Words from the (investment) wise for the week that was (March 10 – 16, 2008)
I was bargaining on a quiet week as there were only a handful of economic releases and no major earnings reports. But credit and liquidity issues ravaged the financial markets and resulted in plenty of white knuckles and shaky knees, climaxing on a particularly sour note on Friday and not quite delivering the birthday present I was hoping for.
Struggling to contain a crisis of confidence in credit markets, the Federal Reserve announced a new Term Securities Lending Facility (TSFL). The Fed will lend up to $200 billion of Treasury securities to primary dealers for a term of 28 days (rather than overnight) against collateral including federal agency debt, mortgage-backed securities of Fannie Mae and Freddie Mac and private AAA-rated residential mortgage-backed securities.
This program essentially aims to improve liquidity by allowing more thinly-traded securities to be used as collateral to borrow highly-traded Treasury securities. “… looks to me like the nationalization of duff loans, although the Fed has not actually purchased the mortgage securities,” remarked London-based David Fuller, author of the Fullermoney newsletter.
The auctions will take place on a weekly basis, commencing on March 27, and participating central banks include the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank.
Wobbling on the brink of collapse from a lack of cash, Bear Stearns received emergency funding on Friday from the Federal Reserve of New York and JP Morgan in the largest government bailout of a US securities firm. The rescue action failed to restore confidence among Bear’s customers and shareholders, who slaughtered the stock price by 47% and sent stock markets tumbling.
The Fed’s board unanimously approved the JP Morgan Chase and Bear Stearns arrangement and issued a press release stating that it was “monitoring market developments closely and will continue to provide liquidity as needed”./font>
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 round-up.
Economic data were mixed, although the reports did not have much impact on financial markets due to credit worries taking center stage. February retail sales fell by 0.6%, which was short of the expected 0.2% rise. On the positive side, however, the inflation numbers were better than expected as February CPI and CPI excluding food and energy came in flat. CPI is now up 4.0% year on year, and core CPI is up 2.3% year on year.
The better-than-expected inflation reading, together with the reeling stock market, caused pundits to up their expectations of the size of the FOMC’s March 18 rate cut. Fed funds futures now suggest a 64% chance (up from only 6% a week ago) of a 100 basis point cut, with the rest of the bets on a 75 basis point cut.
WEEK’S ECONOMIC REPORTS
Source: Yahoo Finance, March 14, 2008.
In addition to the FOMC’s interest rate announcement on March 18, the next week’s economic highlights, courtesy of Northern Trust, include the following:
1. Industrial production (March 17): The 0.5% drop in the manufacturing man-hours index in February suggests a 0.3% decline in industrial production. The operating rate is projected to have dropped to 81.2 in February. Consensus: -0.1%; Capacity Utilization: 81.3 vs. 81.5 in January.
2. Producer Price Index (March 18): The Producer Price Index for Finished Goods is expected to have risen by 0.3% in February, reflecting higher food and energy prices. The core PPI is most likely to have risen by 0.1% after a 0.2% increase in January. Consensus: +0.4%, core PPI +0.2%.
3. Housing Starts (March 18): Permit extensions for new homes fell by 1.8% in January, inclusive of a 3.0% drop in permits issued for single-family homes. The weakness in permits is indicative of fewer housing starts in February (970,000 versus 1.012 million in January). Consensus: 990,000.
4. Leading Indicators (March 20): Interest rate spread and money supply are the only two components likely to make a positive contribution in February. Stock prices, initial jobless claims, consumer expectations, vendor deliveries, and building permits are expected to make negative contributions. Forecasts of money supply and orders of consumer durables and non-defense capital goods are used in the initial estimate. The manufacturing workweek held steady in February. The net impact is a 0.4% drop in the leading index during February. If our forecast is accurate, this would be the fifth monthly decline in the index, which reinforces expectations of a recession. Consensus: -0.3%
Other reports: Current Account (Q4), NAHB Survey (March 17, Philadelphia Fed Survey (March 20).
Source: Wall Street Journal Online, March 16, 2008.
As was the case during the previous week, the Japanese Nikkei 225 Average and emerging markets again came under strong selling pressure and lost 4.2% and 2.2% respectively. China’s Shanghai Stock Exchange Composite Index (-7.9%) was at the forefront of selling pressure, having lost 35,0% since its peak in October 2007.
The major US indexes experienced a mixed week, with the S&P 500 Index losing 0.4%, the Nasdaq Composite Index closing unchanged and the Dow Jones Industrial Index gaining 0.5%. Gold and silver stocks (+5.0%) and oil services stocks (+1.2%) performed well, whereas brokers (-7.2%) were again dumped by nervous investors.
Elsewhere in the world, bond yields declined in Germany, edged up in the UK and were mixed in Japan.
The dollar’s record-breaking slide prompted complaints from Jean-Claude Trichet, European Central Bank President, and Fukushiro Nukaga, Japanese Finance Minister. Henry Paulson, US Treasury Secretary, also re-emphasized that he was backing a “strong dollar”.
“We’re on an intervention watch,” Stephen Jen, Morgan Stanley’s London-based head of foreign-exchange research, said. “While I don’t think we have reached the threshold yet, the argument in favor of it is gradually becoming compelling.”
Crude’s advance occurred even though the US government’s weekly energy report showed stockpiles had increased by a much larger than expected amount, but possible supply interruptions in Nigeria caused concerns.
Gold jumped by $16 on the news of the Bear Stearns rescue operation, and was also helped by negative real interest rates in the US, the plunging dollar and the strengthening oil price.
As far as other commodities were concerned, agricultural commodities scaled new peaks, but industrial metals experienced some profit-taking.
Political decisions on money flows, labor and technology are “substantially constraining supply growth” of commodities, Goldman analysts including Jeffrey Currie in London wrote in a recent report. “This will likely support the ongoing structural bull market in commodities until these policy-driven investment constraints are removed and/or demand is adjusted.”
However, other analysts are beginning to question the sustainability of the commodities rally. Albert Edwards, global strategist at Société Générale, said: “The unfolding US consumer recession is likely to suck liquidity away from the Emerging Market (EM) region as the US current account deficit declines and EM accumulation of foreign exchange reserves slows sharply. As EM asset prices slide and decoupling arguments evaporate, commodity prices will react sharply as recent speculative ‘safe haven’ froth unwinds.”
Now for a few news items and some words (and graphs) from the investment wise that will hopefully assist to make sense of markets’ action during the shortened week ahead (including option and futures expiration on Thursday).
Bill King (The King Report): Special alert – critical week ahead
“Sunday night is critical. Asia doesn’t matter. But Europe cannot be allowed to tumble.
“Everyone is talking dollar intervention. But there is no one home at the BoJ due to political hankering over the post. I think that the only way to have a significant intervention is to have the ECB, BoE, Bank of Canada and Australia Reserve Bank cut rates sharply.
“In fact, I’d have Volcker make the call and say he is running the deal and it will be similar to the Hunt bailout in 1980. After a couple quarters, you can hike rates if you like.
“There should be other interventionist action and lending facilities proffered. But the global markets need the shock & awe of global coordinated rate cuts of significant magnitude.
“We must reiterate, the only thing preventing a public panic, because they don’t understand the magnitude of credit market problems, is that the stock market is not crashing. And solons know this.
“Hopefully this will buy time.”
Source: Bill King, The King Report, March 14, 2008.
Source: The Wall Street Journal, March 11, 2008.
Jim Sinclair (Mineset): Economic forces converge like never before
“The reason this missive is late is because I am reverberating at the speed of the disintegration. These cursed OTC derivatives and their makers, who incidentally made the international banking community rich beyond your wildest dreams, are now unwinding at lightening speed.
“Do you think any entity with any OTC derivative now has faith in the paper?
“This paper is $550 trillion plus dollars in notional value. The horrible fact is that in bankruptcy notional value becomes real value with the capacity to destroy the world financial system.
“The above is no wild assumption. It is hard, cold fact.
1. Expect currency intervention to slow down the rise of the euro.
“This is it!”
Source: Jim Sinclair’s Mineset, March 13, 2008.
The New York Times: Lower US rates not yet the tonic
Source: New York Times, March 9, 2008.
BCA Research: Stagflation fears escalate
“There is certainly plenty for investors to worry about in the current environment. The global economy and earnings backdrop continues to deteriorate, US housing shows little sign of improving, and the credit crunch continues to intensify. Indeed, it would seem that each positive policy development is met with the fall of another sub-prime related domino. The latest development has been the failure of some investment firms to meet margin calls, sparking fears of forced selling and further deleveraging.
“To amplify concerns, energy and food prices continue to surge, helping to stoke inflation fears. However, we are less worried about broad-based price pressures. It is unlikely that rising commodity prices will lead to a rise in core CPI inflation because manufacturers will be unable to raise prices amidst weak demand. Moreover, the softening job market will help prevent second round effects.
“Bottom line: Stagflation has returned as a hot word. However, as occurred the last time stagflation had its moment in the limelight in 1990, weak growth will soon undermine pricing power.”
Source: BCA Research, March 11, 2008.
Bill King (The King Report): US CFOs are in recession mode
“Optimism reached its lowest point since the optimism index launched six years ago. Pessimists outnumber optimists by a nine-to-one margin, with 72% of CFOs more pessimistic and only 8% more optimistic about the US economy than they were last quarter.
“Weak consumer demand and turmoil in the credit and housing markets are the top macro-concerns of CFOs. The high cost of labor ranked as the top internal concern.”
“Credit conditions have directly hurt 35% of companies, through decreased availability of credit and higher interest rates (up 118 basis points on average). 60% of firms have postponed expansion plans in response to credit market unrest.”
Source: Bill King, The King Report, March 13, 2008.
Asha Bangalore (Northern Trust): Fed sees need to address liquidity problems again
“In addition, the Fed increased swap lines with the European Central Bank and Swiss National Bank of amounts up to $30 billion and $6 billion, respectively. These initiatives follow after the Fed announced last week an increase in the size of Term Auction Facility and extended the term of open market repurchase agreements.
“Will these actions unfreeze credit markets? It is a matter of time before we see the results. Market spreads had widened in recent days and raised new concerns about the credit crunch. In light of these actions, it appears the Fed will probably settle with a 50 bps reduction in the federal funds rate on March 18 versus the market expectations of a more aggressive move.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 11, 2008.
BCA Research: US Term Securities Lending Facility an important step
“The Treasury swap appears designed to alleviate pressures some dealers were experiencing over the decline in value of their holdings of agency bonds and MBS. Allowing dealers to swap these securities for Treasurys should stop these spreads from widening further, since dealers can sell Treasurys into the market instead of selling agencies and MBS. Thus, the TSLF will encourage some spread tightening in high-grade securities, but the announcement is unlikely to mark the end of the credit crisis or a peak in lower-quality spreads (especially subprime and Alt-A mortgage debt). For that, we need to see action directed at the bad bank debts or the struggling subprime homeowners.
“Bottom line: The TSLF is clearly a positive step but, in the absence of aggressive fiscal action, the pain in credit markets is likely to persist while home prices continue to fall and default/foreclosure rates rise.”
Source: BCA Research, March 13, 2008.
Times Online: Hedge funds on the brink as US Fed cash fails to ease crisis
“The potential closure of six funds came as a leading private equity executive, who declined to be named, said that such funds were ‘snapping like twigs’, with one failing every day.
“Yesterday Patti Cook, Freddie Mac’s chief business officer, predicted that the Federal Reserve’s $200 billion bond lending facility this week would fail to solve the long-term problem of Wall Street’s deepening credit crisis.
“The funds’ predicament – seven funds have been frozen this month – was seen as evidence that the initiative by America’s central bank to allow lenders to swap their risky mortgage-backed bonds for safer Treasury debt, will be of help only in the short term.”
Source: Suzy Jagger, Times Online, March 13, 2008.
The Wall Street Journal: Brainstorming about bailouts
“In the audience, Myron Scholes – Nobel laureate in finance, veteran of the Long-Term Capital Management hedge-fund debacle and now chairman of his own hedge fund – was listening and scribbling on a yellow legal pad. His conclusion, one gaining momentum, is that the government eventually will spend a lot of taxpayer money to clean up the current credit mess …”
Source: David Wessel, The Wall Street Journal, March 13, 2008.
MarketWatch: Freddie Mac sees US home prices falling further
“According to the purchase-only price index of the Office of Federal Housing Enterprise Oversight, or OFHEO, prices are down 2.5% from the peak. Meanwhile, according to the Case-Shiller national index, prices are down 10.2% from the peak.
“Home prices fell 8.9% last year, the largest decline in the Case-Shiller home price index in at least 20 years, Standard & Poor’s reported February 26.
“The same day, a separate measure of home values reported by OFHEO showed a 0.3% decline in home prices in 2007. It was the first annual decline recorded in the 16-year history of the OFHEO purchase-only price index.”
Source: Robert Schroeder, MarketWatch, March 12, 2008.
Bloomberg: US home defaults, foreclosures rise 60% in February
“More than 223,000 properties were in some stage of default, or 1 in every 557 US households, Irvine, California-based RealtyTrac, a seller of foreclosure data, said today in a statement. Nevada, California and Florida had the highest rates.
“‘With declining prices, there is a pervasive problem of not being able to refinance or sell,’ said Susan Wachter, professor of real estate at the University of Pennsylvania’s Wharton School in Philadelphia. ‘I’m very concerned.’
“About $460 billion of adjustable-rate mortgages are scheduled to reset this year and another $420 billion will rise in 2011, according to New York-based analysts at Citigroup. Homeowners faced higher payments as fourth-quarter home prices fell 8.9%, the biggest drop in 20 years as measured by the S&P/Case-Shiller home price index.
“Foreclosure filings are likely to be ‘explosive’ in May and June as more payments jump, after remaining at current levels this month and next, Rick Sharga, executive vice president of RealtyTrac, said in an interview. There may be between 750,000 and 1 million bank repossessions in 2008. Bank seizures rose 110% in February from a year ago, he said.”
Source: Alan Mirabella and Sharon Lynch, Bloomberg, March 13, 2008.
The Wall Street Journal: Latest trouble spot for banks – souring home-equity loans
“When times were good, banks raked in billions of dollars in profit from home-equity loans, which allow borrowers to tap the accumulated value in their property with either a loan for a specific amount or a line of credit. As long as home prices were rising, lenders had little to worry about. But falling home values are leaving banks with little or nothing to collect on many home-equity loans in case of default. Some stretched borrowers are keeping up with their mortgage and credit cards – but not their home-equity loan.
“The problems are already causing trouble for J.P. Morgan Chase and Wells Fargo, and are expected to hit other large banks when first-quarter earnings results are released next month. The pain is likely to deepen through the rest of 2008, sapping capital levels and resulting in tighter lending standards as banks try to reduce their risk.”
Source: Robin Sidel, The Wall Street Journal, March 12, 2008.
Asha Bangalore (Northern Trust): February retail sales show significant pullback in consumer spending
“The January-February average, serving as a proxy of total retail sales in the first quarter, shows a decline in retail sales of 0.2% compared with a 3.6% annualized increase in the fourth quarter.
“The main take away from the February retail sales report is that consumer spending shows a marked deceleration in the first quarter compared with the fourth quarter. It is quite likely that consumer spending will post a decline in the first quarter, the first quarterly drop since the fourth quarter of 1991.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, March 13, 2008.
Bloomberg: S&P says end in sight for writedowns on subprime debt
“Writedowns from subprime-tied securities will probably rise to $285 billion, or $20 billion more than S&P forecast two months ago, S&P said today in a report. More than $150 billion have been reported already by banks, brokers and insurers, the firm said. S&P raised its estimate as it assumes deeper losses on collateralized debt obligations.
“‘There’ll be plenty of trouble around this quarter, but it’s just not going to be as much subprime trouble,’ Tanya Azarchs, New York-based S&P’s managing director for financial institutions, said in a telephone interview.
“The world’s largest banks and securities firms, led by Citigroup, UBS and Merrill Lynch, have reported more than $188 billion of mortgage-related losses since the start of last year, according to data compiled by Bloomberg. Subprime writedowns are coming not only at banks, brokers and insurers, but also hedge funds and institutional investors, S&P said.
“S&P, Moody’s Investors Service and Fitch Ratings have been criticized by lawmakers and regulators for failing to anticipate the record home foreclosures that led to a slump in securities linked to mortgages to people with poor credit. S&P assigned AAA ratings to about 85% of mortgage CDO classes created in 2005, 2006, and 2007, according to the report. Some AAA classes of CDOs lost all of their value last year.
“‘I don’t want to be unduly skeptical here but the basis of the comments from S&P, I believe, require further examination,’ said Mike Mett, a retired lawyer and former counsel to the Wisconsin securities commissioner …”
Source: Jody Shenn, Bloomberg, March 13, 2008.
Frank Veneroso (Veneroso Associates): A big second wave of mortgage losses lies ahead
“For some of these AAA rated securities almost half the underlying is already in foreclosure, seizure or default.
“How are these securities being valued by their holders? Some may be still marked at model or par. Some may have been marked down to year end ABX marks. On the AAA tranches that would price them at around 70, down from par. But now AAA ABX is priced at 50 or so.
“What happens when these securities get rerated? Even if the downgrade is by one level only the results are disastrous since AA ABX is now trading at just above 20.
“This says that the hidden losses due to rating agency failure and favorable marks by institutions on top of that implies that $1 trillion plus in losses could conceivably show up as the rating agencies and the auditors do their work.
“Of course, maybe ABX has overshot to the downside. Maybe institutions will not need to write down such paper to prevailing ABX prices. But if recession unfolds and we approach mean reversion in house prices they almost surely will have to.”
Source: Frank Veneroso, Veneroso Associates, March 11, 2008.
Reuters: Banks face “systemic margin call”, $325 billion hit
“JPMorgan, which sent a default notice to Thornburg Mortgage after the lender missed a $28 million margin call, said more default notices and margin calls were likely. The Carlyle Group’s mortgage fund also failed to meet $37 million in margin calls this week.
“‘A systemic credit crunch is underway, driven primarily by bank writedowns for subprime mortgages,’ according to the report co-authored by analyst Christopher Flanagan. ‘We would characterize this situation as a systemic margin call.’”
Source: Walden Siew, Reuters, March 8, 2008.
David Galland (Casey Research): Derivates next?
• US annual gross domestic product is about $15 trillion.
Source: David Galland, Casey Research – The Room, March 14, 2008.
Katharina Bart (Dow Jones Newswires): UBS to create “bad bank”
“This so-called ‘bad bank’ could be created by May 6, when the Zurich-based bank reports first-quarter results, analysts say. Its purpose would be to quarantine the $88 billion in risky assets that UBS still holds on its balance sheet, in a move analysts say would reassure investors and prop up the slumping share price.
“‘Initially, we would expect no impact on group earnings,’ Bear Stearns analyst Chris Wheeler wrote in a note to investors. ‘The creation of a ‘bad bank’ won’t solve all UBS’s problems. However, it could be an important step in aggressively dealing with issues it is facing’ and make UBS’s ongoing business easier to analyze.
“Any losses related to the ‘bad bank’ would still be reflected in UBS’s final profit-and-loss statements, but by separating them from the bank’s finance-based business, it would allow investors, analysts and ratings agencies to more easily evaluate progress in investment banking and private banking, the two main bank units.”
Source: Katharina Bart, Dow Jones Newswires (via Intesatrade), March 12, 2008.
Financial Times: Trichet signals alarm at euro’s rise
“‘In present circumstances, we are concerned about excessive exchange rate moves,’ he said in prepared comments after a meeting of the world’s central bank governors in Basel, Switzerland. ‘Excessive volatility and disorderly movements…are undesirable for economic growth.’
“The comments mark a change of tack. The ECB took a hard-line on interest rates at last week’s policy-setting meeting, when the bank made clear that combating eurozone inflation – at a 14-year high of 3.2% – was its priority. Mr Trichet had failed to express concern about the euro at that point, sending the currency above $1.54 for the first time.
“Monday’s (verbal) intervention, which pushed down the euro, appeared to be aimed at calming market movements. Full-blown central bank intervention – which would almost certainly require US support to succeed – still seems unlikely.
“Mr Trichet’s decision to wait until Monday before commenting on the euro suggested he had been anxious last week not to confuse the central bank’s message on combating inflation.”
Source: Ralph Atkins, Financial Times, March 10, 2008.
Bloomberg: US dollar’s slump puts Morgan, Goldman on “intervention watch”
“The currency today fell below $1.56 per euro and slumped to the lowest level in 12 years versus the yen. That has prompted complaints from European Central Bank President Jean-Claude Trichet and Japanese Finance Minister Fukushiro Nukaga. US Treasury Secretary Henry Paulson said today he backs a ‘strong dollar’ and refused to elaborate when questioned at a press conference in Washington.
“The challenge for policy makers is fighting the $3.2 trillion-a-day currency market while the Federal Reserve cuts interest rates and the US economy falters. With traders increasing bets on a weaker dollar, the Group of Seven nations may be compelled to act, some strategists said.
“‘We’re on an intervention watch,’ Stephen Jen, Morgan Stanley’s London-based head of foreign-exchange research, said in a telephone interview today. ‘While I don’t think we have reached the threshold yet, the argument in favor of it is gradually becoming compelling.’
“The dollar today dipped below 100 yen for the first time since 1995, when the G-7 last stepped in to prop up the US currency. It’s lost 15% against the euro since September as the Fed’s rate reductions dull the currency’s allure.”
Source: John Fraher and Simon Kennedy, Bloomberg, March 13, 2008.
David Fuller (Fullermoney): Intervention will not cause major US dollar rebound
“However with US interest rates declining, the Fed printing, America’s economy the epicentre of global weakness and its creditor governments already holding what they regard as uncomfortably large dollar positions, the greenback is unlikely to stage more than short-covering rallies until the US economy is recovering and the Fed raising interest rates.
“Consequently, it is unlikely that multilateral intervention to support the dollar, which would probably have to be repeated, could produce more than some short, sharp rallies. Given the perilous state of the US economy, I believe it will be some time before we see a major rebound by the US Dollar Index.”
Source: David Fuller, Fullermoney, March 14, 2008.
John Authers (Financial Times): Wall Street threw in the towel
“Meanwhile, the equity market has given up its attempt to deny the credit crisis and has lapsed into a bear market, defined as a 20% fall from peak to trough. Europe, Japan and China are already in bear markets. The S&P 500 is down only 17%, but this is an illusion of the weak dollar: in euro terms it is down 27%.
“Optimists draw parallels with two shallow bear markets: 1990 (which lasted a year, with a fall of 19.9%) and 1998 (a four-month decline of 19.3%). But the 1998 comparison is specious. The US was not in recession. The crisis was concentrated in the Long-Term Capital Management hedge fund. All the interested parties could be gathered into one room. Hope springs eternal, as market rallies in recent months attest, but there is no chance that this crisis can be solved so easily.
“The 1990 parallel is more beguiling. Then as now the US was heading into a recession, and the problem centred on irresponsible home lending.
“But that bear market included Iraq’s invasion of Kuwait. Most importantly, the financial system has changed, and now relies on credit and money markets that barely existed in 1990. It is ever more apparent that they are not functioning.
“On Monday, Wall Street threw in the towel. The morning’s worst fallers are a list of the groups that dominated the world of securitised finance over the last two decades: the mortgage agencies Fannie Mae and Freddie Mac, the bond insurers Ambac and MBIA, and the investment banks most deeply involved in mortgage finance. As with the economy, we have clarity: the credit market model is broken and must be fixed.”
Source: John Authers, Financial Times, March 10, 2008.
Richard Russell (Dow Theory Letters): Stock market already discounting the worst
“Let’s say, for example, that yesterday saw a cyclical market low. But with current valuations of 18 times earnings on the S&P and dividend yields below 2%, this is not an historic bear market low of the 1949 or 1974 or 1980 variety. No, this would be more like a cycle low of the 1962 or the 2002 variety.
“Now let’s concentrate on the current situation. Here’s some of my thinking. If the bear market is to continue, not one but BOTH Averages – Industrial and Transports – would have to break under their January lows. I’ve been impressed with the Transport action all along, and I’m even more impressed with the Transports after yesterday’s action. At yesterday’s close, the Transports were a huge 458 points above their January lows.
“Consider this – if the horrendous news of the last few months didn’t succeed in driving the Transports below their January lows, I wonder what it would take to batter the Trannies to new lows? I honestly don’t know. For that reason I’m going to proceed as if the market had discounted the worst at the mid-January lows.
“It always seems impossible that the stock market can discount events six months or even a year ahead. Yet the collective wisdom of the stock market is an incredible phenomenon. Barton Biggs has just written a book (‘Wealth, War & Wisdom’) about the amazing ability of the stock market to discount, to look ahead. Personally, I’ve seen the market exert its ‘forward wisdom’ over and over again. For that reason, I don’t doubt that at the mid-January lows the stock market may have discounted the worst of the whole sub-prime, liquidity, and bank situation.
“Strange phenomena exist in this world of ours, and one of the strangest is the incredible, almost eerie, ability of the stock market in its collective wisdom to look ahead and ‘see’ things that no one man or group of men can see.
“That being the case, then the trillion dollar question is this – did the stock market at its mid-January lows discount the worst that could be seen ahead? My answer is ‘Yes, I think it did.’ But in this business, you always have to ask yourself, ‘How will I know if I’m wrong? What must happen to prove to me that I’m wrong?’
“And the answer is clear enough – the Industrials would have to break to a new low and the Transports would have to confirm by violating their own January lows.”
Source: Richard Russell, Dow Theory Letters, March 12, 2008.
Richard Russell (Dow Theory Letters): Bear market bottom later in 2008
“Since the stock market typically hits bottom around the middle of a recession, then working backwards Steve thinks that the stock market could hit bottom around April or May. But if this is fated to be BIG recession, say a sixteen month recession, then the stock market should hit bottom about nine months into the recession, which means a market bottom in the July to August 2008 period.”
Source: Richard Russell, Dow Theory Letters, March 10, 2008.
John Hussman (Hussman Funds): Brace for continued stock market difficulty for bulk of 2008
“A run-of-the mill bear runs about 15 months, so if we mark the highs somewhere about July to October of last year, it would not be unreasonable to brace for the possibility of continued market difficulty for the bulk of 2008. If that is the case, we can also expect strong intermittent ‘bear market rallies’ as we saw off the January low. Better valuations and periodic improvement in market internals may allow us to accept some amount of risk from time to time this year, but we’re not in any hurry to ‘buy the dips’ without supporting evidence, particularly giving growing debt problems in the economy.”
Source: John Hussman, Hussman Funds, March 10, 2008.
Yutaka Yoshino (Nikko Citigroup): Triggers for a rebound for US stocks
“In the five times the DJIA has undergone substantial corrections during economic slowdowns, real interest rates declined so far they became negative four times. In each of these cases, interest rates turned negative and stocks bottomed at roughly the same time.
“US interest rates have been lowered five times since September 2007. Shares have risen in advance of the FOMC’s announcements three times (prior to cuts announced on October 31, December 11, and January 29), then dropped after the announcements. Despite substantially lower interest rates, stocks have continued to fall.
“Now, however, because share prices have corrected substantially in advance of the next FOMC meeting, if another cut brings real interest rates to around zero, we believe this could be a powerful trigger for a rally.”
Source: Yutaka Yoshino, Nikko Citigroup, March 12, 2008.
Jeffrey Saut (Raymond James): “Kiss and tell” week for stock markets
“Indeed, we think this is ‘kiss and tell’ week and we continue to trade, and invest, accordingly.”
Source: Jeffrey Saut, Raymond James, March 10, 2008.
Bill King (The King Report): Vicious bear market looming for US bonds
Source: Bill King, The King Report, March 13, 2008.
Bloomberg: TIPS’ yields show Fed has lost control of inflation
“The yield on the five-year Treasury Inflation-Protected Security (TIPS) due in 2012 has been negative since February 29, ending last week at minus 0.16%. The notes, which were first sold in 1997, have never before traded below zero. Even so, firms from Deutsche Asset Management to Vanguard Group, the second-biggest US mutual fund company, say TIPS are a bargain.
“For the first time in a generation, money managers must come to grips with a central bank that’s more intent on spurring the economy than restraining price increases. With oil above $100 a barrel, gold approaching $1,000 an ounce and the dollar at a record low against the euro, TIPS show investors aren’t convinced Fed Chairman Ben S. Bernanke will be able to tame inflation once policy makers stop cutting interest rates.
“‘The way TIPS are trading now, investors believe headline inflation will stay lofty and are willing to give up the real yield for that,’ said Brian Brennan, a money manager who helps oversee $11 billion in fixed-income assets at T. Rowe Price Group Inc. Prices for the securities indicate ‘a real concern of a recession and high headline inflation’, he said.
“Because TIPS pay a principal amount that rises in tandem with the consumer price index, buyers accept lower yields in a bet the inflation adjustment will make up the difference.”
Source: Sandra Hernandez and Deborah Finestone, Bloomberg, March 10, 2008.
Eoin Treacy (Fullermoney): Be careful with investment in TIPS
“CPI-U jumped from 2% to 4.3% since August, at least in part due to the surge in oil and food prices. It is now testing the upper side of the 16-year range and would need to sustain a move above 5% to indicate that this inflation measure had moved upwards from its base. This may occur given the consistent uptrend in oil prices, but if one is investing in TIPS; one is betting solely on price appreciation at these levels. If inflation measures break upwards then other assets, such as gold, will appreciate much more that these fixed income investments. If the CPI-U falls back from the upper side of the range, then the reason for holding these securities will have diminished and prices could fall quite quickly.”
Source: Eoin Treacy, Fullermoney, March 12, 2008.
Richard Russell (Dow Theory Letters): Gold above $1,000!
“‘Gold above one thousand dollars an ounce! You idiot, you paid too much for gold. What if gold corrects here? What if you turn out to be the ultimate greater fool? Forget about paying a thousand bucks for gold, you may spend the rest of your life waiting to get your money back.’
“That, I believe, is the fear and the sentiment surrounding gold at this point. Of course, if gold advances about 1,000 and remains there, then sentiment will change. Once people get used to gold above 1,000 the sentiment becomes, ‘Gosh, I remember gold under 1,000 when it was selling as cheap as dirt. We should have loaded up on the yellow metal at 900 or 950 or 970. Then it was the bargain that nobody understood.’
“One major change has occurred between the gold bull market of the 1970s and the one we’re now in. The 1970’s gold bull market was essentially a US gold bull market. What happened is the US dictated what would happen with gold. Not so today.
“The current bull market in gold is GLOBAL. Gold isn’t rising today because Americans are loading up on gold (actually, they are not). The real impetus behind gold today is Chinese buying and Indian buying and Arab buying and worldwide buying. Gold is no longer controlled by what happens in the US futures market. What’s happening to gold is a product of Asian central banks, Chinese citizens, Russian billionaires buying. As I said above, this is an international market based on people and central banks around the world accumulating wealth. This is a DIFFERENT gold bull market.”
Source: Richard Russell, Dow Theory Letters, March 14, 2008.
Bloomberg: Sprott sees financial turmoil pushing gold to $2,000
“This year’s decline in banking and brokerage stocks will worsen, said Sprott, 63, founder and chairman of Sprott Asset Management, which manages about $7 billion. In response, the company is short selling financial stocks and increasing holdings in bullion and mining companies, Sprott said. He declined to name which bank he thought may collapse.
“‘We’re in a systemic financial meltdown,’ Sprott said in an interview … ‘There are probably 10 companies that are broke that are still trading – banks and financial institutions.’
“Sprott, who in 2004 foresaw uranium and crude-oil prices rising, expects the global financial system will come under increased stress as banks, faced with slipping stock prices and capital erosion tied to subprime-mortgage loans, battle to raise money to offset losses caused by asset writedowns.”
Source: Stewart Bailey, Bloomberg, March 10, 2008.
Bloomberg: Goldman sees “explosive” commodity rallies
“Political decisions on money flows, labor and technology are ‘substantially constraining supply growth’ of commodities, Goldman analysts including Jeffrey Currie in London wrote in a report today. ‘This will likely support the ongoing structural bull market in commodities until these policy-driven investment constraints are removed and/or demand is adjusted.’
“Commodities are in their seventh year of gains as underinvestment in refineries, mines and land sent prices for oil, gold, platinum and wheat to records. More natural resources are controlled by political entities than at any time since the 17th century, according to the Goldman report.
“Crude at $175 a barrel ‘represents the price level required to maintain trend economic growth against our anemic supply growth forecasts, assuming growth in the US re-accelerates early next year,’ Goldman said.”
Source: Claudia Carpenter and Alexander Kwiatkowski, Bloomberg, March 14, 2008.
Albert Edwards (Société Générale): Uravelling commodities
“‘Investors believe they have found a safe haven in commodities and decoupling emerging markets – and commodities have become totally detached from fundamental and cyclical logic in the process,’ he says. ‘The structural arguments supporting these bubbles will turn to cyclical sand.’ Mr Edwards believes one factor will trump all others to destroy the emerging market and commodity boom.
“‘The unfolding US consumer recession is likely to suck liquidity away from the Emerging Market (EM) region as the US current account deficit declines and EM accumulation of foreign exchange reserves slows sharply. As EM asset prices slide and decoupling arguments evaporate, commodity prices will react sharply as recent speculative ‘safe haven’ froth unwinds.’
“Mr Edwards goes on: ‘After the biggest cost push pressures on inflation from commodity prices in decades, isn’t it absolutely amazing that the worst core inflation can do is hover around 2% (slightly higher in the US, slightly lower in Europe and ‘slightly zero’ in Japan). As commodity prices slide in this downturn, expect negative headline CPI inflation within 12 months.’”
Source: Albert Edwards, Société Générale (via Financial Times), March 12, 2008.
BCA Research: UK housing – foundations are crumbling
“The release of the RICS survey showed that house price expectations among realtors plunged more-than-expected yet again in February to -64.1% (from -54.7%). The index is now at levels comparable to the early 1990s recession, which coincided with a multi-year contraction in annual house price inflation. The RICS survey’s sales-to-stock ratio also dropped further, warning that the supply/demand equilibrium continues to shift in favor of lower prices.
“While residential real estate prices have not yet started to decline on a year-over-year basis, the market is cooling rapidly and our models warn of this outcome by mid-year. In turn, the wealth effects will reverberate throughout the economy, dramatically curtailing consumer spending and overall economic growth.
“While price pressures have lingered, a housing bear market is a significant deflationary shock and will help alleviate BoE concerns. Bottom line: The BoE will be forced to ease significantly in the months ahead. Stay overweight gilts within a global hedged fixed income portfolio and bearish sterling.”
Source: BCA Research, March 12, 2008.
Matthew Vincent (Financial Times): UK – a plastic bag budget
Source: Matthew Vincent, Financial Times, March 12, 2008.
Mark Mobius (Franklin Templeton Investments): Emerging markets – corrections offer opportunities
“For example, we consider China a compelling market. As new money comes into our funds, we continue to invest in Chinese companies that we expect will perform over a five-year period. We are focusing on the energy, materials, banking and telecommunications sectors. Energy and materials stocks are expected to benefit from greater revenues and earnings due to relatively high commodity prices and higher infrastructure and energy demand from China and the rest of the world. Banking reforms and growing demand for financial services make banks attractive investments, while the potential for growth in telecommunications leads us to remain positive on this sector. China is a well-known growth story, and we believe we’re still seeing the beginning of its growth cycle.
“We also have significant investments in Brazil and Russia, which we are overweight relative to the MSCI Emerging Markets Index. The Brazilian economy has recorded a strong current account surplus, supported by a record trade surplus due to the high volume and prices of commodity exports. Brazil is a major agricultural producer and exporter of food products and raw materials. International confidence in Brazil also has been high. Russia also has vast natural resources. We’re aware that the Russian stock index is exposed to a correction in energy prices, but we believe Russian commodity- related stocks in our portfolio are fundamentally strong and should continue to make good profits and record substantial margins, even allowing for price corrections.
“History has shown that the best time to buy is when everyone is selling. The markets may to be volatile at times, but emerging markets’ underlying fundamentals remain intact.”
Source: Mark Mobius, Franklin Templeton Investments, March 12, 2008.
John Authers (Financial Times): Chinese domestic equity bubble has burst
Source: John Authers, Financial Times, March 12, 2008.
UBS Investment Research: The impact of South Africa’s power crisis
Erratic power supply is a constraint on growth. Even assuming the best-case scenario, maintenance rates similar to those in January result in peak demand exceeding available supply in the medium term. Consequently, we expect repeats of the blackouts experienced in January and view power as a constraining factor for economic activity in the next two to four years.
Slower growth, increased macro vulnerability, but rates on hold. Power shortages will result in slower growth and we have cut our 2008 GDP forecast to 3.2% from 4.0%. We expect deterioration in inflation and external balances and see the potential for further currency weakness. However, we expect interest rates to remain on hold this year.
Click here for the full report.
Source: Reinhard Cluse and John Orford, UBS Investment Research, March 3, 2008.
3 comments to Words from the (investment) wise for the week that was (March 10 – 16, 2008)
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