Words from the (investment) wise for the week that was (June 16 – 22, 2008)
Sentiment deteriorated further during the past week as oil prices rebounded, more bad news in the financial sector surfaced, economic woes mounted and inflationary pressures intensified, compounding already-jittery investors’ anxiety.
Status Quo’s lyrics “Down down deeper and down” came to mind as global stock markets took a battering. The Dow Jones Industrial Index, for example, plunged by 3.8% over the week to below 12,000 – its lowest level since March. Commensurate with extreme bearishness, short interest on the New York Stock Exchange jumped to an all-time high during the week.
At the centre of investors’ angst was the perception that the credit crisis has not yet played itself out. These fears were supported by Goldman Sachs analysts who said last week they did not expect the credit crisis to peak before 2009, and that US banks might need to raise $65 billion of additional capital (on top of $159 billion raised so far) to cope with additional losses from the sub-prime fallout.
On a related note, Moody’s downgraded the credit ratings of Ambac Financial (ABK) and MBIA (MBI), citing their limited ability to raise new capital and write new business. Banks were also in focus as analysts cut their price targets for, among others, Goldman Sachs (GS), Citigroup (C) and Wachovia (WB).
In one of the most bearish reports for a while, The Royal Bank of Scotland advised clients to brace themselves for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks. “A very nasty period is soon to be upon us – be prepared,” said Bob Janjuah, the bank’s credit strategist (who gained credibility after his warnings last year about an impending credit crisis).
Richard Russell, 83-year old author of the Dow Theory Letters, expressed concern about the stock market’s negative breadth and said: “I did a double-take when I read Lowry’s statistics … Buying Power Index at a multi-year low and Selling Pressure Index at a multi-year high. And the two Indices at about their widest (most bearish) spread in history or since the 1930s. What the devil could this mean? My guess can be summed up in one word – trouble.”
But there is hope still, according to David Fuller (Fullermoney) who pointed out that Investors Intelligence‘s sentiment index (bottom section of the chart on the left) was extremely bearish. “There has never been a reading at current or lower levels that was not soon followed by a sharp rebound, including during the last bear market. This indicates to me that we are within a week or two of a bear squeeze, providing at least a tradable rally …”
Back to Richard Russell for the last word: “Lousy Fridays are often followed by rotten Mondays.” To which I add: When in doubt (and there is a ton of doubt), better to err on the side of caution than to do something stupid.
I am flying to Slovenia and Switzerland, in my opinion the jewels of “old” and “new” Europe respectively, next weekend for a combination of work and leisure. Blog posts will unfortunately be rather slow during my 10-day absence, and specifically “Words from the Wise” will take a break next Sunday as I will be in midair when the review needs to be compiled.
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 reports in the US were largely overlooked last week as market participants focused on corporate news, although there were several notable releases.
• The NAHB Housing Market Index fell by 1 point to 18, bringing it back to the record low reached in December and before that not seen since 1985.
• After plummeting since the beginning of this year, consumer confidence is showing tentative signs of stabilizing, according to the ABC News/Washington Post Consumer Comfort Index.
• Industrial Production fell by 0.2% in May, following an outsized 0.7% decline in April. Overall, the report is consistent with continued modest declines in manufacturing.
• The Producer Price Index for finished goods rose by a large 1.4% in June as expected, following a 0.2% increase in April. Inflation was once again led by large price increases of food and energy products.
Summarizing the US economic scenario, Paul Kasriel, chief economist of Northern Trust, said: “… despite the Fed’s aggressive Federal funds rate reductions, money and credit growth have slowed significantly … to absolutely low rates. The implication of this is that real economic activity is likely to be very sluggish until financial institutions rebuild their capital positions and that the inflationary flames are likely to subside as they are deprived of the ‘oxygen’ of credit growth.”
The highlight of next week’s economic news will be the FOMC policy announcement on Wednesday. Economists expect the Fed funds rate to remain unchanged at 2.0%, but uncertainty regarding the wording of the policy statement means it has market-moving potential.
“We fully expect that the FOMC will devote a relatively large amount of ‘ink’ to the inflationary threats in its no-change policy statement on June 25, but we also expect the FOMC to reiterate that the downside risks to economic growth still dominate its policy decisions in the near term,” said Kasriel.
Elsewhere in the world, escalating inflation concerns are at the top of policymakers’ agendas. In addition to rampant inflation in emerging markets, the Eurozone and UK are also shouldering strongly rising prices.
• Consumer price inflation in the Eurozone was up 3.7% in year-ago terms in May. The rate is far above the European Central Bank’s 2% inflation target and, given the ECB’s more hawkish tone lately, markets are increasingly expecting the bank to tighten.
• Consumer prices shot ahead in May in the UK, rising by 3.3% in year-ago terms. The deteriorating inflation outlook has reduced the likelihood of imminent monetary easing, while a recent statement by Bank of England Governor Mervyn King suggests that rate increases are also unlikely.
WEEK’S ECONOMIC REPORTS
Source: Yahoo Finance, June 20, 2008.
In addition to the FOMC’s interest rate decision on Wednesday, June 25, next week’s economic highlights, courtesy of Northern Trust, include the following:
1. Conference Board’s June Index of Consumer Confidence (June 24) – Consensus: 56.5, Previous: 57.2.
2. May Durable Goods Orders (June 25) – Consensus: 0.0%, Previous: -0.5%.
3. May New Home Sales (June 25) – Consensus: 515K, Previous: 526K.
4. FOMC decision (June 25) – Consensus: no change in Fed funds target.
5. Q1 Final GDP (June 26) – Consensus: 1.0%, Previous: 0.9%.
6. May Existing Home Sales (June 26) – Consensus: 5,000K, Previous: 4,890K.
7. May Personal Income (June 27) – Consensus: 0.4%, Previous: 0.2%.
8. May Personal Consumption Expenditures (PCE) (June 27) – Consensus: 0.7%, Previous: 0.2%.
9. May Core PCE Price Index (June 27) – Consensus: 0.2%, Previous: 0.1%.
10. June Final University of Michigan Consumer Attitudes Index (June 27) – Consensus: 56.9, Previous: 56.7.
Source: Wall Street Journal Online, June 22, 2008.
The Nikkei 225 Average (-0.2%) was the only developed market to survive the sell-off relatively unscathed. David Fuller (Fullermoney) regards Japan as “the best industrialized stock market for today’s economic climate”.
The performance of emerging markets (-0.9%) – the big casualties of the previous week with a steep decline of 5.3% – varied from the Hong Kong Hang Seng Index (+0.7%) and the Russian Trading System Index (+0.8%) that ended the week in the black, to the less fortunate markets such as the Brazilian Bovespa Index (-3.9%) and the Indian BSE 30 Sensex Index ( 4.1%). Year-to-date returns show the performance of emerging markets (+12.0%) still handsomely ahead of mature markets (-9.7%).
The US stock markets faced the brunt of heavy selling pressure and closed on a very weak note on Friday – option and futures expiration day. The index movements tell the story: Dow Jones Industrial Index -3.8% (YTD -10.7%), S&P 500 Index -3.1% (YTD -10.2%), Nasdaq Composite Index -2.0% (YTD 9.3%) and Russell 2000 Index -1.1% (YTD -5.3%).
At the centre of the sub-prime fallout, the Philadelphia Bank Index dropped to its lowest level in five years, closing down 5.9% on the back of further credit-related concerns and analysts downgrading their price targets for a number of companies.
Fedex (FDX), viewed as a bellwether for the broader economy, reported earnings that missed the consensus estimate and issued 2009 earnings guidance well below expectations, citing a weak US economy and record fuel prices.
Ford (F) and General Motors (GM) retreated by 8% and 16% respectively for the week after Ford said it would be difficult to “break even” in 2009, and Standard & Poor’s put a negative credit rating watch on both companies. It makes one wonder about the old adage stating that “As GM goes, so goes the nation” …
Gold stocks (+4.8%) and platinum stocks (+4.6%) were among the few to keep head above water during the sell-off.
The Dow Jones Industrial Index and the S&P 500 Index are solidly below both their 50- and 200-day moving averages, and are now challenging their March lows of 11,740 and 1,273 respectively. The Nasdaq Composite Index has also now succumbed to both moving averages, whereas the Russell 2000 Index is right at its 50-day moving average (and already below the key 200-day line).
I penned some (rather sobering) thoughts on the fundamental outlook for the US stock in a post a few days ago. Here is the link: US Stock Market: Muddling Through the Fundamentals.
Federal Reserve and European Central Bank officials last week moderated market participants’ expectations of interest rate increases, resulting in rates coming off the boil as seen in the US three-month Treasury Bill rate dropping by 16 basis points to 1.80%. Fed funds futures moved to price in only a 10% chance that the Fed will raise rates by 25 basis points at Wednesday’s FOMC meeting, compared with 22% a week ago.
The front end of the Treasury yield curve, being most sensitive to Fed policy moves, gained, with the yield on the two-year Note dropping by 19 basis points during the week to close at 2.85%. The yield on the 10-year Note, which is more sensitive to inflation pressures, declined by 12 basis points to 4.14%.
As far as the rest of the world is concerned, short-dated bond yields were mostly lower. For example, the yield on the UK two-year Gilt declined by 16 basis points to 5.29%, whereas the German two-year Schatz yield dropped by 9 basis points to 4.60%.
Safe-haven considerations played a role pushing up bond prices, but BCA Research warned that “… government bond markets will remain at risk until oil prices correct decisively or there is evidence that the disinflationary impact of the ongoing slowdown in the G7 economy is starting to unfold”.
US mortgage rates were virtually unchanged, with the 15-year fixed rate declining by 1 basis point to 5.99% and the 5-year ARM 1 basis point higher at 5.88%.
Credit market stress increased as shown by the widening spreads in both the US and Europe. The CDX (North American, investment grade) Index rose by 11 basis points to 126, and the Markit iTraxx Europe Crossover Index by 14 basis points to 500.
A realization that the Fed might not hike interest rate as quickly as expected caused the US dollar to trade lower. The euro rose by 1.4% against the dollar in anticipation of the ECB carrying out its threat of increasing interest rates a notch next month. Other major currencies – the British pound (+1.4%) Swiss Franc (+1.0%) and Japanese yen (+0.9%) – also made headway against the greenback.
Commodity markets as a whole rose by 1.8% as a softer US dollar encouraged buying of precious and industrial metals.
However, movements in the crude oil price remained the focal point. West Texas Intermediate closed a volatile week nearly unchanged at $134.62 per barrel after trading as high as $139.89 (a new record) and as low as $131.19. Trading triggers included the US government’s oil inventories report that showed a mixed picture of demand, an announcement that China was increasing its gasoline and diesel prices, and news that Israel performed a military exercise to simulate the bombing of nuclear facilities in Iran.
The chart below shows the past week’s performance of various commodities.
Now for a few news items and some words and charts from the investment wise that will hopefully assist in navigating the stormy waters of financial markets. And remember, the emphasis at this point should be on the return of capital rather than the return on capital.
Hat tip: Phil’s Stock World, June 17, 2008.
Giles Keating (Credit Suisse): World economy moves toward long-term balance
Source: Credit Suisse, June 16, 2008.
Bloomberg: G8 says economy faces “headwinds”, oil prices a threat
Source: Mike Fern, Bloomberg, June 16, 2008.
Bloomberg: Henry Paulson – “strong” dollar is in US’s interest
Source: Bloomberg, June 14, 2008.
Ambrose Evans-Pritchard (Telegraph): RBS issues global stock and credit crash alert
“‘A very nasty period is soon to be upon us – be prepared,’ said Bob Janjuah, the bank’s credit strategist.
“A report by the bank’s research team warns that the S&P 500 Index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as ‘all the chickens come home to roost’ from the excesses of the global boom, with contagion spreading across Europe and emerging markets.
“Such a slide on world bourses would amount to one of the worst bear markets over the last century.
“RBS said the iTraxx index of high-grade corporate bonds could soar to 130/150 while the ‘Crossover’ index of lower grade corporate bonds could reach 650/700 in a renewed bout of panic on the debt markets.
“‘I do not think I can be much blunter. If you have to be in credit, focus on quality, short durations, non-cyclical defensive names. Cash is the key safe haven. This is about not losing your money, and not losing your job,’ said Mr Janjuah, who became a City star after his grim warnings last year about the credit crisis proved all too accurate.
“RBS expects Wall Street to rally a little further into early July before short-lived momentum from America’s fiscal boost begins to fizzle out, and the delayed effects of the oil spike inflict their damage.”
Source: Ambrose Evans-Pritchard, Telegraph, June 19, 2008.
Telegraph: Morgan Stanley warns of “catastrophic event” as ECB fights Federal Reserve
“‘We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe,’ said a report by Morgan Stanley’s European experts.
“Just as then, Washington has slashed rates to bail out the banks and prevent an economic hard-landing, while Frankfurt has stuck to its hawkish line – ignoring angry protests from politicians and squeals of pain from Europe’s export industry.
“Indeed, the ECB has let the de facto interest rate – Euribor – rise by over 100 basis points since the credit crisis began.
“Just as then, the dollar has plummeted far enough to cause worldwide alarm. It is potentially worse for Europe this time because the yen and yuan have also fallen to near record lows. So has sterling.
“Morgan Stanley doubts that Europe’s monetary union will break up under pressure, but it warns that corked pressures will have to find release one way or another.
“This will most likely occur through property slumps and banking purges in the vulnerable countries of the Club Med region and the euro-satellite states of Eastern Europe.”
Source: Ambrose Evans-Pritchard, Telegraph, June 17, 2008.
David Fuller (Fullermoney): Inflation threat more serious than banking crisis
“I agree that there are many economic difficulties which are not supportive of stock markets. I regard today’s inflationary problems, which are global, as more serious than the banking crisis which is mainly confined to the west. There is a risk that central banks, having fanned the flames of inflation with excessive monetary growth relative to GDP, will now overreact in their efforts to douse this fire.
“I have often mentioned that most of the inflation was coming from resources prices and government services in many countries, not least the UK. Unfortunately but inevitably, soaring prices for food and energy are highly emotive. I maintain that the prices consumers pay for these staples will stay high, more often than not, despite sharp fluctuations in underlying commodity prices.
“However, given the annualised data, if commodity prices levelled out for a year, their contribution to inflation data would be zero. Thereafter if jawboning and the economic slowdown mostly contain wages, central banks will declare at least a partial victory against inflation, albeit at the less publicised price of a lower standard of living for many people. The claim of lower inflation would probably not hold up under close scrutiny but at least central banks would be able to switch their emphasis to stimulating economic growth for a while.”
Source: David Fuller, Fullermoney, June 18, 2008.
CNBC: Goldman’s Jan Hatzius on Fed rates, inflation and jawboning
Source: CNBC, June 16, 2008.
Bill King (The King Report): The recession in GDP is here
“Note that since January, the month we had been saying for some time that represented the peak of the business cycle, real GDP has declined at a 2.2% annual rate. So, do not be fooled by that 0.9% first quarter GDP print – it is masking erosion in activity beneath the veneer of quarterly averages.”
Source: Bill King, The King Report, June 19, 2008.
Paul Kasriel (Northern Trust): Housing starts plumb new cyclical low
Source : Paul Kasriel, Northern Trust – Week in Review, June 16 – 20, 2008.
Paul Kasriel (Northern Trust): Manufacturing output remains in the pits
Source : Paul Kasriel, Northern Trust – Week in Review, June 16 – 20, 2008.
Paul Kasriel (Northern Trust): Continuing unemployment claims continue to suggest recession
Source: Paul Kasriel, Northern Trust – Daily Global Commentary, June 19, 2008.
Ed McKelvey (Goldman Sachs): Fed tightening would be inappropriate
“He notes that interest rate futures are implying that at least one 25 basis point rise is virtually certain by the time of the Federal Open Market Committee’s monetary policy meeting on September 16, with considerable probability of more increases to come.
“‘We cannot rule out a rate hike given the warnings issued by Fed chairman [Ben] Bernanke and vice-chairman [Donald] Kohn about long-term inflation expectations,’ Mr McKelvey says.
“‘With retail sales also firming up, we can imagine a scenario in which Fed officials feel compelled to make good on these words.’
“However, Mr McKelvey lists three main reasons why a tightening would be inappropriate at this stage.
“First, the economy is fundamentally weak, with tax rebates driving the surge in retail sales. Second, financial markets remain fragile; and third, worries about inflation are overdone.
“‘As these points become apparent, we think Fed officials will see things our way,’ Mr McKelvey says.
“‘We continue to believe that most FOMC members want to see three things before tightening – labour market improvement, some clear signs of stability in the housing market, and much more progress towards normalcy in the financial markets.’”
Source: Ed McKelvey, Goldman Sachs (via Financial Times), June 16, 2008.
Bill King (The King Report): Bank credit continues to contract
US Commercial Bank Credit (seasonally adjusted)
Source: Bill King, The King Report, June 16, 2008.
Bill King (The King Report): Be careful about “bogus CPI”
“For May, the BLS has energy prices up 4.4% after showing no change in April and gasoline +5.7% m/m, with April -2.0%! In June, the BLS should rectify the under-reporting of energy inflation. Gasoline futures are up 33% since March. If the BLS actual allows the full fury of energy inflation from the spring to appear in June, the CPI will be horrendous unless the BLS finds other prices to seasonally adjust lower.”
US Department of Energy (DOE) Retail Automotive Gasoline Total All Grades Average Price
Source: Bill King, The King Report, June 16, 2008.
Paul Kasriel (Northern Trust): PPI data point to profit margin squeeze
“Right now the Fed’s bet and ours is that an environment in which aggregate economic demand is weak will be conducive to bringing down the overall inflation rate later this year after a month or two more of higher energy prices. Part of our bet on weak aggregate demand has to do with the ongoing credit crunch. Without rapidly growing credit, inflation has a difficult time sustaining itself. Bank credit and money supply growth have shown a sharp deceleration in recent weeks, which, if continued, will tend to damp aggregate demand and inflation going forward.”
Source : Paul Kasriel, Northern Trust – Week in Review, June 16 – 20, 2008.
BCA Research: US inflation angst remains high, but core CPI should move lower
“The Fed has sounded more hawkish of late, worried that longer-term inflation expectations will soon follow the rise in shorter-term expectations. The multi-year boom in pipeline price pressures and ever-sinking dollar have sparked heightened inflation fears, even in the face of a domestic recession and housing deflation. Importantly, pipeline pressures still hit a brick-wall when they reach retail outlets, and there is no likelihood of any leakage into wages given the uptrend in the unemployment rate.
“Bottom line: Core CPI should move lower over the balance of the year, but inflation angst may not ease until oil prices decisively correct.”
Source: BCA Research, June 16, 2008.
Financial Times: Goldman close to $7 billion SIV bail-out
“The US bank’s proposed reorganisation of the so-called structured investment vehicle is set to be just the first of a number of deals that could see about $18 billion worth of SIV assets restructured in the coming months.
“The deal, which could be signed as early as Tuesday, is likely to be closely watched by the financial industry, since Cheyne is one of the largest independent SIVs – and the deal marks the first time that any collapsed SIV has been restructured in this way. The SIV went into receivership last autumn when the value of its credit assets, such as mortgage-linked securities, plunged.
“The Cheyne restructuring, which has been brokered after nearly 10 months of negotiations, will require the receivers to organise an auction of the Cheyne assets in the coming weeks, to establish a transparent price for these instruments. This is important because in recent months it has often proved impossible to value these murky assets.
“Once this price is established, Goldman will then create a new off-balance sheet vehicle to buy the assets, with the transfer of assets being funded by the US bank for just one day before being sold on to the new vehicle. Under the plan senior creditors in the SIV will be given a range of options including reinvesting in this new vehicle.
“… the move will bolster hopes that banks are starting to create solutions to the long-running woes of SIVs, and the plethora of other, shadowy credit entities that have exploded in size this decade, in the so-called ‘shadow banking world’.”
Source: Anousha Sakoui, Financial Times, June 16, 2008.
Bloomberg: John Paulson says writedowns may reach $1.3 trillion
Source: Tom Cahill and Poppy Trowbridge, Bloomberg, June 18, 2008.
BCA Research: Commodity pits driving monetary policy and government bonds
“Moreover, the macro backdrop in the developed world is not conducive to sustained underlying price pressures. The US and Japan are close to or in recession, the UK economy is heading there rapidly, and the euro area is on target for a period of below-trend growth.
“So far, there is no evidence of second round effects in any of these economies or risk of a wage inflation spiral. In fact, monetary restraint in response to commodity induced price pressures over the next few months would likely amplify the downturn in global growth. Still, government bond markets will remain at risk until oil prices correct decisively or there is evidence that the disinflationary impact of the ongoing slowdown in the G7 economy is starting to unfold. For now, we recommend standing aside and maintaining a benchmark duration allocation. Stay tuned.”
Source: BCA Research, June 19, 2008.
Bloomberg: China “not smart” to invest in US bonds
“‘I don’t think it’s a smart move to invest in US bonds,’ said Cheng Siwei, former vice chairman of the National People’s Congress, China’s legislature, at a Beijing conference. ‘We need smart capitalists to invest ourselves,’ instead of lending money to American investors and earning interest, he said.
“Cheng’s remarks on November 7 that China should improve the structure of its foreign reserves by favoring stronger currencies helped pushed the dollar to record lows against the euro. He said today his comments represented his ‘personal opinion, not the government’s policy.’
“Countries in Asia have amassed a record $4.2 trillion in foreign exchange reserves since the 1997-98 financial crisis, seeking to protect their economies from a similar regional currency slump.”
Source: Belinda Cao, Bloomberg, June 13, 2008.
David Fuller (Fullermoney): “It is different this time” is seldom a good bet
1. Cease buying and commence selling when the crowd is euphoric.
2. Buy or at least hold onto your long positions when the news is all gloom and doom.
“But, David, what if it really is different this time?
“It might be, but that is seldom a good bet. Meanwhile, stock markets appear at least temporarily oversold and crude oil has not extended its uptrend. Today’s pessimism is not a dramatic, climactic signal such as we last saw in January and March, but it is an indication that people are becoming too pessimistic once again.”
Source: David Fuller, Fullermoney, June 19 2008.
David Fuller (Fullermoney): Bearish sentiment indicates stock market rebound
Richard Russell (Dow Theory Letters): Lowry’s statistics spell trouble
Source: Richard Russell, Dow Theory Letters, June 19, 2008.
Financial Times: US corporate earnings expected to fall
“Second-quarter earnings for S&P 500 companies are forecast by analysts to fall 9%, according to Thomson Reuters.
“The bulk of the latest quarterly decline in profits is led by financials, seen falling 53%, and consumer discretionary groups, forecast to slide 14%.
“In contrast, energy companies are expected to boost earnings growth by 22% during the quarter as oil remains near a record $140 a barrel.
“However, the surge in energy and food prices in recent months is feeding into much higher production costs at a time when the economy remains sluggish. Given the weak economic backdrop, economists doubt that companies can fully pass along their higher production and service costs to consumers.
“In spite of recent stimulus cheques being sent to many consumers, corporate profit margins look vulnerable.
“Analysts expect third-quarter earnings growth to rebound with a gain of 13.9% over the same period last year when the first impact of the credit crisis was felt.”
Source: Michael Mackenzie, Financial Times, June 18, 2008.
Reuters: Goldman reduces price targets for US banks
“The new capital would be on top of $120 billion already raised by the industry, analysts led by Richard Ramsden said.
“‘Banks will not turn until a peak in credit costs is in sight,’ the analysts wrote. ‘Moreover, weaker banks are unlikely to benefit from consolidation as bank deals always slow when credit is deteriorating and larger banks are hamstrung by their own problem assets as well as accounting requirements.’
“Goldman said it lowered its price targets for 14 banking companies and cut its 2008 earnings-per-share forecasts for 11.
“Among the banks for which Goldman cut both are BB&T, PNC Financial Services, SunTrust Banks, US Bancorp and Wells Fargo.
“Goldman also lowered its price targets for Wachovia and Washington Mutual, and its earnings outlook for Bank of America.”
Source: Reuters, June 17, 2008.
GaveKal: Lower oil prices should boost Chinese equities
Source: GaveKal – Checking the Boxes, June 20, 2008.
Telegraph: China and India lose their appeal for investors on inflation fears
“The latest survey of investors by Merrill Lynch shows that Europe has become the most unpopular region, while Britain is still trapped in the doldrums.
“But the big surprise is the sudden change in view on the emerging powers of Asia, as overheating and spiralling oil costs spoil the boom.
“‘World growth is slowing and yet central banks might still have to tighten monetary policy, that is what is scaring people,’ said David Bowers, the organiser of the survey. The vast majority of fund managers think earnings forecasts have lost touch with reality.
“The exodus from China reached fever pitch this month as investors slashed their net ‘weighting’ position to -58, down from -14 in May. The Shanghai bourse had already fallen by almost half since October.
“India fell to -63 as investors took fright at the country’s budget and trade deficits. There is concern over a relapse towards Nehru-era policies after Delhi halted trading in a range of commodity futures and restricted rice exports.
“The survey of 204 fund managers worldwide suggests that the love affair with emerging markets is going cold.
“Fund managers are still super-bullish on Russia, betting that the energy boom has life yet. A net 62% are overweight oil and gas shares. The most hated trio are travel and leisure (-66), banks (-62) and property (-60).
“A record number (net 29%) are now underweight on European equities; many have switched into cash as they wait for the European Central Bank to inflict punishment – ever more likely after eurozone inflation reached an all-time high of 3.7% in May.
“As the new story unfolds, America is coming back into favour, emerging as a sort of safe haven in a fast-changing world where trusted institutions command a premium. Investors are quietly rotating back into Wall Street – despite a chorus of pessimists. A net 23% are overweight US equities, the highest since August 2001.
“The long awaited ‘decoupling’ has begun. The United States looks like the winner after all.”
Source: Telegraph, June 19, 2008.
David Fuller (Fullermoney): Japan – the best industrialized stock market for today’s economic climate?
“Sure, one could easily argue that Japan is a politically ossified old people’s home, destined to disappoint investors in perpetuity. This claim is not short of circumstantial evidence.
“If the bears are right, Japan’s stock market will soon break downwards once again. After all, on weekly charts the Nikkei and Topix bounced in March from where one might expect, looking at the earlier data, but have now rallied back to their overhanging top formations and the declining 200-day MAs.
“Interestingly, however, Japan is the only developed country stock market that I am aware of where the reaction lows for major indices since March are still rising, albeit only just. Consequently the Nikkei and Topix have shown relative strength since mid-May, as we can see from the daily charts.
“I have said before that Japan cannot hold out on its own, but if Wall Street and other markets are now steadying in response to an oversold condition then Japan is a likely upside leader. Obviously the higher reaction lows need to hold, otherwise Japan falls back into its trading range of the previous three months, as have many other indices.
“Why might it maintain this relative performance? I can think of two good reasons: 1. Japan, I believe, is the most efficient user of oil, although Germany is probably a close second. 2. Japan certainly has the lowest inflation rate of any country, but it is likely to rise.
“These two factors could be significant at a time when everyone is understandably concerned about high oil prices and global inflationary problems. However Japan has the world’s highest savings rates, partly due to the long deflation, but the prospect of higher inflation should encourage consumer demand. Also, we often hear about Japan’s demographic problems but at least that means fewer poor to feed. Japan also has the lowest interest rates and a soft currency.”
Source: David Fuller, Fullermoney, June 16, 2008.
GaveKal: Is this the beginning of the commodities correction?
Source: GaveKal – Checking the Boxes, June 20, 2008.
News Daily: T Boone Pickens – oil production has topped out
“‘I do believe you have peaked out at 85 million barrels a day globally,’ Pickens, who heads BP Capital hedge fund with more than $4 billion under management, said during testimony to the Senate Energy and Natural Resources Committee.
“The United States alone has been using ‘21 million barrels of the 85 million and producing about 7 of the 21, so if I could take just a minute on this point, the demand is about 86.4 million barrels a day, and when the demand is greater than the supply, the price has to go up until it kills demand,’ Pickens told lawmakers.”
Source: News Daily, June 17, 2008.
Bloomberg: Emergency oil summit preview
Source: Bloomberg, June 19, 2008.
Financial Times: Saudi plans to raise oil output
Source: Richard Edgar, Financial Times, June 16, 2008.
GaveKal: Can oil roll over?
• Option # 1: New supply comes on stream. This takes time. Even if OPEC opens the spigot (and Saudis looked poised to do just that), increased production will not come on line overnight.
• Option # 2: Demand backs off. We are already seeing this. Not just with America’s gas guzzlers cutting back, but in Asia where slowing growth in industrial production/fixed asset investment will get an extra downward shove as many governments reduce fuel subsidies.
• Option # 3: Sledgehammer monetary policies. Central banks could kill off liquidity to cool inflation (the Volcker method), but they would kill their economies in the process, and put companies into bankruptcy.
• Option # 4: A ‘Plan B’ on energy: Governments could take coordinated action to reduce the speculative component of the oil bubble by: cutting back subsidies, announcing rational energy programs, tightening regulations on the trading of energy futures, etc.
“In light of the unattractiveness of the other three options, it is reasonable to think that a global coordinated effort – a ‘Plan B’ – would come to fruition. After all, the current generation of policymakers will not want to be remembered for having fiddled while Rome burned. However, after nothing happened at last weekend’s G8, hope is waning. At this point, it looks like ‘Option #2’ is the more likely outcome – fuel demand will back off. But in the process, someone out there, a marginal or less stable member of the world economic community, will go bust. That’s the reality we are living in today, and that is why we are seeing things like China’s domestic stock market declining ten days in a row, India intervening to support its currency, Vietnam swooning under 25% inflation, etc.
“What’s an investor to do in this environment? As we see it, it makes sense to stick with countries where inflation/monetary aggregates are within reason: i.e., the US, Japan, Taiwan and Switzerland. Coincidentally, these are also the nations that have been outperforming over the past couple of weeks.”
Source: GaveKal – Checking the Boxes, June 18, 2008.
The New York Times: Americans finally driving less
“But this is the year American drivers appear to be finally succumbing to price shock at the pump, according to a new report by Cambridge Energy Research Associates … It says the slowdown in the economy and soaring gasoline prices have finally persuaded Americans to drive fewer miles in fewer gas-guzzling vehicles.
“‘US gasoline demand will likely decline in 2008 for the first time in more than 17 years,’ says the report … ‘For the first time since the 1970s and early 1980s the number of miles driven by Americans has clearly begun trending downward.’
“The Transportation Department reported on Wednesday that Americans drove 1.8% fewer miles on public roads in April 2008 compared with the same month last year, the sixth consecutive month of driving mileage declines.
“Sales of pickup trucks, minivans and sport utility vehicles have fallen below 50% of new passenger vehicle sales this year for the first time since 2001, the report says, as consumers turned to smaller vehicles in favor of fuel economy. ‘It’s kind of stunning,’ said Aaron F. Brady, a co-author of the report. ‘It was over 50% as late as February and by May it fell under 44%. It’s like falling off a cliff.’
“Drivers, meanwhile, are becoming more prudent in their driving habits, either by using public transportation, carpooling or just cutting down on unnecessary trips, the two authors said in an interview. ‘Public transit ridership is surging all over the country,’ said Samantha Gross, the other author.”
Source: Clifford Krauss, The New York Times, June 19, 2008.
Bloomberg: China raises fuel, electricity prices
Source: Wang Ying and Theresa Tang, Bloomberg, June 19, 2008.
Financial Times: Fed holds clue to gold’s next move
“With supply issues taking a back seat, the answer depends on which of gold’s demand drivers – let’s call them physical, funk, funds, fuel and forex – commands the tiller.
“The impact of physical demand is weak. World Gold Council figures show jewellery demand, for instance, fell 21% between the first quarter of 2007 and the same period in 2008, but gold prices still rose.
“Financial market and geopolitical-induced funk is most potent when it comes out of the blue, so there is no knowing what could soon trigger a flight to gold. But it seems to have lost some of its safe-haven status in this regard of late.
“A flow of money into products such as exchange-traded funds has been a powerful force for pushing gold higher. Demand for gold ETFs doubled to 73 tonnes, or $2.2 billion, over the year to the end of March. Retail investors like gold.
“A more powerful, long-dormant force may be back. Gold bulls can again promote the metal as a hedge against inflation. And at the vanguard of inflation is the soaring price of fuel. Oil and gold have enjoyed a tight correlation since mid-2007, but it has been somewhat estranged during crude’s recent leap towards $140.
“But the best guide to trends in gold has long been found in the forex markets. The correlation between the dollar and gold price is long and tight. The greenback’s pull-back from record lows over recent months triggered gold’s 12% fall from its peak to today’s $886.
“With the dollar so sensitive to interest rate policy, the US Federal Reserve holds the clue to gold’s next move.”
Source: Jamie Chisholm, Financial Times, June 18, 2008.
Telegraph: Things will get worse, warns Bank of England governor Mervyn King
“The coming months represent the biggest challenge for the economy for two decades, Mervyn King said, adding that some households will find them ‘particularly difficult’.
“In his most sombre message yet, Mr King said families were being squeezed hard by higher electricity and food prices on the one hand and slowly-increasing wages on the other.
“He told Alistair Darling and leading City dignitaries in London that the experience would be even tougher than the credit crunch, and warned that the ‘era of cheap mortgage finance … is over’.
“Mr King said: “This year our real take-home pay will rise at a slower pace than national productivity. Rising fuel, gas, electricity and food prices, mean that average real take-home pay will stagnate this year.
“‘It will not be an easy time, and I know that some families will find it particularly difficult.’”
Source: Edmund Conway and Robert Winnett, Telegraph, June 19, 2008.
Financial Times: UK house price declines intensifying
Source: Daniel Garrahan, Financial Times, June 13, 2008.
BCA Research: Euro area price pressures persist
“Yesterday’s CPI report showed that euro area headline inflation rose in May to 3.7% YoY (from 3.3%). While the jump was largely driven by surging energy and food prices, the core measure also edged higher on the month.
“The release will only help reinforce the ECB’s recent hawkish rhetoric. The central bank has become increasingly determined to reign in price pressures and inflation expectations, due to growing concerns of pass-through. Indeed, ECB President Jean-Claude Trichet warned earlier this month that the central bank may lift the policy rate by 25 basis points. While a one-off rate hike is a possibility, it will be difficult to attain the consensus needed from the PIGS (Portugal, Italy, Greece and Spain), given that their economies are on track for a period of below-trend growth.
“Still, the ECB will continue to talk aggressively and try and jawbone inflation expectations lower, at least until there is clear evidence that price pressures are starting to ease. Bottom line: Although the backup in euro area bond yields look stretched (and we have switched to a benchmark duration allocation), we remain underweight euro area bonds within a global hedged fixed income portfolio.”
Source: BCA Research, June 17, 2008.
Financial Times: German investor confidence plunges
“The ZEW index, which is intended to give a guide to future economic developments, dropped by 11 points to minus 52.4 points this month, its lowest since December 1992. That suggested fears are mounting of a significant economic slowdown.
“But analysts pointed out that the survey was not necessarily a good guide to the scale of the expected deceleration. Recently it has tended to exaggerate trends in activity. By contrast, the Ifo German business confidence survey has remained relatively strong, reflecting the confidence of business leaders.
“‘While industry captains see business evolving in line with the long-run trend in the next six months, investors seem to see Germany heading for a recession,’ said Elga Bartsch at Morgan Stanley. ‘Eventually one of them will be proven wrong. We believe that it is likely to be the investor community.’”
Source: Ralph Atkins, Financial Times, June 17, 2008.
Bloomberg: EU seeks to rescue new treaty
Source: Bloomberg, June 19, 2008.
Ambrose Evans-Pritchard (Telegraph): Emerging markets face inflation meltdown
“As the stark reality becomes ever clearer, this year’s correction in emerging market bourses and bond markets has now accelerated into a full-fledged rout.
“Shanghai’s composite index touched a fourteen-month low of 2,900 yesterday. It follows moves this week by the central bank raised reserve requirement yet again, draining a further $60 billion from the banking system. Chinese stocks have now slumped by almost 50% since peaking in October.
“In India, Mumbai’s BSE index has lost 27% of its value as the exodus of foreign funds accelerates. The central bank has raised rates to 8% to curb inflation and halt a run on the rupee, but critics still say the country waited too long to tackle overheating. The current account deficit has shot up to near 3.5% of GDP. A plethora of subsidies has pushed the budget deficit to 9% of GDP.
“Russia, Brazil, India, Vietnam, South Africa, Indonesia, Nigeria, and Chile – among others – have all had to raise interest rates or tighten monetary policy in recent days. Most are still behind the curve.
“‘The inflation genie is out of the bottle: easy money is the culprit,’ said Joachim Fels, chief economist at Morgan Stanley.
“‘Weighted global interest rates are 4.3%, while global inflation is above 5%. The real policy rate in the world is negative,’ he said
“The currencies of Korea, Thailand, the Phillippines, and Malaysia have come under pressure this week as investors scramble for dollars in moves that echo the East Asia crisis in 1997-1998. Several countries have had to intervene to slow the currency slide.
“The sudden shift in sentiment appears to follow comments by Ben Bernanke and Tim Geithner, the heads of the US Federal Reserve and the New York Fed, leaving no doubt that Washington has lost patience with the crumbling dollar.
“It is almost unprecedented for Fed officials to take a public stand on the Greenback. The orchestrated move is clearly aimed at halting the vicious circle in the oil markets, where crude prices are feeding off dollar weakness – with multiples of leverage.”
Source: Ambrose Evans-Pritchard, Telegraph, June 17, 2008.
Financial Times: Brazil’s central bank warns on inflation
“‘The biggest concern over the next 12 months for Brazil and the rest of the world is inflation,’ he said in an interview in São Paulo. ‘The risk is that prices for food and raw materials will continue to rise. If every central banker decides that this is a problem for other countries, nobody will do anything and there will be [faster] worldwide inflation.’
“The US Federal Reserve and other central banks have cut interest rates over the past nine months to ward off the threat of recession. But Mr Meirelles said he was confident that central bankers would now turn their attention to the greater threat of inflation.
“‘It is important that now we are seeing authorities in general taking a different attitude, which is welcome,’ he said. ‘Inflation is really the most important challenge now.’
“Brazil’s central bank began raising its target overnight interest rate in April after two years of monetary loosening. The rate, known as the Selic, fell from 19.75% in September 2005 to 11.25% in September 2007. The bank has since raised it twice by half a percentage point each time in April and May, to 12.25%.
“Most economists expect the rate to reach 14.25% by the year end.”
Source: Jonathan Wheatley, Financial Times, June 18, 2008.
Financial Times: New Zealand poised to fall into recession
“GDP numbers for the January-March quarter due this month are forecast to show a contraction of at least 0.3%. TD Securities and other economic forecasters are predicting a 0.2% decline for the April-June quarter.
“With a GDP of NZ$155 billion ($116 billion), New Zealand’s economy is small by world standards but is watched with interest by the US, UK and Australia, which are also grappling with the ill-effects of rising household debt, large current account deficits and a correction in the housing market.
“Strong indications from the Reserve Bank of New Zealand that interest rates – at 8.25 per cent second only to Iceland in the developed world – will be heading down in the coming months have taken the heat out of the yen carry trade, through which Japanese professional and retail investors hunted high-yielding currencies such as the Kiwi, the New Zealand dollar.”
Source: Peter Smith, Financial Times, June 15, 2008.
Financial Times: Hendrik du Toit on Africa and commodities
Source: Pauline Skypala, Financial Times, June 13, 2008.
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