Words from the (investment) wise for the week that was (July 28 – August 3, 2008)
As oil prices seesawed through the past week, fresh uncertainty about the outlook for the beleaguered financial sector triggered another wave of volatility in financial markets.
With the exception of Friday, crude prices closed each day with a gain or loss of more than 1%, with US stocks doing likewise as sentiment waxed and waned on the back of a barrage of economic and corporate earnings reports. Economic data were mixed, whereas earnings were mostly better than feared. After all the action, the S&P 500 Index closed the week virtually unchanged, posting a small gain of 0.2%.
David Fuller (Fullermoney) re-emphasizes that the oil price is currently by far the most important factor in terms of global GDP growth. Consequently it is also a huge influence on the direction of various stock market indices, and big moves up or down have a psychological leash effect on currencies and other commodities.
Source: Financial Times, July 29, 2008.
Also center to the roller-coaster ride was Merrill Lynch (MER), plunging 11.6% on Monday, prior to announcing drastic steps to right its capital position on Tuesday. Its stock fell by 9.5% to a 10-year low on the news, but then rebounded to finish the day 7.9% higher.
Traders speculated that the latest capital raise was a sign that the worst was over for financials, but Meredith Whitney, analyst of Oppenheimer & Co and “godmother” of financials, had no illusions and said in an interview that 25 institutions would have to bolster their balance sheets within the next two months.
Offering some reprieve to the financial sector, the Fed, together with the European Central Bank and the Swiss National bank, announced that “emergency” lending facilities to bolster the money markets would stay in force until January 30. The facilities were implemented to improve liquidity arising from the credit market turmoil.
Formalizing the housing bill, President Bush signed into law legislation to support homeowners facing foreclosure and to offer a lifeline to Fannie Mae (FNM) and Freddie Mac (FNM).
Separately, the SEC is extending its temporary restriction on naked short selling on 19 financial institutions until August 12.
Next, a tag cloud of the text of all the articles I have read during the past week. This is a way of visualizing word frequencies at a glance. It is quite obvious that the key areas last week were “banks”, “prices”, “inflation” and “growth”, with “housing” and “financial” also prominent. As the saying goes: A picture paints a thousand words …
Volatility of the S&P Financials Index is as high as it has been since 1987. Gavekal states: “Spikes in volatility have often signaled a turning point.” I maintain that what is good for the banks is good for the overall stock market and vice versa, and one should pay particular attention to this group.
Stock Trader’s Almanac alerts us that August typically ranks among the worst months of the year and anchors the middle of the worst four months of the year, namely July to October. “The month is generally weak in the first half, then stronger in the middle,” says editor Jeffrey Hirsch.
This is an exceptionally difficult market to read. In my opinion, we are still in a primary bear market, but this does not preclude powerful rallies. From a short-term perspective, a decline below the July 28 lows will cause a serious headwind for any recovery rally, whereas a drop below the mid-July lows will significantly increase the risk of another general sell-off. On a multi-year horizon, we are probably in for an extended convalescence period of relatively low returns. In short, not a dartboard market, but also not necessarily bad from a canny stock-picking perspective.
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 released in the US during the past week included the following key data:
• Real GDP increased by 1.9% in the second quarter at an annualized rate, below the consensus expectation of 2.4% growth. Over the past year, real GDP has increased by 1.8%. Growth was 0.9% in the first quarter, revised downward from 1% last month. Relative to the first quarter, trade and consumer spending were positives for growth; there was also a smaller decline in homebuilding. A large drop in inventories offset these positives to some extent.
• The economy lost fewer jobs than expected in July, but it is certainly not out of the woods yet. Payrolls fell by 51,000, while losses for the previous two months were revised downward. However, the unemployment rate increased by 20 basis points to 5.7% – the highest level in more than four years.
• The Institute for Supply Management’s Manufacturing Index inched slightly lower to 50 for July compared with June’s 50.2. The modest dip is about on par with expectations and the ISM Index is consistent with a sluggish economy that has avoided a severe downturn.
• The Conference Board Index of Consumer Confidence rebounded slightly in July, rising to 51.9 from June’s 51.0 (revised from 50.4).
Summarizing the economic situation, Drew Matus, economist of Merrill Lynch, said in a research report: “Recent data releases and reports suggest that the consumer will continue to be pressured on all fronts: income (or cash flow), wealth and credit. Consumers can spend using any of these buckets. However, with the labor market continuing to weaken, housing continuing to deteriorate and credit harder to come by, the outlook for spending remains bleak despite recent declines in gasoline prices.”
“The US may now be in a ‘very long’ recession that will drive the unemployment rate higher, with little that the Federal Reserve can do to help,” remarked Harvard University’s Martin Feldstein. “I don’t see recovery on the horizon,” Feldstein, who headed the National Bureau of Economic Research until June and serves on the group’s recession-dating panel, said in an interview with Bloomberg.
Hat tip: Barry Ritholtz’s The Big Picture, July 31, 2008.
As far as the Fed’s upcoming interest rate decision on Tuesday is concerned, Asha Bangalore (Northern Trust) said: “It is nearly certain the Fed will leave the Federal funds rate unchanged at the August 5 meeting. The market expects a higher Federal funds rate at the end of the year. We do not. The details of the GDP report point to significant weakness in the economy. Against this backdrop and financial market fragility, the Fed would only exacerbate the economic situation by raising the Federal funds rate in haste. Fighting inflation will have to remain on the back burner until financial and economic conditions improve. By that time, inflation is likely to be moderating as it is a lagging economic process.”
Asha’s colleague Paul Kasriel (Northern Trust) added: “If it walks like a recession and talks like a recession, it must be a recession. Is the Fed going to raise its funds rate target over the remainder of 2008? Not bloody likely!”
In the Eurozone, inflation accelerated to the fastest pace in more than 16 years, with the 15-nation number rising to 4.1% in July. Furthermore, economic sentiment declined to its lowest level in five years and the manufacturing PMI dropped to 47.4 in July from 49.2 in June. (A value below 50 means contracting activity.) Germany, the largest economy of the region, seems destined to record negative GDP growth in the second quarter.
Also, the data from Britain remain grim, with the Nationwide Housing Price Index falling for the ninth consecutive month in July (down 8.1% since a year ago), consumer confidence plunging to its lowest level since the survey began in 1974, and the manufacturing PMI dropping from 45.9 in June to 44.3 last month – the lowest reading since December 1998.
Moving to Asia, industrial production in Japan contracted 2% month to month in June, making it three down-months out of the past four. Inflation accelerated to 1.9% in June, the fastest pace in more than a decade.
China’s manufacturing PMI dropped below 50 for the first time since 2005, suggesting a contraction in manufacturing that is hurt by both slower exports and higher input costs.
In summary, a more pronounced slowdown in global economic activity is rapidly manifesting itself.
WEEK’S ECONOMIC REPORTS
Source: Yahoo Finance August 1, 2008.
In addition to the Federal Open Market Committee interest rate announcement (Tuesday, August 5) and Bank of England and European Central Bank rate decisions (Thursday, August 7), next week’s economic highlights, courtesy of Northern Trust, include the following:
1. Personal Income and Spending (August 4): The earnings and payroll numbers for June indicate moderate growth in income (+0.2%). Auto sales fell to an annual rate of 13.6 million from 14.3 million in May. Non-auto retail sales were lackluster, excluding price-related hikes in gas and food sales. All of the available information points to a steady reading of consumer spending in July. Consensus: Personal Income -0.2%, Consumer Spending 0.5%.
2. Other reports: Factory orders (August 4), Pending Home Sales (August 7), Productivity and Costs (August 8).
Source: Wall Street Journal Online, August 3, 2008.
The Japanese Nikkei 225 Average was the worst performer among developed markets, declining by 1.8%.
The emerging markets category included a mixed bunch, varying from Turkey (+14.4%), the Philippines (+2.9%) and India (+2.7%) that performed strongly, to the less fortunate markets such as Pakistan (-7.8%), Taiwan (-3.2%) and China (-2.2%).
The MSCI World Index has been outperforming the MSCI Emerging Markets Index over the past month (-2.5% versus -4.2%), the past three months ( 9.4% versus -12.6%) and the year to date (-14.0% versus -16.4%). (Click here for a comprehensive global stock market performance round-up.)
The US stock markets were mixed, with mid-cap and small-cap stocks outperforming their larger counterparts. The major index movements were: Dow Jones Industrial Index -0.4% (YTD -14.6%), S&P 500 Index +0.2% (YTD -14.2%), Nasdaq Composite Index 0% (YTD 12.9%) and Russell 2000 Index +0.8% (YTD -6.5%).
The paper products group was the best performer for the week, rising by 18%. Both members of the group, International Paper (IP) and MeadWestvaco (MWV), rose after posting better-than-expected earnings reports. The personal products group was the second-best-performing group, up by 14%, led by Avon Products (AVP), which reported earnings in excess of the analyst consensus estimate.
The real estate management and development group was the worst performer, down by 26%, led down by its single member, CB Richard Ellis Group (CBG), which reported earnings substantially below expectations. The specialized finance group (-7%) was also among the underperformers. Stock exchange operator NYSE Euronext (NYX) reported earnings that were slightly below the consensus estimate.
As far as corporate news was concerned, Exxon Mobil (XOM) – the world’s largest company by market capitalization – posted a 14% increase in net income to $11.68 billion, marking the largest quarterly profit in US history.
General Motors (GM) declined by 14%, swinging to a massive $15.5 billion second-quarter net loss as consumer preferences shifted away from large trucks and SUVs in the face of record gasoline prices.
The two-year US Treasury Note dropped by 21 basis points during the week to close at 2.51%. Similarly, the UK two-year Gilt yield declined by 19 basis points to 4.86%, the German two-year Schatz yield by 17 basis points to 4.27% and the Japanese two-year bond yield by 3 basis points to 0.75%.
US mortgage rates also declined, with the 15-year fixed rate dropping by 7 basis points to 5.97% and the 5-year ARM 9 basis points higher at 5.95%.
Credit markets eased somewhat as shown by the slightly narrower spreads of both the CDX (North American, investment grade) Index and the Markit iTraxx Europe Crossover Index.
Individually, the greenback gained ground against the euro (-0.9%), the British pound (-0.8%) and the Swiss franc (-1.3%), but lost marginally against the Japanese yen (+0.2%).
The Australian dollar declined sharply on indications that the Reserve Bank of Australia would seriously consider cutting interest rates at its policy meeting next week. With the Chinese manufacturing PMI falling below 50, concerns were also raised that Chinese demand for Australian commodities might have peaked.
Platinum (-5.5%) and palladium (-4.2%) came under heavy selling pressure as poor results from the vehicle manufacturers stoked fears of much weaker demand. Gold bullion (-2.1%) experienced further weakness, but silver (+0.8%) bucked the trend.
The chart below shows the past week’s performance of the various commodities.
Now for a few news items and some words and charts from the investment wise that will hopefully assist in preserving our capital in these demanding times. And remember the old Boy Scout motto: “Be prepared” for all eventualities.
Barron’s: Nouriel Roubini – $2 trillion of credit-related losses
Source: Robin Goldwyn Blumenthal, Barron’s, August 4, 2008.
Charlie Rose: A conversation with Pimco’s Mohamed El-Erian
Source: Charlie Rose, July 24, 2008.
CNBC: Housing, economy still far from recovery – Greenspan
“In an exclusive interview on CNBC, Greenspan said the US economy is holding up ‘rather well’ considering the ‘extraordinary pressures from the financial sector’. But he added that a recession appears inevitable.”
Click here for the full article.
Editor’s comment: Greenspan has been the world’s worst economic forecaster.
Source: CNBC, July 31, 2008.
Mr Mortgage: Meredith Whitney, godmother of financials, gives her outlook
Source: Mr Mortgage, July 30, 2008.
Bloomberg: Harvard’s Feldstein – US may be in “very long” recession
“‘I don’t see recovery’ on the horizon, Feldstein, who headed the National Bureau of Economic Research until June and serves on the group’s recession-dating panel, said in an interview with Bloomberg Radio.
“Feldstein said the Fed has already lowered interest rates as much as it can to help growth, and that exports offer the only bright spot, while they aren’t strong enough to fuel a recovery. A former adviser to President Ronald Reagan, he also warned that policies proposed by Senator Barack Obama, the presumptive Democratic presidential candidate, would prolong the downturn.
“The next president ‘should not be raising taxes’, Feldstein said. He said he was ‘really surprised’ that Obama ‘hasn’t backed off his proposals for a major tax increase’.
“Feldstein said today’s gross domestic product figures reinforced his view that the economy entered a recession in December or January. GDP shrank at the end of 2007 and grew less than forecast in this year’s second quarter, the Commerce Department reported today.
“Fed officials have lowered their benchmark rate to 2% from 5.25% since September, bringing the reductions to a halt in June amid rising concern that inflation will accelerate. Feldstein indicated the central bank should refrain from lowering borrowing costs further.”
Source: Kathleen Hays and Timothy R. Homan, Bloomberg, July 31, 2008.
Asha Bangalore (Northern Trust): GDP growth – temporary boost from stimulus package
“Real GDP grew at a slightly slower pace during the period of revision (2005-2007). The most noteworthy aspect was the contraction in real GDP growth in the fourth quarter of 2007 (-0.2%) from an increase of 0.6% as per the previously published estimate.
“In the second quarter, consumer spending grew at an annual rate of 1.5%, which is an improvement from the 0.9% increase in the first quarter. The fiscal stimulus package gave a boost to consumer spending in the second quarter. This being a one-off event implies that going forward consumer spending is most likely to show significant weakness in the absence of extra dollars from tax rebates.
“Exports of goods and services grew at an annual rate of 9.2% in the second quarter, while imports fell 6.6%. The resultant sharp narrowing of the trade gap (-$395.2 billion versus -$462.0 billion) was another big plus for the headline. Imports have declined for three straight quarters, which has helped to narrow the trade gap. The outstanding growth in exports may not be a repeat story because incoming data from trading partners of the US has been weak, suggesting that less positive contributions from exports are likely in the quarters ahead.
“Essentially, economic growth has slowed over the past two years. We have gone down the laundry list of the different components of GDP and concluded that it is unlikely that any one sector can possibly give a lift to economic growth in the near term.”
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, July 31, 2008.
Paul Kasriel (Northern Trust): If it walks like a recession and talks like a recession, it must be a recession
Payroll Employment: -51,000 in July versus -51,000 in June, net gain of 26,000 jobs after revisions of payroll estimates for May and June.
Hourly earnings: +6 cents to $18.06, 3.4% yoy change versus 3.4% yoy change in June; cycle high is 4.28% yoy change in Dec. 2006.
“Total nonfarm payrolls fell by 51,000 in July – the seventh consecutive monthly decline. Private nonfarm payrolls fell by 76,000 in July. Although revisions to May and June total payrolls netted out to a plus 26,000 jobs, these revisions netted out to a minus 11,000 jobs in the private sector. There were job losses across a wide spectrum of industries as evidenced by the July diffusion index falling a full point to 41.2 – the lowest reading since August 2003.
“In the past 12 months, private nonfarm payrolls have declined by a net 535,000. In the past 12 months, the so-called birth/death adjustment has added a net 853,000 jobs. If the birth/death adjustment is excluded, private nonfarm payrolls declined by 1,388,000 in the 12 months ended July 2008. If the birth/death adjustment is inaccurately biasing upward private nonfarm employment, then all of the other government economic statistics that are derived from nonfarm payrolls also are inaccurately biased upward. Without the birth/death adjustment, perhaps the US economy might not look quite as ‘resilient’ as it allegedly is thought to be by The Wall Street Journal and its op-ed contributors.
“After the November elections, the National Bureau of Economic Research will tell us what we and the Fed already know – the US economy currently is in a recession. Industrial commodity prices appear to have peaked, which will begin to moderate the trend in headline US inflation in a couple of months. Businesses have little pricing power at the consumer level. There is no evidence of a wage-price spiral. The inflation-expectations’ anchor does not appear to be dragging. The dollar appears to have stabilized, in large part because of economic growth in the rest of the world appears to be slowing significantly. Losses continue to mount on the books of financial institutions, which will inhibit credit creation. Is the Fed going to raise its funds rate target over the remainder of 2008? Not bloody likely!”
Source: Paul Kasriel, Northern Trust – Daily Global Commentary, August 1, 2008.
Los Angeles Times: White House cuts GDP growth forecast
“‘US gross domestic product will grow 1.6% this year and expand 2.2% in 2009, the White House’s Council of Economic Advisers said in a mid-year review today. The forecasts were slashed from an outlook in February for 2.7% growth this year and 3% for 2009.
“The effects of the economic slump have worsened the job market, and the White House forecast the jobless rate will average 5.3% this year and 5.6% in 2009. The unemployment rate averaged 5.1% in the first six months of 2008 and was at 5.5% in June, unchanged from the 3 1/2-year high reached in May.
“‘The US economy has continued to expand, but growth has slowed as a result of the sharp housing decline, disruptions in financial markets, and high energy prices,’ the report said. ‘Because of the recent slower economic growth, the labor market is likely to remain sluggish for a period of time before returning to better performance.’
“The consumer price index will rise 3.8% this year, compared with a February forecast for 2.7%, the White House said. Next year, the cost of living will increase 2.3%, faster than the 2.1% gain predicted five months ago.
“The White House’s latest forecast for GDP growth was similar to private economists for this year and more optimistic for 2009. The economy will expand 1.6% in 2008 and grow 1.7% in 2009, according to the median estimate of economists surveyed by Blue Chip Economic Indicators this month.”
Source: Los Angeles Times, July 28, 2008.
Bill King (The King Report): US budget deficit soaring
Source: Bill King, The King Report, July 29, 2008.
Financial Times: US credit crunch set to last for months
“He said that with interest rates at 2% the Fed was well-placed to cope with any negative surprises on growth. By contrast, he said, it was not as well positioned to deal with any negative surprises on inflation.
“Even without any such surprises, the Minneapolis Fed chief also said real interest rates were at levels that, if sustained for too long, would not be compatible with medium-term price stability.”
Source: Krishna Guha, Financial Times, July 27, 2008.
Bill Gross (Pimco): Writing off 1 trillion dollars
Source: Bill Gross, Pimco, August 2008.
Bloomberg: Bush signs measure for homeowners, Fannie, Freddie
“Bush signed the measure at the White House shortly after 7 a.m., spokesman Tony Fratto said. Treasury Secretary Henry Paulson, Housing and Urban Development Secretary Steve Preston and Federal Housing Administration Director Brian Montgomery were among those present.
“‘We look forward to putting in place new authorities to improve confidence and stability in markets, and to provide better oversight for Fannie Mae and Freddie Mac,’ Fratto said.
“The law is aimed at stemming foreclosures and halting a free-fall in housing prices by providing federal insurance for refinanced 30-year mortgages for homeowners struggling to make their monthly payments.
“The measure also is designed to restore confidence in Fannie Mae and Freddie Mac by tightening regulations and authorizing the Treasury secretary to inject capital into the two biggest U.S. providers of mortgage money.”
Source: Roger Runningen, Bloomberg, July 30, 2008.
Bloomberg: Poole says Fannie, Freddie should be private firms
Click here for the full article.
Source: Bloomberg, July 25, 2008.
Financial Times: US delays accounting changes
“The Financial Accounting Standards Board voted to delay until January 2010 the introduction of rules that will force banks to consolidate more off-balance-sheet vehicles directly in their accounts.
“Robert Herz, FASB chairman, said that the move was made reluctantly after a staff recommendation for a delay because there might not be enough time for all companies to adjust to the up-heaval.
“‘It does pain me to allow something that has been abused by certain folks, to let that go on for another year,’ he said.”
Source: Paul J Davies and Joanna Chung, Financial Times, July 30, 2008.
Drew Matus (Merrill Lynch): Housing, credit and labor … oh my!
“High inventories suggest still-falling house prices putting further pressure on consumers’ balance sheets. Although new home inventories declined in the latest month, the supply of both new and existing homes on the market remains elevated. As existing homes are occupied by consumers (as opposed to owned by builders) and with existing home sales making up more than 90% of all home sales in June, the high level of inventories in this category may be more meaningful to the consumer. Indeed, the low level of turnover in occupied homes suggests that more consumers may be feeling stuck in a losing trade.
“Access to credit is likely to become harder to come by and more expensive. The just released Beige Book appeared to capture some of the not-yet released Senior Loan Officer Survey for July (we estimate the release of this survey on 11 August). The Beige Book noted that ‘most districts reported a further tightening of credit standards…’ Given how tight banks’ lending standards have already become, it is hard to fathom how much tighter standards can get.
“Consumer cash flows seem unlikely to improve anytime soon. The labor market weakness evident in the claims figures suggest continued weakness in non-farm payrolls.
“The Treasury’s refunding announcement will highlight the adverse effects on the budget of the rebate program and the risk to the budget posed by additional stimulus packages. We believe the deteriorating funding outlook may prompt the Treasury to re-introduce the 3-year note. This would be the second security re-introduced by the Treasury this calendar year as the Treasury responds to the worsening fiscal outlook.”
Click here for the full report.
Source: Drew Matus, Merrill Lynch – The Market Economist, July 25, 2008.
Standard & Poor’s: S&P/Case-Shiller Composite Home Price Indices – record low annual declines
“The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Indices. Both composite indices continue to report annual declines in excess of 15.0%. The 10-City Composite posted a new record low of -16.9%, and the 20-City Composite recorded a record low of -15.8%.
“‘The overall real estate market continued to slide in May, with the 10-City and 20 City Composites declining by 1.0% and 0.9% for the month, respectively. Since August 2006, there has not been one month where we have seen overall price increases, as measured by the two Composites, says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s.”
Source: Standard & Poor’s, July 29, 2008.
Bill Gross (Pimco): Mooooo!
Source: Bill Gross, Pimco, August 2008.
BCA Research: US housing – from bad to worse?
“Congress is trying to ease the burden on stretched homeowners, and moved decisively to prevent a meltdown in the GSEs. However, while positive, these efforts are not sufficient to turn things around. The ongoing economic slump and intense inflation fears are worsening the already grim housing outlook.
“Bond yields have risen in recent months, pushed up by increasing inflation concerns and comments from some members of the FOMC – Federal Open Mouth Committee. Financial institutions are also (belatedly) widening spreads and tightening lending standards.
“Moreover, the stock of unsold houses remains far too high to stabilize house prices, especially existing home inventories which hit a new high last month. Bottom line: Mortgage rates and inventories need to decline before housing stabilizes. Until then, the economy and banking system will remain at risk.”
Source: BCA Research, July 28, 2008.
Asha Bangalore (Northern Trust): Consumer Confidence Index stabilizes, but consumers pessimistic about jobs
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, July 29, 2008.
Bill King (The King Report): Has deleveraging even begun?
Source: Bill King, The King Report, July 30, 2008.
The New York Times: Worried banks sharply reduce business loans
“Two vital forms of credit used by companies – commercial and industrial loans from banks, and short-term ‘commercial paper’ not backed by collateral – collectively dropped almost 3% over the last year, to $3.27 trillion from $3.36 trillion, according to Federal Reserve data. That is the largest annual decline since the credit tightening that began with the last recession, in 2001.
“The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt.”
“‘The second half of the year is shot,’ said Michael T. Darda, chief economist at the trading firm MKM Partners in Greenwich, who was until recently optimistic that the economy would continue expanding. ‘Access to capital and credit is essential to growth. If that access is restrained or blocked, the economic system takes a hit.’
“Companies that rely on credit are now delaying and canceling expansion plans as they struggle to secure finance.”
Source: Peter D. Goodman, The New York Times, July 29, 2008.
James Quinn (Telegraph): Merrill Lynch bids to raise $8.5 billion as it faces further writedowns
“Merrill, which just two weeks ago announced plans to raise almost $8 billion from asset sales including its 20% stake in financial news provider Bloomberg, revealed that it needs to raise the money after disclosing that it will take a financial ‘hit’ of $10.6 billion in the third quarter.
“The news will come as a surprise to the financial community, which had hoped that the worse was over for Merrill, which has already been one of the largest victims to date of the continuing credit crisis.
“Prior to this latest series of writedowns and exceptional losses, Merrill has already written down $40 billion in assets and other instruments.
“But chairman and chief executive John Thain said that the news was positive, because of the fact it has been able to off-load the ‘substantial majority’ of its positions in a certain type of complex debt vehicle.
“Mr Thain, who took over from Stan O’Neal last December, said the news marked a ‘significant milestone in our risk reduction efforts’.”
Source: James Quinn, Telegraph, July 29, 2008.
Financial Times: Banks pressed to follow Merrill’s debt sale
“Merrill’s move to sell collateralised debt obligations (CDOs) for $6.7 billion, or 22 cents on the dollar – announced on Monday night – raised hopes that other banks would be able to strike similar deals and purge their balance sheets of bad assets.
“However, the low price paid by Lone Star Funds, a distressed debt investor, to buy Merrill’s CDOs sparked fears that the financial system could enter another spiral of huge writedowns followed by highly dilutive capital raisings.
“Merrill on Tuesday raised $8.5 billion – to offset $5.7 billion of writedowns caused by the CDO sales and other losses – by selling shares at $22.50, a 7.5% discount to Monday’s close.
“Mike Mayo, Deutsche Bank analyst, said Merrill’s action, a fortnight after John Thain, chief executive, said that it did not need more capital, ‘raises ongoing credibility issues for the industry’.”
Source: Francesco Guerrera, Ben White and Henny Sender, Financial Times, July 29, 2008.
Financial Times: Pimco’s Joe McDevitt on bonds and inflation
Source: Financial Times, July 28, 2008.
David Pfaendler (Dresdner Kleinwort): Bond yields to fall
“He believes the oil price shock and the unwinding of asset bubbles, over-leverage and economic imbalances in general should keep growth significantly below trend and real yields depressed for a protracted period of time.
“‘Price stability-oriented central banks – having learned their lessons from the 1970s – should become more hawkish in the near-term, thereby limiting the upward pressure on long-run inflation expectations,’ Mr Pfaendler says. ‘As a result, we are convinced that the deflationary forces of the ‘Great Unwind’ should gain the upper hand in 2009 and thereby bond markets in the developed world will not break out of the environment of structurally low yields which has been ruling over the current decade.’
“However, he believes inflation will peak around autumn and then fall significantly into 2009.
“He adds that the positive growth effects of US tax rebates should dissipate, raising the risk of a simultaneous recession in the US, the eurozone and the UK during winter.
“‘Therefore, real yields and inflation expectations should be able to fall in tandem, making long-duration as well as curve-steepening exposure across developed bond markets attractive again.’”
Source: Daniel Pfaendler, Dresdner Kleinwort (via Financial Times), July 29, 2008.
Richard Russell (Dow Theory Letters): Message to foreign creditors
“Do you remember Treasury Secretary Paulson rushing all over the world — Beijing, Moscow, Berlin, Tokyo – you name it. What was he doing? I think he was beseeching our creditors, ‘Look, you’ve got to help us and at the same time help yourself. Hold on to your US bonds, hold on to your Fannie and Freddie paper, keep buying our paper and our bonds. If you don’t, we’re all facing a catastrophe.
“‘The dollar on a purchasing power parity is ridiculously cheap now. And as soon as possible, we’ll raise rates and that will strengthen the dollar. In the mean time, we’ll talk the strong dollar. And we promise that we will not let the dollar hit the skids. A stronger dollar will help us and help you. Just hold our bonds, hold our paper, and keep buying our bonds. Furthermore, we’ll allow your Sovereign Wealth Funds to buy our assets. Buy all of the US you want. But rest assured, WE WILL DEFEND THE DOLLAR.’
“In my opinion, that was the deal. That was the reason why Paulson was running all over the world with his secret message.”
Source: Richard Russell, Dow Theory Letters, July 30, 2008.
Reuters: US Treasury to boost 10-year note sales
“Analysts estimate the Treasury will announce plans to sell $15 billion to $16 billion in 10-year notes and $9 billion to $10 billion in long bonds at its refunding announcement on Wednesday.
“‘There’s a realization that these higher deficits are going to be with us for a while because the outlook for growth in the second half and into next year has deteriorated,’ said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey. ‘It’s an appropriate time for the Treasury to be locking in some longer-term borrowing.’”
Source: David Lawder, Reuters, July 25, 2008.
Paul Kasriel (Northern Trust): S&P 500 corporate profits leave little recession doubt
Source: Paul Kasriel, Northern Trust – Daily Global Commentary, July 28, 2008.
Richard Russel (Dow Theory Letters): Is bull still alive?
Source: Richard Russell, Dow Theory Letters, August 1, 2008.
David Fuller (Fullermoney): Outlook for Western banks?
“What can we conclude about the Western banks today?
“I would now describe my view as cautiously bullish, which requires some explanation. Cautious because some further write downs and dilution of shareholders’ equity remains possible, and even if this was discounted by the recent lows, I do not see a business model for rapid recovery. In other words, while it would be a relief to see less cowboy capitalism from the banks, profits growth under more conservative management policies is likely to seem pedestrian for a while, not least while the deflationary, recessionary winds continue to blow.
“Taking a longer-term view, I would not be surprised to see a signification consolidation within the Western banking industry over the next few years. This will inevitably favour the strong players. Meanwhile, conservative investors may prefer bank bonds to equity.
“Looking at the charts’ action for bank indices such as S&P 500 Regional Banks, DJ Euro Banks and FTSE 350 Banks, we certainly had climactic action in mid-July, as pointed out at the time. We have also seen some of the biggest rallies since bear markets for the deeply troubled Western bank sectors commenced, not least because of short covering. That probably marks at least the beginning of the bottoming out process.
“While these bank indices have eased in the last three days, after encountering overhead resistance evident from the January-March range lows, they have retained more of the recent rally than broader indices in the USA, Continental Europe and the UK. This may have something to do with the recent investigations regarding shorting, but it could also indicate that the banks themselves are less bearish of their sector. From a bullish perspective, it would be encouraging if bank indices maintained their recent relative strength and also held at least half of this month’s gains.”
Source: David Fuller, Fullermoney, July 28, 2008.
GaveKal: S&P Financials – Spikes in volatility usually signal turning points
Source: GaveKal – Checking the Boxes, July 29, 2008.
Paul Danis (Lehman Brothers): Japanese rally has legs
“‘After strongly underperforming from early 2006 to March this year, Japan has outperformed the global equity market by 14% in dollar terms and 24% in local currency terms since mid-March,’ he says. ‘We think that the rally has legs.’
“Mr Danis notes that the total cash yield in Japan has bucked the global trend and kept rising as net stock buybacks have increased, in contrast to the US and UK. ‘We view this development as supportive for two reasons. First, it reduces equity supply. Second, it is a vote of confidence from the Japanese corporate sector.’
“Mr Danis also says that while the economic backdrop in Japan is far from great, he expects growth to be strong relative to the rest of the world. ‘Some key Japanese economic indicators are showing resilience, and there are continued signs that Japan’s economy is exiting a deflationary period.’
“He adds that analysts have aggressively marked down Japanese company earnings expectations, while for the World ex-Japan composite, earnings are still at peak levels. ‘There is scope for this gap to close, which should benefit Japanese stocks relative to global markets in aggregate.
“‘We recommend investors with a global mandate overweight Japan in equity-dedicated portfolios.’”
Source: Paul Danis, Lehman Brothers (via Financial Times), July 28, 2008.
GaveKal: Australian dollar grossly overvalued against US dollar
Source: GaveKal – Checking the Boxes, July 28, 2008.
Victoria Marklew (Northern Trust): Central European currencies running out of steam?
“With Eurozone membership coming up next January, Slovakia’s central bank is focused on keeping its policy rate level with the ECB’s refi rate. As a result, the bank yesterday left its two-week repo rate unchanged at 4.25% and will follow any subsequent ECB moves in the run-up to January 1. In the Big Three, however, the picture is more complicated. All three have been hit by a surge in inflation thanks to rocketing food and fuel prices. June’s (EU-harmonized) annual rate came in at 6.7% in Hungary and in the Czech Republic, and at 4.6% in Poland. Currency appreciation has helped to restrain import price pressures somewhat in all three countries, but the Hungarian and Polish central banks remain biased toward tightening. However, the Czech central bank has shifted to a more dovish stance, and may even lower its policy rate next week.”
Source: Victoria Marklew, Northern Trust – Daily Global Commentary, July 30, 2008.
Financial Times: Zimbabwe to lop zeroes off currency
“State media on Sunday quoted Gideon Gono, the Reserve Bank of Zimbabwe governor and one of the members of the ruling elite targeted by fresh western sanctions last week, as saying he would extend a currency policy that has so far failed to stem hyperinflation.
“‘This time, we will make sure that those zeroes that would come knocking on the governor’s window will not return,’ Mr Gono was quoted as saying on Saturday in a speech to farmers.
“Independent estimates put Zimbabwe’s inflation rate well above the official 2.2 million per cent, prompting the introduction last week of a 100 billion Zimbabwean dollar note. Even state media reported Mr Gono’s comments ‘drew laughter’ from his audience.
“The governor is expected to chop three or six zeroes from the currency, following a three-zero cut in 2006.
“Beside the inflationary zeroes haunting Mr Gono, analysts and some opposition politicians say the crumbling economy in what was once a regional bread basket is perhaps the single greatest factor that might force Robert Mugabe, president, into relaxing his grip on power.”
“The government blames the economic strife on ‘illegal’ sanctions, condemning opponents who point to violence land seizures that have contributed to a drastic fall in agricultural output.”
Source: Tom Burgis and Tony Hawkins, Financial Times, July 27, 2008.
BCA Research: Food and energy prices – prolonged correction underway?
“Inflation angst should begin to recede now that food and energy prices are gradually coming off the boil. As prices continue to correct, it should become clear that prior price increases have not filtered into a generalized inflation upturn, and consumer prices remain under control (at least in developed countries). Our Leading Economic Indicator (LEI) for the G7 shows no signs that weakness is approaching an end and the emerging Asia LEI is warning of a cooling in the rapidly growing developing world, led by a softening in the Chinese economy.
“The weaker growth outlook along with reductions in energy subsidies, and a tightening in policy by several emerging market central banks (because of inflation concerns related to the commodity boom) will only reinforce the tendency for commodity demand growth to slow.
“Bottom line: Prices are set to correct further and the inflation scare should retreat along with expectations for rate hikes.”
Source: BCA Research, July 30, 2008.
David Fuller (Fullermoney): Oil price key to global GDP growth and stock markets
“2. Supply and demand for crude oil is difficult to forecast, at the best of times, which these are not. In recent years, supply has probably been adversely affected by costs and shortages of manpower or equipment, at least as much as depletion. Demand is inevitably price sensitive, not least during spikes.
“So where do we stand in terms of the Peak Oil debate?
“I am a long-term believer in Peak Oil but a short-term sceptic. Even some of the best and most farsighted analysts often predict dramatic, seminal events many years before they actually occur, not least I suspect because life is short and our time is precious.
“Meanwhile, the daily chart of crude oil has shown increasingly conclusive evidence of a significant peak commencing with that big downward dynamic on 15th July.”
Source: David Fuller, Fullermoney, July 29, 2008.
Reuters: Gold options point to $1,200
“Gold has soared furiously – a few years ago the metal was trading at $250 an ounce – as investors poured into the market due to inflation fears, a weakened dollar and market turmoil.
“‘There are a lot of people who think that by the end of the year we’ll be trading $1,200 to $1,500. They are not very expensive options, so people are buying them,” said John Bilello, COMEX gold options floor trader.
“Bilello said that many option investors were currently adjusting positions after gold’s sharp fall but he saw recent strong volume of December $1,000 calls, bull call spreads between $1,200 and $1,300, and the selling of put options – all of which are betting that gold will rise further.”
Source: Frank Tang, Reuters, July 25, 2008.
Frank Holmes (US Global Investors): Consider gold now
Source: Frank Holmes, US Global Investors – Weekly Investor Alert, August 1, 2008.
Bloomberg: European inflation quickened to 16-year high in July
“The inflation rate for the 15-nation euro region rose to 4.1% from 4% in June, the European Union statistics office in Luxembourg said today. The rate, the highest since April 1992, matched the median estimate of 36 economists in a Bloomberg News survey. A separate report showed unemployment was 7.3% in June, exceeding the 7.2% median forecast.
“The ECB, which aims to keep inflation just below 2%, raised its key interest rate by a quarter point to 4.25% on July 3, a seven-year high. The risk is that higher borrowing costs will exacerbate the economic slowdown. Europe’s manufacturing and service industries are contracting and confidence in the economic outlook this month plunged the most since the September 11 terrorist attacks in 2001.”
“‘The growth outlook has deteriorated,’ said Martin van Vliet, an economist at ING Group in Amsterdam, who doesn’t expect the ECB to raise rates again. ‘But the ECB will keep open the possibility of one further rate hike because a wage-price spiral could be even more damaging than the economic downturn we’re seeing now.’”
Source: Fergal O’Brien, Bloomberg, July 31, 2008.
Christopher Wood (CLSA): Data from Britain remains grim
“It is surely only a matter of time before the Bank of England stops worrying about ‘inflation’. Macro traders should stay short sterling and continue to bet on falling interest rates. With the oil-led commodity complex showing signs of breaking down, the same trades should be put on in Australia in terms of shorting the currency and betting on falling rates. The money markets are now discounting only a 25bp interest rate cut by March 2009 in both Britain and Australia.”
Source: Christopher Wood, Greed & Fear – CLSA, July 31, 2008.
Bloomberg: Australia facing “once-in-100-year” housing slump
“The cause is a combination of rising default rates, the biggest drop in home prices in five years, the highest borrowing costs in a decade and slowing economic growth.
“Prices in the property market – described by the International Monetary Fund in April as one of the world’s most ‘overvalued’ – will fall 30% by 2010, according to Gerard Minack, senior economist at Morgan Stanley in Sydney. Prices dropped in all of Australia’s major cities last month for the first time since just before the Great Depression.
“‘Australia is headed for a once-in-100-year real-estate slump,’ John Edwards, chief executive officer of Residex Ltd., said. ‘I have never seen the convergence of so many negatives.’”
Source: Jacob Greber, Bloomberg, July 31, 2008.
Bloomberg: IMF sees “soft landing” in Japan
“Bank of Japan ‘policy should remain accommodative’ as IMF directors see ‘little risk in delaying monetary tightening’, the Washington-based lender said today in its annual review of the Japanese economy. ‘Directors look forward to a gradual normalization of interest rates once downside risks to growth recede.’
“The fund’s 1.5% growth forecast for this year matches the median estimate among economists surveyed by Bloomberg News. The assessment indicates Japan will avoid a contraction even as exports weaken, hurt by slowing demand in the US and Europe.
“‘The Japanese economy has shown resilience to the US slowdown and global financial turmoil,’ the IMF said in the review. ‘The near-term economic outlook is for a soft-landing, although there remain risks from the global economy.’
“Inflation excluding food and fuel prices is ‘expected to stay contained’ and an ‘undervalued’ yen may rise against other currencies, it said.”
Source: Christopher Swann, Bloomberg, July 29, 2008.
Financial Times: Japanese inflation at highest level in a decade
“Japan was until recently in deflation and so price pressures remain mild compared with most of the world. Excluding energy and food, CPI rose just 0.1% last month.
“Japan’s inflation is not caused by domestic demand, so the Bank of Japan is seen to have little scope to raise rates from the current level of 0.5%. The bank’s concern is increasingly turning towards growth.
“This month, the central bank cut its economic growth forecast from 1.5% to 1.2% for the year ending March 2009.
“The squeeze on consumers is likely to hit consumption in the second quarter. Coupled with last month’s first export decline in more than 4½ years, some economists are forecasting that second-quarter GDP growth will be negative.”
Source: Lindsay Whipp, Financial Times, July 26, 2008.
Ambrose Evans-Pritchard (Telegraph): Kremlin’s heavy hand triggers foreign exodus
“The move follows last week’s assault on steel and coal giant Mechel for alleged overpricing of raw materials and using offshore trading to cut its tax bill.
“Moscow’s RTS stock market index has fallen by 25% since May on fears that premier Vladimir Putin is once again using probes or other heavy-handed methods to reorder the strategic landscape.
“The bare-knuckle fight for control over BP’s Russian TNK-BP has deeply shocked investors in the City and New York. The joint venture had been launched in 2003 with the personal blessing of Mr Putin, making it quite different from the foreign resource grab during the Yeltsin era that so enrages Russian nationalists.
“‘The market is panicking and foreign investors are pulling out of equities,’ said Michael Ganske, a Russia expert at Commerzbank.
“‘People fear that the rule of law is breaking down. I think this is an overreaction, but the Russian government has to be careful in the way it uses rhetoric in this investment climate,’ he said.”
Source: Ambrose Evans-Pritchard, Telegraph, July 31, 2008.
Financial Times: India “aggressive” on inflation
Source: James Lamont, Financial Times, July 29, 2008.
US Global Investors: Weak Chinese PMI reduces risk of overtightening
Source: Frank Holmes, US Global Investors – Weekly Investor Alert, August 1, 2008.
4 comments to Words from the (investment) wise for the week that was (July 28 – August 3, 2008)
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