losses could be $250 billion. Some insurers might go bankrupt.

“Step nine would be a meltdown in the ‘shadow financial system’. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.

“Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.

“Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.

“Step 12 would be a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices’.

“‘Total losses in the financial system will add up to more than $1 000 billion and the economic recession will become deeper more protracted and severe,’ says Prof Roubini.


“Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot. These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.”

Source: Martin Wolf, Financial Times, February 19, 2008.

The peak of an iceberg, Captain Bernanke?


Source: Phil’s Stock World, February 21, 2008.

Bill King (The King Report): Surprise in FOMC minutes
“… a surprise appeared in the [FOMC] minutes when it disclosed that there was an unannounced ‘emergency meeting’ (conference call) on January 9. The minutes show that at the January 22 ‘emergency meeting’ Fed officials expressed concern that a rate cut would be misinterpreted by the market as an attempt to boost equity prices. This is a transparent attempt to euchre the public and game the historical record because that’s precisely why the Fed cut rates – to boost asset prices or at least keep them from freefall.

“Let’s be frank, Fed officials know that the minutes will be carefully scrutinized so they say what they think they must say in order to cast themselves and their decisions in the best light. Don’t expect honesty.

“The Fed minutes also showed that the Fed viewed inflation as ‘disappointing’. It’s worse now.”

Source: Bill King, The King Report, February 21, 2008.

Asha Bangalore (Northern Trust): US Leading Economic Indicators confirm weak economic conditions
“The Index of Leading Economic Indicators (LEI) confirms the underlying weak status of the US economy. The LEI fell 0.1% in January, which marks the fourth consecutive monthly decline. On a quarterly basis, the 1.3% year-to-year drop of the LEI during the first quarter (assuming flat readings in February and March) is the largest decline on record for the current cycle. Historically, large year-to-year declines in the LEI are associated with recessions (with the one exception in 1967) as shown in the chart. Essentially, the LEI sends a signal of weakening economic conditions in the months ahead.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 21, 2008.

GaveKal: Rate spreads to trigger rebound in US Leading Economic Indicators
“Of the ten variables that comprise the Index of Leading Economic Indicators (LEI), the change in the interest rate spread is historically the one that has caused the LEI to bottom, and thus it is a good signal that the end of a recession is near.

“A closer look at the underlying interest rate spread (the difference in yields between 3-month deposits and 10-year Treasuries) provides reason to be optimistic that this will soon turn positive, and the underlying spread has improved markedly in the past few weeks. The determined rate cuts by the Fed have driven down the short end, while a rebound in long bond yields this month provides hope that the recent forced-buying of long government paper might be coming to an end. If these trends can be sustained, we should expect this critical component to turn positive very soon.

“The onus today is very much on the rate spread and M2 growth, if we are to see the US LEI rebound – in short, the components that are under the Fed’s control. Thus, it is up to the Fed to spark a return to positive territory of the US LEI indicator.”


Source: GaveKal – Checking the Boxes, February 22, 2008.

Asha Bangalore (Northern Trust): Factory survey shows significant weakness
“The Federal Reserve Bank of Philadelphia’s factory survey of February kicked off a weak start for factory readings. The general business conditions index dropped to minus 24 from minus 20 in January. As shown in the chart, readings below minus 20 occur during recessions.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 21, 2008.

Asha Bangalore (Northern Trust): Home builders’ survey – housing recovery not here yet
“The Housing Market Index (HMI) of the National Association of Home Builders rose 1 point to 20 in February. The February reading is two points above the cycle low of 18.0 set in December 2007.


“Is this a sign of a turnaround? Before the champagne is brought, here are a few more details.

“There is a 9.6-month supply of new single-family homes unsold in the marketplace. Incentives to sell these homes are growing in magnitude and creativity everyday. Reflecting the pressure from growing inventories of unsold homes, the median price of a single-family home fell 10.4% on a year-to-year basis in December, the largest drop since December 1970. In a nutshell, the housing market recovery is many months away.”


Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 19, 2008.

BCA Research: US housing – hitting rock bottom
“The February US homebuilder survey showed a tiny flicker of life: buyer traffic and current activity were up, and expectations held above their recent record low.

“The US housing slide is not over, but the gloom could crest in the first half of 2008. Whether housing sentiment has hit rock bottom, there has been some good news: inventories have eased, refinancing activity has surged and the government has taken action to unplug the jumbo mortgage market. We repeat our conclusion from a month ago: the drag on the economy from housing is not over, but it will diminish on a rate of change basis IF inventories finally recede this spring. Importantly, a sense that the drop in house prices is not becoming open-ended is necessary to stabilize the relentless rioting in the credit markets.”


Source: BCA Research, February 21, 2008.

Asha Bangalore (Northern Trust): Growth rather than inflation is primary focus of Fed
“The Consumer Price Index (CPI) moved up 0.4% in January, putting the year-to-year gain at 4.3%. The cycle high was 4.69% year-to-year change in September 2005. More recently, the year-to-year change in the CPI has held over 4.0% for three straight months. The sharp overall gain in the CPI during January reflects higher energy and food prices, with each advancing 0.7% in January following gains of 1.7% and 0.1% in December.


“The core CPI moved up 0.3% in January, after nine consecutive monthly of 0.2% gains. In the three months ended January, the core CPI has risen at an annual rate of 3.1%.

“The year-to-year change in the core CPI of 2.5% in January is up from a recent low of 2.1% in August and September of 2007. The year-to-year change in the core CPI is above the Fed’s comfort level of 2.0%.

“Conclusion: The upward trend of the core CPI places the Fed in a tight spot. However, the minutes of the January meetings and the Fed’s forecast strongly suggest that the Fed views inflation as a lagging indicator that will reach the comfort zone of the FOMC by 2009. Therefore, in the inflation-growth debate, there should be room to ease further before the Fed switches to a watch-and-wait mode.”

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, February 20, 2008.

Bill King (The King Report): Inflation genie is out of the bottle
“The inflation genie, which has been out of the bottle for years, has intensified into a pernicious force. And an increasing number of market participants are experiencing inflation epiphanies.

“On Tuesday, bonds tanked, stocks opened sharply higher but faltered and commodities roared on the market’s V8 moment of inflation recognition. Gold soared $26; platinum exploded $91, copper surged 20 handles and oil traded above $100. Gasoline has rallied from $2.22 on February 7 to a record $2.62 yesterday. This is an 18% increase in less than two weeks – and drive season buying is still ahead of us.

“Retail gasoline prices are usually 100+ cents above wholesale prices. Ergo, if drive season buying is at a normal clip, we’re looking at well over $4 a gallon for gasoline in the coming months. Natural gas soared to a 15-month high – all energy sectors are rallying. Soybeans traded at a record high.

“Yesterday the markets mocked Ben Bernanke and his ignorant or duplicitous claim that ‘inflation remains well anchored’. The guy is either an inveterate fool or liar. Ben, the low inflation scam is over.”

Source: Bill King, The King Report, February 20, 2008.

David Galland (Casey Research): Rising tide of inflation making itself known
“… the rising tide of inflation that is beginning to make itself known here in the US and around the world. This past week, we learned that even the Comedic Politicized Inflation index (CPI) is beginning to slip the leash. As you can see in the chart below from
Shadow Government Statistics, which tracks inflation the good old-fashioned way – i.e. the way it was done before the recent rounds of jiggering – the actual rate of inflation is in a steady upward trend. It is only going to get worse from here.


“On that front, we have been surveying global inflation and finding that, with only few exceptions, the trend I brought to your attention last week holds true … the inflation we are experiencing is indeed a global occurrence.

“That is not to say that there are no deflationary pressures, there clearly are. Much of which is related to the declining net worth of homeowners around the globe whose inflated real estate values are headed in the wrong direction.

“Accept that the stagflationary sludge – faltering economies concurrent with higher prices – that will result from what’s coming next to the world’s economy will be to almost nobody’s liking.”

Source: David Galland, Casey Research – The Room, February 22, 2008.

Condé Nast, Portfolio.com: The bankers’ bailout
“Washington is quietly planning a massive rescue for banks stuck in the subprime mess. Does anybody really think Wall Street deserves to be bailed out?


Illustration by: James Victore

“Since the onset of the subprime crisis last summer, the White House has repeatedly rejected the notion of a government bailout, either for homeowners facing foreclosure or for the banks and mortgage companies that made the now souring loans. ‘There’s no bailout with government money, none whatsoever,’ Treasury Secretary Hank Paulson emphasized.

“But even as the administration has stuck to its laissez-faire stance in public, behind the scenes a covert bailout has been under way, with a number of public and quasi-public agencies quietly dispensing vast sums to financial institutions saddled with worthless or near worthless mortgage securities. All the while, homeowners at the heart of the problem have been left largely to their own woes.

“The rescue operation brings to mind John Kenneth Galbraith’s dictum that in the United States, the only respectable form of socialism is socialism for the rich.”

Source: John Cassidy, Condé Nast, Portfolio.com, March 2008.

Financial Times: US banks borrow $50 billion via new Fed facility
“US banks have been quietly borrowing massive amounts of money from the Federal Reserve in recent weeks by using a new measure the Fed introduced two months ago to help ease the credit crunch. The use of the Fed’s Term Auction Facility (TAF), which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.

“US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year.

“However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support. ‘The TAF … allows the banks to borrow money against all sort of dodgy collateral,’ says Christopher Wood, analyst at CLSA. ‘The banks are increasingly giving the Fed the garbage collateral nobody else wants to take … [this] suggests a perilous condition for America’s banking system.’

“The Fed announced the TAF tool on December 12 as part of a co-ordinated package of measures unveiled by leading western central banks to calm money markets.”

Source: Gillian Tett, Financial Times, February 18, 2008.

The New York Times: Credit default swaps are next to face big credit test
“Few Americans have heard of credit default swaps, arcane financial instruments invented by Wall Street about a decade ago. But if the economy keeps slowing, credit default swaps, like subprime mortgages, may become a household term.


“Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts.

“The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion – roughly twice the size of the entire United States stock market.

“No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity.”

Source: Gretchen Morgenson, The New York Times, February 17, 2008.

Jeffrey Saut (Raymond James): Stock market outlook turning favorable
“… we are treating the January lows of 11 971.19 (DJIA), and 4 140.29 (DJTA) as ‘internal lows’ until proven wrong. Additionally, we would view a breakout above the Dow’s recent reaction high of 12 750 as very constructive action.

“Meanwhile: 1) it’s been six months since the Fed began cutting interest rates, which is the typical time lag when rate cuts start to be impactful; 2) the economic stimulus package passed; 3) income tax refunds have started to flow and the stimulus packages’ rebate checks will start in 12 weeks; 4) conforming ‘mortgage caps’ will be raised from $417 000 to $730 000 in eight weeks (the refi application index has already soared); 5) money supply (M2) has increased $90 billion over the last two weeks; and don’t look now, but Ben Bernanke allowed the Federal Funds rate to dip from 3.00% to 2.75% for a day last week before snapping it right back to 3.00% in what we consider to be a signal short-term interest rates will be lowered again at the March FOMC meeting … causing one old Wall Street wag to lament, ‘Every government sponsored economic stimulus program since 1948 has worked, so I am inclined to give this one the benefit of the doubt!’”

Source: Jeffrey Saut, Raymond James, February 19, 2008.

Kevin Gardiner (HSBC): Worst may be behind equities
“The worst might now be behind global equity markets, says Kevin Gardiner, head of global equity strategy at HSBC. Mr Gardiner notes that investors remain deeply nervous about both ongoing banking write-downs and the possibility of a US recession. ‘Further forced selling by wrong-sided institutions remains a very real risk,’ he says. ‘The safest short-term call is still for further volatility.’

“But he points out that US banks’ shareholders’ funds appear stable, suggesting that a credit crunch remains a risk rather than reality. Meanwhile, the order of magnitude of the peak-to-trough decline in the S&P 500 index to date is similar to that seen at the time of the last major US recession, and during the Long-Term Capital Management hedge fund crisis, he says – adding that the duration of the current correction is, so far, somewhere in between the two.

“He says that while investors remain reluctant to take earnings at face value, aggregate dividends look comfortably covered. HSBC’s dividend-based estimate of the implied risk premium on the US market has not been materially higher in its 22-year sample period.

“Mr Gardiner adds: ‘For Europe, around 15% of the stocks in the MSCI Europe index have a dividend that is as large or larger than the Bund yield, is expected to grow, and is at least 1.5 times covered by rising earnings in 2008 (on consensus estimates).’”

Source: Kevin Gardiner, HSBC (via Financial Times), February 19, 2008.

Eoin Treacy (Fullermoney): Give benefit of doubt to upside for stock markets
“No one knows if stock markets have bottomed or whether we will see another wave of selling pressure in Q2, but for the medium-term downtrends to be reaffirmed, they need to sustain moves to new lows and no major market has done this to date. I believe we can continue to give the benefit of the doubt to the upside as long as global indices can sustain their rallies above those January 22 lows.”

Source: Eoin Treacy, Fullermoney, February 22, 2008.

BCA Research: Record US cash reserves – waiting to be deployed
“There is a massive mountain of US investable cash sitting on the sidelines, earning an ever dwindling rate of interest. This cash pile will help buoy financial markets, but only once the buyers’ strike in the credit markets ends.

“Cash is flowing into retail and institutional money market funds at a record pace, which reflects the extreme pessimism that exists towards risk assets. However, the desire to hold money market funds and T-bills will not last as aggressive interest rate cuts means that investors now receive unattractively low returns.

“It will still take a positive catalyst before sidelined cash gets re-deployed towards risk assets (i.e. an end to the credit crunch and less economic pessimism). However, the run-up in cash reserves underscores that there will be no shortage of liquidity to propel asset prices once risk-taking returns.”


Source: BCA Research, February 18, 2008.

Richard Russell (Dow Theory Letters): US bonds appear to be topping out
“And what about this? As Ben Bernanke lowers short rates, the bonds appear to be in the process of topping out. Short rates down and longer rates rising? What’s this all about? It’s about the bond market looking ahead to inflation and MAYBE better business this summer or even this fall. Better business means rising interest rates for longer-term maturities, and now we’re talking about the bonds. So while the Fed is driving short rates lower, the bonds are looking ahead, and they appear to be in the process of topping out.

“Below, I include a chart of the long T-bond. What could it be telling us? Is it good news or bad news or simply worries about inflation? Honestly, I’m just not sure yet.”


Source: Richard Russell, Dow Theory Letters, February 20, 2008.

Andrew Milligan (Standard Life Investments): US dollar bides time
“The dollar is likely to stage a recovery as capital inflows into the US improve and concerns about the US current account deficit turn out be overdone, says Andrew Milligan, head of global strategy at Standard Life Investments. He points out that the current account deficit has actually improved since late 2006, and says if overseas investors were wary about holding dollars in any form, they would already have begun to pull out.

“‘Investors are in fact putting money into the US,’ he says. ‘We can see this in the monthly Treasury International Capital reports, which have consistently shown sufficient inflows to match the trade deficit.’

“Mr Milligan concedes that overseas investors will be cautious about buying, for example, US corporate bonds or complex credit derivatives – but notes that the US sells many other assets. … long-term investors like Sovereign Wealth Funds have already begun hunting for bargains in equities following their recent slide.

“Higher real US interest rates are not needed to attract capital. In fact, the deeper the US recession, the more the Fed will ease policy, leading to a steeper yield curve and lower real interest rates, which will improve the valuations of US assets. ‘Global investors are starting to realise the attractions of US assets, leading to a stable and then stronger currency.’”

Source: Andrew Milligan, Standard Life Investments (via Financial Times), February 21, 2008.

John Authers (Financial Times): Inflation and the US dollar
“Economists will tell you that ceteris paribus – all else being equal – higher inflation leads to a lower exchange rate. If a currency’s buying power is reduced, it should weaken compared with other currencies. But all other things are not equal at present. So when Wednesday’s price inflation data in the US showed prices rising faster than expected, the dollar gained strongly.

“This is partly because persistent inflationary pressures make it harder for the Federal Reserve to cut interest rates, and higher rates (ceteris paribus) keep the currency higher. But Fed Funds futures suggest the market is confident that the Fed must keep cutting, including at its meeting next month.

“More intriguingly, rising inflation implies that economic activity is not slacking. In recent weeks, the US market has plainly been more scared about the ‘Japanese’ outcome – in which economic activity collapses, bringing inflation down with it. This can be seen in the still low inflation expectations implied by Treasury inflation-protected securities (Tips). Evidence that the US can avoid such a nightmare scenario is good news for the dollar and for stocks.

“There is every reason to expect the ‘headline’ rate, now at 4.3%, to continue to grow faster than the ‘core’ rate, which excludes energy and food: oil is now about $100 per barrel, and agricultural commodities are in a bull market (up almost 15% this year). That shows that inflation is alive and well in the world, and that demand in the emerging world is very resilient.

“Ceteris paribus, that would justify the market’s resurgent faith in emerging market stocks, which have rallied more than 10% in less than a month.”

Source: John Authers, Financial Times, February 20, 2008.

Islamic Republic News Agency (IRNA): Iran and Russia can rid world of US dollar’s slavery
“Iran’s Ambassador to Moscow said here Friday Iran and Russia, as major energy suppliers, can rid the world of US dollar’s slavery by promoting oil and gas deals using different currencies.

“Gholam-Reza Ansari further emphasized in an interview with ‘Echo Moscow Radio’, ‘We have been trying to launch an Oil Stock Market in Iran and also trying to find substitute currencies for Iran’s oil sales, that can be Russia’s ruble.’ He appreciated Russian Prime Minister’s First Deputy Dimitri Medoviv’s Friday remarks on Russia’s intention to sell its oil using rubles, saying, ‘That was a brave move.’

“Elsewhere in his interview, Ansari rejected Western countries’ position against Iran’s achievements in peaceful nuclear technology and aerospace engineering, arguing, ‘By sending a satellite to earth orbit Iran intends to decrease the hazards of natural disasters, such as floods and earthquakes.’ He added, ‘Such moves are totally within the framework of international laws and conventions, pursuing absolutely no military objectives.’”

Source: Islamic Republic News Agency (IRNA), February 15, 2008.

GaveKal: Industrial metal prices rising strongly
“Industrial metal prices have risen +12% YTD. In addition, major Asian steel manufacturers have started signing contracts to purchase iron ore for +65% above the previously determined price (and upcoming contracts, such as the ones with Rio Tinto, may be significantly more expensive). Moreover, after two and a half months of declines (largely due to the hold-up for iron ore negotiations), Baltic freight rates have rebounded +22% this month.

“At first glance, these price movements may seem odd, given the widespread anticipation of a global slowdown and the possible weakening of exports from Asia. Where are shipping rates and industrial metals finding their support? To a large degree, we think the above strength can be explained by what is currently unfolding in China, and elsewhere in Asia.

“For a start, accelerating inflation across Asia and Arab countries is triggering a massive rush to improve public infrastructures. Over the past month, China’s CPI rose to a new ten-year high of +7.1% YoY in January (higher than December’s +6.5% reading and November’s +6.9%). This puts Beijing in an awkward position: With the credit crunch continuing to spread, with global demand slowing, and with the added strains from the recent snowstorm, Chinese policymakers are more reluctant to fight inflation with aggressive credit tightening. Instead, we have argued that China (along with other Asian and Arab countries) will try to fight inflation by plowing money into infrastructure projects and hoping for efficiency gains (with the model here being the deployment of the US interstate highways system in the 1950s and its consequent impact on productivity gains, distribution costs, production costs, etc …).

“… betting on a continued increase in Asian and Arab infrastructure spending, along with faster currency appreciation, makes sense.”


Source: GaveKal – Checking the Boxes, February 19, 2008.

BCA Research: Commodities – rotation, rotation, rotation
“A sustained broad-based rally in commodity prices is unlikely over the next few months. Instead, investors should focus on rotation within this asset class.

“Six years into the bull market in primary goods, it is worthwhile to step back and put the spectacular performance of the commodity complex into perspective. We believe that the structural uptrend is still intact: Supply responses to higher prices have been limited, demand from developing economies is robust, and investor interest in commodities as an ‘asset class’ continues to grow.

“That said, we maintain our view that cyclical pressures will continue to cause commodity prices to churn in the coming months. Buying laggards makes sense in this environment as near-dated assets that have already suffered a shakeout should find support, while those that have gone vertical are at risk of correcting materially.

“We are looking to upgrade base metals once global growth expectations improve, and plan to downgrade precious metals once the reflation cycle becomes advanced. We recommend beginning by shorting silver on any additional strength.”


Source: BCA Research, February 20, 2008.

Reuters: China’s inflation hits 11-year peak
“Many economists said inflation was likely to intensify, even as the impact of recent fierce weather fades, because of rapid money growth and rising raw material costs that have not yet been passed on to the consumer.

“Mounting popular concern over inflation poses a stiff policy challenge for China’s leaders, who want to use the Olympic Games in August to showcase Beijing’s economic stability.

“‘The acceleration in money and credit growth in January suggests that inflation is likely to have further legs to run,’ Hong Liang and Yu Song, economists with Goldman Sachs in Hong Kong, said in a note to clients. They said February’s consumer price index (CPI) was likely to rise by much more than 7% (January in 7.1%), compared with a year earlier, and may approach double digits.

“‘Therefore, we believe it is far too early to expect any policy loosening in China. To the contrary, policy makers in China will likely try to tighten monetary policy further, with more reserve requirement ratio hikes, faster yuan appreciation, and more heavy-handed controls over bank lending,’ they said.

“The rise in January’s CPI, up from 6.5% in December, was in line with market forecasts and was the highest since September 1996. Other Asian countries are also grappling with rising prices. Inflation in Singapore is at a 25-year high.”

Source: Jason Subler, Reuters, February 19, 2008.

GaveKal: Inflation pressures building up in emerging markets
“… it is undeniable that inflation is generally on the rise around the world. And the question has to be: How much of a threat does this acceleration in inflation present to our economic systems? Is the world now doomed to repeat the stagflation scenario of the 1970s? We do not think so.

“Over the past few years, we have argued ad nauseam that the world is now very different than it was in the 1970s. And one of these differences is that the OECD is no longer the main driver of global economic activity. We live in a world where growth in the OECD is slowing, and inflation is still not too much of a concern (interestingly, Canadian and Swedish CPI were lower than expected this month).

“But meanwhile, growth in the emerging markets is still strong, and inflation there is a real problem. Worse yet, consumption in the emerging markets is far more geared towards raw materials then it is in the OECD …, so the continued rise in commodities is far more of an issue for emerging markets then it is for the rich OECD. For example, the Indian consumer cannot tolerate an increase in food prices the way a US consumer can.

“Consequently, the policy response to fight inflation will most likely have to come from emerging markets more than the OECD. We should thus continue to expect tighter monetary polices, currency revaluations and more spending on infrastructure from the emerging world.”

Source: GaveKal – Checking the Boxes, February 21, 2008.

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9 comments to Words from the (investment) wise for the week that was (Feb 18 – 24, 2008)

  • So many investment gurus, so many opinions ……

    Read all about last week’s roller-coaster ride on stock markets in my regular weekly blog post, highlighting some thought-provoking news items and quotes from market commentators….

  • Meg

    Love your newsletter. Thanks.

  • joey

    Thanks again for this, Prieur.

    For me, Morgensen’s New York Times article about credit default swaps was very elucidating.

    Also, GaveKal’s case for increased infrastructure spending in China, India, etc. was interesting – to facilitate increased productivity…’fight’ inflation with productivity gains rather than monetary/fiscal ‘jiggering’…


  • Santoli, like BCA also mentioned the huge amount of sidelined cash by retail investors.

    The rebound in the Dry Baltic Index, base metals, also underscore the ROW rest of world is still ok.

    FT reporting that Ambak is to be the beneficiary of a bailout on Monday or Tuesday is apt to create a huge short covering rally in the stock karket and give it a much needed lift.

    A positive resolution to the bond insurer that results in a stock market rally this week would be consistent with some cycle studies I mentioned at my blogsite on Jan 23 suggesting that the Jan 22 stock market low would hold and a rally would ensue into the March 18 FOMC meeting. For investors who would be interested in following the thread, the story can be found here: http://financialfuturesandequitymarketanalysis.com/2008/01/23/cycle-mania-rocks-stock-market-read-all-about-it-John-Bougearel-Event-Driven-Investment-Research-Director-of-Futures-and-Equity-Research-%20at-Structural-Logic.aspx

    Should we get the anticipated rally into the March 18 FOMC meeting, investors who got caught with their chips on the table in January (including myself) may wish to take that as an opportunity to make some portfolio adjustments.

    The market uncertainty will remain extremely high, and retests of the year lows are expected.Worse yet, if the recession turns out to be more than mild, the year lows could give way to new lows.

  • I think Richard Russell is right on this one: watch the Transports. But he isn’t right because of Dow Theory signals. I would watch the Transports because it appears that they will likely form the left shoulder of a head and shoulders topping pattern.

    Also, why isn’t anyone mentioning the impending breakdown in the Dollar Index and the potentially very bullish breakout in Copper?

    For a disciplined and quantitative approach, check http://www.thetechnicaltake.com

  • michael bailey

    Canadian comments taken from guests on Business News Network. Look at folks who are employed by sprott.com for examples.

  • Isn’t Richard Russel hair splitting? If they’re up in some sectors and down in others, shouldn’t the impact of the entire thing be valuated and not simply say we’re okay because mining is booming?

    Are they still in denial? –Durano, done!

  • Prieur,

    It seems that the commodity space is getting major inflows from the institutional space.

    Do you know of any research service that tracks this? I know one reason growth & tech had their day in the 90’s was because of the change in the “asset allocation” models that pension funds and large investors use.

    I believe that hard assets will be the next bubble and would like ways to track in advance how much people have “bought in” to the story. We are probably many years away from that point. Just curious.

    Love your blog.

  • Dan Modricker

    Why is appreciation in home prices and rents, as well as stock prices …. called “asset -inflation” rather than consumer price inflation? If we had considered the inflation of home prices as part of consumer price inflation, we wouldn’t be surprised to hear the Fed claim that “inflation is under control”. The prices of houses is falling rapidly, much to the chagrin of the Fed. We are now confronted with “stagflation” .. a slowing or stagnant economy .. with inflation that is being reduced by Chindia but being increased by asset bubbles (including oil).

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